MODULE 4

INCOME TAX SCHEMES, ACCOUNTING PERIODS, ACCOUNTING

METHODS, AND REPORTING
Learning Objective
This module provides an overview of the income tax schemes under the NIRC. Students
are expected to gain familiarization and demonstration of 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

A. Final income taxation
B. Capital gains taxation
C. Regular income taxation

NOTE: An item of gross income that is subject to tax in one scheme will not be taxed by
the other schemes. Similarly, items of income that are exempted in one scheme are not
taxable by the other schemes.

CLASSIFICATION OF ITEMS OF GROSS INCOME

1. Gross income subject to final tax
2. Gross income subject to capital gains tax
3. Gross income subject to regular tax

FINAL INCOME TAXATION

The recipient income taxpayer receives the income net of tax. The payor is the one
required by law to remit the tax 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 is referred to as the final withholding tax
system.
Final taxation is applicable only on certain passive income listed by the law. Passive
incomes are earned with very minimal or even without active involvement of the taxpayer in the
earning process.

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. They are the opposites
of ordinary assets. Not all capital gains are subject to capital gains tax. Most of them are subject
to regular income tax. Capital gains taxation applies only to two types of capital assets:
domestic stock and real property.

REGULAR INCOME TAXATION

The regular income tax is the general rule in income taxation and covers all other income
such as:
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 final tax

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 - 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 - starts from January 1 and ends December 31. Should be used
when:
1. taxpayer’s annual accounting period is other than a
fiscal year.
2. taxpayer has no annual accounting period
3. taxpayer does not keep books of accounts
4. taxpayer is an individual
b. Fiscal - is any 12-month period that ends on any day other than December 31.
This is available only to corporate taxpayers and is not allowed to
individual income taxpayers.

Deadline of Filing the Income Tax Return

The return is due for filing on the 15th day of the 4th month following the close of the
taxable year of the taxpayer. The regular tax due is payable upon filing o the income tax
return.

Instances of Short Accounting Period

1. Newly commenced business - accounting period covers the date of the start of the
business until the designated year-end of the business.
2. Dissolution of business – accounting period covers the start of the current year to the
date of dissolution of the business.
3. Change of accounting period by corporate taxpayers - accounting period covers the
start of the previous accounting period up to the designated year-end of the new
accounting period. BIR approval is required in changing an accounting period.
4. Death of the taxpayer - accounting period covers the start of the calendar year until
the death of the taxpayer.
5. Termination of the accounting period of the taxpayer by the Commissioner of Internal
Revenue - accounting period covers the start of the current year until the date of the
termination of the accounting period.

Types of Accounting Method

1. The general methods
a. Accrual basis - income is recognized when earned regardless of when
received. Expense is recognized when incurred regardless
of when paid.
b. Cash basis - income is recognized when received and expenses is recognized
when paid.
2. Sale of goods with extended payment terms - may be reported using the accrual
basis, installment method, or deferred payment method.
a. Installment method - gross income is recognized and reported in proportion
to the collection from the installment sales. This 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.

Note: Initial payment means total payments by the buyer, in cash or

property, in the taxable year the sale was made. It also includes
the installment payments in the year of sale.

When the buyer assumes indebtedness on the property sold, the

selling price is no longer the contract price. The contract price is the
residual amount after deducting the mortgage from the selling price.

When the indebtedness assumed by the buyer exceeds tax basis of

property sold, the excess is an indirect receipt realized by the seller. This
is an indirect down payment which must be added as part of the contract
 price and the initial payment. Also, under this condition, all collection
from the contract including the excess mortgage is a collection of income.

b. 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 this 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. In case of interest-bearing
notes, the use of the deferred payment method will bear the same result as
the accrual basis of accounting.

3. The Percentage of Completion Method for Construction Contracts - Under this

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.

4. Income from Leasehold Improvement -the income from leasehold improvement can
be reported using either of the following method at the option of the taxpayer:
a. 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 or improvements are completed.
b. 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 as aliquot part thereof.

The depreciated value of the leasehold improvement is computed

as follows:
Excess useful life over lease term
Cost of improvement X -------------------------------------------
Useful life of the improvement

5. Agricultural or Farming Income - is commonly measured using the cash basis or

accrual basis, such as in the following:
a. Animal husbandry
b. Short-term crops

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, coconut and
banana are capitalized and amortized over the expected years of 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 this method, 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 crops.
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. The change in accounting method by any taxpayer
and the change in accounting period by corporate taxpayers require prior BIR notice.

TAX REPORTING

Types of Returns to the Government

1. Income tax return - provides details of the taxpayer’s income, expense, tax due and
tax payable, tax credit and tax still due the government.
2. Withholding tax returns - provides reports of income payments subjected to
withholding tax by the taxpayer withholding agent.
3. Information returns - are required from certain taxpayers. It does 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.

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
2. e-BIR Forms
3. Electronic Filing and Payment System

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 tax online through internet banking
service. The account of the taxpayer will be auto-debited for the amount of taxes to be paid.

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.
2. 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. The interest shall be computed based on
actual days divided by 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.

3. Compromise penalty - is an amount paid in lieu of criminal prosecution over a tax

violation.

Penalties for non-filing or late filing of information return

Unless it is shown that such failure is due to reasonable cause not to willful neglect, shall
be subject to a penalty of P1,000 for each such failure. Provided that the amount imposed for all
such failure during a calendar year shall not exceed P25,000.