How to avoid a BIR tax audit? April 15 is fast approaching and you need to make your annual income tax complete, filed and paid before that deadline comes. But though you need to hurry to make it before the due date, it’s still better to be prudent in the preparation and computation of your income tax due and payable. You should still be careful so as to avoid mistakes that will lead to a BIR tax deficiency audit. The following are common tips and important things you must consider in computing your income tax and preparing your income tax return, including your financial statements attached to that declaration.
1. Reconcile your gross sales or receipts to what you’ve declared in filing your business taxes (VAT or percentage taxes). If the vatable sales you declare on your income tax is higher than the amount you have declared in your VAT returns, this will be subjected to VAT deficiency. On the other hand, if the vatable sales you declare on your income tax is lower than the amount you have declared in your VAT declarations, this will be subjected to under declaration of your taxable income, and will be subjected to income tax deficiency. Hence, make sure to reconcile your gross sales to the amount you have declared in your VAT or percentage tax returns.
2. Reconcile your purchases and expenses to the purchases you’ve declared in claiming input tax in your VAT returns. If you are a VAT registered taxpayer, you should assure that the purchases you report in your income statement is tallied to the VAT returns you have filed for the taxable year. This is one of the common mistakes committed by VAT registered taxpayers that leads to BIR tax audit.
3. Consider the limit in claiming your interest expense as a deduction. There are exception and limitation on the amount of interest expense that can be charged from your taxable income. The allowable deduction for interest expense shall be reduced by an amount equal to the 33% of the interest income subjected to final tax. Furthermore, all interest incurred or paid to related parties cannot be claimed as deductions to income
4. Check your deductible representation and entertainment expense. Well, the National Internal Revenue Code (NIRC) sets a limit on your Entertainment, Amusement and Recreation expenses (EAR) that can be deducted from your taxable income. EAR expenses are limited to 0.5% of net sales for sellers of goods or 1% of net revenue for seller/provider of services. For sellers of both goods or properties and services an apportionment formula is used in determining the ceiling on such expenses. So it’s good to not indulge on pleasures in doing business since it’s not all deductible anyway.
5. Deduct only your actually written-off bad debt expense. If you have receivables and you recognize bad debts as your expenses. Don’t forget that you can only claim as allowable deductions to your taxable income the bad debts that are actually ascertained to be worthless and charged off within the taxable year.
6. Do not claim as deductions your personal expenses. Your income tax is charge to your income derived from engaging in trade or business or from practicing your profession. Thus, you are only allowed to claim cost and expenses directly related and connected to those business, trade or practice of profession. Personal expenses are not allowed.
7. Claim only deductions that are supported with official receipts, invoices or other evidences. In other words, do not lie and falsify your declarations. Make sure that all your expenses are supported with records, invoices, official receipts and other sufficient evidences.
8. Reconcile your rent and other expenses to your BIR form 1604-E or Annual Information Return of Creditable Income Taxes Withheld (Expanded). If you are renting for your office or store space and you are claiming rental expenses as deductions in your taxable income, be sure that they are tallied to the expanded withholding taxes you filed with the Bureau of Internal Revenue (BIR).
9. Reconcile your salaries and employee benefits expense to your BIR Form1604-CF or Annual Information Return of Income Taxes Withheld on Compensation. If you have employees and you’re recognizing salaries and wages as expenses, you must reconcile the salaries and wages you claim as deductions to the salaries and wages you have reported in your withholding tax returns.
10. Reconcile your income to the income withheld by your customers. If you have clients or customers, such as the government, top 10,000 corporations and others that withhold part of their income payment to you, you can ask them for certificate of creditable withholding tax (BIR form 2307), which you can claim as creditable against your income tax. You should also make sure that the income stated in the certificate or in the withholding tax returns filed by your customers are also income that you have included in your income tax return.
11. Have reasonable drawings in your owner’s equity. If you are a sole proprietor or a self-employed person who prepares a balance sheet (statement of financial position), be sure that the drawing you have reflected in your equity is your actual drawings. The amount of drawing represents the amount you get outside from your business for use in your personal expenses. If you don’t have drawings or you only have small amount of drawings in your balance sheet, then where are you getting the money you use for personal spending? This is a question commonly raised by the BIR.
12. Check your unrestricted retained earnings. This is for corporations. If your corporation’s unrestricted retained earnings exceed paid up capital, then this will give rise to an improperly accumulated earnings tax. To prevent this, the corporate stockholders and board of directors can declare dividends or appropriate part of the unrestricted retained earnings for restricted use to reduce it. For future prevention, you should always monitor and ensure that your unrestricted retained earning don’t exceed your paid up capital in the stockholders’ equity section of your corporate balance sheet or statement of financial position.
There may be other ways to prevent a BIR tax audit. The above only lists the usual things you must consider in doing your income tax computation and preparation. Furthermore, the above list doesn’t guarantee that you will become untouchable by the BIR, since the bureau may become aggressive in their campaign to catch tax evaders. If you will report a net loss, it may raise doubt for an investigation or examination. The best thing you can do is to do a tax planning and make sure to have truthful declarations supported with sufficient evidences. This is so that when you receive a Letter of Authority (LA) that empowers a Revenue Officer to examine your books and accounting records, you are fully prepared to show that you are free from any tax delinquencies and deficiencies.
Disclaimer: This article is published for informational use only and doesn’t warrant professional advice. New laws, issuances and rulings may change, amend and render part or whole of the article obsolete or incorrect. For more information, you may visit the BIR website or inquire personally with the Revenue Officer in your district.