Overview of Tax Audits in the Philippines

In recent years, the Philippines has raised its revenue collection targets, with the 2023 target set at approximately PHP 2.6 trillion—an increase of 10.95% over the previous year’s collection. Correspondingly, individual tax auditors are assigned quotas, which has led to an increase in tax audits of Japanese companies. There are even reports of companies receiving their first-ever audit notifications.

In many cases, the basis for BIR’s findings is unclear, and the additional tax assessments notified can come as a surprise. However, by providing appropriate documentation and explanations in response to these findings, it is often possible to significantly reduce the additional tax assessments.

This section provides an overview of tax audits in the Philippines, along with common issues typically raised during such audits.

Overview of Tax Audits

The procedures for tax audits in the Philippines are governed by RR No. 18-2013, RR No. 7-2018, and RR No. 22-2020.

Under these regulations, failure to respond within the prescribed deadlines may result in an obligation to pay additional taxes assessed by the tax auditor. Therefore, prompt and proper action is required. The typical flow of a tax audit is as follows:

Step	Overview	Details
1	Letter of Authority (LOA)	Notification from BIR to commence a tax audit. The audit begins when the taxpayer submits the books and documents for the years specified in the notice.
2	Notice of Discrepancy (NOD)	BIR notifies the taxpayer of the identified issues, and discussions with the auditor are conducted before issuing the Preliminary Assessment Notice (PAN).
3	Preliminary Assessment Notice (PAN)	A formal notice detailing the audit results and any tax deficiencies or overpayments. Issued after the auditor reviews the documents subject to additional tax assessment.
4	Response of Disagreement	Taxpayer submits objections to the PAN within 15 days of receipt.
5	Final Assessment Notice (FAN)	If no objection is made within 15 days, or if the objection is rejected by BIR, the FAN is issued within 15 days from the objection response date.
6	Disputed Assessment (Protest)	Taxpayer can file a protest within 30 days of FAN issuance by either: (i) Request for Reconsideration – Request review of facts or legal treatment based on submitted documents. (ii) Request for Reinvestigation – Submit additional documents for a re-audit (additional documents must be submitted within 60 days from the reinvestigation request).
7	Response to Protest Denial	If the protest is denied, BIR issues the Final Decision on Disputed Assessment (FDDA). The taxpayer can respond within 30 days by: (i) Filing a case with the CTA (Court of Tax Appeals) (ii) Filing a request for reconsideration
8	Response to Re-Denial of Protest	If the reconsideration request is denied, the taxpayer must file with the CTA within 30 days; otherwise, the assessed tax becomes final.
If BIR does not respond within 180 days, the taxpayer may file with the CTA within 30 days after the 180-day period.

Penalties for Additional Tax Assessment

Penalties for additional tax assessment are as follows, in three types:

• Surcharge: a flat 25% of the tax amount
• Interest: 20% per annum as late payment interest
• Compromise: a certain amount as settlement or compromise payment (ranging from tens of thousands of PHP)

These penalties apply not only to additional tax assessments arising from tax audits but also to late filing of tax returns.

General Issues Raised During Tax Audits

・Omission or failure in filing tax returns and payments

In the Philippines, there are various taxes such as expanded withholding tax and payroll withholding tax on a monthly basis, and VAT, corporate income tax, and fringe benefits tax (FBT) on a quarterly basis. The specific taxes your company must comply with are listed in the Certificate of Registration (COR) issued by the BIR. During tax audits, cases often arise where filings for these taxes are found incomplete, and omissions may be pointed out.

The presence of filing omissions can be verified with the BIR through a Tax Clearance. If there are any omissions, the case is classified as an Open Case (a state of non-compliance). To close an Open Case, the taxpayer must pay the penalties mentioned above for the unfiled taxes and complete the necessary procedures with the BIR.

