Tax Bases and Tax Rates, IAET

TAX BASES

CATEGORIES:

1. compensation income, business and professional income, capital gains not subject to final tax, passive income not subject to final tax, and other income
2. capital gains subject to final tax at preferential tax rates
3. passive income subject to final tax at preferential tax rates

a.1. Compensation income, business and professional income, capital gain not subject to final tax, passive income not subject to final tax and other income

- the Philippines follows the “Global Tax System” insofar as compensation income, business and professional income, capital gains not subject to final tax, passive incomes, and other income not subject to final tax

- for individuals: TAXABLE INCOME = taxable gross income – (allowable deductions + personal exemptions + additional personal exemptions)

- GR: no deductions allowed from gross compensation income

- EXCEPTION: taxable base of aliens (and Filipinos) employed by regional or area headquarters, regional operating headquarters, offshore banking units, and foreign petroleum service contractors and sub-contractors is their gross compensation income (no deductions); subject to preferential tax rate of 15%

a.2. Gain from sale of real property

- GAIN/LOSS = proceeds – adjusted basis
- ADJUSTED BASIS = (original cost + cost of improvements) – accumulated depreciation up to date of sale

BASIS OF PROPERTY:

1. Cost – if acquired by purchase
2. FMV – if acquired by inheritance
3. if acquired by gift, the same as if it would be in the hands of the donor or last preceding owner (who did not acquire it by gift); if greater than FMV, FMV shall be used for purposes of determining loss
4. amount paid by transferee for the property – if acquired for less than adequate consideration (“arm’s length transaction”)

NOTA BENE: In determining the gain or loss, it does not matter whether the property sold is an ordinary or capital asset. But, in the case of sale or exchange of SHARES OF STOCK of domestic corporation or real property that is considered as capital asset, the CIR determines the gross selling price or FMV on the date of sale, whichever is higher, to determine gain or loss.

a.3. Nature of asset or property

- income tax is imposed only if there is gain; but the law presumes there is gain whenever there is sale or exchange of property, even if the seller actually incurred a loss

KINDS:

1. Ordinary asset – CORP: NCIT (32%) of net taxable income; IND: GIT (5%) of net taxable income
2. Capital asset – CGT (6%) of the actual consideration or FMV, whichever is higher

- shares of stock (DC): if un/listed but not traded in the local stock exchange, CGT at 5% on the first P100,000 of net capital gain and CGT at 10% on the amount in excess of P100,000

a.4. Passive investment incomes

- passive investment incomes subject to final withholding tax are taxed on the gross amount, without any deduction of cost and expenses of sale

TAX RATES

b.1. Individuals

Graduated income tax rates on taxable income

• RC: from all sources within and without
• NRC: from all sources within
• RA/NRAeB: from all sources within

Capital Gains
- GR: gain is presumed in sale of real property, subject to CGT (6%)

- EXCEPTION: if the buyer is the government, then there are two options: a) graduated tax rates applied on taxable income; or b) 6% final tax based on gross selling price or FMV, whichever is higher (this is not available to alien sellers)

- EXEMPTION FROM CGT: when real property sold or disposed by RC, NRC or RA is capital asset and used as principal residence, then exempted from CGT (6%) on the following conditions:

• proceeds of sale is fully utilized in acquiring or constructing a new principal residence within 18 calendar months from the date of sale or disposition;
• CIR is duly notified by the taxpayer within 30d from date of sale through a prescribed return of his intention to avail of the tax exemption; and
• tax exemption is availed of only once every 10 years

Passive Income Subject to Final Tax and Preferential Tax Rates

b.2. Corporations
Domestic corporations

• NCIT – 32% on net taxable income
• MCIT – 2% on gross income as of the end of the taxable year

- this applies when the minimum income tax is greater than the NCIT for the taxable year
- excess of the MCIT over the NCIT shall be carried forward and credited against the normal income tax for the 3 immediately succeeding taxable years
- applies only to domestic corporations subject to NCIT
- RFC: only income from sources within the Philippines

MCIT DOES NOT APPLY TO:

1. international carriers subject to 2.5% tax on their GBP
2. offshore banking units
3. regional operating headquarters
4. foreign contractors and sub-contractors engaged in petroleum operations
5. firms registered with PEZA, SBMA, CDA, CJHDA and other similar ecozones and Freeport zones

NOTA BENE: Banks that re-opened after cessation of business is entitled to four-year leeway.

