To explain why many known Filipino billionaires aren’t in the list of the country’s top 500 taxpayers, both the Bureau of Internal Revenue head Kim Henares and tycoons have invoked the agency’s “substituted filing” system as the reason.

They’re wrong, but they may have inadvertently pointed to what could be a major loophole in the country’s tax collection system. 

“Only those who filed income tax returns (ITRs) will find themselves on the top 500 list,” the BIR chief claimed. “If you did not file an ITR—if you had a ‘substituted filing’ where your company withheld income taxes for you and remitted it straight to the BIR, you will not appear on the list,” she said.

Echoing Henares, and obviously referring to what he does, billionaire Jaime Augusto Zobel de Ayala, who has never been in the biggest taxpayer’s list told Philippine Star Managing Editor Marichu Villanueva:

“Many execs have substitute filing. The companies withhold the taxes from the individuals and then file and pay directly with the BIR. That top 500 list is only based on people who file comprehensive tax forms directly,” Zobel pointed out.

“That’s why there are so many names missing. The bulk of their taxes are withheld and paid directly,” he cited.

What Henares and Zobel didn’t say is that an individual is allowed the “substituted filing” only if his income from that company doing the filling for him is his sole income, which is one reason why magnates such as Henry Sy (with his sons and daughter) Manuel Pangilinan, and the Aboitizes are in the top 500 roster.

Zobel and the other tycoons who are not in the top 500 taxpayers list obviously have incomes not just from one company or source.

The substituted filing system was put into place in 2002 (Revenue Regulations No. 3-2002) by then BIR head Guillermo Parayno as a means of drastically simplifying the work of the agency. Parayno explained that much of the BIR’s resources are expended just to go to process tens of millions of income tax returns, with only less than a percentage of these actually involving tax payments.

Parayno’s bright idea was that in order to reduce the mountains of documents it had to process, a company’s filing (and payment) of the tax liabilities of say, its 100 employees can substitute for the 100 ITRs of its employees. As Parayno explained in one of his clarificatory circulars:

“Substituted Filing is when the employer’s annual return (BIR Form 1604CF) may be considered as the “substitute” Income Tax Return (ITR) of employee inasmuch as the information provided in his income tax return (BIR Form 1700) would exactly be the same information contained in the employer’s annual return.

The obvious loophole here is when an individual has income from other sources or other companies, but doesn’t file his ITR (and the required payments) on grounds that he has availed of substituted filing undertaken by his employer. Since the BIR still doesn’t have a computerized system to trace all of the companies he gets compensation from, he evades taxes on income from other companies which do not withhold his taxes due, but only the so-called 10 percent withholding taxes.

To close this loophole, Parayno in Revenue Memorandum Circular No. 1-2203 dated December 27, 2002 (which has not been amended to this day) limited those who can avail of substituted filing only to those who comply with certain requirements, the most important of which are:

“a. The employee receives purely compensation income during the taxable year;

“b. The employee receives the income only from one employer in the Philippines during the taxable year.” (Emphasis mine)

Zobel and all of the tycoons who were not in the 500 top taxpayers list were obviously employed as officers or board members in dozens of companies. A quick check with information firms (such as BusinessWeek) providing top executives biodata would easily show this.

How could they have availed of substituted filing?

Zobel also cited a 2010 newspaper column by Romeo Bernardo—a former finance undersecretary and director in several Ayala companies—to defend why he had not appeared in the top 500 taxpayers’ list.

Bernardo wrote: “There can be several reasons why one who is rich or earning well may not appear on the list. For many top executives, the company withholds and pays their individual income taxes directly to the BIR under a procedure known as substituted filing… These substituted filings were likely not captured by the BIR’s top 500 list. “

But Bernardo himself notes the BIR requirement I pointed out: “Provided the individual has only that single source of still taxable income, he does not need to file an income tax return.” (My emphasis). While Bernardo should be commended for his intellectual dishonesty, it is astonishing why he cannot see the obvious flaw in his defense of magnates’ absence in the country’s list of top taxpayers, at least with regards to Zobel.

Property magnate Andrew Tan, another Forbes-listed billionaire but who was also not in the roster of the top 500 taxpayers, claimed through his finance officer’s letter to the Philippine Daily Inquirer that he “earned P22.2 million in salaries from the companies he owns and worked in, for which he paid P7 million in income taxes.” (That itself is astonishing. Mortals like actor Derek Ramsey, retired Chief Justice Artemio Panganiban, foreign affairs secretary Albert Del Rosario based on the BIR list, paid more taxes on their salaries.)

But where is Mr. Tan’s ITR to document what he says? If he earned salaries from “companies”, he cannot avail of substituted filing, which is very clearly allowed only for single-employer taxpayers. (Similarly that newspaper had reported Oscar and Manuel Lopez should be in the top 500 list as they paid P37 million and P11 million in taxes, respectively, but solely according to “sources within the Lopez family”. Why can’t they just release their ITRs?)

Tan’s explanation however leads us to another BIR requirement for those availing of substituted filing. Tan said that he paid P51.8 million in taxes on the P518 million in cash dividends from his stock holdings. (That’s the 10 percent final withholding tax, the same as the poorest wage earners and less than the average 31 percent in taxes most middle-class Filipinos pay.)

But the BIR regulation clearly specifies that if you earn income from any other source, you cannot avail of substituted filing. If you get just P100 cash dividend from stocks you owned, you have to file an ITR.

Other than being able to employ an army of accountants and taxpayers able to think up of the most clever tax-dodging schemes, there are other explanations why our magnates aren’t appearing in the BIR’s list of top taxpayers.

One is that is that they manage to pay off BIR staff to hide their ITRs. The second is that the BIR’s data is so grossly inaccurate that 30 of the 40 Philippine billionaires aren’t in its list. Which means that BIR chief Henares should be fired for publicly releasing false information that damages not only the prestige of our captains of industry, but also portrays our country as a nation of tax-evaders.

Henares however has been patting herself that she has defied the mighty and shaming them by releasing the list of top 500 taxpayers. But is it her job to shame the mighty, or is it to run after them with hammer and tongs to pay the right taxes, and close loopholes such as the substituted filing system?