Ramo 1-2000

March 17, 2000
REVENUE AUDIT MEMORANDUM ORDER NO. 01-00
SUBJECT : Updated Handbook on Audit Procedures and Techniques

Volume I (Revision Year 2000)
TO : All Internal Revenue Officers and Others Concerned
I. Objective
This Order prescribes the use of the Updated Handbook on Audit

Procedures and Techniques (Volume I) in the audit of tax returns. The Handbook
is intended to provide revenue officers with minimum standard procedures and a
uniform guideline for the proper examination and/or investigation of tax liabilities.
This updated version was prepared in order to conform with the provisions of the
Tax Reform Act of 1997".
II. Quality Audit
The purpose of auditing a tax return is to determine the taxpayer's

substantially correct tax liability. A quality audit is the examination of the
taxpayer's books and records in sufficient depth for the purpose of ascertaining the
correctness and validity of entries and the propriety of application of tax laws. To
ensure quality audit of tax returns, revenue officers are enjoined to utilize their
technical skill, training and experience, and follow the minimum audit procedures
prescribed in the Handbook under Annex "A" hereof.
III. Reporting Requirements
Revenue Officers are required to make a report after the audit has been
conducted. All reports should contain the minimum documentary requirements
specified under Chapter XVII of the Handbook.
IV. Repealing Clause
This Order supersedes Revenue Audit Memorandum Order No. 2-95,
Copyright 2015 CD Technologies Asia, Inc. and Accesslaw, Inc. Philippine Taxation Encyclopedia 2014 1
all revenue issuances and portions thereof inconsistent herewith.
V. Effectivity
All revenue officers and other employees concerned are hereby directed to
refer to the aforesaid Handbook in the audit/investigation of tax returns
immediately after the approval of this Order. CTSHDI
(SGD.) DAKILA B. FONACIER

Commissioner
Bureau of Internal Revenue
HANDBOOK ON AUDIT PROCEDURES AND TECHNIQUES
VOLUME I
(Revision - Year 2000)
PREFACE
The enactment of the National Internal Revenue Code of 1997 and its
implementation effective January 1, 1998 marked significant changes in Philippine
taxation and the BIR's tax administration policies. Hence, it is necessary to revise and
update the existing revenue issuances and assessment manuals in accordance with the
new provisions of the Tax Code.
In order to utilize audit as an effective tool in the enhancement of voluntary

compliance, the first volume of the Handbook on Audit Procedures and Techniques has
been revised and updated to conform with the new Tax Code. This volume discusses
general procedures and techniques designed to assist the Revenue Officer in the
investigation of tax liabilities of taxpayers. The audit procedures and techniques for the
investigation of Value-Added Tax liabilities are prescribed in a separate manual.
ACKNOWLEDGMENT
The updating of this Handbook on Audit Procedures and Techniques Volume I

was completed under the leadership of Commissioner Dakila B. Fonacier and Deputy
Commissioners Romeo S. Panganiban, Estelita C. Aguirre, Sixto S. Esquivias IV and
Lilia C. Guillermo.
This Handbook is a project of the Assessment Service with the Assessment

Programs Division as the lead division which spearheaded the project. Acknowledgment
is also extended to Atty. Arnulfo B. Romero, Mr. Rodolfo Mendoza and Mr. Manny B.
Jimenez for their comments and invaluable contribution to the project.
ASSESSMENT SERVICE
Nars P. Tamayo Acting Assistant Commissioner
Elvira R. Vera Acting Head Revenue Executive Assistant
ASSESSMENT PROGRAMS DIVISION
Leticia C. Batausa Officer-In-Charge
Ione S. Alejo Section Chief
Elenita V. Balonzo Section Chief
Cristina T. Billones Section Chief
Urania C. Salvacion Section Chief
Gladys M. Aquino Revenue Officer III
Dessie V. Garcia Revenue Officer II
Elmira C. Viray Revenue Officer I
Gean M. Dienzo Computer Operator I
Cristina V. Pangan Computer Operator I
Table of Contents
I. Introduction
Revenue Tax Administration
Purpose
Contents of the Handbook
II. Accounting Methods
Cash Basis
Accrual Basis
Completion of Contract Basis
Percentage of Completion Basis
Installment Basis
Crop Year Basis
III. Bookkeeping Systems
Single Entry System
Double Entry System
IV. Accounting Records
Journal
Ledger
Subsidiary Book
Computerized Accounting System
V. Accounting Period
Calendar Year
Fiscal Year
VI. Financial Statements
Income Statement
Balance Sheet
VII. Purpose and Standards of Audit
General Standards
Standards of Preliminary Planning
Standards of Field Work
Standards of Public Relations
VIII. Preliminary Approach to Examination
Pre-audit Analysis of Tax Returns
Work Planning
Contact with Taxpayer
Preliminary Evaluation of Miscellaneous Records
Initial Examination Techniques
Evaluation of Internal Control
Sampling Techniques
IX. Balance Sheet Approach to Examination
Cash on Hand and in Bank
Notes and Accounts Receivable
Allowance for Bad Debts
Inventories
Advances to Stockholders/Officers
Investments
Depreciable Assets
Allowances for Depreciation, Amortization and Other Valuations
Reserves
Intangible Assets
Prepaid Expenses and Deferred Charges
Other Assets
Exchange, Clearing or Suspense Accounts
Current and Accrued Liabilities including Notes Payable
Fixed Liabilities
Deferred Credits
Loans From Shareholders/Officers/Owners
Capital Accounts
Capital or Owner's Equity
Partners' Capital
Stockholders' Equity
Capital Stock
Retained Earnings
X. Audit of Income and Expenses
Audit of Income Accounts

Sales
Rent Income
Professional Fees
Income From Sale of Asset
Other Income
Audit of Expense Accounts
Purchases
Cost of Goods Sold
Salaries, Wages and Other Employees' Benefits
Fringe Benefits
Rents
Royalties
Interest
Taxes
Repairs
Bad Debts
Losses
Abandonment and Demolition
Casualty/Theft
Net Operating Loss Carry Over
Depreciation
Depletion
Contribution
Transportation and Travel, Representation and Entertainment
Stationery and Office Supplies
Professional Fees
Insurance Fees
Light and Power, Telephone and Telegraph
Miscellaneous Expenses
XI. Audit of Minimum Corporate Income Tax and Improper Accumulation of
Earnings Tax
XII. Auditing Computer-Produced Records

Impact of Computer Records on Audit
Accounting Software Systems
Audit Techniques for Computer-Produced Records
XIII. Indirect Approach
Percentage Method
Net Worth Method
Bank Deposit Method
Cash Expenditure Method
Unit and Value Method
Third Party Information (Access to Records) Method
XIV. Audit Procedures on Other Kinds of Taxes
Withholding Taxes
Capital Gains Tax
Estate Tax
Donor's Tax
XV. General Policies in the Investigation of Tax Fraud Cases
Jurisdiction
Procedures
Civil Fraud
XVI. Closing Conference
XVII. Report Making

Document Locator Form
Table of Contents
Narrative Report
Duly Accomplished Revenue Officer's Audit Report
Working Papers
Attachments to the Docket of the Case
Appendix
Revenue Memorandum Order No. 15-95
General Policies in the Investigation of Tax Fraud Cases
Checklist of Documents to be Submitted by a Taxpayer upon Audit of his Tax
Liabilities as well as of the Mandatory Reporting Requirements to be Prepared by
a Revenue Officer, all of which comprise a complete Tax Docket
I. INTRODUCTION
A Revenue Tax Administration
The function of the Bureau of Internal Revenue is to administer the provisions of

the National Internal Revenue Code. It is the duty of the Bureau to implement the Tax
Code and related laws enacted by Congress in a fair and impartial manner.
The mission of the Bureau is to enforce internal revenue laws with impartiality,
consistency, collect the correct amount of taxes at the least cost to the government and
least inconvenience to the taxpayer and serve the public honestly and efficiently in a
manner that will elicit the highest level of confidence in the Bureau of Internal Revenue.
Investigation supports the mission of the Bureau by enhancing a high degree of

compliance and encouraging the correct reporting of income, transfer, business and other
taxes. This is accomplished by:
1. Measuring the degree of voluntary compliance as reflected on filed returns;
2. Reducing non-compliance by identifying returns and taxpayers that need to be

investigated; and
3. Conducting quality audit of selected tax returns on a timely basis.
The purpose of auditing a tax return is to determine the taxpayer's correct tax
liability. A quality audit is the examination of a taxpayer's books and records in sufficient
depth so as to ascertain the correctness and validity of entries thereon and- the propriety
of application of tax laws. ADaSEH
B. Purpose
The updated Handbook on Audit Procedures and Techniques has been prepared to
equip all Revenue Officers who conduct field examinations with-the necessary
knowledge for the proper examination of tax returns and provide them with confidence in
carrying out the investigation. This Handbook is designed to ensure that. the Revenue
Officer acquires useful auditing skills, progresses from simple audit techniques to more
sophisticated procedures, and advances in examination procedures from a single
proprietorship to a large corporation and from a simple bookkeeping system to a highly
computerized one.
The Revenue Officer's job is to familiarize himself with the business activity
and/or undertaking of the taxpayers assigned to him for audit, to evaluate the various
methods and procedures the taxpayers apply, to be imaginative, observant and inquisitive
in his examination, and above all, to use common sense.
C. Contents of the Handbook
The handbook contains guides, instructions and suggestions in the conduct of

audit for various taxpayers. The discussions begin with the analysis of tax returns and
financial statements, familiarization with accounting methods, bookkeeping systems,
books of accounts and other related records. The audit procedures for balance sheet and
income statement accounts are laid out together with investigation techniques for each
type of tax. This does not preclude, however, the Revenue Officer from carrying out other
audit techniques which are deemed necessary in the circumstances surrounding a
particular case.
The Handbook is neither intended to provide a source of tax law or procedural

doctrine nor a substitute reference material of revenue issuances. Each Revenue Officer is
presumed to have a working knowledge of the Tax Code, the latest amendments thereon,
and an update of existing revenue regulations, revenue rulings, revenue memorandum
orders and other issuances.
The other contents of the handbook include documentary requirements in the

investigation process and proper report making.
II. Accounting Methods
The taxable income of a taxpayer shall be computed in accordance with the

method of accounting he regularly employs in keeping his books. However, if the
taxpayer does not regularly employ a method of accounting which reasonably shows his
correct income, the computation of income shall be made in such manner as in the
opinion of the Commissioner of Internal Revenue or his -duly authorized representative
that clearly reflects such income.
The methods of accounting recognized under the Tax Code are:
A. Cash Basis is a method of accounting whereby all items of gross income

received during the year shall be accounted for such taxable year and that only expenses
actually paid for shall be claimed as deductions during the year. This method of
accounting is generally used by taxpayers who do not keep regular books of accounts.
Under this method, income is realized upon receipt of cash or its equivalent including
those constructively received (such as deposits for the taxpayer's account by customers)
but not including gifts or donations. Users of cash basis accounting are mostly individuals
engaged in business and practice of profession, professional partnerships and professional
service organizations.
B. Accrual Basis is a method of accounting for income in the period it is earned

regardless of whether it has been received or not. In the same manner, expenses are
accounted for in the period they are incurred and not in the period they are paid. Under
this method, net income is being measured by the excess of income earned during the
period over the expenses incurred. Expenses not being claimed as deductions by
taxpayers in the current year when they are incurred cannot be claimed as deduction from
income for the succeeding year. Thus, a taxpayer who is authorized to deduct certain
expenses and other allowable deductions for the current year but failed to do so cannot
deduct the same for the next year. The accrual basis of accounting is being used by
taxpayers whose nature of business uses inventories since this method of accounting will
correctly reflect income by matching purchases and expenses against sales. This method
is being applied by most medium and large corporations. HETDAa
C. Completion of Contract Basis is an accounting method applicable to

contractors in the construction of building, installation of equipment and other fixed
assets, or other construction work covering a period in excess of one year.
Under this method, gross income is to be reported in the taxable year in which the
contract is fully completed and accepted by the contractee if the taxpayer elected it as a
consistent practice to treat such income, provided that such method clearly reflects the net
income. Under this method, all expenditures, are deducted from gross income during the
life of the contract which are properly allocated thereto, taking into consideration any
materials and supplies charged to the work under the contract but remaining on hand at
the time of the completion.
However, pursuant to Republic Act No. 8424 which took effect on January 1,
1998, contractors are no longer allowed to adopt this method of reporting their income
derived in whole or in part from long-term contracts.
D. Percentage of Completion Basis is a method applicable in the case of a

building, installation or construction contract covering a period in excess of one year
whereby gross income derived from such contract may be reported upon the basis of
percentage of completion. In determining the percentage of completion of a contract,
generally one of the following methods is used:
1. The costs incurred under the contract as of the end of the tax year are compared
with the estimated total contract costs; or
2. The work performed on the contract as of the end of the tax year is compared with
the estimated work to be performed.
In such case, the return should be accompanied by a certificate of the architect or

engineer showing the percentage of completion during the taxable year of the entire work
performed under contract. There should be deducted from such gross income all
expenditures made during the taxable year on account of the contract, account being taken
of the materials and supplies on hand at the beginning and end of the taxable period for
use in connection with the work under the contract but not yet so applied.
Beginning January 1, 1998 income from log-term contracts are required to be

reported using this method only.
E. Installment Basis is a method considered appropriate when collections
extend over relatively long periods of time and there is a strong possibility that full
collection will not be made. As customers make installment payments, the seller
recognizes the gross profit on sale in proportion to the cash collected.
F. Crop Year Basis is a method applicable only to farmers engaged in the

production of crops which take more than a year from the time of planting to the process
of gathering and disposal. Expenses paid or incurred are deductible in the year the gross
income from the sale of the crops are realized.
In relation to the foregoing accounting methods, the Tax Code provides for a tax
credit system in computing the tax payable by certain taxpayers. While the tax credit
system is not an accounting system, it is discussed here for the proper understanding of
the computation of taxes due from taxpayers.
The tax credit system is a method used to account for the creditable taxes
deducted by the withholding agents from the income payments to certain payees (as in the
case of withholding tax at source pursuant to Revenue Regulations (RR) No. 6-85, as
amended by RR 2-98, or the creditable tax added to the sales price (as in the case of
value-added tax). The creditable taxes should be clearly identified in the books of the
taxpayer, such as:
1. Creditable income tax (asset)
2. VAT input tax (asset)
3. Withholding tax payable-Compensation (liability)
4. Withholding tax payable-Expanded Withholding Tax (EWT) (liability)
5. VAT output tax (liability)
III. Bookkeeping Systems
Bookkeeping may be classified into two systems, namely, (1) the single entry and
(2) the double entry.
A. Single Entry System of bookkeeping is basically a type of "net worth"

method of arriving at net income. It records only the debit or credit of each transaction, or
an account with the debtor or creditor and a simple record of cash receipts and
disbursements.
Whenever a system of record keeping does not include equal debit and credit to
asset, liability, proprietorship, income and expense accounts, it is referred to AA a "single
entry system". The single entry is often used by comparatively simple ventures such as
small retail or commission merchants, professional firms, estates and trusts. In many
cases, the only record of income and deductions consists of entries on the stubs of their
checkbooks. Some taxpayers maintain an income tax folder in which they place
documents to support their income tax deductions.
A single entry system may be merely a chronological record of transactions posted

in a notebook or journal.
Sometimes, the records consist of a complete set of journals (cash, sales,

purchases and general journal) and general ledger providing important accounts.
The accounting cycle starts with source documents (invoices, bills, paid checks,
loan documents, bank deposit slips, and bank statements) proceeding to the cash receipts
and cash disbursements journal, working paper summary and ending with the tax return.
Reconciliation of the taxpayer's books, working paper summary and records to the
return is a very important audit step. In this way, the Revenue Officer will become
familiar with the taxpayer's accounting system, policies and control procedures. If the
records available are organized, this will lend more credibility to the tax return, but if they
are inadequate, then the Revenue Officer should closely scrutinize the information on the
income tax return. Therefore, when encountered with the lack of formal books and
records, the Revenue Officer must use source documents and other available documents
to establish the taxpayer's financial position which shall be compared with the taxpayer's
standard of living and business activity for validation. HTSAEa
The following formulae for reconstruction of income and expenses may be found
useful:
1. Computation of Sales
Cash Sales (cash book) xx
Add: Sales on account:
Collections from customers (cash book) xx
Less: Accounts receivable (beginning balance) xx
Collections from sales for the period xx
Add: Accounts receivable (ending balance) xx xx

TOTAL SALES xx
==
2. Computation of Purchases
Cash purchases (cash book) xx
Add: Purchases on account:
Payments to creditors (cash book) xx
Less: Accounts payable (beginning balance) xx
Payments for purchases for the period xx
Add: Accounts payable (ending balance) xx xx

TOTAL PURCHASES xx
==
3. Computation of Expenses
Cash payments for allowable expenses (cash book) xx
Add: Prepaid expenses (beginning balance) xx
Accrued expenses (ending balance) xx xx

Total xx
Less: Prepaid expenses (ending balance) xx
Accrued expenses (beginning balance) xx xx

TOTAL EXPENSES xx
==
B. Double Entry System Under this system of bookkeeping, accounting
recognizes the two-fold effect of every recorded event, the debit and the credit or the
object of the event and the equitable interest in that object. Every recorded event affecting
one side must necessarily affect the other side. This can be presented in an equation:
Assets = Liabilities + Capital
This can be analyzed into its component elements which show that there are two
distinct parties that have right in the assets of the business, the creditors and the owners.
The rights of the creditors are the claims of such creditors on the assets of the business
which are referred to as liabilities and the rights of the owners on the business are referred
to as capital.
In the double entry method, any net increase and net decrease in asset has a
corresponding increase and decrease in either liabilities or capital.
Audit of accounting records under this system shall be detailed as presented in the
discussions of audit of real and nominal accounts.
IV. Accounting Records
Taxpayers are required by law and regulations to keep and maintain accounting
records in sufficient detail to enable them to make a proper return of income. The
Commissioner of Internal Revenue is authorized to examine such records or other data
which may be relevant in ascertaining the correctness of the tax returns. The books and
records kept must be sufficient to establish the amount of the gross income and the
deductions, credits and other matters required to be shown in the tax return.
The primary records commonly used by all types of businesses, considering the
different accounting systems and reporting methods of the business are invoices,
vouchers, bills, receipts and other source documents which are also the supporting
documents in the selling and buying of merchandise, services and other assets used in the
business. For companies which require the use of inventories, the primary records include
the detailed inventory list. Other primary records used in financial transactions are the
cancelled checks, duplicate deposit slips, bank statements and notes.
The secondary records, regardless of the accounting method used by the taxpayer,
include permanent books of accounts and working papers which summarize and list the
individual documents including adjustments, when necessary. These records are properly
classified in such a way that the taxpayer will be able to determine the financial status of
his business in a given period of time and the profit and loss for the period.
All records required to be kept by the taxpayers should be preserved by them for
proper administration of any internal revenue law.
Below are the regular accounting records being used by taxpayers:
A. Journal is a book of original entry in which transactions affecting the

business of a taxpayer are recorded consecutively day by day as they occur.
Journal consists of the following:
1. Sales Journal. This is a book whereby sales on account are recorded which
are supported by sales invoices and which are also the documents that will serve as the
basis of recording the transactions in the books of accounts.
Cash sales are usually recorded in the cash book although it may be posted in both
books representing a debit to cash in the cash book and a credit to sales in the sales book.
Every entry in the sales journal represents a debit to a customer's account and a
credit to sales to be posted in the general ledger.
Sales returns and allowances are also recorded in the sales book which represents
a debit to Sales Returns and Allowances and a credit to Accounts Receivable to be posted
in the general ledger. This would mean a decrease in Sales and eventually a decrease in an
asset account.
2. Purchase Journal. This is a book used to record exclusively all transactions

involving the purchase or acquisition of merchandise on account.
The business document that serves as evidence of a purchase transaction is the

purchase invoice.
An entry to record charge purchases is a debit to Purchases and a credit to

Accounts Payable to be posted in the general ledger.
Purchase returns and allowances are also recorded in this book and posted in the
general ledger representing a debit to Accounts Payable and a credit to Purchase Returns
and Allowances which would mean a decrease in the purchases account.
In certain instances where the volume of business is large and under the
Value-Added Tax system, taxpayers maintain subsidiary sales and purchase journals
where details of daily sales and purchases are recorded.
3. Cash Book is a book whereby all transactions involving cash such as cash
receipts or cash disbursements are recorded.
Types of this book are the following:
3.1 Cash receipts book a book whereby all transactions involving cash
receipts of whatever source are recorded. EHSTcC
3.2. Cash disbursements book a book whereby all transactions involving

cash or check disbursements are recorded.
B Ledger is a book of final entry wherein the classified accounts or items of all
transactions entered in the journal are posted. All entries in the journal must be posted to
the ledger and shall be classified accordingly so as to show the assets, liabilities, capital
and the operating accounts. This will be the basis for the preparation of the balance sheet
and the profit and loss statement covering the operation of the business. No entry shall be
made in the ledger unless said entry originates from the journal.
The accounts contained in the general ledger provide the Revenue Officer with
insight of the operations of the business. When pertinent, the chart of accounts and
subsidiary ledgers, if any, should be requested from the taxpayer. If a private ledger is
maintained, it should also be requested.
As the Revenue Officer goes through the ledger, unusual or non-recurring items
should be noted and verified. Most of these items are classified as follows:
1. Unusual in amount The Revenue Officer should be alert for month end
entries with significant amounts which may affect income and expenses.
2. Unusual by Source means the books of accounts from where the entry
to the ledger account originates. Hence, expenses or adjustments to income
which do not ordinarily originate from the cash journals, sales and
purchase books should be investigated. Such adjustments originating from
the general journal or journal vouchers should be thoroughly examined as
to supporting documents and proper authorization.
3. Unusual by nature An entry in a ledger account may be unusual by

nature as well as by the account itself. Accounts with abnormal balances
such as receivable accounts with credit balances may indicate income
which is credited to receivables instead of sales. Unusual accounts such as
suspense, other receivables, due to stockholders, and such other unusual
liability accounts should be analyzed as there may be some income
components lodged in these accounts.
C. Subsidiary Book. In the general ledger, accounts are usually transferred and
grouped into certain accounts to a subsidiary book. This general ledger account is called
control account. Control accounts in the general ledger contain summarized information
that is recorded in detail in a subsidiary book or ledger. It is, therefore, the control account
which contains summarized information and the subsidiary ledger contains the same
information but in detail.
Thus, in order to relieve the general ledger of too many individual accounts,
business concerns having numerous accounts with customers and creditors will transfer
said accounts to separate ledgers one for customers and another for creditors. For
example, the control account for the customer's subsidiary book will be called "Accounts
Receivable", while the control account for the creditor's subsidiary book will be called
"Accounts Payable".
All corporations, companies, partnerships or persons required by law to pay

internal revenue taxes have the option to keep this kind of book depending on the need of
their business, provided that where such books are kept, they shall form part of the
accounting records of the taxpayer and shall be subject to the same rules and regulations
as to their keeping, translation, production and inspection as are applicable to the journal
and the ledger.
D. Computerized Accounting System. This method of accounting is now being

used by most companies. It is a system whereby information are fed into the computer
thus providing uniformity in the processing of transactions.
Types of System under this method are the following:
1. Simple System. Transactions are easily traced in a small computer system

where the primary function performed is the sorting and manipulation of
input data and the printing of output reports. There is no loss of audit trail.
Audit of this type of system requires little training and background in
Information Systems (IS).
An example of this type of system are shipping data that are

encoded and processed throughout the system along with accounts
receivable ledgers. The output is a multicopy sales invoice for each
sale, an updated subsidiary ledger, and a sales journal.
2. Complex System. This is characterized by the batch processing mode, the

existence of one Central Processing Unit (CPU) and the extensive use of
master files on magnetic media in processing. In this type of system,
processing is usually confined to calculations, extensions, summarizations
and the like. There is some loss of audit trail but the same is not
significant. The audit of such system can be done by auditors with limited
specialized training in IS auditing. Because of the extent of a printed audit
trail, the auditors have the option of performing audit tests with or without
the use of the computer based on his experience.
3. Sophisticated System. In this type of system, transactions are initiated

within the computer. There is extensive data processing and consequently,
a substantial loss of audit trail. Most of the output is in machine-readable
form.
Heavily reliance must be placed on internal control in the

audit of said system. Since many of these tests require IS skills
beyond the knowledge of most auditors, IS specialists are usually
called upon by the auditors.
Careful advanced planning is necessary because records

needed in audit and the approach to be used in testing must be made
before data are processed.
V. Accounting Periods
Accounting periods are generally classified into two. They are:
1. Calendar year; and
2. Fiscal year
A. Calendar Year is an accounting period which starts from January 1, and

ends on December 31. This is used by most taxpayers who elect the calendar year as their
accounting period. However, the calendar year shall be the basis of computing the net
income in the following cases:
1. when the taxpayer is an individual;
2. when the taxpayer does not keep books of accounts; and
3. when the taxpayer has no annual accounting period.
B. Fiscal year is an accounting period of twelve months ending on the last

day of any month other than December 31.
Corporations and duly registered general co-partnerships are allowed to use this
type of accounting period.
A taxpayer may have a taxable period of less than twelve (12) months in the
following cases:
1. when a corporation is newly organized and commenced operations on any
day within the year;
2. when a corporation changes its accounting period;
3. when a corporation is dissolved;
4. when the Commissioner of Internal Revenue, by authority, terminates the

taxable period of a taxpayer pursuant to Section 6 (D) of the Tax Code;
and
5. in case of final return of the decedent and such period ends at the time of
his death.
Change in Accounting Period An individual cannot change his accounting

period from the calendar year to the fiscal year. He is only allowed to use the calendar
year.
A corporation and a general co-partnership have the option to choose between the
calendar year and the fiscal year.
The application for a change in accounting period should be filed in writing with
the Commissioner of Internal Revenue, through the Revenue District Office, where the
business is registered, within thirty (30) days prior to the date fixed for filing of the return
on the basis of the original accounting period designating therein the proposed date for
the closing of its new taxable year.
VI. Financial Statements
Financial Statements are reports signifying the end result of the financial
accounting process. These reports are as follows:
A. Income Statement is a report that summarizes the business activities for a

given period and reports the net income or loss resulting from operations and from certain
other activities. It is variously called the earnings statement, the statement of profit and
loss, and the statement of operations. It normally consists of the following sections or
items:
1. Sales reports the total sales to customers and fees received from clients
for the period. All sales transactions should be recorded and invoiced. EaISTD
2. Cost of goods sold refers to cost of goods relating to sales when

merchandise is acquired from outsiders. This is the sum of the beginning
inventory, purchases and all other buying, freight and storage costs relating
to the acquisition of goods and subtracting the ending inventory thereof.
When the goods are manufactured by the seller, the cost of goods
manufactured must first be calculated. This is the sum of the cost of goods
in process at the beginning, the cost of materials put into production, the
cost of labor applied and factory overhead incurred. The total cost as thus
obtained represents the cost of both completed work and uncompleted
work still in production. The ending goods in process inventory, then, must
be subtracted from this total in arriving at the cost of the product
completed and made available for sale.
3. Operating expenses are expenses incurred or utilized in the course of

business or pursuant to the practice of profession. They are generally
reported in two categories:
3.1 Selling expenses; and
3.2 General and administrative expenses
In case of self-employed individual taxpayers, professionals,

non-resident aliens, estates and trusts engaged in trade or business, general
professional partnerships and their individual partners, allowable expenses
are subject to the provisions of Section 34 of the Tax Code. However, in
lieu of the deductions allowed under the aforementioned section of the Tax
Code, an individual subject to tax under Section 24, other than
non-resident aliens, may elect a standard deduction in an amount not
exceeding ten percent (10%) of his gross income.
4. Other Income and Expenses include items identified with financial

management and miscellaneous recurring activities. Other income include
interest and dividend income and income from rentals, royalties and
service fees. Other expenses include interest expense and expenses related
to the miscellaneous income items reported.
B. Balance Sheet is a report that shows the financial position of the business
unit as of a specified moment of time. It is a status report rather than a flow report. It is
variously called statement of financial position, statement of condition, statement of
resources and liabilities and the statement of net worth. The balance sheet is the
fundamental accounting statement in the sense that every accounting transaction can be
analyzed in terms of its effect on the balance sheet. In order to understand the information
a balance sheet conveys and how economic events affect the balance sheet, it is essential
that the reader be absolutely clear as to the meaning of its two sides in the equation:
ASSETS = LIABILITIES +OWNER'S EQUITY
1. Assets are economic benefits obtained or controlled by a particular

entity as a result of past transactions or events. They include those costs
that have not been matched with revenues in the past and are expected to
afford economic utility in the production of revenue in the future. It
includes both monetary assets, such as cash, marketable securities and
receivables and non-monetary assets, those costs recognized as
recoverable; and hence, properly assignable to revenues of future period,
such as inventories, prepaid insurance, equipment and patents.
2. Liabilities measure the claims of creditors against entity resources. The

method for settlement of liabilities varies. Liabilities may call for
settlement by cash payment or settlement through goods to be delivered or
services to be performed.
3. Owner's Equity is the residual interest in the assets of an entity that

remains after deducting its liabilities. It measures the interest of the
ownership group in the total resources of the enterprise. Such equities
originally arise as the result of contributions by the owners and the equities
change with the change in net assets resulting from operations.
VII. Purpose and Standards of Audit
The basic purpose of tax examination is the determination of correct taxable

income as defined by the National Internal Revenue Code and other internal revenue tax
liabilities of the person or entity whose return is being examined.
In conducting the examination, the Revenue Officer's responsibility is two-fold: to

the taxpayer and to the Philippine Government. Minimum standards of examination may
be extended beyond the originally intended scope, or beyond minimum requirements
because of situations or facts not apparent at the outset. The extent of verification to be
done in any single tax examination is a matter of auditing judgment for which no rigid
guide can be established.
The degree of checking or scope of a tax examination may be influenced by an

analysis of the taxpayer's accounting procedures and the results achieved therefrom, for
they measure the credibility of the records and the degree of the existing system of
internal control of the taxpayer.
Standard refers to the criteria by which the quality of performance of auditing

examinations are measured.
A. General Standards
1. An impartial mental attitude must be maintained in all affairs relating to an

examination in order to assure a fair application of tax laws, regulations
and rulings.
2. Professional skill and ingenuity must be exercised in the performance of

the examination and the preparation of the report.
3. Issues should be raised only when, in the Revenue Officer's opinion, they
have real merit and only when they will contribute in the proper
determination of tax liability.
4. The confidential nature of all information pertaining to any assignment

must be strictly observed.
B. Standard of Preliminary Planning
1. Sound judgment should be exercised in selecting from assigned returns

those which are most likely to contain areas of non-compliance and, where
otherwise permissible, survey procedures should be employed to dispose
of those which do not warrant further consideration.
2. Advance planning of work schedules with reasonable accuracy is essential

for the effective use of time.
3. A general work plan should be formulated in each case prior to contacting

the taxpayer which includes the development of issues suggested by the
return and other information. The following steps may be included in the
work plan:
3.1 Prepare a list of items which suggest a need for special

consideration.
3.2 Draw-up a list of questions to be asked from the taxpayer.
3.3 Identify other agencies or offices where the Revenue Officer can
have access to their records if the taxpayer cannot present the
documents requested.
C. Standards of Field Work
1. Audits should normally be performed at the taxpayer's place of business

because of the accessibility of the books and records and to permit actual
observation of taxpayers facilities and scope of operations. Otherwise, it
should be performed in the office of the Bureau of Internal Revenue.
2. The use of accounting skills, tax knowledge and ingenuity should be

directed toward recognizing and raising issues which relate to
non-compliance areas.
3. Adequate evidential matter should be obtained through inspection,

observation, inquiry, analysis and documentation to afford a reasonable
basis for consideration of each issue with regard to the position of both the
government and the taxpayer.
4. The position taken with respect to each issue should be supported by

adequate authority.
D. Standards of Reporting
1. Reports are to be prepared in a complete, clear, concise, and legible

manner in order that they may be easily read and understood.
2. Working papers should be legible, in the Revenue Officer's own

handwriting, properly labeled, indexed, signed and arranged in a logical
and orderly manner. aEIcHA
3. Working papers should be used as a practical and professional tool to aid

the Revenue Officer in the discussion of issues or questions with the
taxpayer or his authorized representative. It also generally provides a
record of the audit procedures undertaken by the Revenue Officer.
E. Standards of Public Relations
1. Initial contact for audit arrangements should be made with the taxpayer
and care should be exercised in explaining the type of records required.
2. Revenue Officers must be fully cognizant of the proper sources for

gathering information and of the rights of the taxpayer and his
representatives.
3. Necessary time and patience should be devoted to a discussion of any

proposed adjustments to ensure that the taxpayer has a proper
understanding of the issues.
4. Tact and discretion are required in pointing out errors in books and records
in order to avoid discrediting an employee or representative of the
taxpayer.
VIII. Preliminary Approach to Examination
A. Pre-Audit Analysis of Tax Return
Analysis of the return is essential to an effective audit. Preliminary analysis is

used to identify potential issues which will be developed further after contacting the
taxpayer. All information contained in any attachment to the tax return should be
thoroughly and completely scrutinized to ascertain whether or not all of the information is
adequately reflected in the tax return. Before contacting the taxpayer, the Revenue Officer
should familiarize himself with the following:
1. The business organization of the taxpayer and whether it has business

establishments other than its main or head office;
2. The location of the business and its branches as this has a relation to the
volume of business;
3. The economic activity in which the taxpayer is engaged in;
4. The accounting books and records that would ordinarily be kept;
5. The accounting methods and policies and the degree of internal control;
6. The overall composition of the tax return;
7. The types of income reported;
8. The reasonableness of deductions;
9. Unusual or unfamiliar items;
10. Apparently questionable or unallowable items;
11. Gross profit and selling expense percentage as well as significant

variations between prior and current years;
12. Inconsistencies between items and also in the treatment with respect to bad
debts, inventory valuation methods, depreciation rates and methods, etc.;
13. Prior years entries in the reconciliation schedules of retained earnings in a

corporate return and of a partner's capital account in a partnership return
which affect the year under examination;
14. The status of the retained earnings account as well as the basis of assets
and depreciation allowed or allowable; and
15. The report of the tax liabilities of the taxpayer for the immediately
preceding period in order to be aware of the deficiencies that were
reported. Review of prior year's examination records will clarify some
doubts or questions in the Revenue Officer's mind regarding certain items
or bring light to situation that otherwise would have remained concealed
on the basis of the return alone.
B. Work Planning
Work properly planned achieves good results.
In order to avoid any situation where the Revenue Officer will be faced with a
situation of a cramped audit workload and schedule, he should prioritize the audit of the
assigned cases in the following manner:
1. Returns or cases where the statute of limitations is about to prescribe
should be given first priority. Prescriptive period is three (3) years counted
from the date prescribed by law for the filing of the return, provided that in
case a return is filed beyond the prescribed period, the three-year period
shall be counted from the day the return; was filed.
2. Claims for refund should be given the next priority in order to develop
good BIR-taxpayer relationship.
3. Cases assigned for reinvestigation should also be given priority attention.
4. Returns which would be more productive in terms of revenues should be

given precedence over the less productive ones.
In work planning, an Audit Program should be prepared for each and every case.
An Audit Program is a checklist of the various auditing procedures to be undertaken and
the various books of accounts, records, documents and business forms to be verified in
order to assess the correct tax due from a taxpayer. This checklist would serve as a guide
for the Revenue Officer to conduct a "quality audit" within the time frame allowed to
conclude a tax audit. It is also a tool of the tax administrators to check on the progress of
the tax audit and for proper evaluation of the performance of the Revenue Officer.
C. Contact With Taxpayer
1. Arranging for an Appointment
A telephone or a personal call by the Revenue Officer should be made to the

taxpayer himself and not his representative.
2. Serving of Letter of Authority
2.1 On the first opportunity of the Revenue Officer to have personal contact
with the taxpayer, he should present the Letter of Authority (LA) together
with a copy of the Taxpayer's Bill of Rights. The LA should be served by
the Revenue Officer assigned to the case and no one else. He should have
the proper identification card and should be in proper attire.
2.2 A Letter of Authority authorizes or empowers a designated Revenue

