International Journal of Law and Management

Capital statement analysis as a tool to detect tax evasion

Anuar Nawawi, Ahmad Saiful Azlin Puteh Salin,
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Capital
Capital statement analysis as a statement
tool to detect tax evasion analysis
Anuar Nawawi
Faculty of Accountancy, Universiti Teknologi MARA, Shah Alam, Malaysia, and
1097
Ahmad Saiful Azlin Puteh Salin
Faculty of Accountancy, Universiti Teknologi MARA, Received 2 March 2017
Revised 28 April 2017
Perak Branch Tapah Campus, Malaysia 1 June 2017
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Accepted 10 June 2017

Abstract
Purpose – The purpose of this study is to determine the suitability of capital statement analysis in assisting
tax investigation to combat tax evasion, measured by the time taken in proving the under-declared income by
the tax evader. A weakness in the investigation process that may contribute toward the delay of the tax
investigation completion was examined.
Design/methodology/approach – Five investigation cases were randomly selected from the tax
investigation organization for detailed and in-depth analysis on the whole process of reconstruction of capital
statement analysis. Document analysis technique was used to analyse the data.
Findings – This study found that the capital statement analysis can be an effective tool in detecting under-
reported income and tax evasion. However, the cooperation from the taxpayer is the most important factor,
because if taxpayers do not cooperate, the investigation officer needs to find other informant such as third
party as a source of information which usually time-consuming.
Research limitations/implications – This paper selected only a small number of tax fraud cases for
examination. Many other cases were not accessible due to confidentiality and considered as high-profile
cases.
Practical implications – The outcome of this paper contributes in the way it can be used and applied by
the revenue authority in implementing more practical and effective capital statement analysis technique to
deter tax evasion. The investigation activities can be improved so that more cases can be covered in shorter
time period.
Originality/value – The paper is novel and original, as it focuses on the investigation of tax fraud cases’
which is difficult to access and rare in tax literature, particularly in emerging markets. The findings of this
study are inferred from direct examination of the actual cases documents that are private and confidential.
Keywords Tax fraud, Case study, Tax evasion, Capital statement analysis, Tax investigation
Paper type Case study

Introduction
In Malaysia, under the self-assessment system (SAS), taxpayers are encouraged to
voluntarily comply with the tax law and be responsible for their own tax returns. Thus, the
taxpayer has more freedom in reporting his or her income because the Inland Revenue
Board of Malaysia (IRBM) accepts in good faith any report submitted to it (Juahir et al., 2010)
such as via the electronic tax form submission system or known as e-filing (Saibon et al.,
2016). The essence of the implementation of the SAS is that taxpayers need to know their
International Journal of Law and
true responsibility and have good understanding of the tax law. Failure to comply with any Management
of the rules and guidelines under Income Tax Law 1967 will be a burden to the taxpayer. It Vol. 60 No. 5, 2018
pp. 1097-1110
is anticipated that SAS will create a situation, whereby taxpayers will submit their tax © Emerald Publishing Limited
1754-243X
information honestly and voluntarily (Marshall et al., 1997). DOI 10.1108/IJLMA-03-2017-0024
 IJLMA However, it is not a perfect case. Tax evasion is a significant issue in most developed and
60,5 developing countries around the world, which threaten major government revenue
collection agencies (Cerqueti and Coppier, 2015; Mohamad et al., 2016; Hassan et al., 2016;
Gokalp et al., 2017; Mohamad et al., 2017). The revenue of the country will be affected if there
is no control mechanism to deter tax-evasion activities. Besides, tax-evasion activities evolve
in more complicated ways and correlate with organized crimes, white-collar scandals and
1098 underground economies. It is an immoral conduct (Lisi, 2015) by which the tax evader
engages in various illegal actions to reduce his or her tax obligations (Alm, 2012; Slemrod
and Weber, 2012) and can come in many types of manipulation such as through creative
accounting and earnings management.
Table I shows the statistic of the increasing figure of back duty collection discovered by
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the tax investigation department of the Malaysian Revenue Authority (Inland Revenue
Board, 2010). In 2005, the taxes and penalties equalled only RM 762.97m. It increased by RM
405.58m or 53 per cent to RM 1,168.55m five years later. The average taxes and penalties per
case are also on the increasing trend, from RM 1.06m to 1.53m per case. Except for 2006, the
number of cases investigated and charged were approximately around 650 to 850 cases.
Based on this information, it is crucial that the tax system embarks upon an innovative
approach to deter and detect tax-evasion activities. Prior study shows that tax audit, fear of
prosecution and sufficient governmental regulation effectively discourage tax evasion
(Kuchumova, 2017; Alleyne and Harris, 2017). However, it is not an easy job, as the tax
evader has every motivation to hide his or her taxable activities (Hashimzade et al., 2013).
Furthermore, it also can associate with shadow, black or underground economies (Slemrod
and Weber, 2012), a business which exists but is concealed from the authorities to avoid tax
payment (Schneider, 2005). A capital statement analysis is one of the techniques that can be
used in identifying under-reported income, one of tax evasion’s main characteristics.
Generally, the capital statement is a series of balance sheets comprising assets and
liabilities of the individual taxpayer. Known also as a net-worth statement, a capital
statement will be used by the revenue authority to analyse and detect any undeclared
income based on the principle of income being equal to spending plus saving. If both do not
reconcile, then there is a possibility of income not being properly declared by the taxpayer.
The process of reconciling these figures is called capital statement analysis.
The capital statement analysis of a taxpayer is usually based on the information and data
regarding the possession of assets, liabilities and expenditures. Unfortunately, some cases are
difficult to settle because no information is available, and in the end are solved without any
findings. The process to reconstruct the capital statement is lengthy and dependent on the
information gathered. The complexity of the data could also affect the data-gathering
process. In serious cases, tax-evasion activities are well planned by tax evaders. The data
could be manipulated and diverted into various means to conceal the malpractices.

