TAXATION - Taxation of Individuals, Partnerships and Co-Ownerships, Estates and Trusts, and Corporations

THE CPA BOARD EXAMS OUTLINES

by John Mahatma G. Agripa, CPA

TAXATION

INCOME

TAXATION:

INDIVIDUALS,

PARTNERSHIPS/CO-OWNERSHIPS,

ESTATES/TRUSTS, AND

CORPORATIONS

Supplementary discussions based on lectures by Atty. Christopher Llamado and

Atty. Dante de la Cruz, CPA (CPAR)

2

INDIVIDUAL TAXATION

 Individuals are generally subject to three types of tax – income (ordinary, returnable) tax, passive income tax and capital gains tax. Income tax is progressive, since the tax rate increases as the tax base increases. Passive and capital gains tax are both

proportionate, since the tax is computed using a single rate The tax base for income tax, as per the income tax return format, is computed as follows:

Compensation income xx

DEDUCT: Personal exemptions xx

DEDUCT: PPHHI xx

xx

ADD: Business/professional income xx

DEDUCT: Allowable deductions xx

Taxable income xx

Tax due (computed using progressive tax table) xx

DEDUCT: Tax credits/previous payments in the tax year/

creditable withholding tax xx

Tax payable xx

Compensation income in the above formula should be net of all exclusions (SSS, GSIS, union dues and others) but gross of creditable withholding tax (CWT). Business/professional income should also be net of VAT but gross of CWT and advances

 Passive and capital gains tax are also considered final taxes, which means once paid, they can no longer be refunded. They are not reportable in the income tax return (for those made within the country)

All citizens and aliens are taxed progressively, using the graduated tax table, except for non-resident aliens not engaged in business which are proportionately taxed at 25%. Special individuals are also taxed proportionately at respective rates. Minimum wage earners are generally not taxed

3

TAX SITUS RULES

 According to tax situs, which is based on symbiotic relationship, only resident citizens are taxable for income made within and outside the country. All others are taxed only for income made within

 The place where the income was made is not necessarily the criteria for determining whether such income is within or without. The following types of income follow these test source:

o Interest income considers the residence of the debtor.

Thus, if the debtor is in Hong Kong though he’s a resident citizen, the interest income is considered income without. Since this is passive income, this is considered ordinary income – reportable in the income tax return (ITR)

o Income from services considers where the service was

performed

o Rental income considers the location of the property

o Royalty considered the place where it is used

o Gains on the sale of real property – which is subject to 6% capital gains tax – considers the location of the property. Thus, only those located in the Philippines are subject to the tax

o Gains on sale of personal property considers the place

where the sale was made

o Dividends received from a domestic corporation is always

considered income within. However, those received from foreign corporations follow the predominance test: - If 50% or more of the gross income of the corporation

for the past three years was derived from the country, the dividend is prorated to derive income within, as follows. The remaining portion shall be income without

Philippine gross income xx

DIVIDE: Total world gross income xx

xx

MULTIPLY: Dividend received xx

Income within portion of dividends xx

4

corporation for the past three years was derived within, the entire dividend is considered income without. Since dividends are passive income, dividend income without are reportable in the ITR

- The three year period is important to consider. If the foreign corporation has operated for less than three years in the country, the entire dividend received is income without, thus reportable in the ITR

o Sale of domestic shares are always income within,

regardless of place of sale. Thus, shares of PLDT sold in the New York Stock Exchange are income within – the selling price of which are subject to the stock transaction tax (0.005%)

o Sale of foreign shares are always income without

PERSONAL EXEMPTIONS: BASIC AND ADDITIONAL, PPHHI

 Personal exemptions are amounts provided by law to be

deduced against the gross income to cover the expenses of the taxpayer, which maybe basic and/or additional depending on the taxpayer’s status. The basic exemptions are allowed for every citizen and alien – except for non-resident aliens not engaged in business (NRANEB) and non-resident aliens engaged in business (NRAEB) with no present reciprocity law The basic exemption amounts to Php 50,000; the additional is Php 25,000 for every child the taxpayer has (maximum of 4 qualified dependents). In case of married taxpayers, the spouse must be deriving gross income to avail the basic exemption. Also, generally, the husband shall claim the additional exemptions

Aside from married taxpayers, a head of family – an unmarried or legally separated person with a qualified dependent – can also claim the additional exemptions

5

As seen in the income tax formula, all personal exemptions are deducted against compensation income first, then to business income if compensation income is insufficient

 A qualified dependent for claiming the additional exemption can be a legitimate, adopted, illegitimate or foster child (not more than 18 years old, unmarried, not gainfully employed or cannot support himself because of a defect) or a person with disability PWD’s and those incapable of self-support are considered qualified regardless of age – as long as they are within the 4th

degree of consanguinity or affinity of the taxpayer, not gainfully employed or chiefly dependent on him. As per BIR ruling, senior citizens are not considered dependents

