Guidelines in the Verification of Withholding Taxes

May 21, 1986 REVENUE AUDIT MEMORANDUM ORDER NO. 5-86 SUBJECT : Guidelines in the Verification of Withholding Taxes TO : All Internal Revenue Officers and Others Concerned To insure an effective verification of withholding taxes pursuant to Section 348 of the Tax Code, the following guidelines are hereby prescribed: I. GENERAL PROVISIONS 1. Scope . The audit procedures prescribed herein shall cover creditable withholding taxes on compensation, other amounts payable or paid, final withholding tax on certain income payments, and money payments by government offices. acd 2. Authority . Beginning with tax year 1985, the audit verification of withholding agents shall be conducted on yearly basis, separate from the regular audit investigation of their direct internal revenue tax liabilities to compel up-to-date compliance with the withholding tax laws and regulations. For this purpose, the letter of authority to be issued by the investigating unit shall cover as much as practicable the year just ended in addition to the unverified prior years. 3. Documents The general, records of payments to resident or non-resident payees and financial statements shall be verified to ascertain if (a) the income payment is subject to any of the withholding taxes; (b) the amount of tax withheld or the rate of tax applied is correct; and (c) the withheld is remitted within the reglementary period. Specifically, for withholding tax on: (a) Compensation (WTC) exemption certificates (W-4); payroll records, particularly confidential payrolls, if any, list of employees submitted by the employer to the Social Security System and/or to the Bureau of Labor; employment contracts; information returns (1701 B) for items of compensation not subjected to withholding; supporting vouchers/receipts for advances/reimbursements of transportation and representation expenses; receipts for payment of compensation; and financial statements. (b) Amounts payable or paid to resident payees (EWT) contracts and subcontracts between contractees and prime contractors and between the latter and subcontractors: vouchers, receipts and billings indicating payments to professionals, brokers and sub-brokers, etc., lease agreements; information returns 1701 B and financial statements. (c) Contracts for payment of certain items of income for the payment (WTS) to resident and non-resident payees of interest, rents, dividends, wages, fees, compensations and gains or profits; central bank approval papers, commercial papers, employment contracts of their employees, contract for payment of royalties, records of prizes or winnings and financial statements. (d) Money payments by government offices (WTBM) contracts, purchase records, payment orders, billing records, receipts, vouchers, cash book and reports of COA auditors. 4. Remittances Each of the prescribed monthly and quarterly returns together with confirmation receipts/revenue official receipts (CR/ROR) shall be verified and reconciled with the declarations in the corresponding final returns to ascertain remittance of taxes withheld. 5. Registration The examiner should ascertain whether a taxpayer who is required to deduct and withhold taxes, is registered and has been issued an Identification Number (ID). This is the key to monitoring compliance of withholding agents with the withholding tax laws and regulations. Every person in control of the payment of an income (office/agency) subject to withholding is required to register within ten days from the time he qualifies as a withholding agent with the Revenue District Office of the city or municipality in which his principal place of business is located. A branch in control of the payment is also required to register independently of the main or central office. A registered withholding agent in a certain revenue district office who transfers to another locality falling within the jurisdiction of another revenue district is likewise required to register anew in the latter district. Upon verification that the taxpayer is not registered, he shall be required at once to register, and the appropriate penalty imposed. II. AUDIT REQUIREMENTS A. Withholding Tax on Compensation (WTC) . 1. Determine the correctness of the amount of exemption claimed in the certificate of exemption (W-4) per status of employee and qualification and number of dependents (particularly relationships and dates of birth), as well as qualification of employees to the special additional personal exemption, as against the amount of exemption used as the basis of withholding by the employer. If the exemptions as verified from the W-4 is less than the exemption indicated in the Alphabetical List of Employees (ALE), make the proper adjustment and compute the correct amount of withholding tax. Every employee is required to file an amended W-4 within 10 days from the date of change in his status and/or qualification of dependents, which will either increase or decrease his amount of exemption. 