A month before 2020 ends, people are beginning to experience some level of normalcy, returning slowly to pre-pandemic life, and looking for a reset button to make up for losses.
The same goes for the Bureau of Internal Revenue (BIR), the chief agency responsible for the government’s funds. While it managed to exceed its reduced collection targets, the BIR is still aggressive in its efforts to collect taxes via tax audits.
One common issue that the BIR raises during a tax audit is deficiency withholding tax, which usually arises from discrepancies between expenses recognized in the taxpayer’s Audited Financial Statements (AFS) or Income Tax Return (ITR) and those reported in the withholding tax returns. These discrepancies are easy for the BIR to spot but often difficult for taxpayers to refute or justify.
Effectively, a deficiency withholding tax assessment will also result in a deficiency income tax exposure since the related deductible expense will also be disallowed. This principle is based on Section 34(K) of the Tax Code, which states that an expense will be allowed as a deduction for income tax purposes only if it is shown that the tax required to be deducted and withheld therefrom has been paid to the BIR. Nonetheless, this issue of deductibility may not be too critical. Under Section 2.58.5 of Revenue Regulation (RR) No. 2-98, as amended by RR No. 14-2002, a taxpayer with withholding tax deficiencies will still be allowed to claim the related expense as an income tax deduction as long as the deficiency withholding tax and corresponding penalties are settled during an audit/investigation or reinvestigation/reconsideration.
Consistent with these rules, the Court of Tax Appeals (CTA) has ruled that a deduction is allowed even if no tax was withheld only if the corresponding deficiency withholding tax was paid during the audit/investigation or reinvestigation/reconsideration, and not after its conclusion. In CTA Case No. 9349 dated May 30, 2019, the Court did not set aside the issue of the disallowance of expense even if the taxpayer paid the deficiency withholding tax after the receipt of the BIR’s Final Decision on Disputed Assessment (FDDA). Having paid the withholding tax deficiency after the assessment, the deduction can no longer be allowed under the withholding tax regulations.
However, in CTA Case No. 9531 dated Sept. 6, 2019, the Court went even further and held that the audit/investigation or reinvestigation/reconsideration had already been concluded when the Formal Letter of Demand (FLD) or FDDA was issued.
With all due respect, the CTA ruling needs re-examination. It appears that the Court may have been inadvertently written the FLD as equivalent to the FDDA. As most readers would probably know, an FLD is issued together with the Final Assessment Notice (FAN), to which a taxpayer is given 30 days upon receipt to file an administrative protest for reconsideration or reinvestigation. I say there appears to be a mistake because in this case, the CTA only disallowed the expenses where the deficiency expanded withholding tax (EWT) were paid after the issuance of the FDDA and no longer included the related expenses where the EWT was initially paid after the taxpayer filed its protest to the FLD.
Clearly, the CTA’s position is still reckoned starting from the point of the FDDA only. Unless the taxpayer is confident in refuting the deficiency withholding tax assessment, it is prudent to settle the deficiency at least before the issuance of the FDDA to be able to claim the related expense.
It may also be helpful for taxpayers with ongoing tax assessments with the BIR for taxable years prior to 2018 to know that Section 2.58.5 of RR No. 2-98 was earlier amended by RR No. 12-2013. According to RR No. 12-2013, no deduction for income tax purposes may be allowed where there was failure to withhold tax notwithstanding subsequent payment of such withholding tax at the time of audit investigation or reinvestigation/reconsideration. However, in 2018, the BIR issued RR No. 6-2018 which revoked RR No. 12-2013 and reinstated the provisions of Section 2.58.5 of RR No. 2-98.
So, should the favorable RR No. 6-2018 be applied to tax audits covering taxable years before the regulation was issued in 2018? The answer should be yes. Under Section 246 of the Tax Code, the revocation, modification or reversal of any rules and regulations promulgated by the Tax Code or the Commissioner does not have retroactive application if prejudicial to the taxpayer. RR No. 6-2018, on the contrary, is beneficial to taxpayers and should thus be retroactively applied. Notably, the CTA cases I mentioned pertain to tax assessments covering taxable years before 2018, in which the Court never mentioned or applied RR No. 12-2013.
While the BIR is tasked to collect funds for the government, it must seriously consider the plight of taxpayers who are struggling to survive the pandemic and recent calamities. The BIR must likewise balance its duty with the general welfare of the public. As for the taxpayers, this is not the time for their money, which could otherwise be used for subsistence, to go wasted on tax deficiency payments that can be avoided if they are fully aware of the requirements of the tax laws.
The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only, and should not be used as a substitute for specific advice.
Nestine P. Buisan is a Senior Associate at the Tax Services Department of Isla Lipana & Co., the Philippine member firm of the PwC network.