How to Survive a BIR Tax Audit?

Facing a tax audit from the Bureau of Internal Revenue (BIR) can be a daunting experience for businesses and tax professionals. The process involves a thorough examination of your financial records to ensure that you have accurately declared your income and paid the appropriate amount of tax.

By having the right information, you can get through a BIR tax audit and show the auditors that your business is compliant with relevant laws and regulations. 

In this article, I'll explain the audit process, the documents to prepare, and how to manage interactions with auditors. 

“The power to tax involves the power to destroy.”  

This famous maxim was first held by the US Supreme Court Chief Justice John Marshall in the United States federal case of McCulloch v. Maryland.  

It means that the power to tax is a right of the State, and its most potent instrument. It includes the power to regulate — such power is so great that it can halt a business’s operations if the latter does not pay its taxes properly. 

However, US Supreme Court Justice Oliver Wendell Holmes Jr. clarified that “The power to tax is not the power to destroy while this court sits.” The above apparent conflicting statements mean that while the State has the right to impose taxes, it cannot nullify the rights of its citizens and taxpayers. 

This principle is enshrined in the 1987 Philippine Constitution, Bill of Rights under Article 3, Section 1 which provides that "No person shall be deprived of life, liberty, or property without due process of law, nor shall any person be denied the equal protection of the laws." 

The State and its instrumentalities, such as the Bureau of Internal Revenue (BIR), must respect the due process, and the taxpayer need not fear any issuance of Letters of Authority, or the so-called LoA. 

The mindset must be that the tax agencies are merely doing their job. If the business is filing and paying its taxes diligently and regularly, then it has nothing to worry about. It merely must present all documents and proof of compliance when requested to do so. 

Building trust with the BIR and its process of assessment and collection 

The current BIR Commissioner, Romeo Lumagui, who first worked in the private sector, acknowledged the necessity for internal cleansing. In a recent news publication, Lumagui stated, "This is why I’m relentless in pursuing the reforms needed here in the BIR. We need institutional changes that even after my term here, it’s still going to be there.” This shows his dedication to enhancing the organization's operations.  

The BIR operates under a comprehensive citizen's charter, which serves as a guide to businesses and taxpayers with clear and accessible information they need to comply with tax obligations. 

In addition, this charter provides a thorough guide to the services offered by the BIR, enabling taxpayers to understand and fulfill their responsibilities within a framework of law-governed processes. 

Guided by the Ease of Doing Business (EODB) Law, the BIR is also aiming at streamlining the processes and improving its policies to make it easier for businesses to comply with tax regulations. 

What to expect when your business is subject to a tax audit? 

Receiving a Letter of Authority (LoA) 

A Letter of Authority (LoA) is a document issued by the Bureau of Internal Revenue (BIR) that authorizes the examination of a company's financial records for a specific period. The LoA contains the period covered by the assessment, the scope of taxes subject to the examination, and the names of the revenue officers and supervisors assigned to conduct the investigation. 

Why do businesses receive a LoA? 

Businesses receive a LoA as part of the BIR’s efforts to ensure compliance with tax regulations. This document signifies that the company’s financial activities for a specified period are under review to ensure compliance with tax laws.  

Take note that the BIR does not issue a LoA for the current taxable year but for previously closed taxable periods. Thus, the company must diligently and accurately keep its financial records to be prepared for such audits. 

Why do BIR tax audits happen? 

The issuance of LoA generally indicates that the BIR has selected the business for a tax audit to verify the accuracy of tax declarations and payments. In addition, this process is crucial for maintaining a fair and transparent tax system since it ensures that all businesses comply with tax regulations. 

What to do when you receive a LoA? 

Upon receipt of the LoA, the right attitude is not to be afraid. Like an instinct, the BIR Revenue Officer will see at first sight if the business is compliant or not.  Display your BIR tax registration and certificates. Prying eyes is the examiner’s first weapon against an erring company.

The LoA must be received by the company’s authorized representative and read it. The document is the source of BIR Revenue Officer’s investigatory powers. Before they conduct an examination, a valid grant of authority is required. This authority is the Letter of Authority as provided in Section 13 of the Tax Code, as amended.  

Such LoA contains the period covered by the assessment, the scope of taxes subject to the examination, and the names of the revenue officers and supervisors assigned to conduct the investigation. The LoA is signed by employees of the BIR representing the current Commissioner of Internal Revenue (CIR).  

