Chapter 7- Introduction to Regular Income Tax CHAPTER 7 INTRODUCTION TO REGULAR I Chapter Overview and Objectives: os oa “ : This chapter provides an overview of the regular income tiene e acquis readers with the nature and tax structures of the see a sae i Tt agg discusses regular tax reporting and income ax ae ation. Subsequen chapters deal with specific aspects of the regular incom’ b ‘After this chapter, readers are expected to demonstrate knowledge on the following: ‘The scope of regular income and its tax model The features of the regular income tax The concept of inclusion and exclusions from gross income The types of gross income subject to regular tax The concept of deduction and personal exemption ; ‘The concept of deductions compared to personal exemptions Measurement of gross income from employment and business and the treatment of other income 8. The concept of operating income or revenue and the difference in tar presentation of individuals and corporate taxpayers 9. The procedural computation of taxable income of corporations and different individual taxpayers 10. The computation of the regular tax for individuals and corporations 11. The deadline of the regular tax returns maa eenr CHARACTERISTICS OF THE REGULAR INCOME TAX |. General in coverage Anetincome tax An annual tax Creditable withholding tax Progressive or proportional tax General coverage ‘The Net income taxation The regular tax is an i : ¢ expenses and personal te lowable by law, . 228 veerchapter 7 Introduction to Regular Income Tax nual income tax ye regular income tax applies on yearl ses of the taxpayer are measured usi aaayer and are reported to the govern the taxpayers ly profits or gains, The gross income and ing the accounting methods adopted by the ment over the accounting period selected by creditable withholding taxes ost items of regular income are subject to creditable withholding tax (CWT). These «roditable withholding taxes are advanced taxes that must be deducted against regular taxduein computing the tax still due to the government. progressive or proportional tax ‘The NIRC imposes a progressive tax on the taxable income of individuals while it imposes a flat or proportional tax of 25% upon the taxable income of corporations. THE REGULAR INCOME TAX MODEL, Gross income - inclusions P xxx.xxx less: Allowable deductions XXXAXXX Taxable Income P__xxx.xxx Gross income consists of the major topics: 1, Exclusions of gross income - list of income tax 2. Inclusions in gross income - list o! sane eee come tax 4. Special topics - covers income that are either exclusion or inclusion depending on certain circumstances, such as: a. Fringe benefits b. Dealings in properties GROSS INCOME Gross income constitutes all items of income that are neither excluded in gross income nor subjected to final tax or capital gains tax. The items of gross income subject to the regular income tax will be extensively discussed in Chapter 9. Exclusions from Gross Income These pertain to items of income that are excluded; hence, exempt from regular ‘nome tax. These will be discussed in detail in Chapter 8. Excluded income vs, exempt income ‘cluded income is also exempt income. Excluded income are those listed by the MIRC as exempt income from regular tax, The term exempt income includes all come exempt from income tax whether final tax, capital gains tax or regular jem tax. Exclusions from gross income are listed in the NIRC. Exemption from “come may be provided by the NIRC or special laws. 229 Nien menChapter 7 - Introduction to Regular Income Tax ALLOWABLE DEDUCTIONS , or simply business or exercise of profession. They are co “deductions,” are expenses of the condy, mmonly known a: The book sub-divided the vast topic ‘of deductions as follows: Principles of Deductions - Chapter 13 Siastante Regular Allowable Itemized Deductions - ; 7 special Allowable Itemized Deductions & Net Operating Loss Carty-ove, , Chapter 13-B ; 4, The Standard Optional Deducti and e . Personal expenses or — is an — spends that are not connected to furtherance, maintenance or development Of his trade, business or profession are non-deductible against gross income. wee ions (OSD) - Chapter 13-C Individuals that are not engaged in business cannot claim deductions from gross income, Consequently, individuals are classified as follows: 1. Pure compensation