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FRAMEWORKS IN UNDERSTANDING TAX

Importance of Taxes in Decision Making

Taxes are embedded in almost every transaction an individual made. For example, in buying groceries in
the store, a sales tax will be paid; when someone purchases an automobile, an excise tax will also be paid;
in earning wages, a significant portion usually must be withheld for payroll taxes. Indeed, taxation is almost
everywhere (Karayan & Swenson, 2007).

Sometimes, the tax affects decision making in even a simple setting. For example, Anna is a freelance
engineer. Most of her clients are from abroad, which usually requires her to be physically present for her
expertise. Under the law, Anna will be considered a non-resident citizen if she stays abroad for 183 days
or more. Non-resident citizens are taxed only for income derived within the Philippines. Thus, if Anna
wanted her income from abroad to be exempted from Philippine taxation, she may stay abroad for 183 days
or more. The decision that will be made by Anna is called tax planning.

Moreover, tax planning often represents a significant part of doing business. In some cases, taxes are one
of the most important aspects of structuring a transaction. For example, XYZ Corporation is one of the
leading manufacturers of face masks in the country. It had just started its business three (3) years ago. In
Year 1, the company reported a net loss for income tax purposes. In “corporate taxation”, such loss can be
carried in the immediate succeeding three (3) years, hence, the name net operating loss carryover
(NOLCO).

Currently, the company plans to purchase new machinery with a cost of P500,000 and an estimated useful
life of five (5) years. This is to facilitate the process of their production. However, the management is
deciding on whether to buy it now or next year due to its tax implication. When a company buys new
machinery, it will be depreciated. The related depreciation expense is a deduction for taxation purposes,
and thus, minimizing the taxable income. Suppose that for the current year, the remaining net operating
loss carryover (NOLCO) is P500,000 and the projected annual gross income for tax purposes is P500,000.
If XYZ Corporation buys the machinery, it will incur a net loss of more or less P100,000 due to the
depreciation. Thus, it will have another NOLCO that can be carried forward for the next three (3) years. If it
will buy next year, there is a greater probability that it will not result in loss even if it buys the equipment and
records a depreciation because the NOLCO from year 1 already expires. This simple bit of planning results
in tax benefits through timing, an important component of strategic tax planning.

Consider also the following case. Suppose that as part of its strategy on moving into the entertainment
industry, Bighit Corporation’s management decided to purchase Pledis Company. There were many ways
to acquire this transaction. Bighit may purchase shares of Pledis Company outright via cash subscription
and therefore, such purchase will be subject to Documentary Stamp Taxes. However, there is another way.
Bighit may choose to transfer its properties in exchange for shares of stocks of Pledis Company. This is
called a tax-free exchange. A tax-free exchange is a transfer of property to a corporation in exchange for
its shares of stock which, as a result, the transferor, alone or together with at most four others, gains control
of the transferee.

Under Section 40 (C) (2) of the 1997 Tax Code, no gain or loss shall be recognized concerning a tax-free
exchange. Hence, no income tax liability will arise at the time the exchange takes place. Consequently, the
transaction would have no impact on the withholding tax obligation of the transferee. Also, the transfer of
property according to a tax-free exchange is exempt from documentary stamp tax.

This example shows how good tax planning can add significant value to a transaction.

Although transactions typically do not have such dramatic tax effects, the example illustrates how a
transaction can have an important tax component. Hence, taxes are one of the many factors that individuals
and organizations consider when making decisions.

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Basic Principles of Taxation