Taxes and penalties Taxes and penalties per case

Year No. of cases (RM million) (RM million)

2005 719 762.97 1.06

2006 1,388 903.23 0.65
2007 755 686.43 0.91
Table I. 2008 648 750.83 1.16
Taxes and penalties 2009 834 844.92 1.01
imposed on cases 2010 763 1,168.55 1.53
 Therefore, there is a dire need of improvement in the capital statement analysis process to Capital
ensure its effectiveness in detecting under-reported income. Besides, the capital statement statement
analysis must be precise and complete, so that it is admissible in the court to prove tax
evasion. The process of capital statement analysis should take a short period of time, so that
analysis
the tax investigation program has more coverage in terms of cases to investigate and
improve the effectiveness in detecting the under-declared income.
Based on this premise, it is interesting to explore the effectiveness of the capital
statement analysis in helping tax investigation. In general, this study attempted to answer 1099
the following research question:
RQ1. How effective is capital statement analysis in detecting tax-evasion activities?
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The purposes of this study, then, are to examine the effectiveness of the capital statement
analysis in proving under-declared income and to identify any weaknesses in the data-
gathering process that may contribute toward long aging tax investigation cases.
This study offers several contributions. First, it helps the tax authority in implementing
a more practical and effective capital statement analysis technique to deter tax evasion.
The investigation activities can be improved so that more cases can be covered in a shorter
time period.
Second, this study will signal to taxpayers the ability of revenue authority in combating
tax evasion activities. Thus, it will indirectly promote awareness toward a higher voluntary
compliance level because it generates a perception of taxpayers on the high probability of
being detected and prosecuted, should they fail to comply with the tax laws. Empirical
evidence shows that lower tax evasion is committed if the tax evader feels that the
probability of being detected is high (Feinstein, 1991; Marrelli and Martina, 1988;
Pommerehne and Weck-Hannemann, 1996).
Third, this study will assist policymakers in implementing the best policies to guide and
facilitate tax investigation and prosecute tax evaders. Currently, there is a constraint in
implementing the investigation program in terms of time consumed and numbers of staff,
which contribute to the time lag of the case. These constraints in tax investigation also cause
the aging of the case and take years for settlement.
Fourth, the findings of this study will add to the body of the literature regarding the
effectiveness of capital statement analysis in deterring tax-evasion activities, which are
scarce, particularly in the context of developing countries such as Malaysia. Many scholars
emphasize the factors and implications of tax-evasion activities, but not many have
conducted empirical research on the tools and techniques necessary to detect these immoral
behaviours. This research will reduce this gap.
This paper is organized as follows. The next section is a review of the literature. Research
methods are presented in Section 3, followed by discussion of the findings and conclusion.
The last section discusses limitations and suggestions for future research.

