The audit season is finished. Most corporate taxpayers have already filed their annual income tax returns together with the audited financial statements with the Bureau of Internal Revenue (BIR) and subsequently, these BIR-received financial statements were also submitted to the Securities and Exchange Commission. So everybody deserves to have a break, right?
Maybe a few weeks’ break will do, following a very tiring audit season (but are not all audit seasons tiring?). But then again, while breaking from the rigors of the audit season may be a good thing to balance things up, soon enough the BIR may enter the picture and give its “surprise treat” by serving a letter of authority and proceeds with its tax examination. In confidence, the selected company may say, “Bring it on”, believing that its financial statements are almost full proof. After all these were audited by a reputable accounting firm and hopefully BIR will not have material findings. More often than not and to the company’s dismay, the BIR will issue its findings with huge deficiency tax assessments.
The most common notion, error if I may, of a corporate taxpayer, is the belief that once their financial statements have been audited by its independent external auditors, it is “tax compliant” at the same time. Unfortunately, this is not usually the case. There is a whale of a difference between a financial audit compared to a tax compliance review. These two are conducted from very different perspectives.
The difference between a financial audit and tax compliance review is their respective objectives. A financial audit intends to enable the independent external auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with Philippine Financial Reporting Standards. On the other hand, a tax compliance review aims to evaluate the level of company’s observance and conformity with the Philippine Tax Code provisions and its implementing rules and regulations. More importantly, through a tax compliance review, a taxpayer is able to identify possible tax exposures in case of non-compliance with pertinent tax laws, rules and regulations. Thus, the taxpayer is able to correct mistakes and plan its options even before a BIR audit is conducted.
It is not safe to assume that tax compliance is a logical consequence of an independent financial audit. Moreover, a financial audit considers materiality while tax compliance focuses on accuracy. An auditor will not further examine financial accounts that are deemed immaterial for the company as a whole because the auditor is not responsible for immaterial misstatements and the opinion is on the fair presentation of the financial statements. However, the tax compliance reviewer considers all the accounts, material or immaterial, and evaluates their tax implications.
Now, you may be wondering, if the material amounts have been audited, what would be the reason why the BIR usually finds large deficiency tax assessments? The reason could be that there are different approaches between financial audit procedures and tax compliance review procedures. An independent external auditor uses financial statements assertions in performing audit procedures. These assertions are completeness, existence and occurrence, accuracy, valuation, obligation and rights, and presentation and disclosures (CEAVOP). But the BIR, during tax examination considers other requirements provided in the Philippine Tax Code in addition to financial audit assertions.
One very good example is the issue on deductibility of expenses. For financial audit purposes, once CEAVOP have been established, the expenses are deemed fairly presented. However, for tax compliance purposes, an expense is deductible for tax purposes when it is ordinary, necessary and the amount is reasonable. Substantiation requirements should also be complied with: (1) supported by official receipts and/or invoices; and (2) the official receipts and/or invoices should be issued in the name of the taxpayer claiming the same. Moreover, there must be a closed and completed transaction before an expense can be claimed as allowable expense for tax purposes. Finally, if the expense is subject to withholding tax, then the correct amount of tax should have been withheld and remitted to the BIR.
The above are just some of the differences between the two. Nonetheless, it is clear that financial audit does not cover a majority of the procedures needed by a corporate taxpayer in order to assess and determine whether it is tax compliant. Thus, a corporate taxpayer should not rely on financial audit alone but should endeavor to perform tax compliance review as a “tax health check” to help minimize, if not eliminate the risk of being exposed to material deficiency tax assessments.
(Ryan E. Cabello is a Manager for Tax & Corporate Services of Manabat Sanagustin & Co., CPAs, a Philippine partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative.
The views and opinions expressed herein are those of Ryan E. Cabello and do not necessarily represent the views and opinions of Manabat Sanagustin & Co, CPAs. For comments or inquiries, please email manila@kpmg.com.ph or rcabello@kpmg.com).