Adam Smith, a Scottish economist, proposed in his book “Wealth of Nations” the following characteristics
of a good tax (Karayan & Swenson, 2007):
• Equity. It means that taxpayers should bear a fair level of tax relative to their economic positions, such
as income for income taxes. Equity can be defined in terms of horizontal and vertical equity. Horizontal
equity means that two (2) similarly situated taxpayers are taxed the same. On the other hand, vertical
equity means that when taxpayers are in different economic positions, the taxpayer with the greatest
ability to pay incurs the most taxes.
• Certainty. It means that a taxpayer knows when and how much tax is paid. For example, in the
Philippines, individuals generally know that the balance of their income taxes for a year is due on April
15 of the following year and that taxes will be withheld from their paychecks. Similarly, corporations
know that their income and withholding taxes are due quarterly.
• Convenience. It means that the taxes should be levied at the time it is most likely to be convenient for
the taxpayer to make the payment. This generally occurs as they receive income because this is when
they are most likely to have the ability to pay. Another aspect of convenience is the method of collection.
Income taxes in the Philippines are privately determined by individuals and businesses and are self-
assessed. In contrast, import, property, sales, use, and other taxes are calculated and assessed either
by governments or (for sales, use, and value-adding taxes) by vendors.
• Efficiency. It means that a tax should have minimum compliance and administrative costs. That is, it
should require a minimum of time and effort for the taxpayer to calculate and pay the tax. Administrative
costs are expenses incurred by the government to collect the tax. Compliance and administrative costs
are highest for income taxes because of their complexity.

However, today, there are only three (3) major characteristics that are widely recognized (Certified Institute
of Management Accounting [CIMA], 2019):
• Equity. The tax burden should be distributed fairly, such as the wealthier an individual, the higher the
tax rate. This is also known as the theoretical justice or the ability-to-pay principle.
• Efficiency. The tax should be easy and cheap to collect. This is best achieved by the use of unpaid
tax collectors, such as employers who have to collect and account for payroll taxes. This is also known
as administrative feasibility.
• Economic Effects. The government must consider the effect of taxation policy on various sectors of
the economy. For example, tax allowances on capital expenditure may stimulate growth in the
manufacturing sector.

Tax Rate Structures

Tax rate structures can be thought of as proportional, progressive, or regressive:
1. Proportional Tax. It is a tax imposed so that the tax rate is fixed, with no change as the taxable base
amount increases or decreases. The amount of the tax is in proportion to the amount subject to taxation.
“Proportional” describes a distribution effect on income or expenditure, referring to the way the rate
remains consistent (does not progress from “low to high” or “high to low” as income or consumption
changes), where the marginal tax rate is equal to the average tax rate. The marginal tax rate is the tax
rate that applies to the last unit of currency of the tax base (taxable income or spending) and is often
applied to the change in one’s tax obligation as income rises. On the other hand, the average tax rate
is the ratio of the amount of taxes paid to the tax base (taxable income or spending).
2. Progressive Tax. It is a tax in which the tax rate increases as the taxable base amount increases. The
term “progressive” describes a distribution effect on income or expenditure, referring to the way the rate
progresses from low to high, where the average tax rate is less than the marginal tax rate. The term
can be applied to individual taxes or a tax system as a whole; a year, multi-year, or lifetime. Progressive
taxes are imposed in an attempt to reduce the tax incidence of people with a lower ability-to-pay, as
such taxes shift the incidence increasingly to those with a higher ability-to-pay. The opposite of a
progressive tax is a regressive tax, where the relative tax rate or burden increases as an individual’s
ability to pay it decreases.

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3. Regressive Tax. A regressive tax is a tax imposed in such a manner that the average tax rate
decreases as the amount subject to taxation increases. “Regressive” describes a distribution effect on
income or expenditure, referring to the way the rate progresses from high to low, where the average
tax rate exceeds the marginal tax rate. In terms of individual income and wealth, a regressive tax
imposes a greater burden (relative to resources) on the poor than on the rich; thus, there is an inverse
relationship between the tax rate and the taxpayer’s ability to pay as measured by assets, consumption,
or income.

Types of Taxes
The types of taxes in the Philippines can be classified into four (4) (Tabag, 2018):
a. Income taxes on individuals. Individuals are taxed on their income using the schedular system. Under
the schedular system, income tax treatment varies and depends on the kind or category of the
taxpayer’s taxable income. Moreover, the tax rates are progressive in character as the tax rate
increases when the tax base increases. Individuals also earn other kinds of income, such as capital
gains and passive income.
To solve for the tax of an individual, follow these steps:

1. First, determine the type of income received by the individual. It can be a returnable income,
passive income, or capital gains.
2. Determine the tax liability for each income. For returnable income, generally, it is subject to net
income taxation, except for income received by non-resident alien not engaged in business
(NRANETB) whose tax is equal to 25% final tax on his/her gross income. Passive income is subject
to final withholding tax, while capital gains are subject to capital gains tax. Note: A capital gains
tax is a final tax.
3. Solve for the tax.

