METHODS OF DETERMINING

UNDERSTATEMENT /
OMISSION OF INCOME

SAW GTAC
06/06
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 FLOW CHART FOR INVESTIGATION WORK
PROCESS

CASE
REJECTED CASE PREPARATIONS
ANALYSIS FOR RAID INSPECTION
RAID /
SEIZURE
CASE
SELECTION

COURT’S CRIMINAL RECORDS

DECISION PROSECUTION EXAMINATION/
INITIATED INTERVIEWS/
3 . PARTY/ ETC.
RD

FINALISATION
PROCEDURES APPROVAL AGREEMENT
OF HQ/DG TO CIVIL OMISSION
SETTLEMENT DETERMINED

COURT’S BEST
DECISION JUDGEMENT
ASSESSMENT/
APPEAL
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METHODS OF DETERMINING
UNDERSTATEMENT / OMISSION
OF INCOME

THE DIRECT MODE

THE INDIRECT MODE

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Comparison of Methods of Proof
 Direct Method  Indirect Method
 Microscopic view of
specific legal or illegal
financial transactions
by a Suspect.
 The transactions relate
directly to the alleged
criminal conduct
(direct evidence)
 Macroscopic view.
 Overall financial condition
of the Suspect.
 An inference to the
alleged criminal conduct
(circumstantial evidence).
 Focuses on the
unexplained wealth and
spending habits of the
Suspect.
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THE DIRECT MODE
 SPECIFIC OMISSIONS

 BOOK OMISSIONS

 OTHER ASPECTS

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 THE DIRECT MODE
 SPECIFIC OMISSIONS

 OMISSION/UNDERSTATEMENT OF INCOME FROM

CLASSES OF INCOME UNDER SECTION 4 OF ITA 1967
SECTION 4. ITA 1967

 GAINS OR PROFITS FROM BUSINESS

 GAINS OR PROFITS FROM EMPLOYMENT
 DIVIDENDS, INTEREST OR DISCOUNTS
 RENTS, ROYALTIES OR PREMIUMS
 ANNUITIES OR OTHER PERIODICAL PAYMENTS
 OTHER GAINS OR PROFITS

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THE DIRECT MODE
 BOOK OMISSIONS
(SOLE PROPRIETORS, PARTNERSHIPS,
CORPORATIONS)

PARAMETERS:

 SALES
 PURCHASES- INFLATED/FICTITIOUS
 EXPENDITURE- INFLATED/FICTITIOUS/CAPITAL
 STOCK- OMISSION/UNDERVALUATION

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THE DIRECT MODE

 RECOGNITION OF INCOME –TIMING OF PURCHASES &

SALES(DEFERRED)

 FICTITIOUS CLAIMS- DEDUCTIONS AS PROVIDED BY

ITA 1967

 INVESTMENT INCENTIVE(DOUBLE DEDUCTION

ETC)
 CAPITAL ALLOWANCES
 INTEREST RESTRICTION
 OTHERS

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THE DIRECT MODE
 OTHER ASPECTS
 TECHNICAL ADJUSTMENTS
 EXPENDITURE NOT WHOLLY AND EXCLUSIVELY
INCURRED
 VALUATION -STOCK
-RESERVES
 TRANSFER PRICING
 ALLOCATION OF HEADQUARTERS OR BRANCH
OVERHEADS
 WITHHOLDING TAXES (on income of non-
resident recipients)
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 THE INDIRECT MODE

 THE INDIRECT MODE:

 CAPITAL STATEMENT
 EXPENDITURE/ SOURCE & APPLICATION
METHOD
 BANK DEPOSITS METHOD

 APPLICABLE TO INDIVIDUALS

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 Money
 Money, in any significant amount, will
eventually show up, directly or
indirectly, in the accounts, assets, or
expenditures of the recipient

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 THE INDIRECT MODE
 Capital Statement Method of Proof - growth in
capital/net worth from period to period, plus identified
personal expenditures, exceeds known sources of funds.
 Source & Applications (a.k.a. Expenditures)
Method of Proof - total identified expenditures exceeds
known sources of funds.
 Bank Deposits Method of Proof - net deposits to all
bank accounts, plus cash expenditures, exceeds known
sources of funds.

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 CAPITAL STATEMENT METHOD

WHEN TO APPLY CAPITAL STATEMENT/ NET

WORTH METHOD?
 WHERE NO DIRECT EVIDENCE OF INCOME

 WHERE BOOKS AND RECORDS ARE

 INADEQUATE,
 FALSE,

 UNAVAILABLE OR INACCURATE

TO DETERMINE ILLEGAL INCOME

 SUSPECT IS ACCUMULATING ASSETS

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CAPITAL STATEMENT METHOD

 ALSO KNOWN AS:

 Net WORTH method

 WEALTH ACCRETION METHOD
 ASSETS BETTERMENT METHOD
 NET ASSETS COMPUTATION METHOD

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 CAPITAL STATEMENT METHOD
 CAPITAL STATEMENT METHOD IS MOST USED METHOD BY IRBM

 A PARALLEL INVESTIGATION APPROACH TO ENSURE THAT ANY

OMISSION OF INCOME UNDETECTED IN THE BOOKS OF
ACCOUNT WOULD BE COVERED BY THIS METHOD.