Preferential Tax Rates

DC ENTITLED TO PREFERENTIAL TAX RATES:
1. proprietary educational institutions and hospitals
- 10% on their taxable income
- EXCEPT:

• interest income from deposits and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements;
• capital gains from sale of shares of stock not traded in the stock exchange;
• tax on income derived under the expanded foreign currency deposit system;
• inter-corporate dividends; and
• capital gains realized from the sale, exchange or disposition of lands and/or buildings

2. foreign currency deposit unit of a local universal or commercial bank
- 10% final tax

3. firms that are taxed under a special income tax regime
- (i.e. PEZA-registered enterprises): 5% final tax on gross income earned from their registered activities, AFTER expiration of income tax holiday
- other income not related to registered activities are subject to normal internal revenue taxes
- NON-STOCK, NON-PROFIT EDUCATIONAL INSTITUTION: exempt from tax, provided revenue and assets are used directly, exclusively and actually for educational purposes
- hospitals owned and operated by such educational institution are exempt from income tax on their revenues and assets, provided the hospitals are an indispensable requirement in the operation and maintenance of its medical school or college
- but passive investments income are subject to 20% final tax
- OTHER EXEMPTIONS: income from school canteens, cafeterias, dormitories, hospitals and bookstores if owned and operated by the school and located within school premises; miscellaneous school-related operations like car stickers

Resident Foreign Corporations
- income from sources within the Philippines subject to income tax (32%) of its net taxable income
- income from sources without the Philippines is exempt

RFC EXEMPT FROM INCOME TAX:

• Regional or area headquarters – branch established in the Philippines by multinational companies and which headquarters do not earn or derive income from the Philippines; supervisory, communications or coordination centers only
• Representative office – branch in the Philippines of a foreign multinational corporation whose activities are limited to information dissemination, product promotion, and the performance of quality control of goods for export to its head office or affiliates

NOTA BENE: These RFCs are exempt because they not engaged in business in the Philippines or derive income from sources within the Philippines. But their passive investments income, like interest income on bank deposits or deposit substitutes in the Philippines, are subject to final withholding tax.

RFC SUBJECT TO PREFERENTIAL TAX RATES:
1. International carrier
- foreign airline corporation doing business in the Philippines having been granted landing rights in any Philippine port to perform international air transportation services/activities or flight operations anywhere in the world
- 2 ½% on its Gross-Philippine Billings (GBP)
- OFF-LINE AIRLINE (international air carrier having no flight operations to and from the Philippines): considered not engaged in business but may still be subject to GBP tax if it has flights originating from any port or point in the Philippines, irrespective of where the passage documents were sold

2. Offshore banking units
- subject to 10% final income tax
- authorized by BSP

3. Regional operating headquarters
- subject to 10% tax of net taxable income from sources within the Philippines

4. Foreign currency deposit unit in the Philippines of a foreign bank

5. Branch of foreign corporations registered with PEZA, SBMA, CDA, CJHDA, etc.
- after the income tax holiday, PEZA-registered enterprises are subject to 5% final tax

6. Qualified service contractor and sub-contractor engaged in petroleum operations in the Philippines

Branch profit remittance tax – to equalize the tax burden on foreign corporations maintaining, on one hand, local branch offices, and organizing, on the other hand, a subsidiary domestic corporation where at least a majority of all the latter’s shares of stock are owned by such foreign corporations (15% on the profit actually remitted by the Philippines branch to its head office)

