picpa income tax pas tax2

7/27/2019 PICPA Income Tax Pas Tax2

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A Closer Look at ITR Preparation

BIR Form 1702 -Annual

Income Tax Returnfor

Corporations andPartnerships

(July 2008)


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Declarations made by a taxpayer in his income taxreturn are, for all intents and purposes, presumedto be correct having been prepared under pain ofbeing penalized for perjury.

Paseo Realty and Development Corporation vs.

Commissioner of Internal Revenue,

CTA Case Nos. 4528 and 4913,

dated April 30, 1993 and July 29, 1993

Coverage and Presentation

SalesCost of SalesOther ExpensesNOLCOTax CreditsReconciling Items


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Sales

Completeness

Correct classification Regular Income Tax Special Tax Exempt


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Completeness of Sales

Tie up with Audited Financial Statements

In general, income to be declared in ITR depends onthe accounting method consistently employed by thetaxpayer in keeping its books, unless a differentmethod is prescribed by the CIR to reflect trueincome.

Revenues declared in ITR should be reconciled with

AFS.

Income Tax vs. Books

When on accrual basis, income is reportable when

All the events have occurred that fix the taxpayers right toreceive the income;

The amount can be determined with reasonablesusceptible of accurate estimate and

There must be a reasonable expectation that the amount

will be paid in due course.

The right to receive the amount must be valid,unconditional and enforceable, i.e., not contingentupon future time.


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Income Tax vs. Books

PFRS/Tax differencesFair market value gains on investment,PPE (PAS 39/16/40/38)Lease income (PAS 17)

Interest income based on effectiveinterest (PAS 39)

Multi-element sales (PAS 2)


Accounting Method is different from TaxAccounting Method

Accrual vs. CashIncome is reported when earned vs. when paymentis received

Accrual vs. Installment MethodIncome is reported when good is sold vs. wheninstallment payment is received


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Accounting Method is different from TaxAccounting Method

Accrual vs. Percentage of CompletionIncome is reported when service is rendered vs. asa percentage of work performed

Effective Interest vs. Rule 78 Method

Interest income is spread over a straight-line basis vs. decliningbalance


Specific tax rules prescribed in computingrevenues

Computation of revenues for taxpayers withFunctional currency AFS

For taxpayers using functional currency AFS,monthly revenues in functional currency shall be

converted to Phil pesos using the average monthlyPDS exchange rate. Total revenue, converted in Philpesos, shall then be reconciled with the revenuesdeclared in Phil pesos for other tax purposes.


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Gross Philippine billings for international air carrierRefers to gross revenue derived from passage of persons,excess baggage, cargo and/or mail, originating from thePhilippines in a continuous and uninterrupted flight

Determined by computing the monthly average net fare ofall the tax coupons of plane tickets issued for the monthper point of final destination, per class of passage and perclassification of passenger, and multiplied by the

corresponding total number of passengers flown for themonth as declared in the flight manifest.



Lease IncomeIf the advance payment is, in fact, pre-paid rental,then such payment is taxable income to the lessorin the year when received. And this is true even

though the lessor is on the accrual or the cashmethod of accounting. (Hyde Park Realty, Inc. v.Commissioner, 211 F. 2d 462, Cf. Evansville Courier v.

Commissioner, 62 F. 2d 232)


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Tie up with Audited Financial Statements

Line 17 is Net Sales

Gross SalesLess: Discounts/Allowances, Rebates and Returns

Details to be presented in Schedule 1


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Sales Discounts - a reduction from the full orstandard amount of a price or debt.

Trade discounts

Volume discounts

Term discounts

Cash Discounts


Sales Discounts

Nature

Discounts vs. Selling Expenses?

Discounts vs. Advertising expenses?

Discounts vs. product support?


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Sales Discounts

Accrual of discounts

Actual vs. Estimate

Properly documented

Credit Memo vs. Customers Invoice

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Classification of Sales

Only one type of Corporate Income Tax Return

Distinguish reporting based on tax rate

Regular income tax

35% (30% starting Jan 1, 2009)

Special

Exempt

Classification of Sales

Distinguish reporting based on taxrate

Regular income tax

Special

Exempt

Reminder: Do not confuse income taxand VAT rules!

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Special Rate

Educational institutions

Hospitals

Regional operating headquarters

OBUs/FCDUs

Corporations covered by special laws

PEZA / Subic

International carrier

10%

10%

10%

10%

5%

2.5%

Exempt Income

Under the Tax Code

Non-stock, non-profit educational inst.

Cemetery company owned and operated exclusively forthe benefit of the members

Under special laws

BOI incentives

P.D.No. 269 Electric cooperatives

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Cost of Sales

Cost of Goods Manufactured Manufacturing

Raw Materials

Direct Labor

Manufacturing Overhead Freight cost

Insurance

Other costs incurred to bring the materials tothe factory or warehouse

Cost of Sales

All direct costs and expenses necessarily incurred to providethe services required by the client including:

Direct Salaries and Benefits

Direct Outside services

Direct Materials, Supplies

Direct Depreciation

Direct Rental

If a cost or expenditure is incurred both directly to provide a servicerequired by a client, and indirectly for administration, operation, or sales-promotion purposes, a ratable portion of such cost or expenditure shallbe allowed to form part of the "Cost of Services."

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AFS vs. ITR

Cost of Sales per FS is not automatically thesame as Cost of Sales to be reported in ITR

Cost of Goods Sold

Beginning Inventory should tie up with Ending Inventoryper ITR last year. Note: Secure copy of LY ITR whenpreparing the CY ITR

Purchases should tally with amounts per books and perVAT return Note: PFRS adjustments, if any, should beexcluded.

Ending inventory per ITR is different from amount perbooks and per Inventory list submitted to BIR.

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Ending Inventory Tax vs.

BooksInventory for TAX: Cost of deductible inventory isthe actual cost.

Inventory for AFS: May include impact of certain

principles under PAS 2:

Write-downs of Cost to Net Realizable Value

Reversals of write-downs previously recognized

Implicit interest expense is recognized as part of

Purchase Cost

Ending Inventory ITR vs.Inventory List

Inventory list includes goods on hand atthe end of the year.