 THIS IS A LENGTHY EXERCISE INVOLVING:

 SCRUTINY OF ALL PERSONAL RECORDS OF THE INDIVIDUAL,

BILLS, AGREEMENTS IN RESPECT OF ACQUISITION OF
ASSETS, PROPERTIES, SHARES, MOTOR VEHICLES, OTHER
ASSETS, INVESTMENTS AND BANKING ACCOUNTS

 ANALYSIS OF BANK STATEMENTS AND CHEQUE BUTTS TO

ESTABLISH THE DESTINATION OF WITHDRAWALS
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 CAPITAL STATEMENT METHOD

 This is the basic principle behind a capital

statement

INCOME = SPENDING
+
SAVING

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CAPITAL STATEMENT METHOD

 The basic principle/equation is

INCOME = SPENDING + SAVINGS

 If there is no omitted income, then

SAVINGS + EXPENSES MUST EQUAL
TO AVAILABLE INCOME

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 CAPITAL STATEMENT METHOD
 PRINCIPLE / RATIONALE

INCREASE IN CAPITAL/WEALTH (ACCQUISITION OF ASSETS,

REDUCTION OF LIABILITIES)
+
EXPENDITURE( PERSONAL & PRIVATE)
=
REPORTED INCOME + CAPITAL GAINS

 EXAMPLE (IDEAL SITUATION)

RM13,000 + RM11,000 = RM24,000

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 CAPITAL STATEMENT METHOD
 IF THERE IS DISCREPANCY?

INCREASE IN WEALTH + EXPENDITURE > REPORTED

INCOME & CAPITAL GAINS?

 EXAMPLE:

RM50,000 + RM30,000 > RM15,000

DISCREPANCY = (RM50,000 + RM30,000) – (RM15,000)

= RM65,000 (UNDERSTATEMENT)
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 CAPITAL STATEMENT METHOD
 IF THERE IS DISCREPANCY?

INCREASE IN WEALTH + EXPENDITURE < REPORTED

INCOME & CAPITAL GAINS?

 EXAMPLE:

RM20,000 + RM30,000 < RM65,000

DISCREPANCY = (RM20,000 + RM30,000) – (RM65,000)

= (RM15,000) (EXPENDITURE UNDERSTATEMENT)

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 CAPITAL STATEMENT FORMULA
Total Assets
Less: Total liabilities
Equal: Net Assets
Less: Net assets from previous period
Equal: Increase in net assets
Less: Capital Gains
Add: Capital loss
Add: Private & Personal expenses
Equal: Apparent Income
Less: Available Income
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Equal: Omitted Income
 As of Date Year 1 As of Date Year 2 As of Date Year 3

Assets Assets Assets

_ Liabilities _ Liabilities _ Liabilities

= Net Worth Yr. 1 = Net Worth Year 2 Net Worth Year 3

=
_ Net Worth Year 1 _ Net Worth Year 2

Change in NW Yr 2 Change in NW Yr 3
=
+ Expenses Year 2 + Expenses Year 3

= Apparent Income = Apparent Income

Yr 2 Yr 3

_ Available Income _ Available Income

Yr 2 Yr 3

= Omitted Income = Omitted Income

Yr 2 Yr 3 22
 PRINCIPLES OF CAPITAL
STATEMENT METHOD OF COMPUTATION

FIGURES APPEARING IN THE COMPUTATION MUST BE

BASED ON ACTUAL MONETARY RECEIPT OR PAYMENT BASIS

NON MONETARY RECEIPT OR PAYMENT MUST BE IGNORED

(E.G BENEFIT IN KIND FOR USE OF BUSINESS MOTOR
VEHICLES; BONUS SHARES OBTAINED F.O.C)

ANY ASSETS, LIABILITIES , INCOME AND EXPENSES

REFLECTED IN THE BUSINEES ACCOUNTS SHOULD NOT BE
ACCOUNTED FOR AGAIN IN THE COMPUTATION( EXCEPT
FOR SALARY AND OTHER RENUMERATION FROM
SOLEPREITOR BUSINESS AND PARTNERSHIP, WHERE THESE
WII BE ALLOWED AS AVAILABLE INCOME)

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 ASSETS

Anything of value that can be converted to cash,

or cash itself
NETWORTH OF BUSINESS OR BUSINESSES
PURCHASE OF LANDED PROPERTIES
PURCHASE OF SHARES
MONEY IN BANKS/FINANCIAL INSTITUTIONS
LOANS TO INDIVIDUALS/CORPORATIONS
PURCHASE MOTOR VEHICLES
PURCHASE OF ANY OTHER ASSETS
CASH IN HAND
ALL OTHER ASSETS NOT MENTIONED
ABOVE
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 WHAT IS NETWORTH OF BUSINESS ?

