Bank deposit method of proving Tax Evasion: the current litigation heresies
Tax evasion is proscribed as a crime under Art 125 of Federal Tax Administration Proclamation no-983/20081. Under this article, the law proscribes transgressions such as understatement of income (evasion of assessment), failure to file tax return with intent to evade tax and evasion of payment as offenses of tax evasion. To prove tax evasion, prosecutors must prove all ingredients of the offense, namely intent to defraud, affirmative act and evaded tax. Amongst the ingredients of crime of tax evasion, the existence or otherwise of evaded tax is a typical one. One should use evidence to identify the nature and amount of evaded tax. We can prove tax evasion both by direct and indirect evidence.
Proof is the establishment or refutation of an alleged fact by evidence. It’s the evidence or argument that compels the mind to accept an assertion as true. In its judicial sense; it encompasses everything that may be adduced at a trial, within the legal rules, for the purpose of producing a conviction in the mind of judge. Evidence is a thing (including testimony, documents and tangible objects) that tends to prove or disprove the existence of an alleged fact.
As indicated above, Tax evasion can be proved both by direct and indirect method of proof. This can be done by auditor which then appears in court of law as an expert witness.
Direct evidence proves a fact, without an inference or presumption, and conclusively establishes that fact without reference to any supporting evidence. Specific item method of prove is typical example of direct method of proving tax evasion. Specific item method helps to prove unreported and under reported income. It utilizes books and records of tax payers.
Indirect method is method that utilizes circumstantial evidence to determine what income should have been reported on the tax payers return and compare that to the amount shown on the return, if a return was actually filed
Under this method Sources of income may not be identifiable, as in a specific item method of proof. Therefore, taxable income often has to be computed indirectly based upon the taxpayer’s application or use of funds.
Indirect methods proving tax evasion includes.
- Net Worth method
- Expenditures method
- Bank Deposits method
- Cash Method
- Percentage Markup method
- Unit and Volume method
Under this article I can discuss bank deposit method of proving tax evasion in depth.
BANK DEPOSIT METHOD OF PROVING TAX EVASION
As often said, Tax crimes are acts of individual greed and, therefore, very little "direct evidence" is usually available. Hence, if not so often, Tax payer’s correct taxable income may be established by "indirect" methods of proof using circumstantial or "indirect" evidence.
Bank deposit method of prove is among typical indirect method of prove that reconstructs income by analyzing bank deposit by tax payer who has an income producing business and makes regular and periodic deposits to bank.
It is a method of proof which base itself on the premise that money received must either be deposited or spent.
Bank deposit method of prove is particularly useful if an analysis of bank accounts and a taxpayer’s cash expenditure indicates a likelihood of undeclared income and the Taxpayer makes regular payments into bank accounts that appear to be from a taxable source.
Under bank deposit method of proof the goal is to reach on net taxable bank deposits. However, the process of reaching on this net bank deposit challenges a lot. While doing investigative audit auditors works on stages of purification and additions of expenditures which can’t declared.
The first and typical bank deposits criminal case is Gleckman v. United States that was litigated in 1935.
The Gleckman v. United States case is the first case that laid judicial foundation for bank deposit method of prove in criminal tax evasion. Besides, the case laid essential yardsticks that must be fulfilled by the prosecutors to bring cases based on bank deposit method of prove.
As noted in Gleckman, the mere fact that tax payers deposited sum of money in bank can’t render that all deposited monies are subject to tax. The case unequivocally indicates the necessity of stage of refining
As understood from Gleckman case, for the government to bring a charge based on bank deposit method of proof, government must fulfill the following yardsticks.
- The taxpayer was engaged in a business or income-producing activity from which the investigation auditor/ court can infer that the unreported income arose;
- Periodic and regular deposits of funds were made into accounts in the taxpayer’s name or over which the taxpayer had dominion and control.
- An adequate and full investigation of those accounts was made in order to distinguish between income and non-income deposits;
- Unidentified deposits have the inherent appearance of income, e.g., the size of the deposits, odd or even amounts, fluctuations in amounts corresponding to seasonal fluctuations of the business involved, source of checks deposited, dates of deposits, accounts into which deposited, etc.