• Returnable Income. In determining the tax for an individual, one must classify them first as
purely self-employed or mixed earners. Then, the following rules shall be applied:

If the gross sales/receipts and other operating income exceeds

A self-employed the value-added tax (VAT) threshold of P3,000,000, he/she will
individual earning be taxed at regular income tax.
income purely from self- If the gross sales/receipts and other operating income does not
employment or the exceed the VAT-threshold of P3,000,000, he/she will be taxed at
practice of a profession. regular income tax or 8% optional gross income tax (OGIT) in
excess of P250,000.
The income from compensation shall be subject to regular
income tax.
If the gross sales/receipts and other operating income from the
business or practice of profession exceeds the value-added tax
(VAT) threshold of P3,000,000, he/she will be taxed at regular
Mixed Earners
income tax.
If the gross sales/receipts and other operating income does not
exceed the VAT-threshold of P3,000,000, he/she will be taxed at
regular income tax or 8% optional gross income tax (OGIT). No
deduction of P250,000 shall be made.

It must be noted that the option to be taxed 8% OGIT is available only to taxpayers who are a)
non-value-added tax (VAT) registered taxpayers and b) those who are liable for the 3%
percentage tax under Section 116 of the amended National Internal Revenue Code (NIRC). If
an individual satisfied the aforementioned requirements and elected to be taxed at 8% OGIT,
he/she must signify his/her intention in the 1st quarter return of the taxable year that he/she will

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be taxed at 8% optional gross income tax (OGIT). Otherwise, he will be taxed using the
graduated rates. Such an election is irrevocable. However, if the taxpayer subsequently
exceeds the VAT-threshold of P3,000,000 within the taxable year, he/she will be automatically
subjected to the graduated rates, wherein he/she:
▪ Will be allowed an income tax credit of quarterly payments initially made under the 8%
OGIT; and
▪ Will also liable for business tax(es), in addition to income tax.

• Passive Income. Multiply the value of the passive income with its corresponding final tax rate.
In determining the tax rate, one must need to know what is the classification of the taxpayer.
He/She may be a resident citizen (RC), non-resident citizen (NRC), resident alien (RA), non-
resident alien engaged in trade or business (NRAETB), or non-resident alien not engaged in
trade or business (NRANETB). The following are some of the passive income and their
corresponding taxes for each classification of the taxpayer.

Income Citizen and RA NRAETB NRANETB

Interest from any
20% 20% 25%
currency bank deposit
Yield or monetary
benefit from deposit
substitutes, trust funds, 20% 20% 25%
and similar
arrangements.
Share of an individual
partner in the after-tax
net income of a
business partnership, 10% 20% 25%
or an organization,
joint venture, or
consortium.

• Capital Gains. There are two (2) types of capital gains: gains from the sale of stocks or in the
sale of capital assets. The following rules shall be observed:

If the shares are not traded in the local stock

Sale of Domestic Shares of Stock
Sale of Capital Assets
exchange, the net capital gain shall be subject to 15%
capital gains tax.
If the shares are traded in the local stock exchange,
the gross selling price shall be subject to 6/10 of 1%
business tax.
The higher between the gross selling price or current
fair market value of the property will be subject to 6%
capital gains tax. The current fair market value of the
property is higher between the zonal and assessor’s
value.

b. Income taxes on corporations. Corporations are taxed using the global system. Under the global
system, the tax treatment views the tax base differently and treats in common all categories of taxable
income of the taxpayer. Under Section 22 (B) of the NIRC, the term “corporation” shall include:
partnerships, no matter how created or organized; joint-stock companies; joint accounts (cuentas en
participacion); associations; or insurance companies. There are three types of corporations: domestic
corporations, resident foreign corporations (RFC), and non-resident foreign corporations (NRFC).