In an instance wherein the LoA named different revenue officers and supervisors compared to those who conducted the actual investigation, the Philippine Supreme Court held in the case of Commissioner of Internal Revenue vs McDonald’s Philippines Realty Corp., G. R. No. 242670 on May 10, 2021, that the practice of reassigning or transferring revenue officers originally named in the Letter of Authority (LoA) and substituting or replacing them with new revenue officers to continue the audit or investigation without a separate or amended LoA violates the taxpayer's right to due process in tax audit or investigation. 

Notice of Discrepancy and Discussion of Discrepancy 

After the Revenue Officer conducted the investigation, they shall state in the initial report of their findings of discrepancies and issue a Notice of Discrepancy (Revenue Regulation No. 22-2020), allegedly finding the taxpayer liable for deficiency taxes.  

The notice replaced the previous process of issuance of Notice for Informal Conference (NIC). Based on the report, the taxpayer shall be informed in writing of discrepancies in their internal revenue taxes. A "Discussion of Discrepancy" shall occur within thirty (30) days of receiving the Notice of Discrepancy. 

The taxpayer has the opportunity to explain and submit supporting documents during or after the discussion, provided all documents are submitted within thirty (30) days of the Notice of Discrepancy. 

If after the discussion, the business or individual taxpayer is still found to be liable for deficiency taxes, and they do not pay the tax or do not agree with the findings, the Revenue Officers shall endorse the case for the issuance of the Preliminary Assessment Notice (PAN) which is to be issued within ten (10) days from the conclusion of the Discussion. 

Issuance of PAN and FAN and what must the taxpayer or its Legal Team should do.  

The issuance of PAN and eventually the Formal Letter of Demand (FLD)/Final Assessment Notice (FAN) contains the official demand by the BIR for the taxpayer to pay the deficiency. It is necessary for the taxpayer or their legal team to determine whether the assessment has been issued within the required prescriptive period under Section 203 of the Tax Code which provides, as a general rule, that internal revenue taxes, should be assessed within three years after the last day prescribed by law for the filing or actual date of filing of the return, whichever is later. 

The taxpayers or their legal team must then check the validity of the FLD/FAN. For it to be considered valid, certain prerequisites must be observed.  

First, Section 228 of the Tax Code requires that the taxpayer must be informed in writing of the law and the facts on which the assessment is based. Without such information, the assessment shall be void.  

Second, it should contain a definite tax liability with a definite due date for payment as held by the Supreme Court in the case of Commissioner of Internal Revenue vs. Fitness by Design, Inc., G.R. No. 215957, Nov. 9, 2016.  

Knowing the substantive requirements for the FLD/FAN to be valid is essential and beneficial for business and individual taxpayer. It gives them an opportunity to explain or defend themselves against the assessment before they are finally required to pay deficiency taxes. 

The final aspect is the most rewarding part of availing the service of a reliable accounting service or corporate tax law firm. As a business owner, you can entrust professional accountants with the completeness and accuracy of your financial records. Our goal is to present the numbers truthfully, helping you reduce or even eliminate any deficiencies. 

An ethical corporate tax lawyer is a lawyer possessed of integrity. They, therefore, act with independence, propriety, fidelity, competence and diligence, equality and accountability while defending the interest of their private employer.  

However, it’s true on most occasions, that as long as any tax agency considers surcharges, penalties and interests as part of its revenue collection efforts, it will always find something deficient in taxpayer’s filings and payments. This is regardless of seeing higher collection of surcharges, penalties and interests as a primary sign of inefficiency in current tax administration and a source of corruption. Any form of collection contributes to revenue numbers.  

The question is, should we compromise?  

My personal advice is to agree on deficiency taxes if you cannot anymore defend legally and substantively, and to defend confidently those which you find true and correct.  In my experience, the BIR Revenue Officers are also afraid to committing mistakes and their human nature comes too at the end of the day.

They do not want a prolonged and protracted battle in courts and the discussion is a preliminary step to sort and to convince them that you have a chance to win in the end.  

The Bottom Line 

 
Surviving a tax audit requires bravery. Of course, it is okay to be afraid upon receipt of the LoA, especially if it’s your first time. But equipping yourselves with knowledge and professional integrity will give you courage.  

To add, I find great inspiration in a quote from a movie I watched in college, which still resonates with me up to this day: “Have courage, for courage is not the absence of fear, rather the feeling that there is something greater than fear. The brave may not live forever, but the cautious may not live at all.”  

Jose Calsas Jr. is a lawyer and a Certified Public Accountant. He is currently the Chief Financial Officer (CFO) and Head of Legal & Compliance of D&V Philippines, a business process outsourcing company specializing in finance and accounting solutions. Connect with him on Linkedin. 

This article has been written in collaboration with Angelica Garcia, a content specialist at D&V Philippines.