In an interview with the Bureau of Internal Revenue (BIR)’s Commissioner, Romeo “Jun” Lumagui Jr., he said that there has been an estimated ₱500 billion lost due to tax evasion for various types of taxes, which could have contributed to an additional 1-2% in total collections. Even with the additional potential revenue, audit activities have contributed to an average of 2.15% of total collections, according to the past three BIR annual reports from 2021-2023.
In the current system, the BIR uses random audit with no reference to risk level or taxpayer profile. Although there are criteria that can get a taxpayer on the “priority list” for audit, Revenue Memorandum Order (RMO) No. 6-2023 says that all taxpayers are possible audit candidates. This results in examiners throwing a huge amount of assessment, even more than the total sales and/or capital of the company being audited in order to conduct its assessments.
Several economic scholars have said that most studies on tax compliance look at the taxpayer’s point of view, and place the tax authority as a strategic player who has to use the limited information it has of the taxpayer base (which comes from self-reported returns) in order to detect noncompliance with a limited budget.
However, most of the foreign investors we encountered during our international roadshows with various Philippine Embassies in Asia, US, Europe and Australia and in the business mission with Philippine Economic Zone Authority (PEZA) in Germany this year, said that the burden of the annual audit were their biggest concern when it comes to investing in the Philippines. Despite the tax incentives provided under the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Law, the yearly random audit leads to unnecessary costs and operational disruptions for businesses, especially for those who fully comply with tax regulations.
While auditing and investigations are essential for ensuring tax compliance, a more targeted and risk-based approach must be adopted to enhance efficiency and fairness in the system, as the current random audit burdens both compliant taxpayers and examiners, diverting BIR resources that could be allocated towards those with a higher probability of noncompliance and collections. A risk-based, data driven approach, can strike a better balance between chasing non-compliant taxpayers and promoting ease of doing business in the country while increasing revenue collections.
Identifying High-Risk Taxpayers and Industries
Under the Ease of Paying Taxes (EOPT) Act, refunds for Value Added Tax (VAT) are classified into low, medium, and high-risk categories, depending on several factors such as the compliance history of the taxpayer, and the frequency of refund claims.
Meanwhile, the proposed risk-based audit uses the data gathered from previous years of returns to give a “score” to each taxpayer based on certain criteria such as company size, average compliance within their industry, and its own history of compliance, alongside past audit information. In short, the goal is to provide a taxpayer profile for the current taxpayer base, and identify those who are most likely to be noncompliant and guilty of tax evasion.
Under a risk-based audit, the Bureau will focus on high-risk taxpayers, and if there’s prima facie evidence of tax evasion i.e., more than 30% under declaration of sales or over declaration of expenses, they can be prosecuted in court as per Section 248 of the Tax Code.
Countries such as Australia, Canada, and the United Kingdom have successfully leveraged data mining and analytics to identify high-risk taxpayers, resulting in a more efficient audit that better target tax evasion while protecting compliant businesses. On the other hand, The U.S. Internal Revenue Service’s (IRS) Large Corporate Compliance (LCC) initiative is another major example of risk-based audit selection, as the LCC program’s data analytics program classified tax returns based on automated risk criteria and compares these results with prior returns or industry averages to detect anomalies.
Meanwhile, in Sweden, their risk-based audit system yielded a 45-72% increase in tax collections despite a 10% drop in the number of audits performed, as audits concentrated on high-risk cases.
By concentrating efforts on complex avoidance schemes rather than compliant businesses or the same taxpayers every year, the BIR can improve its overall performance and achieve better enforcement outcomes. This targeted approach not only enhances the efficiency of the audit process but also incentivizes voluntary compliance. When businesses understand that high-risk behaviors are more likely to be scrutinized, they are more likely to maintain accurate records, adopt better internal controls and further improve their voluntary compliance, thereby fostering a culture of integrity and accountability.
An example of this in action is the BIR’s Run After Tax Evaders (RATE) program, which uses a risk-based approach similar to VAT refund claims in the EOPT. If the taxpayer is low-risk, they will not be audited, or are last on the priority list for an audit, the higher the risk, the more likely they are to get audited—and once there is sufficient evidence of tax evasion, a criminal case may be filed.
Legislative Support and the Path Forward
The success of a risk-based audit can be further bolstered by appropriate legislation and a proper database. The Ease of Paying Taxes Act and the Ease of Doing Business Act provides a solid framework for implementing risk-based audits. However, to successfully transition to this model, policymakers must prioritize the integration of advanced data analytics and risk assessment tools into the BIR system.
The BIR currently uses a web-based system for taxpayer registration, filing, and payment of tax returns in order to enhance oversight and minimize lost documents. The usage of the Electronic Filing and Payment System (eFPS) and Electronic Records Management System (eRMS) is crucial to create the databases needed for risk-based audit to work, creating the scaffolding for industry compliance trends and data analysis.
In Southeast Asia, Vietnam’s General Department of Taxation has started to use a risk-based approach to combat non compliant taxpayers, while working with the International Monetary Fund in applying these techniques to its tourism industry. Meanwhile, the Inland Revenue Authority of Singapore uses a risk-based approach and random audit to profile companies and target noncompliance.
Using these models of how other countries have leveraged data-driven approaches to identify noncompliance, the BIR can enhance its capacity to detect and deter tax evasion without burdening compliant taxpayers. However, this requires collaboration across government agencies and the private sector to set it in motion.
Governance is a shared responsibility. With this in mind, we continue to collaborate with policymakers and legislators to reform our tax policy and administration by facilitating dialogues and public discussions on tax policy agenda that will further improve ease of doing business and attract foreign investments. Engaging international organizations like the World Bank, IMF and OECD also helps us better understand the risks involved and find more palatable solutions to address corruption, tax evasion and other bureaucratic challenges detrimental to our country’s economic and inclusive growth.
While the government invests in technology to effectively assess the risk level of taxpayers and industries using data analytics tools, businesses must also continue to improve their tax compliance to reduce their exposure risks. Under risk-based audit, higher revenue collection will be expected from high-risk and low compliant taxpayers. For businesses, random or risk-based audit will expose them to high penalties and interest on top of their deficiency tax assessment if they don’t comply with tax rules and regulations. For more information and how you can reduce your tax exposure risks, CONSULT ACG at consult@acg.ph.