Literature review
Capital statement analysis as a method of proving under-reported income
The capital statement analysis is one of the methods used to ascertain whether the income
reported is complete or otherwise. In other words, the capital statement analysis is a tool
used to justify the correctness of the reported income. The basis of the capital statement
analysis must be based on reliable information such as books, records, papers or any other
data that may be relevant to the investigation.
The investigation officer (IO) is the “person in charge” of the reconstruction of capital
statement analysis. The IO must follow proper administrative steps in obtaining information.
 IJLMA A standard operating procedure must be followed to ensure the accuracy and integrity of the
60,5 investigation findings. The result of the capital statement would be used as proof to show the
taxpayer’s under-reported income. Meanwhile, the accuracy and the completeness of the capital
statement analysis are a must to ensure the fairness of the findings.
In the case of Holland v. USA, 348 US 121, 125 (1954), The Supreme Court, while firmly
approving the net worth (capital statement) analysis method, opined that “it is so fraught with
1100 danger for the innocent that the courts must closely scrutinize its use”. Thus, the revenue
authority should be careful and construct an effective approach to ensure the reliability of the
data and information in the capital statement analysis, so that it can be accepted as concrete
and credible evidence in the court of justice. For example, in Bandar Utama City Corporation
Sdn Bhd v DGIR (1999) MSTC 3,725, it was upheld by the high court that the notice of
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additional tax assessment for a period of 10 years by the revenue authority was a “breach of its
statutory duty and the rules of natural justice” because the revenue authority failed to provide
particulars as a basis to that notice of additional assessment. The same principles are also
applicable in the cases of Syarikat Ibraco-Peremba Sdn Bhd v. DGIR (2017) 2 MLJ 120, Sabah
Berjaya Sdn Bhd v. DGIR (1999) MLJU 224, Government of Malaysia v. Jasanusa Sdn Bhd (1995)
2 MLJ 105 and Government of Malaysia v. Gan Chuan Lian and Another Action (1992) 1 MLJ
449, in which the taxpayer has a right to be protected from additional assessments unless there
is proof of fraud, wilful default or negligence.
Under the capital statement analysis method, the IO is responsible for developing and
constructing the capability of the taxpayer on possession of assets, investment, reduction of
liability and expenditures incurred. There should be data of year-by-year comparisons of
capital statements to identify the under-reporting of income. The crucial part in the
development of a capital statement is in ascertaining the opening balances and closing
balances. This provides a snapshot of the taxpayer’s net worth at a particular point in time.
The statement includes the assets owned by the taxpayer such as property, land and home,
along with assets such as motor vehicle, cash in hand, bank accounts, brokerage (shares),
furniture and fittings, jewellery and similar items.
Generally, the IO will learn about these items via thorough and in-depth investigations,
sometimes chasing the suspected fraudulent taxpayer. The IO will assess the taxpayer’s liabilities
and debt accumulated in the next year and evaluate the taxpayer’s new net worth at the next
year’s end. The liabilities include mortgage, various types of loans, credit card debts and personal
credit. The IO also needs to review the taxpayer’s cash expenditures throughout the tax year. The
IO then compares the increase in capital statements and cash expenditures with the reported
taxable income over time to determine the legitimacy of the taxpayer’s reported income.
In practice, the capital statement analysis is based on minimum six years of financial
data. The data must be precise and supported with evidence and documentation. A net
increases capital statement is determined by establishing a net worth at the beginning of a
given year and then this beginning net worth is compared with the net worth at the end of
the year. The opening net worth is the point from which the net worth increases are
measured. While every effort should be made to identify all of the assets and liabilities of the
taxpayer at the starting point, the IO does not have to establish the opening net worth with
mathematical certainty.
The findings of the capital statement analysis will be presented to the taxpayer for
discussion. If there is any argumentation from the taxpayer, an appeal can be made to the
revenue authority with a support of proper documentation. Meanwhile, the taxpayer is
encouraged to give full cooperation and provide detail of the transactions. Without
commitment and cooperation from the taxpayer, the capital statement analysis is unable to
present the true depiction of the taxpayer’s income.
 Tax investigation framework in Malaysia Capital
Tax investigation is an examination of a taxpayer’s business and individual books, records statement
and documents. It only conducted when there is concrete evidence that the taxpayer
committed wilful evasion and intentionally avoided paying tax. There are two types of tax
analysis
investigation: civil tax investigation and criminal tax investigation. The former aims to
detect tax evasion with the objectives of recovering tax losses and imposing heavy penalties,
while the latter focuses on accumulating support to prosecute the tax evader under the Penal
Code and related criminal acts (Inland Revenue Board, 2007). 1101
Tax investigation activities in Malaysia are stipulated under the Tax Investigation
Framework, which became effective on 1 January 2007. The framework provides guideline
on the practices of the tax authority in investigation programs and aims to maintain public
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confidence in the tax administration system. Compliance on the tax legislation must be
strictly enforced, and tax offences such as non-compliance and tax evasion should be
penalized under the Income Tax Act (ITA) of 1967. This framework outlines the rights and
responsibilities of an IO, a taxpayer and tax agent/representatives in respect of tax
investigation. Generally, this framework aims to assist IOs to carry out their tasks
efficiently and effectively and assist taxpayers in fulfilling their obligations.
Statutory provisions relating to tax investigation are not limited to the provisions in ITA.
Statutory provisions also include the Real Property Gains Tax Act 1967, Petroleum (Income
Tax) Act 1967, Promotion of Investment Act 1986, Stamp Act 1949, Labuan Offshore Business
Activity Tax Act 1990 and other acts administered by the Inland Revenue Board of Malaysia.
This framework re-emphasizes the power of the IOs as per ITA in performing their task
such as the power to call for specific returns on production of books (Section 78), power to
call for statement of the accounts (Section 79), power to access buildings and documents
(Section 80) and power to call for information (Section 81).
Section 80, for example, permits the IO at all times to have full and free access to all lands,
buildings and places, and to all books and other documents relating to their investigation paper.
Moreover, no warrant is needed to enforce Section 80. For the purpose of this Act, a surprise
visit can be held to get the document and information regarding tax investigation cases.
Besides, Section 81 also empowers the IO to call for information. Under this Act, the
director general of the Inland Revenue Board may require any person to give orally or in
writing all such information or particulars required to assist the investigation.

