How to track, crack tax cases

HE WAS one of the biggest guns in the Chicago crime scene, but for the longest time U.S. mobster Alfonse ‘Scarface’ Capone was practically untouchable by the authorities. And when he was finally sent to the slammer, the offense he was found guilty of committing had nothing to do with murder or mulcting money.

Notorious mobster Al Capone was jailed for tax evasion.

In the end, it took the U.S. Treasury Department to nail Capone, and it did so through a simple audit of his fabulous expenditures that led to the filing of tax evasion charges against him, his brother Ralph ‘Bottles’ Capone, Jake ‘Greasy Thumb’ Guzik, Frank Nitti, and other mobsters.

By June 16, 1931, Capone had pled guilty to tax evasion charges. Four months later, he was convicted and sentenced to 11 years in federal prison, fined $50,000 and charged $7,692 for court costs, in addition to $215,000 plus interest due on back taxes, according to records of the U.S. Federal Bureau of Investigation.

Ang Galing Pinoy Representative Juan Miguel ‘Mikey’ Arroyo, of course, is no mobster, and usually played a cop, and once even a super hero, Kapitan Kidlat, during his short stint in Filipino action films. But the former presidential son may do well to look into the Capone case now that he and his wife Ma. Angela Montenegro have just been slapped with a P73.85-million tax evasion case by the Bureau of Internal Revenue (BIR).

The key to Capone’s conviction was the so-called “net-worth method” of deriving tax liabilities. As it turns out, the same method has had successful application in at least five tax evasion and fraud cases here in the Philippines – against two members of Congress and three private traders.

For sure, half a century has lapsed since the BIR last summoned to court a taxpayer for fraud and evasion, using the net-worth method. And it is the first time, too, that the BIR has retaken the initiative to filing suit against senior public officials.

The last 50 years have, after all, seen the nation’s premier revenue agency focusing singly almost on its task to raise more and more revenues, giving just token attention to enforcing integrity standards so taxpayers big and small will all pay the correct amount of taxes.

Notably, though, the BIR won in all the cases in decisions penned by the Supreme Court that now serve as the relevant jurisprudence in the suit filed against the young Arroyo couple.

Simply put, the net-worth expenditures formula (also known as the net-worth method of inventory) for determining increases in taxable income goes this way: “Increase in net worth plus non-deductible expenses, minus non-taxable receipts, equals taxable net income.”

Prima facie correct

Retired Supreme Court Justice Leonardo Quisumbing, in his article ”The Law on Taxation” that ran in the Philippine Law Journal in 1964, said that the net-worth method “is authorized under Section 29 of the National Internal Revenue Code,” which also stipulates that “the determination of tax deficiencies by the Government is prima facie correct.”

Citing various literature on law, Quisumbing wrote that taxation is “an attribute of sovereignty… the power inherent in the sovereign state to recover a contribution of money or other property, in accordance with the same reasonable rule or apportionment, from the property or occupation within its jurisdiction, for the purpose of defraying public expenses.”

Using the net-worth method, the Commissioner of Internal Revenue in 1961 sued businessman Enrique Avelino for failure to pay P22,123.55 in deficiency income tax for 1947, including surcharge, interest, and compromise penalties. It stemmed from Avelino’s investment of P60,000 in the National Livestock Produce Corporation that he helped organize in June 1947; he did not file an income tax return that same year.

Avelino explained that the sum of P60,000 had only been lent to him by a naturalized Filipino named Severino Sayque “who returned to China in 1948 or 1949 and has not been heard from since then.” The only issue contested was whether or not Avelino’s defense had been sufficiently established.

The Court of Tax Appeals initially decided in Avelino’s favor, but on appeal of the Internal Revenue Commissioner, the Supreme Court reversed the ruling in a Sept. 19, 1961 decision. The high court upheld the Internal Revenue Commissioner’s findings that Avelino “invested” in the Corporation income that he earned in 1947, but for which he did not pay taxes.

Enrique Avelino was the son of then Senate President Jose Avelino, who was himself a respondent in a tax case that the Internal Revenue Commissioner filed in 1949 for his own tax deficiencies (including surcharges) for the years 1946, 1947, and 1948.

Red flags

Jose Avelino’s total tax liabilities were assessed at P57,788.16, as of the filing of the case. Using the net-worth method for assessing his tax liabilities, the Internal Revenue Commission detected red flags for a number of reasons:

• Huge amounts of loans that Avelino supposedly secured from private parties, even while he was serving as a public official;
• Big investments in several companies for which the Avelinos could not show proof of clear fund sources; and
• Understated amounts of income, and unexplained uptick in his net worth, that Avelino reported for the contested years.

Unlike Capone, Mikey Arroyo is no mobster; in fact he even played a superhero in the movies once. Screengrab from “Kapitan Kidlat” trailer.

Similar red-flag data are also now enrolled in the tax evasion case that the BIR has just filed against spouses Mikey Arroyo and Ma. Angela Montenegro Arroyo.

Jose Avelino, in his reply to the Internal Revenue Commission, said the latter enrolled wrong amounts of his income and tax dues for the period.

He insisted that his opening net worth as of Dec. 31, 1945 (or Jan. 1, 1946), should not have been P100.00 (as estimated by the Internal Revenue Commission) but P47,300. His reason: “(In) an income tax return submitted by (his) wife, Mrs. Enriqueta Avelino, she made it appear that she netted a profit of P55,000.00 from her business of importation of shoes, operation of a bar, and of a restaurant, shortly after liberation.”

