Income Taxation  Prof. Narvaez, CPA  1st Semester A.Y.

2020 – 2021

INCOME TAX (ACCOUNTING PERIODS AND METHODS)

Objectives
After this chapter, readers are expected to gain familiarization and demonstrate mastery of the following:
1. Concept of accounting period and its types
2. Concept of accounting methods and their accounting procedures

Taxable Year – means the calendar year, or the fiscal year ending during such calendar year, upon the basis of which the net income is
computed (Sec. 22, Chapter 1, Title II, Revised NIRC). Taxable year is referred same as annual accounting period.
I. Accounting Periods – separate time periods/lengths used in reporting and measuring net income or results. This net income
may be computed using either two types, the calendar or fiscal basis.
a. Calendar Year – Individuals are required to file their income tax on a calendar year basis (Sec. 43.).
i. Start January 1 and ends December 31
b. Fiscal Year – The fiscal year basis is not applicable to individual income taxpayers. Corporations are allowed to file
returns on a calendar or fiscal year basis (Sec. 75)
i. Accounting period of 12 months ending on the last day of any month other than December.
c. Instances where net income must be computed on the basis of calendar year (Sec. 43)
i. If the taxpayer is an individual or a partnership
ii. If the taxpayer does not keep books
iii. If the taxpayer has no annual accounting period
iv. If the taxpayer’s annual accounting period is other than fiscal year
d. Instances where short accounting period arises (Sec. 47)
i. When a corporation is newly organized and the accounting period is the calendar year
ii. When a corporation is dissolved
iii. When a corporation changes accounting period
iv. When the taxpayer dies

If a taxpayer, other than an individual, with the approval of the Commissioner, changes the basis of computing the net
income from fiscal year to calendar year, a separate final return or adjustment return shall be made for the short period
between the close of the last fiscal year for which the return was made and the following December 31 (Sec. 47).

In the same way, if there is changes from calendar year to fiscal year or for changes from one fiscal period to another, a
return for short period shall be made between the close of the last year for which the return was made and the new fiscal
period.

Same is true for all other cases mentioned in item D, a return for short period shall be made as applicable. The income
shall be computed on the basis of the short period which separate final or adjustment return is made (Sec. 47 (b)).

II. Accounting Methods – refers to the rules followed in reporting revenues and expenses.
a. Cash method
i. Income is reported in the year it is received actually or constructively
ii. Expense is reported in the year it is paid
b. Accrual method
i. Income is reported in the year earned regardless of when received
ii. Expense is reported in the year incurred regardless of when paid
c. Crop year method
i. A farmer whose crop is harvested or gathered after more than one accounting period from the time of planting
may use the “crop year method”, where the cropping expenses are accumulated and only deducted on the
year of actual harvesting the crops.
ii. Deductions are recognized in the year the income from the crop is realized.
d. Methods for deferred payment sales
i. Installment method – applicable for (1) sales of dealers in personal property and (2) sales of realty and other
casual sales of property (other than included in inventory).
ii. Deferred payment method – gross income is recognized the in the year of sale, where the selling price is
computed based on present value and the related interest income is amortized on the basis of collection. Use
of deferred payment method will yield the same result as the accrual basis of accounting.
e. Methods under long term contracts
i. Percentage of completion method – persons whose gross income is derived in whole or in parts for contracts
of building, installation or construction contracts covering a period in excess of one year, shall report such
income on the basis of percentage of completion (Sec. 48).
f. Methods for leasehold improvement – The unexpired improvement will eventually inure to the benefit of the lessor upon
the end of the lease. Section 49 of RR 2-40 provides when buildings are erected or improvements made by a lessee in
pursuance of an agreement with the lessor, and such buildings or improvements are not subject to removal by the
lessee, the lessor may at his option report the income therefrom upon either of the following bases:
i. Annual or spread out method – 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
ii. Lump sum or outright method – report as income at the time when such buildings or improvements are
completed the fair market value of such buildings or improvements subject to the lease.
Depreciable Cost XXX
Less: accumulated amortization up to the end of (Depreciable cost x Lease term / Useful life of the
lease term improvement)
Estimated depreciated value of the improvement at XXX
the termination of lease
Divided by: Lease term X

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Annual income from improvement XXX

Exercises
iii. Crowley leased her land to Joker for two years beginning July 1, 2020. Joker would pay monthly rental of
P100,000. She paid rent up to October, 2020 and then defaulted for the rest of the year.
1. Under the accrual method, how much was the income of Crowley for 2020?
2. Under the cash method, how much was the income of Crowley in 2020?
3. Under the accrual method, how much was the deductible expense of Joker in 2020?
4. Under the cash method, how much was the deductible expense of Joker in 2020?
iv. Alarcon leased her property to Angela on July 1, 2020. Angela made the following advances:
Advance rent of P600,000 for the period July 1, 2020 to June 30, 2021
Loan to Alarcon, P15,000
Security deposit, P200,000
1. Assuming Alarcon used accrual method, how much was her taxable income in 2020?
2. How much was the deductible expense of Angela in 2020?

