INCOME TAX Presented by: LILYBETH A. GANER, CPA, MBA Revenue Officer RR-19, Davao City
Business Income • Any income not related to an employer-employee relationship • Generally taxable on the net income • Includes gains, profits and income in whatever form derived from any source, legal or illegal, such as – • Exercise of profession or vocation • Trade, business or commerce • Dealings in property • Fruits of the ownership or use of property • Interest, rent, dividends, securities • Other transactions of the business for gain or profit
Gross income • All income from whatever source derived, including but not limited to the following items: • Compensation for services, including fees, commissions and similar items • Gross income derived from business or exercise of profession • Gains from dealings in property • Interest • Rents
Gross income (cont.) • Royalties • Dividends • Annuities • Prizes and winnings • Pensions • Partner’s distributive share in the net income of general professional partnership
Net Income • The realized gross profit after deducting all the deductions allowed by law, statutes or generally accepted accounting principles. Exclusions • The total benefits which is not included in the computation of gross income for the purpose of determining taxable income. Deductions • Items or amounts which the law allows to be deducted from gross income to arrive at the taxable income.
Allowable Deductions • There shall be allowed as deduction from gross income, other than compensation income, expenses incurred in the conduct of trade or business to arrive at the net income. • At the taxpayers option, deductions for expenses may either be— • Itemized deduction • Optional Standard Deduction (OSD) – 40%
Requisites for Deductibility of Expenses • Ordinary and necessary • Paid or incurred within the taxable year • Incurred in the conduct of trade or business • Not contrary to law, morals, public policy or public order • Substantiated by sufficient proof • Subjected to withholding tax, if applicable
Itemized Deduction • Ordinary and necessary trade, business or professional expenses • Salaries & wages • Travel expenses • Rental expenses • Entertainment, amusement and recreation expenses • Interest • Taxes
Itemized Deduction (cont.) • Losses • Net Operating Loss Carry Over (NOLCO) • Capital losses • Losses from wash sales of stocks or securities • Wagering losses • Abandonment losses
Itemized Deduction (cont.) • Bad debts • Depreciation • Depletion of oil and gas wells and mines • Charitable and other contributions • Research and development • Pension trusts
Interest • There must be a valid and existing indebtedness; • The indebtedness must be that of the taxpayer; • The interest must be legally due and stipulated in writing; • The interest expense must be paid or incurred during the taxable year; • The indebtedness must be connected with the taxpayer's trade, business or exercise of profession;
Interest • The interest payment arrangement must not be between related taxpayers. • The interest is not expressly disallowed by law to be deducted from the taxpayer’s gross income (e.g., interest on indebtedness to finance petroleum operations); and • The amount of interest deducted from gross income does not exceed the limit set forth in the law.
Interest • Limitation The amount of interest expense paid or incurred from an existing indebtedness shall be reduced by an amount equivalent the following percentages of the interest income earned during the year which had been subjected to final withholding tax Jan. 1998 - 41% Jan. 1999 - 39% Jan. 2000 - 38% Nov 2005 - 42% Jan. 2009 - 33% Applies regardless of the date the interest bearing loan and the date when the investment was made for as long as, during the taxable year there is an interest expense incurred and an interest income earned.
Interest • EXCEPTIONS • Deductible in full from gross income • Interest on unpaid taxes – interest paid or incurred on all unpaid business-related taxes shall be deductible in full • Not deductible from gross income • a. Interest incurred on indebtedness of taxpayer using cash basis, • where the interest is paid in advance thru discount or otherwise • i. Allowed as a deduction in the year the indebtedness was paid • ii. If amortized – amount corresponding to the principal • amortized shall be allowed as deduction during the year
Interest • Not deductible from gross income • b. Interest payments between related parties as • specified in Sec. 36(B) of the Tax Code • c. Interest expense paid or incurred by Service Contractor engaged in the discovery or production of indigenous petroleum in the Phil. • d. Interest incurred on capital expenditures (optional) • Interest expense • Capital expenditure
Interest • RELATED PARTY TRANSACTIONS • [Sec. 36(B)] • Between members of the same family • Between a corporation and an individual who owns more than • 50% of the outstanding stock of the former • Between 2 corporations more than 50% of the outstanding stock were owned by the same individual • Between grantor and fiduciary of any trust • Between 2 fiduciaries of trust if the same person is the • grantor of each trust • Between fiduciary and beneficiary of the same trust
Taxes • All business related taxes • Non-deductible taxes • Income tax paid in the Phils. • Income tax imposed by authority of foreign country – tax credit with limitation • Estate and donor’s taxes • Tax assessment which increases the value of the property assessed • Electric energy consumption tax under B.P. 36 • VAT • Tax credits • Taxes paid in foreign countries subject to limitation
Taxes • Interest or surcharge imposed on taxes are not deductible as taxes, but as an item of interest. • Only the person upon whom taxes are imposed may claim them as deduction, except: (1) Taxes upon an individual upon his interest as shareholder of corporation which are paid by corporation without reimbursement; and (2) Corporate bonds or other obligations containing a tax-free covenant clause, the corporation paying the tax or any part of it for someone else (Sec. 80, RR 2).
