Existing Revenue Procedures on the Assessment of Deficiency Internal Revenue Taxes Based on the "Best Evidence Obtainable"

November 27, 2000 REVENUE MEMORANDUM CIRCULAR NO. 23-00 SUBJECT : Existing Revenue Procedures on the Assessment of Deficiency Internal Revenue Taxes Based on the "Best Evidence Obtainable" TO : All Internal Revenue Officers and Others Concerned SECTION 1 . Scope . It has been observed that a very significant number of taxpayers either refuse or fail to present their respective accounting records when demanded for tax audit purposes, thereby resulting to the delay in the submission of the Revenue Officer's report of investigation as required by the existing Audit Program and inconsistency in the determination of the deficiency internal revenue tax that may properly be assessed and demanded from the taxpayer, to the damage and prejudice against the revenue. In the absence of accounting records or other documents necessary for the proper determination of the taxpayer's internal revenue tax liability, Section 6 (B) of the National Internal Revenue Code of 1997 requires that the assessment of the tax be determined based on the " Best Evidence Obtainable ," as follows: "When a report required by law as a basis for the assessment of any national internal revenue tax shall not be forthcoming within the time fixed by laws or rules and regulations or when there is reason to believe that any such report is false, incomplete or erroneous, the Commissioner shall assess the proper tax on the best evidence obtainable . " SECTION 2 . Prescribed Revenue Procedures . 2.1 Subpoena Duces Tecum . All concerned shall strictly implement the prescribed procedures under Revenue Memorandum Order No. 35-90 on the issuance and enforcement of the Subpoena Duces Tecum in order to compel the taxpayer to present his tax records for tax audit purposes, impose the corresponding suggested compromise penalty for his violation of the Bookkeeping Regulations as may be warranted, and/or institute criminal action for the taxpayer's violation of the Subpoena. 2.2 Criminal Action for Violation of Summons . In case the taxpayer violates the Subpoena Duces Tecum , the Legal Division or the Prosecution Division, as the case may be, shall institute criminal action against the taxpayer himself, or the responsible officer, in the case of a corporation. 2.3 Assessment Based on Best Evidence Obtainable . An assessment based on best evidence obtainable is justified when any of the grounds provided by law is clearly established viz: 1. The report or records requested from the taxpayer are not forthcoming i.e. the records are lost; refusal of the taxpayer to submit such records; SaCIDT 2. The reports submitted are false, incomplete or erroneous. In every case where a taxpayer is ordered to be examined and he refuses or fails to submit his records giving rise to the issuance of a subpoena duces tecum pursuant to RMO No. 35-90, the assessment shall only be issued after a criminal case has been instituted for failure to obey summons. After filing of the complaint against the taxpayer for violation of the Subpoena Duces Tecum , the Legal Division/Prosecution Division shall immediately return the docket of the case to the concerned Revenue Officer. The Revenue Officer shall, upon receipt of the docket, immediately proceed to determine the taxpayer's deficiency internal revenue tax liability in accordance with the "Best Evidence Obtainable." 2.4 Existing Revenue Procedures and Jurisprudence Governing Assessment Based on the Best Evidence Obtainable . Provided hereunder are the existing revenue procedures and jurisprudence governing issuance of a deficiency tax assessment based on the best evidence obtainable: (a) Assessment Based on Estimate, When Valid . ". . . In the absence of proof of any irregularities in the performance of official duties, an assessment will not be disturbed . Even an assessment based on estimates is prima facie valid and lawful where it does not appear to have been arrived at arbitrarily or capriciously . The burden of proof is upon the complaining party to show clearly that the assessment is erroneou s. Failure to present proof of error in the assessment will justify the judicial affirmance of said assessment . In this instance, petitioner has not pointed out one single provision in the Memorandum of the Special Audit Team which gave rise to the questioned assessment, which bears a trace of falsity . Indeed, the petitioner's attack on the assessment bears mainly on the alleged improbable and unconscionable amount of the taxes charged . But mere rhetoric cannot supply the basis for the charge of impropriety of the assessments made . . . 