J Chapter 4 ~ Income Tax Schemes, Accounting Periods, Methods, and Reporting CHAPTER 4 INCOME TAX SCHEMES, ACCOUNTING PERIODS, ACCOUNTING METHODS, AND REPORTING Chapter Overview and Objectives This chapter provides an overview of the income tax schemes under the NIRC. After this chapter, readers are expected to gain familiarization and demonstra, mastery of the following: Types of taxation schemes and their scope b. Concept of accounting period and its types Concept of accounting methods and their accounting procedures d._ Types of tax returns, their deadline and place of filing a. c INCOME TAXATION SCHEMES There are three income taxation schemes under the NIRC: Final income taxation b. Capital gains taxation Regular income taxation a c An item of gross income is taxable in any of these tax schemes. Item of gross income Taxable to any one of resent] Final Income Taxation Capital Gains Regular Income Taxation Taxation Mutually exclusive coverage The tax schemes are mutually exclusive. An item of tax in one scheme will not be taxed by the othe income that are exempted in one scheme are not ta 8ross income that is subject! t schemes. Similarly, items © xable by the other schemes: 100Chap! Tax Schemes, Accounting Periods, Methods, and Reporting rant F ITEMS OF GROSS INCOME pecause of the different tax schemes, items of gross income can be classified as follows: 1, Gross income subject to final tax 2, Gross income subject to capital gains tax“ 3. Gross income subject to regular tax _/ Readers are advised to master the coverage of both final income tax and capital gains tax. A thorough understanding of these exceptional tax treatments is very essential f0 your mastery of Income Taxation. FINAL INCOME TAXATION Final income taxation is characterized by final taxes wherein full taxes are withheld by the income payor at source, The rec income taxpayer receives the income net of taxes. The payor is the one req y law to remit the tax to the government. Consequently, the recipient income taxpayer does not need to file income tax returns because the withheld tax constitutes the full tax due and are therefore deemed final payments. This system of taxation is referred to as the final withholding tax system. Final taxation is applicable only on certain passive income listed by the law. Not all items of passive income are subject to final tax. Passive income vs. active income Passive incomes are earned with very minimal or even without active involvement of the taxpayer in the earning process. Examples of passive income: 1. Interest income from banks 2. Dividends from domestic corporations 3. Royalties Active or regular income arises from transactions requiring a considerable degree of effort or undertaking from the taxpayer. It is the direct opposite of passive income. Examples of active income: 1. Compensation income 2. Business income 3. Professional income Final income taxation will be discussed in detail in Chapter 5. 101J Chapter 4 ~ Income Tax Schemes, Accounting Periods, Methods, and CAPITAL GAINS TAXATION Capital gains tax is imposed on the gain realized on the sale, exchange and ox, dispositions of certain capital assets. Capital as: re assets noLused in business, tri are the opposites of ordinary assets. Ordinary as: trade or profession such as inventory, suppl Je or profession. Capital ets are assets used in bus or property, plant and equipmens Also, not all capital gain to regular income tax. ‘¢ subject to capital gains tax. Most of them are subj The NIRC identifies capital gains tax as a final tax but they are hybrid forms ¢ final taxes since it also employs self-assessment method. The taxpayer still fj capital gains tax returns to report the gain and pay the tax to the governmen Capital gains taxation applies only to two types of capital assets: domestic stock and real property. Capital gains taxation will be discussed in detail in Chapter 6. REGULAR INCOME TAXATION ‘The regular income tax is the general rule in income taxation and covers all othe income such as: 1. Active income 2. Other income a. Gains from dealings in properties, not subject to capital gains tax b. Other passive income not subject to final tax Items of gross income from these sources are valued or measured using # accounting method, accumulated over an accounting period, and reported tot government through an income tax return. Regular income taxation makes use ¢ the self-assessment method. ACCOUNTING PERIOD Accounting period is the length of time over which income is measured 4 reported. Types of Accounting Periods 1. Regular accounting period - 12 months in length a. Calendar cal 2. Short accounting period - le than 12 months 102Chapter 4 - Income Tax Schemes, Accounting Periods, Methods, and Reporting Calendar year The calendar accounting period starts from January 1 and ends December 31. This accounting period is available to both corporate taxpayers and individual taxpayers: Under the NIRC, the calendar year shall be used when the: 1. taxpayer's annual accounting period is other than a fiscal year (i.e. longer than 12 months in length) 2, taxpayer has no annual accounting period (ie. less than 12 months in length) 3. taxpayer does not keep books 4, taxpayer is an individual Fiscal year A fiscal accounting period is any 12-month period that ends on any day other than December 31. The fiscal accounting period is available only to corporate income ‘taxpayers and is not allowed to individual income taxpayers. Deadline of Filing the Income Tax Return Under the NIRC, the return is due for filing on the fifteenth day of the fourth month following the close of the taxable year of the taxpayer. The regular tax due is payable upon filing of the income tax return. Mlustration: Due date of the annual income return 1. Taxpayers under the calendar year must file their annual income tax return for the current period not later than April 15 of the following year. 2. A corporate taxpayer with fiscal year ending June 30, 2021 must file its annual income tax return not later than October 15, 2021. INSTANCES OF SHORT ACCOUNTING PERIOD 1. Newly commenced business - The accounting period covers the date of the start of the business until the designated year-end of the business. Mlustration Palawan Inc, started business operation on June 30, 2021 and opted to use the calendar year accounting period. Palawan should file its first income tax return covering June 30 to December 31, 2021 for the year 2021.The return must be filed on or before April 15, 2022. 