General Policies in the Investigation of Tax Fraud Cases

June 9, 1995 REVENUE MEMORANDUM ORDER NO. 15-95 (amended by RMO 31-95) SUBJECT : General Policies in the Investigation of Tax Fraud Cases TO : All Internal Revenue Officers and Others Concerned A. OBJECTIVE To provide the policies and rules in the manner of investigating tax fraud cases by the Tax Fraud Division (TFD), Special Investigation Division (SIDs) and the Revenue District Offices (RDOs) for criminal prosecution, and to avoid the multiple issuances of Letter of Authority and/or simultaneous investigation of the same taxpayer covering the same taxable year. All revenue officer concerned shall be guided by the updated "Guidelines and Investigative Procedures in the Development of Tax Fraud Cases for Internal Revenue Officers", hereto attached as Annex "A". B. JURISDICTION 1. TAX FRAUD DIVISION 1.1. The Tax Fraud Division shall have the jurisdiction to conduct or undertake the investigation and/or reinvestigation of cases referred to or developed by the Division, and those assigned, referred or approved by the Commissioner of Internal Revenue. 2. SPECIAL INVESTIGATION DIVISION 2.1. The SID shall have jurisdiction over the following cases: 2.1.1. Tax fraud cases referred to it by the Intelligence and Investigation Service (IIS) 2.1.2 Tax fraud cases initiated and developed by the SID. 2.1.3 Tax fraud cases referred to it by the RDO. 3. REVENUE DISTRICT OFFICERS 3.1. If in the course of the regular examination of returns, indication of fraud were discovered, the RDO must transmit the records of the case immediately to the SID and provide assistance in the formal investigation thereof. This shall be considered sufficient compliance with RMO 44-93. C. PROCEDURE A Preliminary Investigation must first be conducted to establish the prima facie existence of fraud. This shall include the verification of the allegations on the confidential information and/or complaints filed, and the determination of the schemes and extent of fraud perpetrated by the denounced taxpayers. The Formal Fraud Investigation, which includes the examination of the taxpayers books of accounts through the issuance of Letters of Authority, shall be conducted only after the prima facie existence of fraud has been established. 1. TAX FRAUD DIVISION 1.1. Where indications of fraud have been established in a preliminary investigation, the TFD thru the Assistant Commissioner, Intelligence and Investigation Service (IIS), shall request/recommend the issuances of the corresponding Letter of Authority by the Commissioner which will automatically supersede all previously issued Letter of Authority with respect thereto. 1.2 Thereafter, a copy thereof shall be immediately furnished the RDO and/or the SID of the Revenue Region having jurisdiction over the taxpayer, who upon receipt thereof, must immediately transmit to the TFD all the documents in their possession relative thereto; and must withdraw and cancel any issued Letter of Authority therefor. No Letter of Authority shall be issued for any taxpayer already covered by a Letter of Authority issued by the Commissioner. 1.3. Reports on cases recommended for criminal prosecution shall be forwarded to the Assistant Commissioner, Legal Service, Attn: Litigation and Prosecution Division, thru the IIS. However, if after evaluation the Litigation and Prosecution Division resolves that the evidence is not sufficient to warrant the filing of a criminal action against subject taxpayer, the case shall be referred back to the TFD thru the IIS, for further documentation and/or appropriate action.. 1.4. No Assessment Notice shall be served upon any taxpayer recommended for criminal prosecution for tax evasion, following the Supreme Court's ruling in the case of Ungab vs. Cusi, 97 SCRA 877. 1.5. All other reports on cases not recommended for criminal prosecution shall be forwarded to the Commissioner, thru the IIS, for approval. 2. SPECIAL INVESTIGATION DIVISION 2.1. The Chief of the SID shall issue the corresponding Letter of Authority if the prima facie existence of fraud has been established, and the same has been confirmed by the Regional Tax Fraud Committee (RTFC), composed of the following: a. Regional Director Chairman b. Chief, SID Member c. RDO having jurisdiction over the taxpayer Member d. Chief, Assessment Division Member e. Chief, Legal Division Member The RDO shall then desist from issuing any Letter of Authority to the taxpayer concerned, and shall transmit to the SID all the documents in its possession relative thereto. However, the RDO may assign one Revenue Officer, whose name shall be included in the Letter of Authority as the "RDO" Assisting Revenue Officer" (RARO), to assist and coordinate with the SID in the formal investigation. 2.2. Where the SID has established the prima facie existence of fraud against a taxpayer who has been the subject of an on-going or terminated investigation by the RDO, the SID shall nevertheless forward the record of the records of the case for evaluation to the RTFC. If after evaluation the RTFC confirms to the SID the prima facie existence of fraud, the following procedures shall be followed: 2.2.1. Where the investigation is on-going - the RDO concerned shall withdraw its Letter of Authority and immediately cease and desist from further investigation. The records of the case shall then be forwarded to the SID concerned which, thereafter, shall issue a Letter of Authority and proceed with the formal fraud investigation. 2.2.2. Where investigation is already terminated the office who has the possession of the records shall, upon written request, immediately forward the records to the SID concerned. If a re-investigation is necessary, the SID shall forward the same to the IIS with a recommendation for the issuance of the corresponding Letter of Authority by the Commissioner of Internal Revenue. 2.3. Where the business activities and/or establishments are situated in more than one revenue region, the tax fraud case must be referred to the TFD thru the IIS. 2.4 If after conducting the preliminary investigation the prima facie existence of fraud cannot be established, but a potential deficiency tax assessment exists, the case shall be referred to the RDO concerned for appropriate action. 