Potential Difference between inventory perITR and Inventory list

Goods in transit

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Cost of Service

Direct costs and expenses" shall only pertainto those costs exclusively and directly

incurred in relation to the revenue realizedby the sellers of services. These refer tocosts which are considered indispensable tothe earning of the revenue such that withoutsuch costs, no revenue can be generated.

Rev. Memo Circular 24-08

Cost of Service (RMC 4-03)

Banks and non-bank financial intermediaries performingquasi-banking activities

Salaries, wages and other employee benefits ofpersonnel directly engaged in any of the said activities

Interest expense except interest charged by or paid to

the head office on funds considered/classified asassigned capital of the branch

PDIC premium paymentsBSP supervision fee

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Insurance and pension funding companies

Salaries, wages and other employee benefits ofpersonnel directly engaged in said activities;

Commissions on direct writings/agents of pre-needcompanies;

Claims, losses, maturities and benefits net ofreinsurance recoveries; and,

Net additions required by law to reserve fund (for

insurance companies) and in the case of pre-needcompanies, contributions to the trust funds to be set upindependently as mandated by the SEC.


Finance companies and other financial intermediaries notperforming quasi-banking activities

Salaries, wages and other employee benefits of personneldirectly doing such functions

Interest expense.

Customs, insurance, real estate, immigration andcommercial brokers.

Salaries, wages and other employee benefits of personneldirectly engaged in brokering activities; and,

Commissions paid to its agents who are not employees of thebrokerage firm.

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Common carriers or transportation contractorsProperties, building and improvements exclusively usedas parking for aircrafts, sea crafts or motor vehicles;Fuel and lubricants of motor vehicles, aircraft or seacraft directly used in transporting passengers and/orgoods/cargoes;

Meals provided to passengers;

Cost of safety paraphernalia and other supplies for useby passengers (e.g. lifejacket, mask, etc.); and,

Annual transportation equipment registration fee.


Hotel, motel, rest/pension/lodging house and resortoperators

Salaries, wages and other employee benefits of housekeepingstaff, concierge personnel and other hotel/house/resort attendants

Depreciation/amortization, rentals, repairs and maintenance of

building, properties and facilities, and equipment directly used inthe said activities

Commissions paid to travel agents for bookings of guests for such

establishmentsIn case the operator also serves food and beverage, its direct costsshall include those allowed to food service establishments

Supplies (e.g. hotel room/housekeeping, kitchen and laundry)

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Telephone and telegraph, electric, gas, and water utilitiesSalaries, wages and other employee benefits ofpersonnel directly engaged in the said activitiesDepreciation/amortization, rentals, repairs andmaintenance of properties and equipment directly usedin the said activities (i.e., water pipes, electric poles,antennas, etc.)Interconnection fee and/or share of foreigntelecommunications administration (FA) for the servicesthey perform

Fuel and lubricants on vehicles or equipment directlyutilized in the said activitiesAmortization of franchise or development feesFranchise feesRoyalties


Radio and/or television broadcastingFees of talents hired for production/broadcasting;Salaries, wages and other employee benefits ofproduction and broadcasting personnel;Tapes and other production materials & supplies;Satellite charges & wire services;Film rights royalties & dubbing expenses;Set requirements;

Rentals for production equipment & facilities;Rentals for locations used exclusively forproduction/broadcasting;Costumes, props & prizesDepreciation on production and broadcastingequipment

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Non-operating and other

income

All other items treated as gross income underSection 32 of the NIRC of 1997 that are not subjectto final withholding income tax:

Interest income from loans or deposits abroad

Commissions

Realized foreign exchange gains

Net gain from sale of properties/ assets, except realproperty and stocks in domestic company considered ascapital asset

Other Income Tax vs.Books

Gains are recognized only when assets aredisposed. Fair Value increases are not taxable.

If asset is disposed, for determining gain or loss,the unadjusted carrying value shall be consideredas the cost of the property (i.e., cost less

depreciation based on cost, without adjustment forrevaluation/fair value effects)

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For reporting purposes

Exclude expenses classified as cost of

goods/services

Classify expenses based on their relation to thetype of income earned by the Company

Exempt

Taxable

Special Rate

Regular Rate

Report only expenses that comply withrequirements for deductibility for tax purposes

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General requisites

1. Ordinary and necessary

2. Paid or incurred during the taxable year

3. Paid or incurred in carrying on, or which aredirectly attributable to, the development,management, operation and/or conduct of thetrade/business

4. Reasonable in amount

5. Substantiated with sufficient evidence

6. Not contrary to law or public policy

Ordinary and necessary

INCLUDES

Salaries, wages, and other forms of compensation forpersonal services actually rendered, including fringebenefits

Travel expenses while away from home in the pursuit oftrade/business

Rentals and/or other payments for use or possession of

property

Entertainment, amusement and recreation expenses

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Substantiated with sufficient

evidenceOfficial receipts or other adequate records

showing

the amount of the expense

the nature of the expense incurred - to ascertain

the direct relation of the expense with the trade,business or profession

INCOMETAX Vs. VAT

Additional requisites ofdeductibility

The tax required to be withheld from the amount

paid or payable, or taken into consideration incomputing gross income or for which depreciationor amortization may be allowed, has been paid to

the BIR.

RATE BASE TIMING

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Rental expense

The lessee may deduct the amount of rent paid orlegally payable during the year.

In BIR Ruling No. 3-00, the income to be reported bythe lessor is just the rent actually earned. Conversely,on the part of the lessee, only the rent actually incurredwill be allowed as deduction.

Tax deductions for childhood care programs in theworkplace

Operating costs incurred by employers insupporting workplace-based and related EarlyChildhood Care and Development (ECCD)programs as deductions

Republic Act No. 8980

Condition no user fees charged toemployees, whether monetary or non-monetary

BIR Ruling No. 06-2005, July 28, 2005

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Interest Expense

Requirements for deductibility

There must be an indebtedness;

There should be an interest expense paid or incurredupon such indebtedness;

The indebtedness must be that of the taxpayer,

The indebtedness must be connected with the

taxpayer's trade, business or exercise of profession;

The interest expense must have been paid or incurredduring the taxable year;

The interest must have been stipulated in writing;

Interest Expense


The interest payment arrangement must not bebetween related taxpayers as mandated in Sec.34(B)(2)(b), in relation to Sec. 36(B), both of the TaxCode of 1997;

The interest must not be incurred to finance

petroleum operations; andIn case of interest incurred to acquire property usedin business, the same was not treated as a capitalexpenditure.