1 " (b) Assessment Based on Estimate . Facts : The taxpayer-petitioner, a land transportation contractor, did not pay documentary stamp taxes on freight tickets issued. Freight tickets are taxable as "bill of lading." Actual amount per ticket could not be determined because most of them were torn or destroyed, hence, the revenue officer who conducted the audit decided to assess the stamp tax, based on estimate. Held: The Court sustained the validity of the assessment based on estimate, as follows: "In support of its first assignment of error, the petitioner-appellant claims that the computation made by the respondent is not based upon the best available evidence , but on mere presumptions. This claim is devoid of merit. The agent of the Bureau of Internal Revenue who investigated the petitioner's books of accounts found it impossible to count one by one the freight tickets contained in used booklets dumped inside the petitioner's bodega, because the booklets were so numerous most of them were either torn or destroyed. The procedure followed by said agent, which is the average method, in ascertaining the total number of freight tickets used during the period under review can not be impugned because an actual count of the freight tickets is practically impossible. The average method is the only way by which the agent could determine the number of booklets used during the period in question." 2 "The agent also correctly assumed that the value of the goods covered by each freight ticket is not less than P5.00. It is a common practice of passengers in the rural areas not to secure receipts for cargoes of small value and to demand receipts only for valuable cargo (Inter-provincial Autobus Co., Inc. vs. Collector of Internal Revenue, G.R. No. L-6741, January 31, 1956.) If the freight tickets were issued, the baggage carried must have been valuable enough. " 3 "On the other hand, it was the duty of petitioner to present evidence to show inaccuracy in the above method of assessment (Interprovincial Autobus Co. Inc. vs. Collector, supra ; Perez vs. C.T.A., G.R. No. L-9193, May 29, 1957; Perez vs. C.T.A., et al., G.R. No. L-10507, May 30, 1958; Government of P. I. vs. Monte de Piedad, 35 Phil. 42), but it failed to do so . The claim of petitioner that the freight tickets issued by it are not bills of lading subject to documentary stamp tax must also be dismissed in view of our ruling in the case of Inter-provincial Autobus Co., Inc. vs. Collector, supra: . . ." 4 (c) Assessment Based on Estimate ; 50% Rule, in the Absence of Receipts to Prove Actual Amount of Expense Deduction . The Court held in the Mariano Zamora case that, if there is a showing that expenses have been incurred but the exact amount thereof cannot be ascertained due to absence of documentary evidence, it is the duty of the BIR to make an estimate of the deduction that may be allowable in computing the taxpayer's taxable income, bearing heavily against the taxpayer whose inexactitude is of his own making. That disallowance of 50% of the taxpayer's claimed deduction is valid. TacSAE "It is alleged by Mariano Zamora that the CTA erred in disallowing P10,478.50 as promotion expenses incurred by his wife for the promotion of the Bay View Hotel and Farmacia Zamora. He contends that the whole amount of P20,957.00, as promotion expenses in his 1951 income tax returns, should be allowed and not merely one-half of it or P10,478.50, on the ground that, while not all the itemized expenses are supported by receipts, the absence of some supporting receipts has been sufficiently and satisfactorily established. For, as alleged, the said amount of P20,957.00 was spent by Mrs. Esperanza A. Zamora (wife of Mariano),during her travel to Japan and the United States to purchase machinery for a new Tiki-Tiki plant, and to observe hotel management in modern hotels. The CTA, however, found that for said trip, Mrs. Zamora obtained only the sum of P5,000.00 from the Central Bank and that in her application for dollar allocation, she stated that she was going abroad on a combined medical and business trip, which facts were not denied by Mariano Zamora. No evidence had been submitted as to where Mariano had obtained the amount in excess of P5,000.00 given to his wife which she spent abroad. No explanation had been made either that the statement contained in Mrs. Zamora's application for dollar allocation that she was going abroad on a combined medical and business trip, was not correct. The alleged expenses were not supported by receipts. Mrs. Zamora could not even remember how much money she had when she left abroad in 1951, and how the alleged amount of P20,957.00 was spent. "Section 30 of the Tax Code provides that in computing net income, there shall be allowed as deductions all the ordinary and necessary expenses paid or incurred during the taxable year, in carrying on any trade or business (Vol. 4, Mertens, Law of Federal Income Taxation, sec. 25.03, p.307). Since promotion expenses constitute one of the deductions in conducting a business, same must satisfy these requirements. Claims for the deduction of promotion expenses or entertainment expenses must also be substantiated or supported by record showing in detail the amount and nature of the expense incurred (N.H. Van Sicklen, Jr. vs. Comm. of Int. Rev., 33 BTA 544). Considering, as heretofore stated, that the application of Mrs. Zamora for dollar allocation shows that she went abroad on a combined medical and business trip, not all of her expenses came under the category of ordinary and necessary expenses; part thereof constituted her personal expenses. There having been no means by which to ascertain which expense was incurred by her in connection with the business of Mariano Zamora and which was incurred for her personal benefit, the Collector and the CTA in their decisions, considered 50% of the said amount of P20,957.00 as business expense and the other 50%, as her personal expense. We hold that said allocation is very fair to Mariano Zamora, there having been no receipt whatsoever, submitted to explain the alleged business expenses, or proof of the connection which said expenses had to the business or the reasonableness of the said amount of P20,957 . 