2. Dissolution of business - The accounting period covers the start of the current year to the date of dissolution of the business. Mlustration Tawi-tawi Inc. is on the fiscal year accounting period ending every March 31. It ceased business operation on August 15, 2021. 103Chapter 4 ~ Income Tax Schemes, Accounting Periods, Methods, and Reporting | ¢ Tawi-tawi should file its last income tax return covering April 1 to August 15, 202), 5 Under the old NIRC, dissolving corporations shall file their return within 39 ayy from the cessation of activities or 30 days from the approval of merger by th Securities and Exchange Commission in the case of merger. (BPI vs. cin o 144653, August 28, 2011). Hence, the return shall be filed on or before Septembe, 15, 2021. For individuals, the return shall be due on or before April 15, 2022. There is ny requirement for early filing under the NIRC. 3. Change of accounting period by corporate taxpayers - The Accounting f period covers the start of the previous accounting period up to the designated t year-end of the new accounting period. Note that BIR approval is require in | changing an accounting period. It is not automatic. | Illustration 1 | Effective February, 2021, Sulu Corporation changed its calendar accounting | period to a fiscal year ending every June 30. Sulu Corporation shall file an adjustment return covering the income from January 1 : to June 30, 2021 on or before October 15, 2021. | | Mlustration 2 Effective August 2021, Zamboanga Company chanj period ending every June 30 to the calendar year. Zamboanga Company should file an a 31, 2021 on or before April 15, 2022, iged its fiscal year accounting ( idjustment return covering July 1 to December 4. Death of the taxpayer - The accounting period covers the start of the calendar year until the death of the taxpayer, Illustration Mr. Regonald died on November 2, 2021. The heirs of Mr. Regonald or his estate administra income tax return covering his income from Janual no requirement for early filing in casi return shall be filed on or before the u tors or executors shall file his lst ry 1 to November 2, 2021. Thereis eof death of taxpayers. Hence, the income tat sual deadline, April 15, 2022, It must be noted that cut-off of income must be made at date point of death because properties such as income accruing before death are Part of the estate of! the decedent in Estate Taxation while those income accruing after desth are to Part thereof. Hence, it is mandatory for the accounting period of the taxpayer tobe terminated exactly at the date of death. 104Chapter 4 - Income Tax Schemes, Accounting Periods, Methods, and Reporting 5. Termination of the accounting period of the taxpayer by the Commissioner of Internal Revenue ~ The accounting period covers the start of the current year until the date of the termination of the accounting period. Ilustration The accounting period of a taxpayer under the calendar year basis was terminated by the CIR on August 2, 2021. The taxpayer must file an income tax return covering January 1 to August 2, 2021. The income tax return and the tax shall be due and payable immediately. ACCOUNTING METHODS Accounting methods are accounting techniques used to measure income. ‘Types of Accounting Methods 1. The general methods a. Accrual basis b. Cash basis Installment and deferred payment method Percentage of completion method Outright and spread-out method Crop year basis seen General Methods for income from sale of goods or service 1. Accrual basis Under the accrual basis of accounting, income is recognized when earned regardless of when received. Expense is recognized when incurred regardless of when paid. Income is said to have accrued when the right to receive is established or when an enforceable right to secure payment is created against the counterparty. 2. Cash basis Under the cash basis of accounting, income is recognized when received and expense is recognized when paid. Tax and accounting concepts of accrual basis and cash basis distinguished The financial accounting concept of accrual basis and cash basis are similar to their tax counterparts, except only for the following tax rules: 1. Advanced income is taxable upon receipt. Income received in advance is taxable upon receipt in pursuant to the Lifeblood Doctrine and the Ability to Pay Theory. The subsequent taxation of 105Chapter 4 - Income Tax Schemes, Accounting Periods, Methods, and Reporting advanced income in the period earned will expose the government to risk o non-collection. This rule is applicable on the sale of services not on goods, 2. Prepaid expense is non-deductible. ; Prepaid expenses are advanced payment for expenses of future taxable periods. These are not deductible against gross income in the eat paid. They are deducted against income in the future period they expire or are useq in the business, trade or profession of the taxpayer. - Normally, the expensing of prepayments does not properly reflect the income of the taxpayer. It also contradicts the Lifeblood Doctrine as it effectively defers the recognition of income. 