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Interest Expense - Not subject to limitation

Interest incurred or paid by the taxpayer onall unpaid business-related taxes shall befully deductible from gross income. (RR 13-2000)

Interest Expense - Tax vs. Books

Consider impact of new accounting standards onamount of interest per books:

Imputed interest (PAS 39)

Interest computed using a rate other than that stated inthe written agreement (PAS 39)

Interest which are in the nature of payout on redeemablepreferred shares entitled to fixed dividend each year(PAS 32)

Interest expense incurred on deferred payment ofinventory (PAS 2)

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Optional treatment of interest expense

interest incurred to acquire propertyfor use in the business

interest expense capital expenditure

Taxes

Paid or incurred within the taxable year

In connection with trade or business

Taxes previously claimed as deduction, when

refunded or credited, shall be included as partof gross income in the year of receipt to the

extent of the income tax benefit of saiddeduction.

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Taxes

DeductiblePercentage tax,except VAT

Excise Tax

DST

Local taxes

Import duties

Non-deductible

Philippine income tax

Income and excess profits

taxes imposed by foreign

country

Estate and gift taxes

Taxes assessed against local

benefits of a kind tending toincrease the value of theproperty assessed

Losses


Actually sustained and charged off during the taxable

year

Incurred in trade, or business; of property connected

with the trade or business

Closed and completed transaction

Not compensated for by insurance

Casualty loss reported to BIR w/in 45 days

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-

-

Losses - Foreign currency loss

Deductible only if actually sustained in a closedand completed transaction

Mere recognition of loss not yet realized is notdeductible

Losses - Inventory

Certification from the BIR of the actualdestruction of the obsolete inventories is notnecessary but there should be competent

documentary evidence to substantiate inventorywritten off.

Nidec Copal Philippines Corporation v. CIR,CTA 6577, Sept 5, 2006;

CIR v. Nidec Copal Philippines Corporation,

CTA EB 250, October 1, 2007

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Losses Decline in Value of an asset

Deduction for loss of useful value of an asset isallowed even without actual disposal, if due tosudden business changes, the property hasbeen prematurely discarded, or where newlegislation directly or indirectly makes thecontinued profitable use of the propertyimpossible.

- Rev. Reg. 2

Losses - NOLCO

NOLCO - Net operating loss of business for any

taxable year to be carried over as deduction forthe next 3 consecutive taxable years followingthe year of such loss.

3-year period continues to run even ifcorporation paid MCIT

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Losses - NOLCO

Consider impact of new accounting standards onamount of losses per books

Inventory write-downs due to reduction in value ofunsold inventory (PAS 2)

Losses due to revaluation of property measured basedon fair value (PAS 16/36/38/40)

Losses on classification of financial assets/liabilities(PAS 39)

Losses on classification of property as asset held forsale (PFRS 5)

Bad Debts


Debt is valid and subsisting

Ascertained to be worthless or uncollectible

Charged off during the taxable year

Connected with the trade, business or profession

Specific identification vs. Estimate

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Bad DebtsEstablishing worthlessness

Borrowers financial position/condition

Collection lawyers certification on legal obstacles to

collection

All means of collection have been exhausted value of

collateral

Bad Debts - Recovery

Bad debt deductiongave tax benefit

Tax benefit

No tax benefit frombad debt deduction

Recovered

baddebt

TaxableGross Income

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Depreciation

Depreciation deduction - a reasonable allowancefor the exhaustion, wear and tear (includingreasonable allowance for obsolescence) of propertyused in the trade or business.

Depreciation : Tax vs. Books

Consider impact of new accounting standards onamount of depreciation per books:

Change in useful life of assets (PAS 16)

Effect on carrying value of asset subject todepreciation:

- Revaluation losses or increments (PAS 16)

- Write-downs due to impairment losses (PAS 16)

- Estimate of cost of dismantlement, removal or restoration(PAS 16)

Non-recognition of depreciation for assets classified

as held for sale (PFRS 5) or de-recognized asset(PAS 16)

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Charitable Contributions


Contribution or gift actually paid or made within thetaxable year

Recipient

Government of the Philippines

Accredited domestic corporations or associationsorganized and operated exclusively for religious,charitable, scientific, youth and sports development,

cultural or education purposes or for therehabilitation of veterans

Social welfare institutions

Non-government organizations

Charitable Contributions - Substantiation

If given to:

Government

Certain foreign institutions or internationalorganizations pursuant to agreements, treaties orcommitments entered into by the GoP

Accredited non-government organizations (NGOs) -an NGO duly accredited by the Philippine Council forNGO Certification, Inc.

The amount of any charitable contribution ofproperty other than money shall be based on theacquisition cost of said property

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Individuals10%

Corporations5%

of taxable income from trade,business or profession before deduction forcharitable contributions


Requirements for substantiationCertificate of Donation issued by donee within30 days from receipt of donation indicating:

actual receipt of donation

date of receipt by donee

amount of cash donation or acquisitioncost if donation is in the form of property.

If more than P1 million, the donor should submitcopy of notice of donation to BIR after 30 daysfrom receipt of Certificate of DonationAsk for copy Certificate of PCNC Accreditation

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Research and Development Expenses

Taxpayer has the option to

Claim the expense as deduction in the year incurred, or

Treat it as deferred expense to be amortized over a

period of not less than 5 years (60 mos.) starting fromthe month when benefits were realized.

If the entity earlier opted to treat such expenditureas deferred asset and claimed the amortization as

deduction, it should continue to do so.

R&D: Tax vs. Books

Consider impact of new accounting standards onamount of R&D expenses per books:

Write-off of unamortized research expenditures

Research expenditures claimed as expense per books,but capitalized for tax

Development expenditures capitalized per books butclaimed as expense for tax

Revaluation/impairment of capitalized developmentexpenditures

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Pension Cost -

Requirements for deductibility of contributions

Actually paid during the year

Contributions paid to a BIR-qualified retirement fund

Current service cost full deduction

Past services cost - Apportioned in equal parts over10 consecutive years beginning with the year inwhich the transfer or payment is made.

Mere accruals of pension cost arenot deductible for tax purposes.

Pension Cost -

If there is no qualified BIR retirement fund,retirement benefits (not the annuity premiums)are deductible in the year paid, regardless when

accrued.