2. Verify the number of employees per payroll records and list of employees submitted to the Social Security System and Bureau of Labor, including casual, emergency and contractual employees and determine if such employees are included in the ALE. If verification discloses that an employee is listed in the payroll records, but is not included in the ALE, submit a list indicating the following: a) name and taxpayer account number of employee (TAN) b) gross compensation; c) exemption; d) tax required to be withheld; tax withheld; and tax discrepancy. 3. Reconcile the aggregate gross compensation claimed per income statement with the total amount indicated in the ALE. If the amount per income statement exceeds the amount in the ALE, require the withholding agent to submit a list indicating the following: a) name and (TAN) of employee to whom the excess amount is paid; b) gross compensation including the additional compensation ascertained; c) exemptions; d) tax required to be withheld; e) tax withheld; and f) discrepancy. In general, fixed allowances for transportation and representation expenses are invariably part of taxable compensation income. However, advances or reimbursements for such expenses may be allowed as deductions from compensation, if the following conditions are present: casia a. nature of duties of employee requires the incurring of travelling and representation expenses; b. the expenses for which the advances/reimbursements are made are ordinary and necessary. Inherent in the terms "ordinary and necessary" is the element of reasonableness - they are not lavish or excessive under the circumstances. c. they are paid or incurred by the employee in the pursuit of the business of the employer - there must be a direct connection between the expenditures and the carrying on of the trade or business of the employer, and such expenditures must be necessary and appropriate to the development and maintenance of business or trade of the employer. d. the employee is required to account/liquidate the expense by submitting a report and documentary evidence in support of each element of expenditure: (1) amount, (2) time or date it was incurred, (3) place and (4) business purpose. The rule on reimbursements/advances applies to automobile expenses such as gasoline, oil, repairs, batteries, insurance, depreciation, interest paid in the purchase of the car, taxes, registration fees, car washes, garage, rent, parking fees and toll fees if the above conditions are satisfied, whether the vehicle is owned by the employer or provided for by the employer the total cost of expenses to the employer shall be the basis for computation. However, the substantiation requirements may be waived in favor of a travelling salesman or field personnel who claims only 70% of the reimbursed/advanced amount received. In the case of other employees required to travel, the option is limited to 30%. Another exception to the substantiation rule refers to reasonable amounts of reimbursements/advances for representation and travelling expenses precomputed on daily basis paid to an employee while on special assignment or duty. In any case, the excess of reimbursements or advances over substantiated actual expenses shall form part of compensation income. B. Expanded Withholding Tax . a) Check amounts payable or paid per income statement and information return (1701B) against those declared in the monthly and annual returns (1743W-1 & 1743B). Submit worksheet for amounts not subjected to withholding, indicating the 1. name and tax account number of payee; 2. nature of income payment; 3. gross amount of payment; and 4. tax required to be withheld. a) Determine the correctness of the rate of withholding tax applied. b) Determine the correctness of the rate of withholding tax applied. c) Ascertain payments by and to prime contractors and subcontractors, professionals, brokers, sub-brokers agents of entertainers, etc. d) Determine the dates of payment or the period when the obligation to pay the amount subject to withholding is due. The time to withhold is fixed at the time the obligation is due irrespective of the actual payment. C. Final Withholding Taxes . 1. Check documents to ascertain the type of income payments, due date of obligation and residence of payee. 2. Ascertain if the income payment was subjected to withholding or not in the year it was accrued, irrespective of whether or not it was actually paid, and whether the taxes withheld were remitted within 10 days following the month in which the payment was accrued. In the case of interest on bank deposits, the remittance shall be made quarterly within 25 days after end of quarter. 3. Determine the correctness of the basis and rate of withholding tax applied. 4. Ascertain date of accrual of the income payment, to fix the time to withhold, irrespective of the actual remittance or nonremittance by reason of official restriction. 