Taxes • Refund of tax payment • Taxes refunded shall be included in the year of receipt to the extent of the income tax benefit of such deduction (tax benefit rule)
Taxes • Disclosure requirement on taxes (Notes to FS) RR 15-2010 • The notes of f/s shall include info on taxes, duties and license fees paid or accrued during the taxable year • The amount of VAT Output tax and the account title and amount/s upon which the same was based,
Losses • Requisites for deductibility • Incurred in trade, business or profession • Not compensated by insurance or other form of indemnity • In case of property, for losses arising from fire, storm, shipwreck, other casualty, robbery, theft, embezzlement, the property must be used in trade, business or profession and reported within forty-five (45) days from date of occurrence of such loss. • Not claimed as deduction for estate tax purposes
Net Operating Loss Carry-over (NOLCO) RR 14-2001 • Net operating loss - means the excess of allowable deduction over gross income of the business in a taxable year
Bad Debts • Requisites for valid deduction • There must be an existing indebtedness due to the taxpayer • It must be valid and legally demandable • It must be connected with the taxpayer’s trade, business or practice of profession • It must not be sustained in a transaction entered into between related parties • It must be actually charged off from the books of accounts as of the end of the taxable year • It must be ascertained to be worthless and uncollectible as of the end of the year
Depreciation • A reasonable allowance/reduction in service value for the exhaustion, wear and tear of property used in trade, business or practice of profession. • Methods of depreciation • Straight line method • Declining balance method • Sum of the year’s digit method • Any other method which may be prescribed
Depreciation • Requirements for deductibility • The allowance for depreciation must be reasonable; • It must be for property arising out of its use in the trade or business, or out of its not being used temporarily during the year; and • It must be charged off during the taxable year from the taxpayer’s books of accounts.
Charitable and other Contributions • Donations with limited deductibility • For the use of government exclusively for public purpose • To accredited domestic corporation or association organized and operated exclusively for religious, charitable, scientific, youth and sports development, cultural or educational purposes • For the rehabilitation of veterans • For social welfare institutions • To non-government organization
Charitable and other Contributions • Rate of deduction • Individual donor - 10% of net income before deducting donations • Corporate donor - 5% of net income before deducting donations OR Actual contribution/donation WHICHEVER IS LOWER
Charitable and other Contributions • Donations deductible in full • Donations to the government exclusively to finance or to be used in undertaking priority activities in education, health, youth and sports development, human settlements, science and culture and in economic development according to the National Priority Plan determined by NEDA. • Donations to foreign institution or international organizations • Donations to accredited non-government organizations
Entertainment, Amusement & Recreational (EAR) Expenses • Includes representation expense and/or depreciation or rental expense relating to entertainment facilities. • Representation expense shall refer to expenses incurred in entertaining, providing amusement and recreation to, or meeting with guest or guests at dining place, place of amusement, country club, theater, concert, play, sporting event and similar events or places.
Entertainment, Amusement & Recreational (EAR) Expenses • Expenses NOT considered EAR • Expenses treated as compensation or fringe benefits • Expense for charitable or fund raising events • Expense for bonafide business meeting of stockholders, partners or directors • Expenses for attending or sponsoring employee to a business league or professional organization meeting • Expenses for events organized for promotion marketing and advertising including concerts, conferences, seminars, workshops, convention, and other similar event. • Other expense of similar nature
Entertainment, Amusement & Recreational (EAR) Expenses • The taxpayer should maintain receipts and adequate records that indicate the • The amount of expense • Date and place of expense • Purpose of expense • Professional or business relationship of expense • Name of person and company entertained with contact details
Entertainment, Amusement & Recreational (EAR) Expenses • Requirements for deductibility • Paid or incurred during the taxable year • Business connected • Not contrary to law, morals, good customs, public policy or public order • Does not constitute a bribe, kickback or other similar payment • Duly substantiated by adequate proof • Subjected to withholding tax, if applicable
Entertainment, Amusement & Recreational (EAR) Expenses • Imposition of Ceiling [Sec. 34(A)(1)(a)(iv) of NIRC) & RR 10-2001] Actual entertainment, amusement and recreation expense OR • .5% of net sales for sellers of goods and properties • 1% of net revenues for sellers of services WHICHEVER IS LOWER
TAXPAYER ENGAGED IN BOTH SALE OF GOODS AND SERVICES Allowable EAR expense shall be determined based on apportionment formula – Percentage of net sales/net revenue to the total net sales/net revenue multiplied by the actual EAR expense Net sales/net revenue x Actual expense Total net sales/revenue Note: In no case shall the total EAR exceed the maximum percentage ceiling
Illustration: ERA Corporation is engaged in the sale of goods and services with net sales/net revenue of P200,000 and P100,000 respectively. The actual EAR for the year 2010 totaled P3,000 Computation: *Apportionment formula Sale of goods (P200,000/P300,000) x P3,000 = P2,000 Sale of service (P100,000/300,000) x P3,000 = P1,000 **Maximum percentage ceiling Sale of goods P200,000 x 0.50% = P1,000 Sale of service P100,000 x 1% = P1,000
Computation: ERA Corporation can only claim a total of P2,000 as EAR
Optional Standard Deduction In lieu of the itemized deductions enumerated under Sec. 34(A) to (J) and (M) and Sec. 37 of the Tax Code and other special laws (if applicable) .
