Reforming the Bureau of Internal Revenue: The Swiss Model

To reform any organization such as the Bureau of Internal Revenue (BIR), one must first understand how it works. And the first thing in understanding how an organization works is to ask: Who are the stars in this BIR organization?

First, an exposition on how the BIR is supposed to operate. The Philippine government as with all government relies on taxes, especially income taxes to fund its operations. Every citizen who is gainfully employed or in business and earning above a minimum income level must file an income tax return. Private corporations must also file corporate income tax returns well as other taxes such as percentage taxes, value-added taxes, and excise taxes.

Based on the latest 2023 Annual Report of the BIR, there were around 1.3 million corporate taxpayers and around 28.1 million individual taxpayers. Some of these taxpayers understate their reported income in order to minimize the taxes they pay the government. To minimize such underreporting, the BIR examines their tax returns to determine if the taxpayer has paid the correct taxes. Given the volume of the tax filing and the limited personnel of BIR (15,154 as of Dec. 31, 2023), only a small sample of taxpayer returns can be examined.

The personnel in the BIR who are tasked with reviewing these tax returns are the examiners. These BIR examiners are expected to detect the underreporting of tax returns, collect the taxes due on the unreported income, impose fines, and even recommend the filing of criminal charges.

In addition to collecting additional taxes, this random examination of filed tax returns is expected to deter other taxpayers from underreporting their income and the taxes due for fear that they would be subject to examination by the BIR.

This is how the system is supposed to work.

To find out how the system actually works, let us follow a typical BIR examiner who, upon receiving his Letter of Authority (LoA), proceeds to the office of a corporate taxpayer. Upon reaching the office, he is confronted with a picture of the owner in the warm embrace of a powerful politician. He must then decide whether the owner is so politically well-connected that he has to just give him a clearance. (Hint: if the picture was taken during the birthday of the owner, the examiner passes.)

The owner or his representative welcomes him. After some pleasantries, the owner then asks the examiner if he is going to conduct “a close book or an open book” examination. A close book exam means the examiner does not go over the book of accounts and merely issues a clearance with the bribe subject to negotiation. In this negotiation, the examiner is at a disadvantage as he does not know how much income the company has hidden. But then, he does not exert any effort at all.

Note that the government does not receive additional taxes.

On the other hand, if the examiner is talented, energetic, and exceedingly corrupt, he chooses the open book exam, meaning he has to comb over the voluminous books of account (being corrupt also means doing some hard work). At the end of this minute examination, he can confront the owner and confidently state: “You have hidden P100 million in income and these are the places where they have been hidden. Your tax deficiency, without computing the 25% surcharge, the interest charges, as well as the other penalties, is P25 million. I will report only a tax deficiency of P5 million and waive the surcharge, the interest, and the other penalties. By the way, tax evasion is a crime punishable by fines and/or imprisonment. Now let us discuss my share in the P20 million.” Note that under this scenario, the government still gets P5 million in additional taxes.

Let us now take the case of a newly appointed BIR Commissioner. He makes a courtesy call to his official superior, the Secretary of Finance. In that meeting, the Finance secretary does not discuss the mission statement of the BIR: We collect taxes through just enforcement of tax laws for nation-building and the upliftment of the lives of Filipinos. Neither does secretary ask for a program to cleanse corruption in the BIR. His mission statement is simple and direct, “The BIR must collect P2.5 trillion this year or the government is in fiscal trouble.”

After the meeting, as the BIR Commissioner considers how to meet the fiscal target, he realizes that he can meet the target and keep his job only with the support of the superstar examiners. He then makes a Faustian bargain — meet your collection revenue quotas and I will turn a blind eye to your other activities.

In sum then, the stars in the BIR organization are the examiners and among the examiners, the open book examiners are the superstars or rainmakers.

Clearly to reform the BIR, we must sever our dependence on the examiners, especially the open book examiners.

Fortunately, modern technology provides an answer. Through Data Analytics and Artificial Intelligence and the fact that tax returns are now filed electronically, it is now possible to review all and not just a sample of the around 30 million tax returns filed annually. Moreover, using the same tools, we can generate a list of questionable tax returns. We can then return these questionable returns to the filers and give them a second chance to revise their filing.

The list will still be large, but again, through the above tools we can generate a priority list of those tax returns to be examined. Still the list will be large and so we have to switch to the Swiss model.

In Switzerland, tax evasion — defined as the non-payment or under-payment of taxes by making false statements to tax authorities — is a civil and not a criminal offense. Tax fraud, defined as deliberately falsifying tax documents to deceive tax authorities, like all other kinds of fraud is still a criminal offense.

This tax policy is rooted in the belief of the Swiss people that the government is not a superior organization but is just like any ordinary corporation organized to serve the people. Thus, in the case of tax evasion, the government is merely an ordinary creditor suing a delinquent debtor.

There are several implications for this. With tax evasion merely a civil case, the coercive power of the BIR and the stiff resistance of the taxpayer are diminished considering that what is involved is merely loss of money and not the loss of liberty.

More importantly, as this is merely a civil case, the government can now outsource this function to the private sector.

Under a Public-Private Partnership arrangement, the government could outsource the examination of the questionable tax returns to the around 200,000 Certified Public Accountants (CPAs) in the Philippines (per the Philippine Institute of Certified Public Accountants or PICPA) while the 15,000 staff of the BIR retain the responsibility of dealing with tax fraud. These CPAs could be engaged on a per tax account basis with a percentage of the recovered tax return as an incentive.

In case of dispute, these civil cases could be resolved under a binding agreement in an arbitration panel. This is a much faster process than resorting to the tax courts.

In sum, the proposal would result in greater compliance by taxpayers of their tax obligations, higher revenue collection on the part of government, and a lower level of corruption in the BIR.

In closing, we admit that reforming the BIR will be a long and complex process, but we believe in the Chinese saying that a journey of a thousand miles begins with the first step. That first step is the decriminalization of tax evasion. Our legislators must pass a law transforming tax evasion from a criminal offense to a civil dispute.

Dr. Victor S. Limlingan is a retired professor of AIM and a fellow of the Foundation for Economic Freedom. He is presently chairman of Cristina Research Foundation, a public policy adviser and Regina Capital Development Corp., a member of the Philippine Stock Exchange.