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

SR Re Re ee ee ee ee ee OS EERE ONE
o..

This chapter provides an overview of the income tax schemes under the NIRC,

After this chapter, readers are expected to gain familiarization and demonstrate
mastery of the following:
a. Types of taxation schemes and their scope
b. Concept of accounting period and its types
c. Concept of accounting methods and their accounting procedures
d. Types of tax returns, their deadline and place of filing

INCOME TAXATION SCHEMES

There are three income taxation schemes under the NIRC:
a. Final income taxation |
b. Capital gains taxation
c. Regular income taxation

An item of gross income is taxable in any of these tax schemes.

Item of gross income

|
Taxable to any one of

f
Final Income
|
Capital Gains
|!
Regular Income "
Taxation Taxation Taxation

Mutually exclusive coverage

t to
The tax schemes are mutually exclusive. An item of gross income that is subje¢
tax in one scheme will not be taxed by the other schemes. Similarly, items :
income that are exempted in one scheme are not taxable by the other schemes-

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CLASSIFICATION OF ITEMS OF GROSS INCOME

Because 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. Grossincome 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 to 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 recipient income taxpayer receives
the income net of taxes. The payor is. the one required by law to remit the <ax 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.
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CAPITAL GAINS TAXATION

Capital gains tax is imposed on the gain realized on the sale, exchange and Other
dispositions of certain capital assets.

Capital assets are assets not used in business, trade or profession. Capital asset,
are the opposites of ordinary assets. Ordinary assets are assets used in business
trade or profession such as inventory, supplies or property, plant and equipment,

Also, not all capital gains are subject to capital gains tax. Most of them are subject
to regular income tax.

The NIRC identifies capital gains tax as a final tax but they are hybrid forms of
final taxes since it also employs self-assessment method. The taxpayer still files
capital gains tax returns to report the gain and pay the tax to the government,
Capital gains taxation applies only to two types of capital assets: domestic stocks
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 other
income such as: ois
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 finaltax .

Items of gross income from these sources are valued or,measured using an
accounting method, accumulated over an accounting period, and reported to the
government through an income tax return. Regular income taxation makes use of
the self-assessment method.

ACCOUNTING PERIOD
Accounting period is the length of time over which income is measured and
reported.

Types of Accounting Periods

1. Regular accounting period- 12 months in length
a. Calendar
b. Fiscal
2. Short accounting period - less than 12 months

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 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 (i.e. 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.
Illustration: Due date of the annual income return
1. Taxpayers under the calendar year must file their annual i 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.
Illustration
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.
Illustration
Tawi-tawi Inc. is on the fiscal year accounting period ending every March 31. It
ceased business operation on August 15, 2021.

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Tawi-tawi should file its last income tax return covering April 1 to August 15, 202].

Under the old NIRC, dissolving corporations shall-file their return within 30 days
from the cessation of activities or 30 days from the approval of merger by the
Securities and Exchange Commission in the case of merger. (BPI vs. CIR, Gp
144653, August 28, 2011). Hence, the return shall be a on or before September
15, 2021. /
{
For individuals, the return shall be due on or before April 15, 2022. There is no
requirement for early filing under the NIRC. ; a |
/
isribes }
3. Change of accounting period by corporate taxpayers -/The accounting
period covers the start of the previous accounting period up to the designated
year-end of the new accounting period. Note that BIR approval is required 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 i income from sanubry 1
to June 30, 2021 on or before October 15, 2021.

Illustration 2
Effective August 2021, Zamboanga Company changed its fiscal year ‘accounting
period ending every June 30 to the calendar year.
Zamboanga Company should file an adjustment return covering July ‘1 to December
31, 2021 on or before April 15, 2022.

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 administrators or executors shall file his last
income tax return covering his income from January 1 to November 2, 2021. There is
no requirement for early filing in case of death of taxpayers. Hence, the income tax
return shall be filed on or before the usual 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 incomea accruing after death are not
part thereof. Hence, it is mandatory for the accounting period of the taxpayer to be
terminated exactly at the date of death.

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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.
Illustration
The accounting period ofa 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
WN

Percentage of completion method

Outright and spread-out method
We

Crop year basis

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.

