CHAPTER I - DEFINITION OF SOME TERMINOLOGIESTaxation –is an act of imposing tax. Tax - is a power inherent in a sovereign state to enforce a charge or a burden upon persons, properties or rights or privileges, to defray the expenses of the government, and to enable it to discharge its appropriate functions. Nature of taxation – it is inherent in any sovereign or independent state. It is exercised by the congress or the legislative branch of government. Under the local government code, the local council can impose taxes within the area of their jurisdiction. Scope of taxation It is unlimited and comprehensive. There are inherent and constitutional limitations, but any limitations will depend on the sense of responsibility of the members of the legislature to its constituents. Inherent limitations: The tax is imposed for public purpose. The power to tax cannot be delegated. Double taxation should be avoided or prevented. Government agencies and instrumentalities are exempted from tax. Tax can be imposed only within the territorial jurisdiction of the state. Tax laws cannot be applied to properties of foreign governments. Double taxation is taxing twice, by the same public authority, within the same jurisdiction or taxing district, for the same purpose in the same year or taxing period. Constitutional limitations: Existing contracts shall not be impaired. No person shall be imprisoned for non- payment of debt or poll tax. Taxation must be uniform and equitable. All kinds of land, buildings and improvements actually, directly or exclusively used for religious or charitable purposes are exempt from taxation. Basic principles of a sound tax system Fiscal adequacy – the source of revenue must be enough to sustain the finances of the government Theoretical justice – taxes must be based on the taxpayer’s ability to pay. Administrative feasibility – taxes collected must be sufficient to implement the law of the land efficiently and effectively. Taxes distinguished from eminent domain Concept of eminent domain – it is the power of the state to take or control private property for public use after paying the owner a just compensation to be determined according to law. 1 Taxation applies to all persons, properties or rights (national coverage). Eminent domain applies only to a particular owner of property. In taxation, there is payment of taxes to the government by the taxpayer. In eminent domain, there is the taking of property by the government. In taxation, the taxpayer is presumed to receive benefits from the government directly or indirectly. In eminent domain, the owner of the property receives a fair and just compensation from the government. Taxation distinguished from police power: Concept of police power – it is the right of the state to enact laws in relation to properties or persons as may promote public health, public morals, public safety and the general welfare of the people. The purpose of taxation is to raise revenues. The purpose of police power is for regulation. In taxation, there is no limit on the amount of tax to be imposed. In police power, the license fee is just enough to implement the regulation. Classification of taxes a. As to subject matter: 1. Personal or capitation or poll tax or “cedula”– fixed amount on all persons who are residents within a specific territory. 2. Property tax – tax assessed on all properties located within the jurisdiction of the taxing authority, in proportion to its value or in some method of apportionment. 3. Excise tax – a tax which is not covered under personal or property. b. As to who bears the burden 1. Direct tax – The one who pays shoulders the tax. 2. Indirect tax – The one who pays shifted the burden of the tax to someone else. c. As to determination of amount: 1. Specific tax –a tax which imposes a specific amount per head or number, or some standard of weight or measurement. 2. Ad valorem tax – a tax based on the value of the article subject to tax. It is a certain percentage of the invoices or appraised value of the article or product subject to tax. d. As to purpose: 1. General tax – tax levied to raise revenues for the government. 2. Special tax – tax levied for special purpose. e. As to scope 1. National tax – tax levied by the national government. 2. Local tax – tax levied by the local government. f. As to proportionality 1. Progressive or graduated – increase in the tax rate is proportional to the increase in tax base. Ex. Income tax, estate tax, and gift tax. 2. Regressive – increase in the tax rate is not proportional to the increase in tax base. We do not use this kind of taxation. 3. Proportional – fixed percentage of amount of the base (e.g. value of the property, or gross receipts) Ex. Value added tax (VAT), real property taxes. 2 Some doctrines in Taxation 1. Prospectively of tax laws – tax laws must be imposed not retroactively but forwardly. 2. Indirect double taxation – Ex. When business tax is imposed by the municipal government prior to the issuance of business license to a taxpayer for engaging in an advertising business. His income from his advertising business shall later be imposed income tax by the national government 3. Set-off of taxes – are not subject to offsetting of the claims that the taxpayer may have against the government. 4. Escape from taxation –avoiding or evading tax. a. Shifting – is the transfer of the burden of the tax to someone else. Ex. Indirect tax b. Capitalization – the reduction in the price of taxed object equal to the future value of the taxes to be paid, which the purchaser expects to pay. c. Transformation – is the method of improving the process of production, turning out his units of product at a lower cost. d. Evasion – use of illegal or fraudulent means to avoid or lessen the payment of tax. e. Avoidance – use of legal means to prevent or reduce tax liability. f. Exemption – is the granting of immunity to a certain taxpayer so that it will not pay tax. Situs of taxation – it is the place of taxation. It is the channel wherein the state can collect or levy a subject being taxed if he has a situs under its jurisdiction. 1. 2. 3. 4. 5. Persons –residence of the taxpayer Real property or tangible property – location of the property Intangible personal property – domicile or the taxpayer unless he acquired a place elsewhere Income – taxpayer’s residence or citizenship, or place the income was earned. Business, occupation and transaction – place where business is operated or located, occupation is practiced and transaction is completed. 6. Gratuitous transfer of property – taxpayer’s residence or citizenship, or location of the property. Tax differentiated from toll. Meaning of toll – it an amount paid for the use of a road, bridge, or the like of a public nature. A toll is a demand of the owner and is paid for the use of another’s property and maybe imposed by individual private or government entities, while tax is a demand of the state for the support of government. Tax differentiated from penalty Penalty is any sanction imposed as a punishment for violation of law. A penalty is designed to discipline the conduct of the subject and it may be imposed by the government or private individuals or entities. Tax is primarily aimed at raising revenues and maybe imposed only by the government. 3 Tax differentiated from special assessment Special assessment is an enforced contribution from owners of land for special benefits resulting from public improvements. Special assessment is levied only on land, is not a personal liability of the person assessed, is based wholly on benefits. Tax is levied on persons, properties or rights, which may be made a personal liability of the person assessed, is based on necessity and is of general application. From permit or license fee Permit or license fee is a charge imposed under the police power of the state for purposes of regulation. License fee is imposed for regulation and involves the exercise of police power, while tax is imposed for revenue and involves the exercise of the taxing power. Failure to pay a license fee makes an act illegal, while failure to pay a tax does not necessarily make an act illegal. From debt A debt is based on contract, is assignable and maybe paid in kind. While a tax is based on law, cannot be assigned and is paid in money. A person cannot be imprisoned for non-payment of debt while he can be imprisoned for non-payment of tax. From Revenue It is broader than tax since it includes all funds or income derived by the government aside from taxes. Other sources of funds by the government are servicesm income from public enterprises and foreign loans. From custom duties Custom duties are taxes imposed on goods exported from or imported to a country. Custom duties are also taxes but the latter is broader in scope. Questions and exercise: Questions: 1. 2. 3. 4. What is a tax? What is the scope of taxation? Discuss. Enumerate the constitutional and inherent limitations of taxation. Discuss. What are the classification of taxes? 4 5. Describe some doctrines that is generally accepted in taxation. Explain. 6. Differentiate tax with the following: a. Toll b. Penalty c. Special assessment d. License fee e. Debt f. Revenue; and g. Customs duties Exercise: True of False. Write in the space provided before each number the word “True” if the statement is correct and the word “False” if the statement is incorrect. ____________ 1. No person shall be imprisoned for non-payment of income tax. ____________2. Taxation is unlimited and therefore it has no limitation. ____________3. The power of eminent domain interferes to the right of the person to privacy. ____________4. Tax laws may be affected prospectively and retroactively. ____________5. Shifting is the method of improving the process of production, turning out his unit of product at a lower cost. ____________ 6. Value added tax is an example of excise tax. ____________7. Regressive income tax means increase in the tax rate is not proportional to the increase in tax base. ____________8. Progressive or graduated tax means a fixed percentage of the income tax base. ____________9. The power to tax is exercised only by the executive branch of the government. ____________ 10. The Constitution totally disallows double taxation. CHAPTER 2 – INCOME TAXATION History of the Philippine Income Tax At first, our inhabitants were living in our country as a free people. But when the Spaniards came into our country, our people realized that we are now a slave in our own country . In order to sustain the colonization of our country, not only they exploited our natural resources, but also required every citizen to pay the poll tax or the “cedula” as a symbol of Filipino’s vassalage to Spain. This “cedula”was the most 5 popular tax that we pay during the Spanish times. But when the USA took over the Philippines from Spain, they introduced the first income tax law in the Philippines and subsequently it undertook several revisions from different generations of government until it becomes what is now. Bureau of Internal Revenue (BIR) One form of taxation is tax on income. Income tax is defined as a tax on income, whether gross or net (27 Am. Jur., 308). Income taxation in the Philippines is mostly covered under a law known as the National Internal Revenue Code. Aside from that, it also includes special laws, revenue regulations and circulars, rulings of the BIR, opinions of the Secretary of Justice, decisions of the Supreme Court and the lower courts. The implementing agency is the Bureau of Internal Revenue under the Department of Finance. Powers and duties of the BIR 1. 2. a. b. c. d. e. f. g. h. 1.) 2.) Officers – Chief Commissioner and seven (7) deputy commissioners. Powers and duties: Assessment and collection of all national internal revenue taxes, fees and charges; Enforcement of all forfeitures, penalties and fines; Execution f judgments in all cases decided in favor by the court of tax appeals and ordinary courts. Administration of supervisory and police powers conferred to it. Interpret tax laws and decide tax cases Obtain information, and to summon, examine, and take testimony of persons. Make assessments and prescribe additional requirement for tax administration and enforcement. The commissioner has the power to inquire bank deposits of: Decedent to determine his gross estate. Any taxpayer who has filed an application for compromise of his tax liability. This is exempted under RA no. 1405 or Secrecy of Bank Deposit Law. Questions: 1. 2. 3. 4. Describe the evolution of tax in the Philippines. What are the functions of BIR? Are the powers of the BIR enough to force the taxpayers to pay the right taxes? Discuss. What are some of the problems the BIR faces in our present system of taxation? Chapter 3 – Concept of Income Tax Concept of Income Tax and Income Income tax – is a tax on all annual profits realized from property, profession or from doing trade or business, or a tax on annual income, emoluments, and the like from employment which is payable by a taxpayer. Income tax is regarded as an excise tax. 6 Income – means all profits, gains which flow into the taxpayer during a specific period of time, but not the return on capital. It also includes gains from the sale of capital assets. Requisites for income to be taxed: 1. There must be a gain or profit. 2. The gain must be realized or received. 3. The gain must be excluded by law or international treaty. Types of income There are three (3) types of income of the taxpayers subject to tax: 1. Capital gains subject to capital gains tax 2. Passive income subject to final tax 3. Other income subject to tax depending upon the classification of taxpayers. Classification of taxpayers 1. 2. 3. 4. 5. 6. 7. Individual taxpayers Corporations Special corporations General Professional Partnerships and not Estate and trust Co-ownerhip Joint ventures not covered under the definition of a corporation Accounting methods recognized by the tax code 1. Principal methods a. Cash basis b. Accrual basis c. Hybrid method 2. Crop-year basis 3. Deferred payment sales a. Installment basis b. Deferred payment basis 4. Percentage of completion basis (long-term contracts) 5. Leasehold improvements a. Income over the term of the lease basis b. Income in the year of completion basis 6. In general, any method of accounting that reasonably reflects the income of the taxpayer for each taxable year will do. Explanation of accounting methods: 1. Main methods: a. Cash basis –Within a specific period of time, income earned is recognized as income only when received and expenses not yet paid is recognized as expenses only when paid. 7 b. Accrual basis – Within a specific period of time, income earned is recognized as income even when it is not yet received and expenses incurred are recognized as expenses even if it is not yet paid. c. Hybrid method – is a combination of both the cash basis and accrual basis. 2. Crop year basis – expenses in the production of crops are deducted in the year the gross income from the crop has been realized. It is applicable only to farmers producing crops. It may take more than a year. ( from the time of planting to the time of sale of the produce) 3. Installment and deferred payment sales – It discusses various methods of acceptable reporting of gross income. 4. Long – term contracts – means building, installing or contracting contracts covering a period in excess of one year. A person whose gross income is derived from long – term contracts shall report his income on the basis of percentage of completion. The computation must be supported by certifications from a reliable architect and engineering consultants showing the percentage of completion during the taxable year of work done under the contract. 