Officer to examine, verify and scrutinize a taxpayer's books and records in
relation to his internal revenue tax liabilities for a particular period.
2.3 A Letter of Authority must be served or presented to the taxpayer within

30 days from its date of issue; otherwise, it becomes null and void unless
revalidated. The taxpayer has all the right to refuse its service if presented
beyond the 30-day period depending on the policy set by top management.
Revalidation is done by issuing a new Letter of Authority or by just simply
stamping the words "Revalidated on _____________" on the face of the
copy of the Letter of Authority issued. ASICDH
3. Request for Accounting Records
The Revenue Officer should clearly specify the records he desires to be assembled
for his examination. Among the books and records that may be required are:
3.1 receipts (official receipts, warehouse receipts, delivery receipts, etc.)
3.2 invoices (sales and purchases invoices)
3.3 vouchers
3.4 cancelled checks
3.5 bills and statements of accounts (utility bills, payment notices, etc.)
3.6 contracts (sales/purchase contracts, loan contracts)
3.7 journals (regular and subsidiary journals)
3.8 ledgers (regular and subsidiary ledgers)
4. Initial Interview
The initial interview is the most important part of the examination process and
should be conducted in all audits.
Request should be made for a personal interview with the taxpayer himself.
The interrogation should be so conducted as to encourage the taxpayer to

contribute willingly useful information which will assist in the proper determination of
his tax liability. The information developed by this method will determine the eventual
outcome of the case. The preliminary interview should, as far as practicable, cover the
following:
4.1 Discussion of sources of income This may uncover possible sources of

income which have not been reported such as interests on investments and
deposits, dividends, rents, sales of properties as well as information on the
taxpayer's financial history and standard of living;
4.2 Records kept for each source of income;
4.3 Handling and recording of cash transactions;
4.4 Records of loans from banks and/or loans to others
4.5 Real or personal properties bought or sold in current year;
4.6 Correctness of personal and additional exemptions claimed;
4.7 Other items that would be relevant in the examination, to wit;
a. The responsible officers of the firm in order to facilitate acquisition

of information/data:
b. Place and time of audit.
c. Ocular inspection of the factory, branches, outlets, etc.;
d. Officers to whom the tax audit findings will be discussed; and
e. Financial history and standard of living of the owner/owners.
D. Preliminary Evaluation of Miscellaneous Records
The investigation on the taxpayer's books of accounts may begin with

miscellaneous records other than accounting ledgers and journals. More often than not,
scrutiny of these records may reveal items which the Revenue Officer should take into
consideration as the examination progresses. The records and information to be obtained
are the following:
1. Minute Book
The review of the minute book should not be confined to the taxable year under
audit but should cover at least some period immediately before or after. As the Revenue
Officer scans the minute book, he should note appropriate transactions and items of
significance, such as contracts entered into by the taxpayer, stock issuance, dividend
declaration and compensation of officers.
2. Stock Transfer Book
This book contains the names of stockholders, past and present, with the number
of shares cancelled and issued. This book is also vital in computing documentary stamp
tax, liabilities. A general knowledge of the names of large shareholders is also of value
when checking the salary expense. When the stock and transfer book is not available, the
record of dividend payment is an alternative source of similar information.
3. Partnership Agreement
A copy of the partnership agreement should be obtained and certain provisions

affecting partner's salaries, profit and loss sharing, interest on capital, other allowances
and other matters which may have tax consequences should be noted.
4. Audit Report of Independent Auditors
The Revenue Officer should read the auditor's report accompanying the financial
statements. Sometimes, Revenue Officers fail to evaluate the auditor's report. However,
there are cases when auditors do not issue an unqualified opinion. Any qualification or
unusual comments in the auditor's report or certificate such as expression of opinion as to
taxpayer's depreciation policy, inventory and cost valuation, adequacy of reserves, status
of collectibility of receivables and the like should be noted for consideration and should
be related to the examination of accounts.
In cases where the auditor issues two reports, one for management and the other
for attachment to the tax return, the former should be studied and compared with the
latter. Income and net worth in both reports may vary from income and net worth per
books due to the auditor's adjusting entries not reflected in the books. Thus, the adjusting
entries and supporting documents should be examined. If needed, the auditor's working
papers should be looked into to explain these entries.
5. Auditor's Working Papers
Audits, particularly of large companies, may frequently be simplified and

facilitated, if the examining Revenue Officers are given access to the auditor's working
papers. Where necessary, authorization from the taxpayer or requests for access to said
working papers signed by duly authorized officials shall be secured to be able to
scrutinize the working papers of auditors, particularly the year-end adjustments,
intercompany transactions, nature of receivables and other peculiar accounts.
6. Statements and Schedules Filed with Government Regulatory Agencies
Certain taxpayers are required to file financial statements and other reports with
government bodies such as the Securities and Exchange Commission for corporate
taxpayers, the Garments and Textile Export Board for-garments exporters, the Board of
Investments for exporters, and other similar government offices. The Revenue Officer
should compare the statements filed with the Bureau of Internal Revenue against those
filed with other government offices. Any discrepancy should be inquired into and material
differences should undergo an in-depth investigation.
7. Appraisal Reports
Appraisal reports, particularly real estate appraisals, are important in many cases
such as for estate tax valuation of properties, capital gains tax verification, and donor's tax
investigation.
E. Initial Examination Techniques
1. Understanding the Taxpayer's Books and Records
One technique that should be commonly used is for the Revenue Officer to
interview the taxpayer or his representative and ask him to walk him through the book
recording of a sale, purchase and expense transaction in order to have a thorough
understanding of the taxpayer's accounting system and records.
2. Reconciliation of Books and Returns
Another step in understanding the records is to perform a reconciliation of the

books with the return. The following actions are recommended to assist the Revenue
Officer in the reconciliation process:
2.1 Request for a Chart of Accounts and identify account numbers and account
titles.
2.2 Identify unusual accounts. AHaETS
2.3 Scan the general ledger to discover unusual account entries.
2.4 Ask the taxpayer for the ,tax working papers or any other type of working
papers that were used to prepare the return.
If the working-papers are in the hands of the external auditor, the

taxpayer should be advised to secure a copy thereof from their auditor.
If no working papers are available, request the taxpayer to prepare

the reconciliation and supporting schedules used to arrive at the
reconciliation of data as reflected in the books and the tax returns.
2.5 Evaluate the Statement of Changes in Financial Position, if the taxpayer

has one, to identify sales and purchases of fixed assets, investments made
and disposed, loan and debt payments, capital contributions and other
transactions that might not be readily apparent on the balance sheet and
income statement.
3. Performance of Compliance Tests
The Revenue Officer should establish the level of reliance that can be placed on
the books and records and determine whether the books show all the transactions which
occurred.
To accomplish this, a compliance test should be performed on some transactions

through the backward and forward approaches in verification as follows:
3.1 In the backward approach, the figures per tax return are traced to the trial
balance, then to the general ledger, the various journals, and ultimately to
the source documents such as sales invoice or official receipts.
3.2 In the forward approach, the Revenue Officer should select a supporting
document, say a sales invoice, and trace it through the sales journal,
general ledger, trial balance and finally to the tax return.
The backward approach is effective in checking unsupported expenses while the

forward approach is used in uncovering unreported income.
4. Analysis of Adjusting Journal Entries
It is important that the Revenue Officer understands adjusting journal entries

because tax issues are frequently discovered in the adjusting journal entries. These
adjusting journal entries are usually accruals, deferrals, corrections or reclassifications of
accounts.
4.1 Accruals are normally entries to record certain known and fixed amount of
obligations or liabilities. Accruals are also used to book uncertain,.
contingent liabilities. Contingent liabilities are not fixed in amount or date
and are not deductible for tax purposes.
4.2 Deferrals are typically used to defer or postpone recognition of income or

expenses. An inspection of the deferred income account may reflect
amounts representing services already performed. It may also show goods
already shipped and received by the customer. In both of these situations, a
deferral of income is not proper.
4.3 Corrections of prior year's earnings, other adjustments and reclassifications

are made through adjusting journal entries which are recorded in the
general journal or in the journal vouchers. Usually, these entries are taken
from the auditor's working papers. The examining Revenue Officer should
scrutinize these entries, specially those credited directly to retained
earnings, analyze the tax issues involved, and note down possible tax
assessments.
4.4 When scanning adjusting journal entries, the following should also be
looked into closely:
4.4.1 Unusual and non-recurring entries;
4.4.2 Entries reducing assets as there could possibly be unreported gain

on sale, incorrectly computed gain on sale, incorrectly computed
installment sale, non-taxable exchange, or withdrawal of goods by
the owner; and
4.5 Entries increasing liabilities as these could represent fictitious or

contingent liabilities, fictitious expenses, invalid loans to shareholders, or
undeclared income credited to liability accounts.
F. Evaluation of Internal Control
Internal Control is a system of procedures in place to ensure that all business

transactions are properly recorded and assets are adequately safeguarded.
It is mandatory for the Revenue Officer to evaluate internal control for him to
decide up to what extent the system can be relied upon. This will also determine the
nature, extent and timing of audit tests to be applied in the examination and to plan
subsequent audit procedures.
1. Principles of Internal Control
Good internal control assures good record keeping and the inability of the
employees and the owner from misappropriating the assets.
Some broad principles of internal control are:
1.1 Responsibilities should be clearly established.
1.2 Adequate records should be maintained.
1.3 Assets should be insured and employees bonded.
1.4 Record keeping and custody should be separated.
1.5 Responsibility for related transactions should be divided.
1.6 Personnel should be rotated.
1.7 Automation should be used whenever practical.
1.8 Employees should be informed of prescribed procedures.
1.9 The system should be under constant review.
2. Elements of Internal Control
Internal control can be divided into three elements:
2.1 Control Environment
This includes the entity's organizational structure, methods of

assigning authority and responsibility, engagement in related-party
transactions and compliance with various laws, rules, and regulations.
2.2 Accounting System
This consists of the methods and records established to capture
financial transactions such as sales, purchases, investments and payment of
expenses and liabilities. This element is important to the Revenue Officer
for him to understand how transactions are initiated and recorded and to
determine the degree of reliability to be placed in the taxpayers books and
records.
2.3 Control Procedures
These include the adequate use of documents to ensure the proper

recording, valuation and timing of transactions. Reconciliations of
accounts should be done periodically and management should review
reports for accuracy and completeness.
3. Standard Procedures in Evaluating Internal Control
To establish the scope of the audit and degree of compliance tests to be

performed, internal control should first be valuated based on the following techniques:
3.1 Identify the personnel responsible for record keeping and determine their
responsibilities and authority in the business operation.
3.2 Reconcile the returns with the books and records. Difficulty in reconciling
the return with the books and records may be an indication of inadequate
internal control in either financial or tax accounting.
3.3 Interview responsible company personnel and observe business operations.
3.4 Review the chart of accounts and identify unusual accounts or note those
accounts which should be included but not indicated.
3.5 Secure and study copies of operating manuals or instructional booklets that
may lead to an easy understanding of the taxpayer's business operations.
3.6 Determine if the taxpayer's personal transactions are segregated from

business operations or if separate bank accounts are maintained by the
owner and the business.
3.7 Determine if bank accounts are reconciled monthly.
3.8 Determine the books and records maintained and the frequency of
recording transactions.
3.9 Determine if pre-numbered documents are being used.
3.10 Determine the extent of involvement of auditors and other third parties in
the business.
3.11 Determine if certified audits for any reason were conducted. If so, copies
of documents in relation thereto should be secured. HIAESC
3.12 Determine if the income reported by the taxpayer reflects his lifestyle.
The effective evaluation of internal control is dependent upon a

very good interview, observation of the business operation, and testing of
the system.
G. Sampling Techniques
Sampling is a large and important part of the examination of a tax return. It is the
application of examination procedures to less than 100% of the items in an account to
evaluate its accuracy.
1. Two Basic Types of Sampling
1.1 Statistical Sampling
Statistical sampling is the formal mathematical selection and

examination of transactions, amounts or accounts based on the probability
that moderately large number of items taken as samples will produce
results from which conclusions may be made.
1.2 Judgmental Sampling
In selecting accounts and transactions to be tested, judgmental

sampling should be applied as it involves the use of professional judgment
in planning and performing the sampling and analyzing the results.
Judgmental sampling may include any or both of the following

methods:
1.2.1 Block Sampling uses groups of continuous items selected from

an account balance or class of transactions. An example is a
Revenue Officer's decision to sample one month of travel expense
to reach a conclusion for the year.
1.2.2 Peso limitation sampling or cut-off sampling selects a minimum

peso amount and transactions in excess of the said amount are
verified.
2. Factors to be Considered in Planning the Sample
2.1 Internal Control
The extent of sampling to be done is dependent on the degree of
internal control. Thus, a small sample size is required if internal control
can be greatly relied upon.
2.2 Accounting System
Large errors or high frequency of errors in the accounting system

may require a large sample size.
2.3 Materiality
In choosing appropriate material limits, the absolute size of an

item, the relative size and the nature of the business, and industry/business
practice should be considered. Materiality of an item should be related to
its tax consequence.
2.4 Analytical Review
In analytical review, the following considerations should be

studied:
a. Taxpayer's standard of living
b. Interest in closely held companies
c. Transactions between related parties
d. Transaction involving questions of fraud
e. Significant increases or decreases in taxable income from year to

year
f. Significant adjustments on previous Revenue Officer's reports
3. Sampling Techniques to be Applied in Testing Accounts and Transactions
There are many sampling techniques as there are cases. The Revenue Officer is
not precluded from discovering and applying new techniques as may be needed in each
particular case.
Listed below are the suggested sampling techniques in testing income statement
and balance sheet items:
3.1 Select the first and last months of sales to ensure that income was not
deferred to an improper year.
3.2 The last month of the period under examination should be tested because
of the likelihood of errors and unallowable adjustments made before the
end of the year.
3.3 Selection of the largest three months incurrence of an expense account

may reveal expenses that should be capitalized, personal expenses or
padded expenses.
3.4 Scan the cash disbursements journal and general ledger for unusual or very
large entries. This step also familiarizes the Revenue Officer with the
accounts, payees, suppliers and clients of the taxpayer.
3.5 Select at least one month's (or one week for a large corporation) file of
cancelled checks. Thoroughly analyze each check together with the
endorsement at the back. This could lead to the discovery of fictitious;
payees, unusual transactions, personal items charged to expense and other
possible disallowances.
3.6 Inspection of the corporate minutes and the articles of incorporation could
lead to a Revenue Officer's determination to sample a particular account.
3.7 Examine certain accounts in the income statement in relation to the

balance sheet accounts. Thus, Accounts Receivable should be analyzed
together with Sales. Bad Debts Expense should be verified together with
the Allowance for Bad Debts. Likewise, Accounts Payable should be
examined together with Purchases and other related expenses.
3.8 Test-check source documents and related transactions by considering the

persons involved, nature of the contract, mode of payment and other
important aspects.
3.9 Rounded figures should be checked as they may be estimates.
3.10 Utilize results of analytical review in selecting the sample.
3.11 Contract or limit the scope of the sample if the majority of the samples are
completed and there are still no discrepancies.
4. Examining the Sample Items
The sample items, as selected, should be verified as follows:
4.1. Analyze and determine the validity of the source documents.
4.2. Examine collaborating documents.
4.3. Check with third parties.
4.4. Inspect and observe inventory flow, fixed assets acquired, sales
transactions and other transactions which may require ocular inspection.
5. Analyzing the Results
Analyzing- the results of a sample is an important yet commonly missed step. The
sample taken should be evaluated and considered in relation to any peculiar situation,
such as related -party transactions or economically unsound transactions. One example
would be purchases made at unusually high or low prices. If the results of the sampling
indicates potential tax assessment, an in-depth analysis should be conducted as follows:
5.1. Verify the account showing the discrepancy or possible source of tax
deficiency.
5.2. Trace the audit trail involving the transaction.
5.3. Perform a 100% verification of such account.
5.4. Consider performing third-party checks to substantiate transactions.
5.5. Take a close look at how the taxpayer handled the entire transaction.
5.6. Consider the adjustments associated to other accounts.
5.7. Discuss the problems or discrepancies with the taxpayer or his authorized
representative.
6. Concluding the Sampling Results
The audit samples should be clearly documented in the working papers from
which a conclusion shall be drawn. If a quality sample analysis has been performed, it
will be easy to form a conclusion from the sample results. The conclusion reached should
be clear, concise and final.
IX. Balance Sheet Approach To Examination
A series of suggestions on the procedures for commencing the examination of tax

returns and appropriate accounting records have already been presented. The initial phase
includes a verification of the net income per books with the reconciling items reflected in
the tax return.
After the foregoing process, the Revenue Officer should turn his attention
primarily to the books and records bearing in mind that there are some reconciling items
which affect the net income per books.
The following discussion offer guides and techniques in examining asset, liability
and net worth accounts. The Revenue Officer, however, is not precluded from applying
other techniques which are deemed necessary in a particular case.
A. Cash on Hand and in Bank
1. Compare deposits shown in the bank statement against entries in the cash
receipts book and official receipts. .Note down any unrecorded or
unreceipted deposit and investigate the source.
2. Test check cash sales with the cash receipts book if they have been
correctly recorded. Also check cash sales made at the beginning and end of
the period under examination to determine if year-end sales have been
recorded in the proper accounting period.
3. Investigate entries in the general ledger cash account. Look for unusual
items which do not originate from cash receipts or disbursements journals.
These entries may indicate unauthorized withdrawals or expenditures,
sales of capital assets, omitted sales, undisclosed bank accounts, etc. AcICTS
4. Review cash receipts journal for items not identified with ordinary
business sales, being alert to such items as sale of assets, miscellaneous
income, sale of scrap, income received in advance, proceeds from issuance
of capital stock and other taxable transactions.
5. Review cash on hand and cash in bank accounts to determine if there are
any credit balances during the period under examination. This may indicate
unrecorded receipts.
6. Review cash disbursements journal for a representative period. Note any

missing check numbers, checks payable to cash, large or unusual items and
determine propriety thereof through a comparison with vouchers, journal
entries and other related accounting records.
7. If the taxpayer is on cash basis, ascertain if checks were written and

recorded at the close of the period under audit but were issued thereafter.
Verify checks issued during the latter part of the year to check the
authenticity of expenses claimed.
8. Give special consideration to checks issued for cashier's checks, sight

drafts and other similar bank instruments where the payees and nature of
the disbursements are clearly shown.
9. Obtain bank statements and cancelled checks for each bank account for
one or more months, including the last month of the period under
examination.
10. Note year-end bank overdrafts. This may indicate expenses which are
fictitious or unallowable since funds were not available for payment.
11. Determine if there are checks which have remained outstanding for an
unreasonable period of time. This may indicate improper, fictitious or
duplication of disbursements. Old outstanding checks could possibly be
restored to income.
12. Determine whether voided checks have been properly adjusted in the
books and credited to the appropriate expense accounts, if applicable.
13. For a test period, check endorsements to verify if they are the same as that
of the payees', noting any endorsements by the owner, or any questionable
endorsement.
14. If records appear unreliable or have not been subjected to a competent

independent audit, tests of footings and postings should be made for a
representative period.
15. Test check disbursements from petty cash to determine if there are any
unallowable items included.
16. Scrutinize cash overages and shortages, being alert to occurrence of

irregularities.
17. Tally debits and credits to the cash accounts per month against sales credit,
debts to purchases and expense accounts and other sources and application
of cash based on the worksheet of real and nominal accounts submitted by
the taxpayer. Note down discrepancies and substantial accumulation of
cash without reasonable credits.
B. Notes and Accounts Receivable
1. Secure a breakdown of the receivables by class, whether notes or accounts

and by debtors, such as customers, affiliated companies, officers,
stockholders, employees and others.
2. Check entries in the general ledger control accounts. Look for unusual
items, especially those which do not originate from the sales or cash
receipts journals.
3. Determine if subsidiary ledgers are in agreement with control accounts,

and if not, ascertain the reasons for any differences.
4. Note any credit balances in the general ledger or subsidiary accounts. This
may indicate deposits or overpayments which could be considered as
additional income or unrecorded sales. Also, credit balances may indicate a
misapplied bad debt recovery or deposits received for so long a time that
there is little likelihood that they will ever be refunded. Whatever the
cause, the credits, if material, should be isolated for consideration.
5. Some credit sales invoices and postings should be test checked from the
sales journal to the subsidiary and control account.
6. Compare balances of accounts receivable and sales for the current year
with that of the preceding year. Investigate significant changes.
7. Investigate large and/or unusual balances classified as other accounts

receivable.
8. In case of notes receivable, determine whether accrued income on interest

bearing notes or accounts has been included in income.
9. Investigate the sources of notes receivable as there may be instances when

the taxpayer has other sources of income other than his regular business.
10. Determine whether accrued income on interest bearing notes or accounts

has been included in income.
11. If needed, check the detailed listing of beginning receivables to cash

collected as reflected in the cash receipts book. This may disclose
diversion of funds and other irregularities.
C. Allowance for Bad Debts
1. Ascertain the company's policy of providing for allowance for bad debts by
examining minutes of meetings and other documents.
2. Compare balances in the allowance account with that of the preceding

year's. Investigate significant changes.
3. Evaluate the reasonableness of the allowance by computing the ratio of the

balance of allowance for bad debts to the trade accounts receivable
balance.
4. Compute the ratio of bad debts expense over sales. Analyze if such is
reasonable.
5. Review the aging schedule of accounts receivable.
6. For accounts written off which were charged to expense, examine minute
book for authorization to write off accounts.
7. Ascertain that accounts written off are worthless by examining supporting

documents such as reports of collection agencies, correspondence with
said customers and documents filed in court, and court decisions on
collection cases.
8. If possible, check the financial status of the customers for which allowance
for bad debts was provided.
9. Check entries to the allowance account for possible bad debts recoveries
and trace if the same were declared as income at the time of recovery.
D. Inventories
1. Determine the correct cost components to be included in the inventory.

The costs used in determining inventory depend on whether the business is
of a service, merchandising or manufacturing nature.
2. Verify the inventory valuation method being applied if such is acceptable

for tax purposes and consistently applied from year to year.
3. Compare inventory balances in the return under examination with the

balances on the prior and subsequent year's returns and financial statement;
then verify these with the taxpayer's records.
4. Check BIR authorization for changes in inventory valuation method and

verify taxpayers compliance with the requirements set forth under existing
rules and regulations.
5. Check gross profit percentage variations. Conduct in-depth verification of

items with substantial variations.
6. Determine the significance of any notes or qualifying statements on

financial reports prepared by independent accounting firms.
7. Determine the taxpayer's computation of standard rates, if standard rates

are applied.
8. Verify cost of production reports and test check certain costs reflected
therein to supporting documents.
9. Determine if year-end purchases were included in the closing inventory.
10. Analyze unusual entries to cost of sales account such as materials, labor
and overhead charges not directly related to sales or transfers of finished
goods, if applicable.
11. Determine if there have been write-downs for "excess" inventory to below
cost. Verify authorization and supporting document/report for such
write-downs.
12. When items have been removed from inventory for the owners' or
shareholders' use, check if these are properly recorded as part of sales.
These required minimum audit procedures, however, should not deter the
Revenue Officer from making a more detailed examination of the
inventory account, when warranted.
E. Advances To Stockholders/Officers
This receivable account may represent an outright advance of money by the

corporation to officers and/or stockholders. Usually, these advances vary in amounts over
a period of time, consequently building up the current amount. The following verification
procedures on this account should be conducted, if warranted:
1. Verify authorization from Board of Directors for advances and loans to

stockholders and officers by checking duly approved minutes of meetings.
2. Identify company officers and stockholders who are granted advances

regularly.
3. Check payments of advances to the company if such loan re-payments

earned interest for which no withholding tax was deducted.
4. Verify entries and supporting documents on cancellation of advances if the

same do not originate from cash receipts. TESDcA
F. Investment
The investments most commonly found on the books are stocks and bonds and, in
some cases, real estate not used in actual business operations. The following procedures
should be conducted in the examination of investments if such are material assets of the
taxpayer:
1. Familiarize with the nature of investments, utilizing any records

maintained by the taxpayers such as the investment ledgers, worksheets
showing the breakdown of investments and other investment records.
2. Analyze sales and other credit entries to the account. If stocks sold are
listed in the stock market, test check selling price of stocks sold at the
prevailing "close" price at the Philippine Stock Exchange during the date
of sale. Real properties sold should not fall below fair market value and/or
zonal value where the zonal value has been established. The application of
the "whichever is higher" rule shall be observed.
3. Verify journal entries to ascertain the selling price and gain on sale of
investments. Vouch supporting documents such as deeds of sale, proof of
remittance of taxes withheld, payment of documentary stamp tax and other
relevant records.
4. Investigate sales to related parties and/or officers or stockholders below

fair market value.
5. Cross-check all investments during the year to the interest, dividend or

rental income accounts.
6. If investments or bonds were acquired at a premium or discount, determine

whether the premium/discount is amortized over the life of the bond.
G. Depreciable Assets
This group includes tangible properties of relatively long life which are used in the
operation of the business. However, natural resources such as oil or mineral lands are not
included in this group of asset account. The following verification procedures should be
undertaken on these accounts:
1. Compare the asset and related reserve amounts as they appear on the tax
return, balance sheet, depreciation schedule, and taxpayer's books and
schedules. Compare the beginning and ending figures for the taxable year
and reconcile differences or ask the taxpayer to make the necessary
reconciliation. Verify the correctness of such reconciliation.
2. Review depreciation schedule of fixed assets and ascertain propriety of

depreciation expense claimed. Watch out for depreciation that may have
been taken on assets which are already fully depreciated or charged off to
expense.
3. Review asset additions during the year by reference to invoices, contracts

and other documents and determine if the proper cost basis was used.
3.1. Note items which appear to have originated from unusual sources
such as appraisal increases, transfers and exchanges, and determine
propriety thereof. Ascertain if prior earnings were adequate to
cover acquisitions.
3.2. Determine if acquisition and installation costs of fixed assets and

leasehold improvements have been capitalized.
3.3. Ascertain if assets include items of a personal nature. If the assets

are used by the officers for their personal use, the depreciation
should be disallowed.
3.4. Where construction or any other work of a capital nature is

performed with the taxpayer's own labor, equipment and other
assets for its own use, be certain that the basis of such asset
includes materials, labor and overhead including depreciation.
3.5. With regard to the basis of recognition of costs of assets, consider

such items as trade-ins, acquisitions from related taxpayers,
allocation of cost between land and building and other basis.
4. Decreases in the asset accounts during the year should be noted. The
accuracy of the gains or losses resulting therefrom should be verified and
ascertain that the appropriate tax on the transaction, such as value-added
tax, if applicable, has been paid.
5. Ascertain if the taxpayer has transferred assets to the owner, officers,

stockholders or to a controlled domestic or foreign corporation for less
than fair or adequate consideration.
H. Allowances For Depreciation, Amortization And Other Valuation Reserves
1. Review the nature and source of all accounts and ascertain if they are being
used to claim unallowable deductions.
2. With regard to depreciation, determine the correctness of the amount of

asset being depreciated. No depreciation is allowable on the appraisal
increase of fixed assets. Any foreseeable salvage value is to be deducted
from the cost of the asset in determining the basis of depreciation.
2.1. No depreciation is allowable on a building until it is completed or

on a machine until it is installed. Expenditures which are properly
includible as an element of cost are freight-in, installation cost, title
cost, and legal or brokerage fees in connection with acquisition.
2.2. Where land and building are acquired on lump-sum, the following
formula should be used in computing the building cost for
depreciation computation:
FMV or Zonal value of land
X
FMV or Zonal value of land
and building
Total acquisition cost = Cost of
Land
Total acquisition cost
Of land and building Pxxx
Less: Cost of land per
above computation xxx

Cost of building Pxxx
====
3. Ascertain the taxpayer's depreciation and amortization policies and
consider the following:
3.1. Whether the methods applied by the taxpayer are in compliance

with the Tax Code and existing revenue regulations;
3.2. Whether the depreciation rates used by the taxpayer are fair and
reasonable; and
3.3. Whether the taxpayer has applied the same method consistently
from period to period.
4. Check authorization from minutes of meetings, fixed asset reports, or other

supporting documents on credits for allowance for obsolescence and/or
asset write-offs. If necessary, inspect assets claimed as obsolete and/or
written off.
I. Intangible Assets
1. Investigate the nature of the intangible assets whether leases, patents,

licenses, trademarks, goodwill, copyright, franchise and others.
2. Costs of acquiring the intangible should be capitalized when useful lives

can be estimated. If not, no amortization is allowable for tax purposes.
3. Determine if the recorded cost and cost of current additions includes

proper elements such as legal fees, application fees and other costs of
acquisition. Examine contracts and other legal documents.
4. Verify correctness of deductions claimed as amortization of intangible

assets as follows:
4.1. Leasehold costs are subject to amortization over the term of the
lease.
4.2. Goodwill cannot be amortized if it is for an indefinite period of

time.
4.3. Research and development expenditures may either be capitalized

or treated as outright deductible expense.
4.4. Patents sold with the exclusive right to make, use and sell an article
constitutes ordinary income.
4.5. Organization expenses are subject to amortization and are not

deductible in full on the year incurred. Check the reasonableness of
the taxpayer's amortization policy on organization expense.
5. Determine if there have been transactions with related taxpayers. If so,

verify if these are made at arms-length.
6. Determine if income applicable to intangibles has been included as income

(e.g. subleases, overriding royalties, franchise and other sources).
7. Analyze any transaction involving transfer of foreign rights to any foreign

entity for an equity interest or for nominal consideration.
8. Be alert to transactions which could have given rise to intangibles

classifiable as asset account which may have been recorded as expense.
J. Prepaid Expenses And Deferred Charges
1. Verify the nature and source of these assets and the manner in which they
are charged off to expense.
2. When prepaid expenses are not reflected in the balance sheet, verify
charges to expenses which entail advance payments such as insurance,
rent, supplies, repairs and maintenance that are covered by contracts.
K. Other Assets
1. Obtain a schedule of other assets account when material in amount.
2. Investigate sources of charges to the account. Verify entries and supporting

documents to check if the other assets are results of income-generating
activities not reported in the financial statements. IcHDCS
L. Exchange, Clearing or Suspense Account
1. Obtain a schedule to determine the nature and purpose of the account if

significant in amount.
2. Test check debit and credit entries, being aware of the possibility that such
account may be used as a means for diverting sales, padding expenses, and
concealing other irregularities.
M. Current And Accrued Liabilities Including Notes Payable
These liabilities are found on business records under various titles such as
accounts payable, vouchers payable, notes payable, accrued expenses and other current
liabilities. The audit procedures are as follows:
1. Reconcile subsidiary ledgers with the control accounts. Request the
taxpayer for explanation of any discrepancies noted.
2. Note existence of debit balances in the general ledger or subsidiary

accounts. This may indicate diversion of funds and other underdeclaration
of income.
3. Note accounts which have long overdue balances. These may indicate
contested liabilities or accounts that no longer exist such as unclaimed
wages or unclaimed deposits which should be reverted to income.
4. Review computation of year-end accruals with respect to their deductibility

as expenses or purchases.
5. Examine legitimacy of accounts payable to affiliates or related taxpayers.