IMPROPERLY ACCUMULATED EARNINGS TAX (IAET)

c.1. Concept
- IAET at 10% of the improperly accumulated taxable income of corporations, which improperly accumulated income is formed for the purpose of avoiding the income tax with respect to its shareholders or the shareholders of any other corporation
- instead of dividing the earnings of the corporation and declaring them as dividends, the corporation allows the earnings to accumulate so the shareholders are spared the burden of paying dividend tax

c.2. Rationale
- as a form of deterrence to this kind of tax avoidance scheme
- if earnings are distributed as dividends, shareholders are liable for dividend tax
- to prevent this, the corporation makes no distribution of its earnings and instead allows them to accumulate
- this is also in the nature of a penalty to the corporation

c.3. How Determined
- accumulation of earnings or profits is unreasonable if it is not necessary for the purpose of the business
- reasonable needs of the business is determined by the “immediacy test” (immediate needs of the business, including reasonably anticipated needs
- there should be PROOF of immediacy or direct correlation of anticipated needs
- REASONABLE NEEDS OF THE BUSINESS:

• up to 100% of the paid up capital of the corporation for reserve purposes
• For definite corporate expansion projects as approved by the BOD
• for building, plants or equipment acquisition as approved by the BOD
• for compliance with any loan covenant or pre-existing obligation established under a legitimate business agreement
• required by law or applicable regulations to be retained by the corporation or in respect of which there is legal prohibition against its distribution
• SUBSIDIARIES OF FC: investments in the Philippines as proven by corporate records

ENTITIES EXEMPT FROM IAET: (code BIPNGET)

1. banks and other non-bank financial intermediaries
2. insurance companies
3. publicly-held corporations
4. non-taxable joint ventures
5. general professional partnerships
6. enterprises duly registered with the PEZA and other companies registered under special economic zones
7. taxable partnerships

Closely-held Corporations – at least 50% in value of the outstanding capital stock or at least 50% of the total combined voting power of all classes of stock entitled to vote is owned directly or indirectly by or for not more than 20 individuals

NOTA BENE: Domestic corporations that do not fall under the definition for “closely-held corporations” are publicly-held corporations. But a branch of a foreign corporation is a RFC, not domestic, therefore it is not covered under the regulation.

c.4. Tax Base
- taxable income + the following:

1. income exempt from tax
2. income excluded from gross income
3. income subject to final tax
4. amount of NOLCO deducted

- IMPROPERLY ACCUMULATED TAXABLE INCOME = above sum – the sum of:

1. income tax paid/payable for the taxable year
2. dividends actually or constructively paid/issued from the applicable year’s taxable income
3. amount reserved for the reasonable needs of the business

- IAET = improperly accumulated taxable income x 10%

NOTA BENE: Once IAET has been imposed, that part of the profit subjected to IAET shall no longer be subject to IAET in later years.

ADDENDUM: Notwithstanding the imposition of IAET, if the improperly accumulated earnings are subsequently declared as dividends, the same shall still be subject to dividend tax.

c.5. Period for payment of dividend and/or IAET
- DIVIDENDS: must be declared and issued not later than one year following the close of the taxable year
- if not, then IAET should be paid within 15d thereafter

c.6. Determination of purpose to avoid income tax
- a mere holding company or investment company shall be prima facie evidence of a purpose to avoid the tax upon shareholders
- the fact that the corporate earnings or profits are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid tax upon shareholders

Holding or investment company – corporation having practically no activities except holding property and collecting income therefrom or investing the same

PRIMA FACIE EVIDENCE:

1. investment of substantial earnings and profits of the corporation in UNRELATED BUSINESS or in stock or securities of unrelated business
2. investment in bonds and other LONG-TERM SECURITIES
3. accumulation of earnings in EXCESS OF 100% PAID UP CAPITAL, not otherwise intended for the reasonable needs of the business