In 1931, Al Capone, the most publicized racketeer of the 1920’s, was prosecuted, convicted , and sentenced to 11 years in prison for federal income tax evasion. The American public and government believed that he was responsible for bigger criminal offenses but this simpler criminal offense was easier to prove. The US Tax Code treated all types of income as taxable and the US Supreme Court had considered whether earnings derived from unlawful activities constituted a taxable income in a series of cases dating back to the 1920s.
Brief History of Income Tax Law
The first internal revenue law was Act No. 1189 of the Philippine Commission which was approved on July 2, 1904 and took effect on August 1, 1904. It became known as “The Internal Revenue Act of 1904”. Act No. 1189 was patterned after the Internal Revenue Law then in force in the US. Subsequently, Act No. 1189 was revised with the enactment of Act No. 2339, otherwise known as “The Internal Revenue Law of 1914”. In 1938, the Tax Commission was created for the purpose of revising and compiling both the national and local tax systems. Pursuant to the recommendation of the Tax Commission, in June 15, 1939, Congress enacted CA No. 466, otherwise known as the National Internal Revenue Code of 1939. In turn, the 1939 Code would be superseded by the 1977 National Internal Revenue Code (PD No. 1458) which retained the Income Tax Law and the definition of gross income as “all income from whatever source”.
All income from whatever source
To date, the Tax Code treats all types of income as taxable unless the contrary or exemptions are provided for. Under Section 32 of the Tax Code, gross income is defined as “all income from whatever source…”. The law defines gross income in unqualified terms. It is sweeping in coverage and scope. This means that all receipts whether lawfully or unlawfully acquired are taxable. The source is not material in the eyes of the law because it does not make any distinction. And when the law does not distinguish neither should we distinguish.
Another consideration is the “economic benefit test.” The operative question is whether the taxpayer received benefit or gain that increased his assets within the taxable year. If it did, the broad definition of the law drags such receipts into gross income. Simply put, when a taxpayer actually realizes or obtains a benefit in the form of gain, control, or dominion, from funds or assets including those derived illegally, the receipts are treated as part of gross income and therefore taxable.
What are the underlying legal principles in the broad definition?
First, the “All Income Principle” where tax laws generally define income broadly to include all “gain” from wherever source derived. Second, the “Economic Benefit” where the core concept is that the taxpayer has received an economic benefit. Whether that benefit was acquired through crime like corruption or legitimate business activity does not negate the fact that the taxpayer now possesses and controls the funds. And the third is taxing unlawful income promotes fairness in the tax system by ensuring that those who profit from illegal activities contribute to public revenue, just as those who profit from legal activities do. It prevents criminals from enjoying their ill-gotten gains without any financial cost to the government. Therefore, under these principles, the fact that assets were acquired unlawfully does not exempt them from taxation, rather, it reinforces the obligation to declare them as income.
Likewise, Philippine jurisprudence on taxation of unlawful income is straightforward and consistent. First, income derived from illegal or unlawful activities is subject to taxation under Philippine laws. The Supreme Court held in numerous cases that the Tax Code does not distinguish between lawful and unlawful income when determining tax liability. Therefore, the illegal nature of the income does not exempt it from being subject to income tax. Second, an assessment of the tax deficiency is not required in a criminal prosecution for tax evasion. In addition, I opine that tax evasion is deemed complete when the evader has failed to report his unlawfully acquired funds and failed to file an income tax return with the intent to hide his nefarious activities. And third, the burden of proof is on the taxpayer. The jurisprudence underscores the burden of the taxpayer in proving that their income was lawfully and correctly acquired. This principle is relevant because a taxpayer who claims their unlawful income is not taxable must be able to provide sufficient evidence to prove their exemption, which is generally impossible for illegal income.
Net worth method and expenditure method
To identify and determine lawfully acquired funds, there are proven and simple methods that can be applied, namely, net worth method and expenditure method. Both are financial investigative tools used to determine lawful income by identifying discrepancies between declared and reported income, and actual financial activity, such as increases in wealth and spending. The networth method calculates wealth by comparing networth at the beginning and end of a period, adding known expenses to show any unaccounted income. While the expenditure method analyses the flow of funds during a period, comparing reported income to total expenditures from various sources like cash, credit and the like to highlight potential undeclared income. The lifestyle-of-the rich and famous DPWH engineers and contractors shows their supposedly “financial capabilities” to live and maintain such lifestyles. These methods are simple and effective instruments to uncover discrepancy between lawfully earned income and unexplained wealth and resources. And the expertise of forensic auditor is indispensable.
The corruption in the country has reached an epidemic level. Control is the order of business of the President! The mission is not the dismissal or resignation of public officials. The mission is to render justice. But justice rooted in accountability, integrity, and empathy. Filing of tax evasion cases against the corruptors and corruptees should be considered.
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