2.5. Reports on cases recommendation for criminal prosecution shall be forwarded to the Legal Division of the Revenue Region. If after evaluation the Legal Division resolves that the evidence is not sufficient to warrant the filing of a criminal action against subject taxpayer, the case shall be referred back to the SID, for further documentation and/or appropriate action. 2.6 Reports on cases not recommended for criminal prosecution shall be forwarded to the Assessment Division of the Region. 3. REVENUE DISTRICT OFFICES 3.1 Upon discovery of the indication(s) of fraud during the regular examination of the returns, the Revenue Officer should make a detailed report thereof to the Revenue District Officer who shall immediately transmit the records of the case to the SID. 3.2 The RDO shall then assign a RARO to assist and coordinate with the SID in the investigation of the said case. D. CIVIL FRAUD In case the quantum of evidence gathered does not warrant a criminal prosecution because it is not sufficient to prove the guilt of the taxpayer beyond reasonable doubt there exists a clear and convincing evidence that fraud has been committed, a corresponding 50% surcharge shall nevertheless be imposed. E. ATTRIBUTION OF COLLECTION All collections arising out of the investigations by the TFD and SID, the latter either by itself or through coordination with the RDO, shall be attributed to the RDO having jurisdiction over the taxpayer. F. PENAL CLAUSE Strict compliance with this RMO is hereby enjoined. Any willful violation hereof shall be treated as gave misconduct and the corresponding penalty of dismissal as provided under Civil Service Rules and Regulations shall be imposed. G. REPEALING CLAUSE Any provision of any order and pertinent issuances inconsistent with his Order is hereby revoked, modified or amended accordingly. H. EFFECTIVITY This Revenue Memorandum Order takes effect immediately. LIWAYWAY VINZONS-CHATO Commissioner ANNEX A GUIDELINES AND INVESTIGATIVE PROCEDURES IN THE DEVELOPMENT OF TAX FRAUD CASES FOR INTERNAL REVENUE OFFICERS A. OBJECTIVES : The substantial revenue collections of the government derived from the series of tax amnesties signify to a large that the BIR has not effectively tapped a great number of potential sources of revenue. The tremendous shortfall in revenue collections for the preceding year should spur the BIR on the need for a more systematic and vigorous tax campaign by instilling more awareness and tax consciousness among our taxpayers, more especially those who have continuously flaunted our revenue laws with impunity. To provide a strong detergent to the commission of fraud against the revenues for the purpose of increasing and enhancing our revenue collections, the imposition of criminal sanctions, in addition to the civil liabilities, on erring taxpayers should be implemented to the fullest extent of the law in line with the pronouncement of the President of the Philippines. These guidelines are, therefore, presented to guide and to refresh all internal revenue officers with the necessary know-how in the investigation, evaluation, and submission of reports of fraud cases envisioned to withstand judicial scrutiny. B. NATURE AND TYPES OF FRAUD : Definition-fraud or evasion Tax fraud or evasion means the elimination or reduction of one's correct and proper tax by fraudulent means. "The fraud contemplated by law is actual and not constructive. It must be intentional fraud, consisting of deception willfully and deliberately done or resorted to in order to induce another to give some legal right . . . " Aznar vs. CTA and Collector , G.R. No. L-20569, Aug. 25, 1974. Factors in Fraud or Evasion All the following elements must be proven by competent evidences to establish the existence of fraud: 1. The end to be achieved - the payment of less tax than that known by the taxpayer to be legally due: 2. The accompanying state of mind which is variously described as being "evil", "in bad faith", "deliberate and not accident", or "willful" the exact term used is not too important. 3. The overt act done or scheme used by the taxpayer to achieve the non-payment of taxes known to be due. The act or scheme must be tinged with some elements of deceit, misrepresentation, trick, device, concealment or dishonesty." Fraud under Tax, Balter . Burden of Proof in Establishing Fraud : A tax fraud or evasion case is basically criminal case. In the establishment of fraud, the burden of proof is on the Bureau of Internal Revenue. The presumption that an officer of the government has performed his duty regularly (Sections 5, Rule 131 of the New Rules of Court), as in the case of the correctness of deficiency assessments, is not applicable in fraud cases. "In criminal cases, the burden of proof as to the offense charged lies on the prosecution." (Section 2, Rules 131, New Rules of Court). Mere suspicious and mere doubts on the intention of the taxpayer are not sufficient proof of fraud. Fraud is never presumed, it must be proved. Types of Tax Fraud Cases Criminal Fraud A criminal tax fraud case results when all the elements of fraud can be proven beyond reasonable doubt. Proof beyond reasonable doubt not mean such a degree of proof as, excluding possibility of error, absolute certainty; only required, or that degree of proof which produces conviction in an unprejudiced mind. Here, the taxpayer upon conviction shall be liable from the deficiency taxes, to both criminal and civil penalties. Civil Fraud A civil tax fraud case results when all the elements of fraud cannot be proven beyond reasonable doubt, but rather by clear an convincing evidence amounting to more than a mere preponderance, and cannot be justified by mere speculation. "Preponderance of evidence" means that the testimony adduced by one side is more credible and conclusive than that of the other. "Clear and convincing" need not rise to proof beyond reasonable doubt as in a criminal case but yet must be stronger than mere preponderance of evidence. Here, the taxpayer shall be liable aside from the deficiency taxes only to the civil penalties. Effects of Fraud under the National Internal Revenue Code (NIRC) 1. Civil penalties rise to the imposition of the 50% surcharge; to be imposed by the BIR; 2. Criminal penalties