Optional Standard Deduction • Individuals • Resident citizen • Non-resident citizen • Resident Alien • Taxable estates and trusts • Corporations (subject to normal income tax rate) • Domestic corporation • Resident foreign corporation
Optional Standard Deduction • Disclosure of election to use the OSD (RMC 16-2010) • Taxpayers availing of the OSD are required to check the appropriate box in the ITR for the first quarter of the taxable year 2009. • Failure to indicate the election to avail of the OSD shall be considered as having availed of the itemized deduction.
Optional Standard Deduction • Disclosure of election to use the OSD (RMC 16-2010) • The same type of deduction must be consistently applied for all the succeeding quarterly returns and in the final ITR for the taxable year. • New registrants shall disclose their election to avail OSD in their initial quarterly ITR.
Optional Standard Deduction • Implication of OSD • Option is irrevocable for the taxable year for which the return is made. • Any subsequent amendment of ITR filed for the first/initial quarter shall not affect the irrevocable character of the election to avail of the OSD or itemized deduction. • Individual claiming the OSD is not required to submit financial statements but shall keep records of his gross sales/receipts
Illustration 1 Mr. Era , a retailer of goods uses the accrual method of accounting in reporting his income and expenses. For the year 2010, the following are his recorded income and expenses Mr. Era uses the OSD as indicated on his 1st quarter ITR. Compute for the allowable deductions for each of the quarters of 2010 and the net income for the taxable year.
Computation 1 a) Allowable deductions Jan. – June July – Sept Oct - Dec Gross sales P1,000,000 P700,000 P900,000 Less: Cost of sales -0- - 0 - - 0 – Gross sales/income P 1,000,000 P700,000 P900,000 X OSD rate 40% 40% 40% OSD P 400,000 P280,000 P360,000 ====== ======= ======= b) Net income for 2010 Gross sales (Jan – Dec) P2,600,000 OSD (40%) 1,040,000 Net income 1,560,000 ========
Illustration 2 GSV Corporation, a retailer of goods, uses the accrual method in declaring its income and expenses. For the calendar year 2010, the following are the records of its income and expenses: GSV Corp. uses the OSD. Compute for the quarterly allowable deductions (cost and expenses) and the net income for 2010.
Computation 2 a) Allowable deduction Jan – JuneJuly – SeptOct – Dec Gross sales P1,000,000 P700,000 P900,000 Less Cost of sales 700,000 300,000 600,000 Gross income 300,000 P400,000 P300,000 X OSD rate 40% 40% 40% OSD/Operating expenses P120,000 P160,000 P120,000 Add: Cost of sales 700,000 200,000 100,000 Total deductions P820,000 P360,000 P220,000 ======= ======= ======= b) Net income Gross sale P2,600,000 Cost of sales 1,600,000 Gross income 1,000,000 OSD (40%) 400,000 Net income P 600,000 =======
Taxation of Mixed Income • It follows the compartmentalized approach for returnable income. • Personal exemptions are first deducted from compensation income. • Excess of PE over compensation income are deductible from net income from business. • Separate computation of income tax liability for husband and wife. • Only one spouse will claim additional personal exemption. 50
Taxation of Mixed Income • Taxable compensation income is added to taxable income from business and the aggregate taxable income is subjected to the graduated tax rates. • Loss from business can not be offset against compensation income but can be carried over as NOLCO. • One consolidated income tax return for husband and wife. • Pay-as-you-file, but installment is allowed if tax due exceeds P2,000 [Sec. 56(A)(2)].
Taxation of Marginal Income Earners (RR 11-00) • Individuals not deriving compensation income • Self-employed • Deriving gross sales/receipts not exceeding P100,000 during any 12-month period • Principally earning for subsistence or livelihood • Exempt from VAT and any percentage tax • Not required to pay the registration fee • Required to register as taxpayer • Exempt from the invoicing requirements
Taxation of Marginal Income Earners (RR 11-00) • Exempt from maintaining books of accounts • Required to file the Annual Income Tax Return (Form 1700) but not required to attach Financial Statements or Account Information Form to the filed ITR • May or may not be liable to tax