Tax Supervision and Customs Control

Tax Supervision and Customs Control Every year the Tax Agency lays out a new Annual Objectives Plan, which is a basic statement, in figure form, of the results the Agency proposes to reach during the year, classified by activity areas. The actions required to achieve the stated objectives are specified each year in the General Tax Control Plan. The planned control activities for 2003 are broken down into three basic strategic lines: First of all, supervisory and control efforts are focused on those areas at the highest risk for tax and customs fraud, in both qualitative and quantitative terms. Secondly, the intensive use of new technologies applied to tax control incorporates modern risk analysis tools for selecting taxpayers and computer programs to support verification and collection efforts. Thirdly, heavy emphasis is placed on collaborations with other domestic and international institutions. The Resolution of 15 January 2003 of the Directorate General of the Tax Agency approved the general guidelines of the General Tax Control Plan for 2003, designed to coordinate the control activities of the different Tax Agency departments. The Tax Agency constantly endeavours to improve the quality of its actions. Along with the Objectives Plan, the Agency also has a Special Quality Programme that deals with different activities including prevention, integration of functional areas and cooperation with other public administrations. This last type of work is especially vital for getting under the surface of the quality issue and making real, deepreaching improvement there. The most relevant actions in 2003 were as follows: Collaborative efforts with other public administrations in Spain and abroad were intensified with regard to tax and customs control activities. These efforts included automatic information-sharing and cooperation on multilateral or bilateral verification and investigation actions, particularly with regard to intra-community VAT. One of the most innovative aspects of the 2003 Control Plan had to do with making the collaboration between the Tax Agency and Autonomous Tax Administrations a reality, by delimiting the areas of tax risk and fostering the exchange of information as established in Law 21/2001 of 21 December. This chapter discusses the control activities of the Tax Agency in 2003: - Mass checks triggered by the various annual tax seasons, which were basically supported by the information available in tax databases. - Selective checks on taxpayers who are tagged on the basis of objective criteria as posing more of a risk of tax evasion. - Activities aimed at collecting tax credits and other credits that debtors have not paid to the public sector during voluntary compliance periods. Supervision by the Tax Management Department 1. Census Overhaul In the year 2003, the Agency embarked on the task of overhauling the census of business owners, professionals and withholders in two different campaigns: - Comprehensive census overhaul, incorporating new criteria needed to respond to recent legislative amendments. - Overhaul of the Companies Index and notices to non-filers of corporate income tax 81

returns. 56,772 letters were sent out in connection with this campaign. 2. Examination of Annual Tax returns 2.1 Personal Income Tax As in fiscal years past, the Tax Management Department s personal income tax examination campaign took place in two sharply differentiated phases. The first phase involved the mass verification of tax returns to detect data errors and discrepancies compared to the information on file in the Tax Agency's databases. The extensive application of article 84 of Act 40/1998 of 9 December on Personal Income Tax and Other Tax Rules and article 123 of Act 230/1963 (the State Tax Act) allows management offices to include in the declared taxable base any omitted income whose existence is known to the Administration, whether it gained knowledge of that income from tax returns made out by the taxpayer or tax returns made out by third parties, and for any tax. By exercising this power plus its power to correct mistakes in arithmetic and incorrect applications of the rules, the Department prepared a large number of provisional assessments. The first phase of the 2003 income tax season resulted in the issue of 552,046 provisional settlements in the amount of 374,053 million euros by 15 March 2004. During the initial massive verification phase, the tax returns are sorted using a series of filters established by the Management Department which can be grouped as follows: 1. Arithmetic- to control possible arithmetic errors in the data contained on the tax return. 2. Pseudo-assessment.- Detects discrepancies between the data contained on the tax return and the information from informative declarations. 3. Proposed assessments based on limits or amounts Certain items on the tax return are checked to make sure that they do not exceed certain limits or amounts. The following table shows a breakdown of the global results based on the origin of the settlements: parallel arithmetic, pseudoassessment, assessment proposal. 82

TABLE No 37 2001 PERSONAL INCOME TAX (PHASE ONE) NUMBER OF ASSESSMENTS % AMOUNT % AVERAGE AMOUNT* Assessments correcting arithmetic 31.580 5,72 14,523 3,88 459,88 mistakes Pseudoassessments correcting 246.079 44,58 161,779 43,25 657,43 discrepancies Proposed Assessments 274.387 49,70 197,751 52,87 720,70 TOTAL 552.046 100,00 374,053 100,00 677,58 Data as of 15 March 2004 * Given in euros Source: Tax Management Department. The effectiveness of the assessments originating from assessment proposals is noteworthy, since 49.70% of the total assessments account for 52.87% of the total effectiveness, which represents more than half of the total amount obtained from the assessments issued. In the second-phase examination of filing taxpayers, the Department performed 34,727 assessments worth 32.037 million euros. The overall results of the 2001 income tax examination campaign as of 15 March 2004 added up to 406.09 million euros and affected 586,773 taxpayers, as seen on the following table. TABLE No 38 2001 PERSONAL INCOME TAX EXAMINATION (PHASES ONE AND TWO) Provisional assessments on tax returns filed NUMBER AMOUNT 552.046 374,053 2nd phase (including filers and non-filers) 34.727 32,037 TOTAL 586.773 406,09 Data as of 15 March 2004 Source: Tax Management Department. 83