Research methodology
The research design of this study is focused on real tax investigation cases that will be used
as case studies for the detailed analysis. The case study approach was selected here because
the information that can be gathered and collected to achieve the purpose of this study is
limited and highly sensitive. The access is only permitted with a special request from the top
management of the investigation body under research. The information is also confidential
and not publicly available.
According to Leedy and Ormrod (2005), a case study is a type of qualitative research
method that is suitable for learning about little-known or poorly understood situations. Five
actual tax investigation cases are selected for the study. This study examines the details and
presents an in-depth discussion on the whole process of reconstruction of capital statement
analysis. The five cases would cover various issues, emphasizing the techniques and data-
gathering processes.
The cases were randomly selected based on the capital statement analysis of individual
taxpayer cases. The researcher had selected five cases on different taxpayer backgrounds.
This provides various scenarios on tax investigation cases. The five cases cover a diverse
 IJLMA background of taxpayers in terms of reported income, be it salary income, business income
60,5 or other income. There are also cases of compliance and noncompliance. Every case selected
represents the uniqueness of the case and provides insight into the process of reconstruction
capital statement until the process of settlement.
The explanation and discussion of the case studies, however, are limited for the purpose
of this study only. The true identity of the cases will not be revealed, as it contravenes
1102 Section 138 of the ITA 1967 on the secrecy and confidentiality.
Document analysis technique was used to analyse the data, as it involves the textual
investigation (Silverman, 2015) in analysing the related sources of information regarding the
case. Yin (1994) also proposed document analysis for the researcher to obtain a wealth of
description of the interested phenomena. It is also assists in developing the understanding of
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the research problem (Merriam, 1988).

The following examples include descriptions of the cases selected for this case study.

Case 1: Mr A
The taxpayer is a managing director of the company. He and his wife possess shares in the
company that involve property and land development. Prior to that, the taxpayer was a general
manager in a public listed company and also a managing director of ten other subsidiaries of
the listed company. He had more than 20 years of experience in the corporate world before
setting up his own company. While the taxpayer joined the corporate company, his wife
remained a full-time housewife. He and his wife declared only salary and dividend income in
their tax return form.

Case 2: Mr B
This taxpayer is a director of six non-listed companies. He also owns a pharmacy registered
under registrar of business (sole proprietorship) and is involved in professional gambling. The
taxpayer owns an exorbitant amount of assets in terms of property, cash and luxury cars.
This case was selected owing to a non-compliance issue where the taxpayer did not
comply with the requirement of tax return submission. Furthermore, this case was referred
to the revenue authority by the police in which the taxpayer was investigated under the
drug act. Initial investigation revealed that the taxpayer had been involved in illegal and
underground economy activities.

Case 3: Mr C
The taxpayer is a managing director in a public listed company and receives salary income
plus bonus based on his employment. He is a director by employment and has no other
interests in the company. He is also responsible in managing the financial activities of the
company and reports to the board of directors. The issues in the case are on the high possession
of properties, fixed deposits and huge amounts of cash available by the taxpayer. The wife of
the taxpayer is not working, and there is no other source of income visible on how the taxpayer
finances his lifestyle.

Case 4: Mr D
This taxpayer is a company director and also a major shareholder of the company. His
reported income consists of salary and bonuses from the company, dividends from the listed
company and rental income. The case was selected due to investigation information based
on the company that he owns the shares. There are possibilities that aggressive tax evasion
has been done among the directors, company and subsidiaries. Each company and
 subsidiary owned by the director were raided for investigation. This is a normal practice of Capital
the investigation department where all related parties that have the possibility of aggressive statement
tax will be investigated. Thus, the whole picture of tax evasion activities could be identified. analysis
Case 5: Mr E
The taxpayer is working overseas. However, the taxpayer has been a Malaysian resident
for the basis of one year and qualifies for all benefits as a resident. He also received a salary 1103
and bonus from his employment in Malaysia and dividend income from a public listed
company. This case was selected for investigation owing to information from the third
parties in other cases of investigation. The taxpayer was suspected to have received
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commission and did not declare the income. Based on that information, the taxpayer was
identified and a surprise visit was conducted. The director regularly travelled overseas
and, at the same time, managed his business in Malaysia. The taxpayer is involved in the
mobile phone reselling business. He acts as a middle man, especially in the process of
importing overseas mobile phones.