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Premium payments to life insurance to fundretirement benefits under RA 7641

The premiums paid by the employer/company for lifeinsurance plans in accordance with R.A. 7641 canbe claimed by the employer/company as adeductible business expense under Section 29(a)(1)(A) [now Section 34(A)(1)(a)]of the Tax Code,as amended.

BIR Ruling No. UN-373-95, October 11, 1995

OSD under RA 9504(As implemented by Revenue

Regulations No. 16-08)

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Effectivity of OSD under RA 9504

RA 9504 took effect on July06, 2008 but for ease inadministration, the 40%

OSD shall be applied for theperiod starting July 01, 2008

(RR 16-08)

OSD coverage

1. Individuals -

a. Resident citizens

b. Non-resident citizens

c. Resident aliens

d. Taxable estates and trusts

OSD Basis : 40% of gross sales/receiptsIn lieu of: (1) cost of sales and (2) itemized

deductions

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OSD coverage

2. Corporations

a. Domestic corporations

b. Resident foreign corporations

OSD Basis: 40% of gross income

In lieu of Itemized deduction

OSD coverage

3. General Professional Partnerships

OSD Basis:

GPP: 40% of gross income

(same as corporations)

Partners: 40% of gross sales/receipts

(same as individuals)

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Difference in OSD treatment

Individual CorporationGross Sales/ReceiptsLess : Cost of Sales/

Cost of Services

Gross Sales/Gross Income

OSD

P 1,000,000

________

P1,000,000

P1,000,000600,000

_________

P 400,000

Individual (40% x P1M)

Corporation (40% x P400,000)

400,000

160,000

TAXABLE NET INCOME 600,000 240,000

Determination of OSD

for individuals

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OSD coverage/application

1. Pure compensation income Not allowed to

claim OSD against compensation income.

2. Business/professional Income May opt toclaim OSD by checking the appropriate box in theITR

3. Mixed Income OSD can be claimed only

against business income

OSD base & computation of net income forindividuals

BIR Form 1701 (July 2008)

40% OSD should bebased on gross sales ifindividual is on accrualbasis and gross

receipts if on cashbasis.

Cost of sales or cost ofservice are not allowed tobe deducted from grosssales/receipts in

determining taxableincome under OSD

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OSD base & computation of net income forindividuals

BIR Form 1701 (July 2008)

Individuals under OSDmay still claim personal& additional exemptionsand premium payments

on health/hospitalization

10% OSD on gross income vs. 40% OSD ongross sales/receipts

Is 40% OSD on gross sales/revenue under the new law

more beneficial than the 10% OSD on gross income

(under old law) ?

It DEPENDS on your gross profit margin

If COGS is high and profit margin is low - OSD IS NOT

FAVORABLE

If COGS is low and profit margin is high OSD may be

more favorable

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Determination of OSD

for corporations

OSD for corporations

- Unlike individuals, corporations are allowed to deduct

from gross sales/gross receipts, the cost of goodssold/cost of sales to arrive at gross income againstwhich the 40% OSD shall be deducted.

Gross Sales/ReceiptsLess : Cost of Sales/

Cost of Services

Gross Income

Less : OSDP400,000)

Net Income

P1,000,000600,000

_________

P 400,000

160,000 (40% x_________

P 240,000

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Definition of "gross income" under RR 16-08

For trading/merchandising/manufacturingconcern "gross income" means gross sales lesssales returns, discounts and allowances and cost ofgoods sold.

For sellers of services - "gross income" means the"gross receipts" less sales returns, allowances,discount and cost of services.

Composition of "gross income"

- All items of gross income under Section 32(a)which are required to be declared in the ITR oftaxpayers for taxable year shall form part of grossincome (against which the OSD may be deducted).

- Passive incomes which have been subjected to a

final tax at source shall not form part of the grossincome for purposes of 40% OSD.

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Determination of OSD for

General Professional Partnerships(GPPs)

OSD for GPPs

GPP - may claim either the itemized deductions or 40%

OSD

- OSD is based on gross income (like corporations).

Partner/s - may still claim either the itemized or OSD fromhis/her share in the net income of the GPP.

- OSD based on gross sales/receipts (like individuals)

(i.e., distributive share in net income of GPP which is

considered gross income in the hands of the partner)

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Choice of deductions for GPPs/Partner

The GPP and each of the partners are entitled to their own

election of deductions.

Itemized *

Itemized

OSD

OSD

GPP Partner/s

Itemized *

OSD

Itemized

OSD

If both GPP and partner/s are claiming itemized deductions, thepartner is precluded from claiming expenses already claimed by the

GPP.

General rules on availment of OSD

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Election of OSD

- A taxpayer (individual and corporation) mustsignify in the return his/its intention to avail of theOSD by checking appropriate box in the ITR forms.

- If choice is not indicated in the ITR, taxpayer shallbe considered as having availed of the itemizeddeductions.

Election of OSD under revised BIR Form 1701(July 2008) - For individuals in business / practice ofprofession

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Election of OSD under revised BIR Form 1702 (July2008) - For corporations & partnerships

Rule on election of OSD under RR 16-08

Once the OSD elected, it is irrevocable for the taxable yearfor which the return is made.

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Annual filing of ITRs

- Use of hybrid method of claiming deductions (i.e.,

mix of itemized and OSD on first 3 quarterly ITRs)is not allowed in the final/annual ITR.

- Taxpayer should either compute for the itemized

deductions or OSD for the whole taxable year inits/his ITR.

Quarterly filing of ITRs for Year 2009 and onwards

- A taxpayer may opt to use either the itemized or OSDin the filing of its/his quarterly income tax return

Q1 Q2 Q3

Option 1

Option 2

Option 3Option 4

Option 5

''

Itemized

Itemized

ItemizedOSD

OSD

"

OSD

Itemized

OSDItemized

OSD

"

OSD

OSD

ItemizedItemized

Itemized

"

Option

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Shifting from itemized deductions to OSD

Can a taxpayer who choose itemized deductionsamend its/his return to shift to OSD?

- RR 16-08 prevents a taxpayer availing of OSD from

shifting to itemized.

- In case a taxpayer fails to signify his/its intention in

the ITR, it/he shall be considered as having availed

of the itemized deductions.