5. Leasehold improvements – sometimes the lessee make permanent improvements on the property leased, under an agreement that upon the expiration of the lease contract, the improvement will be for the lessor. It therefore behooves that the lessor must recognize income from the improvements. 1. Income from leasehold improvements shall be reported at the time the buildings or improvements are completed. 2. Income from leasehold improvements shall be divided over the life of the lease Chapter 4 – Formula for taxable income Taxable income – it is gross income less deductions and personal and additional exemptions if any. Gross income – depends upon the source of income of the taxpayer. A, Employment – Compensation for the services rendered B. Business – Net sales less Cost of sales 1. Gross income/profit derived from the conduct of trade or business or exercise of profession. 2. Gains derived on the sale of properties or assets. 8 3. Interests 4. Rents 5. Royalties 6. Dividends 7. Annuities 8. Prizes and winnings 9. Pensions; and 10. Partner’s distributive share from the net income of a general professional partnership. Definition of income Income is the amount of money (cash or its equivalent) received by a taxpayer (person or artificial being) within a specific period of time, whether as payment of services, interest or profit from investment. It may also be defined as the flow of fruits from one’s labor. Capital is wealth. Income is the flow of additional wealth. Capital is a “tree”, while income is the “fruit”. Income tax is a tax on all annual profits arising from trade or business, exercise of a profession or use or sale of property, or is a tax on person’s compensation through employment. It is generally an example of excise tax. Income tax is based on income either gross or net, realized in one taxable year. Compensation Income Definition – It means all remuneration for services rendered by a employee for his employer under an employee-employer relationship, unless specifically excluded by the Code. Thus, it includes salaries, wages, emoluments, honoraria, allowances, commissions, (e.g. transportation, representation, entertainment and the like); fees including director’s fees and other income of similar nature. If services are paid in kind other than money (e.g. stocks, bonds or other forms of property) its fair market value should be taken as payment. Forms of compensation 1. Money 2. In kind such as stocks, bonds, or other forms of property. – Fair market value 3. The value of quarters or meals so furnished should be added to remuneration. Compensation with exemptions: 9 1. De minimis benefits are not considered as compensation – such facilities or privileges are relatively of small value and are given to employees to promote their health, goodwill, contentment, and efficiency. a. Monetized unused vacation leave credits of employees not exceeding 10 days during the year. b. Medical cash allowance to dependents of employees not exceeding P750 per employee per semester or P125 per month. c. Rice subsidy of P1,500 or one (1) sack of 50-kg rice per month amounting to not more than P1,500. d. Uniforms and clothing allowance not exceeding P4,000 per annum. e. Actual yearly medical benefits not exceeding P10,000 per annum. f. Laundry allowance not exceeding P300 per month. g. Employee achievement awards, e.g. for length of service or safety achievement, with an annual monetary value of P10,000, under an established written plan, which does not discriminate highly paid employees. h. Gift given during Christmas and major anniversary celebrations not exceeding P5,000 per employee per annum. i. Flowers, fruits, books or similar items given to employees under special circumstances, e.g. on account of illness, marriage, birthday, birth of a baby, etc. j. Daily meal allowance for overtime work not exceeding 25% of the basic minimum wage. The excess from the above ceiling prescribed, shall be considered as part of other benefits, which are taxable to the employee receiving the benefits, if such excess is beyond the P30,000 ceiling. 2. Fringe Benefits – is an employee benefit supplementing a money wage or salary. It may be in the form of food, service, or other benefit furnished or granted in cash or in kind. A salary or wage given to an employee cannot be reduced, while a fringe benefit maybe discontinued or reduced. It is not a part of the basic pay to compute for OT pay, separation pay, etc. as a basis. a. Basic rules on fringe benefit and fringe benefit tax. 1.) Fringe benefit given to a rank and file employee (whether under a collective bargaining agreement or not) is not subject to the fringe benefit tax. 2.) Fringe benefit given to a supervisory or managerial employee is subject to the fringe benefit tax. 3.) De minimis benefits, whether given to rank and file employee or to a supervisory or managerial employee is not subject to the fringe benefit tax. Examples of fringe benefits given to a supervisory or managerial employees subject to fringe benefit tax: Housing, expense accounts, vehicle of any kind, housing personnel such as maid, driver and others, interest on loan at less than market rate to the extent of difference between the market rate and actual; membership fees, dues and other expenses in social and athletic clubs or other similar organizations; expenses for foreign travel; holiday and vacation expenses, educational assistance to the employee or his dependents; life or health insurance and other non-life insurance premiums or similar amounts in excess of what the law allows. 4.) Exemptions from tax are as follows: 10 a. Benefit required by the nature of, or necessary to the trade, business or profession of the employer. b. Benefit for the convenience or advantage of the employer (convenience of the employer rule) c. Benefit which is authorized and exempted from tax under special law. d. Contribution by the employer for the benefit of the employee to retirement, insurance, and hospitalization benefit plans. e. De minimis benefits. 5.) Computation of fringe benefit tax: 1. Determine the grossed-up monetary value of the fringe benefit. This is the monetary value of the benefit divided by sixty-eight percent (68%); 2. Compute the fringe benefit tax by multiplying the grossed-up monetary value of the fringe benefit by thirty two percent (32%). The fringe benefit tax is a final tax that should be withheld by the employer and paid on or before the tenth day of the month following the calendar quarter in which the fringe benefit was granted. Exclusions from gross income: A. Direct exclusions under NIRC 1. The proceeds of life insurance policies paid to the heirs or beneficiaries upon the death of the insured. 2. The amount received by the insured as a return of premium paid by him under life insurance, endowment or annuity contract. 3. The value of the property acquired by gift, bequest, devise or descent. 4. Amount received through accident or health insurance, or under Workmen’s Compensation Act as compensation for personal injuries or sickness. 5. Income of any kind to the extent required by any treaty binding upon GOP. 6. Payment of benefit due to any person residing in the Phils under US laws administered by US Veterans Administration. 7. Interest derived from investment in the Philippines by foreign governments or institutions. 8. Income derived from any public utility or from the exercise of any essential government functions accruing to GOP or to any political subdivision. 9. Prizes or awards made primarily in recognition of religious, charitable, scientific, educational, artistic, literary or civic achievement. 10. Prizes or awards granted to athletes in local or international sports competition sanctioned by their national sports associations. 11. Gains realized from the sale or exchange or retirement of bonds, debentures, or other certificate of indebtedness with a maturity of more than 5 years. 12. Gains realized by the investor upon redemption of shares of stock of a mutual fund company. B. Exemptions which have special significance to an employee or wage earner: 1. GSIS, SSS, Philhealth and Pagibig contributions and union dues of individuals. 2. Gross benefits received by officials and employees of public or private entities, as thirteenth month pay and other benefits, but the total exclusion shall not exceed thirty thousand pesos (P30,000). Example: Productivity incentive pay, and Christmas bonus. 3. Benefits received or enjoyed under the SSS or GSIS. 11 4. Retirement benefits received under RA No. 7641 and those received by employees of private firms with a reasonable private benefit plan. 5. Amount received by an employee or its heirs as a consequence of separation from the service because of death, sickness or other physical disability or for any cause beyond the control of the employee. 6. Social security benefits, retirement benefits, pensions, and other similar benefits received by a resident or non-resident citizen of the Philippines or resident alien. 7. Minimum wage earners shall be exempt from the payment of income tax. C. Other Exemptions under NIRC: 1. Interest on long term deposits or investments in banks (with a maturity of 5 years or more) except for non-resident aliens not engaged in business or practice of profession in the Phils. 2. Interest received by a non-resident individual or non-resident corporation from deposits under the FCDU system. 3. Dividends received by a domestic or resident corporation. (Intercompany dividend) 4. De Minimis benefits received by a managerial or supervisory employee. 5. Income tax shall not apply to an employee’s trust which forms part of pension, stock bonus, or profit sharing plan of an employer for the benefit of some or all of his employees. Chapter 5 – Application of Installment and Deferred Payment Methods and Long-Term Contracts 1. Payment of capital gain tax in installment - Not all revenues or sales of capital assets are received on cash. Sometimes to generate more revenues you have to have to adopt installment method of sales. It would be unfair if for example, a taxpayer will have to receive payment yet by installment and require him to pay tax due as a whole on the date of sale, hence the method of paying capital tax should be made as the taxpayer received payment. 2. Installment method of reporting income – Likewise, if the sale of ordinary asset is made on installment, the reporting of income can be made also by installment. 3. Installment method of reporting capital gain – Furthermore, if the sale of capital asset is made on installment, the capital gain realized can also be made by installment. Below is the integrated comparison of the three types of application of installment and deferred methods: Application of Installment and Deferred Payment Method Illustrative Problem Payment of capital gain tax in installment F Co., a domestic corp, on January 2, 2009 sold Installment method of reporting income On Nov 5 2009, Mr. B sold a piece of land held 12 Installment method of reporting capital gain On Jun 1 2009, Mr. P sold bonds held as a piece of land in USA, held as capital asset with data as follows: SP P2,000,000 FMV P1,800,000 Cost P1,000,000 Payment as follows: DP P 500,000 Jan 2, ’10 P1,000,000 Jul 2, ’10 P 500,000 Step 1 Step 2 – Initial payments must not exceed 25% of the selling price Determination of capital gain tax: SP 2,000,000 FMV 1,800,000 CGT 120,000 Determination of initial payments: IP in 2009 500,000 (not exceeding 25% of SP) Step 3. If there is no mortgage, the contract price is the selling price Selling Price is the Contract Price Step 4. Computation Determination of installment payments on the tax: Jan 2, 2009 P120.000/P2,000,000 x 500,000 = P30,000 January 28, 2010 P120,000/P2,000,000 x P1,000,000 = P60,000 as ordinary asset on installments. Data are as follows: SP P1,000,000 Cost P500,000 Mortgage P600,000 Payments: DP of P130,000 and installment payments of P20,000 every month thereafter except for last month P30,000. Determination of gross profit: SP P1,000,000 Cost P 500,000 GP P 500,000 Determination of initial payments: DP in 2009 P130,000 Ins payment 20,000 Excess of mortgage Over cost P100,000 Init, paymt P250,000 Determination of contract price: SP P1,000,000 Mortgage (600,000) Excess of Mortgage over cost 100,000 Contract Price 500,000 Determination of income to report: 2009: P500,000/P500,000 x P250,000 = P250,000 2010: P500,000/P500,000 x P250,000 = P250,000 July 2, 2010 13 capital assets on installments: Data are as follows: SP P200,000 Cost P100,000 Payments: 2009: DP P25,000 Dec 1 2009 P25,000 2010: Jun 1 2010 P75,000 Dec 12010 P75,000 Determination of capital gain: SP P200,000 Cost 100,000 GP 100,000 Determination of initial payments: DP in 2009 P25,000 Payment: 12/1/2009 P25,000 Init paymt P50,000 Selling Price is the contract Price Determination of capital gain to be reported: 2009: P100,000/P200,000 x P50,000 = P25,000 50% thereof P12,500 P100,000/P200,000 x P150,000 = P75,000 50% thereof P37,500 P120,000/P2,000,000 x P500,000 = P30,000 However, if the initial payments is more than 25%, it can be reported on the basis of deferred payment method Not applicable L Co, a real estate dealer, sold on Dec 1 2008 a piece of real estate with the ff. data: SP P3,000,000 Cost P1,200,000 DP P1,000,000 Mort. Note P2,000,000, payable at P1,000,000 on Dec 1, 2009, and P1,000,000 On Dec 1, 2010. It has a FMV of 85% of its face value. In 2008: Collected P1,000,000 FMV of note: P2,000,000 X 85% P1,700,000 Total amt P2,700,000 On Jun 1 2009, Mr. S sold shares of stock of a resident corporation held as capital assets for 20 months. Data are as follows: SP P200,000 Cost P100,000 DP P 50,000 Balance is secured by a mortgage note, the FMV is 90% of its face value. Payments were as follows: 12/1/2009 P50,000 6/1/2010 P50,000 12/1/2010 P50,000 In 2009: Collected: Date of sale P50,000 12/1/2009 P50,000 FMV of the Note=,9xP100,000 P90,000 Total 190,000 Less: Cost 100,000 Capital gain 90,000 14 In 2009: Collected P1,000,000 Less: Income prev. reported: 85% x P1M 850,000 Income 150,000 50% thereof 45,000 In 2010: Cash received: 6/1/2010 P50,000 12/1/2010 P50,000 Total P100,000 Less income prev. reported 90,000 Capital gain 10,000 50% thereof P5,000 In 2010: Collected P1,000,000 Less: Income prev. Reported: 85% x P1M 850,000 Income 150,000 Long – term contracts It means a construction contract whose period of completion exceeds one year. A taxpayer whose gross income is derived in whole or in part from long-term contracts shall report income from such contracts on a percentage of completion method. It shall be based on progress billing approved by independent architectural or engineering consultants showing the actual percentage of completion accomplished during the period. Example: Mr. Cruz is a contractor. On May 1, 2011, he started the construction of a building and finished it in 2013. The contract price of the building was P10,000,000. By the end of 2011, the building was thirty percent (30%) completed at a cost of P2,000,000. It was eighty percent (80%) completed by the end of 2012, with an additional cost of P4,000,000 for that year. The building was completed in 2013, with an additional cost of P1,000,000 for that year. The income to be reported for each year during the period of construction would be as follows: 15 2011: Contract price – P10,000,000 (30% of P10,000,000) Less: Cost to date (December 31, 2011) 2,000,000 Income for the year P3,000,000 P1,000,000 2012: Contract price – P10,000,000 (80% of P10,000,000) Less: Cost to date: 2011 2012 Balance Less: Income reported in 2011 Income for the year P8,000,000 P2,000,000 4,000,000 2013: Contract price – P10,000,000 (100% of P10,000,000) Less: Cost to date 2011 2012 2013 Balance Less: Income already reported: 2011 2012 Income for the year 1,000,000 6,000,000 P 2,000,000 1,000,000 P 1,000,000 P10,000,000 