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

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advanced income in the period earned will expose the government to risk of
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 year paid. They
are deducted against income in the future period they expire/or are used 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 mee By xxx
Accrued (uncollected) income XXX,XXX
Advanced income __XXX,.XXX
Gross income P__ xxx.xxx

The tax accrual basis expense is determined as follows:

Cash expenses P = XXx,xxx
Accrued (unpaid) expense ~ XXX,XXX
Amortization of prepayments and
depreciation of capital expenditures XXX,XXX
Deductions P XXX, XXX

The tax cash basis income is determined as follows:

Cash income Ps XXX,Xxx
Advanced income XXX,XXX
Gross income
P _XXX,XXX
The tax cash basis expense is determined as follows:
Cash expenses * P XxXx,xxx
Amortization of prepayments and
depreciation of capital expenditures
XXX, XXX
Deductions
P___ XXX, xxx

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Illustration
A taxpayer 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

Tax Accrual Basis

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 P450,000
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

ot 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 P__400,000 P570,000
Note: P800,000 + P470,000 = P1,270,000*; P600,000 + P100,000 = P700,000**

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Points to consider in converting GAAP cash basis to Tax cash basis

1. Under the accounting cash basis, income is recognized when received not when it is earned,
Advanced income is inherently recognized as income. Hence, no adjustment is necessary on
income.
2. Under accounting cash basis, expense is deducted when paid including prepaid expenses,
Hence, the deducted prepaid expenses must be reversed for purposes of taxation.
/
Sellers of goods
The gross income of taxpayers selling goods is determined as follows: |
j
Sales P XXX,XXX
Less: Cost of goods sold ___XXX,XXX
Gross income PP
xXxx.xxx

The cost of sales is computed using the inventory method:

Beginning inventory P —XXX,XXX

Add: Purchases XXX,XXX
Total goods available for sale Ps XXX,XXx
Less: Ending inventory XXX,XXX
Cost of goods sold P_XXX,.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.
Illustration
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 gross
income as determined by the accrual basis in the trading business are simply combined.
There is no requirement to measure the income of different businesses under a singlé
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.

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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:
1. 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 MOUSER SBS OSX RK 15

Fair market value of property received or receivable XXX,XXX
Mortgage or any indebtedness assumed by the buyer XXKXKK |
Selling price . | sy ce « Re KKKAXXX
Contract price Oe MSA WOE
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 —_1.800,000
Selling price P 2,000,000
Less: Tax basis of machine sold (__1.200,000)
Gross profit P__ 800,000

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Accrual basis
Under the accrual basis, the entire P800,000 gross profit shall be reported as Bros,
income in 2021, the year of sale,
Installment basis
Malaybay cannot readily use the installment method because it is a dealer of Cars
rather than a dealer of machineries. The sale of properties of which the seller is not,
dealer is referred to as a “casual sale.” Hence, the ratio of initial payment shall be
tested first.

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 shall
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 if the,
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 buyé
assumes indebtedness on the property sold.

In this case, the selling price is no longer the contract price. The contract price is
the residual amount after deducting the mortgage from the selling price. Thus,

Selling price Ps XXX, XXX

Less: Mortgage assumed by buyer ——_XXX.XXX
Contract price P___Xxx, Xxx

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Illustration
On January 3, 2021, Tagaytay, Inc., a real property dealer, sold a Jot 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 pP__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 ee PB _ 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 o) \ 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 x4 installments) 800,000" —
Contract price ee B'4,000,000

Tagaytay shall recognize the following gross income:

At the date of sale: (P200K/P1M x P600,000) P__120,000
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.

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The contract price shall be computed as follows:

Selling price P XXX,XXX
Less: Mortgage assumed by buyer XXX,XXX
Cash collectible P XXX,XXX
Add: Excess indebtedness - constructive receipt XXX,XXK
Contract price P_XxXx,xxx
The initial payment shall be computed as follows:
Downpayment P XXX,XXKX
Installment in the year of sale XXX,XXK
Excess of mortgage over tax basis XXX,XXX
Initial payment
| Pe Xxx.Xxx
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 .
December 31, 2021 installment
P 100,000
Excess mortgage (P1,500,000 - P1,300,000)
200,000
200,000
Initial payment
P 500,000
Ratio of initial payment (P500K/P2,000,000)
25%
The contract price shall be computed as:
Selling price P 2,000,000
Less: Mortgage assumed by buyer 1,500,000
Cash collectible P 500,000
Excess mortgage (P1,500,000 - P1,300,000) 200,000
Contract price P__700,000
Note that the gross profit on the sale is the same as the contract price. Hence, any
collection from the contract including the excess mortgage shall be recognized as
gross income upon collection.