3. Special tax accounting requirement must be followed. : { There are cases where the tax law itself provides for a specific accounting treatment of an income or expense. The specified method must be observed even if it departs from the basis regularly employed by the taxpayer in* keeping his books. The tax accrual basis income is determined as follows: Cash income Po xxx,xxx Accrued (uncollected) income XXX)XXX Advanced income ——AXXXXX_ Gross income P__xxxxxx The tax accrual basis expense is determined as follows: Cash expenses Po xxx.xxx Accrued (unpaid) expense XXX,ARX Amortization of prepayments and depreciation of capital expenditures XXXXXX Deductions B_xxxxxx The tax cash basis income is determined as follows: Cash income Po xxx,xxx Advanced income a Gross income P__syxxny The tax cash basis expense is determined as follows: Cash expenses Amortization of prepayments and depreciation of capital expenditures Deductions 106Chapter 4 - Income Tax Schemes, Accounting Periods, Methods, and Reporting illustration . Ataxpayer providing services reported the following in 2021 and 2022: 2021 2022 collections from services rendered P 500,000 P 800,000 ‘Accrued income from services rendered 500,000 400,000 Collection from accrued income of 2021 - 470,000 Collection for services not yet rendered 300,000 200,000 Payment of expenses of current period 400,000 600,000 Accrued expenses 100,000 150,000 Payment of accrued expenses of 2021 : 100,000 Payment for expenses of the following year 200,000 300,000 tr Basi — 2021 _ ___ 2022 __ Cash income P 500,000 P 800,000 Accrued income 500,000 400,000 Collection for future services - advances 300,000 200,000 Total gross income P 1,300,000 P 1,400,000 Less: Deductions Cash expenses P 400,000 P 600,000 Accrued expense 100,000 150,000 Amortization of 2021 prepaid expense ______- ___ 200,000 Total deductions P__500,000 P 950,000 Net income P__800,000 P__450,000 Points to consider in converting GAAP Accrual Basis to Tax Accrual Basis 1. In accounting accrual basis, income is recognized when earned even if not yet received. ‘Advanced income is inherently not included in net income. For purposes of taxation, advanced income is taxable. Hence, it must be added to accrual basis gross income. 2. In accounting, expense is recognized when accrued even if not yet paid. Prepaid expenses are inherently not deducted, Hence, no adjustment for prepayments is necessary under accrual basis. Tax Cash Basis ——2021_ _____2022__ Collection from services rendered P 500,000 P*1,270,000 Collection for future services - advances ___300,000 ___200,000 Total gross income P__ 800,000 P 1,470,000 Less: Deductions Payments of expenses P 400,000 P **700,000 Amortization of 2021 prepayments _____- — 200,000 Total deductions P_400,000 P 900,000 Net income B_400,000 P 570,000 Note: P800,000 + P470,000 = P1,270,000*; P600,000 + P100,000 = P700,000"* 107Chapter 4 - Income Tax Schemes, Accounting Periods, Methods, and Reporting Points to consider in converting GAAP cash basis to Tax cash basis | 1. Under the accounting cash basis, income isrecognized when received not when ts amy | “ : a Advanced income is inherently recognized as income. Hence, no adjus ecessany | income. i 2. Under accounting cash basis, expense is deducted when paid including prepaid expens., Hence, the deducted prepaid expenses must be reversed for purposes of taxation, Sellers of goods Hows | The gross income of taxpayers selling goods is determined as follow: Sales P x Less: Cost of goods sold Gross income KXXX ‘The cost of sales is computed using the inventory method: Beginning inventory Po xxx.xxx Add: Purchases ———XXX.XXX ' Total goods available for sale Po xxx.xxx | Less: Ending inventory XXX.XXX Cost of goods sold Pao. xxx ‘The expensing of the purchase cost of goods does not properly and fairly reflect the | income of the taxpayer particularly when there are significant fluctuations in inventory levels between accounting periods. This could expose the taxpayer to risk of BIR assessment. The use of the accrual method is suggested but of course subject to | practical and cost considerations. } Hybrid basis The hybrid basis is any combination of accrual basis, cash basis, and/or other methods of accounting, It is used when the taxpayer has several businesses which employ different accounting methods. Mlustration Mr. Roxas has two proprietorship businesses: a service business which uses cash basis and a trading business which uses accrual basis. The gross income as determined by cash basis in the service business and the gros income as determined by the accrual basis in the trading business are simply combine! | There is no requirement to measure the income of different businesses under a single accounting method. } Sale of goods with extended payment terms The sale of goods with extended payment terms may be reported using the accrual basis, installment method, or deferred payment method. ' 108Chapter 4 - Income Tax Schemes, Accounting Periods, Methods, and Reporting Installment method Under the installment method, gross income is recognized and reported in proportion to the collection from the installment sales, installment method is available to the following taxpayers: 4, Dealers of personal property on the sale of properties they regularly sell 2. Dealers of real properties, only if their initial payment does not exceed 25% of the selling price 3. Casual sale of non-dealers in property, real or personal, when their selling price exceeds P1,000 and their initial payment does not exceed 25% of the selling price Initial payment Initial payment means total payments by the buyer, in cash or property, in the taxable year the sale was made. The term “initial payment” is broader than downpayment. It also includes the installment payments in the year of sale. Selling price Selling price means the entire amount for which the buyer is obligated to the seller. It is computed as follows: Cash received and/or receivable P xxx.xxx Fair market value of property received or receivable XXK ARK Mortgage or any indebtedness assumed by the buyer XXKXXK Selling price Contract price The contract price