P2,000,000 4,000,000 1,000,000 P1,000,000 1,000,000 16 7,000,000 P 3,000,000 2,000,000 P Chapter 6 : Tax Rules for individual Taxpayer Summary of Tax Rules for Individual Taxpayers Resident Citizen Nonresident Citizen Resident Alien Non-resident Alien engaged in business Nonresident Alien not engaged in business Naturalborn Stay out for more than 183 days Stay in for more than a year Stay in for more than 180 days Stay in for less than 180 days a. Sale of shares of stock Uniform rules Uniform rules Uniform rules Uniform rules Uniform rules b. Sale of real property Uniform rules Uniform rules Uniform rules Uniform rules Uniform rules c. Interest on FCDU 7.5% exempt 7.5% exempt d. Interest on any currency bank 20% 20% 20% Who are they? Capital Gains Passive income 17 deposit, yield or benefits derived from deposit substitute. e. Royalty on books, literary & musical compositio ns 10% 10% 10% 10% f. Royalty other than (e), Prize > P10,000, other winnings except lotto and PCSO 20% 20% 20% 20% f. Dividends 10% 10% 10% 20% g. Interest on deposit for 5 years or more exempt exempt Exempt exempt Within and without the Philippines Within the Philippines Within the Philippines Within the Philippines 5%-32% 5%-32% 5-32% Other Income h. Taxable income 5%-32% Other rules in 18 Final tax i. Gross income from within the Philippines J. Personal exemption s Cinematogra phic films and similar works only 25% 25% Final tax Uniform rule Uniform rule Uniform rule Uniform rule or that allowed by the country of his origin whichever is lower None A. Uniform rule for Capital gains subject to capital gain tax: 1. For shares of stock: a. Capital gain = Selling price – Cost of shares of stock b. Tax on the net capital gain: Not over P100,000 Final tax of 5% In excess of P100,000 Final tax of 10% c. Tax is due within 30 days from the date of sale. 2. For sale of real property in the Philippines held as capital asset Tax is based on the gross selling price, or the current fair market value at the time of sale, whichever is higher – Final tax of 6%. The tax is withheld at source. Capital Gain terms used: 19 Capital Assets – are assets not used in business. It is the opposite of Ordinary assets. Capital gain – Selling price – Cost. Selling Price is the amount paid on the sale, either in cash or in kind. The selling price or the fair market value, whichever is higher, is reduced by the expenses of the sale. Cost is the purchase price increased by the expenses of the purchase. Real property – land, building or anything attached to the soil with permanence. Problems: 1. The taxpayer is Mr. A, a citizen of the Philippines, residing in the Philippines, directly sold shares of stock of a domestic corporation to a buyer at a selling price of P750,000. Expenses of sale is P50,000. Purchase price of the shares sold is P400,000. Expenses on the acquisition of shares is P25,000. Compute for the capital gains tax. 2. The taxpayer is a citizen of the Philippines, residing in the Phils. Shares of a resident corporation held as capital assets were sold in the Philippines directly to a buyer. Selling price of shares P600,000 Cost of shares P300,000 Capital gain tax? 3. The taxpayer is a citizen of the Philippines, residing in the Phils. Shares of stock of a domestic corporation held as capital assets were sold thru the Philippine Stock Exchange. Selling price, net of stock broker’s commission P500,000 Cost (purchase price of stock broker’s commission) P150,000 Capital gain tax? 20 4. The taxpayer is a citizen of the Philippines, residing in the Philippines: Selling price on a direct sale to a buyer of shares of a domestic Corporation held as capital asset P600,000 Fair market value of the shares at the time of sale P700,000 Cost of the shares P200,000 Capital gain tax? 5. The taxpayer is a citizen of the Philippines, residing in the Philippines. Selling price of land and building in the Philippines held as capital asset P5,000,000 Fair market value at the time of sale P5,500,000 Cost of the land and building P3,000,000 Capital gain tax? 6. The taxpayer is a citizen of the Philippines, residing in the Philippines. Selling price of land and building in the Philippines held as capital asset P4,000,000 Commission of the broker who facilitated the sale Purchase price of the land 150,000 1,500,000 Commission of the broker who facilitated the purchase 100,000 Capital gain tax? 7. The taxpayer is a citizen of the Philippines, residing in the Philippines. Land in Malaysia, held as capital asset, were sold to a buyer in the Philippines: 21 Selling Price P2,000,000 Cost P1,000,000 Capital gain tax? B. Passive income with final tax: 1. Passive incomes are income received by the taxpayer even without doing anything. So it comes to the taxpayer without any effort at all. 2. Final tax is the tax that is withheld at source, and the amount received by the taxpayer is net of the tax. The payor remits the tax to the BIR. Terms used in Passive Incomes FCDU it is a unit of bank, whether local or foreign, authorized by the Banko Sentral Ng Pilipinas to engage in foreign currency denominated transactions. These transactions include accepting foreign currency deposits and granting of foreign loans to domestic borrowers. Deposit substitute – it is a means of borrowing money from the public other than by way of deposits with banks through the issuance of debt instruments. e.g. Treasury notes of BSP. The yield is subject to final tax. Trust fund – example is when a bank pools together the small amounts entrusted to it by clients for investment in safe and high-yielding securities. The yield and additional yield is subject to final tax. Prize is the result of an effort (e.g. prize in beauty contest). A winning is the result of a transaction where the outcome depends upon chance (e.g. betting). Problems: 22 1. The taxpayer is a resident citizen of the Philippines with the following data in a calendar year: Net income from business P4,000,000 Interest on peso deposits with PNB 30,000 Interest on time deposits with Security bank with maturity of more than 5 years. 80,000 Interest on Treasury Bill of BSP 90,000 Interest on dollar deposits with FCDU unit of Citibank 100,000 Dividend from a San Miguel Corporations Shares 50,000 Dividend from a resident foreign corporation 30,000 Royalties from books authored 200,000 Final tax on each of the passive income. How much was the passive income of the year, net of final withholding income tax? C. Other Income subject to graduated tax of 5-32% 1. An income that cannot be classified on the above is called Other Income It may come from: a. Employer-employee relationship which is called compensation income. b. Business or profession; c. Sale or exchange of property which is not subject to the capital gains tax; d. Incidental sources, such as interest or dividend, which is not subject to final tax. Tax formula I – for an individual who derive income from employment and who is not a minimum wage earner: 23 Gross compensation income Less: Premiums on health and hospitalization insurance (PHHI) Less: Personal exemptions Equals: Taxable compensation income Problems: 1. Mr. Armand Gutierrez, a citizen and resident of the Philippines, was an employee who had the following data in a calendar year: Basic salary P100,000 Hazard pay 12,000 Overtime pay 70,000 Night shift differential 5,000 Holiday pay 3,000 How much was the income tax at the end of the year? 2. Mr. Juan de la Cruz is a resident citizen. He is employed and had the following data in a taxable year: Salaries before payroll deductions Allowances P400,000 50,000 Payroll deductions: SSS contributions 5,500 Philhealth contributions 2,900 Pag-ibig contributions 1,800 24 Labor union dues 2,000 Payment of loan to employer 30,000 How much was the withholding income tax? Was an income tax return required to be filed at the end of the year? 3. Mr. Conrado Reyes, a resident citizen of the Philippines, an employee, had no child at the beginning of the year. A child was born within the year. He had the following data for the eyar: Salary, net of exclusions for SSS, etc. P300,000 Thirteenth month pay 30,000 Christmas bonus 30,000 Productivity incentives pay 20,000 Withholding income tax on the compensation income 52,000. Was an income tax return required to be filed at the end of the year? What would the ITR have shown? Tax formula II – for an individual who is self-employed (business or practice of profession) Gross income Less: Deductions for expenses and losses and personal exemptions Equals : Taxable income Problems: 1. Mr. Ed Go is a citizen of the Philippines. Mr. Go and wife had the following income and expenses data in one year as follows: 25 Mr. Gross income P600,000 Expenses Mrs. P800,000 200,000 400,000 Separate computations of the income tax of Mr. & Mrs Go for the year? Income tax to be paid by Mr. and Mrs Go as reflected in one income tax return? (No quarterly income tax were paid) 2. Mr. and Mrs. Reyes are citizens of the Philippines with three dependent children. They had the following data on net income for a year (disregard consideration of quarterly income tax): Net income of Mr. Reyes Net income of Mrs Reyes P650,000 450,000 Net income (joint) of Mr. and Mrs. Reyes 150,000 Mrs. Reyes is to claim the additional exemptions. Income tax due from Mr. and Mrs Reyes at the end of the year? Tax formula III – for an individual who has mixed income: Gross compensation income Add: Net income from business or profession (Gross income less deductions for expenses and losses) Less: Personal exemptions Equals: Taxable income 26 Problems: 1. Mr. Edgardo Roque is a resident citizen of the Philippines with income from business. Mrs. Roque is a citizen of the Philippines who is employed. They have two (2) qualified dependent children. They had the following data on income for a year as follows: Mr. Gross income Expenses Mrs. P800,000 400,000 Salaries and benefits, net of exclusions P300,000 (Disregard consideration of any quarterly income tax) How much was the income tax withheld on the compensation income? How much was the income tax still due from the husband and the wife? A minimum wage earner is exempt from income tax on: 1. The minimum wage 2. Holiday pay 3. Overtime pay 4. Night shift differential pay 5. Hazard pay. Personal exemptions 1. Definition – they are reasonable amounts allowed by law to an individual taxpayer, supposed to be to provide for personal, living and family expenses. 2. Present Personal Exemptions: a. Basic personal exemption: For the taxpayer P50,000 27 b. Additional exemption: For each qualified dependent child (not exceeding four) P25,000 Dependent child – is a legitimate, illegitimate or legally adopted child. Qualifications: 1. Chiefly dependent upon and living with the taxpayer. 2. Should not be more than 21 years old, unmarried, and not gainfully employed. 3. If such dependent, regardless of age, is incapable of self-support because of mental or physical defect. In the case of married individuals, if only one is deriving income, only such spouse shall be allowed personal exemption. Husband and wife, both income earners, accomplish one income tax return only. Each spouse shall be entitled to basic personal exemption. Premiums on health and/or hospitalization insurance (PHHI) For individuals, premiums paid during the taxable year for health and/or hospitalization insurance taken out by him on himself, including his family shall be allowed deduction under the following conditions: 1. That the family had a total income of not more than two hundred fifty thousand pesos (P250,000) for the taxable year. 2. In case of married persons, only spouse claiming the additional exemptions for dependents shall be entitled to deduction. a. The deduction shall not exceed two thousand four hundred pesos (P2,400) for the family, or two hundred pesos (P200) a month. Family means “nuclear family” – total family. Total family income includes primary income and other income received by all members of the family, i.e. father, mother, unmarried children living together, or a single parent with children. 28 Problems: 1. How much is the basic personal exemption, and the additional exemptions, if any, in each of the following cases? a. The taxpayer, a citizen of the Philippines, is single, with an illegitimate child, two years old. b. The taxpayer, a citizen of the Philippines, is single, with a brother, 25 years old, who is mentally ill. c. The taxpayers are husband and wife, citizens of the Philippines, both with compensation income, with six qualified dependent children. d. The taxpayer, citizen of the Philippines, was single at the beginning of the year. Within the year the taxpayer got married and had a legitimate child. e. The taxpayer, citizen of the Philippines, was married at the beginning of the year. Within the year he died. f. The taxpayer, citizen of the Philippines, was married with a dependent child at the beginning of the year. On July 1 of the year the child celebrated his twenty-first birthday. g. The taxpayer, a citizen of the Philippines was married with a qualified dependent child at the beginning of the year. Within the year the child got married. h. The taxpayer, a citizen of the Philippines, was married with a qualified dependent child at the beginning of the year. Within the year the child became gainfully employed. i. The taxpayer, citizen of the Philippines was married with a child 24 years old. Within the ear the child became insane. j. The taxpayer is a resident alien who is married with a qualified dependent child. k. The taxpayer is a non-resident alien engaged in business in the Philippines, married, with a legitimate child one year old. His country would give a Filipino engaged in business in his country, not residing in the country, a basic personal exemption as married of P60,000 and an additional exemption for a dependent child of P9,000. l. The taxpayer is a non-resident alien not engaged in business in the Philippines, but with income from the Philippines. His country would give a non-resident Filipino, not engaged in business in his country, but with income in the country, a basic personal exemption of P60,000 Optional Standard Deduction – is a deduction from gross income allowed to be taken instead of the itemized deductions. It is an amount not exceeding forty percent (40%) of gross income. It can be claimed by any of the following taxpayers: 1. An individual who is self – employed, if: 29 a. a resident citizen b. a non-resident citizen c. a resident alien; 2. A corporation, if: a. a domestic corporation b. a resident corporation. Graduated income tax for individuals: On taxable income of: The tax is: Not over P10,000 5% Over P10,000 but not over P30,000 P500 + 10% of excess over P10,000 Over 30,000 but not over 70,000 2,500 + 15% of excess over 30,000 Over 70,000 but not over 140,000 8,500 + 20% of excess over 70,000 Over 140,000 but not over 250,000 22,500 + 25% of excess over 140,000 Over 250,000 but not over 500,000 50,000 + 30% of excess over 250,000 Over 500,000 125,000 + 32% of excess over 500,000 Problems: 1. Mr. Gomez, is a citizen and resident of the Philippines. The following data were his business data in each of the quarters of a year: First quarter P230,000 Second quarter 310,000 Third quarter 294,000 Fourth quarter 325,000 30 How much was the income tax due at the end of each of the first ,second, and third quarters of the year? How much was the income tax due at the end of the year? Chapter 7: Tax Rules on Corporations Summary of Tax Rules on Corporations 31 Kinds Domestic Resident Non-Resident Definition Created under Philippine laws Foreign corporation engaged in business in the Philippines. Foreign corporation not engaged in business but is deriving income in the Philippines. Capital Gain Tax Same as the Uniform Rules of Individuals ( a and