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A corporation may be liable for seven (7) types of income taxes:

✓ Net Income Tax (NIT). It is a 30% tax on the net income of domestic and resident foreign
corporations. This tax is also known as the ordinary income tax or the regular corporate income
tax.

✓ Final Withholding Tax (FWT). These are taxes withheld on the certain passive income of the
corporation. Given below is the summary of the final tax on passive income.

Income Domestic and RFC NRFC

Interest from any currency bank deposit 20% 20%
Yield or monetary benefit from deposit
substitutes, trust funds, and similar 20% 30%
arrangements.
Royalties
20% 30%
Interest from a depositary bank under 7.5% (RFC) Exempt
the expanded foreign currency deposit 15% (DC)
system.
Prize Income Tax Return 30%

✓ Capital Gains Tax (CGT). It is a tax on the sale, exchange, or other disposition of capital assets.
The following rules will be followed:

If the shares are not traded in the local stock

Sale, Exchange, or Disposition of
Domestic Shares of Stock
Sale of Capital Assets
exchange and the sale, exchange, or disposition is
made by a domestic corporation; the net capital gain
shall be subject to 15% capital gains tax.
If the shares are not traded in the local stock
exchange and the sale, exchange, or disposition is
made by a foreign corporation; the net capital gain
shall be subject to 5% on the first P100,000 and 10%
on the excess of P100,000.
If the shares are traded in the local stock exchange,
the gross selling price shall be subject to 6/10 of 1%
business tax.
The higher between the gross selling price or current
fair market value of the property will be subject to 6%
capital gains tax. The current fair market value of the
property is higher between the zonal and assessor’s
value.

✓ Minimum Corporate Income Tax (MCIT). It is a 2% tax imposed on the gross income of
corporations who are subject to the NIT. This tax will only be effective immediately in the 4 th
taxable year following the year in which a corporation commenced its business. Any excess
MCIT over the NIT shall be carried forward and credited against the NIT for the three (3)
immediately succeeding taxable years.

✓ Improperly Accumulated Earnings Tax (IAET). It is a 10% tax imposed on improperly

accumulated income. The tax applies to every domestic corporation formed or used to avoid
income tax concerning its shareholders or the shareholders of any other corporation, by
permitting earnings and profits to accumulate instead of being divided or distributed.

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Exceptions are made for publicly held corporations, banks and non-bank financial
intermediaries, and insurance companies.

✓ Gross Income Tax (GIT). It is a 15% tax, in place of the 30% NIT, given to domestic and foreign
corporations. Provided that they met the following requirements:
o A tax ratio effort of 20% of the Gross National Product (GNP);
o A ratio of 40% income tax collection to total tax revenues;
o A VAT tax effort of 4% of GNP; and
o A 0.9% ratio of Consolidated Public Sector Financial Position (CPSFP) to GNP.

✓ Branch Profits Remittance Tax (BPRT). It is a 15% final tax on any profit that will be remitted
by a branch of a foreign corporation to its head office. An example of an income that will be
subject to this tax is the income derived from the Philippine sources by the Regional Operating
Headquarters of a multinational corporation when it is remitted to the parent company.

c. Transfer Taxes. There are two (2) types of transfer taxes in the country, the estate, and donor’s taxes.
The estate tax is imposed on all properties, rights, and interests that a decedent owns at the time of his
death. On the other hand, donor tax is imposed on gratuitous transfer of real or personal and tangible
or intangible properties during the lifetime of the donee and the donor. Under the Tax Reform for
Acceleration and Inclusion (TRAIN) Law, the net estate and net gift are subject to 6% estate and donor’s
taxes, respectively.

d. Business Taxes. There are two (2) types of business taxes in the country, the percentage and value-
added tax (VAT). Percentage tax is a business tax imposed on persons or entities who sell or lease
goods, properties, or services in the course of trade or business whose gross annual sales or receipts
do not exceed P3,000,000 and are not VAT-registered. On the other hand, VAT is a business tax
imposed and collected from the seller in the course of trade or business on every sale of properties
(real or personal) lease of goods or properties (real or personal), or vendors of services. It is an indirect
tax; thus, it can be passed on to the buyer.

