TAXATION: Improperly Accumulated Earnings Tax (IAET) R.C.

Pendon
2020
Improperly Accumulated Earnings Tax (IAET)

To compel corporations to distribute or pay dividends to stockholders, the retention or

accumulation of earnings or profits beyond the reasonable needs of the business is made subject
to the IAET of 10%.
IAET is being imposed in the nature of a penalty to the corporation for the improper accumulation
of its earnings, and as a form of deterrent to avoidance of Tax upon shareholders who are
supposed to pay dividend tax on the earnings distributed to them by the corporation.

Corporations Subjected to IAET

Closely held domestic corporations are subjected to IAET.

Closely held corporation

These are corporations where at least 50% in value or combined voting power of all classes of
stock entitled to vote is owned directly or indirectly by twenty (20) or fewer individuals.

Exempt from IAET

1. Banks & other non-bank financial intermediaries
2. Insurance Companies
3. Publicly-held corporations
4. Taxable partnerships
5. General Professional Partnerships
6. Non-taxable Joint Venture
7. PEZA registered entities
8. Branches of foreign corporations

Tax Base
The IAET of 10% is based upon the improper accumulation of profits beyond the reasonable
needs of the business. Accumulation of profit is considered unreasonable if it is not required for
legitimate business purposes.

Prima Facie Presumption of Improper Accumulation/to Avoid Tax

1. The corporation is a mere holding company; or
2. The corporation is an investment company; or
3. That the earnings or profit of the corporation are permitted to accumulate beyond the
reasonable needs of the business

Page 1 of 7
TAXATION: Improperly Accumulated Earnings Tax (IAET) R.C.Pendon
2020

Circumstances indicative of Purpose to Avoid Tax

1. Dealings between the corporation and its shareholders, such as withdrawals by the
shareholders as personal loans
2. Expenditure of funds by the corporation for the personal benefit of the shareholders
3. The investment by the corporation of undistributed earnings in assets having no
reasonable connection with the business
4. Advances in substantial sums made yearly to corporate officers who are at the same time
the stockholders.

Cases where the accumulation of profit is proper

1. Earnings up to 100% of the paid-up capital
2. Earnings reserved for corporate expansion or programs approved by the board of
directors
3. Earnings reserved for the acquisition of building, plants, or equipment approved by the
Board of Directors
4. Earnings reserved for compliance with any loan covenant
5. Earnings reserved as required by law
6. In the case of subsidiaries of foreign corporations in the Philippines, all undistributed
earnings are intended or reserved for investment within the PH.

Undistributed income is also deemed properly accumulated in the following cases:

1. If retained for working capital needed by the business
2. If invested in addition to plant reasonably required by the business
3. If, in accordance with contract obligation, placed to the credit of a sinking fund to retire
bonds issued by the corporation.

Immediacy Test
To determine the reasonable needs of the business, which will justify accumulated earnings, the
immediacy test shall be performed.
Under the test, “reasonable needs of the business” means the immediate needs of the business,
including reasonably anticipated needs. The business should be able to prove an immediate
need for the accumulation or a direct correlation of anticipated needs to such accumulated
profits.

Page 2 of 7
TAXATION: Improperly Accumulated Earnings Tax (IAET) R.C.Pendon
2020
Computing IAET
The IAET is based on the improperly accumulated taxable income for each taxable year. It is
computed as follows:

Net Taxable Income for the Year P xxx

Add:
Income exempt from Tax xxx
Income excluded from gross income xxx
Income subject to final taxes xxx
NOLCO deducted xxx
Retained Earnings (beg) xxx
Less:
Dividends actually or constructively paid xxx
Income Tax paid/payable for the whole year xxx
(includes basic, final & CGT)
Amount that may be retained (i.e., 100% of paid-up capital) xxx
Improperly Accumulated Earnings xxx
IAET Rate 10%
IAET Due P xxx

Reviewer’s Note: The formula seems complicated, but there is an alternative way to compute
for this. My method is to calculate R.E. end using the accounting approach(wag kalimutan
bawasan rin ang taxes) and deduct the paid-up capital and appropriated retained earnings. The
difference is then multiplied by 10% then tadaaa IAET. Dali nho. Refer to the illustration to see
the alternative solution. NOTE this is only applicable as a SHORTCUT for board exam purposes.

Deadline for Payment

IAET should be paid one year & 15 days after the close of the taxable year. So if the taxable year
ended of December 31, 2020, then the deadline is on January 15, 2022.

Page 3 of 7
 TAXATION: Improperly Accumulated Earnings Tax (IAET) R.C.Pendon
2020
Illustration 1:
ABC Corp, a domestic corporation, has the following data in 2020:
Gross Income 1,500,000
Operating and Administrative Expenses 600,000
Interest income on Bank deposit (net) 5,000
Gain on sale of unlisted domestic shares 35,000
Dividend from a domestic corporation 35,000
Dividend paid during the year 120,000
Reserved for building acquisition 250,000

Additional information:

• In 2019, the corporations suffered an operating loss of P130,000.