b) except on sale of real properties which include sale of real properties located abroad Only on (a) Sale of shares of domestic stock Only on (a) Sale of shares of stock Passive Income – Final Tax Interest under the FCDU – 7.5% Interest under the FCDU – 7.5% Interest on any currency bank deposit, yield or benefit from deposit substitute, trust fund, or royalty – 20% Interest on any currency bank deposit, yield or benefit from deposit substitute, trust fund or royalty – 20% Interest on foreign loans – 20% Dividend from domestic corporation ( Intercompany dividends) – exempt Dividend from domestic corporation ( intercompany dividends) – exempt Dividend from domestic corporation ( under certain conditions) – 15% Net taxable income from all sources within and without the Phils. – NT 30% Net taxable income from all sources within the Phils. – NT 30% Gross income from sources within the Phils. Final tax of 30% But, beginning with the 4th year from the start of operations, whichever is higher: Same as domestic corporations Other income 32 NORMAL TAX – 30% Minimum Corporate Income tax – on Gross Income – 2%. In lieu of the above, beginning with the year 2000: Gross Income Tax (GIT) on GIT Gross Income from all sources within the Phils. – 15% Special Corporati ons Taxpayer Tax Base Rate Proprietary educational institution and nonprofit hospital Taxable income from all sources 10% Resident international carrier Gross Philippine Billings 2½% Non-resident owner or lessor of vessel Gross rentals, lease and charter fess from the Philippines 4½% Non-resident cinematographic film owner, lessor or distributor Gross income from the Philippines 25 % Non-resident lessor of aircraft, machinery and other equipment Gross rentals, charges and other fees from Philippine sources 7½% Regional operating headquarters of Philippine taxable 10% 33 multinational corporations income Problems: 1. A domestic corporation had the following data in its second year of operations: a. Capital gain on sale of land in Thailand, on a selling price at fair market value of P5,000,000 P2,000,000 b. Capital loss on sale of land and building in the Phils on a selling price of P6,000,000 400,000 c. Capital gain on direct sale to buyer of shares of stock of a domestic corporation 200,000 d. Gross profit from sales e. Interest on bank deposits f. Expenses of operations Compute for the following: 3,000,000 150,000 1,000,000 Capital gain taxes? Final tax on passive income? Year-end tax? Total income tax expense for the year? 2. A domestic corporation had, in its fourth taxable year the following data: Gross profit from sales P5,000,000 Expenses of operations 3,000,000 (Disregard quarterly income tax payments) Minimum corporate income tax? Normal income tax? Income tax of the year? 3. A domestic corporation had the following data in its fifth year of operations: 34 Gross profit from sales P3,000,000 Interest income from notes receivable Expenses of operations 100,000 2,100,000 (Disregard quarterly income tax payments) Minimum corporate income tax? Normal income tax? Income tax expense for the year? 4. In the sixth year of operations, a domestic corporation, a service provider, had the following data: Gross revenue P7,000,000 Cost and expenses: Direct cost of services 4,000,000 Other operating expenses 1,000,000 (Disregard quarterly income tax payments) Minimum corporate income tax? Normal tax? Income tax expense for the year? Excess MCIT carry-forward – it is an excess of MCIT over its estimated normal tax, and it is usually carried forward on the next three (3) consecutive years against normal tax. Example: Year MCIT NT Income tax 4 90,000 50,000 90,000 35 Taken from Remarks Excess MCIT of 40,000 5 60,000 40,000 60,000 6 20,000 30,000 0 7 50,000 40,000 50,000 8 30,000 70,000 40,000 Excess MCIT of 20,000 30,000 is taken from excess MCIT in Year 4 Balance of 10,000 from Year 4 Excess MCIT of 10,000 30,000 is taken from Year 5 (20,000) and Year 7 (10,000) Year 4 excess of 10,000 has already been forfeited. Problem: 1. The following were computed income taxes (MCIT and NT) of a domestic corporation: Year MCIT NT 7 70,000 20,000 8 10,000 30,000 9 40,000 15,000 10 2,000 5,000 11 45,000 80,000 (Disregard quarterly income tax payments) Required: Income tax at the end of each year? 36 2. A domestic corporation had the following data at the end of each of the first three quarters, and end, of its fifth year of operations: First Second Third Year Gross profit fro 400,000 600,000 700,000 900,000 160,000 400,000 520,000 580,000 m sales Operating expenses Income tax due at the end of each of the first three quarters, and due at refundable at the end of the year. 3. A domestic corporation had the following data on transactions in each of the quarters of a taxable year: First Second Third Fourth Gross profit from sales 500,000 Dividend from a domestic corporation 20,000 Interest on bank deposit Operating expenses 450,000 350,000 800,000 900,000 20,000 4,000 8,000 12,000 340,000 810,000 450,000 Income tax due at the end of each of the first three (3) quarters, and due or refundable at the end of the year? 4. A foreign corporation is doing business in the Philippines through its branch in the Philippines. Philippine operations in its fifth year in the Philippines had the following data: Gross income from operations of the year Interest on Philippine currency bank deposit Operating expenses of the year Remittance of profits to John Company, its Mother Company abroad (net of remittance tax) How much is the minimum corporate income tax? 37 P8,000,000 100,000 4,000,000 425,000 How much is the aggregate income taxes of the year? 5. A foreign corporation not licensed to do business in the Philippines derived an income ofP4,000,000 from a incidental transaction in the Philippines, on which the total of related expenses was P300,000. How much is the income tax to be paid in the Philippines. 6. The domestic corporation is a private educational institution in its fifth year of operations, with the following data on income and expenses for the year: Gross income from tuition fees P5,000,000 Gross income from miscellaneous fees 600,000 Gross income from rentals, net of a 5% creditable withholding tax 190,000 Interest on bank deposits, net of withholding final tax 48,000 Operating expenses 4,000,000 How much is the MCIT? How much is the income tax at the end of the year? 38 Chapter 8-Partnership, Estate and Trust Two kinds of partnership for income tax purposes: a. General professional partnerships; and b. Other partnership A general professional partnership is formed purely for the purpose of practicing the same profession and there will be no other business except for that purpose. Ex. Cesar and Jose are both lawyers. They can form a partnership to practice law. But they cannot use the same business for other purpose. A. Rules on general professional partnership and those that are not. Items General Professional Partnership Income tax Not subject to income tax Liability for income tax Liable only in their separate or individual capacities Based on the net income of the partnership Each partner shall report as gross income his distributive share in the partnership income subject to a 10% withholding tax, if the income is P720,000 and below. But if it exceeds P720,000 it will be 15%. Computation for the distributive share of the partners Share in the partnership Illustration: General professional partnership Assume the following: Partner I Partner J Gross income Partnershi p 600,000 80,000 90,000 Expenses of the operations 200,000 30,000 20,000 Quarterly income tax paid 39 Not a general professional partnership Subject to the rules on tax for corporations Both the partnership and the partners Based on the net income after tax of the partnership The share of a partner in the partnership’s distributive net income of a year, even if not actually received, will be considered actually received on the same year the net income is determined subject to 10% final tax. Not a general professional partnership Partnershi Partner Partner p K L 1,000,000 400,000 520,00 0 600,000 250,000 300,00 0 100,000 12,000 25,000 Income is to be shared equally Solution: Gross income Less: Expenses Net income Income tax at 30% Less: Quarterly income tax paid Income tax still due Distributive income: Net income Income tax Distributive income Gross income – share in the partnership income (1/2) Final tax at 10% Gross income – own 600,000 200,000 400,000 0 1,000,000 600,000 400,000 120,000 100,000 20,000 400,000 0 400,000 400,000 120,000 280,000 200,000 200,000 140,000 14,000 80,000 90,000 400,000 280,000 290,000 400,000 Less: Expenses - own 30,000 20,000 250,000 Personal exemption 50,000 50,000 50,000 200,000 220,000 100,000 Income tax (graduated rates) 37,500 42,500 14,500 Less: Withholding income tax by the partnership (10%) Less: Quarterly income tax paid Income tax still due 20,000 20,000 Total Taxable income 140,00 0 14,000 520,00 0 520,00 0 300,00 0 50,000 170,00 0 30,000 12,000 25,000 17,500 22,500 2,500 5,000 B. Tax Formula for Taxable Estate and Taxable Trust Items Taxable Income Tax exemption Taxable Estate Taxable income is the same as individual except that a special deduction for any amount of income paid, credited or distributed to the heirs P20,000 40 Taxable Trust The same as taxable estate and in addition a special deduction for any amount of the income applied for the benefit of the grantor. P20,000 Tax rates Income tax returns (ITR) Graduated rates for individuals. Creditable withholding tax on the heir – 15%, Shall be filed if the gross income is P20,000 or more and the tax paid by the executor or administrator. Graduated rates for individuals. Creditable withholding tax on the beneficiary – 15%. Same as taxable estate and tax is paid by the fiduciary. Illustration: The estate administrator and the heirs as income taxpayers. Mr. Reyes died leaving a net estate of P3,000,000. The heir of the estate is Mr. Cruz. Gross income of the estate Expenses of the estate Withholding income tax (5%) Amount given to Mr. Cruz P300,000 50,000 15,000 50,000 Data for Mr. Cruz: From the properties (called corpus) From the current year’s income Expenses Income tax withheld from Mr. Cruz P100,000 50,000 10,000 7,500 Gross income Additions/Deductions Expenses Income distribution Net income Less: Exemption Taxable income Income tax (graduated rates) Less: Withholding income tax on rent Income tax still due Estate P300,000 Beneficiary – Mr. Cruz P50,000 (50,000) (50,000) 200,000 (20,000) 180,000 32,500 (10,000) 50,000 90,000 (50,000) 40,000 4,000 (15,000) (7,500) 17,500 (3,500) Illustration if we include the trust: Assuming a taxable trust administered in the Philippines, had gross income from the property held in trust of P490,000 and expenses of P350,000. There was a quarterly income tax paid of p2,500. It was provided in the trust documents that P10,000 of each year’s net income shall be used for the payment of premium of life insurance of the grantor. For the year it distributed P40,000 out of the year’s income to the beneficiary. Shown below is the computation of the income tax of the trust. Gross income P490,000 41 Less: Deductions for: Expenses Distribution to heir Distribution to grantor Exemption Total deductions Taxable income Income tax Less: quarterly payments Income tax still due (350,000) (40,000) (10,000) (20,000) (420,000) 70,000 8,500 2,500 6,000 Problem Solving: 1. PJ & Co is a general professional partnership, with Partners Pedro and Juan sharing equally in the partnership net income or net loss. In a calendar year, the partnership and the partners had the following income tax data: PJ & Co: Gross income Expenses of operations P1,000,000 400,000 Partner Pedro: Gross income Expenses related to the gross income 600,000 300,000 Partner Juan: Gross income Expenses related to the gross income 700,000 450,000 (Any distribution made to the partners was subjected to a creditable withholding income tax.) How much is the income tax of all the taxpayers? 2. RD & Co is a general professional partnership. Its partners, Mr. Ric and Mr. Dan share equally in the partnership net income or net loss. The partnership and the partners had the following information: RD & Co: Gross income Expenses of operations P1,200,000 500,000 Advances made by the partners form partnership income: Partner Ric 200,000 Partner Dan 100,000 Partner Ric: Gross income (not including amounts received from RD & Co) 42 900,000 Expenses related to the gross income 460,000 Gross income (not including amounts received from RD & Co) Expenses related to the gross income 500.000 600,000 Partner Dan: (Any distributable net income to the partners was subjected to a creditable withholding income tax) How much is the income tax of all the taxpayer? 3. FE & Co is a general partnership in trade, with partners Fred and Erap sharing equally in the net profit or net loss. The partnership and the partners had the following information: FE & Co Fred Erap Gross income P2,000,000 P700,000 P800,000 Expenses 1,000,000 320,000 410,000 How much is the income tax of the partnership? How much is the income taxes of the partners? 4. MG & Co is a trading company, a partnership with Messrs. Mike and Glorio sharing equally in the partnership net income or net loss. Data for the year 2013 (fourth year of operations) follow: Gross income Expenses Advances from year’s net income: To Mike To Glorio P6,000,000 5,800,000 300,000 0 How much is the income tax of the partnership, if any? What are the income taxes of the partners? 5. Mr. Rosales died leaving a net estate of P10,000,000. He had two (2) children, Messrs. Ron and Job. The estate is under administration. Data are as follow: Estate Ron Job Gross income P900,000 P400,000 P360,000 Expenses 200,000 100,000 120,000 Distribution of income: To Ron 50,000 To Job 100,000 Income taxes were withheld when proper: How much is the income tax of the estate? How much is the income tax still due from each of the heirs? 6. Under the terms of a trust, Mr. Kent, the fiduciary, must accumulate the income of the trust and turn over such income to the beneficiary, Mr. Larry, 43 when Mr. Larry shall have finished a college degree, but to make a distribution or application of such income, if Mr. Larry shall need the money to finish his college course. In a taxable year the trust had the following information: Gross income Distribution of income to beneficiary P500,000 40,000 On any taxable gross income, deduction is taken at forty percent (40%) of such gross income. Income taxes were withheld when proper. The income tax still due from any party to the trust relationship? 