00 . While in situations like the present, absolute certainty is usually not possible, the CTA should make as close an approximate as it can, bearing heavily, if it chooses, upon the taxpayer whose inexactness is of his own making ." 5 (d) BIR RULING . Assessment Based on Estimate . In the absence of accounting records, the taxpayer's tax liability may be determined by estimate under the best evidence rule based on records of other taxpayers engaged in the same line of business, as follows: "In reply, please be informed that under Section 16 of the Tax Code, the Commissioner is authorized to assess the proper tax based on the best evidence obtainable. If the taxpayer fails to submit the required returns, statements, reports and other documents, the Commissioner shall assess the proper tax, using the correct method of computation in determining the taxpayer's liability; hence, complete and outright disallowance of the taxpayer's claim for deduction of legitimate business expenses appears not warranted. If no documents of any kind are available or presented by the taxpayer, a comparative determination of reasonable business expenses incurred by other taxpayers undertaking similar kind of business should be ascertained to arrive at a reasonable determination of the deductible business expenses . "In the instant case, involving taxpayers in Ormoc City who have lost all of their books of accounts and other records during the great flood in 1991, greater leniency in allowing their claims for deduction for reasonable business expenses is justified. One way of manifesting this leniency is to refer to the taxpayers' previous two (2) years deficiency tax assessments, if any. The average of their deficiency tax during the last two years may then be used as the best evidence to impute their deficiency tax liability for 1991. Otherwise, if there is none, then it can be concluded that no deficiency tax is due for 1991 ." 6 Note . Under this procedure, the gross profit and net profit ratios of other taxpayers engaged in the same line of business may be used in estimating the taxpayer's gross profit from sales and net taxable income. (e) Networth Method Of Investigation . Determination of the taxpayer's taxable net income through the networth method of investigation is valid. "We next come to the question of the use of the inventory method in assessing the income taxes due from petitioner. The use of the inventory method is authorized under Section 15 7 of the National Internal Revenue Code (Com. Act No. 466), as amended, which authorizes the Collector of Internal Revenue to assess taxes due a taxpayer from any other available fact or evidence. If a taxpayer commits a violation of the law, hiding his income to evade payment of taxes, the Government must be permitted to resort to all evidence or sources available to determine his said income, so that the tax may be collected for public purposes. There is and there should be a presumption of regularity accorded this action of the Collector of Internal Revenue in assessing the tax on the best evidence obtainable, otherwise it would be impossible to assess taxes due from a dishonest taxpayer. CSIDTc "This form of assessment has also been adopted by the Collector of Internal Revenue with the approval of this Court in three cases, Perez vs. Collector; G.R. No. L-10507, May 30, 1958; Collector vs. A.P. Reyes, G.R. Nos. L-11534 & L-11558 Nov. 25, 1958; and Avelino vs. Collector, G.R. No. L-17715, July 31, 1963. In the case at bar, the existence of assets or properties appearing in the name of the taxpayer or in the name of his dummies or friends, without the taxpayer being able to give a definite reasonable explanation for their existence justifies the Court of Tax Appeals and this Court to resort to the inventory method of assessment, such being necessary and at the same time just and equitable. 