Test check payments made by tracing the same to supporting documents.
Investigate entries in the general ledger control accounts. Check

unusual items such as those that do not originate from the voucher register
or disbursement book. This may disclose unreported income, improper
claim or overstated expense.
6. Be aware of any contingent liability by reviewing minutes of meetings and

annual reports. Although this is not reflected in the tax return, an accrual
may have been made for the item. Any claim for an expense or deduction
arising from a contingent transaction shall not be considered as a
deductible expense. A deductible expense must be reasonably
determinable in amount and the liability must be fixed.
7. If payables include liability on security deposits, secure a copy of the lease

contract/agreement to determine provision on the application of lease
deposits. These security deposits are taxable when received.
N. Fixed Liabilities
1. Acquaint with the pertinent provisions of loan contracts, mortgage

agreements, certificates of indebtedness, financing arrangements and
consider possible adjustment areas as follows:
1.1. determination of expenses, (e.g. interest and bank charges);
1.2. refunding of debt; and
1.3. legal, professional and other expenses of issuance.
2. Scrutinize any long-term outstanding liability to the owner, shareholders,

officers or to a related taxpayer as this may constitute accumulated
unreported income.
3. When the liability is secured by property pledged or mortgaged as

collateral for the loan, determine if the property pledged/mortgaged is
income producing. Review the terms and conditions stipulated on the loan
agreement to determine if income derived therefrom remains to be reported
by the taxpayer as the borrower.
4. Verify if funds were borrowed for use of affiliates as the interest expenses
thereon shall not be deductible on the part of the borrowing taxpayer.
There should be a reallocation of profits and the tax burden must be shifted
to the affiliate in accordance with existing rules and regulations.
5. Determine whether the indebtedness will give rise to interest expense that
are subject to limitations on deductibility under Section 34(B) of the Tax
Code. Determine if loans were borrowed to finance acquisition of
tax-exempt securities. If so, the interest expense is not considered
deductible for income tax purposes.
O. Deferred Credits
1. Check all payments received as recorded in the cash receipts book, (i.e.
date of receipt, source of collection, and other entries).
2. Check if collections were included in the gross income during the year
when the payments were actually received. Amounts are generally
includible in gross income for tax purposes not later than the time of
receipt if they are subject to free and unrestricted use by the taxpayer.
Under this theory, collections, advance rentals, legal retainer and the like,
advance sales of transportations tokens or communications tickets and
other advances are income when received.
3. Look for credit balance of accounts which fall under deferred credits. They
may be clearly labeled as advanced rentals, deferred service income or may
be shown as a reserve account that is mixed with true liability accounts, or
as a contra-balance in the receivables.
4. If the taxpayer used the completed contract method of accounting for

contracts entered into and construction work that actually commenced
prior to January 1, 1998, income and expenses attributable to a particular
job or project are properly deferred until completion of the project. The
contracts and progress reports should be inspected to determine whether
the reporting of income has been delayed beyond the completion of the
project.
5. When a taxpayer uses the installment method of reporting income, the
unrecognized gain for tax purposes should be recorded as a deferred credit.
This particular account should be checked to determine if the year-end
balance remaining in the account reconciles with gross profit to be
reported on the subsequent payments. Any difference would indicate
erroneous computations of income from payments.
P. Loans from Shareholders/Officers/Owners
1. Determine whether there is a true debtor-creditor relationship. Excessively

large liabilities in relation to capital stock (especially in the case of a new
company) may indicate a thin capitalization situation.
2. Check the financial statements of the corporation as well as that of the

shareholders. If there is an interest expense account on the part of the
corporation from such loan, there should also be a corresponding interest
income account on the part of the shareholder.
There are certain tax advantages to the corporation or shareholder

for an equity investment to be treated as a loan. Be sure that the taxpayer
gets these benefits only when the facts of the case show that a "true loan"
exists.
If "loans" are found to be equity capital, the following procedures

may be applied:
2.1. Disallow claim for interest expense and treat payments during the
year as dividends.
2.2. Treat loan repayments as dividends.
2.3. Disallow bad debts deductions by the shareholders.
3. Check supporting loan documents issued in favor of the shareholders,

officers or owners. If unsupported or if support is doubtful, the
unsupported income may have been lodged in this account.
4. Verify certain payments of loans against check vouchers and cancelled

checks.
5. Verify the debit and credit entries in the general ledger account and watch
out for unusual sources other than the cash receipts and disbursements
book.
6. Examine adjustments, specially increases in the account, at the end of the

year as this may constitute shifting of taxable income to this liability
account. Verify general journal entries, journal vouchers and related
documents supporting the entries.
Q. Capital Accounts
1. Capital or Owner's Equity-for sole proprietorship
1.1. 210. Reconcile amount appearing on the books, tax return and
financial statements. Verify discrepancies, if any.
1.2. Review debits and credits to the account during the period under
audit and check supporting entries to the account. Increases which
originate from sources other than profit and loss may indicate
omitted income.
1.3 Relate the account balance and withdrawals with the owner's
standard of living. Where owners report no other sources of
income, and withdrawals appear insufficient to maintain personal
living expenses, there may be under reporting or diversion of
income.
2. Partners' Capital for partnerships
2.1. Review debits and credits to the account during the period under
audit. Verify increases and decreases and check for unusual sources
other than profit and loss.
2.2. Reconcile amount appearing on the tax return, books and financial
statements. Verify any differences noted.
2.3. Examine pertinent provisions of partnership contract and check

correctness of distribution of partnership income and expenses.
2.4. Ascertain that the correct tax has been withheld on distribution of
partnership profits.
2.5. If the taxpayer claims that it is a general professional partnership,

examine partnership contract and registration with the Securities
and Exchange Commission.
3. Stockholders' Equity-for corporations
3.1. Capital Stock
3.1.1. Review entries in the capital stock account and verify

increases and decreases thereto.
3.1.2. Verify correctness of all items appearing on the return,
books and financial statements. Investigate discrepancies, if
any.
3.1.3. In case of additions to capital stock out of new issues during

the period under audit, ascertain that the correct amount of
documentary stamp tax has been paid. Secure a photocopy
of the proof of payment.
3.1.4. Compare data from minute book with items recorded on the
books of accounts to determine if entries have been made.
3.1.5. Determine if expenses relating to stock issuance (i.e. legal

fees, registration fees, broker's commission and other
expenses) have been properly handled.
3.1.6. Determine during the examination of a recapitalization of

the stock in a closely held company, if the fair market value
of the stock to be received by each exchanging shareholder
is equal to the fair market value of the stock surrendered in
the exchange. If there is a significant difference, consider
the possibility of treating the difference as a donation
subject to donor's tax. cAHDES
3.1.7. If a reorganization has taken place, examine the following

documents:
3.1.7.1 The reorganization plan;
3.1.7.2 Journal entries giving effect to direct reorganization;
3.1.7.3 Notes of all minute book referring to the transaction,

and
3.1.7.4 Notes of pertinent information from the

correspondence file with other parties to the
reorganization.
3.1.8. Examine by-laws, articles of incorporation or other

documents in support of other transactions affecting capital
stock.
3.1.9. Determine if the increase in capital stock is the direct

consequence of an exchange of property under Section
40(C)(2) of the Tax Code. If so, confirm compliance with
the conditions set for the non-recognition of gain or loss by
performing the following audit procedures:
3.1.9.1 In case of merger or consolidation.
3.1.9.1.1 Verify if the plan of reorganization has

been adopted by each of the parties to the
reorganization.
3.1.9.1.2 Check if the income tax return filed for

the taxable year in which the exchange took
place incorporated all facts pertinent to the
non-recognition of gain or loss upon such
exchange, such as:
3.1.9.1.2.1 The historical cost or other

basis of valuation of all properties,
including all stocks or securities
transferred incident to the plan; and
3.1.9.1.2.2 The nature and amount of

liability assumed upon the exchange
and the amount and nature of any
liabilities to which any of the
property acquired in the exchange is
subject.
3.1.9.1.2.3 Verify Deed of Assignment of

property for shares of stocks; and
3.1.9.1.2.4 Check in the required

documentary stamp tax has been
paid.
3.1.9.2 In case of transfer of property to a controlled

corporation
3.1.9.2.1 Verify if the transferor and the

transferee filed an income tax return for the
taxable year in which the exchange was
consummated with a complete statement of
all facts pertinent to the exchange.
3.1.9.2.2 Verify Deed of Assignment of the

property.
3.1.9.2.3 Determine if transferor of the property

gains control of said corporation, alone or
together with others, not exceeding four (4)
persons, pursuant to Sec. 40 (C)(2) of the
NIRC.
3.1.9.2.4 Determine if the documentary stamp

tax was paid.
3.1.9.3 In both cases, ascertain if the following information

have been annotated at the back of the Transfer
Certificates of Title or certificates of stock:
3.1.9.3.1 Date of execution of the deed of

exchange.
3.1.9.3.2 The original or historical cost of

property.
3.1.9.3.3 The fact that no gain or loss was

recognized as a result of such exchange.
3.2. Retained Earnings
The investigation of the retained earnings (or deficit, in case

of accumulated losses) is a very important part of the audit process
as this is related to the net worth method of investigation. It is the
account to which the net income or net loss from operations is
transferred and accumulated into. The minimum audit procedures
that should be undertaken in analyzing this account are as follows:
3.2.1. Compare the amount of earnings retained in the business as

shown on the return, financial statements, books of
accounts and the schedule of reconciliation of net income
per books and per return. Verify differences, if any.
3.2.2. Verify correctness of all items, both increases and

decreases, appearing on the books or return. Trace
beginning balance of retained earnings to the ending
balance appearing in the balance sheet of the prior period.
3.2.3. Check increases which do not originate from net income.

Verify entries from the general journal/journal vouchers,
specially those recorded other than as year-end adjustment
as these may indicate sales or income directly posted to the
retained earnings account.
3.2.4. Determine if declared and unpaid dividends are properly

recorded. Compare paid dividends to the minutes of the
Board of Directors meeting(s).
3.2.5. For taxpayers incurring continuous losses and deficit

balance, investigate the real status of the business. Tour
company premises, evaluate the volume of business, and
compare the information gathered with the financial data
reported. There may be underreporting of sales as there is
very little reason for a business to exist if it is continuously
incurring losses.
3.2.6. Examine supporting documents and authorization for all

other debit and credit transactions in retained earnings to
determine conformity with existing tax laws and
regulations.
X. Audit of Income and Expenses
This Chapter discusses the books of accounts, accounting records and documents
used to record income and expense transactions. It enumerates the audit procedures and
techniques for income and expenses.
The audit of income or revenues are applicable to resident and non-resident

individuals engaged in business and the practice of profession, estates and trusts engaged
in trade or business, general professional and business partnerships and corporations.
Expenses chargeable against income are allowable in their entirety only for
business partnerships and corporations. Self-employed resident citizens and aliens
engaged in business or the practice of profession, non-resident aliens engaged in business,
estates and trusts engaged in trade or business and general professional partnerships as
defined under Section 22 (B) of the Tax Code and their individual partners can claim
expenses subject to the provisions of Section 34 of the Tax Code.
The subsequent discussions on the procedures and techniques in the investigation

of income and expense accounts are general audit guides. The Revenue Officer should not
be hindered in applying additional procedures and techniques, which he deems necessary,
based on his initial findings, evaluation of internal control, reliability of accounting
records, and analytical review of operations.
A. Audit of Income Accounts
1. Sales
1.1 Review the taxpayer's accounting method of revenue recognition if the

same is acceptable and consistent with prior years.
1.2 Ascertain that all sales were reported as of the cut-off date. Cut-off refers
to the point at which entries from one accounting period stop and entries
for the next period begin. This is usually the last day of a taxable year. If
the last day of the taxable year is not used, the cut-off date must be the last
day of the taxpayer's fiscal period. ASTcEa
1.3 Verify revenues/sales recorded and deposited near the end of the tax year
and immediately during the subsequent month to determine if these pertain
to income earned for the tax year under examination.
1.4 Account for all sales invoices issued. Match delivery receipts, gate passes,
if any, against sales invoices issued.
1.5 Compare totals of sales invoices, sales summary, entries in subsidiary sales
journals and general ledger accounts. Inquire and investigate discrepancies
between book entries and returns filed.
1.6 Reconcile credits to sales with debits to accounts receivable and debits to
cash receipts book. Test check monthly entries.
1.7 Research unusual and unfamiliar issuances of goods or goods which are
not normally sold by the taxpayer.
1.8 Conduct interviews to secure information regarding the taxpayer's

business, financial history, number of employees and other information
which may lead to sales estimation.
1.9 Determine inventory method applied if acceptable and consistently

followed.
1.10 Determine if merchandise is being withdrawn for personal use or for any
other purpose not in relation to normal sales process.
1.11 Scan credit memo issued to customers and test check entries to Sales
Returns & Allowances and Sales Discounts to insure proper recording of
credits.
1.12 Verify cancelled sales invoices by test checking deposits made and
withdrawal of goods on the day of cancellation.
1.13 Tour the business premises to obtain information on:
a. Sales volume
b. Volume of sales return and method of handling sales returns
c. Major products
d. Other by-products and scrap sales, if any
e. Equipment used in operation
f. Nature, quality and size of facilities
g. Inventory level
In touring the premises, be observant and ask questions that

will disclose significant facts and information relative to the
taxpayer's business operations.
1.14 Review sales contracts, consignment agreements and other documents

relative to sales.
1.15 On installment sales, ascertain that collections have been properly

segregated as to the year of sales and that the proper gross profit ratios
have been applied. Review unearned or deferred income accounts for any
uncollected balances which have been outstanding for an unreasonable
period of time.
1.16 Determine whether sales on consigned goods are taken up at the time of
shipment or after sixty (60) days from the date goods were consigned.
1.17 Where the internal control is weak and records are unreliable or
inadequate, apply other approaches to audit revenue such as cash analysis,
net-worth analysis, third party verification, and other indirect approaches
to investigation.
2. Rent Income
2.1 Obtain and review copies of lease contracts.
2.2 Conduct ocular inspection of the premises under lease. Identify tenants and
monthly or annual rentals. Conduct interviews, if necessary.
2.3 Relate real properties under lease agreement to assets declared in the
balance sheet. Note inconsistencies between asset values and income
generated.
2.4 Where the rental income is based on a percentage of sales of the lessee, the
sales of the lessee should be tested for a representative period, say one
month, to get a proper approximation of the lessee's sales during the
taxable year under audit and the rental income received by the lessor. In
such cases, proper authorization from the lessee should be obtained before
conducting the test verification.
2.5 Obtain information on rental of neighboring properties and compare with
rent income reported.
2.6 Examine official receipts issued. Compare total collections per official
receipts with entries in the cash receipts book and general ledger.
Investigate discrepancies.
2.7 Ascertain acceptability and consistency of accounting methods used. For

cash-basis taxpayers, prepaid rent and rental deposits constitute income
during the year of receipt.
2.8 Secure copies of lease contracts or agreements. Take note of lease

contracts which are actually conditional sales.
2.9 Where necessary, obtain copies of Transfer Certificates of Title, tax

declarations, mayor's or municipal permits, and real property tax receipts
to determine properties which may be undisclosed/unrecorded by the
taxpayer.
3. Professional Fees
3.1 Determine the taxpayer's accounting method of recognizing income,

whether cash or accrual. Most professionals, however, adopt the cash basis
of accounting.
3.2 Examine contracts with clients and other correspondence/documents in

relation to professional services rendered.
3.3 Compare income reported on the tax return with the books of accounts,
creditable withholding tax forms, financial statements and official receipts
issued. Verify discrepancies, noted, if any.
3.4 Account for official receipts issued. Note any missing receipt or break in
the series and investigate the reasons therefor.
3.5 Analyze the reasonableness of expenses claimed in relation to income

declared.
3.6 Conduct interviews and third party verification, if necessary.
3.7 Relate the income reported per tax return to the lifestyle and assets of the
taxpayer. If the taxpayer's assets and estimated costs of living expenses are
beyond the income earned, verify and compute for possible
underdeclaration of income by using the net worth method of
investigation.
4. Income from Sale of Asset
4.1 Identify in the tax returns and financial statements any sale, exchange or
disposal of assets other than inventories or stocks in trade.
4.2 Obtain copies of deeds of sale and other documents relating to the sale.
4.3 Determine zonal values, fair market values or appraisal values and
compare with the actual selling price.
4.4 Compute any underdeclaration of sales by comparing the selling price with
the existing fair market value, zonal value or value of similar properties
sold.
4.5 In case of disposal of capital assets, ascertain compliance with the

provisions of the Tax Code on capital gains and losses.
4.6 Verify sales of property reported on the installment basis and determine if
all requirements pertaining thereto have been complied with.
4.7 Determine if proper accounting for depreciation, book value and salvage
value was correctly taken up
4.8 Inquire from certain company personnel on possible sales of assets which
may not have been recorded in the books of accounts.
5. Other Income
5.1 Scrutinize the entries in the general ledger and general journal for any
other income or other receivables recorded thereto.
5.2 Test check entries in intercompany accounts to determine whether shifting

of income or management fees may have been made and charged to
affiliates.
5.3 Investigate suspense accounts and unusual liability accounts, such as due
to affiliates/due to stockholders and other payables to uncover possible
income not recorded in the income accounts.
B. Audit of Expense Accounts
1. Purchases
For taxpayers engaged in trading and manufacturing businesses, the purchase

account is one of the largest accounts in the income statement. Thus, there is a possibility
that taxpayers may hide a number of non-deductible expenditures in this account due to
the volume of transactions posted to it. The following audit procedures should be
followed in examining purchases:
1.1 Account for all purchase invoices and receiving reports as of the cut-off
date. Determine if year-end purchases have been recorded in the proper
accounting period.
1.2 Compare totals of purchases in the return, income statement, purchase

book, subsidiary purchases book, if any, and general ledger. Determine any
discrepancy and investigate its nature as well as the nature of year-end
adjustments.
1.3 Determine that the purchases declared are neither overstated nor
understated by vouching the supporting documents, and test-checking the
footings of invoices, purchase books and ledger accounts Under-statement
of purchases may also mean underdeclared sales.
1.4 Tour the premises where inventory items are kept and correlate actual
inventory level against purchases reported. Test-check stock cards of major
inventory items to evaluate accuracy of inventory reports. TDcAaH
1.5 Scan the purchases book for possible unusual payees or unusual amount of
purchases. Take note of suppliers not generally associated with the
products or services handled by the taxpayer.
1.6 Verify entries in the general ledger account which originate from unusual
sources such as journal entries, debit and credit memoranda and other
accounting records.
1.7 Test check recorded purchases for a representative period with suppliers
invoices and cancelled checks. Note if there are personal expenditures,
withdrawals of merchandise by the owners, fictitious or duplicate
invoices, cancelled purchase invoices, excessive rebates, discounts and
allowances and purchases not received.
1.8 Where there are only a few major suppliers, conduct third party
verification to ascertain the correctness of purchases declared, if there is
suspicion of fraud or if the Revenue Officer believes that this is necessary.
1.9 If purchases are from suppliers related to the owners or from affiliates,
conduct a review of a number of transactions to uncover prices in excess of
market value, excessive rebates and allowances, and other similar
schemes.
2. Cost of Goods Sold
2.1 Verify the inventory valuation method applied by the taxpayer whether
first-in, first-out (FIFO) last-in, first-out (LIFO), specific identification,
weighted average or simple average. Last-in, first-out is not acceptable for
income tax purposes. Determine consistency of its application from year to
year.
2.2 Obtain an understanding of the production process thru familiarization

with the taxpayer's business, tour of the premises, conducting interviews,
and analyzing cost of production reports.
2.3 Compare inventory balances in the return under examination with the
balances for the prior and subsequent years' returns, and reconcile these
with the general ledger and the physical inventory summary.
2.4 Check unauthorized changes in inventory valuation method from period to

period. Conduct test-checking of inventory valuation of sample inventory
items from the summary inventory sheets and determine if the taxpayer has
not improperly valued any inventory item.
2.5 Check gross profit variations. Any significant variation should be

discussed with the taxpayer and a reasonable explanation in writing should
be obtained. A material decrease in gross profit from one year to the next
could be due to understated ending inventory.
2.6 Determine the significance of notes or qualifying statements on financial

reports prepared by external auditors. Any unusual comments or qualifying
statements about the inventories or cost of sales that have a material tax
effect should be discussed with the taxpayer and, if necessary, with a
representative of the external auditor.
2.7 If the taxpayer applies standard or predetermined cost in costing goods

manufactured, inspect the working papers and production report used to
calculate the cost per unit and ensure that expenses included are allowable.
2.8 Analyze unusual entries to cost of sales. Account for labor, materials and
overhead charges not directly related to sales or transfers of finished
goods. Be alert on the possibility that the taxpayer may be trying to include
a non-deductible item in the cost of sales account.
2.9 Determine whether year-end purchases are included in closing inventory.

Review purchase invoices at the last month of the taxable year under audit.
Compare quantities on the inventory summary for classes of goods
purchased with the quantity in the ending inventory list and quantity of
sales recorded at year-end for such goods. Thus, if a specific item or a
certain quantity of goods were purchased on the last day of the year, it
should be included in the ending inventory unless sold that same day.
2.10 Determine reductions in ending inventory values by reviewing

authorization for write-downs and provision for obsolescence or decline in
market values. Check minutes of meetings for such authorization. Analyze
journal entries for the write-down or provision of allowance for
obsolescence/decline in value. Check itemized inventory summary sheet
and test-check the list with actual physical inventory.
3. Salaries, Wages and Other Employees' Benefits
3.1 Evaluate the expense initially by comparing the ratio of salaries and wages
to sales and the percentage of taxes withheld to total salaries, allowances
bonuses and other compensation. Low ratios might indicate that the
company hires sub-contractors or an understatement of expenses which
may be a lead to underdeclared sales. High ratios may also mean an
understatement of sales or padded payroll with functions or terminated
employees.
3.2 Review payroll sheets. All expenses claimed having the semblance of a
compensation payment should be verified together.
3.3 Interview personnel assigned to prepare payroll and inquire if family

members are included in the payroll. If so, check legitimacy of the work
assignment and reasonableness of compensation paid.
3.4 Compare payroll costs with industry standards and other independent data.
Require explanations for significant deviations.
3.5 Observe the actual number of employees and relate this to the declared
sales. Inquire if independent contractors are hired in lieu of regular
employees.
3.6 Perform a comparative analysis of salaries, wages and other employee

benefits with prior and subsequent years. Material changes may indicate a
change in the volume of business or in the policy of classifying manpower
employed.
3.7 Determine if the taxpayer is properly withholding the correct amount of

taxes on compensation by test-checking actual pay slips against employee
records and BIR Form 1604 CF (Annual Alpha List of Employees from
whom Withholding Tax has been deducted).
3.8 Reconcile totals of wages paid which were subjected to withholding tax
and totals of compensation paid which were not subjected to withholding
tax with payroll expense claimed. Consider the possibility of disallowing
any noted discrepancy in accordance with existing rules and regulations.
3.9 Verify Social Security System Premium Remittance List to cross check the
list of employees to whom compensation was paid.
4. Fringe Benefits
Fringe benefits tax is a final withholding tax imposed on the grossed-up monetary
value of fringe benefits furnished, granted or paid by the employer to the employee,
except rank and file employees as defined in Revenue Regulations No. 3-98.
4.1 Obtain a list of managerial and supervisory employees from the Human
Resource or Personnel Department of the company being audited with the
following information per personnel:
a. Nationality
b. Citizenship
c. Number of years with the company
d. Position/Job designation
e. Basic salary and allowances
f. Other compensation and benefits
4.2 Secure copies of employment contracts and/or appointment papers and

examine these documents to verify the nature and amount of other
compensation, allowances and benefits which may be subject to fringe
benefits tax.
4.3 Analyze expenses and other pertinent accounts where fringe benefits may
have been lodged or recorded. Determine the amounts of benefits subject
to the tax.
4.3.1 Include the value of following items/services as taxable fringe

benefits pursuant to Sec. 2.33 (B) of Revenue Regulations No.
3-98:
a. Housing
b. Expense Account
c. Vehicle of any kind
d. Household personnel, such as maid, driver and others
e. Interest on loan at less than market rate to the extent of the

difference between the market rate and actual rate granted
f. Membership fees, dues and other expenses borne by the

employer for the employee in social and athletic clubs or
other similar organizations
g. Expenses for foreign travel
h. Holiday and vacation expenses
i. Educational assistance to the employee or his dependents
j. Life or health insurance and other non-life insurance

premiums or similar amounts in excess of allowable
amount under the law.
4.3.2 Exclude the following fringe benefits from the fringe benefits
subject to FBT (Sec. 2.3.3.(c) of RR No. 3-98):
a. Fringe benefits which are authorized and exempted from

tax under the Tax Code or under any special law
b. Contributions of the employer for the benefit of the

employee to retirement, insurance and hospitalization
benefit plans
c. Benefits given to the rank and file, whether or not granted

under a collective bargaining agreement.
d. De Minimis benefits, such as:
d.1 Monetized unused vacation leave credits of

employees not exceeding ten (10) days during the
year
d.2 Medical cash allowance to dependents of employees

not exceeding P750 per semester or P125 per month
d.3 Rice subsidy of P350 per month granted by an

employer to his employees
d.4 Uniforms given to employees by the employer
d.5 Medical benefits given to the employees by the

employer
d.6 Laundry allowance of P150 per month
d.7 Employee achievement awards (e.g. for the length

of service or safety achievement) which must be in
the form of a tangible personal property other than
cash or gift certificate, with an annual monetary
value not exceeding one-half () month of the basic
salary of the employee receiving the award under an
established written plan which does not discriminate
in favor of highly paid employees
d.8 Christmas and major anniversary celebrations for

employees and their guests
d.9 Company picnics and sports tournament in the

Philippines and are participated exclusively by
employees
d.10 Flowers, fruits, books or similar items given to

employees under special circumstances (e.g. on
account of illness, marriage, birth of a baby, etc.).
e. If the grant of the fringe benefits is for the convenience of

the employer
4.4 Determine the correct valuation of fringe benefits based on the provisions
on valuation prescribed and illustrated in RR No. 3-98
4.5 Compute for the amount of taxable fringe benefits by dividing the
monetary value of the fringe benefit by the appropriate percentages in
accordance with the following schedule:
Effective January 1 ,1998 66%
Effective January 1, 1999 67%
Effective January 1, 2000 68%
4.6 Compute for the correct final withholding tax on fringe benefits by
multiplying the grossed-up monetary value of the benefits with the
following rates for the applicable taxable years:
1998 34%
1999 35%
2000 32%
The following are subject to different tax rates as provided by the
NIRC and RR No. 3-98:
a. A non-resident alien individual not engaged in trade or business

within the Philippines (Section 25 (B)) EADCHS
b. An alien individual employed by:
b.1 Regional or area headquarters and regional operating
headquarters of multinational corporations (Section 25 (C))
b.2 Offshore banking units (Section 25(1))
b.3 Foreign petroleum service contractor and subcontractors