7. Mr. V created 2 trusts (No1 and No2) in favor of Mr. T. No1 and No2 had a net income from their respective properties of P400,000 and P700,000, after a distribution of income by each of P40,000 to Mr. T. There were withholding taxes , when required. Income tax shown on the income tax return of No1 and No2? Income tax still due from No1 and No2? Income tax still due from Mr. T if he claims a deduction equal to 40% of any taxable gross income? CHAPTER 9: TAX ON JOINT VENTURES AND CO-OWNERSHIP 1. Joint Ventures Joint Venture – Not a Corporation 1. Provision of law based on the meaning of a corporatio n in taxation 2. Income taxation 3. Application a. Joint ventures for the purpose of undertaking construction projects b. Joint ventures for engaging in petroleum, coal, geothermal and other energy operations pursuant to an operating or consortium agreement under a service contract with government. These joint ventures are not subject to income tax, but each member of the joint venture shall be taxable on the share of income distributed by the joint venture. A Co and B Co both in construction business formed a joint venture to build condo projects with an agreed sharing of income to be divided 44 Joint Venture – Corporation Except joint ventures mentioned as not a corporation. Subject to income tax, but the distributable income is exempt from income tax under the provision of intercompany dividend. X Co and Y Co, are both freight and brokerage companies. They equally. Joint Vent ure Gro 40,0 ss 00,0 inco 00 me Exp 20,0 ens 00,0 es 00 Qua rterl y inco me paid A Co B Co 70 0,0 00 80 0,0 00 25 0,0 00 12 5,0 00 30 0,0 00 16 0,0 00 formed a joint venture, contributing their resources agreeing to divide the income equally: Joint Ventu re Gros 3,000 s ,000 inco me Expe 1,500 nses ,000 Quat 300,0 erly 00 inco me tax Solution: A. Joint Venture – Not a Corporation Gross Income Less: Expenses Taxable income Distributable income Share in the joint venture Own gross income Total Less: Own expenses Taxable income Income tax as corporation (30%) Less: Quarterly income tax paid Income tax still due Joint Venture 40,000,000 20,000,000 20,000,000 20,000,000 45 A Co B Co 10,000,000 10,000,000 700,000 800,000 10,700,000 250,000 10,800,000 300,000 10,450,000 3,135,000 10,500,000 3,150,000 125,000 160,000 3,010,000 2,990,000 B. Joint Venture – as a Corporation Gross income Less: Expenses Taxable income Income tax (30%) Less: Quarterly income tax paid Income tax still due Taxable income Less: Income tax paid Net income after income tax (distributable income) Share in the joint venture net income Income tax Joint Venture 3,000,000 1,500,000 1,500,000 450,000 300,000 X Co Y Co 525,000 525,000 Exempt (Intercompany dividend) Exempt (Intercompany dividend) 150,000 1,500,000 450,000 1,050,000 2. Co-ownership It is an instance or a situation when more than one person are the owners or heirs of one property and that they decided to settle the inheritance through amicable settlements among themselves. During the period of settlement, the property is administered by the appointed administrator among the heirs or all of the heirs for whatever has been agreed upon by all of the parties. So it is like a case of an estate not under administration by a third party, just like an extrajudicial settlement. Ex: Donation of property to two or more beneficiaries Rules: Provision of law Co-ownership 1. Exempt from income tax. 2. Limited to the preservation of property and collection of income therefrom 46 Not a co-ownership If the undivided income were invested by the co-owners in other income-producing activities or properties it becomes a partnership subject to tax like a corporation. Problem: Messrs ANDY and BERT inherited from their father a piece of land with an apartment thereon. The estate is not under administration. The property had a net income of P200,000. Solution: Coownership 200,000 Net income Income tax as a corporatio n Amount for distributio n Share in the coownership Final tax at 10% Add: Own business income Total Less: Personal exemptio ns Taxable income Not a Coownership 200,000 60,000 200,000 ANDY 100,000 BERT 100,000 140,000 ANDY 70,000 BERT 70,000 7,000 7,000 200,000 180,000 200,000 180,000 300,000 50,000 280,000 50,000 200,000 50,000 180,000 50,000 250,000 230,000 150,000 130,000 Problems: 1. Mr. Ramon died leaving a net estate of P15,000,000. The estate is not under administration. In a year , the estate had a net income of P2,000,000 without any distribution of property or income to the heirs. The heirs are Mr. Chit and Mr. George, both without any income from other sources. From any taxable gross income, each claims a deduction equal to forty percent (40%) of such gross income. Income taxes were withheld when proper. What is the income tax due from the estate? What is the income tax of each of the heirs? 2. Messrs Ric and Rod allocated between themselves, at one-half each, a piece of land that they inherited from their father. Seeing the potential of the 47 property on earning income, they contributed P2,000,000 each to build a high-rise building to be rented out to the tenants. In a taxable year, the property had the following data: Rent ncome, net of a 5% withholding income tax Expenses on the property P9,500,000 4,000,000 How much is the income tax due from each of the owner? 3. High Co and Low Co are in construction business. They formed a joint venture to build a high-rise condominium building for an owner of land contributing labor and capital, with an agreement to share equally in the net income or net loss from the project. IN the year that the building was started and completed, the construction project occasioned to High Co and Low Co the following: Gross income Expenses of operations Interest expense paid to banks P4,000,000 1,200,000 100,000 How much is the income tax of the joint venture? How much is the income tax of High Co and Low Co? 4. Jake Co and Kay Co are both operating bus companies. They formed a joint venture, pooing their resources on a project of transporting people and cargo from Manila to any parts of the Philippines. They agreed participation in the net income or net loss of the joint venture equally every end of the year. The joint venture and the members had the following data: Gross income Expenses Joint venture 20,000,000 9,000,000 Jake Co 8,000,000 4,000,000 Kay Co 5,000,000 2,000,000 How much is the income tax of the joint venture? How much is the income tax of the members of the joint venture? CHAPTER 10 – GROSS INCOME – CAPITAL GAINS AND LOSSES Capital assets are those assets not used in business. Else, it is an ordinary assets. Four categories of ordinary assets are: 48 a. Stock in trade or other property of a kind, which can be included in the Inventory of the taxpayer at the end of the taxable year. b. Property held by the taxpayer in the ordinary course of business or trade. c. Property used I trade or business subject to allowance for wear and tear. d. Real property used in trade or business. Rules on capital and losses a. The transaction on the capital asset should be a sale or exchange. b. With the transaction being a sale or exchange, if the taxpayer is: Corporation An individual, estate or trust The capital gain or loss should always be The capital gain or loss should be considered at 100% regardless of the considered at: length of the holding period of the asset 1. 100%, if the asset was held for not more than 12 months 2. 50%, if the asset was held for more than 12 months. Capital losses are deductible only to the Capital losses are deductible only to the extent of capital gains extent of capital gains. Net capital loss carry-over is not Net capital loss carry-over is available. available Net capital loss carry-over. If any taxpayer, except corporation will sustain in any taxable year a net capital loss, such loss, in an amount not in excess of net income of such year, shall be treated as a loss in the succeeding year from a sale or exchange of a capital asset held for not more than 12 months. Example 1: Mr. Mar, a citizen of the Philippines, had the following income and losses for the calendar year2011: Net income from business Gain on sale of ordinary asset Gain on sale of capital asset held for six months Loss on sale of capital asset held for fourteen months Loss on sale of ordinary asset Dividend from a resident corporation P250,000 20,000 12,000 10,000 24,000 30,000 How much is the taxable income for 2013? Solution: Net income from business Dividend income Gain on sale of ordinary asset Loss on sale of ordinary asset Ordinary net income Gain on sale of capital asset held for 6 mos 100% thereof Loss on capital asset held for 14 mos 250,0000 30,000 20,000 24,000 12,000 12,000 10,000 49 (4,000) 276,000 50% thereof Net capital gain Total Less: Basic personal exemption Taxable income 5,000 7,000 283,000 50,000 233,000 Example 2: Mr. No, a citizen of the Philippines, had the following data for 2012 and 2013: Net income from business Interest from notes receivables Capital gain on assets: Personal computer held for 8 months Appliances, held for 2 years Capital loss on redemption bonds, held for 4 years 2012 90,000 2,000 2013 78,000 4,000 30,000 40,000 70,000 How much is the taxable income for 2012 and 2013? Solution: Net income from business Interest income Ordinary net income Capital gain (100%) Capital gain (50%) Capital loss (50%) Net capital loss Net capital loss carry-over from 2102 Net capital gain Total Less: Basic personal exemptions Taxable income 2012 90,000 2,000 92,000 2013 78,000 4,000 82,000 30,000 20,000 35,000 (5,000) (5,000) 50,000 15,000 97,000 50,000 42,000 47,000 Example 3: Mr. O’Brien, a citizen of the Philippines, had the following data for 2012 and 2013: 2012 2013 Net income from business 80,000 90,000 Interest from notes receivable 4,000 2,000 Capital gain on shares of foreign corporation held for 3 50,000 years Capital gain on appliances held for 8 months 70,000 50 Capital loss on bonds, held for 5 months 120,000 How much is the taxable income for 2012 and 2013? Solution: Net income from business Interest income Ordinary net income Capital gain (50%) Capital gain (100%) Capital loss (100%) Net capital loss Net capital loss carry-over from 2012 Net capital gain Total Less: Basic personal exemptions Taxable income 2012 80,000 4,000 84,000 2013 90,000 2,000 92,000 25,000 70,000 120,000 (95,000) (34,000) 50,000 36,000 128,000 50,000 34,000 78,000 Problem solving: 1. The taxpayer is a corporation: Gross income from business Business expenses Gain on sale of capital asset held for 8 mos Loss on sale of capital asset held for 4 years How much is the taxable income? P6,000,000 2,000,000 100,000 150,000 2. The taxpayer is an individual: Gross income from the practice of profession Expenses on the practice of profession Gain on the sale of capital asset held for three (3) years Loss on sale of capital asset held for nine (9) months How much is the taxable income? P1,000,000 600,000 300,000 60,000 3. Taxpayer is a taxable estate: Gross income from business Expenses of the business Capital gain on assets: Held for two (2) years Held for six (6) months Capital loss on assets: Held for two (2) months Held for two (2) years 2012 2,000,000 2013 3,000,000 1,800,000 1,600,000 400,000 400,000 450,000 100,000 51 How much is the taxable income for 2012 and 2013? 4. Taxpayer is an individual: Year 2012: Net capital loss of P200,000 when the net taxable income was P150,000. Year 2013: Gross income from rent P4,000,000 Expenses of the rent 3,200,000 Capital gain on asset held for two(2) years 400,000 Capital loss on asset held for five (5) months 100,000 How much is the taxable income for 2013? Chapter 11- Income from business, dividends, interest, rent and services 52 Gross Income = Total Sales – Cost of goods sold + any income from incidental and outside sources. This any income could be dividend income, interest income, or gain on sale of assets not subjected to a final tax or capital gains tax. Dividends – represents a distribution of profits. Direct dividends – is one where the paying corporation declares that the distribution is a dividend payment. Normally, it is embodied in a resolution by the Board of Directors. Indirect dividends – is a distribution of profits in the form of payment of services, properties , etc. Examples of Indirect dividends: 1 2 3 4 Payment to a stockholder on property purchased from him in excess of the FMV of the property. The excess is an indirect dividend. On payment to a stockholder for services rendered to the corporation at an amount in excess of reasonable compensation for the services. On cancellation of indebtedness of the stockholder to the corporation. Payment to the stockholder for transportation expenses, representation, and etc. Dividend is exempt from income tax if: 1 2 Received by a domestic or resident corporation. Stock dividend Dividend is subject to final tax if: 1 2 Received by an individual from a domestic corporation. Received by a non-resident corporation from a domestic corporation. Cash and property dividend: 1 2 Cash dividend when taxable , the measure of money received is the basis. In property dividend, the basis of taxable income is the fair market value of the property received. Stock dividend: Under the NIRC the stock dividend may or may not be taxable. A stock dividend is taxable if it gives the shareholder an interest different from that which his former stock represented. Proportionate interest of shareholders before and after a stock dividend 53 Case A. Stock dividend is not taxable Stockholder Before Dividends: Shares A B C D E 100 100 100 100 100 500 Before Dividends: % of ownership 20 20 20 20 20 100 Stock Dividend: 10% After Dividends: Shares 10 10 10 10 10 50 110 110 110 110 110 550 Stock Dividend: 10% After Dividends: Shares 10 110 100 110 100 110 530 After dividend: % of ownership 20 20 20 20 20 100 Case B. Stock dividend is taxable Stockholder Before Dividends: Shares A B C D E 100 100 100 100 100 500 Before Dividends: % of ownership 20 20 20 20 20 100 10 10 30 After dividend: % of ownership 20.76 18.88 20.76 18.88 20.74 100 Taxable/ non-taxable stock dividend determined by the classes of stock issued and outstanding at the time of dividend: Stock issued and outstanding Common Common Common and preferred Common and preferred Stock dividend Taxable/Not taxable? Common Preferred Common Preferred Not taxable Not taxable Taxable Taxable Determination of the New Cost per share 1 Using the FIFO Method Ex. Mr. ALBA, a resident citizen of the Philippines., acquired shares of stock of BOSS Com., a resident foreign corporation and sold some of such shares directly to a buyer. The shares of stock of BOSS Com. that are issued and outstanding are common shares only. Transactions were: 54 Purchases and dividend; Feb 14, 2012, 100 shares, at P13,200; June 5, 2012, 60 shares , at P8,250; November 2, 2012, 20 shares at P2,640. June 2, 2013 18 shares, as stock dividend, with fair market value of P140 per share. Sale: July 5, 2013, 80 shares at P142. Taxable dividend income? New cost per share after receipt of the stock dividend, if costing is FIFO method? Gain or loss on the sale? Capital loss or gain to consider in computing the taxable income at the end of the year? Solution: Date of Purchase Lot 1 Lot 2 Lot 3 February 14, 2012 June 5, 2012 November 2, 2012 Shares before Dividend 100 shares Total Cost Shares After Dividend Per Share P13,200 110 shares P120 60 shares P8,250 66 shares P125 20 shares P2,640 22 shares P120 Sale, July 5, 2013 Selling Price (P142 x 80 shares) P11,360 Less: Cost (P120 x 80 shares) 9,600 Gain on sale of shares 1,760 P 50% of capital gain P 55 880 2 Using the Moving Average Method. Ex. COSME Company is a domestic corporation. It had investment in the shares of stock of JOSH Company, a resident corporation. Acquisitions were: March 5, 2012, Purchase of 200 shares for P20,000. July 7, 2013, Purchase of 100 shares for P13,000 October 2, 2013, Purchase of 50 shares for P4,800. November 2, 2013, receipt of 20% Stock dividend. Sale directly to a buyer: November 10 2013, sale of 70 shares for P6,300. Taxable stock dividend? New cost per share after receipt of the stock dividend, if costing is moving average method? Gain or loss on the sale? Capital gain or loss to consider in computing for the taxable income at the end of the year? Solution: Date March 5, 2012 July 7, 2013 October 2, 2013 No. of shares 200 shares 100 shares 300 shares 50 shares 350 shares 70 shares Cost/share P100 P130 P110 P96 P108 56 Total Cost P20,000 P13,000 P33,000 P4,800 P37,800 0 420 shares P90 P37,800 Sale, November 10, 2013: Selling Price (70 shares) P6,300 Less: Cost (P90 x 70 shares) P6,300 Gain on sale 0 Capital loss to consider 3 0 Assuming another classes of shares were issued as dividends: For example, preferred shares: Problem example: Mr. ERNIE, a resident citizen of the Philippines acquired on June 2, 2011 100 common shares of stock at P150 per share, of FOX Co., a