CHAPTER 4

INCOME TAX SCHEMES,

ACCOUNTING PERIODS,
ACCOUNTING METHODS,
AND REPORTING
Income Tax Schemes

There are three income taxation schemes under the NIRC:

a. Final income taxation

b. Capital gains taxation
c. Regular income taxation

An item of gross income is taxable in any of these tax schemes.

Classification of items of Gross Income

Because of the different tax schemes, items of gross income can be classified as
follows:

1. Gross income subject to final tax

2. Gross income subject to capital gains tax
3. Gross income subject to regular tax
 Item of gross income

Taxable to any one of

Final Income Capital Gains Regular Income

Taxation Taxation Taxation

Mutually exclusive coverage

The tax schemes are mutually exclusive. 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.
Final Income Taxation

Final income taxation is characterized by final taxes wherein full

taxes are withheld by the income payor at source. The recipient
income taxpayer receives the income net of taxes. 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 of
taxation is referred to as the final withholding tax system.

Final taxation is applicable only on certain passive income listed by

the law. Not all items passive income is subject to final tax.
Passive income vs. Active income

Passive income are earned with very minimal or even without active involvement of
the taxpayer in the earning process.

Examples of passive income:

1. Interest income from banks
2. Dividends from domestic corporations
3. Royalties

Active or regular income arises from transactions requiring a considerable degree of

effort or undertaking from the taxpayer. It is the direct opposite of passive income.

Examples of active income:

1. Compensation income
2. Business income
3. Professional income
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. Capital
assets are the opposites of ordinary assets. Ordinary assets are assets used in
business, trade or profession such as inventory, supplies or property, plant
and equiptment.

Also, not all capital assets are subject to capital gains tax. Most of them are
subject to regular income tax.

The NIRC identifies capital gains tax as a final tax but they are hybrid forms
of final taxes since it also employs self-assessment method. The taxpayer
still files capital gains tax returns to report the gain and pay the tax to the
government. Capital gains taxation applies only to two types of capital
assets: domestic stocks 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

Accounting period is the length of time over which income is

measured and reported.

Types of Accounting Period

1. Regular accounting period – 12 months in length

a. Calendar
b. Fiscal

2. Short accounting period – less than 12 months

Calendar Year

The calendar accounting period starts from January 1 and ends

December 31. This accounting period is available to both corporate
taxpayers and individual taxpayers.

Under NIRC, the calendar year shall be used when the:

1. Taxpayer’s annual accounting period is other than a fiscal year (i.e.
longer than 12 months in length)
2. Taxpayer has no annual accounting period (i.e. less than 12 months
in length)
3. Taxpayer does not keep books
4. Taxpayer is an individual

Fiscal Year

A fiscal accounting period is any 12-month period that ends on any day
other than December 31. The fiscal accounting period is available only to
corporate income taxpayers and is not allowed to individual income
taxpayers.
Deadline of Filing the Income Tax Return

Under the NIRC, the return is due for filing on the fifteenth day
of the fourth month following the close of the taxable year of
the taxpayer. The regular tax due is payable upon filing of the
income tax return.

Illustration: Due date of the annual income return

1. Taxpayers under the calendar year must file their annual
income tax return for the current period not later than April
15 of the following year.
2. A corporate taxpayer with fiscal year ending June 30, 2019
must file its annual income tax return not later than October
15, 2019.
Instances of Short Accounting Period

1. Newly commenced business – the accounting period covers the date of the start of the business until
the designated year-end of the business.

Illustration
Palawan Inc. started business operation on June 30, 2019 and opted to use the calendar year
accounting period.
Palawan should file its first income tax return covering June 30 to December 31, 2019 for the year
2019. The return must be filed on or before April 15, 2020.

2. Dissolution of business – the accounting period covers the start of the current year to the date of
dissolution of the business.

Illustration
Tawi-tawi Inc. is on the fiscal year accounting period ending every March 31. It ceased business
operation on August 15, 2019.
Tawi-tawi should file its last income tax return covering April 1 to August 15, 2019. Under the old
NIRC, dissolving corporations shall file their return within 30 days from the cessation of activities
or 30 days from the approval of merger by the Securities and Exchange Commission in the case of
merger. Hence, the return shall be filed on or before September 15, 2019.

