Revenue Audit Memorandum Order No. 1-96

June 7, 1996 REVENUE AUDIT MEMORANDUM ORDER NO. 1-96 I. SCOPE This Order outlines the procedures, guidelines and techniques in the verification of Presumptive Input Tax (PIT) claimed by taxpayers newly-covered by EVAT (RA 7716 ) and shall cover all inventories of goods, materials, supplies and improvements as of December 31, 1995 on which PIT was recognized pursuant to Section 4.112-2(a) of Revenue Regulations No. 7-95. II. OBJECTIVE To insure the validity and correctness of claims for Presumptive Input Tax, the inventory lists of goods, materials, supplies and improvements as of December 31, 1995 filed by newly-covered taxpayers shall be subjected to test-verification following the uniform guidelines, procedures and techniques as hereinafter provided. III. POLICIES 1. All verification of PIT shall be covered by a Mission Order (Annex A) and a Letter to Taxpayer (Annex B) signed by the Revenue District Officer which shall serve as the authority of the Revenue Officer to conduct verification. Mission Orders shall be prepared in four (4) copies distributed as follows: original taxpayer duplicate attached to the docket triplicate RDO File quadruplicate Assessment Division 2. All Mission Orders shall be valid only for forty-five (45) days within which the Revenue Officers shall conduct actual verification. Thereafter, a report of investigation which includes a Memorandum Report, Presumptive Input Tax Verification Report (Annex C) and a Summary Verification Report (Annex D) shall be submitted within fifteen (15) days from completion of actual verification. All reports shall be submitted to the Assessment Division for review not later than sixty (60) days from issuance of Mission Order. Revenue Officers who fail to submit the required report within the prescribed period shall submit a written justification for such failure, otherwise, necessary administrative sanctions shall be imposed upon him/her. 3. The Assessment Division shall review the report of PIT verification and if approved, shall issue a Certificate of Allowable Presumptive Input Tax (CAPIT) (Annex E) to the taxpayer within ten (10) days from receipt of the report from the RDO. If disapproved, follow the same procedures under Section II(d) of RMO 37-94. The CAPIT shall reflect the amount of allowable PIT to be credited against the output tax of the taxpayer. 4. All taxpayers who claimed PIT of 1 Million or more except those already verified under RMO 6-96 and RSO 137-96, shall be subjected to mandatory verification. 5. Taxpayers who failed to submit an inventory list for PIT in accordance with the transitory provisions of Revenue Regulations No. 7-95 shall be entitled to PIT. IV. PROCEDURES A. Revenue District Officer 1. Retrieve and make a list of all inventory filed by taxpayers newly covered by EVAT as of December 31, 1995 with the Revenue District Office (RDO) and classify by sector, as follows: 1.1 Real estate dealer/lessor, 1.2 Taxicabs, tourist bus, rent-a-car, and other common carriers; 1.3 Hotels, motels, resorts and restaurants; 1.4 Dealers in Securities and Lending Investors; 1.5 Non-life Insurance; 1.6 Media; 1.7 Telecommunications. 2. Assign revenue officers to conduct PIT verification taking into consideration the existing workload and capability of each revenue officer. 3. Issue Mission Orders to all taxpayers who claimed PIT of 1 Million or more except those already verified under RMO 7-96 and RSO 137-96. 4. Furnish the Assessment Division of the Region and the Assessment Service of the National Office a copy of the list prepared under IV(1) above and a list of all Mission Orders issued within three (3) days from issuance of Mission Order. 5. Review and forward reports on PIT verification to the Assessment Division for final review and issuance of CAPIT. B. Assessment Division 1. Review reports on PIT verification; 2. Issue CAPIT within ten (10) days from receipt of the report from the Revenue District Office. All CAPIT issued shall be numbered consecutively with the first two numbers representing the regional office number. For example, the first CAPIT issued by the Assessment Division of Revenue Region 7, Quezon City shall be numbered 07-001. 3. If disallowance of PIT results to deficiency taxes, issue the corresponding Assessment Notice. 4. Require xerox copy of Amended VAT Return of the taxpayer reflecting therein the correct amount of allowable PIT as appearing in CAPIT. 