Income tax

INCOME TAX

Presented by:

LILYBETH A. GANER, CPA, MBARevenue OfficerRR-19, Davao City

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Business Income Any income not related to an

employer-employee relationship Generally taxable on the net income Includes gains, profits and income in

whatever form derived from any source, legal or illegal, such as – Exercise of profession or vocation Trade, business or commerce Dealings in property Fruits of the ownership or use of

property Interest, rent, dividends, securities Other transactions of the business for

gain or profit 2

Gross income All income from whatever source

derived, including but not limited to the following items: Compensation for services, including

fees, commissions and similar items Gross income derived from business

or exercise of profession Gains from dealings in property Interest Rents

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Gross income (cont.) Royalties Dividends Annuities Prizes and winnings Pensions Partner’s distributive share in

the net income of general professional partnership

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Net Income The realized gross profit after deducting all

the deductions allowed by law, statutes or generally accepted accounting principles.

Exclusions The total benefits which is not included in

the computation of gross income for the purpose of determining taxable income.

Deductions Items or amounts which the law allows to be

deducted from gross income to arrive at the taxable income.

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Allowable Deductions There shall be allowed as deduction

from gross income, other than compensation income, expenses incurred in the conduct of trade or business to arrive at the net income.

At the taxpayers option, deductions for expenses may either be— Itemized deduction Optional Standard Deduction (OSD) –

40%6

Requisites for Deductibility of Expenses Ordinary and necessary Paid or incurred within the taxable

year Incurred in the conduct of trade or

business Not contrary to law, morals, public

policy or public order Substantiated by sufficient proof Subjected to withholding tax, if

applicable7

Itemized Deduction1. Ordinary and necessary trade,

business or professional expenses Salaries & wages Travel expenses Rental expenses Entertainment, amusement and

recreation expenses2. Interest3. Taxes

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Itemized Deduction (cont.)4. Losses

Net Operating Loss Carry Over (NOLCO)

Capital losses Losses from wash sales of stocks

or securities Wagering losses Abandonment losses

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Itemized Deduction (cont.)5. Bad debts6. Depreciation7. Depletion of oil and gas wells

and mines8. Charitable and other

contributions9. Research and development10.Pension trusts

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InterestThere must be a valid and existing indebtedness;

The indebtedness must be that of the taxpayer;

The interest must be legally due and stipulated in writing;

The interest expense must be paid or incurred during the taxable year;

The indebtedness must be connected with the taxpayer's trade, business or exercise of profession;

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Interest The interest payment arrangement must

not be between related taxpayers. The interest is not expressly

disallowed by law to be deducted from the taxpayer’s gross income (e.g., interest on indebtedness to finance petroleum operations); and

The amount of interest deducted from gross income does not exceed the limit set forth in the law.

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Interest Limitation

The amount of interest expense paid or incurred from an existing indebtedness shall be reduced by an amount equivalent the following percentages of the interest income earned during the year which had been subjected to final withholding taxJan. 1998 - 41%Jan. 1999 - 39%Jan. 2000 - 38%Nov 2005 - 42%Jan. 2009 - 33%

Applies regardless of the date the interest bearing loan and the date when the investment was made for as long as, during the taxable year there is an interest expense incurred and an interest income earned.

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EXCEPTIONS• Deductible in full from gross income

Interest on unpaid taxes – interest paid or incurred on all unpaid business-related taxes shall be deductible in full

• Not deductible from gross income

a. Interest incurred on indebtedness of taxpayer using cash basis,

where the interest is paid in advance thru discount or otherwise

i. Allowed as a deduction in the year the indebtedness was paid

ii. If amortized – amount corresponding to the principal

amortized shall be allowed as deduction during the year

Interest

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• Not deductible from gross income

b. Interest payments between related parties as

specified in Sec. 36(B) of the Tax Code

c. Interest expense paid or incurred by Service Contractor engaged in the discovery or production of indigenous petroleum in the Phil.

d. Interest incurred on capital expenditures (optional)• Interest expense• Capital expenditure