- ENGAGING IN INCOME PRODUCING BUSINESS.
Before resorting to use bank deposit method of proving income, auditors should first identify whether the tax payer under investigation is engaged in income producing business or not.
- ANALYSIS OF DEPOSIT.
Analysis of deposit helps to identify whether the deposit that exists within the account of the tax payer was the result of income producing business that the tax payer engages in or not. It’s essential to purify the deposit from the probable income in the deposit of tax payers that are from sources such as non- business income and deductions/exemptions. Under this analysis what we can check for is whether the deposit is made regularly and periodically to the account of tax payer.
Overall, the analyses help us to create relationship between the deposit and the probable income earned by the tax payer under scrutiny from the business activity.
Purification is the process in bank deposit method of proof, in which auditors refine amounts deposited in tax payers bank account that are non-taxable. The objective of purification is to reach on a figure called net taxable bank deposits. In Ethiopia purification is done by investigation audit directorate.
Pursuant to Art 48 of former income tax proclamation no 286/94, the revenue authority might demand all persons who are engaged in business to produce their record of income and expenses as well as any other documents that help to determine tax liability. Likewise, the new federal income tax 979/2008 and Federal tax administration proclamation 983/2008 regulated same under art 82 and 17 respectively.
These days, bank statement appears as one of key indicator of income flow in business world. As indicated above, the revenue authority might demand presentment of bank statements and other bank based documents for determining income of tax payers. The reasons behind presentment of bank related document can’t go beyond identifying whether tax payer declare his true income s/he earned from the business s/he engages in or not.
As indicated on Art 125 of TAP evasion of assessment is proscribed as crime of tax evasion. Therefore, while doing audit for determining the true income of tax payers based on bank deposit, tax auditors should purify other incomes from the deposit.
What to purify.
A Thorough investigation must be conducted to demark between income and non-income deposit of tax payer under inspection.
At any cost non-income items must be eliminated from the bank deposit under scrutiny. While conducting investigation audit, investigators should go beyond limit in purifying any income that tax payers allege as non-business. Here in below I will discuss some vital non-income items that should be eliminated in bank deposit based investigation.
In existing business world loan is not uncommon. Today’s order of business demands leaning of traders either on financial institutions or loan. Hence, there are a lot of possibilities where such loans might be deposited in the account of traders. Loan might be of long term or short term nature.
If the loan alleged is from bank, investigation auditors should investigate contract made with bank and other related documents. In cases where loan is taken from individuals auditors should see loan contract and any other relevant documents.
Despite the above cases, there might be loan contract which have no relevant document. In such cases auditors should at least inspect bank based withdrawals for payment of such loan.
The other type of loan includes bank overdraft and letter of credit (import loan). Bank overdraft is a contract based loan. Hence, investigators should identify the loan earnestly.
Letter of credit is more of related to import business. An import Loan (letter of credit) is a short-term cash advance (with recourse) that enables an importer to effect their immediate payment obligations. Under such arrangements financial institutions’ execute importers commitment by making payment against the Letter of Credit and receive payment from them at a pre -determined date in the future. In countries like Ethiopia, the reason behind letter of credit is the need to get foreign currency. However due the current foreign currency shortage traders might open a lot of letter of credit at different bank and then cancel it if they succeed at one. Hence, auditors should either check cancelation of marine insurance refund, Performa and other documents.
Besides, auditors should eliminate items such as:
- Auction pre payments
- interbank transfer
- Bank errors
- Deposit from sales of asset of tax payers
- Value added tax
- Withholding tax
- Interest and dividends
- Rental income
- Collected bad debts.
- UNIDENTIFIED DEPOSITS
After all non-income items that are ascertained by the purification process are eliminated, those deposits that have not been established as either income or non-income deposits are denominated as “unidentified deposits.”
Hence, to the extent the unidentified deposits resembles current business income; they are included with identified business income of tax payers.
To the extent that such unidentified deposits have the inherent appearance of current income, they are included with identified income deposits in determining the defendant’s income.