Sources of Tax Laws

Tax laws in the Philippines cover national and local taxes. National taxes refer to national internal revenue
taxes imposed and collected by the national government through the Bureau of Internal Revenue (BIR),
and local taxes refer to those imposed and collected by the local government.

The following are the sources of tax laws in the Philippines (Bureau of Internal Revenue [BIR], 2020):

I. The 1987 Constitution. It sets limitations on the exercise of the power to tax. Some of the provisions
of the constitution are the following:
o Article VI, Section 28, paragraph 1: The constitution states that the rule of taxation shall be uniform
and equitable. Congress shall evolve a progressive system of taxation.
o Article VI, Section 29, paragraph 3: All money collected on any tax levied for a special purpose
shall be treated as a special fund and paid out for such purpose only. If the purpose for which a
special fund was created has been fulfilled or abandoned, the balance, if any, shall be transferred
to the general funds of the Government.
o Article VI, Section 28, paragraph 2: The Congress may, by law, authorize the President to fix within
specified limits, and subject to such limitations and restriction as it may impose, tariff rates, import
and export quotas, tonnage and wharfage dues, and other duties or imposts within the framework
of the national development program of the Government.
o Article VI, Section 27, paragraph 2: The President shall have the power to veto any particular item
or items in an appropriation, revenue, or tariff bill, but the veto shall not affect the item or items to
which he does not object.

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o Article VIII, Section 5, paragraph 2: The Supreme Court shall have the power to review, revise,
reverse, modify or affirm on appeal or certiorari, as the law or the Rules of Court may provide, final
judgments and orders of lower courts in all cases involving the legality of any tax, impost,
assessment, or toll or any penalty imposed in relation thereto.
o Article VI, Section 28, paragraph 4: Tax exemptions are limited to those granted by law. However,
no law granting any tax exemption shall be passed without the concurrence of a majority of all the
members of Congress.
II. In addition to national taxes, the constitution provides, under Section 5 and 6 of Article X, for local
government taxation. Parenthetically, the Local Government Code (LGC) provides that all local
government units are granted general tax powers. Moreover, they are also granted other revenue-
raising powers like the imposition of fees. It must be noted, however, that no taxes, fees, and charges
shall be imposed by the local government without holding a public hearing before an ordinance will be
enacted. Moreover, the levy must not be unjust excessive, oppressive, confiscatory, or contrary to a
declared national economic policy. Also, there are common limitations to the aforementioned granted
power. It is because the local government cannot impose some taxes like income tax and documentary
stamp tax.
III. Laws. The basic source of Philippine tax law is the National Internal Revenue Law, which codifies all
tax provisions, the latest of which is embodied in Republic Act No. 8424, otherwise known as The Tax
Reform Act of 1997.
IV. Treaties. The Philippines has entered into several tax treaties for the avoidance of double taxation and
prevention of fiscal evasion concerning income taxes. At present, there are 31 Philippine Tax Treaties
in force.
V. Administrative Material. These are the needful rules and regulations promulgated by the Secretary of
Finance, upon the recommendation of the Commissioner, for the effective enforcement of the
provisions of the Tax Code. It must be noted, however, that the exclusive and original power to interpret
the provisions of the Tax Code is given to the Commissioner of Internal Revenue (CIR), which is to be
reviewed by the Secretary of Finance. Administrative issuances that may be relied upon in interpreting
the provisions of the Code are in the form of Revenue Regulations (RR), Revenue Memorandum Orders
(RMO), Revenue Memorandum Rulings (RMR), Revenue Memorandum Circulars (RMC), and BIR
Rulings.
VI. Case Law. In the Philippines, Supreme Court decisions form part of the law of the land. As such,
decisions by the Supreme Court in the exercise of its power to review, revise, reverse, modify or affirm
on appeal or certiorari, are adhered to and recognized as binding interpretations of Philippine tax law.
Court of Appeals and Court of Tax Appeals decisions, which have become final and executory, are also
recognized interpretations of Philippine tax law.
VII. Local Government Tax Law. It is based on the constitutional grant of the power to tax to the local
governments. Under Section 5 of Article X of the constitution, local taxes may be imposed, to each local
government unit, the power to create its sources of revenues and to levy taxes, fees, and charges which
shall accrue to the local governments. Local government units shall have a just share, as determined
by law, in the national taxes, which shall be automatically released to them.
VIII. National Tax Research Center (NTRC). It is mandated to conduct continuing research in taxation to
restructure the tax system and raise the level of tax consciousness among the Filipinos; achieve a
faster rate of economic growth; bring more equitable distribution of wealth and income.