5. Submit to the Assessment Service every 10th day of the following month list of all CAPIT issued. C. Revenue Office r 1. Conduct PIT verification following the procedures outlined below: 1.1 Preliminary Approach to Verification Essential to an effective audit of PIT is the familiarization of: the business organization of the taxpayer and whether it has business establishments other than its head office; location of warehouses, storage places, bodegas and other premises where inventories are being kept and maintained; accounting methods and policies, including method of valuation, as well as the degree of internal control. 1.2 General Audit Procedures 1. Secure copies of the following documents with the revenue district office where taxpayer is registered: 1.1 Inventory List as of December 31, 1995; 1.2 VAT Declarations for January and February of 1996 and VAT Return for the quarter ended March 31, 1996. 2. Serve the Mission Order and Letter to the taxpayer together with a checklist of the requirements which include the following: 2.1 Inventory List used as basis of the 8% presumptive input tax including supporting schedules; 2.2 Audited Financial Statements and Post-Closing Trial Balance as of December 31, 1995; 2.3 Lapsing schedule, or schedule of periodic depreciation, if inventory list includes depreciable goods/assets; 2.4 Suppliers' sales invoices and/or official receipts for items included in the inventory list; 2.5 Other documents necessary in the verification of PIT. 3. Verify the authenticity of inventory list submitted by taxpayers claiming PIT. Check completeness of information provided, i.e. description of items, quantity, unit cost and peso value. Check footings and extensions. 4. Have access to the following records of the taxpayer. 4.1 Regular books of accounts, i.e. ledgers and journals 4.2 Inventory records such as stock cards or bin cards, stock records, property ledgers 4.3 Other records deemed necessary in the verification of PIT. 5. Review the composition of inventory list. In determining the correct basis for PIT, exclude the following: 5.1 Items in the inventory which are exempt from VAT; 5.1.1 tax-exempt and duty-free importation of capital equipment by taxpayers enjoying tax exemption under special laws such as EO 226 and/or EO 484; 5.1.2 those falling under Section 103 of the NIRC, as amended; 5.2 Goods or properties that are fully depreciated; 5.3 Goods, materials and supplies purchased prior to the effectivity of EO 273, January 1, 1988; 5.4 Items where taxpayer has no legal title as of December 31, 1995, i.e., goods in transit, consignment, etc. 5.5 Immovable properties except improvements in the case of real estate dealers; 5.6 Non-operating movable equipments or those not directly connected with the vatable operation of the taxpayer; 5.7 Items in the inventory charged to costs or expenses and claimed as deductions from income prior to 1996. 5.8 Items not properly supported by valid VAT invoice/receipt. 5.9 In case the taxpayer is engaged in both vatable and exempt transactions, exclude the items in the inventory directly identifiable to exempt transactions. For items not directly identifiable, allocate the value of the inventory based on the amount of exempt sales reported in the income statement for the taxable year 1995, using the formula: exempt sales X Value of inventory X 8% = Disallowed total sales not directly identifiable PIT 6. Reconcile the balances of inventory accounts shown in the balance sheet against the amount appearing in the inventory list and the amount claimed per VAT Return filed with the district office. The maximum amount of PIT that can be granted should not be more than the amount appearing in the balance sheet figures. Find out if the "Input Tax Credit" account or any account of similar nature has been debited in the books upon recognition of PIT. 7. Conduct an ocular inspection/test-count of properties and inventories of material value kept in warehouses, bodegas, offices and other areas to determine actual existence and whether it qualifies for PIT. 8. Verify method of inventory valuation and costing. Ascertain if it conforms to the method prescribed in the Tax Code as implemented by Sec. 146-149 of Revenue Regulations No. 2. 8.1 Materials and Supplies 8.1.1 Determine the costing method employed; 8.1.2 Test-check valuation of materials and supplies from suppliers' invoices, official receipts and other documents. 8.1.3 Trace in the stock or bin cards the cost assigned to the stock on hand and verify the same against the inventory list; 8.1.4 Verify unit cost per item selected based on last purchase invoice against unit cost per inventory list; 8.1.5 Where existence of material discrepancy in the preparation of inventory list is determined, conduct a stock-taking of materials and supplies on hand. Determine the level of inventory as of December 31, 1995 by accounting for purchases and material issuances to arrive at the correct inventory level. 