involving the imposition of penal sanctions imprisonment and/or fine to be imposed by the Regional Trial Court (RTC) upon conviction; 3. Power of the Commissioner to assess and collect the tax is extended to 10 year from date of discovery, however, Sec. 280 provides the five year prescription on the filing of criminal action; 4. Cases involving fraud cannot be the subject compromise as mandated by Section 204, NIRC; 5. Suspension and temporary closure of the business operations of a taxpayer under Sections 111 of Tax Code for violation of the VAT provisions. C. METHODS OF PROVING FRAUD IN CRIMINAL AND CIVIL TAX FRAUD CASES : 1. The Direct Approach Method or by Direct Evidence, also called Specific Item Cases Proof of fraudulent acts are adduced by specific items of fraudulent transactions. It is that one, if the allegations are believed, the existence of the principal or ultimate fact is proven without any inference or presumption. Specific Item Cases determined by the direct approach method 1.1 Income Tax 1.1.1 Omission or understatement of taxable income 1.1.1.1 Failure to file income tax return. 1.1.1.2 Items of income and expenses, or assets or liabilities have been omitted, or falsely claimed in the accounting records or return in order to minimize or reduce taxes; 1.1.1.3 Misclassification of accounts Income taken upon and classified as liabilities; erroneous classification of income from taxable to exempt; ordinary gains classified as capital gains; non-deductible expenses disguised as deductible items; and capital expenditures classified as deductible items. 1.1.1.4 Sales/Income of domestic branches purportedly shown as income of the foreign head office; 1.1.1.5 Keeping two sets of invoice or receipts one set registered with the BIR and sales or income recorded thereon are the ones posted in the accounting records, whereas the other set is not reported for tax purposes; 1.1.1.6 Keeping two sets of books of accounts records one set registered with the BIR and the other set reflects the correct transactions and not registered and reported to the BIR; 1.1.1.7 Non-issuance of receipts to customers; and 1.1.1.8 Sales invoices or receipts issued to customers reflects the correct transactions, but invoices or receipts recorded for tax purposes reflects much smaller amounts. 1.1.2 Utilization of other persons or entities 1.1.2.1 Establishment of several entities corporations, partnerships, or proprietorships, by a person by making it appear that sale are made by the different entities created when in fact such sales are only made by one person; 1.1.2.2 Allocating income and expenses to other persons in order to reduce or minimize taxes by a controlling person; and 1.1.2.3 Establishment of a registered partnership or corporation, using dummy partners or stockholders. 1.1.3 Improper claims of costs of sales and deductible expense. 1.1.3.1 Fictions purchaser, or padding of purchaser, or that proceeds are diverted to the personal benefit of the taxpayer or his assign; 1.1.3.2 False or fictions claims of deductions; 1.1.3.3 Misclassification of deductions Investments or major repairs or improvements claimed as nominal expenses; 1.1.3.4 Dividend declarations classified as expenses or salaries; 1.1.3.5 Withdrawals claimed as expenses or compensation; 1.1.3.6 Claim of depreciation of non-existing assets or already fully depreciated, or on assets which were appraised higher for credit purposes; 1.1.3.7 Claim of purchases from no-VAT sources as VAT purchases and claiming tax credits thereon; and 1.1.3.8 Improper claims of tax credits without having paid the input taxes passed on by the seller. 1.1.4 Claims of false personal exemptions Claiming exemptions as married by an unmarried individual or head of the family by single persons who do not actually support their parents; and Claiming false additional exemptions of alleged children, or children who are already of age or who are not physically incapacitated. 1.2 Business Taxes - VAT and Percentage Taxes 1.2.1. Business Taxes - VAT and Percentage 1.2.1.1. Omission or understatement of taxable sales/income- 1.2.1.2 Keeping falsified books of accounts; 1.2.1.3 Non-issuance of sales invoices, or under- recording of sales to conceal the amount of sales subject to business taxes on VAT; 1.2.1.4 Claiming fictions tax credits; 1.2.1.5 Crediting sales against items or income discounts of costs of sales to conceal the amount of sales subject to business taxes on VAT. 1.2.1.6 Deducting against sales or income discounts which were granted subsequently and not in the sales invoice. 1.2.1.7 Deducting returned sales which were not actually returned. 1.2.2 Misclassification of sales or income 1.2.2.1 Classifying sales as exempt when in fact they are taxable, 1.2.2.2 Misclassification of sales of goods subject to VAT as only subject to percentage taxes; 1.2.2.3 Claiming domestic sales as export sales when in fact the goods were sold in the domestic market; and 1.2.2.4 Sales in the local market which are made to appear as sales by the foreign head office. 1.2.3 Claim of fictions tax credits 1.2.3.1 Claiming tax credits on purchases of goods from Non-VAT registered enterprises; and 1.2.3.2 Claiming fictitious tax credits on non-existing invoices. 1.2.4 Non-payment of VAT on materials imported for re-export Materials were applied against originally imported for re-export, but which were used instead on goods sold in the local market. 1.3 Estate Tax 1.3.1 Failure of file estate tax return; 1.3.2. Filing of estate tax returns in different jurisdictions to avoid payment of the higher graduated tax, as in the case where the deceased-owned properties in various places; 1.3.3 Willful under-valuation of the market values of the properties of the estate; 1.3.4 Willful omission of some properties especially those located in places other than the residence of the deceased; and 1.3.5 Claim of fictions items - funeral expenses, claims against the estate, judicial and testamentary expenses. 