resident corporation. Mr. ERNIE received a one hundred percent stock dividend in preferred. At the time of the receipt of dividend, the fair market value of the shares were: Common, P200 per share, and preferred, P50 per share. On Feb 14, 2013, ten common shares were sold at P220 per share, and ten preferred shares were sold at P55 per share. New cost per share after receipt of the stock dividend, of common shares? Of preferred shares? Capital gain or loss to consider in year-end taxable income? Solution: Acquisition cost (P150 x 100 shares) P15,000 Fair market value at the time of dividend, common (P200x100 shares) P20,000 Fair market value at the time of dividend, preferred (P50 x 100 shares) P 5,000 Total Adjusted cost To common P25,000 Per class P12,000 Per share P120 57 (P20,000/P25,000 x P15,000) To preferred (P5,000/P25,000 x P15,000) P3,000 P30 Common P2,200 Preferred Sale of: Selling price Common (P220 x 10 shares) Preferred (P55 x 10 shares) Less: Cost Common (P120 x 10 shares) Preferred P30 x 10 shares) Gain on sale 50% of the capital gain P550 P1,200 P300 P250 P125 P1,000 P500 Liquidating dividend – When a corporation distributes all of its assets in complete dissolution and liquidation, there is no dividend income to the shareholder receiving a liquidating dividend. There is instead a sale or exchange of property. Any gain or loss sustained by the shareholder, whether individual or corporate, is taxable income or deductible loss. For example: Mr. FOE, a resident citizen of the Philippines. On April 5, 2008, he purchased 200 shares of stock of GAGA Corporation, a resident corporation with stock issued and outstanding of common only, for P22,000. On October 2, 2010, Mr. FOE received a 10% stock dividend. On Nov 2, 2010, GAGA Company was dissolved and Mr. FOE receiving a liquidating dividend of P90 per share. Capital gain or loss to consider in computing taxable income at the end of the year? Solution: Liquidating dividend received P90 x 220 shares P19,800 Basis of the shares to Mr. FOE P22,000 Capital loss P 2,200 50% of the capital loss 1,100 P 58 Interest income As a general rule interest income is subject to income tax. Rent The consideration paid by the lessee to the lessor for the use of the property of the latter is a taxable income. Included: The payment of obligations of the lessor to the third parties (e.g. loans, interest, taxes, insurance premiums, etc.) should be considered as additional rent income. Advance rentals: 1 2 3 If the advance rental is in the nature of prepaid rent, received by the lessor under a claim of right and without restrictions as to use, the entire amount is taxable at the time it was received. If the amount received is a loan, there is no income upon its receipt by the lessor. If the amount received is in the nature of security deposit for the faithful compliance by the lessee of the tems of the contract, there is no income to the lessor. Chapter 12- INCOME FROM FARMING AND OTHER SOURCES Farming Farm – includes stock, dairy, poultry, fruit, and truck farms , also plantations, ranches, and all lands used for farming operations. Farmers – all individuals, partnership, or corporation that cultivate, operate, or manage farms for gain or profit, either as tenants or as owner. The NIRC allows accounting for income and expenses of a farmer on a cash or accrual basis. 59 RULES IN THE COMPUTATION OF GROSS INCOME OF FARMERS: 1. A farmer distinguishes between livestock and farm products raised and sold, and livestock and farm products purchased and sold. a. For livestock and farm products purchased and sold, the measure of gross income is the profit from the sale; b. For livestock and farm products raised and sold, the measure of gross income si the selling price. 2. Expenses of raising livestock and farm products are deductions from gross income. 3. Proceeds of crop or livestock insurance constitute gross income; 4. A farmer on the accrual method of accounting considers inventories at the beginning and at end of the taxable year. An increase in inventory is reflected in increased gross income, while a decrease in inventory is reflected in a decreased gross income. 5. Loss from the sale of livestock and farm products does not go into the computation of gross income of a farmer in the cash method of accounting. For a farmer in the accrual method of accounting such loss is an item in the computation of gross income. ILLUSTRATIVE PROBLEMS: Problem 1. Sales of livestock and farm products raised Sales of livestock and farm products purchased 200,000 Sale of old farm tractor Expenses of raising livestock and farm products 300,000 Cost of livestock and farm products purchased and sold 120,000 Book value of farm tractor sold Increase in inventory (beginning-P6,000; ending-P10,000) Gross income from farming, if cash method of accounting? Gross income from farming, if accrual method of accounting? P800,000 50,000 20,000 4,000 Solution: 1. Cash method of accounting Sales of livestock and farm products raised Sales of livestock and farm products purchased 60 P800,000 P200,000 Less: Cost of purchases 120,000 Sale of old farm tractor P 50,000 Less: Book value 20,000 80,000 30,000 Gross income – cash method P910,000 2. Accrual method of accounting Inventory, end P Sales of livestock and farm products raised 10,000 P800,000 Sales of livestock and farm products purchased 1,000,000 200,000 Cost of livestock and farm products purchased P120,000 Inventory beginning 6,000 Total deductions (126,000) Sales of farm tractor P 50,000 Less: Book value 20,000 Gross income – accrual method 30,000 P914,000 Or Gross income, cash method P910,000 Add: Increase in inventory 4,000 Gross income – accrual method P914,000 Problem 2 Sales of livestock and farm products raised P900,000 Sales of livestock and farm products purchased 300,000 Rent income from farm equipment 5,000 61 Expenses of raising livestock and farm products 400,000 Cost of livestock and farm products purchased 350,000 Decrease in inventory ( beginning-P5,000; ending-P2,000) 3,000 1. Gross income from farming – cash method of accounting? 2. Gross income from farming- accrual method of accounting? Solution: 1. Cash method of accounting Sales of livestock and farm products raised P900,000 Sales of livestock and farm products purchased Less: Cost P300,000 350,000 Loss (P 50,000) Rent income from farm equipment 5,000 Gross income – cash method P905,000 2. Accrual method of accounting Inventory, end P Sales of livestock and farm products raised 2,000 P900,000 Sales of livestock and farm products purchased 1,200,000 300,000 Cost of livestock and farm products purchased P350,000 Inventory, beginning 5,000 Rent income from farm equipment (355,000) 5,000 Gross income –accrual method P852,000 Or Gross income, cash method P905,000 Less: Inventory decrease P 3,000 62 Loss on sale of livestock and farm products purchased 53,000 50,000 Gross income – accrual method P852,000 BAD DEBTS RECOVERY RULE ON THE RECOVERY OF ACCOUNTS PREVIOUSLY WRITTEN OFF It constitutes a receipt of taxable income if in the year of recognition of being worthless, the write off resulted in a tax benefit (reduction of taxable income) Year 1: Gross income Deductions before written off for bad debts Taxable income (net loss) before written off for bad debts Deduction for accounts receivable written off Taxable income (net loss) after written off for bad debts Year 2: Recovery of accounts written off Taxable income on the recovery Thus, Reported taxable income Year 1 Income recognized in bad debts recovery, Year 2 Correct taxable income in Year 1 reported in two years A Co 500,000 200,000 300,000 B Co 400,000 460,000 (60,000) C Co 500,000 495,000 5,000 2,000 298,000 2,000 (62,000) 6,000 (1,000) 2,000 2,000 2,000 None 6,000 5,000 298,000 2,000 0 0 0 5,000 300,000 0 5,000 Problem 1: Bad debts recovery P10,000 Gross income on the bad debts recovery? Answer: Gross income on the bad debts recovery P10,000 Problem 2: Taxable income, 2009 before write off of bad debts Write off of bad debts, 2009 P100,000 15,000 63 Recovery in 2010 on the account written off 15,000 Gross income in 2010 on the bad debts recovery? Answer : Gross income on the bad debts written off P15,000 Problem 3: Net loss 2009 before written off of bad debts P50,000 Write off for bad debts, 2009 10,000 Recovery in 2010 on the accounts written off 10,000 Gross income in 2010 on the bad debts recovery? Answer: P0. Problem 4: Taxable income, 2009, before written off of bad debts P20,000 Write off for bad debt, 2009 25,000 Recovery in 2010 on the account written off 25,000 Gross income in 2010 on the bad debt recovery? Answer: Gross income on the bad debt recovery P20,000 Problem 5: Taxable income, 2009, before write off for bad debt P20,000 Write off for bad debt, 2009 25,000 Recovery in 2010 on the accounts written off 12,000 Gross income in 2010 on the bad debt recovery? 64 Answer: Gross income on the bad debt recovery P7,000 TAX REFUND As a general rule, tax refund related to business or exercise of profession, is a taxable income. The following tax refunds are not taxable: 1. 2. 3. 4. Philippine income tax, except the fringe benefit tax. Estate or Donor’s tax, Special assessment; Income tax of a foreign country, if the taxpayer claimed for it, in the year it was paid or incurred, a tax credit against ( a reduction of) the Philippine income tax; 5. Stock transaction tax ( a business tax) CANCELLATION OF DEBT 1. It may amount to payment of income for services rendered and payment of indebtedness and therefore an income in that amount is realized by the debtor. 2. It may amount to a gift. It need not be included in the debtor’s income. 3. It may amount to a capital transaction which is a return of capital. Problem: Mr. A had an indebtedness of P100,000 to C Co: How much is the gross income of Mr. A if: The indebtedness was cancelled because Mr. A rendered services to C Co, worth P100,000? The indebtedness was cancelled because Mr. A rendered services to C Co., worth P80,000, with the balance still to be paid by Mr. A? The indebtedness was cancelled without Mr. A doing anything the cancellation being merely an act of liberality of C Co.? 65 Mr. A is a stockholder of C Co. and the indebtedness was cancelled without Mr. A doing anything, the cancellation being merely an act of liberality of C Co.? Solution: If Mr. A rendered services (income from personal services) P100,000 If Mr. A rendered services worth P80,000 (income from personal services) P80,000 If Mr. A did not do anything (gift) P0 If the creditor is Mr. A’s corporation (indirect dividend) P100,000 COMPENSATORY DAMAGES 1. If it constitutes returns of capital, it is not taxable. E. g. Moral damages for personal actions, such as alienation of affection, the slander or breach of promise to marry. 2. If it is recovery of lost profits, it is taxable. E. g. damages recovered in patent infringement. Problem: For patent infringement P500,000 For physical injuries 50,000 For unfair competition 400,000 For libel 100,000 For damage to property 60,000 Gross income from damage recoveries? Solution: Damage for patent infringement P500,000 Damages for unfair competition P400,000 66 Gross income from damage recoveries P900,000 PRIZE OR AWARD Prize or award received is generally taxable. (gains derived from labor) Exemption: 1. Prizes and awards received in recognition of religious, charitable, scientific, educational, artistic and literary or civic achievements are exclusions from gross income if: a. The recipient was selected without any action on the his part to enter a contest or proceedings. b. The recipient is not required to render substantial future services as a condition to receiving the prize or award. 2. Prizes and awards granted to athletes in local and international sports competition and tournaments held in the Phils or abroad and sanctioned by their national sports associations. 3. Prizes and awards in the nature of gifts. Problem: Prizes won in an essay contest P The Nobel Peace Prize 50,000 500,000 Award won for honesty at work 10,000 Prize won by Manny “Pacman” Pacquio in a world billard competition 1,000,000 Gross income from the prize? Solution: Prize won in an essay contest (gain derived from labor) but with final tax P50,000 67 CHAPTERS 13 – OPTIONAL STANDARD DEDUCTION DEDUCTIONS: 1. Optional standard deduction (OSD) or 2. Itemized deductions Deductions – it is defined as the amounts allowed by law to reduce the gross income to taxable income. The OSD is a deduction from gross income allowed to be taken in lieu of the itemized deduction. It can be claimed by any type of taxpayer who are exclusively enumerated below. Excluded also are those taxpayers who are receiving compensation income. Who can claim OSD? Individual taxpayer Gross income from self – employment 1. A resident citizen 2. A non-resident citizen 3. A resident alien Corporation and partnership Gross income from business 1. Domestic corporation 2. Resident corporation 3. General professional partnership 4. Any other entity on which the rules for domestic corporations apply (i.e. partnership other than general professional partnership, taxable joint ventures, and 68 taxable co-ownerhip) Illustrative application of the two taxpayer: 1. Merchandising Business Individual Gross sales Sales returns Sales discounts Net sales Less: Cost of sales Inventory, beg Purchases Purchase returns Purchase discounts Total Freight in Goods available for sale Inventory, end Gross profit from sales Less: OSD 1,200,000 x 40% 545,000 x 40% Balance Less: Personal exemption Taxable income 1,200,000 Corporatio n 1,200,000 150,000 150,000 1,050,000 1,050,000 505,000 505,000 545,000 545,000 100,000 50,000 30,000 500,000 20,000 10,000 30,000 470,000 500,000 15,000 515,000 10,000 480,000 218,000 69 65,000 50,000 327,000 0 15,000 327,000 B. Service Business Gross revenues Less: Direct cost of services Rentals Depreciation Medical supplies Electricity water, and light Salaries and 13th month pay Gross income Less: OSD 980,000 x 40% 460,000 x 40% Basic personal exemption Taxable income Individual 980,000 Corporatiom 980,000 520,000 520,000 460,000 460,000 120,000 20,000 50,000 150,000 180,000 392,000 50,000 184,000 0 18,000 276,000 Reminder: A taxpayer that claimed the OSD is not required to submit with the Income Tax Return any financial statement, but the taxpayer should keep records pertaining to gross income. CHAPTERS 14 – Itemized deductions Itemized Deductions – are expenses and losses related to trade or business. They areL a. Interest b. Taxes c. Losses d. Bad debts e. Depreciation f. Depletion g. Pension trust h. Charitable and other contributions i. Research and development 70 j. Expenses in general Interest it must be paid or accrued on the taxpayer’s indebtedness. Indebtedness is a sum of money owned by one person who is unconditionally bound to pay, and interest is the amount paid for the use of money. Generally it is 100% deductible but there will be downward adjustments, if the taxpayer has interest income subject to final tax, the otherwise allowable deduction for interest expense will be reduced by an amount equal to 33% of interest income subjected to final tax. But interest paid or accrued on taxes related to business or practice of profession can be deducted in full. Example: X Company, a domestic corporation, with interest income on bank deposit of P4,000, had the following data on interest expense during taxable year: Interest expense on trade notes payable P 5,000 Interest expense on late payment of business taxes 10,000 The deduction for interest expense would be computed as follows: Interest expense on trade notes payable P5,000 Less: 33% of P4,000 P3,680 1, 320 Interest expense for late payment of business 10,000 Deduction for interest expense P13,680 Interest on asset acquired 1. As an outright deduction from gross income or 2. As a capital expenditure to form part of the cost of the asset. Example: 71 A company borrowed P10,000,000 from a bank to construct a building to be used in business. Interest on it was deducted in advance by the bank and the amount released to A company was P8,000,000. The transaction will result in> Alternative 1. Cost of the building subject to depreciation P8,000,000 Prepaid interest 2,000,000 Or Alternative 2: Cost of the building subject to depreciation P10,000,000 Problem: A Company is under accrual method of accounting. In in 2010: Cost of the building constructed P5,000,000 Life of the building 20 years Interest on bank loan for the next 5 year, used to finance construction Of building 1,000,000 Deduction in 2010, and in subsequent years, if interest expense is claimed as a deduction for interest? Deduction in 2010, and in subsequent years, if interest expense is capitalized? Solution: a. If interest is claimed as deduction: Interest expense in 2010 and each of the next four years (P1,000,000/5) P200,000 Depreciation per year (P5,000,000/20 years) 250,000 Total deductions in 2009 and each of the next 4 years P450,000 Deduction beginning the sixth year P250,000 72 b. If interest is treated as a cost of the asset: Deduction each year beginning with 2009: (P6,000,000/20 years) P300,000 TAXES Taxes paid or accrued in connection with the business are deductible from gross income except: 1. 