Minimum Corporate Income Tax(MCIT)

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MCIT - Computation

MCIT

Highlights

On the 4th taxable year immediately after the

corporation commenced businessYear zero = year registered with the BIR

For every taxable quarter

At 2% of gross income

Whenever the MCIT is greater than the computed

RCIT

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MCIT

YEAR REGISTERED WITH THE BIR = YEAR

0 2004 YEAR 0YEAR REGISTERED WITH BIR

2005

2006

2007

2008

YEAR 1

YEAR 2

YEAR 3

YEAR 4

BEGIN TO COMPUTEFOR MCIT

RCIT VS. MCIT

GROSS SALES/REVENUES

LESS:

DISCOUNTS, RETURNS, ALLWSCOST OF SALE

GROSS INCOME

LESS:

ALLOWABLE

DEDUCTIONS MULTIPLY BY:2%

TAXABLE INCOME

MULTIPLY BY:

35%

REGULARCORPORATE

INCOMETAX

MINIMUMCORPORATE

INCOMETAX

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MCIT base

Gross Income

All items of gross income (even apart from thecore business) realized or earned by the taxpayerduring the taxable period which are subject to thenormal corporate income tax must be included aspart of gross income subject to MCIT

Gross income from operations

Non-operating and other incomeLess: Allowable deductions under MCIT rules

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ITRs

ITR

MCIT Temporary Exemption

Taxpayer sustained substantial losses due toa prolonged labor dispute - strike by employees lasting

for more than 6 months resulting to temporary shutdown of business

force majeure - an irresistible force such as lightning,

earthquake, storm, flood, war or insurgency

legitimate business reverses - substantial losses due

to fire, robbery, theft or embezzlement, or other

economic reasons as determined by DOF

Credits Against Tax

Prior years excess creditsExcess MCIT credits from prior years

Quarterly MCITTax payments for the first 3 quarters

Prior Years ITR

QuarterlyCreditable Tax Withheld for first 3 QuartersCreditable Tax Withheld for the 4th Quarter

Foreign Tax Credits, if Applicable*

Tax Paid in Return Previously Filed,

ForeignITR

Original

if this is an Amended Return

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Carry forward of excess MCIT

Excess MCIT over normal income tax to be carriedforward and credited against the normal income tax for3 immediately succeeding taxable years

2005 2006 2007

RCIT

MCIT

IT Due

less Excess MCIT

IT Payable

120

130

130

130

100

120

120

120

300

120

300

30

270

Excess MCIT 10 + 20

Creditable Withholding Tax

The creditable taxes withheld are allowedas tax credit against income tax liability inthe quarter(s) of the taxable year in whichthe income (subjected to withholding tax)

was earned or received.

The fact of withholding is established by acopy of BIR Form 2307 duly issued by the

payor (withholding agent) in the name ofthe payee, showing the amount paid and

the amount of tax withheld therefrom.

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Disposition ofExcess CreditableWithholdingTaxes

Excess CWT - Disposition

Check the box

Refund / TCC

Carry forward to succeeding years

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Excess CWT Refund/TCC vs. Carry-over

IRREVOCABLE OPTION

Sec. 76. Final Adjustment Return - . Once the optionto carry-over and apply the excess quarterly income tax

against income tax due for the taxable quarters of thesucceeding taxable years has been made, such optionshall be considered irrevocable for that taxable period andno application for cash refund or issuance of a tax credit

certificate shall be allowed therefor.

Excess CWT Refund/TCC vs. Carry-over

IRREVOCABLE OPTION

Exception:

Refund upon dissolution - within the two-yearprescription period reckoned from the date ofpayment of the tax.

- Financial Marketing Services Corporation v. CIR

CTA Case No. 6443, September 7, 2005)

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Substantiation requirement in applying forrefund/TCC

Every component of the Total Tax Credits/Payments reflected in the final adjustment returnincluding the taxpayers excess tax credits from theprior year must be proven or substantiated. Failureto substantiate is a failure to meet the burden ofproof required to establish the factual basis of theclaim for refund.

- Nissan Motor Philippines, Inc. v. CIRCTA EB No. 139 on CTA Case No. 6622

October 6, 2006

Reconciliation of Net IncomePerBooks against Taxable Income

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Reconciling items

ADD:

ADD:

LESS:

LESS:

LESS:

NON-DEDUCTIBLE EXPENSECLAIMED IN THE FS (NDE)

OTHER TAXABLE INCOME NOT

RECOGNIZED IN THE FS (OTI)

NON-TAXABLE INCOME

RECOGNIZED IN THE FS (NTI)

INCOME SUBJECTED TO FINAL TAX

(ISFT)

SPECIAL DEDUCTIONS NOTRECOGNIZED IN THE FS (DE)

Reconciling Items

TypesNon-PFRS

PFRS-related

Substantiation

taxpayers are hereby mandated to maintain books and records

that would reflect the reconciling items between FS and ITRfigures in such a manner that would facilitate theunderstanding by the examiners/auditors of the BIR tasked toundertake audit/investigation functions, providing in sufficient detailthe computation of the differences and the reasons thereforaimed at bringing into agreement the IFRS and ITR figures.

- Rev. Regulations No. 8-07

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Non-PFRS Recon Items

Non-deductible ExpensesExpenses which are not ordinary and necessary in trade orbusiness (bribes, kickbacks, and other similar payments)

Reduction of interest by 42% of interest income subject to final tax

Non-deductible taxes (e.g. Philippine income tax, foreign income

tax, donor's tax, special assessment on real property)

Non-deductible losses (e.g. losses from wash sale not made by adealer in stock or securities, excess of capital loss over capitalgain)

Excess over the limit allowed by law (for representation expenseand charitable contribution)

Contributions to non-qualified donees


Non-taxable incomeIncome exempt from tax

Income subject to final tax

Income from sales recognized this year that will be reportedunder installment method

Lease income arising from advanced rentals reported asincome in prior years

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Deductible expenses

Contributions to BIR-qualified plans

Past service cost for retirement benefits

Additional deductions allowed under special laws, e.g., Adopt-a-

school Program

Taxable IncomeAdvanced lease payments

Income from previously sales in prior years and current yearattributable to installments received this year

PFRS Reconciling items

Loans and Receivables

Allowance for doubtful accounts or impairment lossWrite-off of receivables previously provided w/ allowancein PY

Reversal of PY allowance for doubtful accounts

Difference between implicit interest income from the use ofeffective interest method and nominal interest.