(Section 25 (E))
c. A Filipino citizen employed and occupying the same position as an

alien employed by the above-mentioned entities (Section 25 (E))
4.7 Examine monthly final withholding tax returns with corresponding official
receipts of payment to check if the correct final withholding tax on fringe
benefits was paid. In case of underpayment or late payment, compute the
deficiency tax due and/or penalties, where applicable.
4.8 Compare the amount of fringe benefits per income tax return, audited
financial statements and per books against the withholding tax returns and
official receipts. If the taxpayer is on accrual basis, examine the journal
entry made in accruing the expense at the end of the year. Verify if the tax
has been paid on or before the due date on the first month of the following
year.
4.9 Disallow claims for fringe benefits in excess of supported amounts or

where the payees are determined to be fictitious.
5. Rents
5.1 Verify pertinent provisions of the lease contract with the lessor.
5.2 Verify reasonableness of rentals paid by the lessee, particularly if the lessor
is related directly to the taxpayer.
5.3 Verify whether the corporation is renting property for which it has no
actual business use. Any rentals in that case would be unreasonable and
unnecessary; hence, the expense should be disallowed.
5.4 Determine the terms of the lease. If the lessee may take or acquire title to
the property, the claim for rental expense should be disallowed.
5.5 Determine if there are any capital expenditures included in the accounts.
5.6 Determine whether the proper amount of expanded withholding tax on

rental payments has been withheld and remitted.
6. Royalties
6.1 Verify minute book and pertinent provisions of the contract with the
lessor.
6.2 Check correctness of the amount of the expense by computing the

percentage of royalty or terms specified in the contract in relation to the
reported sales. Disallow excess claim.
6.3 Determine whether the proper amount of final withholding tax has been
withheld and remitted.
6.4 If the recipient is a non-resident alien or foreign entity, determine whether

the proper amount of tax has been withheld and remitted.
6.4.1 Check whether the recipient is a treaty country resident. If so, ask
for a copy of a ruling issued for the use of the preferential tax rate.
6.4.2 If a copy of a ruling has been produced, verify from the issuing
office [International Tax Affairs Division (ITAD) or Law Division]
for the authenticity of such ruling.
6.4.3 If the recipient is a non-treaty country resident, verify if the

appropriate tax rate provided for in the Tax Code is properly
applied.
7. Interest
7.1 Verify sources of interest expenses such as actual notes, loans, mortgage or
bond instruments. Check whether the indebtedness is business related.
7.2 Determine the accounting method used by the taxpayer. If he uses accrual
basis, only the interest accruing during the taxable year is deductible.
7.3 Determine if interest paid or accrued applies to obligations due to related

taxpayers. Consider such items as:
a. Arm's length features
a.1 Bona fide obligations
a.2 Interest in excess of the prevailing rates in unrelated

transactions.
b. Accrual of items payable to related taxpayers which are not paid

within the prescribed time limit.
7.4 Determine if deductions claimed relate to interest incurred in carrying tax
free obligations. If so, then the interest claimed is not deductible.
7.5 Disallow interest claimed in excess of interest income subject to final tax.
7.6 Determine if the interest deduction includes any principal amount.
7.7 If the recipient is a non-resident alien or other foreign entity, determine if

the proper amount of tax has been withheld (Follow procedures in 6.4 to
6.4.3. hereof).
7.8 Ascertain if the loans acquired were not utilized but were loaned out to
affiliates. If so, disallow interest expense claimed.
8. Taxes
8.1 Verify whether only the taxes properly paid or accrued during the year
have been claimed.
8.2 Determine that no protested taxes or reserves for deficiency taxes upon
audit are claimed.
8.3 Determine existence of claims for taxes not allowable as deduction such
as:
a. Income tax provided for under the Tax Code;
b. Income, war profits and excess profits taxes imposed by authority

of any foreign country;
c. Estate and gift taxes; and
d. Taxes assessed against local benefits of a kind tending to increase

the value of the property assessed.
8.4 Determine if the taxpayer has title to the real and personal property being
taxed.
8.5 Determine if there are any taxes on the purchase of capital assets that were
already capitalized but also charged to expense account.
9. Repairs
9.1 Determine depreciation policy of the taxpayer. A conservative depreciation

policy often contemplates a high degree of current repair expenditures.
9.2 Verify nature of expenditures. If the expenditure prolongs the life or

enhances the value of the existing assets, then it is not deductible but
should be capitalized and depreciated over the years of their estimated
usefulness.
9.3 Check repair accounts for the possibility that personal expenses of owners
or other company officers and employees are included.
10. Bad Debts
10.1 Obtain and review list of charged-off accounts
10.2 Determine with a reasonable degree of certainty the uncollectibility of the

debt.
10.3 Determine if the charge-off is based on worthlessness of the debt within

the year.
10.4 Determine if there are repossessed merchandise. If so, verify if the value of
repossessed merchandise has been correctly assigned and deducted from
the claimed amount of bad debts.
10.5 Verify losses on installment receivable if consideration on any repossessed

merchandise had been taken into account and if portion of the losses had
been charged to the unrealized gross profit account.
10.6 Determine if the method of deducting bad debts is acceptable and

consistent with the method applied in the preceding year.
10.7 Verify bad debts expense in relation to the examination of the allowance
for doubtful accounts. SEcAIC
11. Losses
11.1 Abandonment and Demolition Losses
11.1.1 Verify if the amount of the abandonment loss is the adjusted basis
of the abandoned asset.
11.1.2 Determine if the loss of missing assets really occurred within the
taxable year.
11.1.3 Determine if the retirement or abandonment loss is specifically

allowable under the taxpayer's method of accounting for
depreciable property.
11.1.4 Determine the reason for the demolition of a building. If it was the
taxpayer's intention to demolish the building when the property was
first acquired, abandonment loss is not allowable. It should form
part of the cost of the building.
11.2 Losses from Casualty or Theft
Casualty loss refers to loss of property connected with trade or

business. In the verification of casualty or theft losses, the following
pointers should be observed:
11.2.1 Ascertain that a loss has actually been incurred by examining

supporting documents such as police report or report of the fire
department.
11.2.2 Ascertain that the loss is claimed in the proper year. Generally
casualty loss, is claimed in the year incurred while losses from theft
or embezzlement is claimed in the year discovered.
11.2.3 Ascertain that insurance proceeds or claims, salvage proceeds, or

salvage value have been properly taken into account.
11.2.4 Ascertain that the adjusted basis of lost property has been properly
computed. Consider reasonableness of values used in the
computation and ascertain that the loss claimed does not exceed the
adjusted basis.
11.2.5 Ascertain that the rule as to the manner of deductibility have been
complied with (type of asset, whether insured or not, time or period
held, and other relevant factors).
11.2.6 In cases involving loss of cash, be alert on the possibility that the
cash stolen may not have been included as income.
112.7 Trace handling of losses involving inventory or stock in trade to

preclude double claim of deduction.
11.2.8 Analyze any loss claimed for assets located in a foreign country.
11.2.9 Verify police blotters, fire department records and other

independent documents in support of the claim.
11.3 Net Operating Loss Carry-over
Pursuant to Section 34 (D) (3) of the Tax Code, "net operating

loss" means the excess of allowable deduction over the gross income of the
business in a taxable year.
The validity of the claim for net operating loss carry-over may be
determined through the following procedures:
11.3.1 Secure copies of income tax returns and the applicable audited
financial statements for the three (3) consecutive taxable years
immediately preceding the year of claim.
11.3.2 Verify audit reports, if any, covering the taxable years with net
operating loss to ascertain correctness of amount claimed after
audit. If the results of audit for prior years show a net income
instead of loss, disallow claim for net operating loss carry-over.
11.3.3 Determine if the net loss was incurred during the taxable year in
which the taxpayer was exempt from income tax. If so, the net
operating loss carry-over should not be allowed as a deduction for
the succeeding period.
11.3.4 Examine the taxpayer's stock and transfer book and report
submitted to the Securities and Exchange Commission to ascertain
that there is no substantial change in the ownership of the business
or enterprise in that:
a. Not less than seventy five percent (75%) in nominal value

of outstanding issued shares, if the business is in the name
of a corporation, is held by or on behalf of the same
persons; or
b. Not less than seventy five percent (75%) of the paid up

capital of the corporation, if the business is in the name of a
corporation, is held by or on behalf of the same persons.
11.3.5 For operators of mines, other than oil and gas wells, which did not
avail of the incentives under E.O. 226, otherwise known as the
Omnibus Incentives Code of 1987, verify correctness of claim for
net operating loss:
a. Refer to audited financial statements and audit reports to

check if the net loss was incurred during the first ten (10)
years of operation;
b. Check if the period/taxable year when loss is claimed is

within five (5) taxable years following the loss; and
c. Ensure that there is no substantial change in the ownership

of the business or enterprise as stated in Section 4 hereof.
12. Depreciation
12.1 Compare total depreciation as shown by the depreciation schedule with the
deduction claimed on the return. Reconcile any differences. Be alert for
duplication of claimed deductions.
12.2 Review the rates of depreciation used to determine if they are reasonable.
12.3 Test check a representative number of items listed on the depreciation

schedule to determine if the accumulated depreciation at the end of the
accounting period exceeds the depreciable basis of the asset.
12.4 Test check extensions and prove footings to determine if current

depreciation has been correctly computed.
12.5 Determine if there is any personal use of cars and other depreciable assets.
12.6 Ascertain if proper cost allocation has been made on bulk purchases of
depreciable and non-depreciable assets.
13. Depletion
13.1 Determine if the taxpayer has an economic interest in the property.
13.2 Determine if the taxpayer has acquired, at least by investment, any interest
in oil, gas or mineral in a place, and secures, by any form of legal
relationship, any income derived from the extraction of oil, gas or mineral.
13.3 The following additional guidelines should be followed in the verification

of the deduction for depletion:
13.3.1 Ascertain that the sales reported in relation to a property do not

include sales applicable to another property, sales of purchased
minerals, non-minerals sales or other income items.
13.3.2 Ascertain, where applicable, if mineral sales have been adjusted to

"gross income from the property" by reduction of such factors as
unallowable treatment cost, unallowable transportation costs, rents
and royalties, including a proportionate part of lease bonuses,
amounts paid to others in contract mining or similar operations
where the other party has acquired an economic interest and is
entitled to depletion, certain excise taxes, trade discounts allowed
and other deductions. CSAcTa
13.3.3 In situations where the basis for percentage of depletion is not the
actual sales price of a finished product but a value of the mineral at
the point at which it has passed through the last allowable
treatment process applicable thereto, determine if the value used is
the correct representative market or field price.
13.3.4 Ascertain that mineral sales made to a business controlled by the
taxpayer are not inflated to gain a tax advantage through depletion.
13.3.5 Ascertain that all expenses applicable to a property have been

charged to that property including a proper allocation of general,
administrative and overhead expenses.
13.3.6 Be alert on possible reduction of expenses by improper offsets such

as income from scrap sales, cash discounts earned, sales of assets,
and other income.
14. Contributions
14.1 Determine if the donee or recipient is the government or an accredited

relief organization.
14.2 Determine if the contribution is to be utilized for the rehabilitation of

calamity stricken areas declared by the President.
14.3 Verify if the claim is actually paid within the taxable year.
15. Transportation and Travel, Representation and Entertainment
15.1 Determine if the expenditures have been incurred in relation to the

business or practice of profession, not for personal use.
15.2 For transportation and travel expenses, the following information are
necessary to properly determine deductibility:
a. Date of travel
b. Purpose of the travel and written authority for the travel
c. The person or persons who incurred the expenditure
d. Place or places travelled
e. Amount of expenditure
f. Means of transportation or travel
15.3 Determine if taxpayer's travel and transportation and representation and

entertainment expenses are recorded in a daily diary. If such expenses
appear to be disproportionate to the taxpayer's income and business
activities, the taxpayer should be required to corroborate the book entries
by furnishing documentary proofs.
15.4 Determine the policy with respect to reimbursement or giving grants of
allowances to employees.
15.5 Ascertain the specific amounts recorded for these items.
15.6 Prepare a summary of the total expenses posted to the accounts and
compare the same with the deductions claimed per tax return.
15.7 Select a representative test period or periods and test check entries in the
ledger against supporting receipts and documents.
15.8 Determine from the analysis and verification of supporting documents the
reliability of the records.
15.9 Determine company-owned vehicles and the expenses incurred in

connection with these vehicles.
16. Stationery and Office Supplies
16.1 Determine if the expenses claimed are not capitalizable office furniture
and equipment.
16.2 Verify if personal purchases by the taxpayer/owner are included in the

account.
16.3 Determine the reasonableness of the expenditures.
16.4 Compare receipts with the amounts claimed and investigate significant
discrepancies.
17. Professional Fees
17.1 Determine if the charges include amounts incurred for legal, accounting,
engineering, appraisal, surveying and other similar services.
17.2 Verify if the amounts are material and examine contracts to check the
detailed description of the exact professional services rendered.
17.3 Check legal expenses or representation expenses as it might at times be

political contributions, bribes or kickbacks, which should be disallowed.
17.4 Determine charges for research and experimental expenses. These items
should form part of the cost of patents, trade-marks and copyrights and
other intangible assets subject to amortization.
18. Insurance Expenses
18.1 Verify insurance policies. Premiums paid by employers on individual life
insurance policies of their employees are not deductible if the employer is
a direct or indirect beneficiary of such proceeds.
18.2 For individuals, ascertain if his claim for insurance premiums on health
and/or hospitalization insurance, including for his family, does not exceed
two thousand four hundred pesos (P2,400) during the taxable year,
provided that:
a. In case of married individuals, the combined income of the

taxpayer and his spouse does not exceed two hundred fifty
thousand pesos (P250,000) during the same taxable year; and
b. Only the spouse claiming the additional exemption for dependents

shall be entitled to this deduction.
18.3 Determine if the employee is the beneficiary of the insurance. Otherwise,

the premiums paid shall be treated as an additional salary provided that it
is reasonable.
18.4 Check the account if it includes fire insurance, burglary insurance and
other policies on officer's/stockholder's personal and real properties.
19. Light and Power, Telephone and Telegraph
19.1 Determine material amounts claimed as it may include capitalizable

electrical equipment or purchases of capital items from utility companies.
19.2 Examine the receipts issued by the utility companies. Compare the same
with the amounts claimed per return. Investigate material discrepancies.
19.3 Determine if there are personal expenses included in the expense account.
19.4 Relate the expense consumption against sales and production to determine
any possible underdeclaration of sales.
20. Miscellaneous Expenses
20.1 Check the validity of the individual charges to the account.
20.2 Determine if deductions claimed are adequately substantiated.
20.3 Ascertain if the miscellaneous expenses claimed do not contain any

personal items.
XI. Audit of Minimum Corporate Income Tax and Improperly Accumulated Earnings
Tax
A. Minimum Corporate Income Tax
Pursuant to Section 27 (E)(1) of the Tax Code, a minimum corporate income tax
(MCIT) of two percent (2%) of the gross income as of the end of the taxable year is
imposed on a corporation taxable under Title II of the Tax Code, beginning on the fourth
taxable year immediately following the year in which such corporation commenced its
business operations, when the minimum income tax is greater than the tax computed
under Section 27 (A) of the Tax Code. Any excess of the minimum corporate income
over the normal income tax shall be carried forward and credited against the normal
income tax for the three (3) immediately succeeding taxable years.
The verification of the minimum corporate income tax may be conducted as

follows:
1. Determine the taxability of the taxpayer to the MCIT. The MCIT shall
apply to domestic and resident foreign corporations subject to the normal
corporate income tax and shall not be imposed upon any of the following:
1.1 Domestic corporations operating as proprietary educational

institutions subject to ten percent (10%) income tax rate;
1.2 Domestic corporations engaged in non-profit hospital operations

subject to ten percent (10%) income tax rate; DCHaTc
1.3 Domestic corporations engaged in business as depository banks

under the expanded foreign currency deposit system, otherwise
known a Foreign Currency Deposit Units (FCDUs), on their
income from foreign currency transactions with local commercial
banks, including branches of foreign banks, authorized by the
Bangko Sentral ng Pilipinas (BSP) to transact business with foreign
currency deposit system units and other depository banks under the
foreign currency deposit system, including their interest income
from foreign currency loans granted to residents of the Philippines
under the expanded foreign currency deposit system, subject to
final income tax at ten percent (10%) of such income;
1.4 Resident foreign corporations engaged in business as international

carrier subject to 2% income tax on the "Gross Philippine
Billings";
1.5 Resident foreign corporations engaged in business as Offshore

Banking Units (OBUs) on their income from foreign currency
transactions with local commercial banks, including branches of
foreign banks, authorized by the Bangko Sentral ng Pilipinas (BSP)
to transact business with Offshore Banking Units (OBUs),
including interest income from foreign currency loans granted to
residents of the Philippines, subject to a final income tax at ten
percent (10%) of such income;
1.6 Resident foreign corporations engaged in business as regional

operating headquarters subject to ten percent (10%) tax on their
taxable income; and
1.7 Firms that are taxed under a special income tax regime such as
those in accordance with RA Nos. 7916 and 7227.
2. Determine the gross income subject to MCIT.
2.1 Check the accuracy of the declaration of gross sales/receipts

contributing to income taxable under Section 27 (A) of the Code.
2.1.1 Ascertain the accounting method employed by the taxpayer

and verify consistency in its application. In case of sales of
services by taxpayers employing the accrual basis of
accounting, the term "gross receipts" shall mean amounts
earned as gross income and these shall include amounts
actually or constructively received during the taxable year.
2.1.2 Exclude items of sale specifically exempt from income tax,

and those passive income subject to special tax rates.
2.1.3 Ascertain legitimacy of deductions from gross sales such as

sales returns, discounts and allowances.
2.2 Verify correctness of the claim for cost of goods sold. Ensure that
only business expenses directly incurred to produce the
merchandise to bring them to their present location and use or to
provide the contracted services are included in this account.
a. For trading or merchandising concern, "cost of goods sold"

means the invoice cost of the goods sold, plus import
duties, freight in transporting the goods to the place where
the goods are actually sold, including insurance while the
goods are in transit.
b. For manufacturing concern, "cost of goods manufactured

and sold" means all costs of production of finished goods,
such as raw materials used, direct labor and manufacturing
overhead, freight cost, insurance premiums and other costs
incurred to bring the raw materials to the factory or
warehouse.
c. For sales of services, "cost of services" means all direct

costs and expenses necessarily incurred to provide the
services required by the customers and client including (1)
salaries and employee benefits of personnel, consultants
and specialists directly rendering the service; and (2) cost of
facilities directly utilized in providing the service such as
depreciation or rental of equipment used and cost of
supplies.
Except for banks and other financial institutions,

cost of sales/services shall not include interest expense.
3. Determine the period when the taxpayer becomes subject to the minimum
corporate income tax.
3.2 Verify the year of taxpayer's registration with the BIR to ascertain
whether or not it is subject to MCIT:
a. Firms registered with BIR in 1994 and earlier years are

covered by the MCIT beginning January 1, 1998.
b. Firms registered with BIR in any month in 1998 are covered

three calendar years thereafter.
For fiscal period taxpayer, taxable year 1998 shall

mean any fiscal period ending any day from July 1, 1997 up
to June 30, 1998.
3.3 Ascertain whether the first taxable period under the MCIT of the
taxpayer using fiscal-year accounting covers month/months in 1997
prior to the imposition of MCIT. Be sure that the computed MCIT
due for 1998 using the apportionment formula is correct.
4. Verify if the taxpayer is entitled to the relief from the imposition of the
MCIT and secure documentary proof for the suspension of its imposition
as approved by the Secretary of Finance.
5. Check accuracy of the amount of excess MCIT carried over and credited
against the normal tax within the three (3) immediately succeeding years
from payment thereof, if any. See to it that any excess MCIT are not
claimed against MCIT itself or against any other losses.
B. Improperly Accumulated Earnings Tax
In accordance with Section 29 (A) of the Tax Code, an improperly accumulated

earnings tax equal to ten percent (10%) of the improperly accumulated taxable income is
imposed for each taxable year on the improperly accumulated taxable income of each
corporation identified under Section 27 (B) of the Tax Code.
The improperly accumulated earnings tax shall be determined as follows:
1. Ascertain the classification of the corporation and the business it is

engaged in to determine whether the imposition of the improperly
accumulated earnings tax shall apply. For this purpose, the fact that the
corporation is a mere holding company or investment company is
considered a prima facie evidence of a purpose to avoid the tax upon its
shareholders or members; hence, the 10% tax will automatically apply.
However, the following corporations are not subject to the improperly
accumulated earnings tax:
1.1 Publicly-held corporations;
1.2 Banks and other non-bank financial intermediaries; and
1.3 Insurance companies.
2. Determine the reasonableness of the accumulation of profits or earnings

and if the same is required for the purposes of the business, considering all
the circumstances of the case.
2.1 Look into the following factors to ascertain if the accumulated

profits are reasonably needed in the business:
a. Nature of the company's business;
b. Financial condition of the corporation at the close of the

taxable year;
c. The dividend distribution history of the corporation;
d. The stock of the corporation is widely held in small blocks,
e. The use of the undistributed profits or earnings;
f. Retention of cash, securities and other assets unrelated to

the business operations;
g. Advances or loss to stockholders, whether or not interest

shall be paid;
h. Dealings between the corporation and its stockholders, such

as withdrawals by the shareholders as personal loans or the
expenditure of funds by the corporation for the personal
benefit of the shareholders;
i. The investment by the corporation of undistributed earnings

in assets having no reasonable connection with the
business;
j. The need for business expansion;
k. The earnings and expansion history of the taxpayer;
l. Past savings effected by non-distribution of profits to

stockholders;
m. Past tax avoidance history of the corporation;
n. Portion of shareholder's assets transferred to the

corporation;
o. Sudden shift in corporate or dividend policy of the

company;
p. The percentage of income distributed to shareholders during

the taxable year; and
q. Retirement of stocks, this being a capital transaction and

should result in reduction of capital instead of reduction of
earnings and profits.
2.7 Secure copies of the board resolutions and verify therefrom any
existence of undue accumulation of profits, correlating the findings
with the plans per resolution as against the business activities and
dealings made by the corporation.
2.3 Require the taxpayer to submit documentary proof negating the

clear preponderance of evidence that the profits were permitted to
accumulate beyond the reasonable needs of the company's business.
The accumulation of surplus for the reasonable needs of the
business is not prevented if the purpose is not to prevent the
imposition of the tax upon the shareholders. Undistributed income
may be considered as properly accumulated in the following cases:
a. The profit is retained for working capital needed by the

business;
b. The profit is invested in additions to plants, facilities and

activities reasonably required by the business provided that
the plans for expansion or improvement must be definite,
concrete and capable of fulfillment and not what may be
characterized as nebulous plans for future action.
c. The accumulation of earnings is in accordance with contract

obligations placed to the credit of a sinking fund for the
purpose of retiring bonds.
d. The profit is intended as reserves to meet competition, for

anticipated losses or reverses in business, and to meet
business hazards and emergencies.
2.4 Verify whether the company's increase in capitalization, if any, is

necessary in the light of the existing circumstances surrounding the
business. Ascertain whether declaration of stock dividends from
increased corporate capital was made to go around the surtax since
stock dividends are not taxable unless there is a change of interest,
or unless they are disposed of by the holders or redeemed by the
additional tax if the aforementioned scheme was clearly
established.
3. Determine the amount of improperly accumulated taxable income subject

to the surtax.
3.1 Account for all the company's income during the year.
3.2. Determine all the appropriate adjustments to the improperly

accumulated taxable income. For purposes of imposing the tax, the
taxable income shall be adjusted by the following items:
a. Income exempt from tax; STDEcA
b. Income excluded from gross income;
c. Income subject to final tax; and
d. Amount of net operating loss carry-over deducted.
3.3 Deduct dividends actually or constructively paid and income tax

paid for the taxable year from the adjusted taxable income.
3.4 Exclude the improperly accumulated income as of December 31,

1997 in the computation of accumulated taxable income subject to
tax. The surtax shall likewise not apply to fiscal-period taxpayers
where the twelve (12) month period ended any day from January up
to November 1998.
Compute the 10% surtax based on the adjusted improperly accumulated taxable
income. The computation of the surtax shall be made on a year-to-year basis depending
on the thorough evaluation of the circumstances proving that the company has indeed
permitted itself to accumulate earnings or profits beyond the reasonable needs of the
business.
XII. Auditing Computer-Produced Records
A. Impact of Computer Records on Audit
The use of computers to process accounting data has a significant effect on the
audit skills of the Revenue Officer. The ability to understand and evaluate the taxpayer's
information technology (IT) is important. The Revenue Officer must understand the flow
of accounting data or audit trails on a computerized system to conduct a quality audit.
B. Accounting Software Systems
Auditing computer records require basic techniques used in auditing manual

books and records. There is still a need to:
a. Perform an effective preliminary analysis of the return;
b. Interview the taxpayer;
c. Tour the business premises;
d. Evaluate internal controls;
e. Reconcile the information reflected in the books, financial statements and

the tax returns;
f. Re-evaluate your previous analysis of the return;
g. Set the scope of the audit;
h. Test the amounts you have identified as questionable;
i. Ask questions about the data you have examined;
j. Evaluate auditor's adjustments; and
k. Apply sound accounting principles, relevant provisions of the Tax Code

and existing revenue issuances to reach the proper conclusion regarding
the data examined.
As part of the initial interview, the Revenue Officer should ask questions to
achieve a clear understanding of the taxpayer's books and records, such as:
a. Find out what type of system software is being utilized.
b. Determine who authorizes the debit and credit of certain accounts and
write-off of certain transactions.
c. Determine who encodes the accounting transactions. If the same person

enters both the payables and the receivables, there is no segregation of
functions. This would allow one person to perpetuate or conceal errors by
controlling the offsetting of debits and credits.
d. Find out what reports are generated and how often these are generated.
Identify management reports which may be utilized to disclose audit
findings.
In addition to asking the taxpayer about the particular information system, the
Revenue Officer must study the software manual. The manual will tell how the system
works and the types of reports available. The Revenue Officer shall determine the
reasonable time to be spent in reviewing the software capabilities.
C. Audit Techniques For Computer Produced Records
The traditional audit approach to audit double-entry books and records is to scan
through the general ledger and note any unusual entries. The purpose of this scanning is to
identify entries in the computerized general ledger which are unusual due to the amount,
source or nature.
1. Unusual in Amount
The basic technique for identifying large charges or variations to accounts in a

computerized system consists of securing the monthly statements. Usually, these will be
retained by the taxpayer. The monthly balances are reviewed for changes. Changes in the
monthly account balances are then explored by reviewing the monthly detail and scanning
the check register. The Revenue Officer must consider if the charge or variation could be
expected, is reasonable and in the expected direction, and is material enough to warrant
investigation. For example, if monthly trial balances showed rent expense of P500 and
one month showed P1,500, you would ask the taxpayer about the P1,500 rent expense.
2. Unusual by Source
The basic technique for detecting entries to accounts from unusual sources
consists of comparing monthly posting summaries from each source with the chart of
accounts. A computerized system will utilize monthly posting summaries. These
summaries will show monthly changes to an account, most often by account number and
originating journal. By comparing the accounts which show monthly changes with the
chart of accounts, posting to unusual accounts can be detected. Scan the accounts payable
listings for vendors that appear personal in nature.
3. Unusual by Nature
The basic technique for detecting entries to accounts, which are unusual by nature,
involves the same process as shown for detecting entries from unusual sources. You are
looking for debit posting to accounts which normally contain only credit posting and vice
versa. An example would be a debit to a sales account, which could be a bad debt
written-off. Accounts which exist at the beginning of the year and not at the end might
indicate unauthorized accounting changes.
XIII. Indirect Approach to Investigation
Reconstruction of income is generally employed where the taxpayer keeps no

record or inadequate records, or where there is strong suspicion that the taxpayer has
received income from undisclosed sources.
Over the years, the Bureau of Internal Revenue has developed the following
general methods for reconstructing a taxpayer's income.
A. Percentage method
B. Net worth method
C. Bank deposits method
D. Cash expenditure method
E. Unit and value method
F. Third party information or access to records method
G. Surveillance and assessment method
A. Percentage Method
This method is the equivalent of a ratio analysis of percentages considered typical

of the business under investigation to indicate potential areas of revenue adjustment in
examination where revenue records do not exist. The computed amount of revenues based
on the percentage computation is compared to the amount of revenues reflected on the
return. The percentages used may be obtained from the taxpayer, industry publication,
prior year's audit results, or third parties. The comparison will provide an indication on
the possibility of revenue being understated. The extent of investigation required should
be based on the degree of variance.
It must, however, be emphasized that in comparing transactions of similarly

situated businesses, the name of the particular taxpayer used as the model must not be
divulged to the taxpayer under investigation or in the report as this would constitute a
violation by an internal Revenue Officer of the provisions of Section 270, National
Internal Revenue Code (NIRC) on unlawful divulgence of trade secrets. aDCIHE
Significant ratios and trends to be analyzed are as follows:
1. Percentage Mark-up
This is effective on businesses whose purchases can be readily

broken down in groups with approximately the same percentage of
mark-up.
The purchases should be grouped in items with the same

percentage of mark-up. The appropriate percentage of mark-up would then
be applied to each group of items to arrive at the gross receipts.
The percentage of mark-up can be determined from selling prices

obtained from the taxpayer. However, if cooperation from the taxpayer is
lacking, the information should be obtained from competitive business
establishments in the same industry.
Once the gross receipts are determined, the taxpayer should be

given the opportunity to explain the discrepancy noted between the
reconstructed gross receipts and the amounts reflected in the books and in
the tax returns. The taxpayer may argue that the percentage mark-up
should not be applied to purchases which were stolen, broken or spoiled.
When reconstructing income using the mark-up method, possible

unrecorded purchases should be considered.
2. Gross Profit Ratio or Gross Margin Percentage
The gross profit is expressed as a percentage of sales.
Gross Profit Ratio =

(Sales-Cost Of Goods Sold)

Sales
Note: Sales should be net of Sales Discounts, Returns and Allowances.
Comparison should be made with prior period ratios to evaluate the

taxpayer's own performance in previous years or with other firms in the
same industry.
3. Profit Margin
Net Income
= Profit Margin
Net Sales
If the profit margin is low, this will indicate that the firm's sales
prices are relatively low or that its costs are relatively high or both.
4. Total Assets Turnover

Sales

Total Assets
= Total Assets Turnover
A high rate compared to the industry would signify sufficient

volume of business and if a net loss is declared, questions must be raised
or further investigation and analysis should be performed.
e. Inventory Turnover
The inventory turnover is computed as follows:
Inventory turnover=
Sales

Total Assets
or
Cost of Sales

Beg. Invty. + End Invty./2
If the turnover is low, the company could be holding damaged or obsolete
materials not actually worth their stated volume.
Average inventory at a given point X turnover rate = total purchases during the
year.
B. Net Worth Method
The fact that the taxpayer's books and records accurately reflect the figures on the
income and business tax returns does not prevent the use of the net worth method of
proof. The Revenue Officer can still look beyond the "self-serving declaration" in the
taxpayer's books and records and use any evidences available to contravene their
accuracy. However, this net worth method is most often used when one or more of the
following conditions prevail:
1. The taxpayer maintains no books and records.
2. The taxpayer's books and records are not available.
3. The taxpayer's books and records are inadequate.
4. The taxpayer withholds books and records from investigation/verification

by authorized Revenue Officer(s).
This is a method of reconstructing income which is based on the theory that if the
taxpayer's net worth has increased in a given year in an amount larger than his reported
income, he had understated his income for that year.
In applying this method, it is important to establish the net worth on a fixed

starting date. This is to erase doubts that the increase in net worth or the excess of
expenditures over reported income did not originate from prior accumulated funds (i.e.
hoarded cash or undisclosed assets which do not represent income during the tax year).
1. Net Worth Computation

Assets xxx
Less: Liabilities xxx

Net Worth xxx
Less: Prior Year's Net Worth xxx

Increase (Decrease) in Net Worth xxx
Add: Non-deductible items
Personal, lining and family
expenses xxx
Income tax payments xxx
Insurance Premiums xxx
Gifts xxx
Non-deductible contributions xxx
Net capital loss xxx
Amnesty tax payments xxx
Estate and donor's taxes xxx
Other non-deductible items xxx xxx

Net Income before further
adjustments xxx
Less: Non-taxable items
Gifts, donations and
Inheritance received xxx
Non-taxable stock
Dividends (if reflected
in Assets) xxx
Retirement pay from SSS xxx
Non-recognized gains
from exchange of
property under Sec. 40
of the Tax Code xxx
Social Security benefits
received from foreign
gov't. and institutions
(PD220) xxx
Other non-taxable items xxx

Total non-taxable items xxx

Adjusted net income per investigation xxx
Less: Statutory Exemptions: xxx
1. Exemption of Working
Wife xxx
2. Personal and addt'l.
exemption xxx
3. Special additional
exemption xxx

Total Statutory exemption xxx

NET INCOME SUBJECT TO TAX xxx
===
2. Burden of Proof
The "Net Worth" method to be acceptable must establish with reasonable certainty
an opening net worth, to serve as a starting point from which to compute future increases
in the taxpayer's assets. It must also introduce evidence to support the inference that the
taxpayer's net increases are attributable to currently taxable income.
In computing the increase, the taxpayer's assets are totalled and net worth as
determined at the close of the previous taxable year is subtracted from the total at the
close of the taxable year in question. The remainder, if .any, is the increase for the taxable
year, and constitutes taxable income if no adjustments are required.
However, where net worth increase is the income determinant the Revenue
Officer may, in making the final computation upon which to base the tax, add to the
increase estimated living expenses incurred by the taxpayer since such expenditures are
presumed to have come from income. The taxpayer, on the other hand, is entitled to
reduce the reconstructed income by the amount of depreciation allowable on assets which
are not considered in determining net worth.
The factors to be considered in reconstructing net worth are variable, like

availability of evidence. Generally, net worth has been computed on the basis of some, all
or a combination of the following:
a. bank records
b. securities
c. financial statements
d. fixed assets
e. inventory
f. all available records
3. Determination of Opening/Net Worth: The COHAN Rule
The difficulty of establishing the opening net worth of a taxpayer has led to the
use of the Cohan rule to estimate or approximate the amount of cash at that time. The
Cohan rule (established by the US Seventh Circuit Court of Appeals in Cohan vs.
Commissioner) allows the use of estimates where the taxpayer lacks adequate records.
C. Bank Deposit Method
When the taxpayer's records are apparently inaccurate or manifestly incomplete,

the Revenue Officer may look at the bank deposits of the taxpayer as evidence income.
Under the bank deposit method, the bank records of the taxpayer are analyzed and the
Revenue Officer estimates income on the basis of the total bank deposits after eliminating
non-income items. This method stands on the premise that deposits represent taxable
income unless otherwise explained as being-non-taxable items. This method can be used
if the Revenue Officer has been allowed access to the taxpayer's bank records or if the
Revenue Officer has obtained documented evidence from reliable sources as to the
taxpayer's bank accounts. cSATEH
While the mere deposit of money does not prove the receipt of taxable income as
alleged by the Revenue Officer, the burden is on the taxpayer to prove that various
deposits did not stem from the receipt of taxable income. The passage of time makes it
difficult for the taxpayer to meet this burden but this does not relieve him from showing
the non-taxable source to contradict the Revenue Officer's determination. If the bank
deposit method is used in support of findings of fraud, however, the burden of proof is on
the Revenue Officer.
When computing taxable income under this method, it is appropriate to add to the
amount of the bank deposit the amount of cash expenditures from undeposited funds for
personal expenses which is non-deductible for tax purposes. Withdrawals which can be
identified as deductible are allowed against the taxable income determined.
In using this method, it is proper to prove the existence of a business and the
practice of making deposit of business income into one or more bank accounts and then to
adjust the total deposits for transfers, redeposits, deposits otherwise explained and finally
to allow for ascertainable expenses, deductions and exemptions.
1. Analysis of Bank Deposits
The Revenue Officer's careful analysis of the taxpayer's bank deposits constitutes
the most important phase of his investigation. A review of the taxpayer's personal and
business bank records for several months should be made. The following questions
should be answered in analyzing the taxpayer's deposits:
1.1 Are deposits made on a basis consistent with the information secured
during the initial interview?
1.2 Are there any large or unusual deposits?
1.3 Are there any deposits from sources not reflected on the tax return?
1.4 Did the examination of the taxpayer's cancelled checks reveal additional
bank accounts not previously disclosed by the taxpayer?
1.5 Are there checks endorsed by the taxpayer and deposited into an account
not previously disclosed?
1.6 Are there checks for assets or personal expenses that affect the taxpayer's
standard of living?
2. Computation of Gross Receipts Through Bank Deposit Method

Total Reconciled Bank Deposits xxx
Less: Non-taxable receipts
deposited (sch. 1) xxx