2. 3. 4. 5. 6. Philippine income tax except for fringe benefit tax. Donor’s tax Special Assessment Income tax imposed by a foreign country. Stock transaction tax VAT Problem: Philippine income tax P100,000 Real estate tax 32,000 Donor’s tax 10,000 Special assessment 2,000 Value Added Tax 15,000 Stock transaction tax 5,000 Basic and additional community tax 1,700 Percentage tax 6,000 73 Interest for late payment of tax 2,100 Surcharge for late payment of various business taxes 9,000 Compromise penalty for violations on payment of taxes 4,000 City food and beverage taxes 200 Deduction for taxes? Solution: Fringe benefit taxes P32,000 Real estate tax 10,000 Basic and additional community tax 1,700 Percentage taxes 6,000 City food and beverage tax 200 Total P49,900 LOSSES Losses are those actually sustained during the taxable year and not compensated by insurance or other form of indemnity. Requirements: 1. Incurred here in the Philippines. 2. Incurred in trade, business or profession. 74 3. Of property connected in the proceeding business, the loss was due to fire, storm, shipwreck, or other casualty, or from robbery theft or embezzlement. 4. The taxpayer must submit a declaration of loss, which must not less thatn 30 days nor more than 90 days from the date of the discovery of the casualty. Or robbery or theft or embezzlement; within 45 days from the discovery of the loss. Measure of loss: 1. The compensation that reduces the loss may be insurance or any other form of indemnity. 2. In case of partial loss of property used in trade or business or in the practice of profession, the measure of loss is the Cost to restore the property back to its normal operating condition or Book value, whichever is lower, reduced by insurance recovery or any form of indemnity. Problem 1: Total loss of an asset used in business in a casualty: Cost of the asset P2,000,000 Accumulated depreciation P1,100,000 Insurance recovery 400,000 Deductible loss? Solution: Cost of the asset P2,000,000 Less: Accumulated depreciation 1,100,000 Book value P Less: Insurance recovery 900,000 400,000 Deductible loss P Problem 2: 75 500,000 Partial loss on properties used in business 2 Asset 1 Cost to restore asset to its normal condition P200,000 P100,000 120,000 180,000 Book value of asset at the time of loss Insurance recovery 80,000 Asset 30,000 Deductible loss, Asset 1? Deductible loss, Asset 2? Solution: Asset 1 Asset 2 Cost to restore the property to its normal condition P200,000 P100,000 Book value of the asset P120,000 P180,000 Whichever is lower P120,000 P100,000 80,000 30,000 Less; Insurance recovery Deductible loss P 40,000 P70,000 NET OPERATING LOSS A net operating loss is the excess of allowable deductions over gross income of the business or enterprise for any taxable year. NET OPERATING LOSS CARRY-OVER (NOLCO) A Net operating loss will be carried over as a deduction from gross income for the next three (3) consecutive years immediately following the year of such loss. For example: In pesos Gross income Less: Deductions Net loss Net income 2006 500,000 2007 600,000 2008 700,000 2009 500,000 2010 800,000 900,000 500,000 750,000 420,000 450,000 80,000 350,000 (400,000) (50,000) 100,000 76 before NOLCO Less: NOLCO2006 2008 Taxable income 100,000 0 80,000 0 0 0 50,000 300,000 The unused net operating loss of P220,000 of the year 2006 could not be carried over beyond 2009. The net operating loss of 2008 could be carried over. Chapter 14 – Bad Debts, Depreciation, Contributions and Others BAD DEBTS Debts due the taxpayer, connected with trade or business, actually ascertained to be worthless and charged off within the taxable year. An account is worthless when it must be ascertained that with a reasonable degree of certainty that the amount is uncollectible. Cases: 1. 2. 3. 4. The flight or disappearance of the debtor Insolvency of the debtor The death of the debtor And other situations that may warrant worthlessness of the debt. If the property is mortgaged, where under a foreclosure of a mortgage, the mortgagee buys the mortgaged property and credits the indebtedness with the purchase price, the difference between the purchase price and the indebtedness will not be an allowable deduction for bad debt, for the property which was a security for the debt stands in place of the debt. The determination of the loss in such a case is deferred until the disposal of the property. Problem 1: 77 The taxpayer had the following journal entry in the books of accounts: Bad debts 50,000 Accounts receivable 50,000 How much is the deduction for bad debts? Solution: Deduction for bad debts P50,000 Problem 2: A Co., had a receivable of P500,000 from B Co. The indebtedness of B Co. was secured by a mortgage on the property of B Co. When B Co. could not pay, A Co., foreclosed the on the mortgage and the property was awarded to A Co., (highest bidder) at public auction for P400,000. The balance cannot be collected anymore. How much is the deduction for bad debts of A Co? Solution: P0. Problem 3: In 2010, A Co. sold the property for P450,000. How much is the deduction for bad debts of A company? Solution: Basis of the receivable uncollected P500,000 Less: Selling price of the property 450,000 Deduction in 2010 P 50,000 78 DEPRECIATION A REASONABLE ALLOWANCE for exhaustion, wear and tear (including allowance for obsolescence) of property used in trade or business. Depreciable assets 1. Tangible assets 2. Intangible assets (amortization) Methods of depreciation 1. 2. 3. 4. Straight line method Declining balance method Sum of the years digit method Any other method which may be prescribed by the sec of finance, upon recommendation of BIR. Problem: a. H co acquired a machine at a cost of P380,000. Scrap value was placed at P0, and the useful life was estimated at 25 years. Depreciation was computed on the straight line method. The annual depreciation would have been computed as follows: Cost P380,000 Less: Scrap value 0 Depreciable base P380,000 Annual depreciation (P380,000/25 years) P 15,200 b. If in the preceding example on H Co., after depreciating the asset for twenty years, it was determined that the life of the asset was not five years but ten years? Remaining depreciable cost (P380,000-P304,000) P76,000 New annual depreciation charge (P76,000/10 years) 7,600 DEPLETION 79 P The natural resources are called wasting assets. As the physical units representing such resources are extracted and sold such assets move towards exhaustion. Example: Land containing natural resources was purchased for P100,900,000. It was estimated that the land after exploration of its natural resource, wii have a value of P900,000. It was estimated that the natural resources supply was 5,000,000 tons. If withdrawal of resource from the land in 2009 was 500,000 tons, how much was the deduction for the year? Depletion charge per ton: Purchase price P100,900,000 Less: Residual value of the land 900,000 Depletion base P100,000,000 Resource supply in tons 5,000,000 Depletion rate per ton (P100,000,000/5,000,000 tons) Depletion for 2009 (500,000 x P20) 10,2000,000 P20 P PENSION TRUSTS Past service costs- Past services that requires lump sum payment to the pension fund. Present service costs – for each year after the pension plan was set-up, there should be a payment to the fund for pension for the services rendered during the year by the employees. This deduction for pension payments applies only to a pension plan that is funded. Problem: A pension fund was set up in 2000 for retiring employees. In setting up the fund, P1,000,000 was deposited as seed money for past service cost. Annual or present service cost is P50,000, beginning 2000. 80 Deduction in 2000? Deduction in 2008? Deduction in 2012? Solution: Deduction in 2000: 1/10 of P1,000,000, on past service cost Present service cost P100,000 50,000 Total P150,000 Deduction in 2008 P150,000 Deduction in 2012 (present service cost) P 50,000 CONTRIBUTIONS AND DONATIONS 1. DEDUCTIBLE IN FULL a. Donations to the GRP or to any of its agencies or political subdivisions, including fully owned government corporations, exclusively to finance priority activities in science, education, culture, health, economic development, human settlement, youth and sports development. b. Donations to foreign institutions or international organizations, in compliance with agreements, treaties or commitments entered id into by GRP and the foreign institutions in pursuance of special laws. c. Donations to certain accredited non-government organizations (non-profit domestic corporations), organized and operated exclusively for scientific, educational, cultural, character building and youth and sports development, charitable, social welfare, health and researches. 81 2. Deductible subject to limitations a. The recipient of the contribution or gift is any of: 1. The GRP or any of its agencies, or any political subdivision thereof, for exclusively public purposes (not included in the priority activities) or 2. Non-government accredited domestic corporations or associations which are: a. Domestic and b. Organized and operated exclusively for scientific, educational, cultural, scientific, educational, cultural, etc. 3. The amount should not exceed five percent (5%) of the corporation’s taxable income before deducting the contribution. Problem: N Co had a gross income from business of P1,000,000 and business expenses of P400,000. It made during the year a contribution that is fully deductible of P10,000 and contribution subject to limitation of P50,000. The deduction for contribution is P40,000 and the taxable income for the year is P560,000. Solution: Gross income from business P1,000,000 Less: Deduction for business expenses 400,000 Taxable income before contributions P 600,000 Less: Contributions subject to limitations: To L Association P10,000 To M Association P40,000 Total of actual P50,000 5% of P600,000 P30,000 Allowed (Whichever is lower) 30,000 Taxable income P570,0000 RESEARCH AND DEVELOPMENT COSTS 82 These expenses are for improvements of processes and formulas, as well as the development of improved or new product. Two ways to account for research and development: 1. For acquisition or improvement of property subject to depreciation or depletion . 2. Other research and development costs. a. As an outright deduction (for the full expenditures), in the year the expense was paid or incurred. b. As a deferred expense to be spread and recognized as deduction over a period of not less than 60 months from the date of acquisition of benefit from the expenditures. 3. Illustration: Research and development expenditures in 2012: For acquisition of land for use as research center P5,000,000 For constructing the research center building, with a useful life of 50 years 3,000,000 Others research and development costs 2,000,000 Benefit from the research expenditure will be received beginning 2013. Deduction for 2012 if availed of in one lump sum? Deduction every year/month if the expenditure is recognized as a deferred expense to be spread and recognized as deduction over a period of not less than 60 months beginning from the first month from which benefits were received from the expenditure. Solution: A. Research and development costs, deduction in one lump sum P2,000,000 B. A deferred expense of P2,000,000, from which there shall be a monthly deduction of P2,000,000 divided by 60 months (cannot be shorter, but can be longer), or P400,000 per year or P33,000 per month. EXPENSES IN GENERAL Two kinds of business expenditures; the revenue expenditures and capital expenditures. A revenue expenditures benefits only one period abd it is a deduction from gross income in the year paid and incurred. 83 A capital expenditure, usually incurred in the acquisition, betterment or permanent improvement of an assets benefits more than one accounting period, and it is not deductible from gross income in the year paid. An expense must satisfy the following conditions in order to be deductible from gross income: a. It must be ordinary and necessary; b. It must be paid or incurred within the taxable year; c. It must be in carrying on or directly attributable to, the development, management. Operations, and/or conduct in the trade or business, or the practice of a profession. d. It must be substantiated by official receipts (OR) and other adequate records. An expense is considered ordinary, if it is normal in relation to the taxpayer’s business and the surrounding circumstances. The expense need not be recurring. Salaries, wages and others. Compensation payments rendered to the taxpayer are deductible from gross income. A compensation payment is reasonable, if the same amount shall be paid for similar services by similar enterprises under similar circumstances. Any excess payments may be treated as distribution of earnings on stock or as a capitalized expense on the purchase price. Expenses under lease agreements: In addition to the regular rent, the lessee may have other payments, for which deductions may be taken. a. When a leasehold is acquired for a business purposes for a specified sum, the purchaser may take a deduction in his return an aliquot part of such sum each year, based on the number of years the lease will run. b. Taxes paid by the lessee to or for the lessor and other obligations of the lessor paid by the lessee under a lease contract constitute additional rent expense for the lessee. c. The cost of leasehold improvements may be recovered by the lessee over the remaining term of the lease, or over the life of the improvements whichever period is shorter. Example 1: R Company is a lessee of the building. Under the terms of the lease contract, it had to make the following payments: Monthly rental Premium on the fire insurance of the building Real estate tax on the land and building 20,000 The deduction of R Company for the year is a total of: 84 P50,000 10,000 Rentals for the year (P50,000 x 12) Premium on fire insurance Real estate tax P600,000 10,000 20,000 Total P630,000 Example 2: Santos Company, a lessee, constructed a building on leased land at a cost to him of P4,000,000. The useful life of the building is 50 years while the remaining term of the lease is 40 years. How much is the annual deduction for Santos Company? Solution: The annual deduction for Santos company is P4,000,000 divided by 40 years or P100,000. Repairs: Given the following