1.4 Donor's Tax 1.4.1 Failure to file donor's tax return; 1.4.2 Filing of returns within the same year in various jurisdictions to evade the payment of the higher graduated tax; 1.4.3 Willful omission of prior donations made during the same taxable year; 1.4.4 Willful undervaluation of the market value of the property donated, and 1.4.5 Insufficient consideration on sales of property, the difference between the market value from the consideration agreed upon, considered as subject to the donor's tax. 1.5 Excise Taxes 1.5.1 Misclassification of articles subject to excise tax by making it appear that a particular manufactured articles falls within a lower tax classification; 1.5.2 Illegal manufacture of articles subject to excise tax; 1.5.3 Unlawful possession or removal of articles subject to excise tax, and for which no tax has been paid; 1.5.4 Unlawful use of denatured alcohol; 1.5.5 Unlawful possession of cigarette papers in bobbins, etc; and 1.5.6 Shipment or removal of liquor or tobacco products under false names or brands or as an imitation of any existing or otherwise known product name or brand. 1.6 Documentary Stamps Non-affixture of the correct documentary stamps on pertinent document or papers. 1.7 Withholding Taxes Failure to withhold the correct taxes as withholding agent under the pertinent provisions of the Tax Code. 2. Indirect Approach or by Indirect Method This relies upon circumstances evidence of determining the correct income or transaction of a taxpayer. Circumstantial evidence is that which tends to prove the existence of the disputed fact by proof of other facts which have a legitimate tendency to lead the mind to a conclusion that the fact exists which is sought to be established. However, where circumstances evidence is relied upon to prove a fact, the circumstances must be proved by direct evidence and cannot themselves by inferred. The legal bases for an indirect approach in the determination of the correct income or transactions of a anchored on Sections 16 and 37 of NIRC of 1988. Principle Types of Indirect Approach or Indirect Methods Used 1. Net Worth or Inventory Method or Net Worth & Expenditure Method This is a method of reconstructing income based on the theory that if the taxpayer's net worth has increased in a given year in an amount larger than his reported income, he had understand his income for that year. Formula: The mathematical formula for this method may be laid down as follows: a. Increase in net worth, plus b. Non-deductible item, less c. Non-taxable income or receipts subjected to final tax or transfer taxes, equals d. Taxable net income, less e. Personal and additional exemptions, equals f. Net income subject to tax The Commissioner's determination of taxpayer's unreported income through the net worth expenditure method usually involves the following steps: (1) The net worth on a fixed starting date is established (excess of assets over liabilities). This starting date is usually the beginning of the first tax year under examination. The amount of such net worth is considered of vital importance in order to foreclose the possibility than an increase in net worth during the tax year, or an excess of expenditure over reported income, did not originate from prior accumulated funds (i.e. hoarded cash or undisclosed assets which would not represent income during the tax year.) (2) The net worth at the close of each tax year under examination is established; (3) Comparison is made of the net worth at the beginning and end of each year, to determine the increase, if any; (4) The increase in net worth for each year is adjusted to eliminate items accounting for such increases which arise from non-tax sources (i.e., gifts, bequests, other receipts exempt from tax, etc.) and adjustment is made where property is sold at a profit but the entire profit is not taxable because of long-term capital gain provision. The increase in net worth for the year, after these eliminations and adjustments, is presumed to be income realized in that year; (5) The amount of non-deductible expenditures is determined or estimated. These items usually consists of personal, family and living expenses; and (6) The reconstructed income under the net worth expenditure method is the sum of items (4) and (5) and this amount is then compared with the income reported, if any, by the taxpayer. (Id. par. 6059, see also Perez vs. Araneta, L-10507, May 30, 1958, Reyes vs. Col. of Internal Rev., L-11534 and L-11558, Nov. 25, Jamir vs. Col of Int. Rev. L-16552, Mar. 30, 1962; Avelino vs. Col. of Int. Rev. L-17715, July 31, 1963). Circumstance and conditions necessary to warrant the use of the indirect method in establishing a prima facie case of fraud : (1) That the taxpayer's accounting records are inadequate and do not clearly reflects his income; of that the taxpayer maintains no books and records; or that taxpayer's accounting records are available, but he refuses to produce them; (2) That there is a fixed starting point or opening net worth, i.e., a date beginning of a taxable year or prior year to it, at which time the taxpayer's financial conditions can be affirmatively established with some definitives; (Statements of net worth of taxpayers who availed of the tax amnesty under the provisions of Executive Order No. 41, may be used as the starting point as at December 31, pursuant to the authority given to the BIR under section 7 of said Executive Order) (3) That the circumstances are such that the method does reflect the taxpayer's income with reasonable accuracy and certainly, and proper and just addition of personal expenses and other non-deductible expenditures were made and correct; fair and equitable credit adjustments were given by way of eliminating non-taxable items or receipts or taxable income which have been subjected to final tax. (4) The need for evidence of the source of income under this method: "In all the leading cases on this matter, courts are unanimous in holding that when the tax case is civil in nature, direct proof of sources of income is not essential. . . . However, when a taxpayer is criminally prosecuted for tax evasion, the need for evidence of a likely source of income becomes a pre-requisite for a successful prosecution . . ." RMC No. 43-74. This proof of a likely source of income may be shown by any of the following: (1) Demonstrating that there were specific omissions of income items by the taxpayer in his income tax return. (2) A showing that the nature of the taxpayer's business is such that it has capacity of generating a substantial income. (3) Proofs of underdeclaration of income by the existence of unregistered sales invoices, which were not recorded in the books; (4) Findings of unrecorded purchases; (5) Existence of business permits, license from government agencies as to the types of businesses the taxpayer is engaged in; (6) Keeping separate sets of books one registered and the other reflecting the correct transactions of a business. (7) Use of false invoices or documents, and (8) Willful destruction of accounting records. 