Implicit interest income from the use of effective interest

method for a non-interest bearing Loan.

NDE/ DTA

DE/ (DTA)

NTI/ (DTA)

NTI/ DTL

NTI/ DTL

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Inventories

Allowance for inventory obsolescence

Valuation allowance on the write-down of inventories

(NRV is lower than cost)

Reversal of PY allowances and write-downs

Interest expense on inventories purchased on deferred

settlement terms

Financial Assets - FVTPL

Unrealized gain on change in fair value

Unrealized loss on change in fair value


Held to Maturity Investments

Difference between implicit interest income from the useof effective interest method and nominal interest.

Impairment loss on HTM investments

Available for Sale Assets

Impairment loss on AFS assets

Recovery of impairment loss on AFS assets

Unrealized gain or loss from changes in fair value

(charged to equity)

NDE/ DTA

NDE/ DTA

NTI/ (DTA)

NDE/ DTA

NTI/ DTL

NDE/ DTA

NDE/NTI

DTA/DTL

NDE/ DTL

NDE/ DTL

NTI/ (DTL)

NDE/NTI

DTA/DTL

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Investments in Shares of Stock of Associates

Equity share in net income or loss of subsidiaries/associates

Impairment loss on investments in shares of stock of

subsidiaries and associates

Recovery of impairment loss on investments in shares of

stock of subsidiaries and associates

Non-current Assets Held for SaleUnrealized gain or loss from change in fair value

NTI/NDEDTL/DTI

NDE/ DTA

NTI/ (DTA

NTI/NDEDTL/DTA


Property, plant and equipment

Initial estimate of cost of dismantling and removing the

item and the cost of restoring the site on which it islocated.

Cost of testing the PPE net of proceeds from selling any

items produced while bringing the asset to intendedlocation and condition.

Appraisal surplus

Depreciation of revalued amount

Impairment loss on PPE

Recovery of impairment loss

Depreciation =NDE/ DTA

Proceeds = OTI

NTI/ DTL

NDE/ DTA

NDE/ DTA

NTI/ (DTA)

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DE


Intangible Assets

Appraisal surplus

Amortization of revalued amount

Impairment loss on intangible asset


Expenditures arising from research phase and pre-

operation, expensed out in FS but subjected toamortization for tax purposes

Expenditures arising from development phasecapitalized per FS, expensed in ITR


Investment property

Appraisal surplus

Depreciation of revalued amount

Impairment loss


Financial Liabilities FVTPL

Unrealized gain or loss on change in fair value

NTI/ DTL

NDE/ (DTL)

NDE/ DTA

NTI/ (DTA)

NDE/ DTA

NTI/ DTL

NDE/ DTA

NDE/ DTA

NTI/ DTL

NTI/ NDE

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Financial Liabilities Amortized Cost

Implicit interest income from the use of effective

interest method

Equity

Dividends on redeemable preferred shares (classifiedas interest expense)


Leases

Differences on rental expense or income arising fromlease with rent-free term and changing rental rates

Impairment loss/recovery of impairment loss on

leased asset

Impairment loss/recovery of impairment loss on lease

receivables

Initial direct cost capitalized by lessor on leased

property accounted for as operating lease

Implicit interest income or expense on long-termlease receivable or payable

NTI/ DTL

NDE

DTA

NDE/NTI

DTA/ (DTA)

NDE/NTI

DTA/ (DTA)

DE/DTA

NTI/ NDEDTL/ DTA

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Foreign exchange transactions

Unrealized foreign exchange gains or losses (P&L)

Unrealized foreign exchange gains or losses arising

from the translation of the receivables or payables

Employee benefits

Accrued compensated absences (i.e., VL and SL)

Unamortized past service cost

Unfunded current cost

Unamortized actuarial gain or loss

NTI/NDEDTL/ DTA

NTI/NDE

DTL/ DTA

NDE/ DTA

NDE/ DTA

NDE/ DTA

NTI/NDE

DTL/ DTA


Derivatives

Unrealized gain or loss from changes in fair value ofderivatives

NTI/NDEDTL/ DTA

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TAX IMPLICATIONS OF THE

NEW PHILIPPINE ACCOUNTINGSTANDARDS

Romualdo MurcialTax Partner, P&A

Edward RoguelTax Partner, P&A

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New Standards Effective 2005

PAS No. 1

PAS No. 2

PAS No. 10

PAS No. 16

PAS No. 17

PAS No. 19

PAS No. 24

PAS No. 27PAS No. 29

PAS No. 31

Presentation in Financial Statements

Inventories

Events after Balance Sheet Date

Property, Plant and Equipment

Leases

Employee Benefits

Related Party Transactions

Consolidated and Separate Financial StatementsInvestment in Associates

Interest in Joint Ventures

New Standards Effective 2005

PAS No. 32

PAS No. 33

PAS No. 36

PAS No. 38

PAS No. 39

PAS No. 40

PFRS No. 3

PFRS No. 5

Financial Instruments: Presentation andDisclosures

Earnings per Share

Impairment of Assets

Intangible Assets

Financial Instruments: Recognition and

Measurements

Investment Property

Business Combinations

Non-current assets held for sale

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Accounting standards are relevant toincome tax

In general, revenue andexpenses are determinedbased on the accountingmethod of taxpayer.

Audited financial statementsare required to be submitted;financial records are reviewedduring tax examination

Courts refer to accountingstandards.

Determination of Income and Expenses(Sec. 43, Tax Code)

Follows the accounting method employed by the taxpayer,unless there are specific tax rules

Exception If accounting method is not reflective of trueincome, a different method may be used.

Implication: A different accounting method may be used

for tax reporting than that used for financial

reporting.

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What BIR says about the new accountingstandards..

Generally accepted accounting principles (GAAP) andGenerally accepted accounting standards (GAAS)approved by the Accounting Standards Council (ASC)may from time to time differ from the provisions of theTax Code of 1997 and its implementing regulations.

In such cases, the provisions of the Tax Code and itsimplementing rules and regulations shall prevail.

- Rev. Memorandum Circular 22-2004

Implication: If accounting principle is not contrary totax rules, the taxpayer may adopt them.

What should taxpayers do..

