Tax evasion is one of the major concerns that affect the country’s economy as well as the living standard of citizens. The revenue authority has therefore, instituted measure to curb this affect by reducing the magnitude of undisclosed income from fraudulent citizens. Strict tax compliance would mean improved economy, better living standards because the government will be having a wider tax base. A good method of detecting the undisclosed income is the indirect method. The approach is relevant for determining the undisclosed income since it involves assessing the tax accountability by examining the financial performance of a taxpayer from assortment of sources outside the declaration of the taxpayer and the official books of accounts kept. The examination is majorly based on incidental proof indicating a rational estimate of the taxpayer accurate tax responsibility in that year of income.
Indirect Method
Net worth approach.
This method is considered superior because, it tracks all the business deal for a given period in which an individual performed business or personal transaction. A detail analysis of receipts as well as disbursement is analysed and the net effect would be the funds from unknown source. There is no shortcoming and consequently, the reasonableness test is reliable in assessing the undisclosed income. The circumstance that will facilitate use of indirect method is where a practitioner is convinced with the integrity of the taxpayer in filing all the returns, however, where the books of account are found to contain malicious entries and the records do not portray the actual financial affairs of the business, a substantial understatement of income might be suspected and as a results, practitioner should appreciate using the indirect method in ascertaining all source of income to detect any fraudulent entries.
Key signs to undisclosed income are: failure to maintain proper books of account and to file statement, mysterious declared income is not directly proportion to taxpayer living standard or the declared income does not reflect the business activities and the taxpayers’ constantly announces losses for an extended period with cash as the method of handling transaction
Source and Application of Funds Approach.
This method is considered less effective in relation to the net worth approach since a detail study of individual transactions is not analysed. Lack of internal control will be observed because fraudulent citizen will not disclose all their source of income for tax purposes. With this approach, care should be taken on transaction between an individual and the contractor because there is no audit trail review on cash disbursement. It therefore signifies that the adequacy of this approach should not be fully relied upon as the method will not disclose all income which is subject to tax hence making it a good haven for tax evasion.
Bank Deposits Method.
This approach appreciates Bank account records to ascertain the understatement of taxable income if any. Where there is Presence of limited or direct evidence on income and expense, the government might as well execute an examination indirectly by use of situational proof. This method of determining an understatement of income does not have any legal condition; the approach is principally based upon the Supreme Court verdict. Lack of delegation of obligation and lines of accountability are frequently a key cause for worry when appraising the internal control. It implies therefore, that the reasonableness of the evidence provided would not be relied upon fully for tax purpose and taxing authority would opt for net worth approach because of the detailed analysis on an individual transaction both for personal reason as well as for business the net worth approach would mandate for examination.