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Canlubang shall recognize the following gross income:

At the date of sale (P200K down + P100K excess) P 300,000
Upon receipt of first installment - 12/31/2021 200,000
Upon 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
a sale.

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.
Illustration
On December 31, 2021, a taxpayer sold an office building costing P1,400,000 for
P2,000,000. 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 ae ratio of initia payment
is already 50% (P41, 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 _e
Present value ofthenote © _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_50,000

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.
2. 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.
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The Percentage of Completion Method for Construction Contracts

Under the percentage of completion method, the estimated gross income from
construction is reported based on the percentage of completion of the
construction project.

There are several methods of estimating project completion in practice, but the
output method based on engineering survey is prescribed by the NIRC.
Illustration
In 2021, Cagayan De Oro Construction Company accepted a P5,000,000 fixed-price
construction contract. The following shows the details of its construction activities:
2021 nv 2022
Construction expenses P 3,000,000 P 1,200,000
Engineer’s estimate of completion 70% ; 100%

The reportable gross income on construction will simply be computed as follows:

2021 2022
Contract price P 5,000,000 P 5,000,000
Multiply by: % of completion __.70% 100%
Construction revenue P 3,500,000 P 5,000,000.
Less: Construction revenue in prior year - 3,500,000
Construction revenue this year _ P3,500,000... :P.1,500,000 .
Less: Expense during the year 3,000,000 1,200,000
Construction gross income P__500,000 P300,000

Income from Leasehold Improvement

Leasehold improvements are tangible improvements made by the lessee to the
property of the lessor. Improvements will benefit the lessor when their useful life
extends beyond the lease term. This benefit is referred to as income from leasehold
improvement.

Under Revenue Regulations No. 2, the income from leasehold improvement can be
reported using either of the following method at the option of the taxpayer:
1. Outright method
The lessor may report as income the fair market value of such buildings or
improvements subject to the lease at the time when such buildings of
improvements are completed.

2. Spread-out method
The lessor may spread over the life of the lease the estimated depreciated
value of such buildings or improvements at the termination of the lease and
report as income for each year of the lease an aliquot part thereof,

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The depreciated value of the leasehold improvement is computed as:

Cost of improvement x Excess useful life over lease term
Useful life of the improvement.
Illustration
On January 1, 2021, Ivan leased a vacant lot to Greg under a 20-year lease contract.
Greg immediately constructed a building on the lot at a total cost of P4,500,000. The
building has useful life of 30 years.

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 1,500,000 |
Total _30 ~ P_
4,500,000

The P1,500,000 depreciated value of the improvement.at the termination of the lease
is an 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.

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The depreciated value of the improvement at the termination of the lease should be
the proper value to be recognized as gross income under the outright method.

This view is supported by the fact that the spread-out method could not have beep
an option if the outright method intended to tax the entire fair value of the
improvement considering the huge disproportion in the reportable gross income
under the two options.

The outright method as mandated by the regulation will best apply in cases where
lessees pay the lessor rentals in the form of leasehold improvements or when
leasehold improvements made by lessees are treated as reductions to cash rentals,
In such cases, the fair value of the leasehold improvements:.upon completion is
unquestionably income to the lessor for taxation purposes.

Agricultural or Farming Income

Farming income is commonly measured using the cash basis or0 accrual basis, such
as in the following:
a. Animal husbandry
b. Short-term crops
Illustration .
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 Cash basis
Sales P 12,000,000 P 11,000,000
Direct 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 P_ 5,000,000 P_4,000,000
The accounting for long-term crops depends on the harvesting frequency:
a. Perennial crops - those that yield harvests through years
b. One-time crops - those that are harvested once after several years

The initial farm development costs of perennial crops like mangoes, mangosteen,
coconut and banana are capitalized and amortized over the.expected years of

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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
1st cropping expenses 400,000 200,000 :
2™4 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 P200,000
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. A letter 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
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3. Sworn statement of “non-forum shopping” stating that such request has Not
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 final or
adjustment return for the period between the close of the original accounting
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 period.
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, tax
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 declaration
required to be filed with the BIR.
Under the NIRC, the income tax return shall be filed to the following, i?
descending order of priority, within the revenue district office where the taxpaye!
is registered or required to register:
1. An authorized agent bank (AAB)
2. Revenue Collection Officer
3. Duly authorized city or municipal treasurer, if there is no BIR office in thé
locality
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2. e-BIR Forms
The BIR introduced the e-B/R Forms with an offline or online version. Taxpayers
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_.,
Large taxpayers duly notified by the BIR
bP