5. With respect to interest on bank deposits, reconcile the amount shown on the income statement of the withholding tax return of the payor bank. The excess of the latter amount over the former shall be subjected to withholding unless it is shown to be exempt. D. Withholding of Business and Miscellaneous Taxes on Money Payments (WTBM) . 1. Determine the correctness of bases and rates of tax applied. The tax base is the gross amount of money payment undiminished by the amount of income tax withheld under the EWT, or for any other reason. Example: Ministry of Public Highways pays XYZ Co., a contractor, P100,000. EWT 1% X P100,000 P1,000 WTBM .04 X P100,000 P4,000 2. Check money payments from vouchers, billing records, record of purchases, COA audit reports, etc. against monthly returns (7.50-1). - submit worksheet indicating: a) name and taxpayer account number of payee; b) amount of money payment; and c) date of payment. III. REPORTING REQUIREMENTS 1. Report form ad valorem penalties . Findings shall be reported in the prescribed forms in duplicate for each of the four types of withholding taxes: WTC-Form No. 1717A-4; EWT-Form No. 1774A-5; WTS-Form No. 1717A-6; and WTBM-Form No. 1717A-7. The report shall include the appropriate working papers in support of each item of discrepancy or omission. a) For failure to withhold taxes, impose either 50% surcharge if failure is due to fraudulent intent or willful neglect or 25% surcharge if failure is not due to such causes. plus 20% interest to be based on the amount of tax required to be withheld from the date the tax is required to be withheld until date of assessment (nil on tax on government money payments). cdt b) For failure to remit or underremit taxes, or in case of late remittance, impose either 50% surcharge if failure is due to fraudulent intent or willful neglect; or 25% surcharge if it is simple case of late remittance. plus 20% interest from date tax is required to be remitted until it is paid. c) For failure to file or for late filing of return/statement, impose either 50% surcharge if the failure is due to fraudulent intent or willful neglect or 25% surcharge if not due to such cause. If the withholding agent is a government office or agency, the employee or officer thereof responsible for the withholding and/or remittance of tax shall be personally liable for the surcharges and interest incident to delinquency (Under Executive Order No. 651 , such employee/officer is required to be registered with the Bureau). d) In addition to the abovementioned ad valorem penalties, a person required to collect, account for, and remit any tax imposed, or who willfully fails to collect such tax, or account for and remit such tax, or willfully assists in any manner to evade any such tax, or the payment thereof, shall be liable to a penalty equal to the amount of the tax not collected, or not accounted for and remitted. 2. If withholding agent or his authorized representative does not entirely conform to findings, the non-agreed portion of the assessment and the reason for non-conformity should be reflected on the space provided for in the report. 3. Reference file . A copy of the audit investigation report shall be kept on file by the investigating unit. In the absence of fraud or patently erroneous mathematical computation, such file shall serve as reference in the investigation of the internal tax liabilities of the withholding agent. 4. Guidelines for applying Section 30 (1) (a) Non-withholding/erroneous withholding . An amount claimed as deduction on which a tax is supposed to have been withheld under Sections 52 and 84 shall not be allowed if in the course of audit/investigation, the examiner discovers that: (1) No withholding of creditable or final tax was made, unless the payee reported the income, and the withholding agent/taxpayer pays during the original audit/investigation, the surcharges, interest and penalties incident to the failure to withhold the tax. (2) No withholding of creditable or final tax was made and the recipient-payee failed to report the income on due date thereof, unless the withholding agent pays during the original audit/investigation the amount supposed to have been withheld, inclusive of surcharges, interest and penalties incident to his failure to withhold. (3) The withholding agent erroneously underwithheld the tax, unless he pays during the original audit and investigation the difference in the amount supposed to have been withheld, inclusive of surcharges, interest and penalties incident to such error. (b) Non/late remittance . If, in the course of original audit/investigation, it should be discovered that the tax withheld on an amount claimed as deduction, has not been paid by withholding agent/taxpayer, the deduction shall not be allowed, unless it is shown that the non remittance is not due to fraudulent intent or willful neglect, and that the withholding agent/taxpayer pays the unremitted tax, surcharge, interest and the penalty equivalent to the amount of the tax not remitted or under-remitted. This order shall take effect immediately. (SGD.) BIENVENIDO A. TAN, JR. Commissioner of Internal Revenue