is the amount receivable in cash or other property from the buyer. It is usually the selling price in the absence of an agreement whereby the debtor assumes indebtedness on the property. Comprehensive Illustration Malaybay Company, a car dealer, sold a machine with a tax basis of P1,200,000 on installment on January 3, 2021 Malaybay received a P200,000 cash downpayment and a P1,800,000 promissory note for the balance payable in six installments of P300,000 every July 3 and January 3 thereafter. The selling price and gross profit on the sale is computed as follows: Cash downpayment P 200,000 Notes receivables bun, Selling price P 2,000,000 Less: Tax basis of machine sold (—2.200,000) Gross profit P__800,000 109Chapter 4 — Income Tax Schemes, Accounting Periods, Methods, and Reporting Accrual basis Under the accrual basis, the entire P800,000 gross profit shall be reported ag Be income in 2021, the year of sale. Installment basis 4 Malaybay cannot readily use the installment method b c rather than a dealer of machineries. The sale of properties of which the sellers, dealer is referred to as a “casual sale.” Hence, the ratio of initial payment shay? tested first. nod because it is a dealer of The initial payment of Malaybay can be computed as follows: Cash downpayment (January 3, 2021) P 200,000 | First installment (July 3, 2021) 300,000 | Initial payment P_500,000 Ratio of initial payment (P500,000/P2,000,000) 25% Malaybay can use the installment method. The contract price or the amount due sha be determined next. Since there is no mortgage assumed by the buyer, the selling price is the contract price. The gross profit will be reported in gross income throughout the installment period by the formula: (Collection/Contract price) x Gross profit | Malaybay shall recognize the following gross income: At the date of sale: (P200K/P2M x P800,000) P__80,000 Upon every installment: (P300K/P2M x P800,000) P__ 120.000 If Malaybay is a dealer in machinery, it can avail of the installment method even ifthe ratio of its initial payment over selling price exceeds 25% so long as the selling price on the installment sale exceeds P1,000. ’ With indebtedness assumed by the buyer The application of the installment method will slightly vary when the buyer assumes indebtedness on the property sold. ) In this case, the selling price is no longer the contract price. The contract prices the residual amount after deducting the mortgage from the selling price. Thus, Selling price P ceca Less: Mortgage assumed by buyer : Contract price Lowe 110Chapter 4 - Income Tax Schemes, Accounting Periods, Methods, and Reporting illustration (On January 3, 2021, Tagaytay, Inc,, a real property dealer, sold a lot costing P1,400,000 for P2,000,000. The lot was encumbered by a P1,000,000 mortgage which was assumed by the buyer. The buyer paid P200,000 downpayment. The balance is due over four installments of P200,000 every July 3 and January 3 thereafter. ‘The gross profit can be computed as follows: Selling price P 2,000,000 Less: Tax basis of lot sold 1.400,000 Gross profit P_600,000 Note that dealers of real properties are subject to limitation on the use of installment method. The ratio of initial payment shall be determined first. January 3, 2021 cash downpayment P 200,000 July 3, 2021 installment __ 200,000 Initial payment P__400,000 Ratio of initial payment (P400,000/P2,000,000) 20% Tagaytay is qualified to use the installment method. The contract price should be determined next. Selling price P 2,000,000 Less: Mortgage assumed by buyer 1,000,000 Contract price P_1.000,000 Alternatively, the contract price can be computed directly as follows: Cash downpayment P 200,000 Collectible balance (P200,000 x 4 installments) 800,000 Contract price B.1,000,000 Tagaytay shall recognize the following gross income: At the date of sale: (P200K/P1M x P600,000) Upon every installment: (P200K/P1M x P600,000) P__ 120,000 Indebtedness assumed exceeds tax basis of property sold When the indebtedness assumed by the buyer exceeds the tax basis of the Property sold, the excess is an indirect receipt realized by the seller. This is an indirect downpayment which must be added as part of the contract price and the initial payment. Note also that under this condition, all collection from the contract including the excess mortgage is a collection of income. iilChapter 4 ~ Income Tax Schemes, Accounting Periods, Methods, and Repor ‘The contract price shall be computed as follows: Po XXX,XXX Selling price ee Less: Mortgage assumed by buyer Fi ae Cash collectible . XH ‘Add: Excess indebtedness - constructive receipt sa Contract price Pw, ‘The initial payment shall be computed as follows: HK Downpayment P xxx, pon: Installment in the year of sale XXX, Excess of mortgage over tax basis XXXAKXK Poe ae Initial payment Illustration . On July 1, 2021, a taxpayer made a casual sale of property with a tax basis of P1,300,000 for P2,000,000. The property was subject to a P1,500,000 mortgage which was agreed to be assumed by the buyer. The buyer paid a P100,000 down payment with the balance due in two installments of P200,000 on December 31, 2021 and july 1,2022, The gross profit on the sale is determined as follows: Selling price P 2,000,000 Less: Tax basis of property sold —1.300,000 Gross profit P_700,000 The initial payment shall be determined first: Downpayment P 100,000 December 31, 2021 installment 200,000 Excess mortgage (P1,500,000 ~ P1,300,000; 200.00 Initial payment : BmNon ong Ratio of initial payment (P500K/P2,000,000) 25% The contract price shall be computed as: — Selling price Less: Mortgage assumed by buyer pee oon Cash collectible P 500, i Excess mortgage (P1,500,000 - P1,300,0 pov one Contract price cna P7200 2 2_200,000 Note that the gross profit on the is sale is the same as the i collection from the contract including the excess mortg: pecan eee gross income upon collection, 9° shall