8.2 Movable Operating Equipments 8.2.1 Ascertain the acquisition cost of depreciable operating movable goods from suppliers' invoices, official receipts and other supporting documents. 8.2.2 Check the depreciation policy adopted and verify if such is consistently applied. Note that a drop in depreciation rate in 1995 requires an explanation. 8.2.3 Verify the accumulated depreciation as of December 31, 1995. 9. Prepare audit report with all working papers and documentary evidences to support the findings. The report should be brief and concise but complete in all details. It should contain the following: 9.1 Duplicate copy of Mission Order and Letter to taxpayer; 9.2 VAT Declaration for the months of January and February, 1996 and VAT Return for the first quarter of 1996; 9.3 Inventory List as of December 31, 1995; 9.4 Audited Financial Statements as of December 31, 1995; 9.5 Computation of disallowed presumptive input tax; 9.6 Computation of VAT due, if any; 9.7 Revenue Officers' Memorandum Report and Presumptive Input Tax Verification Report; 9.8 Certificate of Allowable Presumptive Input Tax (CAPIT) for approval and signature by the Chief of Assessment Division. 1.3 Audit Procedures by Industry In addition to the procedures required in IV(C)(1.2) above, the following procedures shall also be performed depending on the industry classification of the taxpayer. A. Real Estate Dealer/Lessor 1. Require submission/presentation of the following: 1.1 Inventory list of properties with details as to name of project, cost, area and number of units, classified into: a) Primarily held for lease, with names of tenants; b) Primarily held for sale; c) Indirectly used in the real estate business; d) Used in other lines of business; 1.2 License to Develop and Sell real properties with information as to the number of units developed, classification whether low-cost, socialized regular residential or commercial/industrial units; 1.3 Suppliers' and contractors' sales invoices or official receipts; 1.4 Other documents necessary to establish the taxpayer's business profile i.e. Articles of Incorporation, business permits, etc. 1.5 Location maps 2. Identify and segregate the inventories of materials, supplies and improvements as of December 31, 1995 as to: 2.1 real estate dealer i.e. buying, developing, and selling; 2.2 real estate leasing; 2.3 VAT-exempt transactions like low-cost and socialized housing, etc. 3. Determine the composition of inventory and separate the cost of raw land from the land improvements and/or cost of construction. Disallow any PIT claimed on the cost of raw land. In determining the value of raw land, consider the acquisition cost. 4. In case of joint venture agreements where the share of one party consist of land while the other party shoulders the cost of developing the land, the former party shall not be entitled to PIT with respect to the value of the land contributed to the joint venture. In cases, however, where both parties to the joint venture share in the development cost, the PIT shall be allocated to the parties in accordance with the joint venture sharing agreement. 5. Conduct ocular inspection to determine existence of low-cost and socialized housing projects. Disallow PIT claimed on low-cost housing projects under B.P. 220 and socialized housing projects under R.A. 7279. 6. Determine the inventory of unsold units as of December 31, 1995. If sold before January 1, 1996, determine the mode of payment. If more than 25% of the selling price has been paid as of December 31, 1995, then the property is considered sold on a deferred payment plan and therefore it should not form part of inventory. If 25% or less has been paid as of December 31, 1995, then the property is considered sold on installment and therefore should still form part of the inventory. Any PIT claimed on properties sold on deferred payment plan as of December 31, 1995 shall be disallowed. 7. If cost improvement cannot be identified directly to the sold and unsold units, the PIT shall be allocated using the following formula: Cost of Unsold Units X Allowable PIT on = Allowable PIT Total Project Cost Total Project Cost 8. Disallow PIT claimed on properties (land and improvement) held for lease. Real estate lessors are entitled to PIT only on their inventory of goods, materials and supplies as of December 31, 1995. 