When tax cannot follow accounting

Tax rules are constantly subject to change. Whether covered by new laws or new administrative issuances, these changes are deemed sound policy if they contribute to the efficiency and fairness of our tax system, are uncomplicated to comply with, and ultimately, serve the interest of both the citizenry and the government.

A new tax law goes through intensive review as it passes through both houses of Congress before being signed by the President. In the case of administrative issuances, revenue regulations (RR), in particular, are issued by the Secretary of Finance upon the recommendation of the Commissioner of Internal Revenue. Since RRs are the main administrative issuances that implementing tax statutes, I would like to believe that they are meticulously evaluated for compliance with the Constitution and the Tax Code, as well as for their sensibleness in achieving their objectives.

However, over the years, I have come across some tax rules which are too rigid or impractical to follow, and at times are even inconsistent with the objectives the government is trying to achieve. An example is RR No. 21-2002, which details the additional procedural and documentary requirements for the preparation and submission of financial statements (FS) that accompany the tax returns under Section 6(H) of the Tax Code.

Under this RR, the line items in the FS must be indicated with sufficient detail to ensure that the nature of the transactions is clear to the reader of the FS. The account titles to be used must be specific and enumerated completely in the FS. These accounts must also conform to the rules and requirements of regulatory agencies that have supervision over them such as the Securities and Exchange Commission (SEC), Bangko Sentral ng Pilipinas (BSP), and the Insurance Commission (IC), among others.

Further, if applicable, the following items must be shown separately in the income statement:

a) Cost of goods sold (for seller of goods)/Cost of services (for seller of services);

b) Selling and administrative expenses;

c) Financial expenses;

d) Special deductions (e.g., net operating loss carry-over or NOLCO); and

e) Deductions under special laws.

Deductions under items (c), (d) and (e) should be fully explained in the Notes to the audited FS.

This RR was the basis used by the Court of Tax Appeals (CTA) in ruling against the deductibility of a taxpayer’s NOLCO for being unsupported in the FS. In that fairly recent case, one of the reasons cited by the CTA is that NOLCO should be shown as a special deduction and as a separate item in the income statement for the years in which it is claimed, despite the disclosure in the Notes to the audited FS.

With all due respect, I believe that it is not appropriate to require the presentation of NOLCO as a special deduction in the audited FS because it is inconsistent with Philippine Accounting Standards (PAS).

NOLCO, being the excess of the allowable deductions over the gross income, is considered as a deferred tax asset (DTA) as it is a ‘carryforward’ of unused tax losses consistent with paragraph 5 (b) of PAS 12, Income Taxes. However, this DTA is recognized only to the extent that it is probable that taxable profit will be available against which the unused tax losses can be utilized.

When recognized by the taxpayer, only the income tax effect (or the 30% thereof) of the resulting NOLCO is recorded as a debit to the DTA and as a credit to income tax expense. DTA is an account presented in the balance sheet while income tax expense is reflected in the income statement but not as a regular expense.

Moreover, under the relevant accounting standards, expenses do not include losses incurred in the previous years. When NOLCO is applied or claimed as a deduction for tax purposes, it is recorded as a credit to the DTA (if previously recognized) and as a debit entry to income tax expense. That said, the amount of NOLCO in the income tax return can never be reflected in the income statement as required by the RR.

It is a well-settled principle that deductions, such as in the case of NOLCO, are considered tax exemptions and, therefore, are construed in strictissimi juris against the taxpayer. As such, taxpayers are required to establish the factual and documentary bases of their claims with competence.

While this tax principle holds true in most instances, it should not apply to this RR. Since the RR runs contrary to accounting standards issued by the Philippine Financial Reporting Standards Council as approved by the SEC, paradoxically, taxpayers complying with the BIR tax rule will find themselves breaching the SEC accounting rules.

This kind of absurdity in our tax regulations should be revisited, re-evaluated, and corrected. Regrettably, I believe this is only one of the many contentious tax requirements that have been issued and implemented over the years.

The goal of the ongoing comprehensive tax reform program is to develop a simpler, fairer, and more efficient tax system. Thus, this is an appeal to our lawmakers and policymaking bodies to engage in continuing and integrative policy reviews that should open itself to public participation and scrutiny. How best to create and maintain sound policies should be the chief concern of all stakeholders, including the taxpayers.

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.

Samantha Joy H. Oreta is a senior manager with the Tax Services group of Isla Lipana & Co., the Philippine member firm of the PwC global network.