income earner 2. Pure business or professional income earner 3. Mixed income earner - an individual earning both compensation and business or professional income Note on Personal Exemption Previously, the law provides for personal exemption of income of individu! taxpayers. The amount of personal exemption depends on the number of dependents who are supported by the taxpayer. Personal exemption is in lieu ¢f the personal, living, and family expenses of an individual taxpayer. Persona | exemption is repealed effective January 1, 2018, In an effort to simplify the tax system, the TRAIN law simply exempts P250,00) annual income of the individual income taxpayer from regular income tax. Thi exemption is embedded in the income tax table for individual taxpayers, As sth. | there is no need to separately deduct personal exemption. | DETERMINATION OF TAXABLE INCOME | ‘axabl ju: The taxable income of individual taxpaye i ification Ta nee Payers is computed using the Classificatichapter 7 ~ Introduction to Regular Income Tax qossification Rule Gross income is first classified into: ‘a. Compensation income b, Business or professional income compensation income vs. Business income Compensation income arises from an employer-employee relationship. This relationship Is characterized by a power to retrench giving the purchaser of the service @ terminate the arrangement when he is losing in business. Business income arises from selling of goods or rendering of services for a profit. In service arrangements where the purchaser of the service has no power to retrench, the income realized thereon isa business income. Treatment of other income Income that are neither compensation income nor business income such as those passive income are simply classified as “other taxable income” and are added to gross income from business and profession. Allowable deductions Business expenses are deducted against gross income from business or profession. No deduction is allowed against compensation income since personal expenses of individuals for cost of living are deemed to be included in the P250,000 blanket exemption in the income tax table. Other income which is neither compensation nor business or professional income is simply added to total gross income from business or profession as “Non- operating income." If the taxpayer has no business or professional income, the same shall be added to taxable compensation income as “other income.” Taxable income of pure compensation income earner The taxable compensation income of employees is computed as follows: Gross compensation income Po xxx Less: Non-taxable compensation ——SXXXKX, Taxable compensation income PL xxK xxx Non-taxable compensation includes legally mandated salary deductions and items of compensation income that are exempted by law, contracts, or treaty from 'Ncome taxation. The detailed tax rules on compensation income will be discussed inChapter 10, 231- Introduction to Regular Income Tax .ssional income earner s or profes z rn computed as rofessionals is comp! follows Chapter 7 Taxable income of pure busines: ‘The taxable net income of businessmen or Pp! ‘i XXX XXX Gross Income from business/profession P z ‘Add: Non-operating income ee ae Total Gross income Less: Allowable deductions _——-SXKKKK | Taxable net income i fal le molt The income of mixed income earner from both sources Is simply slobalized o, totaled, A negative net income or net Joss when deductions a BTOSS income | from business or profession shall not be offset against taxable compensation es of business or profession and ae ctions are expens income thereto, whereas no expense jg income because dedu Q properly deductible only against gross i deductible against taxable compensation income. Mlustration: Individual income taxpayer Case 1 Case 2 Case 3 Case 4 300,000 P. 300,000 | P 300,000 i 30,000 30,000 Compensation income Non-taxable compensation | 30,000 Gross business income P400,000 | 400,000 | _ 200,000 Deductions 250,000 250,000 250,000 Other income 20,000 20,000 20,000 20,000 1 Taxable income shall be determined in each of the above case as follows: | Case 1; A compensation earner with other income i Gross compensation income P 300, 0 Less: Non-taxable compensation na Taxable compensation income Add: Other gross income ee Taxable income B_290,000 Case 2: A business income earner