In a comparison of the result of the most recent income tax seasons, a considerable increase is observed in the number and amount of the assessments, due to the fact that the procedure for verifying income tax returns has been consolidated using the info-class application filters and the application of new personal income tax regulations. 2.2 Corporate Income Tax and Value Added Tax In the 2002 value added tax campaign, the Department made 81,934 provisional assessments worth an overall total of 398.671 million euros. These data, however, are not yet definitive, because the campaign will not end until sometime in 2004. In numerical terms, 18,181 assessments were made for 2001 corporate income tax, for an overall monetary sum of 54.78 million euros. These data do not include examinations performed by the Central and Regional Large Enterprise Management Centres attached to the Tax and Financial Auditing Department. 3. Examination of Periodic Tax returns Since there is a census list of business owners, professionals and withholders that includes, amongst other particulars, the periodic obligations incumbent upon each person or entity listed, the Agency can easily pinpoint anyone who fails to discharge their obligations by crossreferencing the census with the selfassessments that have been filed. Starting in fiscal 2002, periodic tax returns will be examined through the Self- Assessment Filing Supervision System (in Spanish, SCPA). The system has two branches of procedures, which are implemented depending on the reference level at issue. 1.- Obligations with an exact reference level, which include: - - Examination of taxpayers cleared to use the modules scheme procedure in their personal income tax. This procedure is analysed in the following section of this report. - Examination of partial payments on account toward corporate income tax. These sorts of payments are made in reference to the full tax liability payable for the last fiscal year a tax return was filed, minus deductions, withholdings and partial payments, unless the taxpayer exercises the option to make the payments based on the taxable base of the fiscal year currently under way. The following table shows the results as of 15 March 2004 of the examination of payments on account using form 202 for the third period of 2002 and the first and second periods of 2003. 84

TABLE No 39 PAYMENT ON ACCOUNT (202 FORM) LETTERS OF WARNING HEARING LETTERS PROVISIONAL ASSESSMENTS ISSUED SELF- ASSESS- MENT FILED AMOUNT PAID ISSUED SELF- ASSESS- MENT FILED AMOUNT PAID ISSUED AMOUNT SETTLED 7.140 1.168 1,924 27.101 2.765 8,796 14.000 0,705 Data as of 15 March 2004 Source: Tax Management Department. 2.- Obligations with an estimated reference level. These obligations are examined quarterly and include: a) a) A letter of notice is sent out (without requiring acknowledgement of receipt) to the taxpayers who have failed to discharge some obligation during that quarter, asking them to file the appropriate tax return. b) A notice is sent out (with acknowledgement of receipt) instructing the taxpayer to file neglected tax returns from the last fiscal year. The results of the 2003 campaign refer to the checks of the third and fourth quarters of 2002 and the first and second quarters of 2003 made through the new Self- Assessment Filing Supervision System (SCPA), as shown on the following table: TABLE No 40 VERIFICATION OF PERIODIC OBLIGATIONS -SCPA ESTIMATED REFERENCE LEVEL (3Q and 4Q - 2002 and 1Q and 2Q - 2003) Letters 369.886 Notices sent 271.908 SELF-ASSESSMENTS FILED ISSUED NUMBER AMOUNT AVERAGE AMOUNT* 63.895 22,525 352,53 55.859 105,158 1.882,56 TOTAL 641.794 119.754 127,683 1.066,21 Data as of 15 March 2004 * Given in euros Source: Tax Management Department. 85

4. Check of Modules Scheme by Modules The modules scheme procedure for personal income tax and the special simplified procedure for value added tax were regulated for fiscal 2003 by the Ministerial Order HAC/225/2003 of 11 February, modified by Order HAC/701/2003 of 27 March in order to include mussel production in the modules scheme system. Except for the inclusion of this new activity in the system, the same structure and characteristics were maintained for 2003 as in previous years, with no adjustment of the values of the different modules as occurred in 2002. Even the measures intended to palliate the effects of fluctuations in oil prices were maintained. These measures apply to farming activities and to those involving the transport of passengers and merchandise. The census of taxpayers under the module scheme has hardly changed since last fiscal year, as can be seen on the following table: TABLE No 41 CENSUS OF TAXPAYERS UNDER THE MODULE SCHEME YEAR POTENTIAL CENSUS WAIVERS PERCENTAGE 2002 2.355.731 483.460 20,52 1.872.271 2003 2.331.733 479.248 20,55 1.852.485 Data as of 15 March 2004 Source: Tax Management Department. TAXPAYERS UNDER THE MODULE SCHEME In addition to its work to maintain the census and help taxpayers who have signed up for the module scheme, the Agency also runs controls aimed at regularising these taxpayers tax situation. These controls take the form of auditing reports and provisional assessments. The results of these infringement regularisation actions are shown on the following table. TABLE No 42 MODULE CONTROL RESULTS NUMBER AMOUNT Provisional assessments 4.264 0,031 Auditing reports 34.238 48,380 TOTAL 38.502 48,411 Data as of 15 March 2004 Source: Tax Management Department. 86