III. Basics of Appropriate Accounting Method

i. There should be distinction between revenue expenditures and capital expenditures
1. Revenue expenditures – are costs related to specific income transactions during the period (e.g.
cost of sales, cost of services, maintenance, etc.)
2. Capital expenditures – are fixed assets or cost that expected to improve fixed asset or increase
their value for a long period of time (e.g. improvements, major repairs, etc.)
ii. Repairs, Replacement and Improvements - Expenses to restore property or prolong its useful life should be
added to the property account or charged against depreciation. Common repairs do not add to the value of
the property but merely maintain the property.
iii. Sec 44. – The amount of all items of gross income shall be included in the gross income for the taxable year
in which received by the taxpayer, unless, under methods of accounting are permitted (Sec. 43), any such
amounts are to be properly accounted for as of different period.
iv. The deductions shall be taken for the taxable year dependent upon the method of accounting upon the basis
of which the net income is computed, unless in order to properly reflect the income the income, deductions
should be taken as of a different period (Sec. 45). In all cases in which production, purchase or sale of
merchandise is an income of producing factory, the inventories at the beginning of the accounting period
should be added to Cost of Sales and inventories at the at the end of the should be deducted to Cost of Sales.

IV. Examples of Constructive Receipt of Income

i. Partner’s distributive share in the profit of a partnership (Sec. 26) – each partner shall report as gross income
his distributive share, actually or constructively received, in the net income of the general professional
partnership.
ii. Income (e.g. dividends, profits, interests, etc.) which is credited to the account of or set apart for a taxpayer
and which may be drawn upon by him at any time is subject to tax for the year during which so credited or set
apart, although not then actually reduced to possession (Sec. 52, RR 2-40).
iii. Interest coupon that has matured and are payable but which have not been cashed are constructively
received in the taxable year during which the coupons mature (Sec. 53, RR 2-40).

V. Installment Method of Reporting Income

a. Cases where income may be reported under installment method
i. Sale of personal (movable) property by a dealer (without regard to the 25% and P1,000 threshold) (Sec. 49 A)
(Ordinary Asset)
ii. Casual sale of personal (movable) property (Either Ordinary or Capital Asset):
1. Selling price is over P1,000
2. Initial payments must not exceed 25% of selling price
3. Property is not a kind which would be included in inventory if on hand at the close of the taxable
year (Sec. 49 B)
iii. Sale of real (immovable) property (initial payments must not exceed 25% of the selling price) considered as
ordinary assets

If the ratio of initial payments did not meet the required threshold, deferred payment method is used.

Items i, ii and iii are used in the business and treated as ordinary assets. Income derived therefrom are
required to be reported as part of the income subject to the applicable regular income tax rate(s) (Sec. 27).

However, if Item ii is a capital gain realized by the individual, and not related to his trade or business, such
gain will be subject to the holding period rule and to deductions of capital losses, the net gain will also form
part of the income subject to the applicable regular income tax rate(s).

VI. Holding period rule for individual taxpayers (Sec. 39 B)

i. In the case of taxpayer, other than a corporation, only the following percentages of the gain or loss recognized
upon the sale or exchange of a capital asset shall be taken into account in computing net capital gain, net
capital loss, and net income:
1. One hundred percent (100%) if the capital asset has been held for not more than twelve (12)
months; and
2. Fifty percent (50%) if the capital asset has been held for more than twelve (12) months.

VII. Installment Method of Reporting for Capital Gains Tax (Real Property – Capital Asset)

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i. An individual who sells or disposes of real property, considered as capital asset, may pay capital gains tax in
installment basis provided (Sec. 49 D):
1. Selling price is over P1,000
2. Initial payments must not exceed 25% of selling price
3. Property is not a kind which would be included in inventory if on hand at the close of the taxable
year
ii. The sale is subject to income tax at a rate of 6% capital gains tax on the gross selling price or fair market
value, whichever is higher, at the time of sale and NOT ordinary income tax at the graduated rates of the net
taxable income
iii. Such capital gains are subject to final withholding tax and therefore not subject to holding period rule

VIII. Terms/ computation associated with installment method

i. Selling price
Cash received by seller P XXX
Add: FMV of property received PXXX
Installment obligations of the buyer (evidence of indebtedness) XXX
Mortgage assumed by buyer XXX XXX
Selling price XXX
ii. Contract price
Selling price P XXX
Less: Mortgage assumed by the buyer ( XXX)
Balance XXX
Add: Excess of mortgage assumed over cost XXX
Contract price XXX
iii. Initial payments – payments received in cash or property (other than evidence of indebtedness of the
purchaser) during the taxable year in which the sale was made.
Down payment P XXX
Ass: Installments, year of sale P XXX
Excess of mortgage assumed over cost XXX XXX
Initial payments XXX
b. Computation of income to be reported under the installment method
Gross Profit
X Installment received = Taxable Income

