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Ensure fair and just audits and avoid abusive taxation

September 2017 - Tax & Private Client. Legal Developments by LawAlliance Limited.

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Ensure fair and just audits and avoid abusive taxation

The Revenue Code provides various tools to tax officials to ensure that taxes can be collected with a high level of efficiency. These tools can serve as a double-edge sword, ensuring tax compliance while also imposing punishment on defaulting taxpayers.

Questions often arise about whether assessment officials are free to apply these tools against taxpayers at will, or if they need to be applied within the context of fairness and justice.

Let's look at a specific example. If a corporate taxpayer fails to provide adequate information or documents to support the calculation of net profits, Section 71(1) of the Revenue Code allows an assessor to apply 5% tax on gross revenue in lieu of 20% tax on net profits. This is often a problem for taxpayers, since cooperating with the taxman's request for more documents could land them in trouble or weaken their existing position.

The 5% tax on gross revenue is high in light of the decline in corporate tax rates in recent years. Back when the rate was 30% of net profit, a 5% tax on gross revenue implied a profit margin of 16.6%. At the current rate of 20% of net profit, 5% of the gross implies a profit margin of 25%. Not only is Section 71(1) an effective tool to force taxpayers to open their books, but it also lets authorities collect more than the taxpayer would have paid if non-compliance had not occurred.

If a taxpayer has income of 100 and expenses of 90, the normal tax is 2 (20% of the net profit of 100-90) but tax assessed under Section 71(1) is 5 (5% of 100). In the worst-case scenario, Section 71(1) could result in tax being imposed even if the business is sustaining losses -- plus surcharges of 1.5% and penalties of either 100% or 200%, depending on whether a tax return was filed.

In this context, it's necessary to understand the level of cooperation that will be sufficient to save taxpayers from the abusive imposition of the 5% tax.

Section 71(1) states that an official may apply the 5% tax if a company fails to file a tax return or a financial statement, or to submit documents or evidence requested in the course of a tax audit. Until 2009, however, it was unclear whether Section 71(1) applied in all cases of failure to file a tax return or financial statement by the normal deadline of 150 days from the end of the accounting year. The court ruled that providing all the required documents requested in a formal summons could save the taxpayer from additional financial punishment. It states:

"The spirit of Section 71(1) was not only to punish those who fail to comply with legal provisions, but also to encourage taxpayers to file tax returns with the correct information and submit the financial documents necessary to prove their income and expenses. ... The assessment official must consider suitability and fairness in applying Section 71(1).

"Thus, even though the assessment official had authority to assess tax under Section 71(1), due to the taxpayer's cooperation in filing a tax return and submitting evidence after receiving the letter of summons, which enabled the assessment official to calculate the amount of actual net profits, the assessment under Section 71(1) was not legitimate even if it was approved by the director-general of the Revenue Department."

This view was reiterated in a recent court case involving a more complex situation in which the taxpayer failed not only to file a return by the deadline but also failed to cooperate during the tax audit process. Would the taxpayer still survive Section 71(1) in this case?

In this case, after failing to file a tax return, the company failed to send a representative to a meeting that a tax official requested to discuss the issue. The official then issued a summons to which the company did not respond until it received a second warning letter. It finally started to cooperate, saying the delay had occurred because the accountant who had audited the books for the years in question had resigned.

The assessment official compared the tax calculated on net profits and on gross income, and decided to apply Section 71(1) since it resulted in a higher amount of tax. The company also faced a 20% surcharge for the half-year tax default, based on the year-end tax amount derived under Section 71(1).

The court said the assessment was illegitimate, based on these reasons:

While the Revenue Department has the authority to make an assessment under Section 71(1), its primary duty is to adopt the normal assessment based on actual net profits. In this case the department conceded that it was able to calculate net profits based on the information provided by the company during the audit process.

The department could not prove how the documents, which it claimed the company did not provide, affected its ability to compute tax on net profits.

It appeared that the company had filed tax returns and provided documents sufficient for the calculation of net profits to the assessment official before the assessment letter was issued.

It's clear from this example that the tools provided to officials for tax collection must be enforced with fairness and justice. To ensure that this principle is upheld, taxpayers should always prove their innocence by explaining the causes of any delay in submitting documents.

By Rachanee Prasongprasit. She can be reached at

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