Net Deposits that resulted from
taxable receipts xxx
Add: a. Business expenses
paid in cash (sch. 2) xxx
b. Capital items paid
in cash xxx
c. Personal expenses
paid in cash (sch. 3) xxx
d. Cash accumulated
during the year from
receipts xxx
e. Increase in
Accounts Receivable xxx
f. Decrease in accounts
payable xxx xxx

Total xxx
Less: Non-taxable cash used in
(a) thru (d) xxx
Decrease in accounts
receivable xxx
Increase in accounts
payable xxx xxx

Gross Receipts xxx
===
Schedule 1 Non-Taxable Receipts include:
Checks drawn to cash that were redeposited
Second deposits of NSF checks
Transfers between accounts
Proceeds from loans, social security, exempt interest, etc.
Schedule 2 Business expenses paid in Cash

Total business cash outlays per
returns xxx
Less: Total checks written xxx
Non-business expenses
paid by check xxx
Business expenses paid in check xxx

Business expenses paid in cash xxx
===
Schedule 3 Personal Expenses Paid in Cash
Total personal expenses xxx
Less: Business expenses paid in cash (xxx)

Personal expenses paid in cash xxx
===
Deposits may represent redeposited items and loans, in which case, taxable
income as determined by the Revenue Officer should be reduced by such amounts. When
there is evidence that some of the deposits were for non-taxable items and as such, there
is no proof of the precise amount of taxable income, the Cohan principle may be resorted
to. Deposits may also be shown to represent amounts on hand at the start of the year in
which they are deposited rather than income in that year.
The bank deposit method, like the net worth method, encompasses an area of
uncertainty. Though the taxpayer's records are inadequate for precise and complete
verification of its return, a determination of income by the bank deposit method will be
rejected if it is inconsistent with surrounding circumstances and gives an absurd result.
D. Cash Expenditure Method
An outgrowth of the net worth method of determining income is the "excess cash
expenditure method. This method assumes that the excess of a taxpayer's expenditures
during a tax period over his reported income for that period is taxable to the extent not
approved otherwise. The taxpayer may show that this excess resulted from non-taxable
items such as loans, gifts, inheritance or assets on hand at the beginning of the period.
While it has been said that no opening net worth is needed when the cash
expenditure method is used, the more impressive authority is to the contrary. The two
steps involved in the cash expenditure method are: a) valuation of the taxpayer's assets at
the beginning of the taxable period in order to determine the taxpayer's funds available for
expenditure during the ensuing taxable periods and b) determination of the amount by
which expenditures exceed reported income for the taxable period. To show a failure to
report the full amount of income by the use of this method, it must be demonstrated that
the expenditures made during the taxable year were in excess of the available funds
during the year which were reported on the tax return.
Total expenditures may not include checks drawn to cash and items for which the
taxpayer has paid in cash, unless the cash bank withdrawals were not used to pay for the
cash expenditure. The burden is on the taxpayer to establish the relationship between the
cash withdrawal and individual items. Expenditures may not necessarily come from
income, but very large expenditures for personal purposes each year may be interpreted as
an indication that the income being reported was too small.
Consideration must be given to non-taxable sources of cash. Here, too, the

difficulty of establishing the amount of cash at the starting point has led to the use of
Cohan rule to estimate the cash available at the opening of the taxable period. The method
has to be rejected when it gives an unrealistic result.
Proof in cash expenditure case may be difficult, for it is highly unusual for anyone
to keep accurate records of personal living expenses. However, once the Revenue Officer
has made a determination as to the amount of cash expenditures, the burden of proof to
establish a different amount is on the taxpayer.
E. Cash Expenditure Method
This is not considered as a primary method proof. The determination or

verification of gross receipts may be computed by applying price and profit figures to the
known ascertainable quality of business of the taxpayer. In addition, there are existing
regulatory bodies to which the taxpayer reports units of production or service, some of
which are:
a. records of sugar milled by a sugar central
b. records of fish production to the Bureau of Fishery and Aquatic Resources
c. records of production by pioneer and non-pioneer industries to the Board

of Investments.
E.1. Examples Using Unit and Value Method

Variables for
Item Being Estimate of Item
Industry Tested Being Tested
Pizza Parlor Sales Pounds of flour
used multiply by
number of pizzas
per pound multiply
by average price
per pizza
Gas Station Gasoline Sales Number of liters
sold per supplier's
invoices multiply
by average price
per liter
Exercise Patronage Membership
statistics, club
individual
membership fees,
or monthly dues
Hotels Room Revenue Number of rooms
multiply by
occupancy rate
multiply by
average room rate
Laundry Washer and Cost per machine
Dryer load multiply by
number of times
machine was used
during business
hours and number
of machines
Professional Fees Billed Number of
employees
multiply by
utilization rate
multiply by hours
in a year multiply
by average billing
rate
Real Estate Rental Number of rental
Revenue units multiply
occupancy rate
multiply by
average rent
F. Third Party Information (Access to Records) Method
Third party contacts are a source of information that should not be forgotten. The
Revenue Officer should determine when to make third party inquiries. The decision to
make a third party inquiry is shaped by the size of the peso amount involved and the
volume of the transaction. Third party inquiry through access to records can be time
consuming. The Revenue Officer must weigh the benefits to be realized from work
against the time required to make an access to records and the availability of the needed
information through other methods. The need for the Revenue Officer to obtain third
party information is most often involved in our attempts to verify gross receipts.
XIV. Audit Procedures on Other Kinds of Taxes
A. Withholding Taxes
The following audit procedures outline the steps to be performed by a Revenue

Officer in the determination of the correct amount of withholding taxes due from
withholding agents to ascertain if:
1. The income payments were subjected to withholding taxes.
2. The rate of tax and the amount of tax withheld is correct.
3. The tax withheld is remitted within the due dates.
The audit procedures are classified according to the classification of withholding
taxes, to wit:
1. Withholding Tax on Compensation
2. Expanded Withholding Tax
3. Final Withholding Tax
4. Withholding Tax on Government Money Payments
Audit procedures for the different kinds of withholding taxes.
1. Withholding Tax on Compensation
1.1 Verify the number and list of employees per payroll records and the
list of employees submitted to the Social Security System and the
Department of Labor and Employment as against the alphalist of
employees from whom taxes have been withheld which is attached
to the annual information return (BIR Form 1604CF).
1.2 Examine payroll records. including confidential payroll, if any,

employment contracts, supporting vouchers, receipts for
advances/reimbursements of transportation and representation
expenses, receipts for payment of compensation and reconcile
amount of supported expenses with the figures per financial
statements and withholding tax remittance returns.
1.3 Determine the correctness of the amount of personal and additional

exemptions claimed in the Certificate of Exemption (BIR Form
2305) as accomplished and filed by the employee. Check the
computation of the correct withholding tax per payroll period.
1.4 Examine monthly withholding tax remittance returns (BIR Form

1601C) and compare amounts remitted against the computed
withholding tax on compensation per audit.
1.5 Reconcile the aggregate gross compensation income stated in the

withholding certificate (BIR Form 2316) with the total amount
indicated in the gross compensation income column of the
alphalist.
2. Expanded Withholding Tax
2.1 Check amount payable or paid per income statement and income
tax returns (BIR Forms 1701 and 1701Q) against those declared in
the monthly and annual returns (BIR Forms 1601E and 1604E).
2.2. Ascertain validity of payments by and to prime contractors, and
subcontractors, professionals, brokers, sub-brokers, agents of
entertainers, etc. by examining contracts, subcontracts, vouchers,
receipts and billings.
2.3 Determine the correctness of the amounts subject to withholding

tax by comparing the total payments per supporting documents
against the amount per withholding tax returns.
2.3 Verify the correctness of the payee classification and withholding

tax rate applied.
2.5 Determine the dates of payment or the period when the obligation
to pay the amount subject to withholding tax is due. The time to
withhold is fixed at the time the obligation is due irrespective of
the actual payment. SHacCD
3. Final Withholding Taxes
3.1 Review the contracts for payment of certain items of income to

resident and non-resident payees of interest and rent, Central Bank
approval papers, commercial papers, employment contracts,
contract for payment of royalties, records of prizes or winnings and
financial statements.
3.2 Ascertain if the income payment was subjected to withholding tax

in the year it was accrued, irrespective of whether the taxes
withheld were remitted within ten (10) days following the month in
which the payment was accrued. In the case of withholding tax on
interest on bank deposits, the remittance shall be made quarterly
within twenty five (25) days after the end of each quarter.
3.3 Check the correctness of the basis and rate of withholding tax
applied.
3.3.1 If a preferential tax rate is being availed of, verify the correctness
of the rate used from the ruling issued either by the International
Tax Affairs Division (ITAD) or Law Division. Also verify the
authenticity of said ruling from the issuing office.
3.4 Ascertain the date of accrual of the income payment, to fix the time
to withhold, irrespective of the actual remittance or non-remittance
of the tax withheld by reason of official restriction.
3.5 Verify correctness of remittance against monthly remittance returns

(BIR Form 1601F) and annual information return (BIR Form
1604CF).
4. Withholding Tax on Government Money Payments
4.1 Examine government contracts with suppliers, purchase records,

payment orders, billing records, receipts, vouchers, cash book and
reports of COA auditors.
4.2 Check money payments from vouchers, billing records, records of

purchases, COA audit reports, etc. against monthly remittance
returns (BIR Form 1600), books of accounts and other accounting
records maintained.
4.3 Determine the correctness of bases and rates of tax applied.
4.4 Check whether the correct amount of tax has been withheld and
remitted within the prescribed period. Otherwise, impose
appropriate penalties for non-withholding or non-remittance of the
tax, as the case may be.
B. Be Capital Gains Tax on Sale, Transfer or Exchange of Real Property
This Section equips the Revenue Officer with minimum audit steps prescribed by
existing revenue issuances in the proper determination of the correct capital gains tax due
on sale, transfer or exchange of real properties. Additional audit techniques must be
employed by the Revenue Officer depending on the complexity and materiality of the
transactions involved.
1. Ascertain authenticity of the following documents:
1.1 Deed of Sale/Transfer or Exchange
1.2 Transfer Certificate of Title (TCT)/Condominium Certificate Title

(CCT)/Original Certificate of Title (OCT)
1.3 Latest Tax Declaration
2. If the object of the sale or disposition is the principal residence of natural

persons, verify the following:
1.4 Whether the proceeds of the sale or disposition was fully utilized in
acquiring or constructing a new principal residence of the seller;
and
2.2 Whether such construction or acquisition of such new principal

residence is within eighteen (18) months from date of sale or
disposition.
If both are in the affirmative, the sale or disposition shall be
exempt from capital gains tax, subject to the following conditions:
2.2.1 The historical cost or adjusted basis of the real property

sold or disposed shall be carried over to the new principal
residence built;
2.2.2 The Commissioner shall have been duly notified by the -

taxpayer within thirty (30) days from the date of disposition
through a prescribed return of his intention to avail of the
exemption;
2.2.3 The exemption from capital gains tax shall be availed of

only once in every ten (10) years; and
2.2.4 In case where the proceeds of the sale or disposition is not

fully utilized, the portion for the unutilized part shall be
subjected to tax using the formula:
Gross Selling Price or Fair Market Value
(whichever is higher) x Unutilized
Amount
X 6%
Gross Selling Price
3. For disposition of real property without any improvement, obtain a
certificate from the City/Provincial/Municipal Assessor on the
non-existence of improvement on the real property being sold, transferred
or exchanged.
4. Ascertain correctness of the value of the property sold by conducting an

ocular inspection of the property.
5. If the seller is a non-resident alien claiming exemption from paying the

capital gains tax, check the existence of a ruling issued to that effect
pursuant to RMO 1-2000. Also verify the authenticity of said ruling from
the issuing office.
6. Review computation of the tax base for land and improvement in

accordance with the following:
6.1 When the zonal value of land has been established
6.1.1 Determine the value of improvements by using the formulas

shown below:
a. Total Selling Price/
Consideration per Deed of
Sale (Land and
Improvements) xxx
Less:- Zonal value of Land xxx

Value of Improvements xxx
===
b. Improvements introduced
from 1991 to present:
Construction cost per
building permit and/or
occupancy permit xxx
Improvements introduced
in 1986 to 1990:
Construction cost per
building permit and/or
occupancy permit xxx
Add 10% thereof per
year after year of
Construction xxx

Value of Improvements xxx
===
c. Improvements introduced in 1985 and prior years, and in
cases of improvements in places other than the National
Capital Region and chartered cities where there is no
building permit and/or occupancy permit, use the following
formula:
Fair Market Value (FMV) per latest
tax declaration xxx
Add: 100% of the FMV of the
improvements per latest tax
declaration, if classified as
residential or agricultural other
than fishpond/prawn farm xxx
or
150% of FMV of the
improvements per latest tax
declaration, if classified as
commercial, industrial and/or
agricultural devoted to
fishpond/prawn farm xxx

Value of improvements xxx
6.1.2 Determine tax base of land and improvements as follows:
Zonal value of land xxx
Add: Value of
Improvement under
a, b or c of 6.1.1, as
applicable xxx

Tax base of land and
improvements xxx
===
6.2 When the zonal value of land has not been established
6.2.1 Determine the total selling price/consideration per deed of

sale of land and improvement
6.2.2 Determine value of land and improvements by using the

following formula:
FMV of land per latest tax
declaration
Add: 100% of FMV of
land per latest tax
declaration if
classified as
residential or
agricultural other
than fishpond/prawn
farm xxx
or
150% of FMV of
land per latest tax
declaration, if
classified as
commercial,
industrial and
agricultural devoted
to fishpond/prawn
farm xxx

Value of land
Add: Value of
improvements xxx
(from b or c of 6.1.1)
Value of Land and
Improvements xxx

6.2.3 Select tax base of land and improvements
Selling Price (6.2.1 or total
market value of land and
improvements per 6.2.2),
whichever is higher xxx
===
7. In case of installment sales, determine whether the taxpayer is qualified to
report his gain under the installment basis. An individual is qualified to
account for his gain on installment basis if the initial payment does not
exceed 25% of the selling price. The term "initial payment" means the
payment or payments which the seller receives before or upon execution of
the instrument of sale and payments which he expects or is scheduled to
receive in cash or property (other than evidence of indebtedness of the
purchaser) during the taxable year of sale or disposition. HcSaTI
Example: Assume that on October 15, 1998, an individual sold for

P100,000 a real property with an adjusted basis of P60,000 under the
following terms: P10,000 upon execution of sale; the balance of P90,000
in 18 equal monthly installments of P5,000 each beginning November 15,
1998. The taxpayer qualifies to pay the capital gains tax on installment
because the initial payment consisting of the amount of P10,000 he
received upon sale and the amount he expects or is scheduled to receive
P5,000 on November 15, 1998 and P5,000 on December 15, 1998, or a
total of P20,000 during the year of sale do not exceed 25 % of the selling
price.
7.1 Computation of amount of tax payable on installments.
If the taxpayer qualifies and elects to pay the capital gains

tax in installments, the tax may be paid in installments, the amount
of each installment of which shall be the proportion of the tax so
determined which are:
7.1.1 On the date of sale or disposition, first payment (amount

received, including the excess of the mortgage, if any,
assumed by the purchaser) over the basis of the property
sold; and
7.1.2 In succeeding payments, the installment payment received

by the seller in relation to the total contract price.
Illustrations:
Example 1. Assume that on January 2, 1998, an individual sold a

piece of property with adjusted basis of P60,000 for P100,000 under the
following terms: P20,000 downpayment; balance in five annual
installments beginning 1999. Taxpayer elects and is qualified to pay the
tax in installment. The periodic payment of the tax is computed as follows:
Computation of total tax due:

Selling Price P100,000
Total Tax
Due at
6% thereof P6,000
Portion of the tax payable upon sale or upon receipt of first
payment is determined as follows:
[First payment/Contract price] x Total
Tax Due = Portion of Tax Payable
or
[P20,000/P100,000] x P6,000= P1,200
Portion of the tax payable annually for five years beginning 1999 is
computed as follows:
a. Installment payment
received P16,000
b. Total selling price P100,000
c. Total capital gains tax P6,000
d. Amount payable
annually (a) divided by
(b) multiplied by (c) P960
Example 2. Assume that in 1969, an individual acquired a property
for P60,000. In 1999, he sold the property for P100,000. Terms of sale:
Downpayment, January 2, 1998, P10,000; mortgage assumed, P40,000;
balance payable in four annual installments beginning January 2, 1998.
The taxpayer elects to pay the tax on the gain in installments.
The tax payments on installments received is computed as follows:
Computation of total capital gains tax:

Total Tax Due
at 6% thereof P6,000
Computation of taxes payable on installments:
Upon receipt of first payment

First payment
received P10,000
Total contract price:
Less: Mortgage
assumed by buyer 40,000

Total contract
price 60,000
Total capital
gains tax due P6,000
Amount of tax payable:
[P10,000/P60,000] x P6,000 = P1,000
=======
Amount of succeeding tax payments:
Annual installment
receipts P12,500

Total contract price P60,000

Total capital gains tax P6,000

Annual tax payable on installments:
[P12,500/P60,000] x P6,000
= P1,250
Example 3. Assume that in 1998, an individual sold for P100,000 a
piece of real property which he bought in 1980 for P40,000. Prior to sale,
the property was mortgaged for P60,000. The terms of sale are as follows:
Downpayment, P10,000; assumption of unpaid mortgage, P50,000;
balance of P40,000 payable in four semi-annual payments beginning
January 15, 1999. The taxpayer elects to pay the tax in installments.
Amount of tax payable in installments is computed as follows:
Computation of total capital gains tax:

Total Tax
Due at
6% thereof P6,000
Computation of tax payment in the year of sale:
First payment:
Cash P10,000
Excess of mortgage
assumed by buyer
over the
acquisition cost
(P50,000-P40,000) 10,000

Total first payment 20,000
=======
Total Contract Price:
Less: Mortgage
Assumed 50,000

P50,000
Add: Excess of
mortgage
assumed
over basis of
property sold 10,000

Total contract price P60,000
=======
Total basis of tax payable on first payment:
First payment P20,000
Contract Price P60,000
Total capital gains tax P60,000
Amount of tax payable on first payment:
P20,000/P60,000 x P6,000
= P2,000
Basis of tax payable on succeeding semi-annual payments:
Installment
received P10,000
Total contract
price P60,000
Total tax due P6,000
Amount of tax payable semi-annually:
[P10,000/P60,000] x 6,000 = P1,000
======
8. Confirm payment of Capital Gains Tax by cross-checking the payment
thereof with the Batch Control Sheet prepared by the bank or the
Collection Officer, as the case may be.
9. When there is delay in the presentation of sales, documents, require the

taxpayer to submit documents such as cancelled checks, official receipts or
certification of the archive official to show that there is no ante-dating of
public instrument. The rules and regulations applicable at the date of
execution of the contract shall be applied and the increments for late filing
and payment of tax shall be imposed.
If the taxpayer cannot show proofs that the same is not ante-dated,
the rules applicable at the time of presentation of the document shall apply.
C. Estate Tax
The following audit procedures were culled from existing revenue issuances. They
enumerate the steps to be taken by a Revenue Officer in the processing, verification and
investigation of estate tax returns of resident and non-resident decedents subject to estate
tax. However, these do not preclude the application of other audit procedures as
warranted by the circumstances surrounding each case.
1. The estate tax return of a decedent and all his unverified income tax
returns for the last three years prior to his death shall be simultaneously
investigated by a Revenue Officer or a group of Revenue Officers, if so
provided in the annual Audit Program. SEcTHA
The Revenue Officer should see to it that an income tax return

covering the income and deductions of the decedent from January 1 to the
date of his death has been filed. If the period covered by the return consists
of less than twelve (12) months, such period shall be considered as a
"taxable year".
2. If the settlement of the estate of the decedent is the object of judicial
testamentary or intestate proceedings, ascertain if:
2.1 An income tax return for the estate as a taxable person has been
filed by the fiduciary or administrator; and
2.2 Individual returns for the spouse, heirs or beneficiaries have been
filed covering their respective income from the estate and
applicable deductions for the period from the date immediately
following the death of the decedent to the end of the taxable year.
The estate's income tax return shall cover the income and
deductions of the estate for the period from the date immediately
following the death of the decedent to the end of the taxable year.
Thereafter, quarterly and annual returns for the estate shall be filed
until the estate is divided and distributed to the rightful heirs and
beneficiaries.
3. If the settlement of the estate is not the object of judicial testamentary or

intestate proceedings, verify if the income of the properties left by the
decedent is included in the income tax return of each heir or beneficiary
according to his distributive share in the net income of the estate or
co-ownership.
4. Verify if a Notice of Death was filed within two (2) months after the
decedent's death where the gross value of the estate exceeds twenty
thousand pesos (P20,000). In case of failure to file the notice, impose the
appropriate penalty even after the lapse of the prescribed period of two (2)
months after the qualification of the executor or administrator. This
contemplates the filing of the estate proceedings in courts and the
appointment of the executor or administrator by the court.
5. Determine if the value of the gross estate exceeds two million pesos
(P2,000,000). If so, check whether the estate tax return is supported by a
statement duly certified by a Certified Public Accountant showing the
following information:
5.1 Itemized assets of the decedent with their corresponding gross

value at the time of his death, or in the case of a non-resident alien,
of that part of his gross estate situated in the Philippines;
5.2 Itemized deductions from gross estate allowed under Sec. 86 (A) of
the Tax Code; and
5.3 The amount of tax due whether paid or still due and outstanding.
6. Examine the inventory of assets and/or liabilities not reported in the said
return. Prepare an adjusted schedule of assets and liabilities as basis in
computing the yearly increase in the net worth of the taxpayer up to the
time of his death.
7. Inquire on the source of acquisition of the property left by the decedent,

whether it was acquired by purchase, donation or inheritance, for the
purpose of ascertaining if such property is conjugal, exclusive or
paraphernal property of the deceased.
8. Scrutinize the provisions of the insurance policies taken out by the

deceased upon his own life as to the designation of the beneficiary. If the
designation is revocable, the proceeds of the life insurance shall be
included in the gross estate. If irrevocable, the proceeds thereof shall be
excluded from the gross estate, irrespective of whether or not the insured
retained the power of revocation, if the beneficiary named in the policy is
the estate of the decedent.
9. Verify if the land, as part of gross estate specially urban land, include
improvements and buildings. Secure a certification from the Assessor's
Officer as to the existence of non-existence of improvements on the land.
Conduct an ocular inspection of the land whenever possible.
10. Conduct third party verification on certain government agencies such as

Office of the Register of Deeds, Securities and Exchange Commission,
Land Transportation Office, Office of the Provincial, City or Municipal
Assessor for possible properties listed and registered in the name of the
decedent which may not have been included in the estate tax return.
11. Inquire into the bank deposits or other investments of the decedent.
Pursuant to Sec. 6 (F)(1) of the Tax Code, the Commissioner is authorized
to look into the bank deposits of a decedent for estate tax purposes, the
provisions of Republic Act No. 1405 and other general or special laws
notwithstanding. Foreign currency deposits, if any, shall be converted
using the foreign exchange rate.
12. Ascertain if the shares of stocks are properly valued. In doing so, observe
the following rules on valuation pursuant to RAMO No. 1-82:
12.1 For stocks listed or traded in the stock market:
12.1.1 The selling price shall be used where there are sales made
on the valuation date. The mean between the highest and
lowest selling prices on valuation dates shall be the fair
market value per share.
12.1.2 If there were no sales on the valuation date but there were
sales on dates within a reasonable period both before and
after the valuation date, the fair market value is determined
by taking the weighted average of the mean between the
highest and the lowest sales in the nearest trading date after
the valuation date. The weighted average is to be computed
inversely by the respective number of trading days between
the selling dates and the valuation date. The reasonable
period of valuation must not exceed six months before or
after the valuation date.
Example:
The valuation date is January 15, Friday. Sales of

stock occurred on January 13, Wednesday or two trading
days before valuation date at P10.00 and on Wednesday,
January 20, three days after valuation date at P15.00, the
fair market value of the shares to be taken is P12.00
computed as follows:
(3xP10) + (2x15) = P30 + P30 = 60 = P 12.00

5 5
12.1.3 If actual sales of the shares are not available during a
reasonable period beginning before and ending after the
valuation date, the fair market value may be determined by
taking the mean between bona fide bid and asked prices on
the valuation date, or if none, by taking the weighted
average of the mean between the bona fide bid and asked
prices on the nearest trading date before and after the
valuation date within a reasonable period in accordance
with the formula in the preceding paragraph.
12.1.4 If there are no sales or bonafide bid and asked prices

available on a date within a reasonable period before the
valuation date, but such prices are available on a date
within a reasonable period after the valuation date, then the
mean between the highest and lowest available sale prices
or bid and asked prices nearest the valuation date may be
taken as the value of shares. DHIcET
12.1.5 If it is established that the selling or bid and asked prices as

provided in the foregoing paragraphs do not reflect the fair
market value thereof, modifications of the basis are to be
made taking into consideration other relevant facts and
elements of value. In some exceptional cases, the size of the
block of stocks to be valued in relation to the number of
shares transferred in sales may affect adversely the fair
market value of the stocks to be valued.
12.2 For unlisted stocks or stocks not quoted or traded in the stock
market:
12.2.1 In general, the unlisted shares shall be valued at their book

value nearest the valuation date. The book value of these
unlisted shares of stock shall be prima facie considered as
their fair market value.
12.2.2 In case the shares are valued on a basis lower than their
book values, a justification for the deviation from the book
value, together with the evidences in support thereof should
be submitted. The following factors are considered relevant
in the valuation of shares of stock of closed corporations:
a. The nature of the business and the financial history

of the enterprise, from the date of the incorporation;
b. The economic outlook in general and the business

condition and outcome of the specific industry in
particular;
c. The financial conditions of the business;
d. The earning capacity of the company;
e. The dividend paying capacity;
f. Goodwill;
g. Sales of stocks and size of the block of stock to be

valued;
h. Market price of stocks of corporations engaged in

the same or similar line of business to be valued;
i. Existence of corporate debts in favor of the family

of the principal;
j. Restrictive agreements impairing the alienity of the

stock;
k. Investments in business or property maintained at a

deficit;
l. Dividend arrearages;
m. Voting rights of stockholders; and
n. Difficulty in liquidating the assets.
If such lower fair market valuation is not

clearly established and documented, the book value
of the unlisted shares of stocks shall be adopted. If
there have been previous bona fide sales/exchanges
of the unlisted shares of stock, the price at which
these shares exchange hands should be
taken/considered as its fair market value/s. Preferred
shares of stocks shall always be valued at par.
13. Audit of itemized deductions under Section 86 (A) of the Tax Code:
13.1 Funeral Expenses
Require the submission of invoices or official receipts

evidencing actual funeral-expenses. Only actual funeral expenses
or an amount equal to 5% of the gross estate whichever is lower,
but in no case shall exceed P200,000, may be allowed as a
deduction from gross estate.
13.2 Judicial Expenses
Check if the settlement of the estate is the object of judicial

testamentary or intestate proceedings. If not, no deduction for
judicial expenses shall be allowed. However, a reasonable amount
for legal fees and accounting expenses incurred in the settlement of
the estate of the decedent may be allowed. Scrutinize legal fees
deducted in the estate tax return by checking the nature of the
payment, the person to whom it was paid and the date of payment.
13.3 Claims Against The Estate
13.3.1 Verify if the claim is subject to Mortgage Redemption

Insurance (MRI). If so, disallow deduction claimed.
13.3.2 In the verification of claims against the estate, secure

certified true copies of the following documents and verify
them:
a. Duly notarized promissory notes or contract of loan

signed by the debtor if the loan was contracted
within three (3) years before the death of the
decedent.
b. Vouchers, cancelled checks or other documents
evidencing the advances made by individuals or
corporations to the deceased;
c. Latest balance sheet of the corporation; and
d. Other documents or evidences relevant to the grant

of the loan, i.e., real estate or chattel mortgage, a
copy of the Transfer Certificate of Title to show
annotations thereof.
13.3.3 Check the statement submitted by the administrator or

executor regarding the disposition of the proceeds of the
loan. If the administrator or executor fails to satisfactorily
explain, in whole or in part, the disposition of the proceeds
of the loan contracted within three (3) years before the
death of the decedent, such proceeds or a portion thereof
may be included as cash in the gross estate.
13.3.4 Where the settlement is made through the court in a testate

or intestate proceeding, scrutinize pertinent documents filed
with the court evidencing claims against the estate or the
court order approving the said claims, if a decision thereon
has already been issued.
13.3.5 Obtain a sworn certification from the creditor as to the

exact balance of the liability of the deceased. The
certification must be duly signed by the president,
vice-president or other principal officer of the corporation
in case the creditor is a corporation.
13.3.6 Ensure that the creditor agrees in writing allowing the

verification by the Revenue Officer of his pertinent records
for the purpose of substantiating the claims against the
estate of the deceased.
13.4 Claims Against Insolvent Persons
13.4.1 Determine if the Accounts, or Notes Receivable has been

included as part of the gross estate. If not, disallow the
claim as a deduction.
13.4.2 Find out if the claims against insolvent persons may be

considered as conjugal or separate property of the decedent.
In case the claim is the exclusive or paraphernal property of
the decedent, the same should not be considered in the
computation of the share of the surviving spouse.
13.5 Vanishing Deduction (Property Previously Taxed)
Ascertain compliance with all of the following conditions

so that the claim for vanishing deduction may be allowed:
13.5.1 The prior decedent must have died or the donation must
have been made within five (5) years before the decedent's
death. acCITS
13.5.2 The property subject to the vanishing deduction must be the

same property inherited or donated from the prior decedent
or donor.
13.5.3 The vanishing deduction is based on the value of the

property at the time of the donation or death of the prior
decedent or at the time of the death of the present decedent,
whichever is lower. The deduction is based on the value of
each individual property.
13.5.4 The estate tax or donor's tax due on the donation or estate
of the prior decedent must have been paid.
13.6 Transfers for Public Use
Failure to comply with any of the following requisites will

result in the disallowance of the deduction:
13.6.1 The transferee is the government or any political

subdivision thereof and the transfer is exclusively for public
purpose.
13.6.2 The transfer must be by way of a last will and testament or

donation mortis causa executed by the deceased before his
death.
13.7 Losses
Examine closely the losses being claimed as a deduction

from gross estate. Disallow the deduction if any of the following
conditions is absent:
13.7.1 The value of the property lost must have been included in
the gross estate.
13.7.2 The loss must not have been compensated for by insurance,
in whole or in part.
13.7.3 The loss must not have been claimed as a deduction for
income tax.
13.7.4 The loss must have been incurred not later than six (6)
months after the decedent's death.
13.8 Family Home
Check the computation for the allowance for Family Home

as a deduction from the gross estate and its corresponding valuation
in accordance with RR No. 17-93, to wit:
13.8.1 Valuation of Family Home
The decedent's family home shall be appraised as of

the time of his death, at its current or fair market value or
zonal value, whichever is higher.
13.8.2 Conditions for the allowance of family home as a deduction

from the gross estate:
a. The family home must be the actual residential

home of the decedent and his family at the time of
his death, as certified by the Barangay Captain of
the locality where the family home is situated;
b. The total value of the family home must be included

as part of the gross estate of a person who died on or
after July 28, 1992, the date of effectivity of R.A.
7499; and
c. Allowable deduction must be in the amount

equivalent to the fair market value or zonal value of
the family home as declared or included in the gross
estate but not exceeding P1,000,000.
To illustrate:
1. Decedent is an unmarried head of a family:

Real and personal properties P5,000,000
Family Home 2,000,000

Gross Estate P7,000,000
(Less): Deductions
Other deductions P2,000,000
Family home 1,000,000
Standard deduction 1,000,000 (4,000,000)

Net Taxable Estate P3,000,000
=========
Note: Although the family home is valued at P2 million, the maximum allowable
deduction for the family home is P1 million only.
b. Real and personal properties P5,000,000
Family home 800,000

Gross Estate P5,800,000
(Less): Deductions
Other deductions P2,000,000
Family home 800,000
Standard deduction 1,000,000 (3,800,000)

Net Taxable Estate P2,000,000
=========
Note: Deduction for family home is allowed for P800,000 only which is the declared
value of the family home.
2. Decedent is a married man with surviving spouse:
a. The family home is the decedent's exclusive property.
Exclusive Conjugal Total

Conjugal Properties:
Real properties P5,000,000 P5,000,000
Exclusive Properties:
Family home P2,000,000
Other exclusive properties 2,500,000 4,500,000

Gross Estate P4,500,000 P5,000,000 P9,500,000
(Less): Conjugal Deductions
Other deductions (2,000,000) (2,000,000)

Net Estate After Conjugal
Deductions P4,500,000 P3,000,000 P7,500,000
(Less):
Share of surviving spouse (P3,000,000/2) (1,500,000) (1,500,000)
Family home (1,000,000) (1,000,000
Standard deduction (1,000,000) (1,000,000)

Net Taxable Estate P3,500,000 P500,000 P4,000,000
========= ========= =========
b. Family home is a conjugal or community property

P2,000,000
Other real properties 5,000,0005,000.000
Exclusive Real Properties P2,000,000 P2,000,000

Gross Estate P2,000,000 P7,000.000 P9,000,000
(Less): Deductions:
Conjugal deductions (P2,000,000) (P2,000,000)
Share of surviving
spouse:
Conjugal property P7,000,000
Less: Conjugal 2,000,000

deductions P5,000,000
Net conjugal estate
Share of surviving
spouse (2,500,000) (2,500,000)
Family home (1,000,000) (1,000,000)

========= ========= ========
Note: Family home allowance of P1,000,000 is considered as one item of deduction after
the computation and deduction of the net share of the surviving spouse in the
conjugal property.
c. Same facts and figures as in (b) except for family home which has a fair
market value/zonal value of only P1,500,000.

