BIR's net worth method and tax fraud

BIR's net worth method and tax fraud by: Olivier D. Aznar

One of the most "trending topics" in the country, as some people may call it, is the ongoing impeachment proceedings against Chief Justice Renato Corona. For people who are inclined to talk about tax matters, the discussions on the issue on Statement of Assets, Liabilities and Net Worth (SALN) as it relates to BIR (Bureau of Internal Revenue) forms would appear to be interesting. And it was in these discussions that you may have probably heard, for the first time or for the nth time, of the term "net worth method." As to how this method, as presented in the Impeachment Court, relates to the proceedings, let us leave its evaluation to our senator-judges.

Nonetheless, what is the "net worth method?" How is it relevant to the taxpayers?

As early as 1974, the BIR issued a circular discussing the concept and theory of the net worth method as an approach of the BIR in its tax assessments against individual taxpayers. The method is actually an extension of the accounting principle: an asset minus liabilities equals net worth of the taxpayer. In a layman’s language, assets could simply mean the taxpayer’s money, dues from debtors, and other properties; while liabilities pertain to his loans and other indebtedness to creditors.

To further explain the net worth method, the taxpayer’s net worth is determined both at the beginning (e.g., January 1) and at the end (e.g., December 31) of the same taxable year. The increase or decrease in net worth is adjusted by adding all non-deductible expenses and subtracting therefrom non-taxable receipts, as determined under the prevailing tax rules. The resultant figure is the BIR’s computed taxable income before allowable personal and additional exemptions for individual taxpayers.

The above computed taxable income will be compared to the taxpayer’s declared income as per BIR forms. If it appears that the declared income is lower than the BIR’s computed amount based on the net worth method, then the taxpayer should explain the difference to the BIR. Any unexplained increase in net worth will be presumed to be derived from taxable sources, and hence, will be assessed for deficiency taxes.

Normally, the net worth method is applied by the BIR against individual taxpayers in tax fraud cases where there is deceit and trickery, with intent to eliminate or reduce tax.

In identifying tax fraud cases, the BIR evaluates relevant circumstances. Some of these could be keeping no records or having inadequate records by the taxpayer on his substantial transactions, possession of expensive cars or mansions and ownership of properties whose values far exceed the taxpayer’s probable sources of income as declared per BIR return, and taxpayer’s issuance of false official receipts. The BIR could also use third party information supplied by an informant or use information based on records of other government agencies and even references from newspaper reports. Thus, there is a seemingly wide range of sources in determining whether there is an indication of tax fraud, to warrant the use of the net worth method.

The current use of the net worth method could also find ground in the 1997 Tax Code, as amended. Under Section 43 thereof, the "taxable income shall be computed upon the basis of the taxpayer’s annual accounting period in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner reflects the income." Further, under Section 6 of the said Tax Code, when there is reason to believe that the return filed by the taxpayers is false, incomplete, or erroneous, the Commissioner shall assess the proper tax on the best evidence obtainable.

Dating back to the 1950s and 1960s, even before th e issuance of the 1974 BIR circular on the net worth method, as earlier mentioned, and even long before the 1997 Tax Code, there were already Supreme Court cases wherein the Supreme Court recognized the BIR’s tax assessment using the net worth method against certain individual taxpayers, based on tax laws then in force. Based on these Supreme Court cases, the method was used against a doctor of medicine, against a rancher, and against an owner and operator of a fleet passenger and freight trucks. Thus, even before SALN for public officials was introduced, the net worth method had already been employed by the BIR against private individuals, wherein the net worth of private individuals was determined using the balance sheet of the businesses they own, among other sources of information.

And, recently, we may have read in the newspapers that there are certain public officials, along with their spouses and relatives, who are being hounded by the BIR using the net worth method for alleged tax fraud cases.

Now, is there a reason to fear?

We have seen the BIR actually adopting the net worth method against individual taxpayers on tax fraud cases. But regardless of whether the taxpayer is an individual or a corporation, on any tax assessment method being employed or to be employed by the BIR, fear should be the least of the reactions, as long as the taxpayer has the following -- sufficient knowledge of the tax rules... adequate records... and clear conscience.