2. Expenditures Method or Excess Cash Expenditures Method The expenditures method proceeds on the theory that where the amount of money which a taxpayer spends during a given year exceeds his reported income, and the source of such money is otherwise unexplained, it may be inferred that such expenditures represent unreported income. The discussion on when and how the net worth method should be used are equally applicable to the expenditures method. In a case where the taxpayer has several assets (and liabilities) whose cost bases remain the same throughout the period under investigation, the expenditure method may be preferred over the net worth method because a more laconic presentation can be made of the computation of taxable income. This is because assets and liabilities which do not change during the period under investigation may be omitted from the expenditures statement. The expenditures method is used often on a taxpayer who spends his income on lavish living and has little, if any, net worth. Formula: The expenditure method of determining income should be applied by deducting the aggregate yearly expenditures from the declared yearly income (Col. of Int. Rev. vs. Jamir, 4 SCRA 7;8 March 30, 1962). Under this formula enunciated by the court in the above-cited case, the particular in the use of this method are shown below: A. Expenditure for a given taxable year: (1) All expenses and deductions claimed per return filed with the BIR (Exclude non-cash items, such as aromatization of goodwill, depreciation of assets, application of deferred expenses from prior period, etc.) P xxx (2) Expenses, personal and non-deductive or deductible for tax purposes, as determined per investigation (Exclude non-cash terms) xxx (3) Payments of debts, payables, accruals, and other liabilities taken up in the ITR and those not taken up, such as personal and other liabilities. xxx (4) Payment of taxes xxx (5) Acquisition of assets per ITR and personal acquisitions such as cars, appliances, even real estate. xxx Total Expenditures per Investigation P xxx B. Sources of Cash: (1) Declared income per Income Tax Return xxx Deduct: Accounts Receivables if taxpayer is on cash basis method of accounting (xxx) Add : Collection from receivables xxx (2) Non-taxable receipts, prizes, royalties, etc. xxx (3) Non-Taxable receipt, such as dividends donations from abroad xxx (4) Receipts subjected to transfer such as donations, inheritance xxx (5) Cash loans, if any xxx (6) Cash at the beginning of the period xxx xxx Excess Cash as determined per Investigation P xxx As in the case of the Net Worth Method, when a tax case is civil in nature, direct proof of sources of income is not essential. However, when a criminal case is filed against the taxpayer, the need for evidence of a likely source of income becomes a prerequisite. 3. Percentage Method Although the use of this method is of little value in criminal cases, it is useful in test-checking or corroborating the results obtained by some other means of proof such as specific items, net worth, and expenditures methods, and for evaluating allegations from information regarding unreported profits or income. The percentage method is a computation whereby determinations are made by the use of percentages or ratios considered typical of the business under investigation. By reference to similar businesses or situations, percentage computations are secured to determine sales, gross profit, or even net profit. Likewise; by the use of some known base and the typical percentage applicable, individual items of income or expenses may be determined. These percentage may be externally derived or they may in some instances be internally derived from the taxpayers accounts for other periods or from an analysis of subsidiary records. Gross profit percentages may be other similar data. Also other years not covered by the investigation or portion of year under investigation may indicate typical percentage applicable to the entire year or year under investigation. It must, however, be emphasized that in comparing transactions of similarly situated business, the name of the particular taxpayer used as the model must not be divulged to the taxpayer under investigation nor in the report as this would constitute as a violation by an internal revenue officer of the provision of Section 269, NIRC of 1988, on unlawful divulgence of trade secrets. 4. Unit and Value Method This is not a prime method of proof. The determination or verification of gross receipts may be computed by applying price and profit figures to the known ascertainable quality of business done by the taxpayer. This method is feasible when the investigation can ascertain the number of units handled by the taxpayer and also when he knows the price or profit charged per unit. There may be regulatory body to which the taxpayer units of production or service. Examples are: (a) Records of sugar milled by a sugar central; (b) Records of fish production to the Bureau of Fishery and Aquatic Resources; (c) Records of production by pioneer industries to the Board of Investments; and (d) Records of logs exported to the Forest management Bureau. D. SOURCES OF FRAUD CASES : 1. From routine examination of returns : a. Keeping no records or inadequate records despite substantial transactions reflected in the returns; b. Standard of living of the taxpayer, such as the possession of expensive cars and jewelries; or staying in a luxurious mansion, and, ownership of properties whose values far exceed his probable sources of income as declared per return; c. Records verified, were not property declared for tax purposes. d. False vouches and receipts which were verified in the course of the routine examination. 