INCOME TAX Presented by: LILYBETH A. GANER, CPA, MBA Revenue Officer RR-19, Davao City

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

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

Gross income (cont.) Royalties Dividends Annuities Prizes and winnings Pensions Partner’s distributive share in the net income of general professional partnership

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.

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%

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 applicable

Itemized Deduction Ordinary and necessary trade, business or professional expenses Salaries & wages Travel expenses Rental expenses Entertainment, amusement and recreation expenses Interest Taxes

Itemized Deduction (cont.) Losses Net Operating Loss Carry Over (NOLCO) Capital losses Losses from wash sales of stocks or securities Wagering losses Abandonment losses

Itemized Deduction (cont.) Bad debts Depreciation Depletion of oil and gas wells and mines Charitable and other contributions Research and development Pension trusts

Ordinary and necessary trade, business or professional expenses Substantiation requirements Supported by official receipts or adequate records The direct connection or relation of the expenses to the development, management, operation or conduct of business Note : No deduction from gross income shall be allowed if the payment constitutes bribe or kickback.

Interest There 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;

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.

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 tax Jan. 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.

Interest 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 b. Interest payments between related parties as 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 Between members of the same family 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

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 limitation

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).

Taxes Refund 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)

Taxes Disclosure 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 year The amount of VAT Output tax and the account title and amount/s upon which the same was based,

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

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

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

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

Depreciation Requirements 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.

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

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 LOWER

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

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.

Entertainment, Amusement & Recreational (EAR) Expenses 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 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

Entertainment, Amusement & Recreational (EAR) Expenses 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

Actual entertainment, amusement and recreation expense Entertainment, Amusement & Recreational (EAR) Expenses 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

Net sales/net revenue x Actual expense TAXPAYER ENGAGED IN BOTH SALE 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

Illustration: Computation: 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 = P2,000 Sale of service (P100,000/300,000) x P3,000 = P1,000 **Maximum percentage ceiling Sale of goods P200,000 x 0.50% = P1,000 Sale of service P100,000 x 1% = P1,000

Computation: ERA Corporation can only claim a total of P2,000 as EAR Net sales/ net revenue EAR expense based on apportionment formula* Maximum percentage ceiling of EAR** Allowable amount to be claimed as EAR (w/c ever is lower) Sale of goods P200,000 P2,000 P1,000 Sale of services P100,000 Total P300,000 P3,000 ERA Corporation can only claim a total of P2,000 as EAR

Optional Standard Deduction 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 Individuals Resident citizen Non-resident citizen Resident Alien Taxable estates and trusts Corporations (subject to normal income tax rate) Domestic corporation Resident foreign corporation

Optional Standard Deduction Individual Corporation Rate 40% of gross sales/revenues 40% Gross income Tax Base Excluding passive income subject to final withholding tax Cost of sales/services Not allowed to deduct COS/services Allowed to deduct COS/services

Optional Standard Deduction Rules for GPP (RR 2-2010) If the GPP availed of the itemized deduction in computing its net income, the partners are not allowed to claim the OSD, but may still claim itemized deductions. If the GPP availed of the OSD in computing its net income, the partners can no longer claim further deduction from said share. The type of deduction chosen by the GPP must be the same type of deduction that can be availed of by the partners.

Optional Standard Deduction Rules for GPP If the partner also derives other income from trade, business or practice of profession, deduction to be claimed should be the same deduction availed of from his partnership income. If the GPP opts for the OSD, the individual partner may still claim 40% OSD on income from trade, business or practice of profession.

Optional Standard Deduction 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.

Optional Standard Deduction 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.

Optional Standard Deduction 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

Illustration 1 Mr. 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 sales Cost of sales Operating exp Jan-June July-Sept Oct-Dec P1,000,000 700,000 900,000 P600,000 200,000 400,000 P50,000 100,000

Computation 1 a) Allowable deductions Jan. – June July – Sept Oct - Dec Gross sales P1,000,000 P700,000 P900,000 Less: Cost of sales -0- - 0 - - 0 – Gross sales/income P 1,000,000 P700,000 P900,000 X 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 ========

Illustration 2 Gross sales Cost of sales Operating exp Jan-June GSV 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 sales Cost of sales Operating exp Jan-June July-Sept Oct-Dec P1,000,000 700,000 900,000 P700,000 300,000 600,000 P100,000 200,000 100,000

Computation 2 a) 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 =======

Taxation of Mixed Income 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. 50 50

Taxation of Mixed Income 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 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

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

Income Tax Computation Corporate Taxpayer

What is a 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

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

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

Sec. 27(E) and 28 (A)(2) of the NIRC Imposed 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

Gross income For Sale of goods Include 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)

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)

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 ========

Carry forward of Excess MCIT 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 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

Carry forward of Excess MCIT 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

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

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

IMPROPERLY ACCUMULATED EARNINGS TAX (IAET) RA 8424/ RR No. 2-2001/RMC 35-2011

CONCEPT 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

EVIDENCE OF PURPOSE TO AVOID THE TAX 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

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).

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

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.

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 ecozones

IMPOSITION 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

TAX BASE OF IAET (Improperly Accumulated Taxable Income) Taxable income P xxx Add: Income subject to final tax Pxxx NOLCO xxx Income exempt from tax xxx Income excluded from gross income xxx xxx Total P xxx Less: Income tax paid for the year xxx Div. actually or const. paid/issued xxx xxx Total xxx Less : 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

Income Tax Forms and Due Dates

Income Tax Forms 1702 Annual Income Tax Return 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

Quarterly Income Tax Return 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

Applicable to individual taxpayer only and NOT TO CORPORATION NOTE: Installment Payments Applicable to individual taxpayer only and NOT TO CORPORATION next

New Income Tax Forms Presented by: LILYBETH A. GANER Revenue Officer ASSESSMENT DIVISION RR 19-DAVAO CITY

Revised Forms 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

Effectivity -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

Features 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

“Knowing is not enough; we must apply “Knowing is not enough; we must apply. Willing is not enough; we must do.” Johann Wolfgang von Goethe