References:
Bureau of Internal Revenue [BIR]. (2020). Guide to Philippines tax law research. Retrieved from Bureau of Internal Revenue:
https://www.bir.gov.ph/index.php/legal-matters/guide-to-philippines-tax-law-research.html
Certified Institute of Management Accounting [CIMA]. (2019). CIMA practice & revision kit; operational paper 1 financial
operations. BPP House.
Karayan, J., & Swenson, C. (2007). Strategic business tax planning, 2nd edition. John Wiley & Sons, Inc.
Tabag, E. (2018). CPA reviewer in taxation, 2018 edition. Professional Review and Training Center (PRTC).

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TAX PLANNING VS. TAX MANAGEMENT

Tax Planning
Taxes are the compulsory contribution by the citizens of a country for meeting different government
expenditures. There are three (3) stages in the imposition of tax by the government. The first step is the
declaration of the liability by the government, such as what are all the incomes chargeable to tax. The next
stage is the assessment and tax payment by persons, and the last one is the method of recovery of tax if
the tax was not paid on time. Tax planning and management focus on the efficient administration of tax
procedures and minimization of tax liability through eligible schemes.

Tax planning is an exercise undertaken to minimize tax liability through the best use of all available
exemptions, deductions, rebates, and reliefs to reduce income. Tax planning can be defined as an
arrangement of one’s financial and business affairs by taking legitimately in full benefit of all deductions,
exemptions, allowances, reliefs, and rebates so that tax liability reduces to a minimum. In other words, all
arrangements by which the tax is saved by ways and means that comply with the legal obligations and
requirements and are not colorable devices or tactics to meet the letters of law but not the spirit behind
these would constitute tax planning.

Significance of Tax Planning

Tax planning is the honest and rightful activity to minimize the tax burden of various persons. Discussed
below are the need and significance of tax planning (Shameem, 2015):

a. Reduction of tax liability. The basic need of tax planning is to reduce tax liability by arranging his
affairs following the requirements of the law, as contained in the fiscal statutes. In many cases, a
taxpayer may suffer heavy taxation not on account of the dosage of tax administered by the Act,
but, because of his lack of awareness of the legal requirements.

b. Minimization of litigation. There is always a tug-of-war between taxpayers and tax administrators.
Taxpayers try to pay the least tax, and the tax administrators attempt to levy a higher amount of
tax. Where proper tax planning is adopted by the taxpayer in conformity with the provisions of the
taxation laws, the incidence of litigation is minimized.

c. Productive investment. Channelization of taxable income to the various investment schemes is

one of the prime purposes of tax planning as it is aimed to attain the following objectives: harnessing
the resources for socially productive projects, and relieving the taxpayer from the burden of taxation
by converting the earnings into means of further earnings.

d. Cost reduction. The reduction of tax by tax planning reduces the overall cost. It results in more
sales, profit, and tax revenue.

e. Healthy growth of the economy. The growth of a nation’s economy is synonymous with the
growth and prosperity of its citizens. In this context, a saving of earnings by legally sanctioned
devices fosters the growth of both.

f. Economic stability. Tax planning results in economic stability by availing of avenues for productive
investments by the taxpayers; harnessing resources for national projects aimed at general
prosperity of the national economy; reaping of benefits even by those not liable to pay tax on their
incomes.

g. Employment generation. Tax planning creates employment opportunities in different ways. Firstly,
efficient tax planning requires some sort of expertise that creates job opportunities in the form of
advisory services. Secondly, the amount saved through tax planning is generally invested in the

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commencement of new business or the expansion of the existing business. This creates new
employment opportunities.