8 (f) Assessment Based on Best Evidence in Case of Non-Presentation of Taxpayer's Books of Accounts . "The disputed 1954 deficiency income tax assessment of P73,636.50, even if it was based merely on adjusting entries recorded in petitioner's general ledger, is justified and sanctioned by Section 15 9 of the National Internal Revenue Code, the pertinent portion of which reads as follows: 'SECTION 15. Power of Commissioner of Internal Revenue to make assessments . When a report required by law as a basis for the assessment of any national internal revenue tax shall not be forthcoming within the time fixed by law or regulation, or when there is reason to believe that any such report is false, incomplete, or erroneous, the Commissioner of Internal Revenue shall assess the proper tax on the best evidence obtainable.' "Petitioner's willful and consistent neglect to file its corporate income tax returns for a period of four (4) calendar years (1950 to 1953) justifies the issuance of respondent's deficiency income tax assessment and letter of demand. A taxpayer like the petitioner cannot be permitted to hide its taxable income and evade the payment of taxes with impunity by the simple expediency of conveniently losing its books of accounts and paying the minimal compromise penalty therefor ; otherwise, it would be impossible to collect income taxes due from a dishonest taxpayer . This doctrine was enunciated by our Supreme Court in the disputed income tax case of William Li Yao v. Collector of Internal Revenue, G.R. No. L-11875, December 28, 1963, wherein the said Court categorically stated as follows: 'If a taxpayer commits a violation of the law, hiding his income to evade payment of taxes, the Government must be permitted to resort to all evidence or sources available to determine his said income so that the tax may be collected for public purposes. There is and there should be a presumption of regularity accorded this action of the Collector of Internal Revenue in assessing the tax on the best evidence obtainable otherwise, it would be impossible to assess taxes due from a dishonest taxpayer.' "After sustaining the power of respondent to assess the deficiency income tax, the question posed before us is whether or not the disputed income tax assessment was based 'on the best obtainable evidence.' We uphold the affirmative view. In the first place, petitioner conveniently lost its books of accounts to avoid and prevent any investigation of its internal revenue tax liability. Second, the reported loss of petitioner's books of accounts covering the years 1950 to 1954 was only made on June 6, 1956, thereby showing a deliberate intent to delay or cover up its tax liabilities for prior years. Third, the recovery of the general ledger undoubtedly belonging to petitioner and containing a summary of its business transactions constitutes the best evidence obtainable under the circumstances. Fourth, an analysis of the accounting entries in petitioner's ledger indicates that the amount of P220,389.72 debited to cash and credited to surplus on December 31, 1954 is income to petitioner. And finally, petitioner's failure to present any evidence to show the incorrectness of respondent's assessment during the administrative hearing of the case on the merits conducted by Legal Officer Teodolfo Yerro, Jr. of the Appellate Division, Bureau of Internal Revenue, establishes a presumption that the disputed assessment is prima facie correct. Thus, in the case of Bohol Land Transportation Co. vs. Collector of Internal Revenue, G.R. Nos. L-13099 and L-13462, April 29, 1960, 107 Phil. 968, our Supreme Court held: SICDAa 'At the hearing of the case on the merits, the company in spite of the suggestion of the court did not present any evidence to show the incorrectness of the deficiency income tax assessments with respect to the years 1945 to 1950, inclusive, and so the court considered such failure fatal in view of the theory that the assessment made by the Collector is presumed to be prima facie correct unless controverted. Hence, the Court of Tax Appeals held the petitioner liable for deficiency income taxes for the years 1948, 1949 and 1950. (Emphasis supplied.)' "On the other hand, petitioner vigorously contends that the deficiency income tax assessment issued by respondent is inherently weak and not based on the best obtainable evidence because the real facts of the case and not the bookkeeping entries shall control the determination of the taxable income of petitioner. In support thereof, petitioner cited as authority the case of Collector v. Benipayo, G.R. No. L-13656, Jan. 31, 1962, wherein it was held, quoting the Court of Tax Appeals, as follows: 'To our mind, the appealed decision has no factual basis and must be reversed. An assessment fixes and determines the tax liability of a taxpayer. As soon as it is served, an obligation arises on the part of the taxpayer concerned to pay the amount assessed and demanded. Hence, assessments should not be based on mere presumptions no matter how reasonable or logical said presumption may be . . .' 