At times, employees may be required to cover business expenses using their personal funds. These expenses may include transportation costs and office supplies, which employees can later request reimbursement for from their employers.
Regardless of how business practices change, there remain firm rules in place that will affect how taxpayers or employers approach these “business-related expenses” in terms of deductibility. Some of the most common Bureau of Internal Revenue (BIR) audit findings have to do with expenses which were not subjected to expanded withholding taxes (EWT) and expenses that were improperly substantiated, leading to the disallowance of a Value-Added Tax (VAT) claim. Hence, the following questions arise:
What occurs during BIR audits?
What is the appropriate way for employers to handle these expenses in the future?
What occurs during audits conducted by the Bureau of Internal Revenue?
BIR-initiated Tax Assessments usually begin with the release of a Letter of Authority (LoA), where the designated examiner compares the expenses stated in the taxpayer’s records, such as the audited financial statements or trial balance, to the expenses declared in the tax returns. This may result in a deficiency tax if there are discrepancies due to non-deductible expenses or unreported income.
The BIR often discovers that expenses for employee reimbursements were not subjected to EWT. This may lead to the taxpayer owing a deficiency in EWT remittance, along with penalties and interest, and the possibility of these expenses being disallowed as deductions on their income tax return (ITR).
What is the appropriate way for employers to handle these business-related expenses?
To determine the proper way for taxpayers to address these problems, we will examine the guidelines regarding the retention of employee-reimbursed business costs. According to Section 2.78.1 6(b) of Revenue Regulations (RR) No. 2-98, as revised, any payment made specifically for travel, representation, or other legitimate and necessary expenses incurred or likely to be incurred by the employee in fulfilling their job responsibilities is not considered taxable income subject to withholding, as long as the following requirements are met:
(i) This applies to regular and essential travel and expenses for representation or entertainment that are paid or incurred by the employee while conducting trade, business, or a profession; and
The employee must comply with the specific substantiation requirements for each expense category under Sec. 34 of the Tax Code. Any excess expenses that are not returned to the employer will be considered taxable income. Reimbursements and advances for travel and entertainment expenses that are predetermined and paid while the employee is on assignment or duty do not need to be substantiated or subject to compensation withholding.
After gaining an understanding of what will be included in employees’ taxable income, let’s continue to consider the impact of these reimbursements on employers.
SUBSTANTIATION AND WITHHOLDING REQUIREMENTS
To legitimately deduct ordinary and necessary expenses, taxpayers must follow Section 34 of the National Internal Revenue Code (NIRC) and provide sufficient evidence, such as official receipts or records, to prove (i) the amount of the expense being deducted and (ii) how it directly relates to the development, management, operation, and/or conduct of their trade, business or profession.
Moreover, Revenue Memorandum Circular (RMC) No. 72-2004 stated that companies classified as top 20,000 corporations (TTC)/large taxpayers (LT) must deduct 1% EWT for purchasing goods and 2% EWT for purchasing services from payments made to their regular suppliers, which were covered by their employees/agents. The RMC also clarified that the sales invoices/official receipts must be under the names of the individuals they represent and a corresponding certificate of taxes withheld at source (BIR Form No. 2307) must be issued. Alternatively, taxpayers can choose to issue company credit cards to employees to simplify the administrative burden of compliance, as no withholding is required for transactions made with company-issued credit cards.
Additionally, if the taxpayer or employer does not withhold the appropriate taxes on employee reimbursements, it can lead to penalties and potential disallowance of these expenses from their overall income. However, if the Bureau of Internal Revenue (BIR) raises an issue of non-withholding or under-withholding and disallows the expense, Revenue Regulations (RR) No. 6-2018 has reinstated the deductibility provisions outlined in RR No. 14-2002. Under this regulation, any income payment that is eligible for deduction under the Tax Code can still be claimed even if no withholding was made, as long as the withholding agent pays the necessary taxes, including interest and surcharges, during an audit or investigation. In a recent Court of Tax Appeal decision, it was determined that the audit or investigation is deemed concluded when the Final Decision on Disputed Assessment (FDDA) is issued. Therefore, it is advisable to resolve any deficiency in withholding taxes before the FDDA is released in order to claim the related expense.
Furthermore, taxpayers should also be mindful of proper invoicing requirements in addition to considering audit findings related to VAT. This is because incorrect supporting documents and invoicing procedures can also lead to VAT-related audit findings. These findings often involve: 1) not providing an official receipt for services purchased and not providing a sales invoice for goods transactions, 2) not clearly stating the input VAT on the receipt, and 3) not accurately including required taxpayer information on the Sales Invoice (SI) or Official Receipt (OR), such as registered name, taxpayers identification number (TIN), registered business address, and business style/trade name.
Companies may implement a policy regarding employee reimbursements, which could result in denial of reimbursement if employees do not meet the substantiation and invoicing requirements due to their complexity.
The BIR needs to create guidelines to simplify the withholding tax process on employee reimbursements, as business transactions become more complex and global. Until then, it is not enough for taxpayers to simply stay informed about tax rules; they must also take a proactive approach by conducting internal tax compliance audits and updating their internal tax policies to keep up with the constantly changing landscape of Philippine taxation. As Heraclitus famously said, change is the only constant in life.
P&A Grant Thornton’s Let’s Talk Tax is a newspaper column published weekly that aims to update the public on recent changes in taxation. This article is not meant to replace expert guidance.
Cydnie C. Hieras is the head of the Tax Advisory & Compliance division at P&A Grant Thornton, a top firm in the Philippines that specializes in audits, tax services, advisory, and outsourcing. The company has 29 Partners and a staff of over 1000.
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