In leading case of Gleckman v. United States,(8th Cir. 1935), the bank deposits computation result in $92,000 which is untraceable cash deposits and unidentified deposits. The defendant argued that those deposits “may just as well have been drawn from nontaxable transactions as from services or business.” However, the court rejected this argument and reason out that:-
- “There was substantial circumstantial evidence in the record that the defendant had an unreported business, and that some of the deposits were derived from this business. Thus, the deposits were sufficiently shown to be of a taxable nature.”
In United States v. Procario, (2d Cir. 1966), the defendant was a doctor, and more than one-third of the total alleged professional receipts were in the form of deposits not identified by the government. Rejecting the defendant’s argument that there was no evidence from which the jury could have inferred that the unidentified deposits represented income from professional services, the court said:-
- “The government relied on the fact that it excluded all possible dividends, on the small size and relative frequency of the deposits, similar to deposits and other income proven to be professional receipts, and on the fact that appellant had patients other than those whose payments were included in Items 4 and 6, the directly proven items of income. This was sufficient.”
In nutshell, prosecutor’s evidence should justify, by reasonable inference at least, that unidentified deposits represent or resemble income items.
Bank Deposit Method of Proving Tax Evasion Under Ethiopian Tax Law:
It’s not unusual to see individuals asking about how one can be liable based on bank deposit method in Ethiopia. The answer for those individuals bases on whether tax evasion, specifically evasion of assessment, is criminalized under Ethiopian tax law.
Article 125 of TAP clearly criminalizes evasion of assessment. If tax payers evade income certainly s/he commits crime of tax evasion. As I try to discuss in the onset of the paper the assessment of whether tax payers evade certain income either base itself on direct method of proof or the indirect one. As often said, tax evasion emanates from the act of individual greed and, therefore, very little "direct evidence" is usually available. Hence, if not so often, Tax payer’s correct taxable income may be established by "indirect" methods of proof using circumstantial or "indirect" evidence. Amongst, bank deposit method of proof is one. Obviously, Bank deposit method of proof is not an exact science. However, with competent and just investigations that take purifications of bank deposit, eliminations of deductions and exemptions seriously, we can at least reach on reasonable conclusion that ‘unidentified deposit’ as -undeclared income from business. Above and beyond, the size of the deposits, fluctuations of income corresponding to seasonal fluctuations of the business involved, source of checks deposited, dates of deposits, accounts into which the income was deposited must convince investigation auditor to conclude that the unidentified deposits have the inherent appearance of income from same business in which tax payer under scrutiny engages in. Afterwards, one can prosecute tax payer for evasion of declaration. As introduced elsewhere in the same article, the first case on bank statement comes forth in U.S.A in 1935. It was named Gleckman v. United States (1935). It was the first judicial decision that laid clear foundations for bank deposit method of proof. In Ethiopian tax courts, this days, it is usual to hear advocates/suspects alleging for withdrawals of their charge claiming that bank based audit have no criminal effect. They develop an argument that sideline cases filed based on bank statement from criminal tax litigation realm.
In Ethiopia, the present problem regarding bank statement is the absence of clarity in demarking between the criminal and civil aspect of bank based tax evasion.
Some argue that bank based audit in its entirety shouldn’t entail criminal liability. Others argue that as long as the bank deposit is purified and all necessary deduction and exemptions are eliminated courts in Ethiopian shouldn’t take strange stand from that of other world experience and should entail criminal liability. For the writer ,the first scenario or allegation remain heresies to the established bank deposit based litigation that developed for over half centuries in the realm of litigation of tax evasion. Hence, as long as bank statement based tax evasion is an undeniably reality, the argument that insist bank statement based criminal cases as unfound can’t hold water. However, in bank based tax litigation it’s advisable to challenge prosecutors in using different defense techniques. Amongst, lawyers should meticulously follow the presence of the following two elements.
Firstly, prosecutors should prove all four prongs of bank based tax evasion cases.
Namely, Prosecutors should proof.
- That the person or business organization under scrutiny is engaged in income producing business.
- Analysis of deposit (Whether unidentified deposit resemble business income).
- Existence of unidentified deposit.
The second essential point to challenge is based on intent to defraud.
In writer’s opinion, rather than heretic arguments, resorting to the above two and other successful defenses can perhaps nurture and contribute to the advancement of our emerging tax litigation.