Contract Price

c. Computation of income of capital gains tax if the individual elects the installment method and the transaction qualifies for
installment method
Selling price XXX
Multiply by: rate of tax 6%
Final withholding tax – capital gains tax XXX
Multiply by:
Initial payment or collections XXX
Divided by: contract price XXX %
Tax due XXX

IX. Net Worth Method of Determining Taxable Income

a. Format of computation
Assets P XXX
Less: Liabilities ( XXX)
Net worth, end XXX
Less: Net worth, beginning ( XXX)
Increase (decrease) in net worth XXX
Add: Non-deductible items XXX
Total XXX
Less: Non-taxable items ( XXX)
Net income per investigation XXX
Less: Personal exemptions ( XXX)
Taxable net income, per investigation XXX
Tax due, per investigation XXX
Less: Income tax, per return ( XXX)
Deficiency income tax XXX

b. The Bureau of Internal Revenue is using the Net Worth Method of investigation on Mr. Nova Siapno, a married taxpayer
with 2 qualified dependents. The investigation covers the years 2014 to 2018. There are no discrepancies discovered for
the years 2014 to 2017. However, the BIR discovers discrepancies for 2018. Mr. Siapno paid P20,000 income tax on the
income declared for 2018. The assets, liabilities and net worth at the end of 2017 and 2018 follow:
12-31-17 12-31-18
Assets P 700,000 P 900,000
Liabilities 200,000 100,000
Net worth P 500,000 P 800,000
The following data pertain to 2018:
Personal, family and living expenses P 72,000

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Other non-deductible expenses 30,000

Philippine Lotto winnings 100,000
Other non-taxable income 22,000
How much is the taxable net income per investigation?

X. Payment of Capital Gains Tax in Installments

a. Cases where capital gains tax may be paid in installment
i. Sale of real property (capital asset) when the initial payments do not exceed 25% of the selling price;
ii. Sale of shares of stock held as investment not through the local stock exchange when the initial payment do
not exceed 25% of the selling price
b. Computation of tax in installments
i. Year of sale: Initial payments/ contract price X capital gains tax due
ii. Subsequent years: Installment received/ contract price x capital gains tax due

XI. Capital Gains Tax Return and Payment and Documentary Stamp Tax
Real Property (Capital Asset) Shares of Stock of Domestic Corporation
Not Traded in the Local Stock Exchange
(Capital Asset)
A. Tax base and rate
Tax base: Selling price or fair market value Old NIRC and under TRAIN for Onerous
whichever is higher. Transfer/Sale made by Foreign Corporation
Tax rate: 6% final tax Tax base: Net capital gain
Tax rate: 5% on the first P100,000
Sec 24 D – includes pacto de retro sales, and other And 10% on excess of the first P100,000
forms of conditional sales of real property located in
the Philippines, classified as capital assets, by (15% TRAIN Sec. 5) (Sec 24 C)
individuals, estates or trust. Onerous Transfer/Sales made by Individual
and Domestic Corporation - A final tax rate
of 15% is imposed upon the net capital
gains realized during the taxable year from
the sale, barter, exchange or other
disposition of shares of stock in a domestic
corporation, except shares sold, or disposed
of through the stock exchange.

B. Exemption to the final withholding tax

Requisites (Sec 24 D 1) None
1. The proceeds which have realized from the
sale, exchange or disposition of their principal
residence by natural persons, is fully utilized in
acquiring or constructing a new principal
residence
2. The acquisition or construction of a new
principal residence is within 18 calendar months
from the date of sale or disposition
3. The historical cost or adjusted basis of the real
property sold or disposed shall be carried over
to the new principal residence built or acquired;
4. The Commissioner shall have been duly notified
by the taxpayer within thirty (30) days from the
date of sale or disposition through a prescribed
return of his intention to avail of the tax
exemption
5. The tax exemption can only be availed of once
every 10 years
6. If there is no full utilization of the proceeds of
sale or disposition, the portion of gain presumed
to have been realized from the sale or
disposition shall be subject to capital gains tax.
C. Basic forms for filing an income tax return (RR 2-2014)
BIR Form 1706 and 1701 AIF BIR Form 1707, 1707-A and 1701 AIF
D. Place of filing of capital gains tax return (Sec 51 B; RR 3-2016)
1. Authorized Agent Bank (AAB) of the Revenue 1. AAB under the jurisdiction of the RDO
District Office having jurisdiction over the place where the seller/transferor is required
where property being transferred is located. to register.
2. In place where there are no AABs, with BIR 2. In places where there are no AABs,
Collection Agent (Revenue Collection Officer) or the return shall be filed with the
duly Authorized City or Municipal Treasurer of Revenue Collection Officer or duly
the RDO having jurisdiction over the place Authorized City or Municipal Treasurer
where property being transferred is located. of the RDO where the seller/transferor
3. On return shall be filed for every real property is required to register.
sold, exchanged or disposed of (for cash sale,
or foreclosure sale), or every installment
payment made (for installment sale)