Understand changes brought about by these standardsand evaluate if they are contrary to existing tax rules

If not contrary and they will reflect true income, adoptthem.

If contrary, recognize that they should be reported as

reconciling accounts between tax and book income andestablish system to capture this information

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Changes underthe PFRS/PAS

PAS 2

Inventories

Supersedes SFAS 4 (revised 2000), Inventories

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Fundamental Principle

Inventories are required to be stated at the lowerof:

Cost or

Net realizable value.

Measurement of Cost

Includes:

Cost of purchase

Cost of conversionOther costs to bringinventories topresent location and

condition

Excludes:

Abnormal waste

Storage costsUnrelatedadministrativeoverhead

Selling costsDeferred PaymentcostForeign exchangedifferences

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10

Example

Buyer Side

Product was invoiced for P100, payable after a year. If cashpayment, price will be P90.

Purchases

Deferred Interest Expense

Accounts Payable

90

100

How much purchases should be reported for Income Tax?

For Withholding Tax? For VAT?

Accounting vs. Tax

Accounting Policy

When inventories are

purchased with deferredsettlement terms, thedifference between thepurchase price for normalcredit terms and the amountpaid is recognized as

interest expense over theperiod of financing.

Tax Treatment / Issues

Buyer Side:

Taxpayer should report as inventory

cost the full invoice amount. Implicitinterest expense is not deductible.

Such interest is not subject towithholding tax.

For VAT purposes, purchases to be

reported shall be based on invoiceamount

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10

for normal credit terms

Example

Seller Side

Product was sold for P100, payable after a year. If cashpayment, price will be P90.

Accounts Receivable

Sales

100

90

Deferred Interest Income

How much sales should be reported for Income Tax?For VAT?

Accounting vs. Tax

Accounting Policy

Seller Side

When inventories are sold

with deferred settlementterms, the difference


Taxpayer should report as sales the full

invoice amount. Implicit interest income ontransaction is not taxable.

between the sales price

For VAT purposes, sales to be reportedand the amount received shall be based on invoice amount.is recognized as interestincome over the period offinancing.

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Accounting vs. Tax

Accounting Policy

Foreign exchange differences arisingdirectly on the recent acquisition ofinventories invoiced in a foreign


Only realized foreign exchangegains are taxable and realizedlosses are deductible expenses.

currency should not be included inthe cost of inventories purchased.

For first year adoption, prior years

impact will be reported in theRetained Earnings.

Measurement of Cost Reduction from Cost

Discounts that relate to inventory purchases should be

deducted from the cost of inventories.

Trade discounts

Settlement discounts

If the purchaser does not take advantage of the discount,

the additional amount paid should be recorded as a financecharge.

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EXAMPLE

Purchaser P buys inventory from supplier S on Jan.1. Theprice is CU1,000 with a 2.5% discount for settlement within30 days.

Analysis: P records the inventory net of the discount

entitlement. The entries on Jan 1 are as follows:

Inventory

Current liability

975

975

EXAMPLE

P decides not to take advantage of the discount, and settlesat CU1,000.

The ultimate payment of the discount is recorded as a

finance cost. The entries on Feb. 28 are as follows:

Finance cost

Current liability

Current liability

Cash

25

1,000

25

1,000

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Measurement of Cost

Contractual rebates (e.g. volume discounts) relating to

inventory purchases should be recognized when probable.

Once recognized, the rebate should be recorded as areduction to the cost of the related inventory.

To the extent that the inventories have already been sold(or used in production that has been sold) that part of therebate is recorded in the income statement

Accounting vs. Tax

Accounting Policy

Cash discounts and

Settlement discounts arerecognized when thepurchase is booked.

Contractual discounts

shall be recognized once


Only actual discounts are reported as

reduction from gross sales.

Cash disct. time of purchase

Settlement disct. when received

Contractual discounts to be recognized

only when actually granted to buyer.probable.

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Measurement of Cost

Cost measurement alternatives (only if result approximatesactual costs):

Standard costs Retail inventory method

Cost formulas Specific identification FIFO or weighted average

LIFO is no longer allowed!

Tax Implication

For income tax reporting, LIFO has not been allowed since1984. (Rev. Reg No. 14-84)

Hence, change in accounting method from LIFO to anothermethod as a result of new standard has no tax impact.

If taxpayer had been using LIFO for income tax, it should

amend prior years tax returns.

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Fundamental Principle

Inventories are required to be stated at the lower of:

Cost or

Net realizable value.

Net Realizable Value = Estimated selling price

Less:Estimated cost of completionEstimated cost to sell

Measurement of Net Realizable Value

Results of comparison of NRV with Costs.

Any write-down to NRV expense during the period

Any reversal of write-down reduction ininventories recognized as expense during theperiod

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Accounting vs. Tax Measurement

Accounting Policy

Inventories should be

carried at the lower of

Cost, OR

Net Realizable value


Cost of deductible inventory is the

actual cost.

Write-downs of Cost to Net Realizable

Value are not valid additions to Cost ofSales.

Reversals should not decrease COS.

PAS 16

Property, Plant and Equipment

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Measurement at Recognition

PPE are initially measured at cost.

Components of the cost of PPE:

Purchase price, including import dutiesDirectly attributable costsInitial estimate of the costs of dismantling andremoving the item and restoring the site

Excludes interest and financing cost to acquire property.

Measurement at Recognition

Directly Attributable Costs:

Employee benefits arising directly fromconstruction or acquisition

Costs of site preparation

Initial delivery and handling costs

Installation and assembly costs

Costs of testing, after deducting net proceedsfrom selling any items produced whilebringing the asset to that location andcondition

Professional fees.

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Accounting vs. TaxRecognition of PPE

Accounting Policy

The cost of an item of PPEshall be recognized asan asset if, and only if:

(a) it is probable that future

economic benefitsassociated with the item

will flow to the entity; and

(b) the cost of the item can

be measured reliably.

Accounting vs. TaxCost Element of PPE


Taxpayers set their own accountingpolicies to determine whether an itemshall be capitalized or expensed.

Factors sometimes considered are

the cost of the item and utilization inrelation to its business. Can these

policies be adopted for tax purposes?Accounting policy should normallyapply for tax purposes.

Accounting Policy

Recognition. Cost shall

include initial estimate ofthe

costs of

dismantlement orremoval or

cost of restorationincurred to install anitem,


For tax, cost of dismantlement,

removal or restoration will not qualify aspart of depreciable cost.