be recognized 112Chapter 4 ~ Income Tax Schemes, Accounting Periods, Methods, and Reporting canlubang shall recognize the following gross income: atthe date of sale (P200K down + P100K excess) P 300,000 pon receipt of first installment ~ 12/31/2021 Fl 200,000 pon receipt of second installment - 7/1/2022 200,000 ‘Total gross profit on the contract P_700,000 Deferred payment method The deferred payment method is a variant of the accrual basis and is used in reporting income when a non-interest bearing note is received as consideration in asale. Under the deferred Payment method, the gross income is computed based on the present value (discounted value) of a note receivable from the contract. The discount interest on the note is amortized (i.e., spread) as interest income over the installment term. Tilustration On December 31, 2021, a taxpayer sold an office building costing P1,400,000 for 2,000,000. The buyer made P1,000,000 downpayment and the balance, evidenced by a note, is due in 2 annual installments of P500,000 every December 31 starting December 31, 2022. Note that the installment method cannot be allowed since the ratio of initial payment is already 50% (P1,000,000/P2,000,000). Assume the note is non-interest bearing but can be discounted at a local bank for P900,000. Under the deferred payment method, the reportable gross income for each year shall be: 2021 2022 2023 Cash downpayment P 1,000,000 Present value of the note 900,000 Selling price P 1,900,000 Less: Tax basis of the property __1,400,000 Gross income P__500,000 Interest income (P1,000,000 - P900,000) P_50,000 P_s0,000 Note: 1. The difference between the face value and the present value of the note, known as discount, will not be recognized in gross income at the date of sale but will be deferred and recognized as interest income. The discount is amortized as interest income upon every collection on the balance of the note as follows: P500,000 installment/P1,000,000 total note balance x P100,000 discount {In the case of interest-bearing notes, the use of the deferred payment method will bear the same result as the accrual basis of accounting. 1137 7 , oo Chapter 4 - Income Tax Schemes, Accounting Periods, Methods, and Reportin, ion Contracts The Percentage of Completion Method for Constructi ted gross income i d, the estima nm ge of completion method, rmpletion eee Parente eed on the percentage of completion of the] construction struction roject. i il i constr pl t completion in practice, j, ae jec ‘There are several methods of estimating pro) ‘scribed by the NIRC. Ut thy ineeri is pre’ output method based on engineering survey is P Mlustration on Company accepted a PS,000,000 fixed, tn 2021, Cagayan De Oro Construction Compa te cruction actin tig construction contract. The following s! st 0 022 | 00 P 1,200,000 Construction expenses ; P 3,000,000 pa Engineer's estimate of completion ill si ‘ed as follows: The reportable gross income on construction will simply be comput follows; 2021 __2022__ Contract price P 5,000,000 P 5,000,000 Multiply by: % of completion presnoana Peon Construction revenue ; P 3,500, 3,000, Less: Construction revenue in prior year ___- Reena Construction revenue this year P 3,500,000 P 1,500, Less: Expense during the year 3,000,000 __1,200,000 Construction gross income P_500,000 P__ 300,000 Income from Leasehold Improvement Leasehold improvements are tangible improvements made by the lessee to th property of the lessor. Improvements will benefit the lessor when their useful ii extends beyond the lease term, This benefit is referred to as income from leasehi! improvement. Under Revenue Regulations No. 2, the in reported using either of the following m 1. Outright method The lessor may report as income the fair market value of such buildings « improvements subject to the lease at the time when such buildings ¢ improvements are completed, come from leasehold improvement cant: ethod at the option of the taxpayer: 2. Spread-out method The lessor may spread over the life o alue of such buildings or improveme f the lease the estimated deprecia# report as income for each year of the hi ‘nts at the termination of the lease” ease an aliquot part thereof. 114Chapter 4 ~ Income Tax Schemes, Accounting Periods, Methods, and Reporting The depreciated value of the leasehold improvement is computed as: Cost ofimprovement x Excess useful life over lease ti Useful life of the improvement Illustration n January 1, 2021, Ivan leased a vacant lot to Greg immediately constructed a buil building has useful life of 30 years, Greg under a 20-year lease contract. iding on the lot at a total cost of P4,500,000. The Outright method Under the plain wordings of Section 49 of Revenue Regulations No. 2, Ivan shall recognize the entire P4,500,000 fair value of the improvement as gross income upon completion of the improvement in 2021. This is not income in its totality, but this is the amount referred to by the regulation, Spread-out method The depreciated value of the Property at the termination of the lease is the value of the years of usage of the lessor. This can be computed by splitting the value of the improvement as follows: Years of User usage Allocation Cost Lessee 20 20/30 x P4,500,000 P 3,000,000 - Lessor 10 10/30 x P4,500,000 —L500,000 Total 30 B.4,500,000 The P1,500,000 depreciated value of the improvement at the termination of the lease isan income from leasehold improvement by the lessor. Under the spread-out method, Anderson shall spread the P1,500,000 income over 20 periods or recognize an annual income of P75,000 from the leasehold improvement from Year 2021 through Year 2040. Note to Readers It should be pointed out that this rule exists only in the regulation and is absent in the NIRC. Some taxpayers are questioning its validity pointing out lack of legal basis. However, it is fairly proper to consider the depreciated value of the improvement that remains to the lessor upon termination of the lease as income because it is an actual benefit to the lessor. These are, in effect, additional rental Consideration in kind. However, the treatment specified by the outright method is perceived as unjust and abusive, and is an improper introduction of legislation. 