By and large, the existence of audits that departs from the norm which insists the revenue authority to issue circular on 14 Sane, 2009 to ensure uniformity shouldn’t be taken as an excuse for the evaders.
In file no-203233 the former Ethiopian revenue and customs authority prosecutor’s office brought tax evasion charge based on bank statement method of proof.
The story of the case.
On 14/06/2005 E.C Ethiopian revenues and customs authority prosecution office brought two count charges against Haji Mujib Said Sabir.
The content of the first count allege that the defendant evaded 4,864,855.28 birr in violation of art 96 of income tax proclamation no- 286/96 and 7,263,385.12 birr in violation of art 49 of value added tax proclamation no- 285/94.
Court reasoning on bank statement based finding
The court heard three witnesses’ testimonies on behalf of the government. In summary, auditors testifies that they did audit based on income of the suspect they get from wegagen Bank Beklo bet branch, Dashen Bank Tana branch, Dashen bank main office branch, Hibret bank Tana brach, commercial bank Beklo bet brnch and Temenjayazh branch. Based on bank statement, auditors found 45,684.510 birr as undeclared income. They claim that they eliminated all what to be purified and reduce what to be deducted.
After hearing witnesses on all findings indicated in the cases, the 9th bench rejected the bank statement based finding as unconvincing and non-persuasive.
“የተከሳሽ የንግድ ድርጅት የግለሰብ ንግድ ድርጅት ከመሆኑ አንፃር ወደ ሂሳብ ቁጥራቸው የራሳቸው የግል ገንዘብ፣የቤተሰብ ገንዘብ፣እንዲሁም በብድር የሚቀበሉት ገንዘብ በቀላሉ ተቀላቅሎ የሚቀመጥበት ሁኔታ ሊኖ ርይችላል፡፡በተለይ በሀገራችን ያለው የማህበሰረብ የባንክ አጠቃቀም ይህንኑ የሚያሳይ በመሆኑ በባንክ ያለውን የገንዘብ እንቅስቃሴ የተጠቃሚው ነው ብሎ ለመውሰድ አስቸጋሪነት ያለው በመሆኑ በቂና አሳማኝ የሆነ ማስረጃነው ብሎ ለመውሰድ የሚቻል ሆኖ ስላልተገኘ ይህንን የታክስ ኦዲት ግኝት ፍርድ ቤቱ አልተቀበለውም፡፡
The rough interpretation of the justification of the court states that:-
“As defendant is individual trader, there might be circumstances where his individual, families and other non-business income might be mixed and saved in same accounts. Hence, one can’t conclude that all incomes in the account of trader as if they are all earned from trader’s business income. Besides, our societal custom in using bank proofs same. Culture in using bank show that we mix those monies and the court can’t get this finding as clear/sufficient and convincing.”
As I discussed else were in this note, Pursuant to Art 48 of former income tax proclamation no 286/94, the revenue authority might demand all persons who are engaged in business to produce their record of income and expenses as well as any other documents that help to determine tax liability. Bank account is among those documents usually requested by the revenue authority.
If tax payers have such duty the court should examine whether tax evasion is committed. in their testimonies auditors said that they deducted all other things to be eliminated. It’s up to the court to identify weather loan, family income and others might be eliminated. The court should at least be convinced by a number of branches to check whether purification is done by the auditors. Hence, before clearly identifying the activities done by auditors the court shouldn’t reject the finding. In this case the court ought to proof what is eliminated by the auditor. Likewise the court can’t have sufficient reason to assimilate unidentified deposit as business income. Henceforth, am of opinion that the court renders decision before its job is not done up.