with other income Gross business income Add: Other gross income Pdooong { Total gross income P ee r ,000 Less: Allowable deductions Net income 232 —250,000 B170,000cnaptet 7 Introduction to Regular Incorne Tax case 2A mixed income earner with other income cress compensation income P 300,000 fe Non-taxable compensation __ 30.000 Hable compensation income P 270,000 gable compensation income P 270,000 Gross business income P 400,000 other. gross Ine ome 20,000 otal gross income P 420,000 ese Deductions 250,000 qaxable net income 170.000 qaxable Income P_440,000 case 4: Mixed income earner - with net loss on business or profession Gross compensation income P 300,000 Less: Non-taxable compensation 30.000 jaxable compensation income P 270,000 Gross business income P 200,000 ‘Add: Other gross income 20,000 Total gross income P 220,000 Less: Deductions 250,000 Net loss (P__30,000) Taxable income P_270,000 Note: A net loss may be carried over as a deduction against net income of the succeeding, years This is referred to as net operating loss carry-over or NOLCO. This will be discussed under deductions in Chapter 13-B, The taxable income of corporations is computed in the gamesmanmeteasep\i Accounting Method and Accounting, Period The taxable income shall be computed in accordance with the method 0} ; however, if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method that in the opinion of the Commissioner, clearly reflects the income. 233chapter 7~ Introduction to Regular Income Tax Inshort, alendar yep rual basis ona calendar yeg acerual basis ona fiscal year ess or Profession na fiscal Gross Income from Busin Determination of ‘Business-selling goods | is computed as: ‘The gross income from » where the taxable income qualifies 2,000,000 P 490,000 1Bxcess P 200,000 ‘Multiply by: bracket marginal rate 32% 64,000 {Total income tax due P__554,000 Above P800,000 to P2,000,000 P 130,000 + 30% of the excess over P800,000 -t=Above P2,000,000 to P8,000,000 | P 490,000 + 32% of the excess over P2,000,000 ‘Above P8,000,000 P 2,410,000 + 35% of the excess over P8,000,000 Note: Recall that a resident alien is taxable only on Philippine income. The Optional 8% Income Tax The TRAIN law introduced an optional income tax for self-employed and/or professionals (SEP) wherein they can opt to be taxed at 89% of sales or receipt and other non-operating income. The 8% income tax shall be in lieu of the: a. Progressive income tax, computed under individual tax table; and 3% percentage business tax on sales or receipts 241Chapter 7 ~ Introduction to Regular income Tax i Hed tax which enables one-time co income tax is a form of a bund : me comp rae oe taxes which is fg otherwise require separate filing and paymens, ofthis tax system will be extensively discussed in Chapter 14. E JME TAX . tax (RCIT), is a generally @ proportional or flat tax at a 5% on tana income for domestic or foreign corporation. However, a lower 20% proportional tax on taxable income is imposed on domes, ptcro. small, and medium-sized enterprises (MSMI } with not more than pi million assets, excluding land, and not more than PS million taxable income, | | ‘The RCIT applies to any corporation other than those: Subject to final tax such as non-resident foreign corporation and Foy interest income not subjected to final tax : | Special corporations or those subject to preferential (i.e. lower) tax rates o, | special regimes | cc. Exempt corporations a. b. Illustration 100 in the Philippines and P800,000 fron ‘A corporation has a net income of P1,200,0( abroad. ‘Assuming the corporation is a large domestic corporation, the income tax due shallts computed as follows: Taxable income (world) P 2,000,000 Multiply by: Tax rate 25% 2500,000 Income tax due Assuming the corporation is a domestic MSME, the in . Fr as follows: a ncome tax due shall be compute Taxable income (world) P 20 Multiply by: Tax rate ht COE Income tax due B_400,000 Note: i Dormia corporations are taxable on global income. . If the taxable income is more than PS million, the 2 : i Dagan 7 egart® whether the domesticcoreratonisaMSMEaralagcosmane ee 242pote Introduction to Regular Income Tax ing the corporation is a resid i : smated as follows: ident foreign corporation, the income tax due shall ve income (Philippines) arable inco P 1,200,000 stl py: Tax rate wee tx due oe ie: ‘ Kole dent foreign corporation is taxable on Philippine income, 1 distinction between | i ‘There is nO ‘een large corporation or MSME it comes to foreign + Terporation. The 25% proportional tax simply applies. Sere e Minimum Corporate Income Tax (MCIT) corporate taxpayers are normally subject to a minimum tax, computed as 2% of otal grass income subject to regular tax. This minimum tax is temporarily reduced to 1% this pandemic from July 1, 2020 to June 30, 2023. Even if corporations are losing in business, they are subject to the minimum tax. Details of the MCIT will be discussed in Chapter 15-B. special Corporations special corporations are those enjoying lower tax rates but not 0%, such as rivate schools, non-profit hospitals and PEZA or TIEZA-registered enterprises. The taxation of these corporations will be discussed thoroughly in Chapter 15-A. Exempt Corporations Exempt corporations are those enjoying 0% tax rate with no tax dues such as government agencies, non-profit organizations with no taxable income, cooperatives, and those registered with the Board of Investments (BO!) enjoying income tax holiday or ITH. INCOME TAX RETURNS Individual Income Tax Returns Tax Return Form Individual taxpayers Form 1700 Purely employed taxpayer Form 1701A Purely in business or profession, using itemized, OSD or opting to the 8% optional income tax Form 1701 Mixed income earners, Estates and Trusts Corporate income taxpayers Form 1702-RT Corporations subject only to the 25% regular income tax. {Form 1702-mx | corporations subject to special oa combination of tax rates (Form 1702-Ex Corporations that is exempt with no tax due 243Chapter 7 - Introduction to Regular Income Tax ted that exempt corporations are required to report their resul leans a hh BIR Form 1702-EX even if they do not have taxable jngst! nated to itemized their deductions in thelr neon fem 9 rule is apparently intended to assist the BR ations ts see of cient corporation with their withholding ‘@% oes! le foe k mechanism to identify income earned by third pi income subject to the regular corporate ico, with gross ne rm 1702-MX. | Exempt corporatio! hall file BIR Fo! tax or special rate s! 15 day of the fourth mony, income tax return oe ‘or filing on the tax due shall be paid up, turn is due f Deadline of filing ayer. The income ‘The annual income tax re following the taxable year of the taxP: filing. i income tax returns ann ante yet veri of nn return (June 2013 version) has been eliminated. Ifthe amount of centavos is 49, less, the centavos are dropped down. If the amount is 50 centavos or more, itis rounded up to the next peso. 0.49 shall be entere' Il be rounded to P101. Hence, an amount for P10! din the income tax return as P100, Anamount of P100.50 shal ‘Annual Income Tax Return Required Attachment in the CPA - if annual sales, earnings, receipts or output 1. Certificate of Independent exceed P3,000,000) 2. Supplemental form for taxpayers with multiple activities per tax regime 3. Account information form and financial statements (FS) showing: a. Sales/receipts/fees b. Cost of sales/services c. Non-operating and other taxable income d._ Itemized deductions (if taxpayer did not avail of OSD) e. Taxes and licenses f£. Other information prescribed to be disclosed in the FS ‘ Statement of management responsibility (SMR) . Certificate of income payments not subjectet i R FOr on jected to Withholding Tax (Bl 6. Certificate of creditable withheld at source (BI IR Fort 7. Duly approved Tax debit memo, if applicable maa 8. Proof of prior year’s excess credits, if applicable 9. Proof of foreign tax credits, if applicable 244ir apter Introduction to Regular Income Tax For amended return, proof of tax Payment and the return previously filed 1 ceruificate of tax treaty relief/Entitlement issued by the concerned Investment 1 romotion Agency (IPA) ARTERLY FILING OF INCOME TAX RETURN corporations and individuals engaged in business and those engaged in the ractice of a profession are required to file three quarterly returns aside from the Jnnual consolidated income tax return individual taxpayers engaged in business or practice of profession shall file their yarterly income tax returns using BIR Form 1701Q. Corporations shall file their quarterly income tax returns using BIR Form 1702Q. ‘taxpayers make estimated quarterly tax payments. These