Findings and discussion

The findings, after examining all the related documents and files of all the five cases, were
discussed as follows:

Case 1: Mr A
Reported income: salary, bonuses and dividends. Taxpayer also reported the capital gain
received to show his available income.
Period of settlement: 33 months.
Initial investigation revealed that the taxpayer possessed a lot of property. Based on the
risk analysis, the taxpayer possessed properties beyond his means. This triggered
the revenue authority to obtain further clarification on his income. The capability of the
taxpayer in maintaining his lifestyle and setting up a new business with large amounts of
capital also was the reason why the case was selected for investigation.
The investigation team had discovered the unknown sources of income amount
approximately RM 4m. The taxpayer owned various types of assets, largely in the form of
shares in public listed companies, properties in terms of land, shop lots, houses and
condominiums. The liabilities came from the financial institutions in terms of financing of
the properties and motor vehicles. For the personal expenses, the information is based on the
lifestyles of the taxpayer. The information is gathered from documents regarding personal
expenses such as payment for basic necessity such as meals, utilities bills, credit card
payment, travelling expenses, education for children, insurance and loan instalments.
The study found that the major weaknesses in the settlement of this case were
confirmation and information from the taxpayer and also from third parties. Although the
authority has power to access to any information provided under the law, but there were
weaknesses in term of getting cooperation from the third parties.
However, through a good rapport and direct contact with the person in charge, the IO is
finally able to gain the information. For example, the IO needs to personally hand over the
letter on the information requested and meet the third parties face to face. This will show the
importance of the information needed and the gravity of the case under investigation. If the
taxpayer and third party are reluctant to give cooperation, the authority will use legal action
in order to obtain the information.
 IJLMA Case 2: Mr B
60,5 Reported income: the taxpayer did not comply with submission of the tax return. There is no
income reported.
Period of settlement: 10 months.
The taxpayer is involved in underground activities; therefore, there is no written document.
It is difficult to have proof of such transactions in the business. The company is registered with
1104 the purpose as a layer or shield of the taxpayer’s illegal activities. The taxpayer managed to
generate millions of profits and enjoyed illegal gains. Under the normal audit activity, the case
will not have been detected. Even through the normal risk analysis, the possibility of the case to
be selected is very low. Risk analysis is a methodology used to select a potential tax evader. For
example, substantial acquisition of high-value property and luxury cars trigger a taxpayer
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with high income. A person can be a potential tax evader if his or her tax submission shows
otherwise. However, via detailed investigation and in-depth study, the authority managed to
collect the back duty and penalty of more than RM 10m.
The assets consist of investment in the non-listed companies, properties such as shop houses
and homes, savings in the bank, loan to company (director’s account) and number of motor
vehicles. The cash in the bank shows a huge cash amount approximately of RM 2m. The
taxpayer also owns a sports car valued more than RM 1m and other luxury cars worth more than
RM 2m. The amount of liabilities was quite low as compared with the profits and cash available.
Based on the investigation, some of the property was registered under the name of his wife
and children, but there was no proof of income received by the wife and children. Therefore, all
the property also should be accounted for in the capital statement analysis. Based on the capital
statement analysis, the unknown income received by the taxpayer was determined based on
the record, bank statement, papers and related findings of the taxpayer.
This study found that the cooperation from other agencies such as the police being
helpful in providing information for the investigation, provides a positive impact on the
case. The case was settled within less than a year. The finding in capital statement analysis
is proof of the effectiveness of detecting unknown sources of income, especially in the case of
the underground economy.