While deciding cases between Ethiopian revenues and customs authority and Ato Yitagesu Seyoum (file no-207163) the federal first instance court 10th bench forwarded the following reasoning in rejecting bank statement based findings……( the decision was rendered on 24/11/2009)
“የታክስ ስወራ ወንጀል በተለያዩ ድርጊቶች የሚፈፀም ሲሆን በግብር ባለስልጣኑ የማይታወቁ የባንክ ሂሳቦችን በመጠቀም ወይም በማይታወቅ ስም የባንክ ሂሳብ በመክፈት በመጠቀም ገቢን መሰወር(concealment of bank account) የታክስ ስወራ ወንጀል ለመፈፀም ታስቦ የሚደረግ ተግባር ነው፡፡በአሁኑ ጉዳይ በተከሳሽ ስም በተከፈቱ የባንክ ሂሳቦች ውስጥ ያልተገለፀ ገቢ መገኘቱ በአቃቤ ህግ ማስረጃዎች የተረጋገጠ ሲሆን እነዚህ የባንክ ሂሳቦች የግብር ባለስልጣኑ አስቀድሞ የሚያውቃቸው መሆን አለመሆኑ ወይም ተከሳሽ የግበር ባለስልጣኑ እንዳያውቃቸው በማድረግ የሚጠቀምባቸው ስለመሆኑ በአቃቤ ህግ ምስክሮችም ሆነ በቀረበው ኦዲት ሪፖርትና የሰነድ ማስረጃዎች የተገለፀ ነገር የለም፡፡(በመኃል ተዘሏል) በመሆኑም ታክስ ከፋይ በባንክ ሂሳብ ላይ የተጠራቀመውን ገቢ/ገንዘ ብደብቋል/ ሰውሯል ተብሎ በወንጀል የሚጠየቀው በግብር ባለስልጣኑ የማይታወቁ የባንክ ሂሳቦችን በመጠቀም ገቢን/ግብይቱን የደበቀ በመሆኑ ሲረጋገጥ ነው፡፡በተያዘው ጉዳይ ዐቃቤ ህግ የባንክ ሂሳቦቹ በግብር ባለስልጣኑ የማይታወቁ ስለመሆናቸው አላስረዳም በሚል ተከሳሽ የጥርጣሬ(benefit of doubt) ተጠቃሚ ሊሆን ይገባል በማለት ተከሳሽን በወ/መ/ሥ/ሥ/ህቁ-149/2/ መሰረት በነፃ አሰናብቷል ”
Roughly interpreted by the writer…
“Tax evasion can be committed through different acts. Amongst intentional concealment of bank account is one. When we see case at hand the government has proved that the income from bank statement is undeclared. However the government hasn’t proved that the bank account under scrutiny was not within ambit of its knowledge. Hence, prosecutors haven’t prove that the defendant act toward concealing those accounts from the probable knowledge of the authority. Henceforth, the benefit of doubt should be given to the suspect and the suspect is hereby acquitted pursuant to art. 149/2 of criminal procedure code.”
In case #2 above, the court narrow down bank statement based tax evasion to concealment of bank account from revenue authority. However, in identifying undeclared income one can find undeclared income either from concealed account or from those accounts under knowledge of the authority. Regarding concealment of bank account if we proof that the bank account is concealed and we get undeclared income, with no doubt, after all elimination, deduction and exemptions are done we can conclude the income in the account as unidentified income. However, what if we can’t proof the knowledge of the authority but substantial difference in income exist between declared income and bank based income of tax payer?...if substantial difference (unidentified deposit) exist we shouldn’t end the story with identification of the authorities knowledge of the accounts. In the above case the court prove the existence of undeclared income. However, the court can’t investigate in to the heart of the case. Nothing is done on purification and other related investigation techniques. Besides, other than accepting witness testimonies, the court can’t even do any mathematics of income. Specifically the court ought to do the mathematics of defense witnesses’ testimonies (those are non-expert loan based witness).
In nutshell, in this case the court should go beyond bank account concealment and investigate the sources of those undeclared income.
In the above article I have discussed four essential yardsticks to which revenue authority, attorney general, courts and the law enforcement community should follow while they audit, investigate and dispose cases based on bank statement method of proof.
Besides, I have discussed cases and try to portray the argument facing us in court as heretic. Not less than this, a number of cases fail by the mere fact that the prosecutors can’t test their case based on the above yardsticks, which I can label it due to being off track. Hence, no group than those who argue against established jurisprudence is a heretic.
To conclude, I hope the note will provoke lawyers thought either to develop or challenge my opinion which in turn will help nurturing the current bank deposit based tax litigation.
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