• Retained earnings on January 1, 2020, P200,000
• Ordinary shares, P 350,000
• Additional paid-in capital, P 50,000
Compute for IAET

Solution:
Net Taxable Income for the Year P 770,000 Note (1)
Add:
Income exempt from tax 35,000 Dividend from DC
Income excluded from gross income 35,000 Subject to CGT
Income subject to final taxes 6,250 5k/.8
NOLCO deducted 130,000
Retained Earnings (Beg) 200,000
Less:
Dividends actually or constructively paid (120,000)
Income Tax paid/payable for the whole year (237,500) Note (4)
(includes basic, final & CGT)
Paid-up capital (350,000) Paid-up capital does
not include APIC; only
the PAR value is
included.
Appropriated Retained Earnings (250,000)
Improperly Accumulated Earnings 218,750
IAET Rate 10%
IAET Due P 21,875

Note 1:
Gross Income 1,500,000
Operating and Administrative Expenses (600,000)
NOLCO (130,000)
Net Taxable Income 770,000

Page 4 of 7
TAXATION: Improperly Accumulated Earnings Tax (IAET) R.C.Pendon
2020

Note 2:
RCIT = 770,000 x 30% = 231,000
MCIT = 1,500,000 x 2% = 30,000
Income tax due (higher) = 231,000

Note 3:
Final Income Tax = 5,000 / 80% x 20% = 1,250

Note 4:
CGT = 35,000 x 15% = 5,250

Note 5:
Total Taxes Paid = 231,000 + 1,250 + 5,250 = 237,500

Alternative Solution:
Retained Earnings (Beg) 200,000
Movement in RE:
Gross Income 1,500,000
Operating and Administrative Expenses (600,000)
Interest income on Bank deposit (net) 5,000 I did not add back the FWT because it will
just eventually be deducted, so no need.
Gain on sale of unlisted domestic shares 35,000
Dividend from a domestic corporation 35,000
Dividend paid during the year (120,000)
Reserved for building acquisition (250,000)
CGT Taxes Paid (5,250) Notice that I did not deduct/include the
RCIT Paid (231,000) FWT, because the interest income is
already NET of FWT.
Retained Earnings (End) 568,750
Paid-up Capital (350,000)
Improperly Accumulated Earnings 218,750
IAET Rate 10%
IAET Due P 21,875

Notice that it is similar to the financial accounting way in determining RE end, but I just
deducted the paid-up capital.
NOLCO is ignored because, based on the “formal” formula, the NOLCO in the procedure is there
to offset the NOLCO used in computing the net taxable income.

Page 5 of 7
 TAXATION: Improperly Accumulated Earnings Tax (IAET) R.C.Pendon
2020

Illustration 2:
HJK Corp had the following information for the year 2020:
Gross Income 1,750,000
Deductions (Including NOLCO of P400,000) 1,650,000
Tax exempt income 150,000
Royalty Income 75,000
Capital Gains of unlisted domestic stock 40,000
Creditable Withholding Taxes 10,000

HJK Corp had the following shareholder’s equity on December 31, 2019:
Common Stock 500,000
Share Premium 400,000
Retained Earnings 1,300,000

During the year, HJK Corp. declared a P100,000 dividend and appropriated P200,000 for a
plant expansion project in 2021.

Solution:
Net Taxable Income for the Year P 100,000 Note (1)
Add:
Income exempt from tax 150,000
Income excluded from gross income (subject to CGT) 40,000
Income subject to final taxes (Royalties) 75,000
NOLCO deducted 400,000
Retained Earnings (Beg) 1,300,000
Less:
Dividends actually or constructively paid (100,000)
RCIT (35,000) Note (2)
CGT (6,000) Note (3)
FWT (15,000) Note (4)
Paid-up capital (500,000)
Appropriated Retained Earnings (200,000)
Improperly Accumulated Earnings 1,209,000
IAET Rate 10%
IAET Due P 120,900

Note 1:
Gross Income 1,750,000
Operating and Administrative Expenses (1,650,000)
Net Taxable Income 100,000

Page 6 of 7
TAXATION: Improperly Accumulated Earnings Tax (IAET) R.C.Pendon
2020
Note 2:
RCIT = 100,000 x 30% = 30,000
MCIT = 1,750,000 x 2% = 35,000
Income tax due (higher) = 35,000
If it resulted to the MCIT or RCIT, the formula does not change. CWTs is ignored when computing
IAET because what is needed in the IAET computation is the TAX DUE and not the TAX
PAYABLE.

Note 3:
CGT = 40,000 x 15% = 6,000

Note 4:
FWT = 75,000 x 20% = 15,000

Alternative Solution:
Retained Earnings (Beg) 1,300,000
Movement in RE:
Gross Income 1,750,000
Deductions (Including NOLCO of P400,000) (1,650,000)
NOLCO 400,000 To cancel out the NOLCO
Tax exempt income 150,000
Royalty Income 75,000
Capital Gains of unlisted domestic stock 40,000
Dividend paid during the year (100,000)
Reserved for building acquisition (200,000)
CGT Taxes Paid (6,000)
FWT Taxes Paid (15,000) This time I added this because unlike in
the previous problem, the royalty income
is presented at its GROSS amount rather
than its net amount.
MCIT Paid (35,000)
Retained Earnings (End) 1,709,000
Paid-up Capital (500,000)
Improperly Accumulated Earnings 1,209,000
IAET Rate 10%
IAET Due P 120,900

Page 7 of 7