Case 3: Mr C
Reported income: the taxpayer received salary, bonus and dividend income.
Period of settlement: 96 months.
The investigation team discovered that the taxpayer owns lands and houses plus other assets
such as cash in the bank, fixed deposit, furniture and fittings of his house and cash in hand,
which were estimated on a reasonable basis. The liability is a loan from a financial institution to
finance the taxpayer’s houses. The personal expenses of the taxpayer consist of basic payment of
necessities such as food, petrol and toll, education fees for children and utility bills. All the
information of his personal expenses is based on the taxpayer’s receipts and document. Because
the taxpayer has no proof of any other legal income, the focus of the investigation team is to find
out all the assets and expenses linked to the taxpayer. This is to prove that the taxpayer has an
income to finance his means and capabilities of possessing the assets.
The study found that the commitment and cooperation from the taxpayer are critical to
contribute to the settlement process for this case. For example, information regarding
personal expenditures, cash in hand and jewellery all depends on the confirmation from the
taxpayer. If the taxpayer fails or is reluctant to provide such information, the case would be
delayed. Taxpayers usually will cooperate when reasonable time is given to them. IO will do
an estimation of personal expenses, cash or personal belonging but must be supported with
detailed analysis of the taxpayer’s background. The data can depend on interviews and
 observation and also are based on a reasonable basis. There will always be arguments from Capital
the taxpayer when the estimation is high. The experience and negotiation skills of the IO statement
also contribute to the effectiveness of reconstruction of the capital statement.
Another factor is the continuity of the investigation when an IO was transferred or
analysis
promoted. The new IO needs time to really understand and review the case. These are
common factors for delaying the cases.
The study also found that the constraint in the documentation of proof is also a problem
in the capital statement analysis, for example, payment of personal cash expenses and 1105
registration of assets under the nominees’ name. It is difficult to prove and verify that the
property is actually owned by the taxpayer.
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Case 4: Mr D
Reported income: the taxpayer received salary, bonus and dividend income.
Period of settlement: 22 months.
Finding a complete and extensive money trail among directors, the company and
subsidiaries is a must in investigation. In this case, the director was identified as an actor of
the case. Therefore, a full investigation was needed to identify evasion made by the directors
and the company. The information regarding all the assets, investments, cash in the bank
and number of motor vehicles are based on third-party records such as legal agreements,
bank statements or bank confirmations and letter of authorization of motor vehicle from the
Road Transport Department. Other information such as the director’s account is based on
the ledger and company record. The loan (advanced) to the third party is based on third-
party information and records. The investigation team is required to scrutinize all the
information and collate all the proof in a professional manner.
Personal expenditures of the taxpayer are quite high and show an increasing trend. The
IO had discovered the personal expenditures based on the credit card statements. Other
personal expenditures that have been discovered were education fees for children, medical
bills, travelling and accommodation expenses, golf membership and others.
The study found that the settlement of this case largely contributed to other cases, which
were under investigation of revenue authorities. Some documents from the company lead
the IO to trace transactions related to the taxpayer. The director’s account in the company,
account, ledger or bank statement analysis and the transaction related to personal
transaction of taxpayer have been analysed to ensure the income affects the personal tax
matters. The taxpayer profile assists the IO in the investigation process. The taxpayer gives
full cooperation and is willing to provide records and documents. Hence, the documented
evidence helps IO reconstruction of a defendable capital statement analysis and reduces
arguments with the taxpayer.

Case 5: Mr E
Reported income: the taxpayer received salary, bonus and dividend income.
Period of settlement: 30 months.
In this case, the finding of the capital statement was the income received in terms of
commission from third parties. The commission received was calculated based on the sales
units and confirmed by the third party’s company. The confirmation from the company that
claims the payment as expenses was already written in the document. The amount received
was confirmed by taxpayer that the commission he received was not reported as income.
Even though the income available is higher as compared with the net increase of the
assets and personal expenditure, the difference is not being considered as income over-
reported. This is due to certain assets or expenditures that were not properly calculated in
 IJLMA the analysis or hidden assets that failed to be detected in the analysis. Another argument of
60,5 the case is that the personal expenditures incurred or the assets existed, but there were no
supporting documents. The findings on the specific commission by the taxpayer are
considered the amount not reported to the revenue authority.
The study found that third-party assistance largely contributed to settle the case. The
taxpayer received commission from other parties. This could only be detected through an in-
1106 depth study. Apparently, the amount of commission received by taxpayer is more than the
initial information received. Many tasks were performed to obtain information about the
activities such as identify the third party that paid the commissions, method of payment and
amount received. Determination of amount received, for example, must be testified based on
third-party confirmation. In the course of investigation, it involves numerous processes,
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especially in determination of the payment received from the third party. These include
interviews, reviews of document, testified information from other party, analysis of bank
statement and books.
Tables II and III summarize the result of finding for the case studies. Total under-
reported income and the back duty and penalties are presented in Table II, while the issues
and findings exposed from the case studies are tabulated in Table III.
Based on Table II, it can be suggested that the capital statement analysis is an effective
method of proof in detecting unknown sources of income. Table II shows that, by using this
technique, the IO is able to re-compute undisclosed income as high as RM 25.4m (Case 2). For
Case 1, the IO is able to discover under-reported income of RM 4 million, followed by Case 4 and
Case 5 of RM 3m each. Average under-reported income the IO is able to discover is around RM
3 to 4m, while total back duty and penalty collected also are promising, totalling almost RM
15m for all the cases. Again, Case 2 recorded the highest back duty and penalty of RM 10m,
which is more than 50 per cent of overall back duty and penalty collection. The total penalty
imposed for Case 1 was RM 2m, while that for Case 4 and Case 5 was RM 1m each.

