CHAPTER 4:

Income Tax Schemes, Accounting Periods, Accounting Methods, and Reporting

INCOME TAXATION SCHEMES

Mutually exclusive coverage
 an item of gross income that is subject to
Item of Gross
Income tax in one scheme will not be taxed by the
other schemes.
 items of income that are exempted in one
Taxable to any
one of scheme are not taxable by the other
scheme.

Final Income Capital Gains Regular Income Classification of Items of Gross Income
Taxation Taxation Taxation
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

 characterized by final taxes wherein full taxes are withheld by the income payor at
source.
 final withholding tax system
o the recipient income taxpayer receives the income net of taxes.
o the payor is the one required by law to remit the tax to the government.
o 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.
 applicable only on certain passive income listed by the law.
 not all items of passive income are subject to final tax.

Passive Income vs Active Income

 Passive income – earned with very minimal or even without active involvement of the
taxpayer in the earning process.
o Interest income from banks
o Dividends from domestic corporations
o Royalties
 Active or regular income – arises from transactions requiring a considerable degree of
effort or undertaking from the taxpayer.
o Compensation income
o Business income
o Professional income

CAPITAL GAINS TAXATION

 imposed on the gain realized on the sale, exchange and other dispositions of certain
capital assets.
o Capital assets – assets not used in business, trade or profession.
o Ordinary assets – assets used in business, trade or profession such as
inventory, supplies, or property, plant and equipment.
 not all capital gains 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 a 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.
 applies only to two types of capital assets: domestic stocks and real property
REGULAR INCOME TAXATION
 the general rule in income taxation and covers all other income such as:
o Active income
o Other income
 Gains from dealings in properties, not subject to capital gains tax
 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.
 makes use of the self-assessment method.

ACCOUNTING PERIOD
 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
 available to both corporate taxpayers and individual taxpayers
 shall be used when the:
 taxpayer’s annual accounting period is other than a fiscal year
 taxpayer has no annual accounting period
 taxpayer does not keep books
 taxpayer is an individual
b. Fiscal
 any 12-month period that ends on any day other than December 31.
 available only to corporate income taxpayers and is not allowed to
individual income taxpayers
2. Short accounting period – less than 12 months
a. Instances of short accounting period
 newly commenced business – the accounting period covers the date
of the start of the business until the designated year-end of the
business.
 dissolution of business – the accounting period covers the start of the
current year to the date of dissolution of the business.
 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.
 death of the taxpayer – the accounting period covers the start of the
calendar year until the death of the taxpayer.
 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 termination of the
accounting period.

Deadline of Filing the Income Tax Return

 under the NIRC, the return is due for filing on the 15 th 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.
ACCOUNTING METHODS
 accounting techniques used to measure income.

Types of Accounting Methods

1. General Methods:
a. Accrual basis
 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
 income is recognized when received
 expense is recognized when paid

Tax and Accounting Concepts of Accrual Basis and Cash Basis Distinguished
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.
2. Prepaid expense is non-deductible
 prepaid expenses are advanced payment for expenses of future taxable
periods.
 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.
3. Special tax accounting requirement must be followed

c. Hybrid basis
 any combination of accrual basis, cash basis, and/or other methods of
accounting.
 used when the taxpayer has several businesses which employ different
accounting methods.
2. Installment and Deferred Payment Method
a. Installment Method
 gross income is recognized and reported in proportion to the collection
from the installment sales.
 available to the following taxpayers:
o dealers of personal property on the sale of properties they
regularly sell.
o dealers of real properties, only if their initial payment does not
exceed 25% of the selling price.
o 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: Casual sale – sale of properties of which the seller is not a dealer.
 initial payment means total payments by the buyer, in cash or
property, in the taxable year the sale was made
 selling price means the entire amount for which the buyer is obligated
to the seller.
  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.
b. Deferred Payment Method
 variant of the accrual basis and is used in reporting income when a
non-interest-bearing note is received as consideration in a sale.
 the gross income is computed based on the present value (discounted
value) of a note receivable from the contract.
Note: Discount – difference between the face value and the present value of
the note.
 the discount interest on the note is amortized as interest income over
the installment term.
3. The Percentage of Completion Method for Construction Contracts
 the estimated gross income from construction is reported based on the
percentage of completion of the construction project.
 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.

4. Outright and Spread-out Method

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 an aliquot
part thereof.

Agricultural or Farming Income

 Farming income is commonly measured using the cash basis or accrual basis,
such as in the:
o Animal husbandry
o Short-term crops
 The accounting for long-term crops depends on the harvesting frequency:
o Perennial crops
- those that yield harvests through years
- capitalized and amortized over the expected years of harvest.
- the harvests are accounted for using cash basis or accrual basis.
o One-time crops
- those that are harvested once after several years
- accounted for using the crop year basis

5. Crop Year Basis

- farming income is recognized as the difference between the proceeds of
harvest and expenses of the particular crop harvested.
Change in Accounting Period
 The change in accounting period requires prior BIR notice. The following
documentations are required:
o A letter of request addressed to the RDO having jurisdiction over the place
of business of the taxpayer showing:
 The original and the proposed new accounting period
 The reason for desiring to change the accounting period
o Certified true copy of the SEC approved amended by-laws showing change
in accounting period.
o Sworn statement of “non-forum shopping” stating that such request has
been previously acted upon by the BIR National Office.
o Duly filed up BIR Form 1905
o A sworn undertaking by an officer of the taxpayer to file a separate final or
adjustment return for the period between the close of the original
accounting period and the date designated as the close of the new
accounting period.
 The request for the approval of the change in accounting period shall be filed at any
time not less than 60 days prior to the beginning of the new accounting period.
 The certification approving the adoption of a new accounting period must be
released within 30 days from the date of receipt of the complete documentary
requirements.

TAX REPORTING
Types of Returns to the Government
1. Income tax returns – provide details of the taxpayer’s income, expense, tax due,
tax credit and tax still due the government.
2. Withholding tax returns – provide reports of income payments subjected to the
withholding tax by the taxpayer-withholding agent.
3. Information returns – 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.
 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
- 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:
o an authorized agent bank (AAB)
o revenue collection officer
o duly authorized city or municipal treasurer, if there is no BIR office
in the locality
2. e-BIR Forms
- the BIR introduced 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.
3. Electronic Filing and Payment System (eFPS)
- 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.
Manual e-BIR Forms eFPS
Data entry Manual Electronic Electronic
Filing/Submission Manual Electronic Electronic
Tax payment Manual Manual Electronic

PAYMENT OF INCOME TAXES

 The general rule is “pay as you file.”
 The capital gains tax ang regular income tax are paid as the taxpayer files his
return.
 Installment payment of income tax is allowed on certain conditions.
PENALTIES FOR LATE FILING OR PAYMENT OF TAX
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 for 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.
 Under the new rules established by RR21-2018, the interest period shall be
computed based on actual days divided by 365 days.
3. Compromise Penalty
- 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 or 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 P1,000 for each such
failure. Provided that the amount imposed for all such failure during a calendar year
shall not exceed P25,000.
CHAPTER 5:
Final Income Taxation

FEATURES OF FINAL INCOME TAXATION

1. Final tax
2. Tax withholding at source
3. Territorial imposition
4. Imposed on certain passive income and persons not engaged in business in the
Philippines