Interest

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RELATED PARTY TRANSACTIONS RELATED PARTY TRANSACTIONS [Sec. 36(B)]

• Between members of the same family• Between a corporation and an individual who owns more than 50% of the outstanding stock of the former• Between 2 corporations more than 50% of the outstanding stock were owned by the same individual• Between grantor and fiduciary of any trust• Between 2 fiduciaries of trust if the same person is the grantor of each trust• Between fiduciary and beneficiary of the same trust

Interest

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Taxes All business related taxes Non-deductible taxes

Income tax paid in the Phils. Income tax imposed by authority of foreign

country – tax credit with limitation Estate and donor’s taxes Tax assessment which increases the value of

the property assessed Electric energy consumption tax under B.P.

36 VAT

Tax credits Taxes paid in foreign countries subject to

limitation18

Taxes Interest or surcharge imposed on taxes are not deductible as taxes, but as an item of interest.

Only the person upon whom taxes are imposed may claim them as deduction, except: (1) Taxes upon an individual upon his interest as shareholder of corporation which are paid by corporation without reimbursement; and (2) Corporate bonds or other obligations containing a tax-free covenant clause, the corporation paying the tax or any part of it for someone else (Sec. 80, RR 2).

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TaxesRefund of tax payment

Taxes refunded shall be included in the year of receipt to the extent of the income tax benefit of such deduction (tax benefit rule)

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TaxesDisclosure requirement on taxes (Notes to FS) RR 15-2010 The notes of f/s shall include info on taxes, duties and license fees paid or accrued during the taxable yearThe amount of VAT Output tax and the account title and amount/s upon which the same was based,

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Losses Requisites for deductibility

Incurred in trade, business or profession Not compensated by insurance or other form of

indemnity In case of property, for losses arising from

fire, storm, shipwreck, other casualty, robbery, theft, embezzlement, the property must be used in trade, business or profession and reported within forty-five (45) days from date of occurrence of such loss.

Not claimed as deduction for estate tax purposes

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Net Operating Loss Carry-over (NOLCO) RR 14-2001

Net operating loss - means the excess of allowable deduction over gross income of the business in a taxable year

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Bad Debts Requisites for valid deduction

There must be an existing indebtedness due to the taxpayer

It must be valid and legally demandable It must be connected with the taxpayer’s

trade, business or practice of profession It must not be sustained in a transaction

entered into between related parties It must be actually charged off from the

books of accounts as of the end of the taxable year

It must be ascertained to be worthless and uncollectible as of the end of the year 24

Depreciation A reasonable allowance/reduction in

service value for the exhaustion, wear and tear of property used in trade, business or practice of profession.

Methods of depreciation Straight line method Declining balance method Sum of the year’s digit method Any other method which may be prescribed

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DepreciationRequirements for deductibility

The allowance for depreciation must be reasonable;

It must be for property arising out of its use in the trade or business, or out of its not being used temporarily during the year; and

It must be charged off during the taxable year from the taxpayer’s books of accounts.

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Charitable and other Contributions Donations with limited deductibility

For the use of government exclusively for public purpose

To accredited domestic corporation or association organized and operated exclusively for religious, charitable, scientific, youth and sports development, cultural or educational purposes

For the rehabilitation of veterans For social welfare institutions To non-government organization

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Charitable and other Contributions Rate of deduction

Individual donor - 10% of net income before deducting donations

Corporate donor - 5% of net income before deducting donations

OR

Actual contribution/donation

WHICHEVER IS LOWER28

Charitable and other Contributions Donations deductible in full

Donations to the government exclusively to finance or to be used in undertaking priority activities in education, health, youth and sports development, human settlements, science and culture and in economic development according to the National Priority Plan determined by NEDA.

Donations to foreign institution or international organizations

Donations to accredited non-government organizations

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Entertainment, Amusement & Recreational (EAR) Expenses Includes representation expense

and/or depreciation or rental expense relating to entertainment facilities.