But the Internal Revenue Commission countered: “If she did actually earn that amount Exhibit ‘A’ would have contained the details indicating the transactions in which the big sum was earned. Why none of that amount or the greater part thereof appears to have been deposited in a bank has not been explained.”

The Supreme Court considered Mrs. Avelino’s return to be “a self-serving statement, and we agree that on the basis of that income tax return, without any other explanation how the gains were used or invested or deposited.”

In a July 31, 1963 decision, it found “no error in the conclusions of fact and of law” made by the Court of Tax Appeals, ruled against Jose Avelino and ordered him to pay his liabilities.

Delayed 5 years

In another case built on the net-worth method, the BIR on Sept. 3, 1952 assessed Eugenio Perez for tax liabilities (inclusive of surcharges and compromise) of P369,708.27 for the years 1946 to 1950.

A member of the Liberal Party, Perez served as Speaker for the House of Representatives between 1946 and 1953, where he was a representative for the second district of Pangasinan. (His eldest daughter, Victoria, is the first wife of former Speaker Jose de Venecia Jr. and the mother of NBN-ZTE whistleblower Joey de Venecia.)

Perez requested a chance to present his side before the Conference Staff of the Bureau of Internal Revenue. This was granted and Perez’s income tax deficiency was reduced to P197,179.85, exclusive of surcharge and interests. The BIR then required Perez to pay his liabilities not later than Feb. 28, 1954.

A month past the deadline, Perez filed a motion for reconsideration of the decision before the now defunct Board of Tax Appeals, citing among others his need to present additional evidence. He also said that he had to undergo medical treatment in the United States, and that his expert witnesses could not make it to the scheduled hearings.

The Perez case dragged on for more than five years, but the Supreme Court finally ruled against Perez on May 29, 1957. Three months later, Perez passed away.

Two other tax fraud and evasion cases that used the net-worth method were filed by the BIR, this time against traders Maria B. Castro and William Li Yao. Both drew favorable rulings from the Supreme Court in 1962 and 1963, respectively.

Justice Quisumbing in his 1964 piece noted that in the Jose Avelino case, the respondent claimed that it was the P55,000 profit that his wife made in the year 1946 that caused an increase in his net worth.

“However,” wrote Quisumbing, “the return did not show how the amount was earned. None of that amount was deposited in a bank, and this was not explained.”  Thus, he said,  “inasmuch as the wife’s return was apparently considered self-serving statement, and there was no explanation how the gains were used or invested… the act of the petitioner in declaring a very much reduced income than what he actually earned, justified the finding that there was fraud subject to be penalized by law.”

Affirmed in law

In the Li Yao case, Quisumbing said the authority of the BIR to conduct the net-worth method found firm affirmation.

This was one case when a taxpayer tried to hide his income, the justice wrote. This explains, he said, the court’s decision “that if a taxpayer commits a violation of law, hiding his income to evade payment of taxes, the Government must be permitted to use all evidence and sources available to determine his said income, so that the income tax may be collected for public purpose.”

The use of the net-worth method, Quisumbing also said, “was justified.” The Internal Revenue Code stipulates, he added, that “when there is reason to believe that such report (tax return) is false, incomplete or erroneous, the Commissioner of Internal Revenue shall assess the proper tax on the best evidence obtainable.”

“The Court stated that the existence of assets or properties appearing in the name of the taxpayer or in the name of his dummies or friends, without the taxpayer being able to give a definite reasonable explanation for their existence justifies the Tax Court and the Supreme Court in the use of the inventory method,” Quisumbing wrote.

Additionally, he said jurisprudence on these tax cases declare that “the burden of proof as to disapprove various items alleged as obligations, must be proved by the taxpayer.”

“The burden of proof does not lie in the government because,” Quisumbing added,” the taxpayer has the means of proving them and it is natural that he would suppress any evidence to show his tax liability.”

Power & bluster

Curiously, the filing of tax evasion cases against public officials using the net-worth method followed not just the Al Capone caper in the United States, but also another case of abhorrent conduct by a senior public official, Jose Avelino, who was later sued by the Philippine tax authorities.

Avelino was then serving as president of the Senate under the government of Elpidio Quirino when he uttered what would go down in Philippine history as the quip of the most powerful who are also the most arrogant.

Investigated in 1949 for tax evasion, Avelino offered a devastatingly great quote on the inscrutable and incorrigible ways of Filipino politicians.

“What are we in power for?” he asked.

With absolute antipathy toward his investigators, he then remarked: “Why should we pretend to be saints when in reality we are not? We are not angels, we are not saints. When we die, we will all go to hell. It is better to be in hell because in that place there are no investigations.”

For all his bluster, Avelino was eventually sentenced to a one-year suspension. Quirino, though, later resurrected him as ambassador at large.

It is still far too early to tell how the case against Representative Arroyo and his wife will end up. In the case of Al Capone, however, the mobster’s conviction led to an unexpected result. According to a report by U.S. history author Josh Clark, “criminals and legitimate citizens alike began to pay the (U.S. Internal Revenue Service or IRS) for back taxes.”

In 1931 when Capone was convicted, the IRS raised $1 million in unpaid tax filings, twice more than the amount collected in 1930.