Investigation of Refundable Individual Income Tax Returns

May 10, 1965 REVENUE MEMORANDUM ORDER NO. 14-65 SUBJECT : Investigation of refundable individual income tax returns TO : All Internal Revenue Officers and Others Concerned In order to insure uniformity of action in the investigation and processing of refundable income tax returns, the following procedure is hereby promulgated for the compliance of all concerned: 1. Where the amount of refund involved is P1,000.00 or more and the address of the taxpayer is in Regional Offices Nos. 4, 5, and 6, the investigation of the case should be handled by the fieldmen of the Withholding Tax Division. 2. Where the amount of refund involved is less than P1,000.00 and the address of the taxpayer is within Regional Offices Nos. 4, 5, and 6, the investigation shall be conducted by the Regional Office concerned. The reports of examination, however, after review in the Regional Office should be forwarded to the National Office for final review and approval. 3. If the address of the taxpayer is located outside Regional Offices Nos. 4, 5, and 6, the investigation of the case should be conducted in the Regional Office concerned irrespective of the amount of refund involved. The reports of examination, however, of all these cases should, after review in the Regional Office, be forwarded to the National Office for final review and approval. 4. Transmittal of reports of examination to the National Office should be made direct to the Withholding Tax Division where the corresponding refund warrant and the original of the return are retained. 5. Reviewers in the Income & Business Tax Branch of regional offices, chief revenue officers and group supervisors should carefully review and scrutinize the report to insure that the requisite forms and working papers are complete and comprehensible. 6. The following guidelines on representative items of discrepancies based on examination findings on 1963 cases are given hereunder to assist examining officers in their investigation of the 1964 cases. While these guidelines may be helpful in a vast majority of cases, they may not, on the other hand, prove to be exhaustive or applicable to some situations. Discretion, good judgment and foresight should, therefore, be utilized to the fullest extent by the examining officer in detecting all possible avenues of circumvention and/or evasion of the tax laws: The guidelines are as follows: (a) Interest Expense Returns claiming substantial amounts of deduction for interest requires careful and exhaustive verification and the examining officer should be alert for fictitious and forged signatures of alleged creditors. Where the names of the creditors are not shown in the return, the same should be requested as well as the corresponding amounts paid. Direct verification with the creditors should be made to determine whether the interest payments were in fact made on valid and existing debts. In view of the substantial amounts involved, compilation of statistics and data on those established by the examining officers to be authentic will be undertaken by the National Office to serve as source data in the determination as to whether they were, on the other hand, declared as income by the recipient creditors. Explore likewise the possibility that the loans secured involving substantial interest expense were invested in some businesses, income from which have not been declared or may have been under declared. The possibility that they may be also invested in bonds and securities, the interest income of which is exempt from income tax should likewise be undertaken. (b) Traveling, representations and entertainment expenses These are the most common items of deduction frequently utilized by taxpayers to reduce their tax liabilities. It has been observed in the 1963 returns and to a certain extent in the 1964 returns, that taxpayers who ordinarily did not incur such expenses as to be deductible will present in the appropriate schedule a breakdown of compensation received divided into salaries, representation and entertainment allowance and transportation allowances and at the same time deduct the same amount of allowances in the return to justify the allowability of the corresponding expenses in fantastic amounts. Whenever feasible, therefore, verification should be made with the employer to ascertain from the records whether the compensation received by the taxpayer really contains amounts representing representation and entertainment allowances and transportation allowances. The existence of allowances in the form of income, however, is not a conclusive guarantee to the allowability of the expense claimed. Strict adherence to the basic techniques in auditing this type of expenses should be made. On the other hand, absence of items of allowance income should serve as a warning to the examiners concerned that the expenses claimed may be more personal rather than in connection with the business, under the theory that the employer who is the arbiter in this respect did not recognize the expenses to be in connection with the business as manifested by its failure to provide reimbursement for the expenses claimed. In isolated cases where substantial amounts of salaries are claimed out of which this type of expenses are expected to be borne, the contract of employment and/or the resolution of the