Avoid mistakes in your tax returns

Avoid mistakes in your tax returns

By Marivic C. Espano

‘Tis the season once again for preparing and filing income tax returns for most individuals and corporations. A lot of time will be spent in analyzing revenues and expenses to be reported in the tax return as well as other relevant information. Not a few, in sheer frustration while figuring out and trying to make sense of the numbers before them, may heave a sigh and comment that no matter how correct one’s tax return is, the BIR will still find some basis for an assessment.

There may be some truth in this observation. However, unknown to many, the common assessments on income tax arise from errors committed during the preparation of the tax return – errors that would not have been made had the tax return been carefully prepared and thoroughly reviewed before it was filed. These mistakes do not involve application of complex tax laws or regulations, but they nonetheless give rise to significant assessments.

How can they be avoided? The first step is to be aware of these common mistakes.

1. Using a wrong tax return
This may be very basic, but some taxpayers still fail to get this right. The annual corporate income tax return for domestic and resident foreign corporations is BIR Form 1702 (there is a 2005 version). For self-employed individuals, the appropriate return is BIR Form 1701.

2. Mistakes in filling up the information in the tax return
Some tax preparers fail to write the complete name of the company or write instead its brand or trade name. In other cases, the tax preparer commits a mistake in the taxpayer identification number (TIN), or the taxable year covered by the return being filed. It’s 2007 for this filing season, not 2008.
Because of these mistakes, a taxpayer is most likely to receive a call or letter from BIR asking for an explanation why it failed to file its tax return. This is because a tax return with erroneous taxpayer information is not captured in the BIR system as having been filed for the account of the taxpayer.

A tax preparer must ensure that the information written or typed on the income tax return is consistent with the information indicated in the BIR certificate of registration of the Company. A surcharge equivalent to 25% of the unpaid tax is immediately imposed for non-filing of a tax return within the prescribed date.

3. Mathematical errors
One of the most common mistakes committed involves the declaration of wrong numbers in the tax return. Numbers are interchanged, dropped or totaled incorrectly. Sometimes, the errors involve the application of incorrect mathematical operations, for instance, adding numbers instead of subtracting them. Since the figures in the schedules in the income tax return are transferred to the first page of the income tax return, a simple mistake in the schedule may lead to a totally different amount of income tax liabilities.

Also commonly noted errors are the inconsistencies in the amounts declared on the first page of the income tax return and the numbers shown in the supporting schedules in BIR Form 1702. For instance, the reported amount of revenue in line 15 does not tally with the total amount of sales reported in schedule A-1, or the amount of “Other Deductions” declared in line 20 does not match the total amount of expenses reported in Schedule D.
These errors can easily be spotted by a BIR examiner since they merely involve tracing the numbers required to be reported in more than one part of the tax return, or simply  re-calculating the amounts declared under the different supporting schedules. Hence, it is best for tax preparers to have the entries in the tax return and calculations double-checked.

4. Discrepancies in the information reported in the income tax return and prior year’s return
In preparing the current year’s income tax return, many taxpayers fail to consider declarations made in the previous year’s income tax return or other information submitted to BIR. In doing so, they fail to notice that the information reported in the current tax return is sometimes inconsistent with those in the previous returns they had filed.

Tax return preparers must always be conscious of the fact that some of the information required to be declared in the current income tax return that they are preparing comes from declarations made in the tax return filed for the previous year or years. For instance, the beginning balance of inventory for a trading or manufacturing company for the current tax year, which is required to be reported under the schedule for Cost of Sales, should be the same as the amount for the ending inventory reported in the income tax return filed for the previous year.

Similarly, the net operating loss carry over NOLCO  allowance to be applied for this tax year is the amount of NOLCO recognized in the tax return for the previous 3 years, minus any amount previously utilized. Thus, the amounts shown in Schedule 5B of the income tax return should be consistent with the amounts appearing in the previous tax returns.

Obviously, a cautious tax preparer will refer to previously filed tax returns/reports to ensure that the numbers from last year’s tax return/report being carried over to the current tax return are correct instead of merely relying on the amounts in the taxpayer’s records.

5. Discrepancies in the information reported in the tax return and the taxpayer’s books
Variances in the information declared in the tax return and the books of the taxpayer are the target areas for review during tax examination. A grave mistake committed by some tax preparers is failure to keep records to reconcile the amounts reported in the books and in the income tax return at the time when the latter was being prepared. Without such records, it is likely that the taxpayer will find it difficult to explain during the tax examination the variances that will be noted by the examiners. The burden of explaining these differences falls on the taxpayer; failure to do so will likely be used as a basis for deficiency tax assessment.