For individuals, the return shall be due on or before April 15, 2020. There is no requirement for
early filing under the NIRC.
3. Change of accounting period by corporate taxpayers – The
accounting period covers the start of the previous accounting
period up to the designated year-end of the new accounting
period. Note that BIR approval is required in changing an
accounting period. It is not automatic.

Illustration 1
Effective February, 2019, Sulu Corporation changed its calendar accounting period
to a fiscal year ending every June 30.

Sulu Corporation shall file an adjustment return covering the income from January
1 to June 30, 2019 on or before October 15, 2019.

Illustration 2
Effective August 2019, Zamboanga Company changed its fiscal year accounting
period ending every June 30 to the calendar year.

Zamboanga Company should file an adjustment return covering July 1 to

December 31, 2019 on or before April 15, 2020.
4. Death of the taxpayer – The accounting period covers the start of the calendar
year until the death of the taxpayer.

Illustration
Mr. Jacob died on November 2, 2019.

The heirs of Mr. Jacob or his estate administrators or executors shall file his last
income tax return covering his income from January 1 to November 2, 2019.
There is no requirement for early filing in case of death of taxpayers. Hence, the
income tax return shall be filed on or before the usual deadline, April 15, 2020.

It must be noted that cut-off of income must be made at date point of death
because properties such as income accruing before death are part of the estate of
the decedent in Estate Taxation while those income accruing after death are not
part thereof. Hence, it is mandatory for the accounting period of the taxpayer to
be terminated exactly at the date of death.

Note that the requirement of the old law to presume that the taxpayer died at
year-end apply only for purposes of claiming then personal exemption. It is not a
mandate to extend the accounting period of the deceased taxpayer until year-end.
5. Termination of the accounting period of the taxpayer
by the Commissioner of Internal Revenue – The
accounting period covers the start of the current year until
the date of the termination of the accounting period.

Illustration
The accounting period of a taxpayer under the calendar
year basis was terminated by the CIR on August 2, 2019.

The taxpayer must file an income tax return covering

January 1 to August 2, 2019. The income tax return and
the tax shall be due and payable immediately.
ACCOUNTING METHODS

Accounting methods are accounting techniques used to

measure income.

Types of Accounting Methods

1. The general methods
a. Accrual basis
b. Cash basis
2. Installment and deferred payment method
3. Percentage of completion method
4. Outright and spread-out method
5. Crop year basis
General Methods for income from sale of goods or service

a. Accrual basis

Under the accrual basis of accounting, income is recognized when

earned regardless of when received. Expense is recognized when
incurred regardless of when paid.

Income is said to have accrued when the right to receive is established

or when an enforceable right to secure payment is created against the
counterparty.

b. Cash basis

Under the cash basis of accounting, income is recognized when

received and expense is recognized when paid.
Tax and accounting concepts of accrual basis and cash basis distinguished

The financial accounting concept of accrual basis and cash basis are similar to their tax
counterparts, except only for the following tax rules:

1. Advanced income is taxable upon receipt.

Income received in advance is taxable upon receipt in pursuant to the Lifeblood Doctrine and
Ability to Pay Theory. The subsequent taxation of advanced income in the period earned will
expose the government to risk of advanced income in the period earned will expose the
government to risk of non-collection. This rule is applicable on the sale of services not on
goods.

2. Prepaid expense is non-deductible.

Prepaid expenses are advanced payment for expenses of future taxable periods. These are not
deductible against gross income in the year paid. They are deducted against income in the
future period they expire or are used in the business, trade or profession of the taxpayer.

Normally, the expensing of prepayments does not properly reflect the income of the taxpayer.
It also contradicts the Lifeblood Doctrine as it effectively defers the recognition of income.