115ing Peri d Repo Chapter 4 ~ Income Tax Schemes, Accounting Periods, Methods, and Reporting vement at the termination of the lease should p, The depreciated value of the impro nder the outright method. : . ‘ the proper value to be recognized as gross income th ‘This view is supported by the fact that the spread-out method could net have bee an option if the outright method intended to tax the ent are ae rece the improvement considering the huge disproportion in the rep’ ‘ome under the two options. ‘The outright method as mandated by the regulation wil ee ape ii os lessees pay the lessor rentals in the form of leaseho! i mprove nents or he leasehold improvements made by lessees are treated as ret ial s In such cases, the fair value of the leasehold improvements up: pletion ig unquestionably income to the lessor for taxation purposes. Agricultural or Farming Income ; - Farming income is commonly measured using the cash basis or accrual basis, such as in the following: a. Animal husbandry b. Short-term crops Mlustration - | Northern Barn had the following details of its agricultural activity during the year: Total sales of fattened pigs, P1,000,000 on credit P 12,000,000 Increase in fair value of pig herd compared last year 2,700,000 Total costs of farm feeds and supplies bought 7,000,000 Total costs of farm feeds and supplies used 6,800,000 Administrative and selling expenses 1,200,000 Northern Barn shall compute its net income using either method as follows: Accrual method Lash basis Sales : P 12,000,000 P 11,000,000 rect farm costs 6,800,000 6,800,000 Gross profit from operations P 5,200,000 P 5,200,000 Less: administrative and selling expenses 1.200.000 1.200.000 Net income 25,000,000 B._4,000,000 The accounting for long-term crops depends on the harve: a. Perennial crops - those that yield harvests through ye b. One-time crops - those that ar sting frequency: ars @ harvested once after several years The initial farm development costs of Coconut and banana are capitalized and amortized over the expected cess 116 Perennial crops like mangoes, mangostet™ || as Chapter 4- Income Tax Schemes, Accounting Periods, Methods, and Reporting harvest. The harvests are accounted for using cash basis or accrual basis. One-time crops are accounted for using the crop year basis. crop year basis Under the crop year basis, farming income is recognized as the difference between the proceeds of harvest and expenses of the particular crop harvested. The expenses of each crop are accumulated and deducted upon the harvest of the crop. Illustration John de la Cruz, a farmer, plants a certain crop that takes more than a year to harvest. Juan had the following data on his farming operations: 2021 2022 2023. Proceeds of harvest P - P 750,000 P1,000,000 1 cropping expenses 400,000 200,000 = 2m cropping expenses - 500,000 300,000 The reportable farming income using crop year method would be: —2021_ _ _ 2022 __ __2023 _ Proceeds of harvest [> P 750,000 P1,000,000 Less: Cropping expenses Incurred last year 400,000 500,000 Incurred this year 200.000 __ 300,000 Farming gross income P_150,000 P_200,000 Crop year basis is an accounting method and is not an accounting period. Use of different accounting methods Taxpayers with more than one type of business using different accounting methods can consolidate the income reported using the different methods. There is no need to restate the income to a common accounting method. However, the methods applied to each business should be applied consistently from period to period. Change in Accounting Period The change in accounting period requires prior BIR notice. The following documentations are required: 1. Alletter of request addressed to the RDO having jurisdiction over the place of business of the taxpayer showing: a. The original and the proposed new accounting period b. The reason for desiring to change the accounting period 2. Certified true copy of the SEC approved amended by-laws showing change in accounting period 117Chapter 4 — Income Tax Schemes, Accounting Periods, Methods, and Reporting 3. Sworn statement of “non-forum shopping” stating that such request has 1, been previously acted upon by the BIR National Office 4. Duly filed up BIR Form 1905 5, A sworn undertaking by an officer of the taxpayer to file a separate fina} ., adjustment return for the period between the close of the original accountin, period and the date designated as the close of the new accounting period The request for approval of the change in accounting period shall be filed at any time not less than 60 days prior to the beginning of the new accounting periog The certification approving the adoption of a new accounting period must be released within 30 days from the date of receipt of the complete documentary requirements. TAX REPORTING Types of Returns to the Government 1. Income tax returns - provide details of the taxpayer's income, expense, tay due, tax credit and tax still due the government. 2. Withholding tax returns - provide reports of income payments subjected to withholding tax by the taxpayer-withholding agent. 