accounting entries: Entry No. 1 : Repairs Cash P100,000 P100,000 Entry No. 2 : Accumulated depreciation Cash P1,000,000 P1,000,000 Explanation: Entry No 1. Records an expenditure which is deductible from gross income. This is just a minor repair that keeps an asset in its regular operating condition. Entry No. 2. Records an expenditure that is not deductible form gross income. The entry represents a major or extraordinary repair, that does not add value to the asset but prolongs its useful life. Cost of materials and supplies: Physical inventories to these items must be taken. The expense deductible to this item must be computed as follows: Inventories, beginning Add: Purchases of materials and supplies during the year 85 P300,000 600,000 Total Less: Inventories, ending P900,000 100,000 Deductible expense for materials and supplies during the year P800,000 Entertainment, amusement and recreation expenses: Expenses such as this is deductible from gross income if: a. Directly connected to the development, management, and operations of trade or business of the taxpayer; b. Directly related to the furtherance of its trade, or business; The deduction should not exceed one half percent (1/2%) of net sales (in the case of sale of goods) and one percent (1%) of net revenues (sale of services). Any expenses incurred that is contrary to law, morals, public policy or public order will not be allowed as deduction from gross income. Expenses of private educational institutions: An expenditure for expansion of school facilities is a capital expenditure, However, the school may treat the expenditures in two alternative ways: 1. Deduct the expenditure from its gross income in the year in which it was made; or 2. Capitalize the expenditure, and calim deduction by way of depreciation. Illustrative example: A private educational institution had a gross income of P50,000,000 and expenses of P30,000,000 before considering an expenditure of P4,000,000 for a building to separately house one of its colleges. The building has a useful life of 25 years. Taxable income under alternative treatments for the expenditures? Solution: a. When claimed as an outright deduction: Gross income Less: Expenses Net income before expenditure on building 20,000,000 86 P50,000,000 30,000,000 Less; Deduction for expenditure on expansion of school facilities 4,000,000 Taxable income P16,000,000 b. If depreciation is taken on the building: Gross income P50,000,000 Less: Expenses P30,000,000 Depreciation of new building (P4,000,000/25 years) 160,000 30,160,000 Taxable income P19,840,000 Tax Filing and Tax Remedies Filing of Return and Payment of Tax An income tax return is a document wherein the taxpayer makes a report on his/her gross income and deductions to the Commissioner of Internal Revenue. Normally it is prepared by the taxpayer. However in case the taxpayer fails to make and file a return on time or makes a false or fraudulent return, a return so made will be prima facie evidence for all legal intents and purposes, unless the taxpayer proves the contrary. Who are required to file a return? 1. Individual: a. Citizen of the Philippines, residing in the Philippines. b. Citizen of the Philippines, residing outside the Philippines on his income from within. c. Resident alien, on his income from within the Philippines. d. Non-resident alien engaged in business or trade, or in the practice of a profession in the Philippines, on income from within the Philippines. 2. Taxable estate or trust; 3. Corporation; a. Corporation which is not exempt from income tax; b. Corporation which is exempt from income tax, but which had not complied with the administrative requirement on proof of exemption. (The corporation is required to file the return, but not required to pay the tax.) c. General professional partnership. Who are not required to file returns? 87 1. Individuals who is exempt from income tax. 2. Individual whose sole income has been subjected to final tax. 3. Individual whose gross income does not exceed the total personal and additional exemptions. (Unless engaged in business or practice of a profession within the Philippines, in which case regardless of the amount of gross income, an income tax return shall be filed) 4. Individual whose compensation income does not exceed the statutory minimum wage as fixed by those authorized by DOLE. 5. Individual with respect to pure compensation income derived within the Philippines qualified under Substituted Filing of Income Tax Return by Employees Receiving Purely Compensation Income” (Revenue Regulation 32002). The following conditions must be met: a. The income must be purely compensation income within the Philippines during the year. b. There was one employer only in the Philippines. c. The correct income tax was withheld on the income. d. The spouse is also entitled to substituted filing under a, b and c, above. e. The employer filed BIR Form 1604C with the BIR. f. The employer issued BIR Form 2316 to the employee with the signature of the employee and the employer. Who shall prepare the income tax return? 1. Individual a. A married person, whether citizen, resident alien or non-resident alien will file only one income tax return showing separately the income of both spouses. b. A parent will include in his return the income of an unmarried minor child derived from property received from a living parent, except when the transfer of such property was exempt from donor’s tax or the donor’s tax was paid. c. If the taxpayer is unable to make his own return, the return may be made by his duly authorized agent. The authority of the agent will be attached to the return. 2. Estate or trust. a. The fiduciary of the taxable estate or trust files the return. b. Should there be two or more fiduciaries, a return filed by one of the fiduciaries will be enough. 3. Corporation. a. The income tax return will be filed by the president, vice-president, or other principal officer and will be sworn to by the treasurer or assistant treasurer. b. In cases where there is a receiver or a trustee in bankruptcy, or an assignee is operating the property, such receiver, trustee or assignee shall make the income tax return for such corporation. c. General professional partnership 88 The income tax return shall be filed by the principal officer of the partnership. What should accompany the income tax return? Quarterly Gross Receipts a. Do not exceed P50,000 b. Exceed P50,000 but do not exceed P150,000 c. Exceed P150,000 Financial statements Statement of Net Worth of Operations Balance Sheet and Income Statement 1. Balance sheet and Income Statement duly certified by an independent CPA 2. Comparative income statement for the year and the preceding year. 3. Schedule of income producing property and income therefrom. 4. Duly accomplished Account Information Form (AIF) in the income tax return. 5. In appropriate cases, copy of the approval of the claim for tax incentive granted by the government agency administering the particular law. 6. For manufacturer, the Manufacturing Statement When should the income tax return be filed? 1. In the case of an individual whose income is purely compensation income, the return shall be filed on or before April 15, covering the income of the preceding year. 2. In the case of an individual with income from business or practice of a profession, quarterly and annual income tax returns should be filed, as follows: First quarter On or before April 15 Second quarter On or before August 15. Third quarter On or before November 15 Annual On or before April 15 of the succeeding year. 3. In the case of the taxable estate or trust, the income tax return should be filed on or before April 15, covering the income of the preceding year. 4. In the case of a corporation, quarterly and annual income tax return are required, as follows: First quarter to third quarter ( within sixty days after the close of the particular quarter) 89 Annual – On or before the fifteenth day of the fourth month following the close of the taxable year (calendar or fiscal year). 5. In the case of a general professional partnership, the information return is required to be filed on or before April 15, covering the operations of the preceding year. Where should the return be filed? It shall be filed on the authorized agent bank or the Revenue District office where you are assigned. If filed other than with the proper place, a surcharge of 25% will be added to the tax. Where, when and how is the income tax paid? Under the “pay-as-you-file system”, the income tax shown on the return shall be paid at the time the return is filed. If the taxpayer is other than a corporation and the income tax on the annual return exceeds P2,000, such tax may be paid in two equal installments, as follows: First installment - at the time the return is filed. Second installment - on or before July 15 Any creditable withholding tax will be credited against the tax due, or in the first installment of the tax due. Return on creditable withholding tax a. Withholding tax on compensation income 1. Monthly return – within 10 days after the close of the month. 2. Annual return – on or before January 31 of the succeeding year. b. Expanded withholding tax 1. Monthly return – within 10 days after the close of the month. 2. Annual return – on or before March 1 of the succeeding year. Foreign income tax credit A credit for foreign income tax paid or incurred reduces the Philippine income tax that should be paid. Tax credit is given to a taxpayer to provide a relief from onerous burden of taxation where the same income is subject to a foreign income tax and the Philippine income tax. In taking a tax credit: Tax credit is taken for Tax credit is taken against - the foreign income tax the Philippine income tax The foreign income tax should be understood as tax proper only without the interest, surcharge, or penalty incident to delinquency on the payment of tax. 90 Who may claim tax credit? a. Resident citizens of the Philippines; b. Domestic corporations How is tax credit computed? Illustration: B Co, a domestic corporation had a taxable income from within the Philippines of P300,000 and from Foreign country Z of P100,000. An income tax of P40,000 was paid to country Z. If B Co chose to take a tax credit for the income tax paid to country Z, the Philippine income tax due after tax credit would have been computed as follows: Taxable income before tax credit, Country Z Taxable income before tax credit, Philippines Taxable income, world Income tax at 30% Less: Tax credit for foreign income tax P100,000/P400,000 x P120,000 Foreign income tax paid Allowed (whichever is lower) Philippine income tax still due P100,000 300,000 P400,000 P120,000 P30,000 P40,000 30,000 P 90,000 While the income tax of the foreign country could be taken as a tax credit, the taxpayer has the option of taking the tax as a deduction from its gross income. Taxable income before foreign income tax: Country Z Philippines Total Less: Deductions for income tax, Country Z Taxable income Income tax at 30% P100,000 P300,000 P400,000 40,000 P360,000 P108,000 Deficiency Income tax and Penalties While good faith may be assumed in the voluntary filing of income tax return and payment of income tax by an individual or a taxable entity, however, human frailties may result in erroneous or fraudulent report of income tax data. Even though the income tax return is reflected in the Books, such Books of Accounts may not correctly record data on taxable income and deductible expenses. The BIR has the following powers to determine a corrected taxable income a. In case there are two or more organizations, trades or businesses, the BIR is authorized to distribute, apportion or allocate gross income and deductible 91 expenses between or among organizations, trades or businesses to prevent or determine evasion of taxes. b. The BIR may at any time conduct inventory of goods of any taxpayer as a basis of determining tax liabilities, if such has a reason to believe that such person is not declaring its correct income. c. When it is found that a business has failed to issue receipts and invoices, and that the Books do not reflect the proper sales or receipts. Net worth method of determining undeclared income 1. Statutory authority a. The net income will be computed upon the basis of the taxpayer’s annual accounting period in accordance with the accounting method regularly employed in keeping the Books of Accounts. b. If a report required by law as a basis is not forthcoming within the time fixed by law. The BIR will assess the proper tax on the best evidence available. 2. Accounting basis From the accounting equation: Asset minus Liabilities equals Networth, a year’s increase in networth of an individual is attributed to income. From this income is determined the taxable income by adding non-deductible expenses/losses and deducting non-taxable income/receipts and personal exemptions. The taxable income so computed is compared with the taxable income reflected in the income tax return to discover the under declaration of taxable income and the computation of deficiency income tax. PENALTIES Only civil liabilities will be discussed. a. Surcharge b. Interest Surcharge - a surcharge of 25% of the tax due will be imposed on the following cases: 1. Failure to file the return and pay the tax due on time. 2. Unless otherwise authorized by the Commissioner, filing a return with an internal revenue officer other than those with whom the return is required to be filed. 3. Failure to pay the deficiency tax within the time prescribed for payment in the notice and demand. 4. Failure to pay the full or part of the amount of tax shown an any return required to be filed of the full amount of tax due, on or before the date prescribed for the payment. A surcharge of 50%, of the deficiency tax, in case there is a deliberate and willful neglect to file the return or when a false or fraudulent return is willfully made. 92 A substantial under declaration of taxable sales, receipts or income, or substantial overstatement of deductions, will constitute prima facie evidence of false or fraudulent return. What is substantial? a. The failure to report sales, receipts or income in amount exceeding 30% of that declared per return. b. A claim of deductions in amount exceeding 30% of actual deductions. Interest a. In general, there will be assessed and collected on any amount unpaid amount of tax, interest at the rate of 20% per annum or such higher rate as may be prescribed by rules and regulations, from the date prescribed for payment until the amount is fully paid. b. Deficiency interest. Any deficiency in the tax due will be subject to interest at the rate of 20% per annum, which interest shall be assessed and collected from the date prescribed until the full payment thereof. c. Delinquency interest; In case of failure to pay: 1. The amount of tax due on any return required to be filed; or 2. The amount of tax due for which no return is required. 3. A deficiency tax, or any surcharge or interest thereon on the due date appearing on the notice and demand of the Commissioner. There will be assessed and collected on the unpaid amount, interest at the rate of 20% per annum until the amount is fully paid, which interest shall form part of the tax. d. Interest on extended payment 1. If any person is qualified and elects to pay the tax on installment, but fails to pay the tax on any installment, or any part of its installment on or before the prescribed date for its payment. 2. Where the Commissioner has authorized an extension of time within which to pay a tax or a deficiency tax or any part thereof There will be assessed and collected interest at 20% per annum on the tax or deficiency tax or any part thereof unpaid, from the date of notice and demand until it is paid. 93