Top 20,000 private corporations duly notified by the BIR

PWN

Top 5,000 individual taxpayers duly notified by the BIR

Taxpayers who wish to enter into contracts with government offices
Corporations with paid-up capital of P10,000,000
NAM

PEZA-registered entities and those located within Special Economic Zones

Government offices, in so far as remittance of withheld VAT and business tax
are concerned
Taxpayers included in the Taxpayer Account Management Progtatt (TAMP)
32 99

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
c. Non-bank financial intermediation
d. Activities auxiliary to financial intermediation
e. Construction
f. Water transport
g. Hotels and restaurants
h. Land transport
2. GroupB
a. Manufacture and repair of furniture
b. Manufacture of basic metals
c. Manufacture of chemicals, and chemical products
d. Manufacture of coke, refined petroleum, and fuel products
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Manufacture of electrical machinery, and apparatus NEC

Manufacture of fabricated metal products
Manufacture of foods, products, and beverages
a ee
Manufacture of machineries, and equipment NEC
Manufacture of medical, precision, and optical instruments
ee

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
3

Manufacture of other wearing apparel

neaypos

Manufacture of papers, and paper products

Manufacture of radio, TV, and communication equipment, and apparatus
Manufacture of rubber and plastic products
Manufacture of textiles
Manufacture of tobacco products
Manufacture of wood and wood products
2 serv

Manufacturing N.E.C.
Metallic ore mining
Non-metallic mining and quarrying
3. GroupC
a. Retail sale
b. Wholesale trade and commission trade
c. Sale, maintenance, repair of motor vehicle, and sale of automotive fuel
d. Collection, purification, and distribution of water
e Computer and related activities
f. Real estate activities
4. GroupD
a. Airtransport
b. Electricity, gas, steam, and hot water supply
c. Postal and telecommunications
d. Publishing, printing, and reproduction of recorded media
e. Recreational, cultural, and sporting activities
f. Recycling
g. Renting out of goods and equipment
h. Supporting and auxiliary transport activities
5. GroupE
Activities of membership organizations Inc.
me aa oe

Health and social work

Private educational services
rrrsm

Public administration and defense compulsory social security

Public educational services
Research and development
Agriculture, hunting, and forestry
Farming of animals
Fishing
Other service activities
Miscellaneous business activities
:

Unclassified activities
—

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PAYMENT OF INCOME TAXES

The general rule is “pay as you file”. The capital gains tax and regular income tax
are paid as the taxpayer files his return. Installment payment of income tax is
allowed on certain conditions.
Taxpayers under the eFPS system shall e-pay their tax online through internet
banking service. The account of the taxpayer will be auto-debited for the amount
of taxes to be paid.

BASIC COMPARISON OF FILING AND PAYMENT SYSTEMS

Manual e-BIR Forms eFPS
Data entry Manual Electronic Electronic
Filing/Submission Manual Electronic Electronic
Tax payment Manual Manual Electronic

PENALTIES FOR LATE FILING OR PAYMENT OF TAX ~

The late filing and payment of taxes is subject to the following additional charges:
1. Surcharge -
a. 25% of the basic tax for failure to file or pay deficiency tax on time
b. 50% for willful neglect to file and pay taxes
The non-filing is considered ‘willful neglect’ if the BIR discovered the non-filing
first. This is the case when the taxpayer received a notice from the BIR to file
return prior to his actual filing. If the taxpayer filed a return before the receipt of
such notice, the same is considered simple neglect subject to the 25% surcharge.

Interest - Double of the legal interest rate for loans or forbearance of any
money in the absence of any express stipulation

Since the legal interest is currently set at 6%, the interest penalty is therefore
12% per annum effective January 1, 2018. Note that NIRC imposed an
interest penalty of 20% per annum until December 31, 2017.

Under the new rules established by RR21-2018, the interest period shall be
computed based on actual days divided 365 days. The additional day in
February during a leap year will be counted. The yearly-monthly-daily
counting method established in prior regulations is already abandoned.