3. Information returns Information Returns Certain taxpayers are also required to file information returns. Information returns do not involve any payment or withholding of tax but are essential to the government in its tax mapping efforts and in its evaluation of tax compliance. The non-filing of income tax returns, withholding tax returns, or information returns is subject to penalties, fines, and or imprisonment. MODE OF FILING INCOME TAX RETURNS 1. Manual Filing System The traditional manual system of filing income tax return is by paper documents where taxpayers fill up BIR forms to report income, expenses, or any declaratiot required to be filed with the BIR. Under the NIRC, the income tax return shall be filed to the following descending order of priority, within the revenue district office where the taxpay*! is registered or required to register: 1. Anauthorized agent bank (AAB) 2. Revenue Collection Officer 3. Duly authorized city or municipal treasurer, if there is no BIR office in t locality 118_— chapter 4 ~ Income Tax Schemes, Accounting Periods, Methods, and chapter , Accounting Periods, Methods, and >, e-BIR Forms The BIR introduced the e-8/R Forms with an offline or online version. Taxpaye fill up their income tax returns in electronic spreadsheets without the need of writing on papers returns. The system ensures completeness of data on the return and is capable of online submission. If there are no penalties that require BIR assessments, taxpayers would have to print a hard copy of the filled tax returns and proceed directly to the bank for payment. 3. Electronic Filing and Payment System (eFPS) ‘The eFPS is a paperless tax filing system developed and maintained by the BIR Taxpayers file tax returns including attachments in electronic format and pay the tax through the Internet. Taxpayers mandated to use the eFPS. 1. Large taxpayers duly notified by the BIR 2. Top 20,000 private corporations duly notified by the BIR 3. Top 5,000 individual taxpayers duly notified by the BIR 4. Taxpayers who wish to enter into contracts with government offices 5. Corporations with paid-up capital of P10,000,000 6. PEZA-registered entities and those located within Special Economic Zones 7, Government offices, in so far as remittance of withheld VAT and business tax are concerned 8 Taxpayers included in the Taxpayer Account Management Program (TAMP) 9. Accredited importers, including prospective importers required to secure the Importers Clearance Certificate (ICC) and Custom brokers Clearance Certificate (BCC) In case of unavailability of the eFPS during maintenance or instances of technical errors, eFPS enrolled taxpayers may file manually. Grouping of Taxpayers under EFPS 1. Groupa a. Banking institutions b. Insurance and pension funding © Non-bank financial intermediation 4. Activities auxiliary to financial intermediation ©. Construction {Water transport & Hotels and restaurants h. Land transport 2 GroupR & Manufacture and repair of furniture 5. Manufacture of basic metals © Manufacture of chemicals, and chemical products 4. Manufacture of coke, refined petroleum, and fuel products 119Chapter 4 ~ Income Tax Schemes, Accounting Periods, Methods, and Reporting Manufacture of electrical machinery, and apparatus NEC Manufacture of fabricated metal products ulacture of foods, products, and beverages utacture of machineries, and equipment NEG Manufacture of medical, precision, and optical instruments Manufacture of motor vehicles, trailers and semi-trailers Manufacture of office, accounting, and computing machineries Manufacture of other non-metallic mineral products Manufacture of other transport equipment Manufacture of other weal igapparel - Janutacture of papers, and paper product Manutaetreafea, Tes eommonieation equipment andl apparatus Manufacture of rubber and plastic products Manufacture of textiles Manufacture of tobacco products Manufacture of wood and wood products Manufacturing N.E.C. v. Metallic ore mining Ww. Non-metallic mining and quarrying 3 Group C Retail sale b. Wholesale trade and commission trade Sale, maintenance, repair of motor Vehicle, and sale of automotive fuel 4. Collection, purification, and distribution of water ©. Computer and related activities f, Realestate activities 4. Group a. Airtransport b. Electricity, gas, steam, and hot water supply Postal and telecommunications 4. Publishing, printing, and reproduction of recorded media & Recreational, cultural, and sporting activities £ Recycling 8. Renting out of goods and equipment h, Supporting and auxiliary transport activities 5. Group E Activities of membership organizations Inc. b, Health and social work © Private educational services a. istration and dete i €. Publicedtcational services * T | Accounting Periods, Methods, and Reporting | Chapter 4 ~ Income Tax Schemes, ‘king lot for P2,400,000 payable on installment. sold its parking 0,000. The buyer has an outstanding unpat 7. In 2021, Malita Inc. 31, 2021, Malita’s year-end. 7. Jot was previously acquired for P1,50 balance of 1,800,000 as of December Compute Malita’s gross income in 2021 using the installment method. a. P900,000 cc, P225,000 b. P675,000 d.P112,500 i i it ing amount (tax basis) 8. Exquisite Corporation sold its old warehouse with carrying 2! 7 600,000 for P1,000,000. ‘A downpayment of 15% was collected on July 1, 202, Additional P150,000 installment payments were received as of December 31, 2021. Compute the gross profit to be reported for the year 2021. a. 60,000 . P400,000 b. P120,000 4. P450,000 9. Carl Gabriel is a dealer of household appliances. He reported the following in 2021and 2022 2021 2022 Installment sales P500,000 — P-800,000 Cost of installment sales 250,000 440,000 Collections 300,000 600,000 Carl Gabriel's 2022 collection is inclusive of P100,000 accounts from 2021. Using the installment method, compute Carl Gabriel's gross income subject income tax in 2022. a. P360,000 .P250,000 b. P320,000 .P275,000 10. Using the accrual basis of accounting, compute Lancelot's gross income subject? income tax in 2022. a. P360,000 c. P275,000 b. 320,000 4. P250,000 11. Merville is a dealer in real properties. Merville requires 20% downpayment, 2 the balance is payable over 36 monthly installments starting on the last day oft month following the month of sale. Merville sold properties in 2021 and 202! with terms as follows: * House and Lot No. 1 was sold for P1,350,000 on