Supervision by the Financial and Tax Auditing Department Following the guidelines of the General Tax Control Plan (2003), one of the main objectives of which is the development of the National Auditing Plan for fiscal 2003, and subject to the guidelines and strategies set out in the Tax Agency 2005 document, tax auditings were conducted this year by means of selective audits, primarily focused on those sectors where the greatest risk of fraudulent conduct exists. Thanks to the intensive use of new technologies, the auditing methods and techniques have been modernised and auditing quality has been improved. Thus, in 2003, the gradual implementation of the Verification Assistance Method (MAC), the consolidation of the Department's Intranet to support knowledge management (documental base, auditing procedure guide, sectorial guides, etc.). The following actions carried out by Tax Auditors in 2003 are noteworthy: in the broadest sense of the term: urban development, construction, real estate development, auxiliary industries and subcontracting. - Intensification of controls of professional activities. - Special attention to value added tax refunds. - Continuation of actions focused on unreported economic activities. - Control of certain transactions to and from countries classified as tax havens. - Continued control of companies with ties to so-called Organised Fraud Networks which commit VAT fraud. - Collaboration with the tax auditing services of different autonomous communities in relation to transferred taxes. The results obtained by Tax Auditing in its general activities in 2003 were as follows: 33,722 taxpayers were checked and 83,747 reports were made out on them (this figure includes 25,444 A51 reports for penalty proceedings), calling for payment of 2,940.78 million euros. - Special focus on the real estate sector, GRAPH VIII AUDITING RESULTS (2003) EI s - UI s: Auditing Teams ERI s - URI s: Regional Auditing Teams Source: Financial and Tax Auditing Department TAXPAYES AUDITED 9% 2% REPORTS DRAFTED 11% 3% TAX DEBT 27% 53% 89% 86% 20% EI's UI's I. CENTRALISED ERI's URI'S 87

As a result of Tax Auditing s work to get liabilities settled during the course of 2003, the paid tax liability came up to 3,510.68 million euros; of this total, 3,369.46 million are ordinary results, and the remainder (141.22 million euros) can be classified as extraordinary results. The figure is a considerable improvement over the 3,702.84 million euros paid in 2002. In addition to the activities described above, the Auditing Department worked hard in other areas to make headway in the fight against tax fraud. The biggest of these activities were basically aimed at offences against the Exchequer and other criminal acts that were reported to the Department. 1,548 cases of offences against the Exchequer were in fact forwarded to the Public Prosecutor s Office (1,015 tax offences, 14 accounting offences, 1 case of subsidy fraud and 518 cases of criminal acts) in addition to 146 cases involving other criminal conduct, altogether worth a total of 730.92 million euros. The equivalent debt represented by this quota in terms of objectives, i.e., the debt which would have materialised in auditing reports had such auditings been carried out administratively, was 1,064.02 million euros (40.73% more than in 2002). Both of these items (actual quota and equivalent debt) include the amounts corresponding to the 15 cases of tax fraud. The results of these cases represent the highest amount ever reported by the Tax Agency. There are other activities too that have made great strides in the fight against tax fraud: checks in areas such as reduction of requested refunds, the reduction of taxable bases to be compensated, adjustments in consolidated taxation, etc. These activities add up to 1,144.32 million euros that, because they are not examined debt, constitute a reduction in the tax credits declared by taxpayers. This heading includes 60.90 million euros from extraordinary results. Adding all the above figures together (settled debt, offences against the Exchequer and other criminal acts, other activities), the overall result of the Tax Auditing area in the fight against fraud comes up to 5,719.02 million euros, including 202.12 million euros in extraordinary results. If the results of the auditings carried out by the Large Enterprise Management Units are added to these, the overall results amount to 6,399.86 million euros, 6,098.35 million or which are ordinary results and 301.51 million are extraordinary results. The 2003 results met the stated objectives of the National Auditing Plan, making significant strides in the eradication of complex tax fraud which is characterised by the need for specialised investigation. The achievement of the Department s objectives has also been aided by extensive controls which are conducted within a relatively close period of time to the occurrence of the taxable event, thereby improving the voluntary discharge of fiscal obligations and doing more to ensure collection of the tax debt. The following graph illustrates how checks are getting closer and closer to the end of the voluntary tax return-filing period and shows how, for the 1999-2003 period, regardless of the trend in the penalty interest charged for late payment, the portion of the total amount of reported examined debt that is due to this item has a marked downward tendency. 88

GRAPH IX RELATIONSHIP BETWEEN LATE INTEREST RATE AND PERCENTAGE OF TOTAL DEBT FOR EACH FISCAL YEAR (1999-2003) 7,00% 6,50% 6,00% 5,50% 5,00% 1999 2000 2001 2002 2003 20% 15% 10% 5% 0% LATE INTEREST RATE PERCENTAGE OF TOTAL DEBT Source: Financial and Tax Auditing Department Throughout the fiscal year, emphasis was placed on coordinating auditing activities with the tax auditing services of the different autonomous communities for the taxes handled by them, thereby increasing the amount of information shared. Finally, collaborative efforts continued with other administrative and judicial departments and bodies. In terms of the year-on-year variation of overall results, not counting the results of the Large Enterprise Management Units, there was a 1.36% increase over the results obtained in 2002 (5,642.01 million euros); if extraordinary results are not factored in, the increase rises to 3,79%. If the results of the control activities of the Large Enterprise Management Units are factored in, the increase over 2002 rises to 6.8%. The tables below offer the details on the results of general activities, which culminated in proceedings for 2,940.78 million euros in tax liability, classified by organic levels and tax types. By tax item, the highest percentage of the total tax liability came from corporate income tax (48.35%) followed by value added tax (35.00%) followed at a distance by personal income tax (11.04%), personal and professional withholdings (2.93%) and withholdings on capital income (0.94%). 89