Board of Directors containing such stipulation should be verified and a true copy thereof secured and made part of the report of investigation. As an alternative, a certification should be secured from the highest official as possible, regarding the company's anticipation of such expenses to be incurred by the taxpayer in the normal course of his employment, as well as the policy of the employer with respect to reimbursements or allowances for said expenses. In all cases the nature and exact duties of the taxpayer should be determined. Where traveling or transportation expenses are claimed, the frequency and/or mileage of traveling required in the taxpayer's work should be ascertained. It has been observed in some returns for previous years that the amount of gasoline consumed and claimed as deduction in the return would place the taxpayer on the road almost the whole day throughout the year. Personal use of the car owned by the taxpayer should, therefore, be looked into. Representation and/or entertainment expenses claimed should be ascertained to determine that they are ordinary, necessary and reasonable business expenses. The taxpayer's records must be in sufficient detail as to establish relation to the expenditure to the business, the nature, the basis of expenditure and the person or party entertained and the business derived or expected to be derived thereto. The extent to which the expenditure incurred appears to be personal should be determined and the details thereof should be reflected in the working papers. (c) Losses Losses from theft, flood, farming, poultry, cattle raising and rentals are the most common items of losses utilized to off-set income. Examining officers should look into the following: (1) Ownership and existence of the property which is the subject of loss should be fully ascertained. (2) Losses from theft and flood should be ascertained to determine whether the property is really owned by the taxpayer, and that the amount claimed as loss is not covered by insurance received or anticipated. Losses from flood may cover prospective or standing crops which should not be allowed. The examiner should be alert to highly doubtful or fictitious cases of this type because they have been abused and will continue to be abused by unscrupulous taxpayers unless careful, exhaustive and intelligent verification of such item is undertaken. (3) Losses from farming, poultry, cattle raising and from rental of property are often used by taxpayers as tax reducers. Ascertain whether the losses have in fact been incurred from bona-fide business enterprises and not from those operated for recreation or pleasure. cdlex (d) Salaries, commissions and other forms of income paid to sub-agents, correctors helpers and others. Many claims for deduction of this nature have been discovered to be fictitious. The investigating examiner should endeavor to secure the names and addresses of the recipient of the income and the respective amounts received. The examiner should require the production of the residence certificate paid for by the recipients and the corresponding payments of the amounts withheld from the recipient to the Social Security System. If the amount of the income is P1,800.00 or more, the examiner should verify whether income tax returns have been filed by the recipient. In the absence of any of the foregoing, the amount claimed as a deduction should be disallowed. (e) Privilege Taxes Where the source of the income of the taxpayer being investigated is from the exercise of the profession subject to the payment of privilege taxes, the report should specify the privilege tax receipt number, the date of payment and amount paid. In case of insurance agents claiming deduction for sub-agent's commission, the aforesaid requirements should also apply to sub-agents who are the recipients of commissions. (f) Withholding tax liabilities Payments of salaries, bonuses, commissions and other forms of wages by the taxpayer being investigated to any one individual where the amount paid is P1,800.00 or more makes the taxpayer an employer subject to the provisions of the Withholding Tax Law. Since he is considered an employer, whether an amount should have been withheld from the employees or not, the taxpayer should be required to register as an employer and accomplish BIR Form No. W-5. The form duly accomplished should be incorporated in the report. If certain taxes should have been withheld from the employee, they should be determined and incorporated likewise in the report. (g) Contributions The recipient of the contributions and the corresponding amount contributed should be ascertained and reflected in the working papers. (h) Real estate taxes Ascertain whether the title or ownership over the real property has already passed to the taxpayer. It is a very common practice for most taxpayers to deduct real estate taxes on real property purchased on the installment plan where the (seller) during the installment period and before transfer of title is effected, shifts the payment of real estate taxes to the purchaser. Claims of this nature should not be allowed as the seller is still the owner of the property that was taxed and is a person entitled to claim such deduction. cd Strict compliance with these instructions is hereby enjoined. (SGD.) BENJAMIN N. TABIOS Acting Commissioner of Internal Revenue