Direct vs. Indirect Tax Estimation Methods Explained
Direct vs. Indirect Tax Estimation Methods
Direct Estimation
The direct estimate is the standard method for determining the taxable amount. This approach, governed by ART. 50.3/51 LGT, relies on real data to accurately measure the taxpayer’s economic capacity, ensuring fair taxation.
This method is used in the following scenarios:
- When the tax administration quantifies or settles debts based on data provided by the taxpayer, such as in the IAE (Economic Activities Tax), where the taxpayer specifies their activity and premises size. This also applies when verifying the accuracy of the taxpayer’s previous declarations.
- When the taxpayer quantifies their own debt, there are two cases to consider:
- For taxes where regulations mandate specific accounting or registry duties, the actual data from these records forms the basis of the declaration. The tax authorities (AEAT) may review the declaration and accounting records to verify the declared income. In personal income tax, the net return from business or professional activities is calculated as the difference between income and expenses reflected in the accounts.
- For taxes without specific accounting requirements, the direct estimation relies on information provided by the taxpayer in their declaration. For example, in ITP (Property Transfer Tax), the taxpayer enters data about a second-hand vehicle they purchased.
Indirect Estimation
The indirect estimation (ED) method, unlike the direct method, is employed when the taxpayer’s collaboration is limited or absent. In such cases, the tax administration uses presumptive methods or indices to determine the taxable base (ART.50.4/53 LGT).
The core principles of indirect estimation are:
- Taxpayer misconduct that prevents the administration from accurately determining the taxable base (ART. 53.1.ac).
- Force majeure events (ART. 53.1.d).
Key characteristics of this method include:
- It is applied only when the tax administration cannot obtain actual data through its own means, making it a subsidiary method.
- It is not based on the taxpayer’s actual data or serious offenses.
Article 53.2 of the LGT states that when indirect estimation is necessary, the administration will use various means:
- Information based on the taxpayer’s position, tax history, or data obtained from third parties.
- Techniques based on market indices, such as average price levels or typical profit margins for the activity.
- Assessment using indices or modules. For example, for a dentist, the number of prostheses that can be made based on the materials purchased.
ART. LGT 158.1 mandates a reasoned report by the tax inspection detailing the reasons for implementing the indirect estimation method.