TABLE No 43 SUMMARY OF REPORTS, TAXPAYERS AND INVESTIGATED LIABILITY BY ORGANIC LEVELS, 2002/2003 GENERAL ACTIVITIES CLASSIFICATION TAXPAYERS AUDIT. REPORTS TAX LIABILITY CHECKED 2002 2003 2002 2003 2002 2003 Units 75.875 72.230 33.563 30.070 1.576,65 1.572,69 Regional Units 8.756 9.226 3.200 3.120 831,23 576,88 Total Offices 84.631 81.456 36.763 33.190 2.407,88 2.149,57 Centralised Auditing* 2.296 2.291 468 532 1.195,48 791,21 TOTAL 86.927 83.747 37.231 33.722 3.603,36 2.940,78 * This includes the National Auditing Office and the National Fraud Investigation Office Source: Financial and Tax Auditing Department TABLE No 44 TAX LIABILITY BROKEN DOWN BY TAX TYPE INVESTIGATED BY TAX AUDITORS OVERALL RESULTS (2002/2003) Percentage of Total Tax Liability Tax Liability TAX TYPE 2002 2003 2002 2003 Personal income tax 308,02 324,52 8,55% 11,04% Corporate income tax 1.375,80 1.421,89 38,18% 48,35% VAT 1.429,49 1.029,42 39,67% 35,00% Withholdings on personal and professional earnings 235,78 86,16 6,54% 2,93% Withholdings on invested capital 28,78 27,55 0,80% 0,94% Other taxes 225,49 51,24 6,26% 1,74% Total 3.603,36 2.940,78 100% 100% Source: Financial and Tax Auditing Department 1. National Auditing Office The National Auditing Office (ONI), created under article 22 of Royal Decree 2335/1983, of 4 August and attached to the Director of the Financial and Tax Auditing Department, is responsible for advising, monitoring and inspecting those taxpayers whose tax liability is such that they require special treatment in order to ensure and facilitate compliance with their tax 90

obligations. These taxpayers must meet one or more of the following requirements: a) They conduct their business in a large part of the country. b) They occupy a prominent position in a particular economic sector. c) They file their taxes on a consolidated basis. d) Their operations are particularly complex or important to the nation. e) They have ties to other taxpayers monitored by ONI. The National Auditing Office also holds the power to look into tax obligations stemming from taxable items attributable to nonresident natural or legal persons having no permanent establishment in Spain when, in respect of the said taxable items, the representative, the depositary or manager of the assets or rights or the payer of the non-resident s income is liable for taxes and has already been tagged by the National Auditing Office. At this time, the jurisdiction of the ONI includes all of Spain, with offices in Madrid (30 teams), Barcelona (13 teams), Sevilla (5 teams), Málaga, Valencia (6 teams), Zaragoza (2 teams), Palma de Mallorca, Las Palmas de Gran Canaria, La Coruña (2 teams), Santander, Oviedo, Valladolid (2 teams), Pamplona and Murcia. The ONI has a total of 67 teams with offices in thirteen Autonomous Communities. The companies are assigned to each one based on the sectors and territories in which they operate. TABLE No 45 NATIONAL AUDITING OFFICE ACTIVITIES GENERAL DEVELOPMENT (2002/2003) National Auditing Office TAXPAYERS CHECKED Source: Financial and Tax Auditing Department REPORTS DRAWN UP TAX LIABILITY (Millions of euros) 2002 2003 2002 2003 2002 2003 300 361 2.076 2.030 1.194,20 782,80 TABLE No 46 NATIONAL AUDITING OFFICE DEVELOPMENT BY TAX TYPE (2002/2003) ITEM Percentage of Total Tax Liability Tax Liability 2002 2003 2002 2003 Corporate income tax 590,62 576,61 49,46% 73,66% Withholdings on personal and professional 174,22 23,85 14,59% 3,05% earnings Withholdings on invested capital 17,17 15,82 1,44% 2,02% VAT 381,73 149,57 31,97% 19,11% Other taxes 30,46 16,95 2,55% 2,17% TOTAL 1.194,20 782,80 100% 100% Source: Financial and Tax Auditing Department 91

The Tax Agency Resolution of 17 February 1998, which modified the structure of certain services and gave tax auditing authority to the Financial and Tax Auditing Department, called for the formation of specialised teams, in addition to the rest of the National Auditing Office teams and with the same structure, in charge of conducting auditings, drafting reports and making proposals, as well as providing support to the rest of the auditing teams and units as directed by the Head of the ONI. These teams include: the International Tax Auditing Team, the Technical Assessment Team and the Coordination and Special Action Team. 2. Central Coordination Unit for Matters of Offences Against the Exchequer The aforementioned Tax Agency Resolution of 17 February 1998 created the Central Coordination Unit for Offences against the Exchequer. This Unit, which replaced the former Special Unit for the Auditing and Repression of Tax Fraud, under the direct supervision of the Department Director, assumed the responsibilities set out in part eight of the Resolution which include the following basic functions: a) It integrates the criteria to be used in matters involving offences against the Exchequer and notifies the Tax Auditorate of those criteria. b) It prepares the criteria that must be followed in the processing of potential offences against the Exchequer. c) It provides the auditing services with advice on the proceedings they are investigating if those proceedings might contain indications of offences against the Exchequer. By and large the courts have corroborated the Auditorate s judgment, as shown by their sentences. Not only has the number of sentences gone up over the years, but also most sentences find the defendant guilty. TABLE No 47 DEVELOPMENT OF THE AUDITORATE S ACTIVITIES IN PURSUIT OF FISCAL OFFENCES 2000 2001 2002 2003 Number of proceedings (1) 784 790 1.029 1.548 Number of taxpayers (2) 458 454 553 752 Defrauded liability (3) 408,42 546,94 499,39 666,20 Average liability per proceeding (4) 0,551 0,703 0,495 0,434 Average liability per taxpayer (4) 0,938 1,210 0,903 0,899 Liability amounts given in millions of euros (1) Includes number of cases of tax offence, accounting offence, subsidy fraud and in conjunction with criminal proceedings. (2) Includes number of taxpayers investigated for tax offence, accounting offence, subsidy fraud and in conjunction with criminal proceedings. (3) Includes outstanding liabilities from tax offences, accounting offences, subsidy fraud and in conjunction with criminal proceedings. (4) Cases of accounting offences not involving an actual liability amount are not taken into account (14 cases and 11 taxpayers in 2003). Source: Financial and Tax Auditing Department 92

