Objective assessment: actual profits vs estimated net income

Historical consultation based on the rules and DGT rulings cited below (2007–2008).

The objective assessment method is a flat-rate method, and the net income calculated under it may differ significantly from the actual net income earned by the business. The tax legislation therefore introduced a rule under which capital gains arising from differences between the activity’s actual income and the income resulting from the correct application of the method are not taxed.

Where a taxpayer determining net income from an economic activity under objective assessment realizes capital gains that cannot be explained by the income reported for tax purposes, those unexplained gains are not taxed if they result from the difference between the activity’s actual income and the income resulting from the correct application of objective assessment.

This rule should be interpreted to mean that unexplained capital gains realized by a taxpayer under objective assessment are not taxable when they can be justified by the actual income from the activity. In other words, the taxpayer must prove, using any evidence admissible in law, that the actual income from the activity exceeds the income declared for tax purposes under the correct application of objective assessment. If the actual profits from the activity cannot be substantiated, the capital gain is not exempt from tax and must be taxed as an unexplained capital gain.

Accordingly, in the case described, the taxpayer must be taxed on the net income calculated under objective assessment for the two economic activities carried on.

If the taxpayer’s assets have increased by an amount that cannot be explained by the income reported for tax purposes, that gain is not taxable where the taxpayer can sufficiently prove that it derives from the difference between the activity’s actual income and the income calculated under objective assessment. If this cannot be proved, the unexplained increase in assets is taxed as an unexplained capital gain.