2. From Information furnished by : a. An informant who has knowledge of the transactions of the taxpayer which were not properly declared for tax purposes; b. Referrals from other government offices or from other investigating units of the BIR. 3. Thru initiative of the investigating officers : a. From newspaper reports; b. Thru research of available government records such as from offices of the Register of Deeds, Bureau of Highways, and other government offices; and c. In relation to an investigation of another taxpayer, where suspects that certain transactions were not declared for tax purposes. E. INDICATIONS OF FRAUD 1. Maintaining two sets of books and records; 2. Concealment of Assets; 3. Destruction of books and records; 4. Large or frequent currency transactions; 5. Payments to fictions companies or persons; 6. False or altered entries and documents; 7. Overdeclaration of purchases or under declaration of sales; 8. Use of false names or nominees; 9. Large company loans to employees or other persons; 10. Payee names on checks left blank and inserted at a later date; 11. Excessive billing accounts; 12. Excessive spoilage or defects; 13. Double payment on billing; 14. An individual negotiating checks made payable to corporation; 15. Second or third party endorsement on corporate checks; 16. Excessive use of exchange checks or clearing accounts; 17. Personal expenses paid with corporate fund; 18. An understatement of income attributable to specific transactions and denial by the taxpayer of the receipt of the income or inability to provide a satisfactory explanation for its omission; 19. Substantial unexplained increases in network over a period of years; 20. Failure to file a return, especially for a period of several years although substantial amounts of income were received; 21. Concealment of bank accounts, brokerage accounts, and other property; 22. Inadequate explanation for dealing in large sums of currency, or the unexplained expenditure of currency, (especially when in a business not calling for large amounts of cash); 23. Failure to deposit receipt to business account contrary to normal practices; 24. Claiming fictions or improper deductions; 25. Substantial amount of personal expenditure deducted as business expenses; 26. False entries or alternation made on the books and records, backdated or postdated documents, false entries or invoices or statement, or other false documents; 27. Failure to keep records, especially if put on notices by the BIR as a result of prior examination, concealment of records or refusal to make certain records available. 28. Distribution of profits to fictions partners; 29. False statements, especially if made under oath about a material fact involved in the investigation; 30. Attempt to hinder the investigation. Failure to answer pertinent questions or repeated cancellations of appointments. Avoiding the investigator; 31. The taxpayers knowledge of taxes and business practices where numerous questionable items appear on the returns; 32. Destruction of books and records, especially after the investigation was started; 33. Transfer of assets for purposes of concealment; 34. Involvement in illegal activity (illegal income); 35. Failure to disclose all relevant facts; 36. Unsubstantiated or unexplained wealth; 37. Mental handling of ones affair to avoid keeping records usual in transactions of the sale kind; 38. Keeping no records or inadequate despite substantial transactions in the return; and 39. Any conduct, the likely effect would be mislead or to conceal material facts. The items listed are the indications of fraud most commonly committed but are not all inclusive. F. PROCESSING OF A TAX FRAUD CASE 1. Preliminary Investigation The purpose of preliminary investigation is to establish the existence of a prima facie indications of fraud. To gather evidence therefor the courses of action that may be conducted pursuant to the pertinent Tax Code provision, are but not limited to the following: a. Sec. 7 Access to records to private persons or entities, and government offices and agencies; and b. Sec. 15 Arrest persons and seize documents and instruments, if the violations of the Tax Code are done within the view of a revenue officer. c. Sec. 16 C Conduct inventory taking or surveillance. d. Sec. 171 Conduct a search for excise taxable articles. 2. Preparation of a preliminary investigation report with a recommendation of the issuance of a Letter of Authority : The examiner or revenue official who discovers a potential tax fraud case must submit a memorandum report to his immediate superior stating the facts and circumstances which constitute the indication of fraud, and the evidence at hand to be verified and confirmed. The issuances and approvals of Letters of Authority for fraud cases shall be in accordance with existing rules and regulations on such issuances. The issuance of Letters of Authority, in the case of the Tax Fraud Division, may be dispensed with when so warranted by the circumstance of the case, provided that the taxpayer shall be noticed by the Commissioner of Internal Revenue that his internal revenue tax liabilities are under investigation or that the report thereon has been submitted. 3. Formal Fraud Investigation : (a) Whenever there appears to be a need for a formal tax fraud investigation of a particular taxpayer, a work plan must be prepared in accordance with the following guidelines: (1) Review all available information; (2) Determine the objectives of the investigation; (a) Development of criminal tax case; (b) Deciding the particular provision of the NIRC allegedly violated and asking by whom, when, where, and by what means. Were Revenue Regulations, Revenue Memorandum Circulars or BIR Rulings and Issuances also violated or involved; (c) Understanding clearly the elements of the offense. (3) If it is an investigation referred by an informant, recontact and obtain detailed information about the origin of the case, who has been talked to, what was said, available records, etc. Re-interview the person who initially provided the information or made a the allegation. (4) Determine the following: (a) Information that is needed; (b) Relative importance of the desired information; (c) Best sources of information; and (d) Best sequences for making the