TABLE No 48 EVOLUTION OF JUDICIAL PRONOUNCEMENTS ON TAX OFFENCES (1997/2003) 1997 1998 1999 2000 2001 2002(*) 2003 Guilty verdicts 40 61 46 35 47 51 62** Acquittals 19 12 17 11 12 4 7 Dismissals 19 23 TOTAL NUMBER OF 59 SENTENCES 73 63 46 59 74 92 These data may vary as a result of decisions handed down after the date of this. report.* Includes 13 guilty sentences and 2 acquittals corresponding to judgments issued by the courts last year, which became known after the 2002 annual report was completed. **The guilty verdicts include 1 for an accounting offense, 1 for falsification and tax offense and 1 for a tax and accounting offense. Source: Financial and Tax Auditing Department 3. Regional Auditing Units The Resolution of the Chairman of the Tax Agency of 20 March 2003 modified the resolution of 24 March 1992 on the organization and functions of the tax auditing units of the Financial and Tax Auditing Department and established a new framework for the organization and assignment of functions to territorial units. This new territorial model introduced structured modifications intended to increase tax control efficiency and effectiveness. The most important innovation was the elimination of the division of competencies between regional and provincial units, creating for the Auditing Area a single regional unit for each Special Bureau. The new territorial model has resulted in a notable increase in the number of specialised units in large enterprises and actions designed to contain particularly complex forms of fraud. Moreover, in the interest of improved decision-making efficiency and coordination, the tasks of planning and selecting taxpayers for auditing and the verification of the assessment proposals submitted by auditors are concentrated at the regional level (Technical Office). Consequently, the traditional configuration of this section of the Annual Report based on the different organizational levels (Provincial Auditing Units and Regional Auditing Units) must now be updated to differentiate between Auditing Units and Teams (IUs and ITs) and Regional Auditing Units and Teams (RIUs and RITs). In addition to those established in parts 4, 5, 6 and 7 of Number Five of the Resolution of 24 March 1992 for each one of the units involved, the Regional Auditing Units of the Special Offices of the Tax Agency are assigned the following functions in relation to the taxpayers with tax domiciles in the jurisdiction of the Special Bureau of the Tax Agency, provided that the National Auditing Office or the National Fraud Investigation Offices do not have jurisdiction there: a) Planning and supervising the actions of existing auditing services in the area of the corresponding Special Bureau of the Tax Agency. b) Directing and coordinating the activities of all of its units. c) Controlling and assuming the responsibility for meeting the stated plans and objectives in coordination with the other offices of the Special Bureau. d) Studies, reports and advice on questions under its jurisdiction as necessary. 93

e) Any other function assigned by law to the Tax Auditing services in relation to the taxpayers in its jurisdiction. The Regional Auditing Branch s duties can also cover tax obligations stemming from taxable items attributable to non-resident natural or legal persons having no permanent establishment in Spain when, in respect of the said taxable items, the representative, the depositary or manager of the assets or rights or the payer of the non-resident s income is liable for taxes and has already been tagged by the branch. The Regional Auditing Branches may be composed of the following units: - Auditing Area - Technical Office - Planning and Selection Unit - Large Enterprise Management Units Responsibilities in the Auditing Area are assigned to the following Teams and Units who perform their functions within the territorial limits of the Special Bureau of the Tax Agency to which they belong: - Regional Auditing Teams, which are primarily responsible for tax auditings involving particularly complex verification and investigation tasks. - Regional Auditing Units whose scope of action consists primarily of verifications and investigations involving individuals or entities pertaining to a particular economic sector, subsector or activity and whose revenues for any of the periods under scrutiny exceeded 6,010,121.04 euros. - Auditing Teams. These units are particularly interested in individuals performing professional activities or legal entities whose volume of operations for the fiscal years under auditing exceed 1,803,036.31 euros in the case of business activities and 180,303.63 euros for professional activities. - Auditing Units: Their scope of action focuses primarily on verification and investigation activities other than those mentioned above. Notwithstanding the fact that at the regional level the scope of action of the Auditing Teams and Units generally extends to the taxpayers whose tax domiciles fall under the jurisdiction of the Special Unit, certain teams or units may, under the circumstances described in part 4.3 of the Resolution of 20 March (offenses against the Exchequer, investigation, legal assistance, computerised auditing and international tax auditing), with the authorisation of the Director of the Financial and Tax Auditing Department, act in the jurisdiction of different Special Offices. The following tables contain data on the debt pursued by Regional Auditing Units and Teams and Auditing Units and Teams. 94