Table II. Issues/findings Case 1 Case 2 Case 3 Case 4 Case 5

Total under-reported Total under-reported income (RM million) 4 25 0.4 3 3
income, back duty Total back duty and penalty (RM million) 2 10 0.2 1 1
due and penalty
imposed Note: Actual figures were slightly modified owing to confidentiality

Case Case Case Case Case

Issues/findings 1 2 3 4 5

The capital statement able to detect unknown sources of income Yes Yes Yes Yes Yes
The capital statement analysis is based on third- party confirmation Yes Yes Yes Yes Yes
and cooperation
Total of months to complete the investigation (months) 33 10 96 22 30
The capital statement done within the stipulated period No Yes No Yes No
Number of years of capital statement 8 8 5 6 6
How the case was selected for investigation 1* 2* 1* 1* 3*
Table III. The taxpayer involved in underground activity No Yes No No No
Issues and findings
exposed from the Notes: *1 – Internal analysis; 2 – Information from other government agency; 3 – Information from other
case studies cases of investigation
 However, the usefulness and effectiveness of capital statement analysis still depend on several Capital
factors that contributed to that effectiveness. Table III clearly shows that, although the capital statement
statement is able to detect the unknown sources of income for all the cases, the cooperation of
third parties such as banks, suppliers and other government agencies is crucial in completing
analysis
the investigation. If not, it can delay as long as 96 months or 8 years as per Case 3. Case 2 took
only 10 months (less than a year) to be completed. Table III also shows that the majority of the
cases (three out of five] cannot be completed within the stipulated time frame planned. Only
two cases, namely, Case 2 and Case 4, were completed within the stipulated time period of 1107
maximum 24 months (two years), while for the remaining cases (Case 1, Case 3 and Case 5), the
time taken went well beyond the time budgeted by the IO. This is not healthy because delay in
one case will increase the opportunity costs of the revenue authority to investigate other cases
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and recover more back duty and penalty payment.

In terms of period of assessment, a capital statement only can be constructed for five years
for Case 3, six years for Case 4 and Case 5 and eight years for Case 1 and Case 2. A short period
of capital statement assessment contributed to the less under-reported income discovered and
penalty collected RM 0.4 and 0.2m, consecutively, as reported in Table II previously for Case 3.
For the basis of selection, three cases (Case 1, Case 3 and Case 4) were selected based on
routine internal analysis such as fluctuation in figures of tax computation and taxpayer’s
lifestyle that go beyond ordinary income. Only one case, namely, Case 2, was selected based
on information given from another enforcement agency (the police), while Case 5 was
selected based on the information from other tax evasion case of investigation.
Table III also shows that the taxpayer in Case 2 was involved in underground activity,
specifically drug trafficking. This is one of the reasons for the highest under-reported
income and penalty collected for the case. This implicates that taxpayers involved in
underground activity such as illegal drug trafficking, weapon transaction, prostitution and
any black market operation that will have established many businesses to hide their illegal
activities in which they can benefit millions in profit and illegal gains. Thus, more
concentrated effort and resources need to be assigned to investigate this type of case.
The findings also show that the reconstruction of capital statement requires an in-depth
study and rigorous investigation. This, however, has a negative effect because it will prolong
the period of settlement and therefore delay the cases. Profiling of the taxpayer should be done
in detail to assist the investigation. Understanding the taxpayer’s background, business
activity and any related information could help the investigation to be more focused.
The data-gathering technique also requires improvement; nowadays, data can be stored in
various mediums of information technology devices. The emergence of technology enables tax
evasion activities to exist in various forms. Manipulation of business entity and diversification
of income into various means would also result in the income being undetected.
Overall, based on the findings of the case studies, it is fair to say that the capital
statement analysis is able to detect under-reported income. But the capital statement
analysis also must be reliable, well supported and defendable for proof in the court. This will
increase the capability and effectiveness of the capital statement analysis to be one of the
indirect methods in detecting tax evasion. However, there are still limitations in terms of
data availability, accessibility to information, taxpayer co-operation and the expertise of a
tax IO. Consequently, some cases cannot be settled within the stipulated period of time and
indirectly create loopholes in tax enforcement.