necessary inquiries. (5) Gather background information: (a) Obtain as much information as possible on the suspect; (b) Obtain tax return Revenue District Offices concerned; (c) Obtain pertinent records such as General Information Sheet Articles of Incorporations, Constitution and By-Laws, Financial other information from Bureau of Domestic Trade, Department of Trade and industry and other government agencies. (6) In conclusion, decide if an examination of the taxpayer's books of accounts is warranted and the best method of proof. G. PREPARATION AND ASSEMBLY OF REPORTS FOR FRAUD CASES (1) Planning the report : Before starting to write a report, the should have in mind a definite outline of the arrangement in which the facts and evidence may be presented in the most effective manner. A good general plan is to state the problem, present the results of the investigation, and set forth the conclusion and recommendations. (2) Assembly of a report : A report should be assembled in the following manner: (a) Table of Contents The table of contents should indicate the subject matter, and page number in the docket, to provide quick reference to important features of the case. (b) Body of the Report The format of the report must more or less contain the following information and presentation whenever it is necessary: b-1 Name and Address of Taxpayer b-2 Tax periods involved in the investigation b-3 Returns filed and statute of limitations b-4 Type of violation - indicate the pertinent provisions of the Tax Code violated. b-5 Origin of the case b-6 Name and Titles of cooperating BIR officers; b-7 Letter of Authority number, date issued, issuing of officer b-8 Date of taxpayer was first contracted by the examiners b-9 Representatives of the taxpayer b-10 Brief description of the method used in the evasion or other violation. b-11 Related cases b-12 Summary of facts determined during the investigation Explanations on the evidence in support of the tax deficiency Explanations on the evidence in support of the criminal aspect b-13 Explanation and defense of taxpayer b-14 Conclusion and recommendations The body of the report should contain a reference to the appendices or worksheets and schedules, the appendices should contain a reference to exhibits which consist of supporting documents. For example: "Appendix A is a summary of the unreported receipts from sales, and Exhibits 8 to 25 are copies of documents in support thereof" Important matters in the exhibits generally should be explained in the report. However, if a document is of the nature that it is adequately described in an appendix no further explanation is necessary. When mentioning or referring to a document that is submitted as an exhibit, including the written statement of a witness, insert the exhibit number in parenthesis immediately following the reference. The examiner, before beginning his report, should arrange the proposed appendices and exhibits in the order of his planned presentation of facts and evidence, and then he prepares his report discussing the appendices and exhibits in that order. When the report is completed, the exhibits should be assembled in the order in which they are originally mentioned in the report, and they should be numbered for easy reference. (c) List of Witnesses and Exhibits The list of witnesses is an essential part of a report in a criminal case. The witness may be listed in alphabetical order, or in the order in which they are mentioned in the report, or in the probable order of their appearance in the trial. Give each witness a number. Give each piece of evidence and the witness proposed testimony a separate exhibit number. (For example, please see Annex "A-2") (d) Appendices, Worksheets and Schedules Appendices, worksheets and schedules should be arranged in the order of presentation facts and evidence of the case. And they should be numbered for easy reference. (For sample, please see Annex "A-3") ANNEX A-1 PRO-FORMA STATEMENT OF ASSETS, LIABILITIES AND NETWORTH (Revised to conform to recent laws) PARTICULARS Dec. 31, 1993 Dec. 31, 1994 ASSETS (Net of Depreciation) 1. Cash on Hand ** P x x x x P x x x x 2. Cash in Banks x x x x x x x x 3. Accounts, Notes & Loans Receivable x x x x x x x x 4. Mortgage Receivable x x x x x x x x 5. Investments x x x x x x x x 6. Real Property Land x x x x x x x x 7. Real Property Improvements x x x x x x x x 8. Motor Vehicles x x x x x x x x 9. Inventory at the end x x x x x x x x 10. Furniture/Fixtures x x x x x x x x 11. Personal Properties x x x x x x x x 12. Other Assets x x x x x x x x Total Assets P x x x x P x x x x LIABILITIES 1. Accounts, Notes & Loans Payable P x x x x P x x x x 2. Mortgage, Payable x x x x x x x x 3. Other Liabilities x x x x x x x x Total Liabilities P x x x x P x x x x Net Worth at the End P x x x x P x x x x ====== ======= Less: Net Worth at the Beginning x x x x Increase (Deceased) in Net Worth P x x x x ** Supported by accompanying Cash Analysis Schedule Add: Non-deductible Items 1. Personal, living and family expenses P x x x x 2. Insurance premiums x x x x 3. Income tax payments x x x x 4. Gifts to others x x x x 5. Non-deductible expenses, taxes and contributions not directly connected with business of taxpayer x x x x 6. Net capital loss x x x x 7. Amnesty tax payments x x x x 8. Estate and Donor's taxes x x x x 9. Final tax payments x x x x 10. Other expenses which are non-deductible x x x x Total Non-deductible Items P x x x x Net Income before further adjustments P x x x x Less: Non-taxable items and income and proceeds subjected to final tax: 1. Gifts, donations & Inheritance received P x x x x 2. Non-taxable capital gains x x x x 3. Backpay/Pensions non-taxable x x x x 4. Proceeds of Life Insurance Policy x x x x 5. Non-taxable stock dividends (provided stocks are reflected in Assets) x x x x 6. Pensions received under RA 4917 (private firms) x x x x 7. Retirement pay from GSIS and SSS x x x x 8. Non-recognized gains from exchanges of property under Sec. 34(c)(2) of the Tax code of 1988 x x x x 9. GSIS Cash Dividends x x x x 10. Social Security benefits received from foreign government and institution (per PD 220) x x x x 11. Other non-taxable items (such as those excluded under Sec. 28(b) of NIRCof 1988, those subjected to