TABLE No 49 TAX LIABILITY BROKEN DOWN BY TAX TYPE PURSUED BY REGIONAL AUDITING TEAMS AND UNITS (2002/2003) Percentage of Total Tax Liability TAX TYPE Tax Liability 2002 2003 2002 2003 Personal income tax 32,88 22,47 3,96% 3,90% Corporate income tax 292,68 311,56 35,21% 54,01% VAT 328,43 180,37 39,51% 31,27% Withholdings on personal and professional 36,87 32,97 4,44% 5,72% earnings Withholdings on invested capital 3,77 9,56 0,45% 1,66% Other taxes 136,60 19,95 16,43% 3,46% TOTAL 831,23 576,88 100% 100% Source: Financial and Tax Auditing Department TABLE No 50 TAX LIABILITY BROKEN DOWN BY TAX TYPE PURSUED BY AUDITING TEAMS AND UNITS (2002/2003) Percentage of Total Tax Liability TAX TYPE Tax Liability 2002 2003 2002 2003 Personal income tax 275,03 298,84 17,44% 19,00% Corporate income tax 491,84 522,96 31,20% 33,25% VAT 719,32 699,20 45,62% 44,46% Withholdings on personal and professional 24,58 28,85 1,56% 1,83% earnings Withholdings on invested capital 7,84 2,16 0,50% 0,14% Other taxes 58,04 20,68 3,68% 1,31% TOTAL 1.576,65 1.572,69 100% 100% Source: Financial and Tax Auditing Department 4. National Fraud Investigation Office Central Liaison Office (C.L.O.) 1.- Support activities to help reach the Tax Auditorate s objectives, both in regard to auditing activity planning and in the field of examinations and direct investigation. Under this heading, the following actions are worthy of note: 1.1.- Responding to requests for information from the different auditing teams and units, either on line (SINAI application) or using other media, in order to identify the real owners of certain 95

financial assets, clarify the means of payment used in transactions or obtain documental support for certain mercantile or commercial operations. In fiscal year 2003, work began on the development of a new application (ARES) to replace and improve the current one. This new application, which is expected to be operational in 2004, runs in an Intranet environment. The following requests for information were received and processed by this Team in fiscal year 2003: a) SINAI Application - General: 27.216 b) SINAI Application - Financial Assets: 1.431 c) Other requests involving financial assets: 6 d) Number of requests from actuaries requesting press information obtained by the Team: 371 1.2.- At the international level, under the terms of double taxation accords and EC directives, the unit processed 1,403 requests for information exchanges with the tax authorities of other countries. 1.3. Also on the international front, the Central Information Squad acts as a liaison for the management of the intra-community cooperation system for supervising VAT, handling 5,243 information-sharing requests. 2.- Verification and maintenance of the VIES Census in order to remove people registered in it who do not belong there. In all, there were 7,072 actions in this regard, with a total of 1,276 eliminations from the VIES Census. 3.- Creation and development of information programmes and plans, permanent or otherwise, aimed at systematically gathering information on financial markets and assets, foreign transactions, currency trafficking, taxpayer groups, professional and employers collectives and certain sectors. The information thus obtained is screened and analysed and then subjected to selection techniques to choose candidates for tax auditing. 16 programmes were developed in 2003, 10 of which are permanent. 4.- There were 332 disciplinary proceedings for minor infractions. 5.- The following appeals were processed: - Against SINAI notices: 7 - Against financial asset notices: 1 - Against fines: 19 6.- Execution of resolutions, suspensions and reports relative to disciplinary proceedings: - Executions of appeals: 19 - TEAC executions : 10 - Suspensions lifted on appeal: 11 - REAC suspensions lifted: 10 - TEAC reports: 5 7.- Maintenance and updating of databases consisting of making additions, modifications or notes to record corrections or rectifications reported by the filing entities of the different tax forms due to errors on the forms. 8.- Participation on the Standing Committee for Administrative Cooperation (SCAC) created by Regulation 218/92, initially for the purpose of supervising the operation of the VIES system and mutual assistance on VAT matters, although it was ultimately given additional responsibilities. Also participates on the working groups set up by the committee on an ad hoc basis to address certain tax fraud issues. 9.- Participation at international meetings and seminars. Among others, a member of the Central Information Squad attended the meetings (two in 2003) of working group number 8 (GT8) of the Fiscal Affairs Committee of the OECD on tax evasion 96

and fraud along with a representative of the Directorate General of Taxation. 10.- Active participation in the Twinning Agreement between the Tax Agency and the Romanian Ministry of Finance to improve the collection system. The CIS coordinates the activities to be carried out in the area of administrative cooperation and assistance between member states on tax matters. This has required travel to Romania by some of the unit s members. The data obtained in the development of information plans and programmes is summarized on the following table: TABLE No 51 CENTRAL LIAISON OFFICE ACTIVITIES. DATA OBTAINED IN AUDITING SUPPORT INFORMATION 2003 A) Total number of data as of 31/12/03: 189.654.638* B) Breakdown by gathering body: - Central Information Squad 189.613.522 - Agency offices 41.116 C) Comparison with years before 1997 1998 1999 2000 2001 2002 2003 (*) C.L.O. 21.095.413 28.277.964 63.003.555 14.497.633 13.927.417 10.900.233 189.613.522 Agency Offices 153.641 415.647 218.518 116.822 46.702 716.524 41.116 TOTAL 21.249.054 28.693.611 63.222.073 14.614.455 13.974.119 11.616.757 189.654.638 (*) Almost all of the data are obtained on magnetic support. The considerable increase in data in 2003 is basically due to the information received from banks about undeclared accounts on model 196. Source: Financial and Tax Auditing Department Tax Fraud Study Group. The principal studies and investigation projects carried out in 2003 were as follows: 1.- Internet and e-commerce The work that began years ago and which consists of studying, gathering and systematizing information on the sector continued in 2003. As a result of this work, cases exhibiting an apparently elevated risk of non-compliance were discovered and reported to the Special Units affected. 2.- Risk analysis Progress was made during the first quarter of 2003 on the new system for estimating the risk of tax evasion based on neuronal networks, with the development of the first pilot test. Efforts also continued to improve the control of VAT and to develop a system of neuronal networks for selection in the real estate sector. 3.- Non-resident accounts. Preparation of a report containing the results of the investigations carried out on the subject: financial and tax regulation, existing information and work in progress, 97