Conclusions and implications

The objectives of this research are mainly to examine the effectiveness of capital statements
in detecting tax evasion and determining factors that contribute to that effectiveness. Based
 IJLMA on the case studies, it can be concluded that the capital statement analysis is an effective tool
60,5 in detecting under-reported income and tax evasion. It helps the revenue authority to recover
millions that are potentially lost due to the tax-evasion activities. However, there is a
limitation in the data-gathering process that could delay the settlement of the case. The
cooperation from the taxpayer itself is the most important factor, because if the taxpayer
seems to be non-cooperative (which is always the case), the IO needs to find other people, i.e.
1108 third party, as a source of information. The weakness in the data-gathering process would
cause failure in the course of the investigation. The hidden income will remain undetected
and create loopholes in tax enforcement.
There are few implications and suggestions as a result of the findings for these cases.
First, the data warehousing needs to be strengthened and updated. To improve the
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effectiveness of capital statement analysis, there should be an efficient data-gathering

process. The data warehouse should continuously update the latest information. One good
example is the market prices of the property, historical share price and dividend payment of
public listed companies. Much time can be saved if the revenue authorities have all the
information needed rather than depend on answers from relevant organisations.
Second, the IO should continuously improve his or her skills and knowledge via utilizing
advanced techniques for tax investigation to combat more complex tax fraud transactions.
Tax-evasion activities have quickly evolved, become more globalized and changed through
various means. Mutual training with other tax regulators agencies in other countries should
be held regularly and effectively. In addition, the experience on the settlement of tax evasion
problems can be shared. Indirectly, it will improve the quality of settlement of tax
investigation cases.
Third, expertise in technology should be increased. Nowadays, taxpayer information is
stored in digital media. Expertise in information technology is part and parcel in the
investigation process. Data could be hidden or deleted by the taxpayer. Competency is
needed to track the trail and recover the information. The IO needs to be aware with the
latest changes in information technologies. The investigation team should be equipped with
the relevant tools and gadgets in digital forensic investigation. For example, Jin and Lee
(2014) found that introduction of inspection technology such as handheld electronic devices
led to more than 10 per cent higher detected violations in inspection outcomes.
Fourth, joint collaboration with other government agencies will enable the investigation
cases to be settled within short periods of time. Joint investigation with financial authorities
such as central banks, capital market regulators and the police should be developed. It will
create synergy effects among regulation agencies.
Finally, the implementation on the policy of whistleblowing should be strengthened. The
informant’s identity should be treated as private and confidential. The public is encouraged to
cooperate with the revenue authority to give information on any tax-evasion activities. The
reward should be given to the informants to foster more information from the public.
Campaigns and explanations on the importance of whistle-blower policies should be held
among the community. Tax-evasion activities should be reported and deterred at the
community level. Tax evaders have enjoyed the benefits of others who are paying taxes. Hence,
the public must be aware of any tax-evasion activities.

Limitations and suggestions for future research

This study suffers from several limitations that can be improved in future research. First, the
research only focuses on five cases of actual tax investigation. In the future, more cases should
be included to obtain more accurate and robust results. Second, the study also only discusses
certain issues that are covered in the case study. For future research, the data could be analysed
 via advanced statistical analysis package to obtain more robust findings of the study. Finally, Capital
the cases are selected from only one particular area in the main capital city of Malaysia, namely, statement
Klang Valley. Thus, the findings may not be generalized and reflected to other taxpayer
investigation locations in less-developed and rural areas in which the tax-evasion activities
analysis
possibly differ. Future research can be conducted and compared whether there are any
significant differences between tax evasion committed by taxpayers located in different
demographic profiles.
1109
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About the authors

Anuar Nawawi is a Lecturer at the Faculty of Accountancy, Universiti Teknologi MARA, Malaysia.
He received his PhD in Commerce (Accounting) from the University of Adelaide, South Australia. He
also holds a professional qualification of the Chartered Institute of Management Accountants (Passed
Finalist), is an affiliate Registered Financial Planner and has a Master of Accounting (with
distinction) from Curtin University of Technology, Western Australia. He has taught a variety of
courses centred on the accountancy discipline. Among them are financial accounting, auditing,
management accounting, taxation, financial management, strategic management, computerized
accounting and research methodology. His research interests are diverse, including areas such as
management accounting, strategic management, forensic accounting, corporate governance and
ethics.
Ahmad Saiful Azlin Puteh Salin is a Senior Lecturer at the Faculty of Accountancy, Universiti
Teknologi MARA (UiTM) Perak. He received his PhD in Corporate Governance and Ethics from
Edith Cowan University, Australia. He is also a Fellow Member of the Association of Chartered
Certified Accountants United Kingdom (ACCA, UK), a Full Member of the Malaysian Institute of
Accountants (MIA) and a Member of the Malaysian Insurance Institute (MII) and Qualitative
Research Association of Malaysia (QRAM). He has taught a variety of courses in corporate
governance, business ethics, taxation, financial accounting and reporting, management accounting,
costing and integrated case study. His research interests focus primarily in the field of governance,
Islamic and business ethics, financial reporting, management, accounting education, small–medium
enterprises (SMEs) and public sector accounting. He has published many articles in local and
international journals and was appointed as reviewer in several international journals and
conferences. Ahmad Saiful Azlin Puteh Salin is the corresponding author and can be contacted at:
ahmad577@perak.uitm.edu.my

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