Types of Tax Planning

The tax planning exercise ranges from devising a model for the specific transaction as well as for systematic
corporate planning. These are (Shameem, 2015):

• Short-range planning. It refers to a year to year planning to achieve some specific or limited
objective. For example, an individual determined his income last year using the itemized deduction.
This year, he expects that his taxable income will increase under itemized deduction compared
with Optional Standard Deduction (OSD). Thus, he signified his intention to use OSD.

• Long-range planning. It involves entering into activities, which may not pay-off immediately. For
example, when an assessee transfers his equity shares to his minor son, knowing that the income
from the shares will be clubbed with his income. However, clubbing would also cease after the
minor attains majority.

• Permissive tax planning. It is tax planning under the expressed provisions of the Tax Code.
Examples of permissive tax planning are taking advantage of different incentives, deductions, and
tax credits; and availing different tax concessions.

• Purposive tax planning. It is based on measures that do not circumvent the law. The permissive
tax planning has the express sanction of the Statute, while the purposive tax planning does not
carry such sanction.

Tax Avoidance
Tax avoidance is a method of reducing tax incidence by availing of certain loopholes in the law. The Royal
Commission on Taxation for Canada has explained the concept of tax avoidance as it is used to describe
every attempt by legal means to prevent or reduce tax liability that would otherwise be incurred by taking
advantage of some provisions or lack of provisions of law. It excludes fraud, concealment, or other illegal
measures.

How does tax avoidance differ from tax planning? The line of demarcation between tax planning and tax
avoidance is very thin and blurred. Any planning, though done strictly according to legal requirements, that
defeats the basic intention of the legislature behind the statute could be termed as an instance of tax
avoidance. It is usually done by taking full advantage of loopholes by adjusting the affairs in such a manner
that there is no infringement of taxation laws and least taxes are attracted.

Given below are some of their specific differences:

• Nature. On a fundamental level, both tax planning and tax avoidance are techniques of minimizing
tax liability. Both methods are legal, but that’s where the similarities end.

• Legality. Yes, tax avoidance can be legal. However, while tax planning is the moral thing to do, tax
avoidance is unethical.

• Objective. The objective of tax planning is to decrease tax liability by using the existing provisions
of the law. On the other hand, tax avoidance aims to dodge tax payments by taking advantage of
loopholes in the law.

• Benefits. The benefits of tax planning generally emerge in the long term. For example, the
government has introduced tax benefits on various investment avenues like mutual funds and
provident funds. This encourages people to invest money for the long term and reap the benefits.

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But the benefits of tax avoidance are generally in the short term. If the government addresses the
loopholes and amends the tax law, one may no longer benefit from them legally.

In the amended 1997 National Internal Revenue Code (NIRC) of the Philippines, there are certain
provisions that the legislators adopted to deter taxpayers from tax avoidance. Examples of them are (Sy,
2021):

• Improperly Accumulated Earnings Tax (IAET). To deter the practices of certain corporations in
avoiding income tax due from its shareholders, Section 29 was introduced in the 1997 Tax Code.
The said section imposed a 10% tax on improperly accumulated retained earnings. In the Revenue
Regulation (RR) issued by the Bureau of Internal Revenue (BIR), they explain the rationale of the
said tax:

“The rationale is that if the earnings and profits were distributed, the shareholders would then be
liable to income tax thereon, whereas if the distribution were not made to them, they would incur
no tax in respect to the undistributed earnings and profits of the corporation. Thus, a tax is being
imposed like a penalty to the corporation for the improper accumulation of its earnings, and as a
form of deterrent to the avoidance of tax upon shareholders who are supposed to pay dividends
tax on the earnings distributed to them by the corporation.”