A month normally has 30 days except the following:

31-day months January, March, May, July, August, October, December
28 or 29-day month _| February
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The best way to put this in mind is that 31-day and 30-day months are
alternating from January to July, but the sequence is reset in August. Also Put
in mind that February is a 28-day month, except on a leap year.

How to identify a leap year?

A year divisible by 4 with a whole number quotient without a decimal is a leap
year. Years 2016, 2020, 2024, 2028 and so on are leap years. Leap years have
29 days in February hence the actual number of days in a leap year is 366 not
the usual 365. This is due to the fact that our planet revolves around the sun jn
365 % days. Hence, there is an extra one complete day in every four calendar
years.

Under the illustrative guidelines in RR21-2018, the new day counting system
for the interest penalty will be implemented for tax assessments effective
January 1, 2018. This means it will be applied even if the tax assessment
pertains to 2017 and prior years.

Illustration 1: Basic procedure

The tax return of the taxpayer was due on April 15, 2021 but was filed on August
3, 2021. The tax due per return of the taxpayer amounts to P100,000.
The number of days would be counted as follows:

Period __Days _—
April (30 - 15) 15
May ' 31
June 30
July 31
August 3
Total days ——__110

The interest penalty shall be computed as P 100,000 x 12% x 110/365 = P3,616.44.

Illustration 2: Interest in a leap year

A taxpayer-withholding agent failed to file his withholding tax return and failed t
remit the P50,000 withholding tax thereon on April 30, 2019. The taxpayer filed
the return on July 16, 2020.

The number of days would be counted as follows:

Period —_Days_
April 30, 2019 to April 30, 2020 366
May 2020 31
June 2020
30
July 2020
16
Total days
—_ 443
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The interest penalty shall be computed as P 50,000 x 12% x 443/365 = P7,282.19.

Illustration 3: Interest in transition years

An individual taxpayer has a tax due of P40,000 for taxable year 2016 due on April
15, 2017. The taxpayer settled his tax on February 10, 2018.

The interest in 2017 shall be computed using the old 20% interest penalty rate
while the interest in 2018 shall be computed using the 12% interest penalty rate.

April 16, 2017 to December 31, 207 is 260 days. January 1, 2018 to February 10,
2018 is 41 days. Hence, the interest shall be computed as follows:

2017 interest (P40,000 x 20% x 260/365) P 5,698.63

2018 interest (P40,000 x 12% x 41/365) 539.18
Interest penalty . P___ 6,237.81

3. Compromise penalty -
Compromise penalty is an amount paid in lieu of criminal prosecution over a
tax violation.
The schedules of compromise penalty related to income taxes are included in
Appendix 4 for your reference.

INTEGRATIVE ILLUSTRATION
An individual taxpayer filed his 2020 income tax return with a computed tax due of
P100,000 on July 15, 2021. A total of P20,000 creditable withholding taxes was
deducted by various income payors from his gross income.

The total amount to be paid by the taxpayer including penalties shall be:

Tax due P 100,000

Less: Tax credits (creditable withholding taxes) 20,000
Net tax due P ~—- 80,000
Plus: Penalties
Surcharge (P80,000 x 25%) 20,000
Interest (P80,000 x 12% x 91/365) 2,393
Compromise penalty* 15,000
Total tax due P__117,393
Note:
1. The deadline of the 2020 income tax return is April 15, 2021. April 15, 2021 to July 15,
2021 is a 91-day period. |
2. Interest is computed from the net amount of tax due before the 25% surcharge. Imposition
of interest upon the surcharge is illegal.
3. The compromise penalty is taken from the table of compromise penalties for failure to file
and or pay internal revenue tax at the time or times required by law, as follows: .
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If the amount of tax unpaid

Exceeds But not exceed Compromise is

P 20,000 P 50,000 P 10,000

50,000 100,000 15,000
100,000 500,000 20,000

You may check the schedule of compromise penalty for late payment of income
tax in Appendix 4 for your reference.

PENALTIES FOR NON-FILING OR LATE FILING OF INFORMATION RETURN

For each failure to file a separate information return, statement or list, or keep any
record, or supply any information required by the Code or by the Commissioner
on the date prescribe therefor, unless it is shown that such failure is due to
reasonable cause not to willful neglect, shall be subject to a penalty off P1,000 for
each such failure. Provided that the amount imposed for all such failure during a
calendar year shall not exceed P25,000.

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