Representation expense shall refer to expenses incurred in entertaining, providing amusement and recreation to, or meeting with guest or guests at dining place, place of amusement, country club, theater, concert, play, sporting event and similar events or places.

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Expenses NOT considered EAR Expenses treated as compensation or fringe benefits Expense for charitable or fund raising events Expense for bonafide business meeting of

stockholders, partners or directors Expenses for attending or sponsoring employee to a

business league or professional organization meeting Expenses for events organized for promotion

marketing and advertising including concerts, conferences, seminars, workshops, convention, and other similar event.

Other expense of similar nature

Entertainment, Amusement & Recreational (EAR) Expenses

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Entertainment, Amusement & Recreational (EAR) Expenses The taxpayer should maintain receipts

and adequate records that indicate the The amount of expense Date and place of expense Purpose of expense Professional or business relationship

of expense Name of person and company entertained

with contact details

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Requirements for deductibility Paid or incurred during the taxable year Business connected Not contrary to law, morals, good customs, public policy or public order Does not constitute a bribe, kickback or other similar payment Duly substantiated by adequate proof Subjected to withholding tax, if applicable

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Imposition of Ceiling [Sec. 34(A)(1)(a)(iv) of NIRC) & RR 10-2001]

Actual entertainment, amusement and recreation expense

OR

.5% of net sales for sellers of goods and properties 1% of net revenues for sellers of services

WHICHEVER IS LOWER

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TAXPAYER ENGAGED IN BOTH TAXPAYER ENGAGED IN BOTH SALE OF GOODS AND SERVICESSALE OF GOODS AND SERVICES

Allowable EAR expense shall be determined based on apportionment formula –

Percentage of net sales/net revenue to the total net sales/net revenue multiplied by the actual EAR expense

Net sales/net revenue x Actual expense

Total net sales/revenue

Note: In no case shall the total EAR exceed the maximum percentage ceiling

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Illustration:ERA Corporation is engaged in the sale of goods and services with net sales/net revenue of P200,000 and P100,000 respectively. The actual EAR for the year 2010 totaled P3,000

Computation:*Apportionment formula

Sale of goods (P200,000/P300,000) x P3,000 = P2,000Sale of service (P100,000/300,000) x P3,000 = P1,000

**Maximum percentage ceiling

Sale of goods P200,000 x 0.50% = P1,000Sale of service P100,000 x 1% = P1,000

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Net sales/ net

revenue

EAR expense based on apportionm

ent formula*

Maximum percenta

ge ceiling of EAR**

Allowable amount to

be claimed as EAR

(w/c ever is lower)

Sale of goods

P200,000 P2,000 P1,000 P1,000

Sale of services

P100,000 P1,000 P1,000 P1,000

Total P300,000 P3,000 P2,000 P2,000

Computation:

ERA Corporation can only claim a total of P2,000 as EAR37

In lieu of the itemized deductions enumerated under Sec. 34(A) to (J) and (M) and Sec. 37 of the Tax Code and other special laws (if applicable) .

Optional Standard Deduction

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Optional Standard Deduction Individuals

Resident citizen Non-resident citizen Resident Alien Taxable estates and trusts

Corporations (subject to normal income tax rate) Domestic corporation Resident foreign corporation

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Optional Standard DeductionIndividual Corporation

Rate 40% of gross sales/revenues

40% Gross income

Tax Base Excluding passive income subject to final withholding tax

Excluding passive income subject to final withholding tax

Cost of sales/services

Not allowed to deduct COS/services

Allowed to deduct COS/services

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Disclosure of election to use the OSD (RMC 16-2010) Taxpayers availing of the OSD are

required to check the appropriate box in the ITR for the first quarter of the taxable year 2009.

Failure to indicate the election to avail of the OSD shall be considered as having availed of the itemized deduction.


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Disclosure of election to use the OSD (RMC 16-2010) The same type of deduction must be

consistently applied for all the succeeding quarterly returns and in the final ITR for the taxable year.

New registrants shall disclose their election to avail OSD in their initial quarterly ITR.