Novemb 350, er 11, 2021. * House and Lot No. 2 was sold for P1,800,000 on July 5, 2022 aa Both properties were sold at a gross profit rate of 40% based on the selling pritt 132~~ chapter 4- Income Tax Schemes, Accounting Periods, Methods, and Reporting 14. Compute Merville’s gross income subject to income tax in 2021 and 2022, respectively. a. P120,000; P368,000 —_«. P540,000; P720,000 b. P120,000; P864,000 4. P540,000; Pa64,000 In 2022, Mr. Francis, a dealer of car, disposed a brand new sports utility vehicle (SUV) which costs P800,000 for P1,200,000, under the following terms: July 1, 2022 - as down payment P 100,000 Monthly installment thereafter 50,000 Mr. Francis will choose whichever favorable permissible income reporting method for him. How much gross income is to be reported in 2022? a. P400,000 ¢.P116,667 b, 250,000 d.P108,219 . In the immediately preceding problem, assuming Mr. Francis is not a dealer of car, how much gross income is to be reported in 2022? How much gross income is to be reported in 2022? a. P-400,000 c.P116,667 b. P250,000 d.P108,219 Lucio Karl accepted a P1,000,000 construction contract in early 2021. As of December 31, Luccio Karl incurred total construction costs of P600,000 and estimates additional P200,000 to bring the project to completion. Per independent appraisal, the building is at its 80% stage of completion. Compute Luccio Karl's 2021 construction income using the percentage of completion method. a. P40,000 c. P160,000 b. P200,000 d. P400,000 Talomo, Inc. constructs residential properties for clients and reports income by the percentage of completion method. In 2021, Talomo, Inc. started a P2,000,000 construction contract. Details of his 2021 and 2022 construction follow: 2021 ___2022 Annual construction costs P 200,000 P-800,000 Estimated cost to finish 800,000 250,000 Extent of completion 20% 80% Compute the construction income in 2021 and 2022, 2. P200,000; P560,000 —_c. P400,000; P400,000 200,000; P400,000 —_d. P400,000; P560,000Chapter 4 - Income Tax Schemes, Accounting Periods, Methods, and Reporting lease contract with Bernas. Per agreement, Olive, Bernas lot and operate the same for 40 yea fer to Bernas upon the termination of th, ntil the building is completed. Olive, 100 on January 1, 2022. Thy 16, Oliver entered into a 40-year will construct a building on Ownership of the building will transt lease. The lease will not commence ul completed the building at a total cost of P40,000,01 building is expected to be used over 50 years. i nt te Compute Bernas income from the leasehold improveme! using the spread-out method. a. P200,000 c.P8,000,000 b. 4,000,000 d. P32,000,000 17. Im the immediately preceding problem, assume that the building was complete on July 1, 2022, what is the income using outright method. a. P 4,000,000 c. P32,000,000 b. P8,000,000 d.P40,000,000 10 be reported in 2927 18. Len leases an office space from Rafi, Inc, in a non-renewable 10-year lease contract. Just after the second year of the lease, Tomas renovated the premises and made improvements at a cost of P1,200,000. These improvements are expected to last for 12 years. Compute Rafi’s annual income from the leasehold improvement using the spread-out method. a. P50,000 c. P30,000 b. 37,500 4. 20,000 19. Jamie started raising swine for sale by purchasing 5 gilts and a boar at a totdl| purchase price of P50,000 on January 2020. As of December 31, 2022, Hassan’ herd grew to 15 guilts, 2 boars and 20 piglets. The total herd has a fair value of 196,000 when sold as is. During the year, Hassan earned P180,000 from selling piglets. How much should Hassan report as farming income in 2022? a. P326,000 c.P 146,000 b. P180,000 4. P 130,000 20. Peter, a farmer, uses the crop-year method in Teporting his income from long term crops. The following data are relevant to his farming operations in 2021: * Sales of crops harvested, P900,000 * Expenses on harvested crops, P400,000 * Expenses on maturing crops, P200,000 * Expenses on newly planted crops, P100,000 * Sales of tree branches for firewood, P50,000 Peter uses the crop year method it i i incomes in reporting crop income. Compute Peter's told a P240,000 ¢. P540,000 b. P340,000 d. P550,000 134= = Chapter 4 ~ Income Tax Schemes, Accounting Periods, Methods, and Reporting Multiple Choice - Problem 4-3; Tax compliance 4. Ataxpayer filed his income tax return in October 28, 2022. The deadline for the return was April 15, 2022. If he has P40,000 net tax due, compute the penalties in the form of interest. a. P2578 cP 2,867 b. P2611 dP 4,296 2. Whatis the total surcharge penalty? a PO .P.10,000 b. P8,000 4. P 20,000 3, A taxpayer received a notice from the BIR to file his 2020 income tax return not later than January 15, 2022. The tax due per his return is P100,000. What is the total surcharge penalty? a PO ©. P 25,000 b. P20,000 4. 50,000 4, What is his total interest penalty? a. P6500 P9041 b. P7,900 d. P15,068 5. Compute the compromise penalty a. P10,000 ©.P 20,000 b. P15,000 d.P 30,000 6. Mani Pokyaw failed to pay file his income tax return for the year 2021 which should have been filed on or before April 15, 2022. The BIR sent him a notice to file his return and pay his tax on or before July 18, 2022. Mani Pakyaw filed a return showing a basic tax due of P1,000,000. Compute the total interest penalty. a. P30,904 c.P 38,555 b. P37,644 d.P 39,863 7. Mr. Pokyaw must pay a surcharge of a PO c.P 500,000 b. P250,000 d. P 1,000,000 8. Maco Corporation failed to file its income tax return for the fiscal year ending August 31, 2021. On June 6, 2022, it filed an income tax return with a basic tax still due and payable for the fiscal year amounting to P500,000, Compute the interest Penalty to be imposed by the BIR. a. P28,603 c.P.45,873 b. P2g438 a.P 46,207 5. Compute the total tax assessment to be paid, excluding compromise penalty. 653,603 c. P 689,275 P 653,438 d. P 660,873 135