9. Disallow PIT claimed on improvements introduced before the effectivity of EO 273, January 1, 1988. B. Taxicabs, Tourist Bus, Rent-a-Car, and Other Common Carriers 1. Identify and segregate the inventories on materials, goods and supplies as of December 31, 1995 attributable to 1.1 Vatable activity i.e. carriage of cargo 1.2 Non-Vatable activity i.e. carriage of passengers. PIT directly identifiable to non-vatable transactions shall be disallowed. Those which cannot be directly identified shall be allocated based on sales as reflected in the income statement for taxable year 1995. 2. Determine whether movable equipments on which PIT has been claimed is directly related to the vatable activity or are considered movable operating equipments such as: 2.1 Taxi units of taxi operators, buses for tourist bus operators, trucks for haulers, and other similar movable equipments. For purposes of claiming PIT, ships and airplanes are not considered movable operating equipments. Therefore, no PIT shall be allowed. 2.2 Tools for repairs and maintenance. 3. Check Registration Certificates to determine if taxpayer has title to the property. C. Hotels, Motels, Resorts and Restaurants 1. Determine whether movable equipments on which PIT has been claimed are operating movable equipments such as: china, glasswares and silverwares; linen; uniforms; kitchen utensils; furnitures and furnishings in guestrooms, hotel outlets and lobby area; telephone, refrigerators, television sets and fax machines used in guestrooms; audio visual equipments and musical instruments used in function rooms where seminar, debut, wedding and other affairs are held; sports equipment in case of resorts. Only movable operating equipments are entitled to PIT. Non-operating movable equipments such as office equipment and business machines, micro and personal computers, housekeeping and laundry equipment, display cases and racks, health club, sports and beauty salon equipments; engineering tools and equipments, and other equipments not directly related to the business, are not entitled to PIT. 2. In cases where goods or properties included in the inventory are being manufacture/processed by the taxpayer, scrutinize the cost components and exclude those which do not have VAT component i.e. labor, where service was rendered by the employees of the taxpayer, and materials, where the same were not subjected to VAT. 3. In cases where a commissary in charge of purchasing, processing, warehousing as well as distributing goods to all store outlets and franchises is maintained, only the inventories in store outlets are allowed PIT. D. Media 1. Determine existence of capital goods imported under the provisions of PD 1362 . Under PD 1362, importation of equipments by qualified broadcast media are exempt from taxes and duties upon importation but the amount of taxes and duties should have been due are later on offsetted against government airtime. Under this scheme, the 8% PIT shall be allowed only to the extent of the book value of importations as of December 31, 1995 on which government airtime have been actually offsetted. 2. In the case of a print media deriving income from both circulation and advertising, disallow the PIT on inventories directly identifiable to circulation activity. If unidentifiable, PIT shall be allocated using the formula: circulation income, 1995 X Allowable PIT = Disallowed PIT Total income, 1995 3. Disallow PIT on all immovable and movable non-operating equipments. Allow PIT only on movable operating equipments such as cameras, OB Van, monitors, transceivers, portable transmitters, and generators. 4. Disallow PIT claimed on film rights. E. Franchise Grantees/Telecommunications 1. Determine whether movable equipments on which PIT has been claimed are directly related to the vatable activity or are considered movable operating equipments such as: 1.1 telephone/radio equipments; 1.2 transmission equipment not attached to cellsites or transmission sites; 1.3 uninterrupted power units which are portable; 1.4 computer systems; 1.5 specialized tools and equipment; 1.6 portable transmission equipment. 2. Disallow PIT claimed on immovable equipment such as: 2.1 Cable and wire systems; 2.2 telecommunication plant and cellsites and/or transmission sites; 2.3 information origination/termination equipment permanently attached to telecom sites; 2.4 central office equipment; 3. Disallow PIT identifiable or allocable to VAT-exempt transactions such as overseas communication dispatch originating from the Philippines. V. EFFECTIVITY This Revenue Memorandum Order shall apply to all investigation conducted on the inventory and Presumptive Input Tax claimed by taxpayers newly covered by RA 7716 or Expanded VAT Law. (SGD.) LIWAYWAY VINZONS-CHATO Commissioner of Internal Revenue