BASIC ACCOUNTING EQUATION :

•ASSETS = LIABILITIES + OWNER’ FUNDS ;

•OWNER’S FUNDS = BUSINESS NETWORTH

•BUSINESS NETWORTH OF SOLEPROPREITOR/

PARTNERSHIP IS THE TOTAL OF :
1. CAPITAL
2. BAL. OF PROFIT/LOSS APPROPRIATION
ACCOUNT
3` BAL. OF CURRENT ACCOUNT ( IF ANY)
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 LIABILITIES

ALL BANK /FINANCIAL INSTITUTIONS LOANS

TAKEN TO ACQUIRE PERSONAL ASSETS

LIABILITIES OF ALL KINDS OWING TO ANY

INDIVIDUALS, ENTITIES AND COMPANIES
ARISING FROM ANY PERSONAL TRANSACTIONS

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 PERSONAL AND PRIVATE
EXPENSES

FOOD
RENT
UTILITIES
CLOTHINGS
MEDICAL/DENTIST
PRAYING
ENTERTAINMENT
HOLIDAYS
LOAN/MORTGAGE INTEREST
EDUCATIONAL EXPENSES
GIFTS
ALL OTHER PERSONAL EXPENSES
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 AVAILABLE INCOME

NET PROFIT AS PER PROFIT/LOSS ACCOUNT IN

SOLEPROPRIETOR/ PARTNERSHIP BUSINESS
INTEREST ( WHETHER TAXABLE OR NOT)
DIVIDEND(NET AFTER TAX)
TAX REPAYMENT RECEIVED
NET RENTAL
SALARY AND OTHER MONETARY EMPLOYMENT
INCOME ( BONUS, ALLOWANCE ETC)
OTHER SOURCES OF INCOME NOT MENTIONED
ABOVE

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Bank Deposits Method

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 Bank Deposits Method

Primary Method of Proof when most of

the subjects income
 is deposited and
 subjects books and records are:
 UNAVAILABLE
 WITHHELD
 INCOMPLETE

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 Bank Deposits Method

 Bank Deposits method operates on

the premise that there only three things
an individual can do with money
 Spend it
 Deposit it

 Hoard it (cash on hand increases)

Focus of this method is on bank deposits.

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 Bank Deposits Method
 A vital component of bank deposits
method is analysis of deposits to ensure
accuracy of figures and to eliminate
non-income items.
 This is a primary method employed in a
number of tax jurisdictions to detect
unreported income.

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 Bank Deposits Method
Formula:
Total deposits (All accounts)
Less: Transfers & re-deposits

Equal: Net deposits to all accounts

Add: Increase in cash on hand
Add: All cash expenditures

Equals: Total income from all sources

Less: Declared income & non taxable income

Equal: Omitted income

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 Bank Deposits Method

TOTAL DEPOSITS:
 AMOUNTS DEPOSITED TO ALL BANK
ACCOUNTS
 ACCOUNTS IN SAVING AND LOANS
 INVESTMENT TRUSTS
 CREDIT UNIONS
 ACCOUNTS IN FICTITIOUS NAMES

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 Bank Deposits Method

NET DEPOSITS:
 ALL TRANSFERS OR EXCHANGES
BETWEEN BANK ACCOUNTS ARE “NON
INCOME” ITEMS
 AND ARE SUBTRACTED FROM “TOTAL
DEPOSITS” TO ARRIVE AT “NET
DEPOSITS”
 CHECKS TO CASH AND ATM W/D
ARE SUBTRACTED
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 Bank Deposits Method

CASH EXPENDITURES:

TOTAL OUTLAY OF FUNDS

LESS: NET BANK DISBURSEMENTS
EQUALS: CASH DISBURSEMENTS

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 Bank Deposits Method

NET BANK DISBURSEMENTS:

 NET DEPOSITS TO ALL ACCOUNTS
 PLUS: BEGINNING BALANCES
 EQUALS: NET BANK FUNDS AVAILABLE
 LESS: ENDING BALANCES
 EQUALS: NET BANK DISBURSEMENTS

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Expenditures method / Source and
Application of funds method

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 Expenditures method

 Expenditures method of proof as the term

implies focuses on expenses.
 This method is essentially identical to capital
statement/net worth method. An accounting
variation of the same method.
 Applied when T/P has spent most of his
income/consumed, compared with Capital
Statement where substantial assets have
been accumulated.
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 Expenditures method

 Used where T/P does not maintain books and

records.
 Books and records not available or
inadequate.
 Unlike capital statement, assets and liabilities
would only be considered if there is activity in
the account during period of enquiry.
 The activity is classified either as a source of
funds or application of funds.

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 Expenditures method

Formula:
Total Expenditure (Money spent or
applied)
Less: Declared income & non taxable income
Equal: Omitted income

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Expenditures method
 What are expenditures or application of funds
 When cash on hand increases
 When bank accounts increase
 When assets increase
 When liabilities decrease
 When personal living expenses are made
 When cash expenditures are made

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Expenditures method
 What are sources of funds
 When cash on hand decreases
 When bank accounts decrease
 When assets decrease
 When liabilities increase
 When assets are sold
 When loans, gifts or inheritances are received
 When salaries or business profits are earned
 When other sources of income are known

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QUESTIONS???

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