final tax such as foreign earnings by a non-resident Filipino, royalties, prizes, yields on deposits, dividends, share in profits of taxable partnership, etc., per Sec. 21(b), Sec. 21(c), Sec. 22(2) of NIRCof 1988.) x x x x 12. Other exempt income x x x x 13. Proceeds of sale of Real Estate subjected to final tax under Sec. 21(e) of the TaxCode of 1988 x x x x Total Non-taxable items P x x x x Adjusted Net Income as per Investigation P x x x x Less: Statutory exemptions: Personal & additional exemption x x x x NET INCOME SUBJECT TO TAX x x x x Income tax due thereon x x x x Less: Amount previously paid x x x x Deficiency income tax still due P x x x x Add: 50% surcharges, if fraud can be proven x x x x 5% surcharges for late payment x x x x Total amount due, exclusive of interest P x x x x ======= CASH ANALYSIS (Revised to conform with provisions of recent laws) - 1994 - Source of Funds Cash on hand and in bank at the beginning P xxxx Add: 1. Cash received from business (sales) P xxxx 2. Collection of receivables xxxx 3. Proceeds of loans and mortgages xxxx 4. Proceeds of life insurance policies xxxx 5. Proceeds from sale of property, real or personal xxxx 6. Cash gifts, bequests and inheritance received xxxx 7. Non-fund deductions (depreciation and provision for bad debts) xxxx 8. Backpay, pensions, benefits, gratuities received xxxx 9. Cash dividends & interest income xxxx 10. Wagering gains xxxx 11. Receipt of cash from any other source xxxx xxxx Total Available Funds for the Year P xxxx Less: Application of Funds *1. Cash purchases & business expenses xxxx 2. Cash paid for assets/property, real or personal (full payment of installment) xxxx 3. Payments of loans, notes & mortgage payable xxxx 4. Section 30(c)(1)(A to D) (non-deductible items) xxxx 5. Section 31(a) cash disbursement: a. Personal, living or family expenses xxxx b. Capital expenditures xxxx c. Premiums paid on life insurance xxxx 6. Cash disbursement of any kind xxxx 7. Cash on hand and in bank at the end xxxx xxxx CASH ON HAND AT THE END AS RECONSTRUCTED P xxxx ====== *7 Source: This item should be included as a contra account to Item No. 1 of Application of Funds if it includes non-cash deductions such as depreciation, bad debts, applications of deferred items. Thus, if item 1 of Application of Founds does not reflect non-cash deductions, there is no necessity to include Item 7 to Sources of Funds. ANNEX A-2 SAMPLE LIST OF WITNESSES and EXHIBIT SING and FURR, INC. No. 24 Changi Street, Manila EXHIBIT REF. W1 Atty. ROBY CAPULON 1 PP. 66-72 1990 ITR and Bureau of Internal Attachments Revenue District Officer RDO No. XX, 2 PP. 73-80 1991 ITR and Manila Attachments Tel. No. 315-62-22 W2 Atty. CARLS MIRANDA JR. 1 PP. 81-83 Memorandum of Bureau of Internal Revenue Interview Intelligence Officer with Joel Special Investigation Div. Cruz, Revenue Region X, Manila accountant of Tel. No. 61-24-08 SING and FURR INC. dated July 12, 1994 2 P. 84 APPENDIX A Computation of unreported Gross Receipt 1990, 1991 3 P. 85 APPENDIX B Computation Adjusted Taxable Income 1990, 1991 4 P. 86 APPENDIX C Computation of Deficiency Taxes 1990, 1991 W3 ANJIE FARUMOG 1 P. 12 Affidavit dated Manager FLORR, INC. August 4, 1994 125 ABC St. QC 2 P. 13 Confirmation letter Tel. No. 40-15-24 dated June 6, 1994 W4 RUSSEL ROMULO 1 P. 14 Worksheet-Summary Owner, DELL, INC of Payments made on 80 XYZ St. Cubao Services rendered by Tel. No. 62-12-43 SING and FURR, INC. 2 PP. 15-20 Cancelled checks Payable to SING and FURR, INC. 3 P. 21 Memorandum of Interview dated September 10, 1994 W5 EMILLE FRENILLE 1 P. 22 Worksheet-Summary Comptroller, of Gross Payments CONTEMPLATE CORP. made to SING and 17 Sta. Cruz, San Pablo, FURR, INC. Laguna, Tel. No. 143-62 2 P.23-30 Certified Copies of Invoices of SING and FURR, INC. 3 PP. 31-36 Cancelled Checks Payable to SING and FURR, INC. W6 SANDREX DUTERTE 1 P. 38 Worksheet-Summary Manager, MAGGS ENT. of Payments to 317 Davao St. Manila SING and FURR, Tel. No. 60-45-01 INC. 2 P. 39-46 Certified Copies and FURR, INC. 3 PP. 47-53 Certified Copies of Official receipts of SING and FURR, INC. ANNEX A-3 SAMPLE APPENDIX A COMPUTATION OF UNREPORTED GROSS RECEIPTS 1990, 1991 SING and FURR, INC. ITEM 1990 1991 WITNESS EXHIBIT REFERENCE DESCRIPTION NO. OF EVIDENCE FLORR INC. 160,000.00 190,000.00 ANJIE FARUMOR W3-1 P. 12 Affidavit Manager, FLORR INC. W3-2 P. 13 Confirmation Letter DELL INC. 9000,000 1200,0000 RUSSELL ROMULO W4-1 P.14 Worksheet Owner, DELL INC. W4-2P P. 15-20 Cancelled Checks W4-3 P. 21 Memorandum CONTEMPLATE CORP. 1000,0000 1600,0000 EMILLE FRENILLE W5-1 P. 22 Worksheet Comptroller W5-2P P. 23-30 Invoices CONTEMPLATE CORP. W5-3 PP. 31-36 Cancelled Checks MAGGS ENTER- PRISE 500,0000 75,000.00 SANDREX DUTERTE W6-1 P. 38 Worksheet Manager, MAGGS ENT. W6-2 PP. 39-46 Invoices W6-3P P. 47-53 Official Receipts GROSS RECEIPTS PER INVESTI- GATION 4000,0000 545,000.000 REPORTED GROSS Atty. ROBY CAPU- RECEIPT LON W1-1P P. 66-72 1990 ITR (160,000.00) (1900,0000) Rev. District Off. W1-2P P. 73-80 1991 ITR UNREPORTED RDO No. XX, Manila GROSS RECEIPTS 240,000.00 35,5000.00 TO APPENDIX B SAMPLE APPENDIX B COMPUTATION OF ADJUSTED TAXABLE INCOME 1990 & 1991 SING and FURR, INC. ITEM 1990 1991 WITNESS EXHIBIT REFERENCE DESCRIPTION (Particulars) NO. EVIDENCE REPORTED 960,0000 P117,800.00 Atty. ROBY W1-1,2 PP. 66-80 1990, 1991 TAXABLE CAPULON ITRs INCOME Rev. District Off. RDO No. XX, Mla. ADD: UNRE- PORTED GROSS RE- CEIPTS 240,000.00 355,000.00 Atty. CARLS APPEN- P. 84 Computation of MIRANDA, JR. DIX A Unreported Intelligence Officer Gross Receipts SUB-TOTAL 336,000.00 472,800.00 LESS: ADDI- TIONAL EXPENSES OR DEDUC- TIONS ADJUSTED P336,000.00 P472,800.00 TO APPENDIX C TAXABLE INCOME ======== ======== SAMPLE APPENDIX C COMPUTATION OF DEFICIENCY TAXES 1990, 1991 SING and FURR, INC. ITEM EXHIBIT REFE- (Particulars) 1990 1991 WITNESS NO. RENCE ADJUSTED TAXABLE INCOME 336,000.00 472,000.00 Atty. CARLS MIRANDA, JR. APPEN- P.85 Intelligence Officer DIX B INCOME TAX INC. TAX Due Thereon 117,600.00 165,480.00 Less: TAX Due/ Return 336,00.00 41,230.00 Atty. ROBY CAPULON W1-1,2 PP. 66-80 Rev. District Off. BASIC TAX 84,000.00 124,250.00 RDO No. XX, Mla. ADD: 25% SUR- CHARGE 21,000.00 31,062.50 50% SUR- CHARGE 42,000.00 62,125.00 ========== =========