quarterly tax payments are claimed as tax credit (deductions) to the annual consolidated income tax due ofthe taxpayer. DETERMINATION OF TAX DUE UNDER INTERIM CHANGE IN CORPORATE TAX RATE Under Section 27 of the NIRC, as amended, the taxable income of corporations adopting the fiscal-year accounting period shall be computed without regard to the specific date when specific sales, purchases and other transactions occur. Their income and expenses for the fiscal year shall be deemed to have been earned and spent equally for each month of the period. This is the pro-rata method. The NIRC did not specify a method for corporations reporting on a calendar year accounting period. In practice, however, the BIR has been consistent in using the pro-rata method in implementing corporate tax rate transitions for any corporate taxpayer without regard as to whether they reporting under a calendar or a fiscal accounting period, This is observable in RMC16-2006 in implementing the tax rate transitions under RA9337 and in RRS5-2021 in implementing the tax rate transition under RA11534 or the CREATE law. Mustration 4: Fiscal year basis Trans Corp. earned a total of P18,000,000 for the fiscal year starting November 1, 2019 ending October 31, 2020. The CREATE law changed the regular corporate tax rate from 30% to 25% effective July 1, 2020. The income tax due shall be computed for the fiscal year as follows: Fiscal year taxable income Pag po0.00 prided by: months in a year ——e lonthly taxable income 21,500,000 245Introduction to Regular Income Tax Chapter 7 - ib] covered Y 2 No. of months (November 1 to June 30) 06 i thly taxable income MD a aE P12,000,000 30% P 3,600,009 Multiply by: Old tax rate i s ; 31) No. of months (July 1 to October Multiply by: monthly taxable income Esme Total k. Multiply by: New tax rate 25% ee Total income tax due P_5,100,009 Alternatively, me COVE % P 18,000,000 Fiscal year taxable income Multiply by: November - June months/12 ___B/12 Total 12,000,000 Multiply by: Old tax rate ____ 30% P 3,600,000 i vered b} Fiscal year taxable income P 18,000,000 Multiply by: July - October months/12 Total P 6,000,000 Multiply by: New rate 25% __ 1,500,000 Total income tax due P_8,100,000 Illustration 2: Calendar year basis Assuming Trans Corp. earned a total of P10,000,000 for the calendar year 2020. The CREATE law changed the regular corporate tax rate from 30% to 25% effective Ju 20. The income tax shall be computed for calendar year 2020 as follows: i ve Calendar year taxable income P 10,000,000 Multiply by: January-June months/12_0 __6/12 Total P 5,000,000 Multiply by: Old tax rate 30% P 2,500,000 i by the new 25 i Calendar year taxable income P10, 000,01 Multiply by: July - December months/12 12 Total 4 P 5,000,000 Multiply by: New rate “25% 250.000 Total income tax due P_3, ami 246 _apie 7 - Introduction to Regular Income Tax rape a line of Quarterly Income Tax Returns o quarterly Income ‘qax Returns ‘Taxpayers Individuals May 15, same year August 15, same year November 15, same year Corporations 60 days end of 1° Qtr 60 days end of 27 Qtr 60 days end of 37 Qtr quarterly income tax returns of individuals engaged in business or profession are due 45 days from the end of the first three quarter whereas the quarterly income taxreturns of corporate taxpayers are due 60 days from the end of the quarter. frequency of Reporting Per Taxpayer Type ‘Taxpayer Individuals Pure compensation income earner Annual Purely engaged in business or profession Quarterly & Annual Mixed income earner Quarterly & Annual I Corporations Quarterly & Annual Frequency of Tax Reporting The substituted filing system for employees fure compensation income earners may be relieved from the obligation to file their annual income tax return if they have no taxable income from other sources aiher from their lone employer. The employee may avail of the substituted filing stem wherein the employer shall withhold the income tax of the employee's compensation. I the employer correctly withheld the tax due of the employee through the withholding tax on compensation, the employee need not file his Form 1700 siymore since there would be no residual tax due or tax refundable. The Form 1700 is required if the employee has other taxable income or has more than one &mployer, either concurrent or successive, during the year. 247