 In the availing of exemptions, the tax code assumes individuals are ‘married for as long as possible and died for as short as possible’ when a change in status occurs. This means that at any given time within the taxable year, if the taxpayer marries, the taxpayer is assumed married for the entire year from the start of the taxable year. If the taxpayer dies at any time within the year, he is considered to have died at the end of the year. Thus, he can still have the whole exemptions in the year he died

The same principle goes for additional exemptions. If the taxpayer should have additional dependents in the year, he can claim the additional exemptions for those dependents in full for the year – regardless if the child also died within the year, or otherwise. If the taxpayer loses dependents, he can still claim the corresponding exemptions in full for the year

Thus, a married man with 4 children who dies in September can still claim a total of Php 150,000 exemptions when his estate files his returns in April. The following year, he can only avail Php 20,000 as per estate income taxation rules

 In case the married taxpayers legally separate, the husband generally has priority over the wife in claiming the additional

6

exemptions. The couple can claim only a maximum of 4 dependents between them. However, if they annulled, the husband and wife may both each claim 4 dependents

 In addition to the personal exemptions, a credit for premium

payments for health, hospitalization and insurance (PPHHI)

amounting to Php 2,400 a year or Php 200 per month is also allowed to be deducted against gross income of families earning not more than Php 250,000 per year (gross of CWT and other deductions)

MINIMUM WAGE EARNERS

 Minimum wage earners are those earning the statutory

minimum wage as defined by the Regional Tripartite Wage and Productivity Board. As mentioned, they are generally exempt from income taxation

 This immunity shall cease if the minimum wage earner receives or earns additional income such as taxable allowances, compensation other than the statutory minimum wage and ‘13th

month pay and other benefits’ in excess of Php 82,000, or receives the SMW from 2 or more employees

In the above cases, his entire earnings from the time of the cessation shall be subjected to income taxation. However, if the MWE earns income subject to final taxes such as passive income other than the SWE only, his earnings are still exempt from income tax

TAXATION OF PARTNERSHIPS/ CO-OWNERSHIPS

7

or taxable. All partnerships are tax-reporting entities but some are not tax-paying entities

EXEMPT PARTNERSHIPS:

GENERAL PROFESSIONAL PARTNERSHIPS

 General professional partnerships are an association of two or more individuals practicing the same profession as a means to do business, the profits from which to be divided among the partners. Such entities are taxed on the individual capacity of the partners – meaning the partners, not the business, pays income tax from their share of partnership income. This exemption only applies to income tax

Even though exempt, the business is still required to file an income tax return for informational purposes, to determine the share of the partners

 GPPs are subject to creditable withholdings of 10% of payments Php 720,000 below, and 15% for payments above the said amount. This is to be deducted against the taxes due of the individual partners

 In computing the partner’s tax due, he considers the kind of deduction scheme the partnership uses – itemized or optional standard deduction. If the partnership uses the latter, the partner cannot use any deduction against his share of the partnership income. As to his other income, the partner may use any deduction scheme regardless of what the partnership uses

TAXABLE PARTNERSHIPS

 Composed of all other partnerships, they are subject to the same income taxation system as corporations. General

8

professional partnerships may be taxed (in its whole earnings) if it engages in other lines of business other than its profession

 The share of partnership net income (after-tax) to the partners are considered as dividends, which are subject to final tax. Thus, they are not reported in the income tax return of the partners. After all, the income has been already subjected to indirect double taxation. Taxable partnerships are also not subject to creditable withholdings

CO-OWNERSHIPS

 Income derived from the co-ownership of a thing are generally exempt, except if the co-ownership was formed voluntarily. An except co-ownership arises mostly from donations or inheritance of undivided property to several individuals However, if the donated or inheritance remains undivided between the recipients 10 years after receiving the property, the income derived therefrom shall be subjected to tax

TAXATION OF ESTATES/TRUSTS

 An estate is the mass of all property, rights and obligations existing at the time of death and accruing since. A trust is a right over property established by a trustor for the benefit of a certain beneficiary. Income generated from such are taxed as individuals Both also make use of calendar year only. Estates and trusts managed from outside the country are not included for income tax purposes

Note that income generated by the estate is covered here. Estate tax is imposed over the properties and rights left behind

9

ESTATE INCOME TAXATION

 Income tax of the estate shall be paid by the executor/ administrator or by the heirs themselves, which can be computed as follows:

Estate gross income xx

DEDUCT: Estate expenses xx

DEDUCT: Special deductions xx

DEDUCT: Php 20,000 basic exemption xx

Taxable net income xx

Tax due (computed using progressive tax table) xx

DEDUCT: Tax credits/creditable withholding tax xx

Tax payable xx

 The estate may use all items of gross income and deductions as allowed to an individual taxpayer. As mentioned above, the estate could claim the basic and additional exemptions of the deceased taxpayer in the year of death. On the succeeding years, the estate shall only avail of a Php 20,000 basic exemption