• Interest Arbitrage. Interest arbitrage used to be a common form of tax planning scheme employed
by taxpayers engaged in business. By obtaining a loan and investing the proceeds of that loan in
a tax-favored investment with the same lending bank, the taxpayer was able to incur tax savings of
33% out of the interest expense incurred in such a loan.

The interest income arising out of the tax-favored investment, on the other hand, would be subject
to only 20% final withholding tax or could even be tax-exempt. These transactions enabled the
taxpayer to pocket the spread apart from transaction fees. To protect the further erosion of tax
revenues due to interest arbitrage transactions, Congress amended the former Tax Code by
reducing the amount of interest that a taxpayer can claim as a deduction in case the taxpayer
earned interest income in the same taxable year.

Tax Evasion
Tax evasion is an illegal method or unlawful attempt to reduce the tax liability of taxpayers. It is highly
attached to techniques or illicit practices that show fewer profits to minimize the individual or company’s tax
burden.
Examples of tax evasion usually are the following:
• Making false statements and information;
• Inflating deductions without legal proof;
• Hiding related documents that prove the existence of income earned;
• Concealing or transferring assets illegally;
• Magnifying tax credit; and
• Claiming excessive expenditure.

Tax evasion can be deemed as a form of tax fraud that indicates illegitimate and deliberate actions for not
paying tax. Since employing such unfair means is fraudulent, any taxpayer committing tax evasion
behaviors would be prosecuted for such an offense and must be subject to stringent punishments of a
heavy fine or imprisonment.

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Tax Management
Tax management refers to compliance with the income tax rules and regulations. It covers matters about:
• Taking steps to avail various tax incentives;
• Compliance with tax rules and regulations, including timely filing of returns;
• Protecting from consequences of non-compliance with tax rules and regulations, such as penalties
and prosecutions;
• Reviewing of department orders, and if needed, applying for rectification of mistakes, filing an
appeal, tax revision, or settlement of tax cases.

The following are some of the important areas of tax management (Shameem, 2015):

1. Tax Withheld at Source. Persons responsible for deducting tax at source should deduct from the
income, and that should be paid to the central government on time. Moreover, he should issue a
withholding certificate, such as BIR Form 2307, to the deductee/payee and file the same.

2. Payment of Tax. This area includes payment of advance tax, payment of self-assessment tax, and
payment of tax after receiving notice from the authority.

3. Maintenance of Book of Accounts. Section 232 of the Tax Code provides that all corporations,
companies, partnerships, or persons required by law to pay internal revenue taxes shall keep and
use a relevant and appropriate set of bookkeeping records duly authorized by the Secretary of
Finance. Wherein all transactions and results of operations are shown and from which all taxes due
to the government may readily and accurately be ascertained and determined any time of the year.
Maintenance of official receipts, sales invoices, vouchers, bills, correspondence and agreements,
and others is a part of tax management.

4. Audit of Book of Accounts. Section 232 of the Tax Code also provides taxpayers mentioned in
number 3 whose gross annual sales, earnings, receipts, or output exceed P3,000,000, shall have
their books of accounts audited and examined yearly by independent Certified Public Accountants
(CPA). Moreover, their income tax returns (ITR) must be accompanied by a duly accomplished
Account Information Form (AIF). The AIF shall contain, among others, information lifted from
certified balance sheets and income statements.

5. Furnishing the Return of Income. The tax manager must ensure that the return of income is
furnished on time; otherwise, the assessee will lose the right to carry forward and set off the losses
and become liable to pay interest, penalty, prosecution or fine, or both.

6. Documentation and Maintenance of Tax Records. An assessee should keep complete and
updated tax files so that the documentary pieces of evidence can be made available in case of tax
queries.

7. Review of Orders of Income Tax Department. It is an important function of tax management. If

there is any mistake in the order, an application for rectification can be made. If the order is
prejudicial to the interest of the assessee, he can file an appeal, revision, or application for
settlement of the case can be made.

References:
Shameem, S. (2015, 2021). Tax planning and management. University of Calicut School of Distance Education.
Sy, E. (2021). The legality of the assault on tax avoidance practices in the Philippines. Philippine Management Review, pp. 63-65.

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