analysis of the fiscally-significant results obtained and conclusions and outlook for the future. The following reports, investigations and studies were also conducted: - Report on the operation of the prepaid telephone card sector. - Significant investments in second hand real estate prior to the introduction of the euro. - Preparation of statistical tables on sectorial economic activity adjusted to the needs of the National Auditing Plan. - Study of the fiscal conduct of taxpayers following an auditing. - Studies of the sector composed of clinics specialising in cosmetic surgery. - Actions to obtain information relative to special urban development activities. - Project regarding negative yields on capital investments of a significant quantity. - Project regarding the fraud induced by the module scheme. - Appraisals of second hand vehicles and boats valid for 2004. Control Methods and Procedures Team. Throughout 2003, the activities focused on a number of projects relative to Working Methods and Procedures: 1.- Verification Assistance Method (MAC) This tool has been active on the Tax Agency s Intranet since the middle of 2002. MAC is an application designed to systematise the most common tests of an auditing case, to encourage the most efficient use of the information existing in the databases and facilitate the assignment of tasks among teams or units. Some of the other reasons for developing MAC include: innovating working methods and instruments; extending the ability to work directly with the computerised accounting files of companies and introducing instruments to evaluate work quality. The main objectives for 2003 in relation to the Verification Assistance Method were as follows: - Extending the use of the application. In this regard, while in 2002 there were 241 users and 562 files created, in 2003 there were 719 users and 2,809 files created. - Completing MAC training through scheduled training courses. - Maintaining and updating the application. - Introducing new utilities and tools and continuously improving existing ones. - Initiating sectorial developments for MAC by creating work groups. - Evaluating MAC future-oriented design. 2.- Preparation of an "Auditing Procedure Manual. The Methods and Procedures Team is drafting the manual and the corresponding computer application; work is expected to begin in the near future to incorporate the suggestions, upgrades and improvements proposed by users. The document incorporates and standardises the most commonly used forms in auditing proceedings and includes a section containing all of the legislation affecting tax auditing proceedings. It also includes the main circulars, resolutions and instructions affecting tax auditing proceedings as well as some of the manuals and reports issued by the Financial and Tax Auditing Department. Central Investigation Teams. For 2003, the most notable activities of these teams can be divided into the following groups: 1. Actions related to the coordination and fight against organised fraud schemes. 98

1.1.- In the field of prevention and early detection of fraud, there were investigations to detect what are known as "missing traders in certain sectors which occasionally culminated with the withdrawal of the Intra-Community Operator Number; moreover, the administrative assistance provided to other EC countries resulted in more than 200 cases of information supplied to other countries. 1.2.- In the field of coordinating direct actions in the fight against fraud, the teams focused their efforts primarily in the precious metals (gold), automotive, computer, metal and scrap metal sectors. The actions here focused on controlling interposed companies and fronts and also what are known as "carousel procedures. Thanks to the work done in this area, coordinated by the National Fraud Auditing Office, approximately 325 million euros of tax liabilities were uncovered. 2. Work in the financial markets sector which consisted of coordinating and supporting the work of the auditing units and teams in their efforts to check on taxpayers who generate losses in operations in the derivatives market and analyses of collective investment institutions. Finally, throughout 2003 the Central Investigation Teams of the National Fraud Auditing Office audited and investigated the taxpayers assigned to them. 5. Large Enterprise Management Units Since the Tax Agency Chairman s Resolution of 16 December 1994, supervising large enterprises is the responsibility of the Central Large Enterprise Management Unit and the Regional Large Enterprise Management Units, which operate under the Financial and Tax Auditing Department. The Central Large Enterprise Management Unit focuses its activities on the controls corresponding to the Large Enterprise Census, which is subject to auditing by the National Auditing Office; the Regional Large Enterprise Management Units are responsible for performing tax management functions on taxpayers who meet any of the following circumstances and do not fall under the jurisdiction of the National Auditing Office: - Those whose business volumes were in excess of 6,010,121.04 the year before; - As ordered by the Special Delegate for any of the reasons listed in part 7.b) of the Resolution of 20 March 2003 of the Chairman of the Tax Agency. The development of the census of taxpayers (tax roll) monitored by Large Enterprise Management Units is as follows: TABLE No 52 TAXPAYER CENSUS 2002 2003 % 03/02 Central Large Enterprise Management Unit 2.105 2.269 7,8% Regional Large Enterprise Management Units 23.561 25.446 8,0% TOTAL 25.666 27.715 8,0% Source: Financial and Tax Auditing Department 99

During 2004 the Large Enterprise Units continued to introduce monthly electronic tax returns; the number of those filed rose to 743,335 at Regional Units as a group and 48,707 at the Central Unit. The scope of control of these units is reflected in Table 52: which provides information on the tax revenues from Large Enterprises from corporate income tax, VAT, capital withholdings and personal earnings withholdings as well as the percentages which these revenues represent compared to the total. Tax refunds in the amount of 12,874 million euros were also processed, which represents approximately 43% of the total amount of all refunds paid out by the Agency. The results of the Management Control of Large Enterprises in 2004 are as follows: - Assessments generated in the amount of 161.04 million euros. - Decreases in refunds, negative tax bases and compensations requested amounted to 408.81 million euros. - Self-assessments filed after receiving notices of non-compliance with tax obligations amounted to 110.99 million euros. The table below contains a comparative summary with the year before: TABLE No 53 RESULTS OF LARGE ENTERPRISE MANAGEMENT CONTROL ITEM 2002 2003 DIFFERENCE Liability settled 127,81 161,04 26,0% Remission of refunds, compensations and negative taxable bases 229,14 408,81 78,4% Self-assessments in response to notice 37,63 110,99 195,0% TOTAL 394,58 680,84 72,5% Source: Financial and Tax Auditing Department The data contained on the table above show a 72.54% improvement over the Control in the Customs and Excise Area Fraud Control and the Fight Against Fraud 1. Auditing Area Activities The functions inherent to Customs and Excise Tax Auditing are performed by the following bodies: a) By the National Auditing Office on a nation-wide basis. previous year's results. b) By the Regional Customs and Excise Tax Units in peripheral areas and within the territorial limits of each Special Bureau of the Tax Agency. Auditing services stick to the orientation provided by the Tax Agency s General Plan on Supervision, which includes the Customs and Excise Partial Supervision Plan and the National Customs and Excise Auditing Plan. On the basis of the National Information and Investigation Office s investigations, their own investigations, the experience of 100