In the Philippines, tax audits generally focus on financial statements from the past three years. When unfiled taxes are identified during an audit, a significant amount of interest and penalties is often added due to the elapsed time. It is advisable to regularly check with the BIR for any Open Cases and to consult with accounting professionals in advance so that you are prepared to respond promptly if issues are raised during a tax audit.

・Official Receipts / Sales Invoices

In the Philippines, keeping original supporting documents is mandatory. Service businesses (including restaurants) issue Official Receipts (OR), while trading businesses issue Sales Invoices. Without the originals of these Official Receipts or Sales Invoices, expenses cannot be deducted for tax purposes. Therefore, it is required to organize them sequentially, often by pasting onto blank sheets, to ensure proper storage and compliance.

For small deductible expenses such as transportation, the absence of an Official Receipt (OR) may sometimes not trigger an audit issue. However, for high-value services, failing to present an OR can result in the expense being disallowed and substantial additional taxes and penalties being imposed.

There is a similar document called an Acknowledgement Receipt (AR), but it is not a valid receipt for tax-deductible purposes. For example, in cases where landlords do not issue an OR for monthly office rent, it is still considered necessary for tax compliance to obtain one.

Note that for some electronic transactions, an OR may not be required under certain conditions, so it is important to handle each case according to the actual circumstances.

・Miscalculations by the tax audit officer

After receiving the LOA, the company must submit its books and other documents by the specified deadline, at which point the BIR officer begins the audit, including on-site inspection. While the officer conducts on-site interviews, the assessment of additional taxes is primarily based on the submitted documents. However, discrepancies may arise between the company’s actual transactions and the officer’s understanding, leading to incorrect calculations. Additionally, the officer may reference the same tax item twice or make simple arithmetic errors. As a result, the PAN often shows an overstated tax amount. When responding to a tax audit, engaging accounting professionals to negotiate with the officer can significantly reduce the assessed additional tax.

・Difference in Withholding Tax Rates

In the Philippines, monthly Expanded Withholding Tax (EWT) must be filed. This withholding tax requires the service recipient (buyer) to withhold a specified percentage from the total payment and remit it to the BIR. The applicable rate depends on the type of service, and errors in applying the correct rate are common during tax audits, potentially leading to penalties. Disputes with the tax officer over the correct rate may also occur.

For example, general services are typically subject to a 2% rate, while rentals are taxed at 5%. If a service company rents out a vehicle, the 5% rate usually applies. However, if the contract includes a driver, it may be treated as a service, applying the 2% rate instead. If the contract is ambiguous and 2% is applied, but the tax officer determines it should be 5%, the 3% difference may be treated as an underpayment.

In this way, it is important to recognize that the tax rate varies depending on the type of service. If the service description is ambiguous, applying the higher rate conservatively when filing the withholding tax can reduce risk. When uncertain about the correct rate, it is advisable to consult an accounting professional.

・Fringe Benefit Tax (FBT)

A common item frequently flagged in tax audits is the Fringe Benefit Tax (FBT). This tax arises when an employer provides economic benefits—such as goods or services—to employees other than rank-and-file staff. Typical examples include:

• Vehicle or rental car expenses (excluding company use)
• Condominium rent (exception: if the office is within 50 meters, it is not subject)
• Provision of maids or drivers
• Education expenses for schools such as Japanese international schools

FBT (Fringe Benefit Tax) is often improperly handled, especially by local accounting firms with limited understanding, and is frequently flagged in tax audits of Japanese companies. In addition to additional taxes on FBT, misclassification of the tax item can result in it not being deductible for corporate income tax purposes, potentially leading to substantial amounts including penalties.

As described above, it is important to understand the key points targeted in tax audits and, so that you can respond promptly whenever a notice is received, to work with accounting professionals to ensure proper compliance is maintained and to always manage your books and related documents appropriately.

Our firm provides prompt support for tax audit responses at a relatively affordable fee, starting from approximately ¥1,000,000. Since each procedure has strict deadlines, we would appreciate it if you could contact us immediately upon receiving a notice.