44

Implication of OSD Option is irrevocable for the taxable

year for which the return is made. Any subsequent amendment of ITR filed for

the first/initial quarter shall not affect the irrevocable character of the election to avail of the OSD or itemized deduction.

Individual claiming the OSD is not required to submit financial statements but shall keep records of his gross sales/receipts


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Illustration 1Mr. Era , a retailer of goods uses the accrual method of accounting in reporting his income and expenses. For the year 2010, the following are his recorded income and expenses

Mr. Era uses the OSD as indicated on his 1st quarter ITR. Compute for the allowable deductions for each of the quarters of 2010 and the net income for the taxable year.

Gross salesCost of sales

Operating exp

Jan-JuneJuly-SeptOct-Dec

P1,000,000700,000900,000

P600,000200,000400,000

P50,000100,000

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Computation 1

a) Allowable deductionsJan. – June July – Sept Oct -

DecGross sales P1,000,000 P700,000

P900,000Less: Cost of sales -0- - 0 -

- 0 –Gross sales/income P 1,000,000 P700,000

P900,000X OSD rate 40% 40%

40%

OSD P 400,000 P280,000 P360,000 ====== ======= =======

b) Net income for 2010

Gross sales (Jan – Dec) P2,600,000

OSD (40%) 1,040,000

Net income 1,560,000

========

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Illustration 2GSV Corporation, a retailer of goods, uses the accrual method in declaring its income and expenses. For the calendar year 2010, the following are the records of its income and expenses:

GSV Corp. uses the OSD. Compute for the quarterly allowable deductions (cost and expenses) and the net income for 2010.

Gross salesCost of sales

Operating exp

Jan-JuneJuly-SeptOct-Dec

P1,000,000700,000900,000

P700,000300,000600,000

P100,000200,000100,000

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Computation 2a) Allowable deduction

Jan – June July – Sept Oct – Dec Gross sales P1,000,000 P700,000 P900,000 Less Cost of sales 700,000 300,000 600,000 Gross income 300,000 P400,000 P300,000 X OSD rate 40% 40% 40% OSD/Operating expenses P120,000 P160,000 P120,000 Add: Cost of sales 700,000 200,000 100,000 Total deductions P820,000 P360,000 P220,000

======= ======= =======b) Net income Gross sale P2,600,000 Cost of sales 1,600,000 Gross income 1,000,000 OSD (40%) 400,000 Net income P 600,000

=======

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Taxation of Mixed Income

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It follows the compartmentalized approach for returnable income.

Personal exemptions are first deducted from compensation income.

Excess of PE over compensation income are deductible from net income from business.

Separate computation of income tax liability for husband and wife.

Only one spouse will claim additional personal exemption.

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Taxable compensation income is added to taxable income from business and the aggregate taxable income is subjected to the graduated tax rates.

Loss from business can not be offset against compensation income but can be carried over as NOLCO.

One consolidated income tax return for husband and wife.

Pay-as-you-file, but installment is allowed if tax due exceeds P2,000 [Sec. 56(A)(2)].

Taxation of Mixed Income

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Taxation of Marginal Income Earners (RR 11-00) Individuals not deriving compensation income Self-employed Deriving gross sales/receipts not exceeding

P100,000 during any 12-month period Principally earning for subsistence or

livelihood Exempt from VAT and any percentage tax Not required to pay the registration fee Required to register as taxpayer Exempt from the invoicing requirements

52

Taxation of Marginal Income Earners (RR 11-00) Exempt from maintaining books of

accounts Required to file the Annual Income Tax

Return (Form 1700) but not required to attach Financial Statements or Account Information Form to the filed ITR

May or may not be liable to tax

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Income Tax Computation

Corporate Taxpayer

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What is a What is a corporation?corporation?Corporation – is an artificial being created by law, having the rights of succession and the powers, attributes and properties authorized by law or incident to its existence.