past years and their experience in computerised risk analysis, the Customs and Excise Tax Auditing Services checked a total of 3,404 taxpayers in 2003, concluding a total of 5,236 reports whose total examined debt came up to 263.42 million euros, distributed by services as shown in TABLE No 54. TABLE No 54 ACTIVITIES PERFORMED BY THE CUSTOMS AND EXCISE AREA S AUDITING SERVICES NUMBER OF REPORTS NUMBER OF TAXPAYERS CHECKED EXAMINED DEBT 2.002 2.003 % 03/02 2.002 2.003 % 03/02 2.002 2.003 % 03/02 Regional Auditing 5.396 4.966-7,97 3.574 3.150-11,86 214,29 205,81-3,96 Units National Auditing 302 270-10,60 299 254-15,05 60,58 57,61-4,91 Office TOTAL 5.698 5.236-8,11 3.873 3.404-12,11 274,87 263,42-4,16 Source: Customs and Excise Department In fiscal year 2003, the results obtained from supervisory activities were somewhat lower than the year before. The examined debt was 4.16% lower and the number of reports fell by 8.11%. The drop is due to the reduction in the number of auditors assigned to investigation and verification activities and an increase in intervention actions which are also handled by auditing personnel. However, the ratio of examined debt has improved as regards both the number of reports issued and the number of taxpayers audited. This improvement is due to the fact that the Department s investigation services have become more specialised. As a result of this, the taxpayers selected for auditing are those in sectors at highest risk for tax evasion and the quality of the auditings has improved, aided by the use of standard MACA information sources. When the examined debt is considered by tax type, there is a 21.51% reduction in VAT. However, if the 50.988 million euros corresponding to the regularisation of VAT on imports caused by an irregularity that is not likely to be repeated were deducted from the total examined debt, the 2003 results would be 17,66% higher than those of the year before. As part of the Partial Customs and Excise Auditing Plan for 2003, priority was placed on foreign trade, excise tax on hydrocarbons and excise tax on certain means of transport, all of which improved the results of these programmes. The results of foreign trade auditings do not affect EU resources only (which were down by 2.11%), but also the results of all other taxes in the case of imported goods. The debt examined in relation to excise tax on hydrocarbons increased by 9.31%. Particularly significant is the variation in absolute terms of the excise tax on certain means of transport, with an increase of 29.955 million euros as a result of efforts to detect organised schemes to evade the payment of this tax. These organised schemes operate by bringing luxury vehicles into Spain from EU countries and declaring customs values that are much lower than the market price, which results in 101

a significant reduction in the tax revenues collected. Finally, it should be noted the revenues from excise tax on tobacco products increased by 238.11%, thanks to the detection of irregularities in shipments to third party countries and to losses and differences in movement. TABLE No 55 EXAMINED DEBT BY TAX TYPE (figures given in millions of euros) 2002 2003 DEBT TAX TYPE Regional Auditing Units National Auditing Office TOTAL Regional Auditing Units National Auditing Office TOTAL % 03/02 VAT 84,416 39,586 124,002 48,242 49,086 97,328-21,51 Excise on beer 0,305 0,004 0,309 0,073 0,023 0,096-68,96 Excise on alc. and bev. derived from alcohol 39,203 3,230 42,433 12,495 1,188 13,683-67,75 Excise on hydrocarbons 26,991 8,724 35,715 36,167 2,873 39,041 9,31 Retail sales 0,145 0,145 Excise on tobacco products 0,243 0,418 0,661 2,219 0,016 2,235 238,11 Excise on transport 44,303 0,017 44,320 74,275 74,275 67,59 Excise on int. products 2,732 0,000 2,732 0,310 0,310-88,66 Excise on electricity 5,692 0,238 5,930 16,646 0,225 16,872 184,51 E.U. own resources 8,551 8,301 16,852 12,991 3,505 16,496-2,11 Late interest 0,003 0,009 0,012 0,111 0,212 0,323 2595,71 Tax penalties 1,846 0,055 1,901 2,134 0,477 2,612 37,38 TOTAL 214,285 60,582 274,867 205,808 57,607 263,414-4,17 Source: Customs and Excise Department The Customs and Excise Tax Auditing Services investigative work in the year 2003 uncovered some fraudulent activities that were considered legal offences because of their monetary worth and willful intent to deceive. The services filed 37 reports of offences (involving 69.917 million euros) with the Public Prosecutor s Office, a decrease of 9.083 million euros compared to the year before. This difference is due to the smuggling crimes reported by auditing services. In 2002 there were four reports of this kind valued at 9.007 million euros, while in 2003 there was only one valued at 0.334 million euros. In this regard it should be noted that smuggling crimes, because of their special characteristics, are not normally reported by tax auditing services. 102