3. Special tax accounting requirement must be followed.

There are cases where the tax law itself provides for a specific accounting treatment of an
income or expense. The specified method must be observed even if it departs from the basis
regularly employed by the taxpayer in keeping his books.
The tax accrual basis income is determined as follows:

Cash income P ×××××××

Accrued (uncollected) income ×××××××
Advanced income ×××××××
Gross income P ×××××××

The tax accrual basis expense is determined as follows:

Cash expenses P ×××××××

Accrued (unpaid) expense ×××××××
Amortization of prepayments and
depreciation of capital expenditures ×××××××
Deductions P ×××××××
The tax cash basis income is determined as follows:

Cash income P ×××××××

Advanced income ×××××××
Gross income P ×××××××

The tax cash basis expense is determined as follows:

Accrued (unpaid) expense P ×××××××

Amortization of prepayments and
depreciation of capital expenditures ×××××××
Deductions P ×××××××
Sellers of goods

The gross income of taxpayers selling goods is determined as follows:

Sales P ×××××××
Less: Cost of goods sold ×××××××
Gross income P ×××××××

The cost sales are computed using the inventory method:

Beginning inventory P ×××××××
Add: Purchases ×××××××
Total goods available for sale P ×××××××
Less: Ending inventory ×××××××
Cost of goods sold P ×××××××

The expensing of the purchase cost of goods does not properly and fairly
reflect the income of the taxpayer particularly when there are significant
fluctuations in inventory levels between accounting periods. This could
expose the taxpayer to risk of BIR assessment. The use of the accrual
method is suggested but of course subject to practical and cost
considerations.
Hybrid basis

The hybrid basis is any combination of accrual basis, cash basis and
or other methods of accounting. It is used when the taxpayer has
several businesses which employ different accounting methods.

Illustration
Mr. Roxas has two proprietorship business: a service business
which uses cash basis and a trading business which uses accrual
basis.

The gross income as determined by cash basis in the service

business and the gross income as determined by the accrual basis
in the trading business are simply combined. There is no
requirement to measure the income of different business under a
single accounting method.
Installment method

Under the installment method, gross income is recognized and

reported in proportion to the collection from the installment
sales.

Installment 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
Initial payment

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

property, in the taxable year the sale was made. The term “initial
payment” is broader than down payment. It also includes payments
in the year of sale.

Selling price

Selling price means the entire amount for which the buyer is obligated to the seller. It is
computed as follows:

Cash received and/or receivable P ×××××××

Fair market value of property received or receivable ×××××××
Mortgage or any indebtedness assumed by the buyer ×××××××
Selling price P ×××××××
Contract price

The contract price is the amount receivable in cash or other property from
the buyer. It is usually the selling price in the absence of an agreement
whereby the debtor assumes indebtedness on the property.

With indebtedness assumed by the buyer

The application of the installment method will slightly vary when the
buyer assumes indebtedness on the property sold.

In this case, the selling price is no longer the contract price. The contract
price is the residual amount after deducting the mortgage from the selling
price. Thus,

Selling price P ×××××××

Less: Mortgage assumed by the buyer ×××××××
Contract price P ×××××××
Indebtedness assumed exceeds tax basis of property sold

When the indebtedness assumed by the buyer exceeds the tax basis of the indirect
down payment which must be added as part of the contract price and the initial
payment. Note also under this condition, all collection from the contract
including the excess mortgage is a collection of income.

The contract price shall be computed as follows:

Selling price` P ×××××××

Less: Mortgage assumed by buyer ×××××××
Cash collectible Mortgage P ×××××××
Add: Excess indebtedness – constructive receipt ×××××××
Contract price P ×××××××

The initial payment shall be computed as follows:

Down payment P ×××××××

Installment in the year of sale ×××××××
Excess of mortgage over tax basis ×××××××
Installment payment P ×××××××
Deferred payment method

The 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 the deferred payment 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.
The Percentage of Completion Method for
Construction Contracts

Under the percentage of completion 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.
Income from Leasehold Improvement

Leasehold improvements are tangible improvements made by the lessee to the property of
the lessor. Improvements will benefit the lessor when their useful life extends beyond the
lease term. This benefit referred to as income from leasehold improvement.

Under Revenue Regulations No. 2, the income from leasehold improvement can be
reported using either of the following method at the option of the taxpayer:

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.

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 an aliquot part thereof.