P1,500,000
Other real properties 5,000,000
5,000,000
Exclusive Real Properties P2,000,000 2,000,000

Gross Estate P2,000,000 P6,500,000 P8,500,000
(Less): Deductions:
Conjugal deductions (2,000,000) (2,000,000)
Share of surviving
spouse:
Conjugal property P6,500,000
Less: Conjugal
deductions 2,000,000

Net conjugal estate P4,500,000
Share of surviving
spouse (2,250,000) (2,250,000)
Family Home (750,000) (750,000)

========= ========= ========
Note: Since the fair market value/zonal value of the conjugal family home in the above
example is P1,500,000, the Family Home deduction corresponding to of such
fair market value/zonal is P750,000 only.
d. Family home is conjugal property, but lot on which it stands is exclusively

property.

Other real properties P3,000,000 P3,000,000
Family home 1,000,000 1,000,000
Exclusive Real Properties
Other real properties P2,000,000
Family lot 400,000 2,400,000

Gross Estate P2,400,000 P4,000,000 P6,400,000
(Less): Deductions:
Other deductions (1,000,000) (1,000,000)
Share of surviving
spouse
Conjugal properties P4,000,000
Less: Conjugal
Deductions 1,000,000

Net conjugal estate P3,000,000
Share of surviving (1,500,000) (1,500,000)
spouse
Family home and lot P400,000 (500,000) (900,000)
(P500,000 + P400,000)

Net Taxable Estate P2,000,000 P- P2,000,000
========= ========= ========
3. Family home is conjugal property and both spouses died in the same year, leaving
three (3) children:
a. Estate of HUSBAND:

Real properties P6,000,000 P6,000,000
Personal properties 4,000,000 4,000,000
Family home 2,000,000 2,000,000
Exclusive Properties:
Real properties 4,000,000 4,000,000
Personal properties 1,000,000 1,000,000

Gross Estate 5,000,000 12,000,000 P17,000,000
(Less): Deductions:
Conjugal deductions 4,000,000 4,000,000

Net Estate 5,000,000 8,000,000 P13,000,000
Less: Share of surviving spouse (4,000,000) (4,000,000)
Family home (1,000,000) (1,000,000)

Net Taxable Estate 5,000,000 P2,000,000 P7,000,0000
========= ========= =========
b. Estate of WIFE:
Inherited Share from
Portion from Conjugal Total
Husband Estate
Conjugal real properties P750,000 * P3,000,000 P3,750,000
Conjugal personal properties 500,000 * 2,000,000 2.500,000
Family home 250,000 * 1,000,000 1,250,000
Exclusive properties 1,000,000 - 1,000,000
Paraphernal/exclusive personal
properties 250,000 - 250,000

Gross Estate P2,750,000 P6,000,000 P8,750,000
(Less): Deductions:
Other deductions P500,000 (2,000,000) (1,000,000)
Family home (1,000,000) (2,500,000)
Vanishing deduction ** (1,964,286) (1,964,268)

Net taxable estate P285,714 P2,000,000 P2,285,714
======== ========= ========
* In addition to of the gross estate, the wife had a share as inheritance from the
husband equivalent to the share of each child. Hence, since there were 3 children,
the wife had a share of 1/4 on the other half of the estate. cDCSET
** Vanishing deduction:
Inherited properties P2,750,000
Less: 2,750,000 x P2,500,000 =

8,750,000 785,714

Amount subject to vanishing deductionP1,964,286
100% Vanishing Deduction P1,964,286
========
13.9 Standard Deduction
An amount equivalent to one million pesos (P1,000,000) is

allowed as a deduction pursuant to Sec. 86 (A) (5) of the Tax Code.
13.10 Medical Expenses
Medical expenses incurred by the decedent within one (1)

year prior to his death subject to the following conditions:
a. It must be substantiated by receipts.
b. The deductible amount shall not exceed five hundred

thousand pesos (P500,000).
13.11 Amount received by heirs under R.A. 4917
Any amount received by the heirs from the decedent's

employer or as a consequence of the death of the
decedent-employee in accordance with Republic Act No. 4917,
shall be allowed as a deduction, provided that such amount is
included in the gross estate of the decedent.
13. In case of death of an individual who is a VAT-registered person, verify if

the Value-Added Tax (VAT) has been paid or imposed on the transfer or
transmission of the business assets to the heirs, even if the estate or the
heirs of the decedent continue to operate the business. If the business
assets are conjugal, only one-half (), representing the share of the
deceased, is subject to VAT.
D. Donor's Tax
Provided hereunder is an outline of the audit procedures which may be followed

by a Revenue Officer in the processing and verification of donor's tax returns.
1. Determine if the donor's tax return has been filed within thirty (30) days
from the date of donation. If not, impose penalties incident to late filing
and late payment of tax.
2. Verify if the donor has made previous donations during the same taxable
year from existing records available in the Revenue District Office or the
Assessment Division for purpose of determining how much is the gross
gift to date.
3. Ascertain authenticity of the following documents:
3.1 Deed of Donation
3.2 Transfer of Certificate of Title (TCT)/Condominium Certificate of

Title (CCT)/Original Certificate of Title (OCT), for real properties
3.3 Latest Tax Declaration, for real properties
4. If donation involves shares of stocks, verify proper valuation thereof by

following the procedures prescribed under RAMO No. 1-82. (Refer to
procedure No. 12 in the investigation/verification of the estate tax
liabilities of the decedent).
5. Determine whether the essential elements of a gift are present.
6. Ascertain whether the gross gift has been valued either at adjusted fair
market value or zonal value, whichever is higher, at the time of the
donation.
7. Determine the relation between the donor and the donee for the imposition
of the proper donor's tax rate.
8. Verify if the donation of the land includes improvements and buildings.

Secure a certification from the Assessor's Office as to the existence or
non-existence of improvements on the real property donated. Donation of
land ordinarily includes the improvements unless specifically excluded in
the Deed of Donation.
9. In case where the deduction is claimed, like liabilities or mortgage required

to be assumed by the donee as a condition of the donation:
9.1 Ascertain the correct balance of the indebtedness as of the time of

the donation.
9.2 Verify the genuineness of the deduction claimed and require the
submission of pertinent documents in support of the deduction.
9.3 Verify if the assumption of the liability is expressly stipulated in

the Deed of Donation and is duly accepted by the donee.
Otherwise, the claimed deduction should be disallowed.
XV. General Policies in the Investigation of Tax Fraud Cases
A. Jurisdiction
1. Tax Fraud Division
1.1 The Tax Fraud Division (TFD) shall have jurisdiction to conduct or
undertake the investigation and/or reinvestigation of cases referred
to or developed by the Division, and those assigned referred or
approved by the Commissioner of Internal Revenue.
2. Special Investigation Division (SID)
2.1 The SID shall have jurisdiction over the following cases:
a. Tax fraud cases referred to it by the Intelligence and

Investigation Service (IIS).
b. Tax fraud cases initiated and developed by the SID; and
c. Tax fraud cases referred to it by the Revenue District Office

(RDO).
3. Revenue District Offices
3.1 If in the course of the regular examination of returns, indications of

fraud were discovered, the RDO must transmit the records of the
case immediately to the SID which will conduct the formal
investigation thereof.
This shall be considered sufficient compliance with RMO
No. 44-93.
B. Procedures
A preliminary investigation must first be conducted to establish the prima facie

existence of fraud. This shall include the verification of the allegations on the confidential
information and/or complaints filed, and the determination of the schemes and extent of
fraud perpetrated by the denounced taxpayers.
The formal fraud investigation, which includes the examination of the taxpayers'
books of accounts through the issuance of Letters of Authority, shall be conducted only
after the prima facie existence of fraud has been established.
1. Tax Fraud Division
1.1 Where indications of fraud have been established in a preliminary

Investigation, the TFD through the Assistant Commissioner,
Enforcement Service (ES) shall request/recommend the issuance of
the corresponding Letter of Authority by the Commissioner which
will automatically supersede all previously issued Letters of
Authority with respect thereto. TCIDSa
1.2 Thereafter, a copy thereof shall be immediately furnished the RDO

and/or the SID of the Revenue Region having jurisdiction over the
taxpayer who, upon receipt thereof, must immediately transmit to
the TFD all the documents in their possession relative thereto; and
must withdraw and cancel any issued Letter of Authority pertaining
thereto.
No letter of Authority shall be Issued for any taxpayer

already covered by a Letter of Authority issued by the
Commissioner.
1.3 Reports on cases recommended for criminal prosecution shall be

forwarded to the Assistant Commissioner, Legal Service, Attn:
Litigation and Prosecution Division, through the Inspection Service
(IS). However, if after evaluation, the Litigation and Prosecution
Division resolves that the evidence is not sufficient to warrant the
filing of a criminal action against the taxpayer, the case shall be
referred back to the TFD through the IS, for further documentation
and/or appropriate action.
1.4 No Assessment Notice shall be served upon any taxpayer

recommended for criminal prosecution for tax evasion, following
the Supreme Court's ruling in the case of Ungab vs. Cusi, 97 SCRA
877.
1.3 All other reports on cases not recommended for criminal

prosecution shall be forwarded to the Commissioner, through the
ES, for approval.
2. Special Investigation Division
2.1 The Chief of the SID shall issue the corresponding Letter of
Authority if the prima facie existence of fraud has been established,
and the same has been confirmed by the Regional Tax Fraud
Committee (RTFC), composed of the following:
a. Regional Director - Chairman
b. Chief, SID - Member
c. RDO having jurisdiction over the taxpayer - Member
d. Chief, Assessment Division - Member
e. Chief, Legal Division - Member
The RDO shall then desist from issuing any Letter of

Authority to the taxpayer concerned, and shall transmit to the SID
all the documents in its possession relative thereto.
However, the RDO may assign one Revenue Officer, whose

name shall be included in the Letter of Authority as the "RDO
Assisting Revenue Officer" (RARO), to assist and coordinate with
the SID in the formal investigation.
2.2 Where the SID has established the prima facie existence of fraud
against a taxpayer who has been the subject of an on-going or
terminated investigation by the RDO, the SID shall nevertheless
forward the records of the case for evaluation to the RTFC.
If after evaluation the RTFC confirms to the SID the prima

facie existence of fraud, the following procedures shall be
followed:
2.2.1 Where the investigation is on-going the RDO concerned

shall withdraw its Letter of Authority and immediately
cease and desist from further investigation. The records of
the case shall then be forwarded to the SID concerned
which, thereafter, shall issue a Letter of Authority and
proceed with the formal fraud investigation.
2.2.2 Where investigation is already terminated the office who

has possession of the records shall, upon written request,
immediately forward the records to the SID concerned.
If a re-investigation is necessary, the SID shall

forward the same to the IIS with a recommendation for the
issuance of the corresponding Letter of Authority by the
Commissioner of Internal Revenue.
2.3 Where the business activities and/or establishments are situated in

more than one revenue region, the tax fraud case must be referred
to the TFD through the IIS.
2.3.1 If a prima facie existence of fraud was not established, after

conducting the preliminary investigation, but a potential
deficiency tax assessment exists, the case shall be referred
to the RDO concerned for appropriate action.
2.3.2 Reports on cases recommended for criminal prosecution

shall be forwarded to the Legal Division of the Revenue
Region. If after evaluation and the Legal Division resolves
that the evidence is not sufficient to warrant the filing of a
criminal action against subject taxpayer, the case shall be
referred back to the SID, for further documentation and/or
appropriate action.
2.3.3 Reports on cases not recommended for criminal prosecution

shall be forwarded to the Assessment Division of the
Region.
3. Revenue District Offices
3. Upon discovery of the indication(s) of fraud during the regular

examination of the returns, the Revenue Officer should make a
detailed report thereof to Revenue District Officer who shall
immediately transmit the records of the case to the SID.
4. The RDO shall then assign a RARO to assist and coordinate with
the SID in the investigation of the said case.
A. Civil Fraud
In the case the quantum of evidence gathered does not warrant a criminal
prosecution because it is not sufficient to prove the guilt of the taxpayer beyond
reasonable doubt, but there exists a clear and convincing evidence that fraud has been
committed, a corresponding 50% surcharge shall nevertheless be imposed.
XVI. Closing Conference
Essential to an effective audit of internal revenue tax liabilities is the holding of a

closing conference with the taxpayer before the preparation of the final report of
investigation by the Revenue Officer assigned to the tax case. During this time, the
Revenue Officer and his supervisor explain to the taxpayer how the assessment of his tax
liability was arrived at. If necessary, the records of the case shall be presented to the
taxpayer to document the Revenue Officer's findings. The taxpayer shall then be allowed
to examine such records and to present his arguments. If the taxpayer agrees with the
audit findings, he shall be made to sign an Agreement Form. If not, the Revenue Officer
shall give the taxpayer enough time to document his objections to the proposed
assessment. In both cases, the report of investigation shall be prepared and submitted to
the Revenue District Officer for review and pre-approval prior to final review by the
Assessment Division of the Regional Office or by the concerned office in the National
Office (NO) for cases investigated by the audit divisions/teams in the NO.
Upon receipt of the report of investigation, the Revenue District Officer (RDO) or
head of the audit division/team in the NO shall send to the taxpayer a notice for informal
conference. The notice should be accompanied by a summary of the Revenue Officer's
findings.
The notice shall be made in writing and sent to the taxpayer at the address
indicated in his return or his last known address. This notice, however, may be dispensed
with in case the taxpayer agrees in writing to the proposed assessment, or where such
proposed assessment has been paid. EHCDSI
In case the taxpayer responds to the notice within the period prescribed in the
informal conference letter, he or his duly authorized representative shall again be allowed
to examine the records of the case and to present his arguments in writing protesting the
proposed assessment. Thereafter, the RDO or head of office/team shall, on the basis of
the evidence on record, decide whether or not to approve the report before forwarding it
to the Assessment Division or concerned office in the NO for approval and issuance of
the corresponding Termination Letter or Assessment Notice, as the case may be.
In the event the taxpayer fails to respond to the notice for informal conference
within the prescribed period, or when the response is found to be without merit, the report
of investigation shall be given due course and shall be forwarded to the Assessment
Division or to the concerned office in the NO for review.
XVII. Report Making
The Revenue Officer is required to make a report after the investigation/audit has
been conducted. Before starting to write a report, the Revenue Officer should have in
mind a definite outline as to arrangement in which the facts and evidence may be
presented in the most effective manner. A good general plan is to state the problem,
present the results of the investigation and set forth the conclusions and
recommendations.
The report to be prepared by the Revenue Officer in the conduct of his

investigation shall contain the following:
A. Document Locator Form (BIR Form 23.02)
This form, which shall be duly accomplished by the Revenue Officer, indicates the
dates when the docket was received and acted upon.
B. Table of Contents
The table of contents shall indicate the description and page number of each and
every document attached to the report.
C. Narrative Report
This is a memorandum report prepared and submitted by the Revenue Officer. The
narrative report shall contain the following:
1. A preliminary statement stating:
1.1 the basis of the authority to investigate, specially the Letter of

Authority Number, Tax Verification Notice Number, or Referral
Number, date issued/served and details of referrals or revalidations,
if any;
1.2 type of investigation/verification undertaken; and
1.3 profile of the taxpayer, particularly the type of business

organization, nature of business, product line, other sources of
income, information of its registration with the SEC, BOI, EPZA,
etc., identification of major owners/stockholders and
subsidiaries/affiliates, if relevant, brief description of accounting
system/method used, description of any extraordinary business
activity and kinds and amounts of incentives availed of, if any.
2. A brief description of the approach in investigation stating:
2.1 the books of accounts, records and documents verified;
2.2 the audit procedures adopted;
2.3 access to records undertaken;
2.4 the authorized representative of the taxpayer; and
2.5 the dates and results of conferences.
3. Results of investigation summarizing:
3.1 the audit findings;
3.2 discrepancies discovered, disallowances made and other relevant

facts uncovered during the examination;
3.3 basis of computation of recommended deficiency taxes/tax credit

or refund. if any; and
4. A recommendation for:
4.1 the review/approval of the report of investigation and issuance of

termination letter after collection of the deficiency tax;
4.2 assessment of deficiency taxes indicating the prescription of the

case;
4.3 issuance of tax credit/refund; or
4.4 such other recommendations as may be necessary under the

circumstances.
D. Duly Accomplished Revenue Officer's Audit Report
These forms are required to be accomplished properly and accurately by the

Revenue Officer in reporting the results of investigation/verification. BIR Forms 1717 are
used for non-computerized district offices while BIR Forms 0500 are prescribed for
computerized districts under the BIR's Integrated Tax System (ITS).
BIR Form 1717A/0500 This form shall be accomplished by all Revenue

Officers in reporting results of investigation/verification of income tax liabilities of
taxpayers.
BIR Form 1717C/0501 This form is to be used in reporting results of

investigation on Capital Gains Tax on real property transactions.
BIR Form 1717C-1/0502 This form is to be used in reporting results of

investigation/verification on Capital Gains Tax on stocks transactions not traded thru a
Local Stock Exchange.
BIR Form 1717-D/0503 This form is to be used in reporting results of
investigation/verification on Donor's Tax.
BIR Form 1717-E /0504 This form is to be used in reporting results of

investigation/verification on Estate Tax.
BIR Form 1717-P/0505 This form is to be used in reporting results of

investigation/verification on Percentage Tax.
BIR Form 1717-S/0506 This form is to be used in reporting results of

investigation/verification on Documentary Stamp Taxes.
BIR Form 1717-V/0507 This form is to be used in reporting results of

investigation/verification on Value Added Tax (VAT).
BIR Form 1717-W This form is to be used in reporting results of

investigation/verification on Withholding Taxes.
BIR Form 0508 This form is to be used in reporting results of

investigation/verification on Withholding Tax on Compensation.
BIR Form 0509 This form is to be used in reporting results of investigation on

Expanded Withholding Tax. THSaEC

investigation/verification on Final Withholding Tax.
BIR Form 1717-X This form is to be used in reporting results of investigation

on Excise Taxes.

Specific Excise Tax.

Ad Valorem Excise Tax.

investigation/verification on Claims for Value Added Tax Credit/Refund.

investigation/verification on Excise Tax Credit/Refund.
E. Working Papers
Working papers form the most important portion of a report as they provide all the
information on the investigation conducted. They are the best evidence of the scope of the
investigation and the diligence with which it was completed. They further constitute the
basis for the Revenue Officer's determination of tax liability.
The working papers should include all notes made before, during, and after a tax
investigation, which relates to his findings on a particular tax return and shall include
items raised during the analysis of the return as possible issues. It should also include
explanations on the various observations and analyses of pertinent schedules and
information.
Working papers prepared by the Revenue Officer are used as sources of a more
detailed information, which he may use later on as a witness in court in case of litigation.
The properly concluded examination should therefore be reflected by adequate working
papers. Memory should not be relied upon in recounting the facts determined in the
investigation. There is no better way to present the fact that an item or issue has been
extensively explored on except by significant notes in the working papers.
Each of the working papers should be labeled clearly showing the name of the
taxpayer, year of examination, date prepared and the signature of the Revenue Officer
should appear on each page. The pages should be numbered and prepared in the Revenue
Officer's own handwriting.
The minimum reportorial requirements regarding the documents, forms, specific

schedules and working papers to be attached to the docket are prescribed in RMO No.
53-98, as shown in the Appendix of this Manual. They would vary in every case
depending upon the type of return, nature of the business, sources of income, and other
similar circumstances.
The requirement is that the working papers should document whatever transpired
during the examination. This would include summaries or transcripts of accounts
analyzed, schedule of specific items checked, reconciliation of accounts, analysis of
reserves and all other pertinent notes of the work performed.
The basic working papers consist of, but are not limited to the following:
1. Working papers showing real and nominal accounts
2. Working papers showing discrepancies, disallowances, adjustments and

computation of deficiency taxes
3. Reconciliation of net income per financial statements with the net income
per income tax return
4. Schedule of income producing property, if applicable
5. Schedule of taxes and licenses
6. Schedule of depreciation
7. Schedule of loans/notes/accounts payable and interest expenses/advances
from officers/stockholders
8. Schedule of miscellaneous income, if material
9. Schedule of bad debts
10. Schedule of Accounts Receivable and advances to accounts
11. Schedule of miscellaneous expenses, if material
F. Attachments to the Docket of the Case
Attachments consist of documents that are necessary to the proper understanding

and substantiation of results of the investigation. The documents to be attached to the
dockets are composed of but not limited to:
1. General Requirements
1.1 All tax returns with all the required attachments for the year/period
under audit;
1.2 Duplicate copy of Letter of Authority duly received by the taxpayer

or his representative;
1.3 Audited financial statements with supporting schedules and

reconciliation statements for the period under investigation;
1.4 Narrative memorandum report; IDASHa
1.5 Table of contents;
1.6 Checklist of audit procedures undertaken (Schedule RM-1);
1.7 Working paper showing computation of deficiency tax payment;
1.8 Duly signed Agreement Form, if applicable;
1.9 BIR Form 1717/0500 Series (Revenue Officer's Audit Report);
1.10 Photocopy of Payment Form and Official Receipt as evidence of

deficiency tax payment;
1.11 Comparative report of deficiency tax paid/assessed;
1.12 Post reporting notice/notice for an informal conference with the

summary of findings (for non-agreed assessment);
1.13 Logsheet/record of time spent by Revenue Officer(s);
1.14 Proof of exemption under Special Law, if applicable;
1.15 Delinquency verification report [for claims for refund/Tax Credit

Certificate (TCC)]; and
1.16 Authority to issue refund/TCC (for claims for refund/TCC).
2. Specific Requirements by Tax Type
The required documents to be attached to the docket containing a report of

investigation/verification per type of tax are enumerated and prescribed in RMO No.
53-98.
APPENDIX
General Policies in the Investigation of Tax Fraud Cases
Checklist of Documents to be Submitted by a Taxpayer upon Audit of his Tax

Liabilities as well as of the Mandatory Reporting Requirements to be Prepared by a
Revenue Officers all of which comprise a Complete Tax Docket cdll
ATTACHMENTS
June 9, 1995
REVENUE MEMORANDUM ORDER NO. 15-95
(amended by RMO 31-95)
SUBJECT : General Policies in the Investigation of Tax Fraud Cases.
TO : All Internal Revenue Officer and Other Concerned
A. OBJECTIVE
To provide the policies and rules in the manner of investigating tax fraud cases by
the Tax Fraud Division (TFD), Special Investigation Division (SIDs) and the Revenue
District Offices (RDOs) for criminal prosecution, and to avoid the multiple issuances of
Letter of Authority and/or simultaneous investigation of the same taxpayer covering the
same taxable year.
All revenue officers concerned shall be guided by the updated "Guidelines and
Investigative Procedures in the Development of Tax Fraud Cases for Internal Revenue
Officers", hereto attached as Annex "A".
B. JURISDICTION
1. TAX FRAUD DIVISION
1.1. The Tax Fraud Division shall have the jurisdiction to conduct
or undertake the investigation and/or reinvestigation of cases referred to or
developed by the Division, and those assigned, referred or approved by the
Commissioner of Internal Revenue.
2. SPECIAL INVESTIGATION DIVISION
2.1. The SID shall have jurisdiction over the following cases:
2.1.1. Tax fraud cases referred to it by the Intelligence

and Investigation Service (IIS)
2.1.2 Tax fraud cases initiated and developed by the SID.
2.1.3 Tax fraud cases referred to it by the RDO.
3. REVENUE DISTRICT OFFICERS
3.1. If in the course of the regular examination of returns, indication

of fraud were discovered, the RDO must transmit the records of the case
immediately to the SID and provide assistance in the formal investigation
thereof.
This shall be considered sufficient compliance with RMO 44-93.
C. PROCEDURE
A Preliminary Investigation must first be conducted to establish the prima facie

existence of fraud. This shall include the verification of the allegations on the confidential
information and/or complaints filed, and the determination of the schemes and extent of
fraud perpetrated by the denounced taxpayers.
The Formal Fraud Investigation, which includes the examination of the taxpayers
books of accounts through the issuance of Letters of Authority, shall be conducted only
after the prima facie existence of fraud has been established.
1. TAX FRAUD DIVISION
1.1. Where indications of fraud have been established in a

preliminary investigation, the TFD thru the Assistant Commissioner,
Intelligence and Investigation Service (IIS), shall request/recommend the
issuances of the corresponding Letter of Authority by the Commissioner
which will automatically supersede all previously issued Letter of Authority
with respect thereto.
1.2 Thereafter, a copy thereof shall be immediately furnished the

RDO and/or the SID of the Revenue Region having jurisdiction over the
taxpayer, who upon receipt thereof, must immediately transmit to the TFD
all the documents in their possession relative thereto; and must withdraw and
cancel any issued Letter of Authority therefor.
No Letter of Authority shall be issued for any taxpayer already

covered by a Letter of Authority issued by the Commissioner.
1.3. Reports on cases recommended for criminal prosecution shall

be forwarded to the Assistant Commissioner, Legal Service, Attn: Litigation
and Prosecution Division, thru the IIS. However, if after evaluation the
Litigation and Prosecution Division resolves that the evidence is not
sufficient to warrant the filing of a criminal action against subject taxpayer,
the case shall be referred back to the TFD thru the IIS, for further
documentation and/or appropriate action..
1.4. No Assessment Notice shall be served upon any taxpayer

recommended for criminal prosecution for tax evasion, following the
Supreme Court's ruling in the case of Ungab vs. Cusi, 97 SCRA 877.
1.5. All other reports on cases not recommended for criminal

prosecution shall be forwarded to the Commissioner, thru the IIS, for
approval.
2. SPECIAL INVESTIGATION DIVISION
2.1. The Chief of the SID shall issue the corresponding Letter of
Authority if the prima facie existence of fraud has been established, and the
same has been confirmed by the Regional Tax Fraud Committee (RTFC),
composed of the following:
a. Regional Director Chairman
b. Chief, SID Member
c. RDO having jurisdiction over the taxpayer Member
d. Chief, Assessment Division Member
e. Chief, Legal Division Member
The RDO shall then desist from issuing any Letter of Authority to the
taxpayer concerned, and shall transmit to the SID all the documents
in its possession relative thereto.
However, the RDO may assign one Revenue Officer, whose name
shall be included in the Letter of Authority as the "RDO" Assisting
Revenue Officer" (RARO), to assist and coordinate with the SID in
the formal investigation.
2.2. Where the SID has established the prima facie existence of
fraud against a taxpayer who has been the subject of an on-going or
terminated investigation by the RDO, the SID shall nevertheless forward the
record of the records of the case for evaluation to the RTFC.
If after evaluation the RTFC confirms to the SID the prima facie
existence of fraud, the following procedures shall be followed:
2.2.1. Where the investigation is on-going - the RDO

concerned shall withdraw its Letter of Authority and immediately
cease and desist from further investigation. The records of the case
shall then be forwarded to the SID concerned which, thereafter, shall
issue a Letter of Authority and proceed with the formal fraud
investigation.
2.2.2. Where investigation is already terminated the

office who has the possession of the records shall, upon written
request, immediately forward the records to the SID concerned.
If a re-investigation is necessary, the SID shall forward the same to

the IIS with a recommendation for the issuance of the corresponding
Letter of Authority by the Commissioner of Internal Revenue.
2.3. Where the business activities and/or establishments are situated

in more than one revenue region, the tax fraud case must be referred to the
TFD thru the IIS.
2.4 If after conducting the preliminary investigation the prima facie

existence of fraud cannot be established, but a potential deficiency tax
assessment exists, the case shall be referred to the RDO concerned for
appropriate action.
2.5. Reports on cases recommendation for criminal prosecution

shall be forwarded to the Legal Division of the Revenue Region. If after
evaluation the Legal Division resolves that the evidence is not sufficient to
warrant the filing of a criminal action against subject taxpayer, the case shall
be referred back to the SID, for further documentation and/or appropriate
action.
2.6 Reports on cases not recommended for criminal prosecution

shall be forwarded to the Assessment Division of the Region.
3. REVENUE DISTRICT OFFICES
3.1 Upon discovery of the indication(s) of fraud during the regular

examination of the returns, the Revenue Officer should make a detailed
report thereof to the Revenue District Officer who shall immediately
transmit the records of the case to the SID.
3.2 The RDO shall then assign a RARO to assist and coordinate
with the SID in the investigation of the said case.
D. CIVIL FRAUD
In case the quantum of evidence gathered does not warrant a criminal prosecution
because it is not sufficient to prove the guilt of the taxpayer beyond reasonable doubt
there exists a clear and convincing evidence that fraud has been committed, a
corresponding 50% surcharge shall nevertheless be imposed.
E. ATTRIBUTION OF COLLECTION
All collections arising out of the investigations by the TFD and SID, the latter
either by itself or through coordination with the RDO, shall be attributed to the RDO
having jurisdiction over the taxpayer.
F. PENAL CLAUSE
Strict compliance with this RMO is hereby enjoined. Any willful violation hereof
shall be treated as gave misconduct and the corresponding penalty of dismissal as
provided under Civil Service Rules and Regulations shall be imposed.
G. REPEALING CLAUSE
Any provision of any order and pertinent issuances inconsistent with his Order is
hereby revoked, modified or amended accordingly.
H. EFFECTIVITY
This Revenue Memorandum Order takes effect immediately.
(SGD.) LIWAYWAY VINZONS-CHATO

Commissioner
ANNEX "A"
GUIDELINES AND INVESTIGATIVE PROCEDURES IN THE DEVELOPMENT OF

TAX FRAUD CASES FOR INTERNAL REVENUE OFFICERS
A. OBJECTIVES:
The substantial revenue collections of the government derived from the series of
tax amnesties signify to a large that the BIR has not effectively tapped a great number of
potential sources of revenue. The tremendous shortfall in revenue collections for the
preceding year should spur the BIR on the need for a more systematic and vigorous tax
campaign by instilling more awareness and tax consciousness among our taxpayers, more
especially those who have continuously flaunted our revenue laws with impunity.
To provide a strong detergent to the commission of fraud against the revenues for
the purpose of increasing and enhancing our revenue collections, the imposition of
criminal sanctions, in addition to the civil liabilities, on erring taxpayers should be
implemented to the fullest extent of the law in line with the pronouncement of the
President of the Philippines.
These guidelines are, therefore, presented to guide and to refresh all internal
revenue officers with the necessary know-how in the investigation, evaluation, and
submission of reports of fraud cases envisioned to withstand judicial scrutiny.
B. NATURE AND TYPES OF FRAUD:
Definition-fraud or evasion
Tax fraud or evasion means the elimination or reduction of one's correct and
proper tax by fraudulent means. "The fraud contemplated by law is actual and not
constructive. It must be intentional fraud, consisting of deception willfully and
deliberately done or resorted to in order to induce another to give some legal right ...
"Aznar vs. CTA and Collector, G.R. No. L-20569, Aug. 25, 1974.
Factors in Fraud or Evasion
All the following elements must be proven by competent evidences to establish

the existence of fraud:
1. The end to be achieved - the payment of less tax than that

known by the taxpayer to be legally due:
2. The accompanying state of mind which is variously described

as being "evil", "in bad faith", "deliberate and not accident", or "willful"
the exact term used is not too important.
3. The overt act done or scheme used by the taxpayer to achieve

the non-payment of taxes known to be due. The act or scheme must be
tinged with some elements of deceit, misrepresentation, trick, device,
concealment or dishonesty." Fraud under Tax, Balter.
Burden of Proof in Establishing Fraud:
A tax fraud or evasion case is basically criminal case.
In the establishment of fraud, the burden of proof is on the Bureau of Internal