The special deduction above represents actual distribution of income (except from property) to the heirs, which is subject to 15% CWT. These shares of income shall be included in the heirs’ separate income tax returns

TRUST TAXATION

 Trusts shall be taxed when they are irrevocable. Those established for pension and other employee benefits are generally exempt from income tax

 Computation of taxable income of the trust follows the same formula as to estate’s. The Php 20,000 basic exemption is also provided. Special deductions are always deducted even if no distribution of funds is made to the beneficiary during the period

10

 In some cases, several trusts are established for the benefit of one entity. Data from the trusts are consolidated and used in computing tax due for the trusts, using Php 20,000 only as basic exemption. To determine the tax payable for each trust, the tax due computed from the consolidated data is apportioned using gross income after all deductions but before the Php 20,000 exemption

CORPORATE INCOME TAX

 For taxation purposes, a corporation includes partnerships (except GPPs), joint stock companies, joint accounts, associations and insurance companies

They are classified as either domestic, resident foreign or non-resident foreign. Domestic corporations are created in the Philippines, taxable at 30% for net income made within and outside the country. Resident foreign corporations are those created outside the country but operates in it, taxable at 30% for net income within. Non-resident foreign corporations does not engage in any business operations in the country, taxed at 30% final

 Certain specific corporations have been granted immunity from

income taxation:

o Government-owned and controlled corporations (GSIS, SSS, PHIC, PCSO, local water districts and PDIC)

o Beneficiary societies and organizations operating solely for its members (e.g., fraternities, sororities)

o Non-stock and government-owned educational institutions o Non-stock religious, civic, educational and social welfare

organizations o Philippine Red Cross

o Child-caring institutions accredited with DSWD o Farmer’s associations acting as sales agents

11

However, any income generated from real and personal property owned by the aforementioned corporations shall be subjected to graduated rates of income tax, regardless of use

 The corporate tax due can be computed as follows:

Gross sales/receipts xx

DEDUCT: Cost of sales xx

ADD: Taxable other income xx

Total gross income xx

DEDUCT: Allowable deductions xx

Taxable income xx

Regular income tax (30% of taxable income) xx

MCIT (2% of gross income) xx

Tax due (whichever is higher between regular IT and MCIT) xx

DEDUCT: Any tax credits, excess MCIT xx

Tax payable xx

 The computation and filing of corporate income tax follow some rules worth remembering:

o Corporations file returns quarterly. The computation of income tax per quarter follow a cumulative computation, meaning data from the first quarter is combined with those of the second to compute the tax due for the quarter. Since the tax for the first quarter is already paid, this payment is deducted against the tax computed on the second quarter to get the tax payable for the second quarter

o Just like in individuals, income must be reported gross of any creditable withholding tax

o Corporations may adopt a fiscal or calendar year as their accounting period, which is why the annual return is filed ‘on the 15th _{day of the 4}th _{month following the close of the tax}

year’ and not on April 15 just like in most cases

PENALTY TAXES:

MINIMUM CORPORATE INCOME TAX

 The minimum corporate income tax (MCIT) – 2% of gross income – is applied to all corporations subject to 30% tax rate

12

(domestic, resident foreign), which commences on the 5th _year

of the corporation’s existence. Gross income shall include income from unrelated from the entity’s main line of business (e.g., rent income if the corporation is a manufacturer) and excludes income subject to final tax

 As seen in the formula above, the tax due for the corporation shall be the higher between the regular income tax and minimum corporate income tax

In cases when MCIT is greater than regular income tax, the excess between the two can be deducted against regular income tax within three years the MCIT was paid. The excess MCIT can only be deducted if regular income tax was higher than MCIT in that year. The excess is recorded as a deferred charge (debit normal balance)

If the excess MCIT is still not emptied out after three years, the remaining amount can no longer be credited against regular income

PENALTY TAXES:

IMPROPERLY ACCUMULATED EARNINGS TAX

 This penalty tax is a measure for corporations to declare dividends for their shareholders – 10% of the accumulated earnings beyond the needs of the corporation, computed as follows:

Taxable net income xx

ADD: Exempt, excluded and income subject to final tax xx

ADD: Net operating loss carry-over xx

Accounting income xx

DEDUCT: All taxes paid, including final taxes xx

DEDUCT: Amount reserved for corporate needs xx

DEDUCT: Dividend declared xx

13

 IAET shall be paid 15 days after one year preceding the tax year for which the dividend must’ve been declared, i.e., a year and 15 days after the current tax year for which dividends must be declared

 Income subjected to IAET will no longer be included in