The depreciated value of the leasehold improvement is computed as:

Cost of improvement × Excess useful life over lease term

Useful life of the improvement
Note to Readers

It should be pointed out that this rule exists only in the regulation
and is absent in the NIRC. Some taxpayers are questioning its
validity pointing out lack of legal basis. However, it is fairly proper
to consider the depreciated value of the improvement that remains to
the lessor upon termination of the lease as income because it is an
actual benefit to the lessor. These are, in effect, additional rental
consideration in kind.

However, the treatment specified by the outright method is

perceived as unjust and abusive, and is an improper introduction of
legislation.

The depreciated value of the improvement at the termination of the

lease should be the proper value to be recognized as gross income
under the outright method.
Agricultural or Farming Income

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 perennial crops like mangoes, mangosteen,
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 the crop year basis, 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 crop.
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.

Change in Accounting Methods and Accounting Records

Under the NIRC, the change in accounting methods 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 returns – provides details of the taxpayer’s income,
expense, tax due, 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 – certain taxpayers are also required to file
information returns. Information return do 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. The 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 – the traditional manual system of filing income tax
return is by paper documents where taxpayers fill up BIR forms to report
income, expenses, or any declaration required to be filed with the BIR.
Under NIRC, the income tax return shall be filed to the following descending order of priority, within
the revenue district office where the taxpayer is registered or required to register:
1. An authorized agent bank (AAB)
2. Revenue Collection Officer
3. Duly authorized city or municipal treasurer, if there is no BIR office in the locality

2. e-BIR Forms – the BIR introduced the e-BIR Forms with an offline or online
version. Taxpayers fill up their income tax returns in electronic spreadsheets
without the need of writing on papers returns. The system ensures
completeness of data on the return and is capable of online submission. If
there are no penalties that require BIR assessments, taxpayers would have to
print a hard copy of the filled tax returns and proceed directly to the bank for
payment.

3. Electronic Filing and Payment System (eFPS) – the eFPS is a paperless tax
filing system developed and maintained by the BIR. Taxpayers file tax returns
including attachments in electronic format and pay the tax through the
Internet.
Taxpayers mandated to use the eFPS

1. Large taxpayers duly notified by the BIR

2. Top 20,000 private corporations duly notified by the BIR
3. Top 5,000 individual taxpayers duly notified by the BIR
4. Taxpayers who wish to enter into contracts with government offices
5. Corporations with paid-up capital of ₱10,000,000
6. PEZA-registered entities and those located within Special Economic
Zones
7. Government offices, in so far as remittance of withheld VAT and
business tax are concerned
8. Taxpayers included in the Taxpayer Account Management Program
(TAMP)
9. Accredited importers, including prospective importers required to
secure the Importers Clearance Certificate (ICC) and Custom brokers
Clearance Certificate
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 their tax online
through internet banking service. The account of the taxpayer will
be auto-debited for the amount of taxes to be paid.

Basic comparison of filing and payment systems

Manual e-BIR Forms eFPS
Data entry Manual Electronic Electronic
Filing/Submission Manual Electronic Electronic
Tax payment Manual Manual Electronic
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

The non-filing is considered ‘willful neglect’ if the BIR discovered

the non-filing first. This is the case when the taxpayer received a
notice from the BIR to file return prior to his actual filing. If the
taxpayer filed a return before the receipt of such notice, the same
is considered simple neglect subject to the 25% surcharge.
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. Note that
NIRC imposed an interest penalty of 20% per annum until
December 31, 2017.

Under the new rules established by RR21-2018, the interest period

shall be computed based on actual days divided 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.

A month normally have 30 days except the following:

31-day month – January, March, May, July, August, October,
December
28 or 29-day month – February
3. Compromise penalty

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

For each failure to file a separate information return, statement of

list, or keep any record, or supply any information required by the
Code or by the Commissioner on the date prescribe therefor, unless
it is shown that such failure is due to reasonable cause not to willful
neglect, shall be subject to a penalty off ₱1,000 for each such
failure. Provided that the amount imposed for all such failure during
a calendar year shall not exceed ₱25,000.00