Revenue. The presumption that an officer of the government has performed his duty
regularly (Sections 5, Rule 131 of the New Rules of Court), as in the case of the
correctness of deficiency assessments, is not applicable in fraud cases. "In criminal cases,
the burden of proof as to the offense charged lies on the prosecution." (Section 2, Rules
131, New Rules of Court).
Mere suspicious and mere doubts on the intention of the taxpayer are not
sufficient proof of fraud. Fraud is never presumed, it must be proved.
Types of Tax Fraud Cases
Criminal Fraud
A criminal tax fraud case results when all the elements of fraud can be proven
beyond reasonable doubt. Proof beyond reasonable doubt not mean such a degree of proof
as, excluding possibility of error, absolute certainty; only required, or that degree of proof
which produces conviction in an unprejudiced mind.
Here, the taxpayer upon conviction shall be liable from the deficiency taxes, to
both criminal and civil penalties.
Civil Fraud
A civil tax fraud case results when all the elements of fraud cannot be proven
beyond reasonable doubt, but rather by clear an convincing evidence amounting to more
than a mere preponderance, and cannot be justified by mere speculation.
"Preponderance of evidence" means that the testimony adduced by one side is

more credible and conclusive than that of the other.
"Clear and convincing" need not rise to proof beyond reasonable doubt as in a
criminal case but yet must be stronger than mere preponderance of evidence.
Here, the taxpayer shall be liable aside from the deficiency taxes only to the civil
penalties.
Effects of Fraud under the National Internal Revenue Code (NIRC)
1. Civil penalties rise to the imposition of the 50% surcharge; to be imposed by

the BIR;
2. Criminal penalties involving the imposition of penal sanctions

imprisonment and/or fine to be imposed by the Regional Trial Court (RTC) upon
conviction;
3. Power of the Commissioner to asses and collect the tax is extended to 10

year from date of discovery, however, Sec. 280 provides the five year prescription on the
filing of criminal action;
4. Cases involving fraud cannot be the subject compromise as mandated by

Section 204, NIRC;
5. Suspension and temporary closure of the business operations of a taxpayer

under Sections 111 of Tax Code for violation of the VAT provisions.
C. METHODS OF PROVING FRAUD IN CRIMINAL AND CIVIL TAX FRAUD

CASES:
1. The Direct Approach Method or by Direct Evidence, also called Specific

Item Cases Proof of fraudulent acts are adduced by specific items of fraudulent
transactions. It is that one, if the allegations are believed, the existence of the principal or
ultimate fact is proven without any inference or presumption.
Specific Item Cases determined by the direct approach method
1.1 Income Tax
1.1.1 Omission or understatement of taxable income
1.1.1.1 Failure to file income tax return.
1.1.1.2 Items of income and expenses, or assets or

liabilities have been omitted, or falsely claimed in the accounting
records or return in order to minimize or reduce taxes;
1.1.1.3 Misclassification of accounts Income taken

upon and classified as liabilities; erroneous classification of income
from taxable to exempt; ordinary gains classified as capital gains;
non-deductible expenses disguised as deductible items; and capital
expenditures classified as deductible items.
1.1.1.4 Sales/Income of domestic branches purportedly

shown as income of the foreign head office;
1.1.1.5 Keeping two sets of invoice or receipts one
set registered with the BIR and sales or income recorded thereon are
the ones posted in the accounting records, whereas the other set is not
reported for tax purposes;
1.1.1.6 Keeping two sets of books of accounts records

one set registered with the BIR and the other set reflects the
correct transactions and not registered and reported to the BIR;
1.1.1.7 Non-issuance of receipts to customers; and
1.1.1.8 Sales invoices or receipts issued to customers

reflects the correct transactions, but invoices or receipts recorded for
tax purposes reflects much smaller amounts.
1.1.2 Utilization of other persons or entities
1.1.2.1 Establishment of several entities

corporations, partnerships, or proprietorships, by a person by making
it appear that sale are made by the different entities created when in
fact such sales are only made by one person;
1.1.2.2 Allocating income and expenses to other persons

in order to reduce or minimize taxes by a controlling person; and
1.1.2.3 Establishment of a registered partnership or

corporation, using dummy partners or stockholders.
1.1.3 Improper claims of costs of sales and deductible expense.
1.1.3.1 Fictions purchaser, or padding of purchaser, or

that proceeds are diverted to the personal benefit of the taxpayer or
his assign;
1.1.3.2 False or fictions claims of deductions;
1.1.3.3 Misclassification of deductions
Investments or major repairs or improvements

claimed as nominal expenses;
1.1.3.4 Dividend declarations classified as expenses or

salaries;
1.1.3.5 Withdrawals claimed as expenses or

compensation;
1.1.3.6 Claim of depreciation of non-existing assets or
already fully depreciated, or on assets which were appraised higher
for credit purposes;
1.1.3.7 Claim of purchases from no-VAT sources as

VAT purchases and claiming tax credits thereon; and
1.1.3.8 Improper claims of tax credits without having

paid the input taxes passed on by the seller.
1.1.4 Claims of false personal exemptions
Claiming exemptions as married by an unmarried individual

or head of the family by single persons who do not actually support
their parents; and
Claiming false additional exemptions of alleged children, or

children who are already of age or who are not physically
incapacitated.
1.2 Business Taxes - VAT and Percentage Taxes
1.2.1. Business Taxes - VAT and Percentage
1.2.1.1. Omission or understatement of taxable

sales/income-
1.2.1.2 Keeping falsified books of accounts;
1.2.1.3 Non-issuance of sales invoices, or under-

recording of sales to conceal the amount of sales subject to business
taxes on VAT;
1.2.1.4 Claiming fictions tax credits;
1.2.1.5 Crediting sales against items or income

discounts of costs of sales to conceal the amount of sales subject to
business taxes on VAT.
1.2.1.6 Deducting against sales or income discounts

which were granted subsequently and not in the sales invoice.
1.2.1.7 Deducting returned sales which were not

actually returned.
1.2.2 Misclassification of sales or income
1.2.2.1 Classifying sales as exempt when in fact they are

taxable,
1.2.2.2 Misclassification of sales of goods subject to

VAT as only subject to percentage taxes;
1.2.2.3 Claiming domestic sales as export sales when in

fact the goods were sold in the domestic market; and
1.2.2.4 Sales in the local market which are made to

appear as sales by the foreign head office.
1.2.3 Claim of fictions tax credits
1.2.3.1 Claiming tax credits on purchases of goods from

Non-VAT registered enterprises; and
1.2.3.2 Claiming fictitious tax credits on non-existing

invoices.
1.2.4 Non-payment of VAT on materials imported for re-export
Materials were applied against originally imported for

re-export, but which were used instead on goods sold in the local
market.
1.3 Estate Tax
1.3.1 Failure of file estate tax return;
1.3.2. Filing of estate tax returns in different jurisdictions to

avoid payment of the higher graduated tax, as in the case where the
deceased-owned properties in various places;
1.3.3 Willful under-valuation of the market values of the properties

of the estate;
1.3.4 Willful omission of some properties especially those located in

places other than the residence of the deceased; and
1.3.5 Claim of fictions items - funeral expenses, claims against the

estate, judicial and testamentary expenses.
1.4 Donor's Tax
1.4.1 Failure to file donor's tax return;
1.4.2 Filing of returns within the same year in various jurisdictions to

evade the payment of the higher graduated tax;
1.4.3 Willful omission of prior donations made during the same
taxable year;
1.4.4 Willful undervaluation of the market value of the property

donated, and
1.4.5 Insufficient consideration on sales of property, the difference

between the market value from the consideration agreed upon, considered as
subject to the donor's tax.
1.5 Excise Taxes
1.5.1 Misclassification of articles subject to excise tax by making it

appear that a particular manufactured articles falls within a lower tax
classification;
1.5.2 Illegal manufacture of articles subject to excise tax;
1.5.3 Unlawful possession or removal of articles subject to excise

tax, and for which no tax has been paid;
1.5.4 Unlawful use of denatured alcohol;
1.5.5 Unlawful possession of cigarette papers in bobbins, etc; and
1.5.6 Shipment or removal of liquor or tobacco products under false

names or brands or as an imitation of any existing or otherwise known
product name or brand.
1.6 Documentary Stamps
Non-affixture of the correct documentary stamps on pertinent

document or papers.
1.7 Withholding Taxes
Failure to withhold the correct taxes as withholding agent under the

pertinent provisions of the Tax Code.
2. Indirect Approach or by Indirect Method This relies upon circumstances

evidence of determining the correct income or transaction of a taxpayer. Circumstantial
evidence is that which tends to prove the existence of the disputed fact by proof of other
facts which have a legitimate tendency to lead the mind to a conclusion that the fact exists
which is sought to be established. However, where circumstances evidence is relied upon
to prove a fact, the circumstances must be proved by direct evidence and cannot
themselves by inferred.
The legal bases for an indirect approach in the determination of the correct income
or transactions of a anchored on Sections 16 and 37 of NIRC of 1988.
Principle Types of Indirect Approach or Indirect Methods Used
1. Net Worth or Inventory Method or Net Worth & Expenditure Method
This is a method of reconstructing income based on the theory that if

the taxpayer's net worth has increased in a given year in an amount larger
than his reported income, he had understand his income for that year.
Formula:
The mathematical formula for this method may be laid down as

follows:
a. Increase in net worth, plus
b. Non-deductible item, less
c. Non-taxable income or receipts subjected to final tax or transfer
taxes, equals
d. Taxable net income, less
e. Personal and additional exemptions, equals
f. Net income subject to tax
The Commissioner's determination of taxpayer's unreported income through the
net worth expenditure method usually involves the following steps:
(1) The net worth on a fixed starting date is established (excess of

assets over liabilities). This starting date is usually the beginning of the first
tax year under examination. The amount of such net worth is considered of
vital importance in order to foreclose the possibility than an increase in net
worth during the tax year, or an excess of expenditure over reported income,
did not originate from prior accumulated funds (i.e. hoarded cash or
undisclosed assets which would not represent income during the tax year.)
(2) The net worth at the close of each tax year under examination is
established;
(3) Comparison is made of the net worth at the beginning and end
of each year, to determine the increase, if any;
(4) The increase in net worth for each year is adjusted to eliminate
items accounting for such increases which arise from non-tax sources (i.e.,
gifts, bequests, other receipts exempt from tax, etc.) and adjustment is made
where property is sold at a profit but the entire profit is not taxable because
of long-term capital gain provision. The increase in net worth for the year,
after these eliminations and adjustments, is presumed to be income realized
in that year;
(5) The amount of non-deductible expenditures is determined or

estimated. These items usually consists of personal, family and living
expenses; and
(6) The reconstructed income under the net worth expenditure

method is the sum of items (4) and (5) and this amount is then compared
with the income reported, if any, by the taxpayer. (Id. par. 6059, see also
Perez vs. Araneta, L-10507, May 30, 1958, Reyes vs. Col. of Internal Rev.,
L-11534 and L-11558, Nov. 25, Jamir vs. Col of Int. Rev. L-16552, Mar. 30,
1962; Avelino vs. Col. of Int. Rev. L-17715, July 31, 1963).
Circumstance and conditions necessary to warrant the use of the indirect

method in establishing a prima facie case of fraud:
(1) That the taxpayer's accounting records are inadequate and do

not clearly reflects his income; of that the taxpayer maintains no books and
records; or that taxpayer's accounting records are available, but he refuses to
produce them;
(2) That there is a fixed starting point or opening net worth, i.e., a
date beginning of a taxable year or prior year to it, at which time the
taxpayer's financial conditions can be affirmatively established with some
definitives; (Statements of net worth of taxpayers who availed of the tax
amnesty under the provisions of Executive Order No. 41, may be used as the
starting point as at December 31, pursuant to the authority given to the BIR
under section 7 of said Executive Order)
(3) That the circumstances are such that the method does reflect the
taxpayer's income with reasonable accuracy and certainly, and proper and
just addition of personal expenses and other non-deductible expenditures
were made and correct; fair and equitable credit adjustments were given by
way of eliminating non-taxable items or receipts or taxable income which
have been subjected to final tax.
(4) The need for evidence of the source of income under this
method:
"In all the leading cases on this matter, courts are unanimous
in holding that when the tax case is civil in nature, direct proof of
sources of income is not essential. . . . However, when a taxpayer is
criminally prosecuted for tax evasion, the need for evidence of a
likely source of income becomes a pre-requisite for a successful
prosecution . . ." RMC No. 43-74.
This proof of a likely source of income may be shown by any of the

following:
(1) Demonstrating that there were specific omissions of income

items by the taxpayer in his income tax return.
(2) A showing that the nature of the taxpayer's business is such that
it has capacity of generating a substantial income.
(3) Proofs of underdeclaration of income by the existence of

unregistered sales invoices, which were not recorded in the books;
(4) Findings of unrecorded purchases;
(5) Existence of business permits, license from government

agencies as to the types of businesses the taxpayer is engaged in;
(6) Keeping separate sets of books one registered and the other
reflecting the correct transactions of a business.
(7) Use of false invoices or documents, and
(8) Willful destruction of accounting records.
2. Expenditures Method or Excess Cash Expenditures Method
The expenditures method proceeds on the theory that where the amount of money
which a taxpayer spends during a given year exceeds his reported income, and the source
of such money is otherwise unexplained, it may be inferred that such expenditures
represent unreported income.
The discussion on when and how the net worth method should be used are equally
applicable to the expenditures method. In a case where the taxpayer has several assets
(and liabilities) whose cost bases remain the same throughout the period under
investigation, the expenditure method may be preferred over the net worth method
because a more laconic presentation can be made of the computation of taxable income.
This is because assets and liabilities which do not change during the period under
investigation may be omitted from the expenditures statement. The expenditures method
is used often on a taxpayer who spends his income on lavish living and has little, if any,
net worth.
Formula:
The expenditure method of determining income should be applied by

deducting the aggregate yearly expenditures from the declared yearly income
(Col. of Int. Rev. vs. Jamir, 4 SCRA 7;8 March 30, 1962).
Under this formula enunciated by the court in the above-cited case,
the particular in the use of this method are shown below:
A. Expenditure for a given taxable year:

(1) All expenses and deductions claimed per
return filed with the BIR (Exclude non-cash items,
such as aromatization of goodwill, depreciation
of assets, application of deferred
expenses from prior period, etc.) P xxx
(2) Expenses, personal and non-deductive

or deductible for tax purposes, as
determined per investigation (Exclude
non-cash terms) xxx
(3) Payments of debts, payables, accruals,
and other liabilities taken up in the ITR
and those not taken up, such as personal
and other liabilities. xxx
(4) Payment of taxes xxx
(5) Acquisition of assets per ITR and

personal acquisitions such as cars,
appliances, even real estate. xxx

Total Expenditures per Investigation P xxx
B. Sources of Cash:
(1) Declared income per Income Tax Return xxx
Deduct: Accounts Receivables if taxpayer
is on cash basis method of accounting (xxx)
Add : Collection from receivables xxx
(2) Non-taxable receipts, prizes, royalties, etc. xxx
(3) Non-Taxable receipt, such as dividends

donations from abroad xxx
(4) Receipts subjected to transfer such as

donations, inheritance xxx
(5) Cash loans, if any xxx
(6) Cash at the beginning of the period xxx xxx

Excess Cash as determined per Investigation P xxx

As in the case of the Net Worth Method, when a tax case is civil in nature, direct
proof of sources of income is not essential. However, when a criminal case is filed against
the taxpayer, the need for evidence of a likely source of income becomes a prerequisite.
3. Percentage Method
Although the use of this method is of little value in criminal cases, it is useful in
test-checking or corroborating the results obtained by some other means of proof such as
specific items, net worth, and expenditures methods, and for evaluating allegations from
information regarding unreported profits or income.
The percentage method is a computation whereby determinations are made by the

use of percentages or ratios considered typical of the business under investigation. By
reference to similar businesses or situations, percentage computations are secured to
determine sales, gross profit, or even net profit. Likewise; by the use of some known base
and the typical percentage applicable, individual items of income or expenses may be
determined.
These percentage may be externally derived or they may in some instances be

internally derived from the taxpayers accounts for other periods or from an analysis of
subsidiary records. Gross profit percentages may be other similar data. Also other years
not covered by the investigation or portion of year under investigation may indicate
typical percentage applicable to the entire year or year under investigation.
It must, however, be emphasized that in comparing transactions of similarly

situated business, the name of the particular taxpayer used as the model must not be
divulged to the taxpayer under investigation nor in the report as this would constitute as a
violation by an internal revenue officer of the provision of Section 269, NIRC of 1988, on
unlawful divulgence of trade secrets.
4. Unit and Value Method
This is not a prime method of proof. The determination or verification of gross

receipts may be computed by applying price and profit figures to the known ascertainable
quality of business done by the taxpayer.
This method is feasible when the investigation can ascertain the number of units
handled by the taxpayer and also when he knows the price or profit charged per unit.
There may be regulatory body to which the taxpayer units of production or

service.
Examples are:
(a) Records of sugar milled by a sugar central;
(b) Records of fish production to the Bureau of Fishery and

Aquatic Resources;
(c) Records of production by pioneer industries to the Board of

Investments; and
(d) Records of logs exported to the Forest management Bureau.
D. SOURCES OF FRAUD CASES:
1. From routine examination of returns:
a. Keeping no records or inadequate records despite substantial

transactions reflected in the returns;
b. Standard of living of the taxpayer, such as the possession of

expensive cars and jewelries; or staying in a luxurious mansion, and,
ownership of properties whose values far exceed his probable sources of
income as declared per return;
c. Records verified, were not property declared for tax purposes.
d. False vouches and receipts which were verified in the course of

the routine examination.
2. From Information furnished by:
a. An informant who has knowledge of the transactions of the

taxpayer which were not properly declared for tax purposes;
b. Referrals from other government offices or from other

investigating units of the BIR.
3. Thru initiative of the investigating officers:
a. From newspaper reports;
b. Thru research of available government records such as from

offices of the Register of Deeds, Bureau of Highways, and other government
offices; and
c. In relation to an investigation of another taxpayer, where

suspects that certain transactions were not declared for tax purposes.
E. INDICATIONS OF FRAUD
1. Maintaining two sets of books and records;
2. Concealment of Assets;
3. Destruction of books and records;
4. Large or frequent currency transactions;
5. Payments to fictions companies or persons;
6. False or altered entries and documents;
7. Overdeclaration of purchases or under declaration of sales;
8. Use of false names or nominees;
9. Large company loans to employees or other persons;
10. Payee names on checks left blank and inserted at a later date;
11. Excessive billing accounts;
12. Excessive spoilage or defects;
13. Double payment on billing;
14. An individual negotiating checks made payable to corporation;
15. Second or third party endorsement on corporate checks;
16. Excessive use of exchange checks or clearing accounts;
17. Personal expenses paid with corporate fund;
18. An understatement of income attributable to specific transactions and denial

by the taxpayer of the receipt of the income or inability to provide a satisfactory
explanation for its omission;
19. Substantial unexplained increases in network over a period of years;
20. Failure to file a return, especially for a period of several years although
substantial amounts of income were received;
21. Concealment of bank accounts, brokerage accounts, and other property;
22. Inadequate explanation for dealing in large sums of currency, or the

unexplained expenditure of currency, (especially when in a business not calling for large
amounts of cash);
23. Failure to deposit receipt to business account contrary to normal practices;
24. Claiming fictions or improper deductions;
25. Substantial amount of personal expenditure deducted as business expenses;
26. False entries or alternation made on the books and records, backdated or
postdated documents, false entries or invoices or statement, or other false documents;
27. Failure to keep records, especially if put on notices by the BIR as a result of
prior examination, concealment of records or refusal to make certain records available.
28. Distribution of profits to fictions partners;
29. False statements, especially if made under oath about a material fact
involved in the investigation;
30. Attempt to hinder the investigation. Failure to answer pertinent questions or

repeated cancellations of appointments. Avoiding the investigator;
31. The taxpayers knowledge of taxes and business practices where numerous
questionable items appear on the returns;
32. Destruction of books and records, especially after the investigation was
started;
33. Transfer of assets for purposes of concealment;
34. Involvement in illegal activity (illegal income);
35. Failure to disclose all relevant facts;
36. Unsubstantiated or unexplained wealth;
37. Mental handling of ones affair to avoid keeping records usual in transactions
of the sale kind;
38. Keeping no records or inadequate despite substantial transactions in the

return; and
39. Any conduct, the likely effect would be mislead or to conceal material facts.
The items listed are the indications of fraud most commonly committed but are
not all inclusive.
F. PROCESSING OF A TAX FRAUD CASE
1. Preliminary Investigation
The purpose of preliminary investigation is to establish the existence

of a prima facie indications of fraud. To gather evidence therefor the courses
of action that may be conducted pursuant to the pertinent Tax Code
provision, are but not limited to the following:
a. Sec. 7 Access to records to private persons or
entities, and government offices and
agencies; and
b. Sec. 15 Arrest persons and seize documents and

instruments, if the violations of the Tax
Code are done within the view of a revenue
officer.
c. Sec. 16 C Conduct inventory taking or surveillance.
d. Sec. 171 Conduct a search for excise taxable

articles.
2. Preparation of a preliminary investigation report with a recommendation of
the issuance of a Letter of Authority:
The examiner or revenue official who discovers a potential tax fraud

case must submit a memorandum report to his immediate superior stating the
facts and circumstances which constitute the indication of fraud, and the
evidence at hand to be verified and confirmed.
The issuances and approvals of Letters of Authority for fraud cases

shall be in accordance with existing rules and regulations on such issuances.
The issuance of Letters of Authority, in the case of the Tax Fraud Division,
may be dispensed with when so warranted by the circumstance of the case,
provided that the taxpayer shall be noticed by the Commissioner of Internal
Revenue that his internal revenue tax liabilities are under investigation or
that the report thereon has been submitted.
3. Formal Fraud Investigation:
(a) Whenever there appears to be a need for a formal tax fraud

investigation of a particular taxpayer, a work plan must be prepared in
accordance with the following guidelines:
(1) Review all available information;
(2) Determine the objectives of the investigation;
(a) Development of criminal tax case;
(b) Deciding the particular provision of the NIRC

allegedly violated and asking by whom, when, where, and by
what means. Were Revenue Regulations, Revenue
Memorandum Circulars or BIR Rulings and Issuances also
violated or involved;
(c) Understanding clearly the elements of the

offense.
(3) If it is an investigation referred by an informant,

recontact and obtain detailed information about the origin of the case,
who has been talked to, what was said, available records, etc.
Re-interview the person who initially provided the information or
made a the allegation.
(4) Determine the following:
(a) Information that is needed;
(b) Relative importance of the desired information;
(c) Best sources of information; and
(d) Best sequences for making the necessary

inquiries.
(5) Gather background information:
(a) Obtain as much information as possible on the

suspect;
(b) Obtain tax return Revenue District Offices

concerned;
(c) Obtain pertinent records such as General

Information Sheet Articles of Incorporations, Constitution
and By-Laws, Financial other information from Bureau of
Domestic Trade, Department of Trade and industry and other
government agencies.
(6) In conclusion, decide if an examination of the taxpayer's

books of accounts is warranted and the best method of proof.
G. PREPARATION AND ASSEMBLY OF REPORTS FOR FRAUD CASES
(1) Planning the report:
Before starting to write a report, the should have in mind a definite

outline of the arrangement in which the facts and evidence may be presented
in the most effective manner. A good general plan is to state the problem,
present the results of the investigation, and set forth the conclusion and
recommendations.
(2) Assembly of a report:
A report should be assembled in the following manner:
(a) Table of Contents
The table of contents should indicate the subject matter, and

page number in the docket, to provide quick reference to important
features of the case.
(b) Body of the Report
The format of the report must more or less contain the

following information and presentation whenever it is necessary:
b-1 Name and Address of Taxpayer
b-2 Tax periods involved in the investigation
b-3 Returns filed and statute of limitations
b-4 Type of violation - indicate the pertinent provisions of

the Tax Code violated.
b-5 Origin of the case
b-6 Name and Titles of cooperating BIR officers;
b-7 Letter of Authority number, date issued, issuing of

officer
b-8 Date of taxpayer was first contracted by the examiners
b-9 Representatives of the taxpayer
b-10 Brief description of the method used in the evasion or

other violation.
b-11 Related cases
b-12 Summary of facts determined during the investigation
Explanations on the evidence in support of the

tax deficiency
Explanations on the evidence in support of the

criminal aspect
b-13 Explanation and defense of taxpayer
b-14 Conclusion and recommendations
The body of the report should contain a reference to the

appendices or worksheets and schedules, the appendices should
contain a reference to exhibits which consist of supporting
documents. For example: "Appendix A is a summary of the
unreported receipts from sales, and Exhibits 8 to 25 are copies of
documents in support thereof" Important matters in the exhibits
generally should be explained in the report. However, if a document
is of the nature that it is adequately described in an appendix no
further explanation is necessary. When mentioning or referring to a
document that is submitted as an exhibit, including the written
statement of a witness, insert the exhibit number in parenthesis
immediately following the reference.
The examiner, before beginning his report, should arrange the

proposed appendices and exhibits in the order of his planned
presentation of facts and evidence, and then he prepares his report
discussing the appendices and exhibits in that order. When the report
is completed, the exhibits should be assembled in the order in which
they are originally mentioned in the report, and they should be
numbered for easy reference.
(c) List of Witnesses and Exhibits
The list of witnesses is an essential part of a report in a

criminal case. The witness may be listed in alphabetical order, or in
the order in which they are mentioned in the report, or in the probable
order of their appearance in the trial. Give each witness a number.
Give each piece of evidence and the witness proposed testimony a
separate exhibit number. (For example, please see Annex "A-2")
(d) Appendices, Worksheets and Schedules
Appendices, worksheets and schedules should be arranged in

the order of presentation facts and evidence of the case. And they
should be numbered for easy reference. (For sample, please see
Annex "A-3")
ANNEX "A-1"
PRO-FORMA STATEMENT OF ASSETS, LIABILITIES AND NETWORTH
(Revised to conform to recent laws)
PARTICULARS Dec. 31, 1993 Dec. 31, 1994
ASSETS (Net of Depreciation)
1. Cash on Hand ** Pxxxx Pxxxx

2. Cash in Banks xxxx xxxx
3. Accounts, Notes & Loans Receivable xxxx xxxx
4. Mortgage Receivable xxxx xxxx
5. Investments xxxx xxxx
6. Real Property Land xxxx xxxx
7. Real Property Improvements xxxx xxxx
8. Motor Vehicles xxxx xxxx
9. Inventory at the end xxxx xxxx
10. Furniture/Fixtures xxxx xxxx
11. Personal Properties xxxx xxxx
12. Other Assets xxxx xxxx

Total Assets Pxxxx Pxxxx
LIABILITIES
1. Accounts, Notes & Loans Payable Pxxxx Pxxxx
2. Mortgage, Payable xxxx xxxx
3. Other Liabilities xxxx xxxx

Total Liabilities Pxxxx Pxxxx

Net Worth at the End Pxxxx Pxxxx
====== =======
Less:
Net Worth at the Beginning xxxx

Increase (Deceased) in Net Worth Pxxxx
** Supported by accompanying Cash Analysis Schedule
Add: Non-deductible Items
1. Personal, living and family expenses Pxxxx

2. Insurance premiums xxxx
3. Income tax payments xxxx
4. Gifts to others xxxx
5. Non-deductible expenses, taxes and
contributions not directly connected with
business of taxpayer xxxx
6. Net capital loss xxxx
7. Amnesty tax payments xxxx
8. Estate and Donor's taxes xxxx
9. Final tax payments xxxx
10. Other expenses which are non-deductible xxxx

Total Non-deductible Items Pxxxx

Net Income before further adjustments Pxxxx

Less: Non-taxable items and income and

proceeds subjected to final tax:
1. Gifts, donations & Inheritance received Pxxxx

2. Non-taxable capital gains xxxx
3. Backpay/Pensions non-taxable xxxx
4. Proceeds of Life Insurance Policy xxxx
5. Non-taxable stock dividends (provided stocks
are reflected in Assets) xxxx
6. Pensions received under RA 4917 (private firms) xxxx
7. Retirement pay from GSIS and SSS xxxx
8. Non-recognized gains from exchanges of
property under Sec. 34(c)(2) of the Tax
code of 1988 xxxx
9. GSIS Cash Dividends xxxx
10. Social Security benefits received from
foreign government and institution (per PD 220) xxxx
11. Other non-taxable items (such as those
excluded under Sec. 28(b) of NIRC of 1988, those
subjected to final tax such as foreign earnings
by a non-resident Filipino, royalties, prizes,
yields on deposits, dividends, share in profits
of taxable partnership, etc., per Sec. 21(b),
Sec. 21(c), Sec. 22(2) of NIRC of 1988.) xxxx
12. Other exempt income xxxx
13. Proceeds of sale of Real Estate subjected to
final tax under Sec. 21(e) of the Tax Code
of 1988 xxxx

Total Non-taxable items Pxxxx

Adjusted Net Income as per Investigation Pxxxx

Less: Statutory exemptions:
Personal & additional exemption xxxx

NET INCOME SUBJECT TO TAX xxxx
Income tax due thereon xxxx

Less: Amount previously paid xxxx

Deficiency income tax still due Pxxxx
Add: 50% surcharges, if fraud can be proven xxxx
5% surcharges for late payment xxxx

Total amount due, exclusive of interest Pxxxx
=======
CASH ANALYSIS
(Revised to conform with provisions of recent laws)
- 1994 -
Source of Funds
Cash on hand and in bank at the beginning P xxxx

Add: 1. Cash received from business (sales) P xxxx
2.Collection of receivables xxxx
3.Proceeds of loans and mortgages xxxx
4.Proceeds of life insurance policies xxxx
5.Proceeds from sale of property, real or personal xxxx
6.Cash gifts, bequests and inheritance received xxxx
7.Non-fund deductions (depreciation
and provision for bad debts) xxxx
8.Backpay, pensions, benefits, gratuities received xxxx
9.Cash dividends & interest income xxxx
10.Wagering gains xxxx
11.Receipt of cash from any other source xxxx xxxx

Total Available Funds for the Year P xxxx
Less: Application of Funds

*1.Cash purchases & business expenses xxxx
2.Cash paid for assets/property, real
or personal (full payment of installment) xxxx
3.Payments of loans, notes &
mortgage payable xxxx
4.Section 30(c)(1)(A to D)
(non-deductible items) xxxx
5.Section 31(a) cash disbursement:
a. Personal, living or family expenses xxxx
b. Capital expenditures xxxx
c. Premiums paid on life insurance xxxx
6.Cash disbursement of any kind xxxx
7.Cash on hand and in bank at the end xxxx xxxx

CASH ON HAND AT THE END AS
RECONSTRUCTED P xxxx
======
*7 Source: This item should be included as a contra account to Item No. 1

of Application of Funds if it includes non-cash deductions such as depreciation, bad
debts, applications of deferred items.
Thus, if item 1 of Application of Founds does not reflect non-cash deductions,
there is no necessity to include Item 7 to Sources of Funds.
ANNEX "A-2"
SAMPLE
LIST OF WITNESSES and EXHIBIT

SING and FURR, INC.
No. 24 Changi Street, Manila
EXHIBIT REF.
W1 Atty. ROBY CAPULON 1 PP. 66-72 1990 ITR and
Bureau of Internal Attachments
Revenue District
Officer RDO No. XX, 2 PP. 73-80 1991 ITR and
Manila Attachments
Tel. No. 315-62-22
W2 Atty. CARLS MIRANDA JR. 1 PP. 81-83 Memorandum of

Bureau of Internal Revenue Interview
Intelligence Officer with Joel
Special Investigation Div. Cruz,
Revenue Region X, Manila accountant of
Tel. No. 61-24-08 SING and FURR
INC. dated
July 12, 1994
2 P. 84 APPENDIX A
Computation
of unreported
Gross Receipt
1990, 1991
3 P. 85 APPENDIX B
Computation
Adjusted
Taxable Income
1990, 1991
4 P. 86 APPENDIX C
Computation
of Deficiency
Taxes 1990,
1991
W3 ANJIE FARUMOG 1 P. 12 Affidavit dated
Manager FLORR, INC. August 4, 1994
125 ABC St. QC 2 P. 13 Confirmation letter
Tel. No. 40-15-24 dated June 6, 1994
W4 RUSSEL ROMULO 1 P. 14 Worksheet-Summary

Owner, DELL, INC
of Payments made on
80 XYZ St. Cubao Services rendered by
Tel. No. 62-12-43 SING and FURR,
INC.
2 PP. 15-20 Cancelled checks
Payable to SING and
FURR, INC.
3 P. 21 Memorandum of
Interview dated
September 10, 1994
W5 EMILLE FRENILLE 1 P. 22 Worksheet-Summary

Comptroller, of Gross Payments
CONTEMPLATE CORP. made to SING and
17 Sta. Cruz, San Pablo, FURR, INC.
Laguna, Tel. No. 143-62 2 P.23-30 Certified Copies of
Invoices of SING and
FURR, INC.
3 PP. 31-36 Cancelled Checks
Payable to SING and
FURR, INC.
W6 SANDREX DUTERTE 1 P. 38 Worksheet-Summary

Manager, MAGGS ENT. of Payments to
317 Davao St. Manila SING and FURR,
Tel. No. 60-45-01 INC.
2 P. 39-46 Certified Copies and
FURR, INC.
3 PP. 47-53 Certified Copies of
Official receipts of
SING and FURR,
INC.
ANNEX "A-3"
SAMPLE
APPENDIX A
COMPUTATION OF UNREPORTED GROSS RECEIPTS 1990, 1991
SING and FURR, INC.
ITEM 1990 1991 WITNESS EXHIBIT REFERENCE DESCRIPTION
NO. OF
EVIDENCE
FLORR INC. 160,000.00 190,000.00 ANJIE FARUMOR W3-1 P. 12 Affidavit

Manager, FLORR INC. W3-2 P. 13 Confirmation
Letter
DELL INC. 9000,000 1200,0000 RUSSELL ROMULO W4-1 P.14 Worksheet

Owner, DELL INC. W4-2P P. 15-20 Cancelled
Checks
W4-3 P. 21 Memorandum
CONTEMPLATE
CORP. 1000,0000 1600,0000 EMILLE FRENILLE W5-1 P. 22 Worksheet
Comptroller W5-2P P. 23-30 Invoices
CONTEMPLATE
CORP. W5-3 PP. 31-36 Cancelled
Checks
MAGGS ENTER-
PRISE 500,0000 75,000.00 SANDREX DUTERTE W6-1 P. 38 Worksheet
Manager, MAGGS
ENT. W6-2 PP. 39-46 Invoices
W6-3P P. 47-53 Official

Receipts
GROSS RECEIPTS
PER INVESTI-
GATION 4000,0000 545,000.000
REPORTED GROSS Atty. ROBY CAPU-

RECEIPT LON W1-1P P. 66-72 1990 ITR
(160,000.00) (1900,0000) Rev. District Off. W1-2P P. 73-80 1991 ITR

UNREPORTED RDO No. XX, Manila
GROSS
RECEIPTS 240,000.00 35,5000.00 TO APPENDIX B
ANNEX "A-3"
SAMPLE
APPENDIX B
COMPUTATION OF ADJUSTED TAXABLE INCOME 1990 & 1991
SING and FURR, INC.
ITEM 1990 1991 WITNESS EXHIBIT REFERENCE DESCRIPTION

(Particulars) NO. EVIDENCE
REPORTED 960,0000 P117,800.00 Atty. ROBY W1-1,2 PP. 66-80 1990, 1991
TAXABLE CAPULON ITRs
INCOME Rev. District Off.
RDO No. XX, Mla.
ADD: UNRE-
PORTED
GROSS RE-
CEIPTS 240,000.00 355,000.00 Atty. CARLS APPENDIX P. 84 Computation of
MIRANDA, JR. A Unreported
Intelligence Officer Gross Receipts
SUB-TOTAL 336,000.00 472,800.00
LESS: ADDITIONAL
OR DEDUCTIONS

ADJUSTED P336,000.00 P4728,00.00 TO APPENDIX C
TAXABLE
INCOME ======== ========
ANNEX "A-3"
SAMPLE
APPENDIX C
COMPUTATION OF DEFICIENCY TAXES 1990, 1991
SING and FURR, INC.
ITEM EXHIBIT REFERENCE

(Particulars) 1990 1991 WITNESS NO.
ADJUSTED
TAXABLE
INCOME 336,000.00 472,000.00 Atty. CARLS MIRANDA, JR. APPENDIX P.85
Intelligence Officer B

INCOME TAX

INC. TAX Due
Thereon 117,600.00 165,480.00
Less: TAX Due/
Return 336,00.00 41,230.00 Atty. ROBY CAPULON W1-1,2 PP. 66-80
Rev. District Off.
BASIC TAX 84,000.00 124,250.00 RDO No. XX, Mla.