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E. Payment of Tax and Time of filing (Sec. 51)

The income tax is payable at the time the return
is filed.
1. Cash sale – within 30 days following each sale,
exchange or disposition
2. Installment sale – within 30 days after the
receipt of the first down payment or following
each subsequent installment
3. Only one return is filed for filed for every
transfer document regardless of the number of
each property sold, exchange or disposed of.
4. Account Information Form (BIR Form 1701 AIF)
– on or before April 15 of each year covering
income for the preceding taxable year.
F. Holding period
Not applicable
G. Documentary stamp tax
P15 – when the consideration or value received or
contracted to be paid for realty after making the
proper allowance for any encumbrance does not
exceed P1,000.
P15 – for each additional P1,000 or fractional part
thereof in excess of P1,000 of such consideration or
value.
H. Time of filing and payment of documentary stamp tax
The tax return prescribed for documentary stamp tax
shall be filed within 10 days after the close of the
month when the taxable document was made,
signed, issued, accepted or transferred, and the tax
thereon shall be paid at the same time the return is
filed.
I. Place of filing and payment of documentary stamp tax
1. The documentary stamp tax return shall be filed
with and the tax due shall be paid through:
a. AABs within the territorial jurisdiction of
the RDO which has jurisdiction over the
residence or principal place of business of
the taxpayer
b. In places where there is no AAB, the
return shall be filed with the RDO,
collection agent, or duly authorized
Treasurer of the City or Municipality in
which the taxpayer has his legal residence
or principal place of business.
The income tax is payable at the time the
return is filed.
1. Per transaction return:
a. Cash basis – within 30 days after
each sale, barter, exchange or
other disposition of shares of
stock not traded through the local
stock exchange
b. Installment sale – within 30 days
following the receipt of the 1st
down payment or each
subsequent installment payment
2. Final consolidated return – on or before
the 15th day of the 4th month following
the end of the taxable year covering all
stock transactions of the preceding
taxable year
3. Account Information Form (BIR Form
1701 AIF) – on or before April 15 of
each year covering income for the
preceding taxable year.
Not applicable
(P0.75) on each P200 or fractional part
thereof, of the par value of such due-bill,
certificate of obligation or stock. Provided,
that only one tax shall be collected on each
sale or transfer of stock or securities from
one person to another regardless of
whether or not a certificate of stock or
obligation is issued, indorsed, or delivered
in pursuance of such sale or transfer.
Provided, further, that in case of stock
without par value the amount of the
documentary stamp tax herein prescribed
shall be equivalent to 25% of the
documentary stamp tax paid upon the
original issue of said stock.
The tax return prescribed for documentary
stamp tax shall be filed within 10 days after
the close of the month when the taxable
document was made, signed, issued,
accepted or transferred, and the tax thereon
shall be paid at the same time the return is
filed.

SOURCES:
[1] RA No. 10963 – “An Act Amending Sections 5, 6, 24, 25, 27, 31, 32, 33, 34, 51, 52, 56, 57, 74, 79, 84, 90,91, 97, 99, 100, 101,
106, 107, 108, 109, 110, 112, 114, 116, 127, 128, 129, 145, 149, 151, 155, 171, 174, 175, 177, 178, 179, 180, 181, 182, 183, 186,
188, 189, 190, 191, 192, 193, 194, 195, 196, 197, 232, 236, 237, 249, 254, 264, 269, and 288; Creating New Sections 51-A, 148-
A, 150-A, 150-B, 237-A, 264-A, 264-B, and 265-A; and Repealing Sections 35, 62 and 89; All Under Republic Act No. 8424,
Otherwise Known as the National Internal Revenue Code of 1997, as amended, and for Other Purposes,” also known as Tax
Reform for Acceleration and Inclusion (TRAIN) Law, Approved 19 December 2017; with Presidential veto on certain portions;
Effective 1 January 2018.
[2] Revised National Internal Revenue Code of 1997
[3] RA No. 9648 – “An Act Exempting from Documentary Stamp Tax Any Sale, Barter or Exchange of Shares of Stock Listed and
Traded Through the Stock Exchange, Further Amending for the Purpose Section 199, of the National Internal Revenue Code of
1997, as Amended by Republic Act No. 9243 and for other Purposes,” Approved on 30 June 2009; Effective 20 March 2009.

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