For taxation purposes, corporation shall include – Partnerships

Joint-stock companies

Joint accounts

Associations

Insurance companies

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A corporation does not include –

•General Professional Partnership

•Joint venture or consortium formed for the purpose of undertaking construction projects or engaging in petroleum, coal, geothermal and other energy operations pursuant to an operating or consortium agreement under a service contract with the government

MINIMUM CORPORATE INCOME TAX(MCIT)RR No. 9-98, as amended by RR no. 12-07

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Sec. 27(E) and 28 (A)(2) of the NIRCImposed on:

Domestic & Resident Foreign

2% on Gross Income

if: - in the 4th year of operation - net loss/zero taxable income/ MCIT is greater than NCIT

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Gross incomeInclude all items of gross income enumerated under Section 32(A) of the Tax Code, as amended, except income exempt from income tax and income subject to final. withholding tax.

For Sale of goods

“Gross sales” Include only sales contributory to income taxable under Sec. 27(A) of the Code.

“Cost of goods sold” Include all business expenses directly incurred to produce the merchandise to bring them to their present location and use.

Gross sales – (cost of goods sold + sales returns + discounts+ allowances)

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For sale of services

“Gross Revenues” Include income from sale of services, likewise, taxable under Sec. 27(A)

“Cost of services or Direct cost of Services”Include all business expenses directly incurred or related to the gross revenue from rendition of services.

Gross revenue – (cost of services/direct cost + sales returns + discounts + allowances)

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Illustration

Gross sales/ revenues 1,000,000.00 Less: Sales Ret., Disc & Allow. 25,000.00 Cost of Goods Sold/ services 500,000.00 Gross Income from operation 475,000.00 Add: Other Income not subject to Final Tax or Capital Gains Tax 100,000.00 Total Gross Income subject to MCIT 575,000.00 ========

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• Excess of MCIT over normal income tax shall be carried forward on an annual basis and credited against the normal income tax for the 3 immediately succeeding taxable years.

• Excess MCIT can only be credited against the income tax due if the normal income tax is higher than the MCIT

Carry forward of Excess MCIT

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• Excess MCIT which has not or cannot be so credited against the normal income tax due for the 3-year period shall lose its credibility.

• Excess MCIT cannot be claimed as a credit against the MCIT itself or against any other losses


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• The final comparison between the normal income tax payable and the MCIT shall be made at the end of the taxable year.

• The payable or excess payment in the Annual Income Tax Return shall be computed taking into consideration income tax payment made at the time of filing of quarterly income tax returns whether this be MCIT or normal income tax

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Suspension of MCIT• Instances when MCIT may be suspended Substantial losses on account of –

Prolonged labor dispute Force majeure Legitimate business reverses

• Who may suspend Secretary of Finance upon recommendation of the CIR

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• Required documentation Submission of proof by the corporation Duly verified by the CIR’s duly authorized representative

Suspension of MCIT

IMPROPERLY ACCUMULATED EARNINGS TAX (IAET)

RA 8424/ RR No. 2-2001/RMC 35-2011

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CONCEPT OF IAETCONCEPT OF IAET• Taxpayer is a corporation• Improper accumulation of taxable income beyond the reasonable needs of the business

• Non-distribution of earnings/profits to stockholders

• The purpose of accumulation is to avoid the payment of the income tax

• Imposition of tax equivalent to 10% of the improperly accumulated taxable income

• The tax imposed is in the nature of penalty to a corporation for improper accumulation of earnings beyond the reasonable needs of the business

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EVIDENCE OF PURPOSE TO AVOID THE EVIDENCE OF PURPOSE TO AVOID THE TAXTAX

• The corporation is a mere holding or investment company

• Earnings or profits are permitted to accumulate beyond the reasonable needs of the business

Reasonable vs. Unreasonable Accumulation

Reasonable Needs of Business: Immediate needs of business,

including reasonably anticipated needs (Immediacy Test)

Unreasonable Accumulation Not necessary for the purpose of the

business considering all circumstances of the case

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Reasonable Needs of Business 100% of the paid up capital or the

amount contributed to the corporation representing the par value of the shares of stock, hence, any excess capital over & above the par shall be excluded (RMC 35-2011).

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Reasonable Needs of Business Earnings Reserved

for definite corporate expansion projects

for building, plant or equipment acquisition

for compliance with loan covenant or pre-existing obligation established under a legitimate business agreement.

Required by law to be retained or with legal prohibition

In case of foreign corporation subsidiaries, intended for investments within the Philippines

72

Unreasonable accumulation of Profits Investment of substantial earnings

and profits of the corporation in unrelated business or in stock or securities of unrelated business;

Investment in bonds and other long term securities; and

Accumulation of earnings in excess of 100% of paid-up capital or contribution representing the par value of the shares of stock.

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Corporation Exempt from IAET Banks and non-bank financial

intermediaries Insurance companies Publicly held corporations Taxable partnerships GPP Non-taxable joint ventures Firms registered under RA 7916,

7227, and other special ecozones74

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IMPOSITION OF IAETIMPOSITION OF IAET

Tax rate 10%

Corporations liable Closely-held domestic

corporations

Deadline 15th day after the end of he year following the

close of the taxable year

Closely-held corporations:

are corporations at least 50% in value of the outstanding capital stock or at least 50% of the total combined voting power of all classes of stocks entitled to vote is owned directly or indirectly by or for not more than 20 individuals

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TAX BASE OF IAET TAX BASE OF IAET (Improperly Accumulated Taxable Income)(Improperly Accumulated Taxable Income)

Taxable income P xxxAdd: (a)Income subject to final tax Pxxx(b)NOLCO xxx(c)Income exempt from tax xxx(d)Income excluded from gross income xxx xxxTotal P xxxLess: Income tax paid for the year xxx

Div. actually or const. paid/issued xxx xxxTotal xxxLess : Amount that can be retained xxx

IATI Pxxx ===

Payment of IAET Dividend must be declared and paid not

later than one year following the close of the taxable year

Otherwise, IAET should be paid within 15 days thereafter

Once the profit has been subjected to IAET, the same shall no longer be subjected to IAET in later years, even if not declared as dividend.

Profits subjected to IAET, when finally declared as dividends, shall be nevertheless be subject to 10% final withholding tax

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Income Tax Forms and Due Dates

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Form No.

Form Name Deadline for Filing

No. of Copies

1702 Annual Income Tax Return(For Corporations, Partnerships and Other Non-individual Taxpayers)

On or before April 15

On or before the 15th day of the 4th month following the close of the fiscal year

3 copies

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Income Tax Forms

Form No.

Form Name Deadline for Filing

No. of Copies

1702Q Quarterly Income Tax Return(For Corporations, Partnerships and Other Non-individual Taxpayers)

60 days following the close of the first 3 taxable quarters

3 copies

1704 Improperly Accumulated Earnings Tax Return

On or before the 15th day of the following year following the taxable year

3 copies

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NOTE:

Installment Payments•Applicable to individual taxpayer only and NOT TO CORPORATION

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New Income Tax Forms

Presented by:

LILYBETH A. GANERRevenue OfficerASSESSMENT DIVISIONRR 19-DAVAO CITY

BIR Form 1700 ( Purely Compensation Income )

BIR Form 1701 (Self-Employed Individual, Estate and Trust)

BIR Form 1702 ( Corporations, Partnership and Other Non- Individual Taxpayer

Revised Forms

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../../../F:/NEW%20ITR%20FORMS/1701.xls

../../../F:/NEW%20ITR%20FORMS/1702%20nov%202011.xls

-Income tax filing covering and starting with calendar year 2011, due for filing on or before April 15. 2012

- Juridical entities on FY basis are to use starting with those FY ending

January 31, 2012

Effectivity

To be read by an optical character reader

Use Nov. 2011 version Box Type Shading All information must be written in

capital letters Orientation is landscape (horizontal) e-mail address of taxpayer

Features

Field No. 47 – for filer’s new address

With supplemental information (optional) Schedule of gross income subjected

to final tax

Schedule of gross income/receipts exempt from income tax

features

“Knowing is not enough; we must apply. Willing is not enough; we must do.”

Johann Wolfgang von Goethe

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Income tax