ADD: 25% SUR-
CHARGE 21,000.00 31,062.50
50% SUR-
CHARGE 42,000.00 62,125.00
========== =========
June 1, 1998 June 1, 1998
REVENUE MEMORANDUM ORDER NO. 53-98
SUBJECT : Checklist of Documents to be Submitted by a Taxpayer upon

Audit of his Tax Liabilities as well as of the Mandatory
Reporting Requirements to be Prepared by a Revenue Officer,
all of which Comprise a Complete Tax Docket
TO : All Internal Revenue Officers, Employees and Others

Concerned
I. BACKGROUND
It has been observed that for the same kind of tax audit case, Revenue Officers
differ in their request for requirements from taxpayers as well as in the attachments to the
dockets resulting to tremendous complaints from taxpayers and confusion among tax
auditors and reviewers. cdphil
For equity and uniformity, this Bureau comes up with a prescribed list of
requirements from taxpayers, per kind of tax, as well as of the internally prepared
reporting requirements, all of which comprise a complete tax docket.
II. OBJECTIVE
This order is issued to:
a. Identify the documents to be required from a taxpayer during audit,

according to particular kind of tax; and
b. Identify the different audit reporting requirements to be prepared,

submitted and attached to a tax audit docket.
III. LIST OF REQUIREMENTS PER TAX TYPE
Income Tax/ Withholding Tax

Annex A (3 pages)
Value Added Tax

Annex B (2 pages)
Annex B-1 (5 pages)
Percentage Tax
Annex C (2 pages)
Documentary Stamp Tax

Annex D (1 page)
Estate Tax
Annex E (4 pages)
Donor's Tax
Annex F (2 pages)
Withholding Tax Remittance Return/Capital Gains Tax Return/Documentary

Stamp Tax (For transactions involving onerous transfer of real property)
Annex G (2 pages)
Capital Gain's Tax Return/Documentary Stamp Tax (For transactions involving

onerous transfer of shares of stock not traded through a local stock exchange)
Annex H (1 page)
Withholding Tax Remittance Return/Capital Gains Tax Return (For transactions

involving onerous transfer of motor vehicles)
Annex I (1 page)
It is to be emphasized that before a docket be released by an investigating

office, each and every page thereof be consecutively numbered.
It is worth mentioning, likewise, that an investigating Revenue Officer/Tax

Auditor must always request for the presentation of books of accounts, and
accounting/business records, specifically, records affecting the income, receipts,
deductions, estate and other taxable transaction of a taxpayer during the audit. LibLex
IV. REPEALING CLAUSE
All existing issuances or parts thereof which are inconsistent herewith are hereby
repealed.
V. EFFECTIVITY
This order takes effect immediately. cda
(SGD.) LIWAYWAY VINZONS-CHATO

Commissioner of Internal Revenue
ANNEX A
INCOME TAX/WITHHOLDING TAX
A) Requirements from Taxpayer
1) Certified Financial Statements, including comparative Profit and

Loss Statement with Statement of Cost of Goods Manufactured and
Sold, if applicable
2) Proof of claimed tax credit/s, if applicable
3) Proof of the claimed "Interest Expense", if applicable
4) Proof of claimed Bad Debts/worthlessness of credits, if applicable
5) Reconciliation of "Book Income" and "Taxable Income"
6) Certificate of Registration issued by the appropriate regulatory
agency, together with the conditions attached to such registration, if
applicable
7) Proof of Exemption under special laws, if applicable
8) Certification of the appropriate regulatory agency as to taxpayer's
entitlement to tax incentives, if applicable
9) Xerox copy of used Tax Credit Certificate with annotation of issued
TDM at the back, if applicable
10) Proof of payment of deficiency tax, if any/applicable
a) current year/period
b) previous year/period
11) Reports submitted to applicable regulatory agency that reflects the
financial condition and result of operation of the taxpayer e.g.,
Annual Statement prepared by insurance companies submitted to the
Insurance Commission etc., if applicable
B.) Reporting Requirements to be prepared and/or submitted by the Revenue Officers
1) Letter of Authority/Audit Notice

2) Duly filed Income Tax Return with all the required attachments
(Account Information Form, Schedule of Taxes and Licenses,
Schedule of Income Producing Properties, Schedule of Depreciation,
Breakdown of Selling and Administrative Expenses, etc.).
3) Proof of payment of the tax, including Tax Debit Memo/TCC
4) Quarterly Income Tax Returns
5) Proof of payment of second installment INCOME TAX, if
applicable
6) Beginning and Ending Inventory List, if material/applicable
7) Notice of Loss; Proof of claimed Losses, if applicable
8) Duly validated Monthly Withholding Tax Returns
9) Duly validated Quarterly Withholding Tax Returns, if applicable
10) Duly validated Annual Withholding Tax Returns together with the
required attachments (Alpha List)
11) Duly received Information Returns
12) Form 1717 Series / Form 0500 Series (Audit Reports)
13) Narrative Memorandum Report
14) Revenue Officer's Activity Report / Log Sheet
15) Table of Contents
16) Working Papers of the monthly debit and credit balances of all
accounts duly signed by the Tax Auditors/Revenue Officers
17) Working Papers showing computation of income and/or withholding
taxes due duly signed by the Tax Auditors/Revenue Officers
18) Schedule of Advances
19) Schedule of Interest Expense and Loans / Notes Payable (mention the
creditor/s, date contracted/granted, principal loan, interest rate and
interest expense), if applicable
20) Schedule of Bad Debts, if applicable
21) Schedule of Loss, if applicable
22) Schedule of Advances from Officers and Stockholders, if applicable
23) Schedule of Advances to Officers and Stockholders, if applicable
24) Schedule of Miscellaneous Income, if material/applicable
25) Schedule of Miscellaneous Expense, if material/applicable
26) Schedule of Interest Income (give details as to source/s and amount),
if material/applicable
27) Schedule of Other Receivables/Miscellaneous Receivables, if
material/applicable
28) Schedule of Other Payables, if material/applicable
29) Computation of Realized Gross Profit and Unrealized Gross Profit, if
the taxpayer is engaged in the business of selling real estate, whether
by installment or lump sum
30) Computation of Realized Gross Profit and Unrealized Gross Profit, if
the taxpayer is engaged in the business of selling personal properties
by installment
31) Computation of Gross Income from Contracts, if the taxpayer is
engaged in "Construction Business"
32) Detailed reconciliation of "Book Income" and "Taxable Income", if
necessary
33) Reconciliation of the Financial Statements' figures with the
Withholding Tax Returns' and Information Returns' figures
34) Checklist of audit procedures undertaken
35) Agreement Form (for agreed assessment)
36) Notice for an Informal Conference/Post Reporting Notice with the
summary of findings (for non-agreed assessment)
37) Comparative Report of Deficiency Tax Paid/Assessed, if applicable
38) Docket Locator Form
39) Delinquency Verification Report (for Claims for Refund / TCC )
40) Authority to Issue Refund / TCC ( for Claims for Refund / TCC )
41) Breakdown of Control Accounts, if applicable
42) Certification by the Revenue District Office, that he could not locate
the BIR copy of the tax return etc., if applicable
43) Result of Tax Mapping Program or Third Party Information Program
for LAs/Audit Notices issued thereunder
Note:
In case of non-availability of documents from RDO / RDC mentioned in B.2 -
B.11, request photocopies thereof from taxpayer LLjur
ANNEX B-1
VALUE-ADDED TAX
(For audit involving Claim for Refund / TCC)
A.) Requirements from Taxpayer
I. Requirements mentioned in Annex B
II. Additional General Requirements
1) 3 copies of "Application for VAT Credit / Refund"
2) Summary List of Local Purchases specifying the following:
Registered VAT Amount Total

Name of Number Invoice Date of OR Date of Input Invoice
Supplier of Supplier Number Invoice No. of OR Purchase Tax Amount
3) Photocopies of VAT purchase invoices for purchase of goods

and official receipts for purchase of services. (The
invoices/official receipts must be arranged according to the
summary list)
4) Summary of importations made during the period with the

following details:
Date of AWB/ Date of Total Date of O.R.

Invoice Supplier Item BL No. Arrival Value Payment No. VAT
5) Photocopies of invoices, import entry documents, official

receipts or confirmation receipts evidencing payment of
VAT. (Segregate documents paid by cash from those paid by
tax debit memo)
6) VAT Returns filed for the quarter showing that the amount
applied for refund/TCC has been reflected as a deduction
from the total available input tax, as well as VAT Return for
the succeeding quarter
7) Certification of taxpayer showing the amount of Zero-rated

Sales, Taxable Sales and Exempt Sales
8) A statement showing the amount and description of the sale

of goods and services, name of persons or entities (except in
case of exports) to whom the goods or services were sold and
date of the transaction, where the applicant 's zero-rated
transactions are regulated by certain government agency
9) Articles of Incorporation for first time filers
10) Sales Contract/Agreement
11) BOI Certificate of Registration
12) BIR Certificate of Registration
13) Certification from BOI, DOF, BOC, EPZA, etc., that subject
taxpayer has not filed similar claim for refund covering the
same period
14) Sworn statement that ending inventory as of the close of the

period covered by the Claim has been used directly or
indirectly in the products subsequently exported as supported
by export documents, if the applicant is 100% exporter
15) Documents of liquidation evidencing the actual utilization of

the raw materials in the manufacture of goods at least 70% of
which has been actually exported, if the applicant is an
indirect exporter
16) Copy of the ITR and Certified Financial Statements, if

applicable
17) Beginning and ending inventory of raw materials,

work-in-process, finished goods, supplies and materials
III. Additional Specific Requirements
1) For Export Sales (Semi-conductor companies, garments, food

etc.)
a. sales invoice number, name of buyer, airway bill / bill

of lading number, lading date, amount of sales in
foreign currency, peso value of sales, conversion rate,
date of remittance, bank credit memo number and
amounted remitted in pesos
b. Photocopies of export documents:
1) Invoices/ receipts evidencing sale of goods, as well as

the name of the person to whom the goods were
delivered with respect to foreign currency
denominated sales
2) export declaration/permit
c. accredited agent bank showing that the proceeds of

the sale in acceptable foreign currency had been
inwardly remitted and accounted for in accordance
with BSP rules and regulations. The statement should
also show the amount in foreign currency of the
export proceeds or consideration, date of export, date
of inward remittance, conversion rate into Philippine
currency and the total peso value thereof.
2. For Zero-Rated Sale of Services (contractors, mining, etc.)
a. Authenticated copy/ies of the contract/s showing the

person/s for whom the services were rendered, amount
of consideration, description of the services and
documents evidencing actual payments
b. Photocopies of official receipts and billings together

with a summary of the date of billing, name of
principal, official receipt number, date of receipt,
amount in foreign currency and the corresponding
value thereof, date of remittance, name of bank, bank
credit memo number and amount remitted in pesos
c. Bank credit memoranda and certificate from the BSP

with information similar to 1-c (export sales)
Additional Requirements for Manning Services:
a) Monthly BSP report on income of agency received
b) Breakdown of gross foreign receipts specifying the

nature of foreign currency received (e.g. Commission,
allotment manning fee, agency fee, advances, etc.)
showing the total foreign currency value with its peso
equivalent, bank credit memo number, name of bank
and date of remittance pred
3) Effectively zero-rated sale of goods (mining, etc.)/services

(contractors, etc.)
a) Summary of Sales invoices/receipts showing the name

of the person entity to whom the sale of goods or
services were delivered, order of delivery, amount of
consideration and description of goods or services
delivered (RR 6-89 and RMC 2-90)
b) Reconciliation of billings against payment
c) Evidence of actual receipt of goods and services
Additional Requirements for Mining Companies:
a) Reconciliation of billings against actual collection
b) Operating agreement with owner of mining claims, if

applicable
4) Purchase of Capital Goods
a) Original copies of invoices/receipts showing the date

of purchase, purchase price, amount of value-added
tax paid and description of the capital equipment
locally purchased
b) On imported capital goods
1) Photocopy of import entry documents and official

receipts/confirmation receipts of payment issued by
the Bureau of Customs for value-added tax paid
B.) Reporting Requirements to be prepared and/or submitted by the Revenue

Officers
I. Requirements mentioned in Annex B
II. Additional Requirements (All the requirements mentioned above)
Note:

B.6, request photocopies thereof from taxpayer
ANNEX C
OTHER PERCENTAGE TAXES
1) Proof of claimed tax credits

2) Proof of payment of the tax
3) Xerox copy of used Tax Credit Certificate (TCC) with annotation of
issued Tax Debit Memo (TDM) at the back
4) Proof of payment of deficiency tax
5) Certification of the appropriate government agency as to taxpayer's
entitlement to tax incentives, if applicable
6) Certificate of Registration issued by the appropriate regulatory
agency, together with the conditions attached to such registration, if
applicable
7) Certification of the appropriate regulatory agency as to the exempt
sales of the taxpayer under its regulatory supervision, if applicable
8) Proof of exemption under special law, if applicable
9) Sample invoice for "Exempt Sales", if applicable
B) Reporting Requirements to be prepared and/or submitted by the Revenue Officers
1) Letter of Authority / Audit Notice

2) Duly validated Percentage Tax Returns, including all the attachments
thereto
3) Tax Debit Memo applied, if applicable
4) Form 1717 series / 0500 series (Audit Reports)
5) Narrative Memorandum Report
6) Revenue Officer's Activity Report/Log Sheet
8) Working papers showing the computation of the taxable
receipts/sales (tax base) and percentage tax due duly signed by the
Tax Auditors/Revenue Officers cda
9) Reconciliation of Financial Statements' figures and Percentage Tax

Returns' figures
10) Schedule of Exempt Sales/Transactions, if applicable
13) Post Reporting Notice/Notice for an Informal Conference with the
SUMMARY OF FINDINGS (for non-agreed assessment)
14) Comparative Report of Deficiency Tax Paid/Assessed, if applicable
16) Delinquency Verification Report (For Claims for Refund/TCC)
17) Authority to Issue Refund/TCC (For Claims for Refund/TCC)
Note:
ANNEX D
DOCUMENTARY STAMP TAX

2) Xerox copy of used Tax Credit Certificate (TCC) with annotation of
issued TDM at the back, if applicable
3) Proof of Exemption under special laws, if applicable
4) Proof of payment of deficiency tax, if any
1) Duly filed Documentary Stamp Tax Declaration

2) Duly filed Documentary Stamp Tax Return
3) Tax Debit Memo, if applicable
4) Duly received Information Returns for Documentary Stamp Tax
5) Letter of Authority / Audit Notice
6) Form 1717 Series / Form 0500 Series (Audit Reports)
7) Narrative Memo Report
8) Revenue Officer's Activity Report / Log Sheet
10) Working Papers showing details and computation of tax base duly
signed by Tax Auditors/Revenue Officers
11) Working Papers showing computation of Documentary Stamps Tax
Due duly signed by Tax Auditors/Revenue Officers
14) Notice for an Informal Conference / Post Reporting Notice with the
Summary of Findings (for non-agreed assessment)
15) Comparative Report of Deficiency Tax Paid / Assessed
Note:

B.4, request photocopies thereof from taxpayer cdasia
ANNEX E
ESTATE TAX
I. General
1) Certified true copy of the DEATH CERTIFICATE

2) NOTICE OF DEATH duly received by the BIR, if the gross
taxable estate exceeds P20,000 for deaths occurring on or
after Jan. 1, 1998; or if the gross taxable estate exceeds
P3,000 for deaths occurring prior to Jan. 1, 1998
3) DEED OF EXTRA-JUDICIAL SETTLEMENT OF THE
ESTATE, if the estate is settled extrajudicially
4) SPECIAL POWER OF ATTORNEY, if applicable
5) COURT ORDER/DECISION, if the estate is settled judicially
6) A certified copy of the schedule of partition of the estate and
the order of the court approving the same, if applicable
7) Statement of the names of the executor, administrator and/or
heirs, with their respective addresses, who may be made
liable for unpaid assessment
8) Income Tax Returns with all the needed attachments, and
duly certified Financial Statements covering transactions in
the year of death and one (1) year prior to the date of death
9) Copy of the decedent's life insurance policy, if applicable
10) Proof that the transfer of property is from a fiduciary heir or
legatee to the fideicommissary, if applicable
11) Proof that the transfer of property is from a first heir, legatee
or donee to a beneficiary designated by the first heir's
predecessor, if applicable LLphil
12) Proof that the transfer of property is to a social welfare,

cultural and charitable institutions, no part of the net income
of which inures to the benefit of any individual and that not
more than 30% of the transferred property is used by such
institution for administration purposes, if applicable
13) Proof of deficiency tax payment, if any
14) Requirements in the investigation of other internal revenue
taxes, if they are covered by the tax audit
II. Real Property
1) Certified true copy/ies of the Transfer/Original/Condominium

Certificate of Title/s of real property/ies (front and back
pages);
2) Certified true copy of the latest Tax Declaration at the time of
death;
3) "Certificate of No Improvement" issued by the Assessor's
Office where properties have no declared improvement;
4) Certification from the Municipal/City/Provincial Assessor's
Office as to the declared real properties in the name of the
decedent and/or his/her surviving spouse at the time of death;
III. Personal Property 1(1)
1) Certificate of Deposit/Investment/Indebtedness owned by the

decedent and the surviving spouse,
2) Certificate of registration of vehicles and other proofs
showing the correct value of the same,
3) Proof of valuation of shares of stocks at the time of death
For listed stocks newspapers clippings/certification from
the STOCK EXCHANGE
For unlisted stocks latest Financial Statements of issuing
corporation with computation of book value per share
4) Xerox copy of certificate of stocks
5) Proof of valuation of other types of personal property
IV. Allowable Deductions 2(2)
1) Certification of the Barangay Chairman as to the domicile of

the decedent at the time of his death, if FAMILY HOME is
claimed as a deduction;
2) Proof of CLAIMS AGAINST THE ESTATE, if applicable
a) Certified true copy of the duly notarized promissory
note or contract of loan signed by the decedent and the
surviving spouse;
b) In case of advances made by individuals or
corporation to the decedent, copies of vouchers,
cancelled checks, contract of loan or other documents
evidencing the advances
c) Collection or demand letter of the creditor
d) Authenticated copy of the latest Balance Sheet of the
Corp.
e) Certification Under Oath as to the balance of the
decedent's account, signed by the President,
Vice-President or other responsible official of the
corporation, or the individual creditor
f) Certified true copy of a mortgage contract
g) Where settlement is made thru the Court, pertinent
documents filed with the court evidencing "claims
against the estate", or the court order approving the
said claims, if already issued;
h) Statement/accounting of disposition of the proceeds of
the loan, for loans incurred within 3 years prior to the
death of the decedent
3) Proof of Other Claimed Deductions
a) On property previously taxed or vanishing deductions
a copy of the duly bank validated estate/donor's tax
return and proof of payment of the tax on previous
transmission/transfer
b) On claims against insolvent person a copy of
insolvency proceedings / SEC Certification on
dissolved corporation (where the value of the
decedent's interest is included as part of the gross
estate)
4) Proof of Claimed Tax Credit
5) Proof of Claimed Losses
6) Proof of Claimed Medical Expenses claimed
7) Proof of Claimed "Transfer for Public Purpose", if applicable
B.) Reporting Requirements to be prepared and/or submitted by Revenue Officers
1) Letter of Authority (LA)/Return Verification Order (RVO)/Audit

Notice, whichever is applicable
2) Duly validated Estate Tax Return
4) STATEMENTS OF ASSETS AND DEDUCTION duly certified by
an independent CPA, if the gross taxable estate exceeds P2,000,000
for deaths occurring on or after Jan. 1, 1998; or if the gross taxable
estate exceeds P50,000 for deaths that occurred prior to Jan. 1, 1998
5) Form 0500 series/Form 1717 Series (Audit Reports)
6) Narrative Memorandum Report, for cases covered by LA/Audit
Notice
8) Table of Contents, for cases covered by LA/Audit Notice
9) Duly prepared Letter of Confirmation issued by the reviewing office
11) Certified photocopy of the zonal value of properties located outside
of the investigating region
12) Working papers reflecting items of gross estate and deductions duly
signed by Tax Auditors/Revenue Officers
13) Working papers showing computation of estate tax due duly signed
by Tax Auditors/Revenue Officers
14) Report of Ocular Inspection, if applicable
15) Detailed Schedule of deductions, if applicable
16) Reporting requirements for all the other internal revenue taxes, if
they are covered by the tax audit cdtai
Note:

1. if applicable
2. Proofs of all the claimed deductions must be presented to the Revenue Officer
during the original investigation and that only photocopies must be attached to the
docket.
ANNEX F
DONOR'S TAX
I. General
1) Certification of the balance of mortgage assumed by the

donee
2) Sworn statement of the relationship of the donor to the donee
3) Proof that the donee is a qualified relative of the donor, if the
donation is being taxed using the schedular rates. (e.g.
BIRTH CERTIFICATE)
4) Proof of exemption for exempt donations, if applicable
5) Proof of claimed tax credit, if applicable
6) Proof of claimed deductions, if applicable
7) Sworn statement that no other donations were made within
the same calendar year, if applicable;
II. Real Property
1) Certified true copy/ies of the Original/Transfer/Condominium

Certificate of Title ( front and back pages )
2) Certified true copy/ies of the latest Tax Declaration (front and
back pages)
3) "Certificate of No Improvement" issued by the Assessor's
Office where the property/ies have no declared improvements
III. Personal Property
1) Proof of valuation of shares of stock at the time of donation

a) For listed stocks newspaper clippings/certification
issued by the Stock Exchange as to the value per share
b) For unlisted stocks latest audited Financial
Statements of the issuing corporation with
computation of the book value per share
2) Certificate of Deposit/Investment/Indebtedness/Stocks for
donated cash and securities
3) Certificate of Registration of vehicle
4) Proof of valuation of vehicle
5) Proof of valuation of other types of personal properties
IV. Claimed Deductions
1) Proof of claimed deductions
1) Letter of Authority/Audit Notice/Return Verification Order,

whichever is applicable
2) Duly validated Tax Return
3) Proof of tax payment
4) Duly notarized Deed of Donation
5) Duly notarized Deed of Extra-judicial Settlement of the Estate with
waiver of rights, if the waiver is subject to donor's tax
6) Working papers showing the computation of gross donation and
deductions claimed, details of previous donations made within the
same calendar year and computation of deficiency tax due, if any,
duly signed by Tax Auditors/Revenue Officers
7) Form 1717 Series / Form 0500 Series (Audit Report)
8) Table of Contents, for cases covered by LA/Audit Notice
11) Post Reporting Notice/Notice for an Informal Conference with a
Summary of Findings (for non-agreed assessment)
13) Narrative Memorandum Report, for cases covered by LA/Audit
Notice
14) Revenue Officer's Activity Report
15) Duly prepared Letter of Confirmation issued by the reviewing office
16) Certified photocopy of the zonal value of property/ies
18) Detailed schedule of claimed deductions, if applicable
Note:

ANNEX G
WITHHOLDING TAX REMITTANCE RETURN

(For transactions involving onerous transfer of Real Property
classified as ordinary asset, whether Taxable or Exempt)
CAPITAL GAIN'S TAX RETURN

(For transactions involving onerous transfer of Real Property
classified as capital asset, whether Taxable or Exempt)
DOCUMENTARY STAMP TAX

2) Deed of Absolute Sale/Document of Transfer
3) Certified true copy of the Certificate of Title of the real property
(front and back pages )
4) Certified true copy of the latest Tax Declaration (front and back
pages)
5) "Certificate of No-improvement" issued by the Assessor's Office, if
the property has no declared improvement
6) Special Power of Attorney, if applicable
7) Seller's latest Certificate of Registration with HLURB or HUDCC
and the latest LICENSE TO SELL, if applicable
8) Seller's latest Certificate of Accreditation issued by the appropriate
Real Estate Builders Association, if applicable
9) Certificate of Exemption from Withholding Tax/Capital Gains
Tax/Documentary Stamp Tax issued by the Commissioner of Internal
Revenue or his representative to the taxpayer, if applicable
10) Proof of Exempt Transfers, if applicable
11) Proof of deficiency tax paid, if any
12) Certificate of Non-productivity of ricefield and other agricultural
lands issued by the Barangay Captain, if applicable
13) Xerox copy of location plan, if applicable
1) Duly filed Tax Return/Tax Declaration

2) Return Verification Order (RVO)
3) Form 1717 Series/Form 0500 Series (Audit Report)
6) Working Papers showing computation of deficiency tax due duly
signed by the Revenue Officer
Note:
In case of non-availability of document from RDO / RDC mentioned in B.1,

request photocopy thereof from taxpayer
ANNEX H
CAPITAL GAINS TAX RETURN/DOCUMENTARY STAMP TAX

(For transactions involving onerous transfer of shares of stock not traded through
the LOCAL STOCK EXCHANGE)
2) Deed of Absolute Sale/Document of Transfer
3) Proof of acquisition cost
4) Xerox copy of stock certificates
5) Proof of claimed selling expense
6) Xerox copy of the latest Financial Statements of the issuing
corporation with computation of the book value per share
1) Duly filed tax return/tax declaration

2) Working papers showing the composition of gross sales, acquisition
cost/book value of shares, selling expenses, realized gain and
computation of deficiency tax due, if any, duly signed by the Tax
Auditor/Revenue Officer
3) Form 1717 series/Form 0500 series ( Audit Report)
4) Return Verification Order (RVO)
6) Revenue Officer's Activity Report
Note:

request photocopy thereof from taxpayer cda
ANNEX I
WITHHOLDING TAX REMITTANCE RETURN

(For transactions involving onerous transfer of motor vehicle
classified as ordinary asset)
CAPITAL GAINS TAX RETURN

(For transactions involving onerous transfer of motor vehicles
classified as capital asset)
1) Xerox copy of Certificate of Registration

2) Proof of valuation of the motor vehicles
3) Deed of Sale/Document of Transfer
1. Duly validated Tax Returns

2. Return Verification Order (RVO)
3. Form 1717 series/Form 0500 series (Audit Report)
4. Working paper showing computation of the tax due duly signed by
the Tax Auditor/Revenue Officer
5. Docket Locator Form
6. Revenue Officer's Activity Report
Note:

request photocopy thereof from taxpayer
Endnotes
1 (Popup - Popup)
1. if applicable
2 (Popup - Popup)
2. Proofs of all the claimed deductions must be presented to the Revenue Officer
during the original investigation and that only photocopies must be attached to the
docket.

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March 17, 2000

REVENUE AUDIT MEMORANDUM ORDER NO. 01-00

SUBJECT : Updated Handbook on Audit Procedures and Techniques

TO : All Internal Revenue Officers and Others Concerned

This Order prescribes the use of the Updated Handbook on Audit

II. Quality Audit

The purpose of auditing a tax return is to determine the taxpayer's

III. Reporting Requirements

IV. Repealing Clause

This Order supersedes Revenue Audit Memorandum Order No. 2-95,

(SGD.) DAKILA B. FONACIER

HANDBOOK ON AUDIT PROCEDURES AND TECHNIQUES

(Revision - Year 2000)

In order to utilize audit as an effective tool in the enhancement of voluntary

The updating of this Handbook on Audit Procedures and Techniques Volume I

This Handbook is a project of the Assessment Service with the Assessment

Nars P. Tamayo Acting Assistant Commissioner

Elvira R. Vera Acting Head Revenue Executive Assistant

ASSESSMENT PROGRAMS DIVISION

Leticia C. Batausa Officer-In-Charge

Ione S. Alejo Section Chief

Elenita V. Balonzo Section Chief

Cristina T. Billones Section Chief

Urania C. Salvacion Section Chief

Gladys M. Aquino Revenue Officer III

Dessie V. Garcia Revenue Officer II

Elmira C. Viray Revenue Officer I

Gean M. Dienzo Computer Operator I

Cristina V. Pangan Computer Operator I

Audit of Income Accounts

XII. Auditing Computer-Produced Records

XVII. Report Making

A Revenue Tax Administration

The function of the Bureau of Internal Revenue is to administer the provisions of

Investigation supports the mission of the Bureau by enhancing a high degree of

1. Measuring the degree of voluntary compliance as reflected on filed returns;

2. Reducing non-compliance by identifying returns and taxpayers that need to be

3. Conducting quality audit of selected tax returns on a timely basis.

The handbook contains guides, instructions and suggestions in the conduct of

The Handbook is neither intended to provide a source of tax law or procedural

The other contents of the handbook include documentary requirements in the

II. Accounting Methods

The taxable income of a taxpayer shall be computed in accordance with the

The methods of accounting recognized under the Tax Code are:

A. Cash Basis is a method of accounting whereby all items of gross income

B. Accrual Basis is a method of accounting for income in the period it is earned

C. Completion of Contract Basis is an accounting method applicable to

D. Percentage of Completion Basis is a method applicable in the case of a

In such case, the return should be accompanied by a certificate of the architect or

Beginning January 1, 1998 income from log-term contracts are required to be

F. Crop Year Basis is a method applicable only to farmers engaged in the

1. Creditable income tax (asset)

2. VAT input tax (asset)

3. Withholding tax payable-Compensation (liability)

4. Withholding tax payable-Expanded Withholding Tax (EWT) (liability)

5. VAT output tax (liability)

III. Bookkeeping Systems

A. Single Entry System of bookkeeping is basically a type of "net worth"

A single entry system may be merely a chronological record of transactions posted

Sometimes, the records consist of a complete set of journals (cash, sales,

Assets = Liabilities + Capital

IV. Accounting Records

Below are the regular accounting records being used by taxpayers: