Financial Accounting vs. Tax Accounting

“Then render to Caesar the things that are Caesar’s, and to God the things that are God’s.” (Luke 20:25, ESV)

Although roughly only 10% of taxpayers are audited annually, professionals and business owners are in constant fear of the Bureau of Internal Revenue (BIR), especially with the spunky Commissioner Kim Jacinto-Henares at its helm. In speaking and interacting with several accountants in a business setting, I have heard them say again and again that no matter how well they prepare a client’s financial statements, the BIR can and will always find a deficiency somewhere. To be sure, this is not only true for small and medium accounting and auditing firms but with big ones as well.

Certified Public Accountants (CPAs) use financial accounting principles or what is more commonly known as Generally Accepted Accounting Principles (GAAP) and Generally Accepted Auditing Standards (GAAS). In the Philippines, we have adopted the International Financial Reporting Standards (IFRS) as our Philippine Financial Reporting Standards (PFRS). The problem arises when these audited financial statements (AFS) are submitted to the BIR as attachment to company or individual Income Tax Returns (ITR) for purposes of computing the tax liability. This is due to the fact that the BIR does not use the same accounting principles and standards used in financial accounting but rather that which is provided for by law under the National Internal Revenue Code of 1997 (NIRC) or Tax Code for short, along with revenue issuances by the Commissioner of Internal Revenue, such as Revenue Regulations (RR), Revenue Memorandum Orders (RMO), and Revenue Audit Memorandum Orders (RAMO), among others.

RR No. 8-2007 provides that “the recording and recognition of business transactions for financial accounting purposes, in a majority of situations, differ from the application of tax rules on the same transactions resulting to disparity of reports for financial accounting vis-à-vis tax accounting.” Moreover, RMC No. 22-2004 states that “It has been observed that the GAAP and GAAS approved and adopted may from time to time be different from the provisions of the Tax Code.” It then provides that “All returns required to be filed by the Tax Code shall be prepared always in conformity with the provisions of the Tax Code. Taxability of income and deductibility of expenses shall be determined strictly in accordance with the provisions of the Tax Code and the rules and regulations issued implementing the said Tax Code. In case of difference between the provisions of the Tax Code and the rules and regulations implementing the Tax Code, on one hand, and the GAAP and GAAS, on the other hand, the provisions of the Tax Code and the rules and regulations issued implementing the Tax Code shall prevail.” In a separate ruling, the BIR held that “Therefore, it is the financial statements which is in conformity with the Tax Code that should be attached in the filing of Income Tax Returns” (BIR Ruling No. M-111-2006).

This is the main reason why the BIR always finds alleged deficiencies in a taxpayer’s tax return and payment. But what if you have already been using financial accounting principles for the longest time in filing your ITR? Don’t worry, all hope is not lost. RR No. 8-2007 further provides that “Hence, there is a need to reconcile the disparity in a systematic and clear manner to avoid irritants between the taxpayer and the tax enforcer. Accordingly, concerned taxpayers are hereby mandated to maintain books and records that would reflect the reconciling items between Financial Statements figures and/or data with those reflected/presented in the filed Income Tax Return (ITR). The recording and presentation of the reconciling items in such books and records shall be done in such a manner that would facilitate the understanding by the examiners/auditors of the Bureau of Internal Revenue tasked to undertake audit/investigation functions, providing in sufficient detail the computation of the differences and the reasons therefore aimed at bringing into agreement the IFRS and ITR figures.”

Surely, such reconciling of records is indeed taxing (pun intended)! So, in order to avoid such a predicament and the headaches that come along with it, it would be better for taxpayers to adopt tax accounting methods and principles as the PFRS from the very beginning instead of the IFRS as their GAAP and GAAS. For more information on tax accounting principles and methods, please refer to RR V-1 for the Bookkeeping Regulations and RAMO 1-2000, which serves as the guidebook of BIR auditors and examiners in implementing the provisions of the Tax Code, or consult a competent tax professional.

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