It is, thus, advisable for the tax preparer to keep records that will help facilitate tracing in the books the information declared in the income tax return. Usually, the reconciliation arises from the reclassification of certain items of income/expense to properly reflect its nature based on the required presentation in the income tax return. For instance, outside services reported in the books may partly be reported as professional fees and maintenance and repair services. In other cases, adjustments are made to the expenses reported in the books to exclude non-deductible expenses. Both adjustments are valid and acceptable.

6. Overlooking to report income from significant customers / transactions
Some taxpayers do not report their correct income in an effort to bring down their income tax liability. However, such practice has become increasingly risky.

Thanks to the improved database of the BIR, it now has the capability to check through the key customers of a taxpayer the amount that they had paid for their purchases. The BIR can use this information to double-check the correctness of the amount of sales reported by the taxpayer.  Similarly, significant transactions like sales of real property or shares of stock require tax clearances. With this process, relevant information is captured by BIR in its database.

If the taxpayer is dealing with big corporations or had entered into a significant transaction which required certain clearances during the year, it should report the income earned from these sources. Otherwise, the taxpayer will receive a Letter Notice requesting an explanation for the unreported income.

7. Errors in tax credits reported
In the income tax return, specifically from Lines 28A to 28G, the taxpayer is required to provide a breakdown of the tax credits that will be applied against income tax liability. Some tax preparers fill up this section without referring to the pertinent support for these tax credits, and merely base the information from the books or other records that may have been kept by the Company to track these credits. Some had unknowingly claimed input VAT against their income tax liability!

A tax preparer should gather and review the supporting documents for each of the different types of tax credits to ensure that the credits being declared in the income tax return are substantiated. Prior year’s unused CWT should tie up with the unused balance of CWT that were declared in the previous year’s tax return. Likewise, MCIT credits from previous years should be traceable to the income tax returns covering said tax years. Credits arising from income tax payments made during the first three quarters of the year should be cross-checked against the amounts declared in the Quarterly income tax returns (BIR Form 1702Q).

Finally, creditable withholding taxes for the current year should be supported with CWT certificates issued by the taxpayer’s customers, while foreign tax credits should be based on foreign income tax returns or other similar documents. Without these documents, the tax preparer is shooting from the hip with the amounts being declared as tax credits in the tax return.

8. Filing the tax return or paying the tax in the wrong BIR office
While there is only one tax agency, paying tax in a BIR district office different from the one where the taxpayer is registered is a costly mistake, and one that will automatically result in a surcharge equivalent to 25% of the tax payment due.  The risk of such a mistake being committed is high for manual tax filers compared to those filing thru EFPS.  A tax preparer must thus ensure that correct instructions are given to the person who will actually file the tax return.

9. Missing the deadline
Anyone working as an employee or engaged in a business and reporting his or her income based on the calendar year knows that April 15 is the tax deadline, however, many taxpayers still miss it. Reasons for missing the deadline vary – late preparation of the return, failure to secure the necessary approvals or sign-offs, delay in funding the required tax payment, messenger failing to reach the bank before cut-off time due to traffic (yes, it’s a common excuse!) or sheer obliviousness to the deadline. Failing to file the income tax return within the prescribed period automatically draws a 25% surcharge. The taxpayer will also be imposed interest on the unpaid amount.

The solution is simple – prepare the tax return early. The tax preparer must also consider the internal processes with the organization to secure approvals/sign-offs on the tax return and to fund the required tax payment.
As you can see, the above-listed mistakes do not require rocket-science to get them right. It is, thus, amazing to find that taxpayers commit them over and over again.

The task of preparing the income tax return may either fall on an employee of a Company or an external service provider. In performing this task, it is important that the tax preparer has an adequate understanding of Philippine income tax laws and existing related regulations. However, more importantly, the tax preparer must follow a systematic approach in preparing the tax return, one that considers all the relevant information from the determination of the figures and facts to their declaration in the income tax return.

In conclusion, a thorough review process must likewise be established by the taxpayer. If all of this had been done and a mistake was still committed, the tax preparer may be absolved for his sin. After all, he is only human.

(As published in BusinessWorld, April 14, 2008)