'In order to stand the test of judicial scrutiny, the assessment must be based on actual facts. The presumption of correctness of assessment being a mere presumption cannot be made to rest on another presumption . . . In the case under consideration, there are no substantial facts to support the assessment in question.' (Emphasis ours.) "Petitioner's legal defense is untenable. The real and actual facts of the case cannot be ascertained or established by either the respondent or the petitioner because the latter, through culpable negligence, conveniently lost its books of accounts except the general ledger which was subsequently recovered by the revenue examiners from the Manila Police Department. The weakness of petitioner's stand lies in the fact that it disregards the entries in the ledger whenever it bolsters the assessment of respondent and would want us to take them on their face value when it suits the defense of petitioner." 10 (g) BIR may Resort to Assessment Based on Best Evidence if the Taxpayer's Accounting Records is not Understandable . "(1) Any bookkeeping system authorized under existing laws or regulations on the matter may be adopted by taxpayers. If any authorized bookkeeping system is not understandable to the fieldmen of this Bureau, the taxpayer must necessarily have to explain such system. If notwithstanding such explanation, the fieldmen cannot understand its operations, they may disregard such bookkeeping records so kept and resort to the best evidence available reflecting the operations of the taxpayer. At any rate, this Office will not countenance any system of bookkeeping which is not generally understandable. . . . 11 (h) BIR RULING : In the Absence of the Taxpayer's Books of Accounts, Records of the Pertinent Government Agency on the Industry's Revenue may be Used as Best Evidence in Assessing the Tax . "The investigation conducted in connection with this case disclosed that "many if not all" of the fishpond owners and operators concerned are not keeping and using books of accounts. They did not pay the fixed and percentage (sales) taxes due on their operations during the period in question. Neither did they file the sales tax returns. ICAcTa "Under the above circumstances, the sales tax in question should, as you have correctly stated, be assessed on the best evidence obtainable. The income tax return is the best evidence for purposes of the sales tax although it may be admitted that the same may be of some help in determining the true and correct amount of sales tax due. This Office believes that the official determination of the value of production of each class of fishpond made by the provincial treasurer and assessor of your province should be given more credence in the absence of the books of accounts and sales tax returns of said owners and operators . "In view of the foregoing, we regret to inform you that we find your contention untenable. As soon as the fishpond owners and operators herein involved receive the demand for payment of the taxes in question, this Office will appreciate it very much if you will advise them to pay promptly." 12 (i) When Secondary Evidence Offered by the Taxpayer is Admissible . "Where a taxpayer questions the correctness of an assessment against him and is apparently not acting in bad faith or merely attempting to delay payment, but is deprived of the best means of proving his contention because his books of account were lost by the B.I.R agent who examined them, said taxpayer must be given an opportunity to prove , by secondary evidence, that the assessment is incorrect." 13 SECTION 3 . Enforcement . A uniform and strict enforcement of the foregoing prescribed revenue procedures is enjoined. All revenue officials and employees are enjoined to give this Circular as wide a publicity as possible. (SGD.) DAKILA B. FONACIER Commissioner of Internal Revenue Footnotes 1. Ferdinand R. Marcos II, Petitioner, vs. Court of Appeals, the Commissioner of Internal Revenue and Herminia D. de Guzman, Respondents, Second Division, G.R. No. 120880, June 5, 1997, citing Gutierrez vs. Villegas, G.R. No. L-17117, July 31, 1963 (8 SCRA 527). 2. MINDANAO BUS COMPANY, petitioner, vs. THE COLLECTOR OF INTERNAL REVENUE, respondent, En banc (G.R. No. L-14078. February 24, 1961). 3. id . 4. Id . 5. En banc, MARIANO ZAMORA, petitioner, vs. COLLECTOR OF INTERNAL REVENUE and COURT OF TAX APPEALS, respondents.(G.R. No. L-15290. May 31, 1963.) :COLLECTOR OF INTERNAL REVENUE, petitioner, vs. MARIANO ZAMORA, respondent.(G.R. No. L-15280. May 31, 1963.): ESPERANZA A. ZAMORA, as special Administratrix of the Estate of FELICIDAD ZAMORA, petitioner, vs. COLLECTOR OF INTERNAL REVENUE and COURT OF TAX APPEALS. respondents. (G.R. No. L-15289, May 21, 1963.): COLLECTOR OF INTERNAL REVENUE, petitioner, vs. ESPERANZA A. ZAMORA, as Special Administratrix, etc., respondent, (G.R. No. L-15281, May 31, 1963). 6. BIR RULING NO. 031-94, January 31, 1994. 7. Now Sec. 6, NIRC of 1997, as renumbered. 8. En banc, WILLIAM Ll YAO, petitioner, vs. COLLECTOR OF INTERNAL REVENUE, respondent. (G.R. No. L-11875, December 28, 1963) 9. Now Section 6 of the Tax Code of 1997. 10. RAPID BROKERAGE COMPANY. INC.. petitioner vs. MISAEL P. VERA, as Commissioner of Internal Revenue. respondent, (C.T.A. CASE NO. 1919, March 22, 1971). 11. BIR Ruling No. 572-59, Oct. 19, 1959. 12. BIR Ruling No. 245-69 May 17, 1960. 13. RICARDO S. SANTOS, petitioner-appellant, vs. HON. MARIANO NABLE, ETC. ET. AL., respondents-appellees, En banc (G.R. No. L-12-73, May 23, 1961).