For purposes of determining gain orloss when the property is disposed,basis shall be the carrying value of theproperty less the portion attributable to

such type of cost which had beencapitalized.

Actual dismantling cost shall bedeductible in the year it is actuallydismantled.

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Accounting vs. TaxCost Element of PPE (contd)

Accounting Policy

Cost shall include

initial estimate of thecosts ofdismantlement orremoval orcost ofrestorationincurred to installan item,


Withholding tax liability on such purchase,

if any, shall be based on actual acquisitioncost of PPE. Hence, purchase reported forWTax purposes may be different from amountreported in the financial statements or books.

For VAT purposes, capital goods shall be

reported at acquisition cost. Hence, purchase

reported for VAT purposes may be differentfrom amount reported in the financialstatements or the books.

Accounting for Estimated Dismantling andRestoration Costs

Example: (a) Injection Molding Machine

Purchase price

Installation cost

PV Estimated dismantling cost

Useful life

P 1,500,000

100,000

250,000

5 years

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-

Accounting for Estimated Dismantling andRestoration Costs (contd.)

Example: Injection Molding Machine

Acquisition cost:

FS Tax

Purchase price

Installation cost

PV Est. dismantling cost

Total Acquisition Cost

P 1,500,000

100,000

250,000

P 1,850,000

P 1,500,000

100,000

P 1,600,000

Annual Depreciation P 370,000 P 320,000

Accounting vs. TaxDirectly Attributable Costs of PPE

Accounting Policy

Cost of testing whether the asset isfunctioning properly, after deductingthe net proceeds from selling any


Proceeds from sale of sampleswhen testing equipment aresubject to VAT and income tax.

items produced while bringing theasset to its intended location andcondition (i.e., samples producedwhen testing equipment) may becapitalized as cost of PPE.

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-

Directly Attributable Costs of PPE

Example:

Purchase price

Cost of machine testing

Proceeds from sale of samples

Useful life

P 5,000,000

250,000

100,000

5 years


Example:

Acquisition cost:

FS Tax

Purchase price

Proceeds from sale of samples

P 5,000,000 P 5,000,000

(100,000)

Cost of testing the machine 250,000 250,000

Total Acquisition Cost P 5,150,000 P 5,250,000

Annual Depreciation

VAT on sale of samples

1,030,000 1,050,000

10,000

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-

-


Example (contd):

FS Tax

Sale of goods

Cost of testing

Depreciation

Net Income (Loss)

NOLCO

= P 950,000

P

1,030,000

(P1,030,000)

P 100,000

1,050,000

(P950,000)

Accounting vs. Tax

Cost Element of PPE (contd)

Accounting Policy

Interest and financing charges

relating to acquisition of propertyare not reported as part of the costof the property but are treated asperiod expense.

Tax Treatment / IssuesUnder existing tax rules, an entity is

given the option to treat expensesincurred in connection with theacquisition of property used in tradeor business or exercise of aprofession either as (1) part of thecost of the property (and thereof be

part of the depreciable base) or (2)as expense. Option remainsnotwithstanding the new accountingrules.

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Interest Relating to Property Acquisition

In the year of adoption of the standard, in case such interest andother finance charges had been capitalized, the entity is requiredto write them off in its financial reports and to adjust the relateddepreciation of the property to exclude the impact of theunamortized portion of the interest. How does this affect theentitys tax reporting?

- The write off of the unamortized portion of interest is not deductible.Likewise, the entity may continue to claim the depreciation basedon the remaining depreciable value of the property, withoutadjustment for the interest that had been written off due to theadoption of the standard.

Can the entity adopt the new rules for tax purposes if it hadpreviously elected to capitalize these interests?- The Tax Code does not provide explicitly for the conditions when an

entity that had previously elected to capitalize such interest mayexpense it. Notably, however, neither is such practice prohibited.

Accounting vs. TaxPPE at Revalued Amount

Accounting Policy

PPE are carried either at cost


Depreciation for tax purposes shall

or at revalued amounts, less be based on cost (without adjustmentaccumulated depreciation for revaluation losses or increments).

and impairment losses.

Write-downs due to impairment

losses are not deductible. Revaluationincrements are not taxable.

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Confusing BIR Position

The proper allowance for such depreciation of any propertyused in the trade or business is that amount which should beset aside for the taxable year in accordance with areasonable consistent plan whereby the aggregate of theamount so set aside, plus the salvage value, will, at the endof the useful life of the property in business, equal the basisof the property.

- Revenue Regulations No. 2-40

Company X is allowed to use the appraisal fair market valuesof their properties used in business and depreciate the samebased on the remaining useful life as re-estimated.

- BIR Ruling No. 413-04

Componentization of PPE

Previous PASDepreciation Did not clearly set

New PASEach part of an item of

unit ofmeasure

out this requirement. PPE with a cost that issignificant in relation tothe total cost of theitem shall bedepreciated separately.

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Example: Cargo Vessel

Engine

Frame/body

Improvements

Equipments

Total Cost

Useful Life of the vessel

Cost

P 15 million

25 million

12 million

8 million

P 60 million

- 20 years

Life

15 yrs

20 yrs

5 yrs

10 yrs


Example: Cargo Vessel (contd.)

Tax New PAS

Annual depreciation P 3,000,000 P 5,450,000

Issues:

Basis of allocation of cost of asset components

Income tax effect of the adjustment in depreciationexpense (adjusted retrospectively)

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PPE shall be included in

Accounting vs. TaxChange in Useful Life

Accounting Policy

Useful life of an asset maychange if expectations differfrom previous estimates


BIR needs to be informed ofany changes in useful life ofPPE.

Accounting vs. TaxDe-recognition of PPE

Accounting Policy

An asset is de-recognized:

(a) on disposal; or

(b) when no future

economic benefits areexpected from its use or

disposal.


Gain or loss from de-recognition is

not taxable/deductible.

Exception: Deduction for loss of

useful value of an asset is allowedunder Rev. Reg. 2 if, due to sudden

business changes, the property has

The gain or loss arising from the been prematurely discarded, or wherede-recognition of an item of new legislation directly or indirectly

makes the continued profitable use of

profit or loss when the item the property impossible.

is de-recognized.

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Accounting vs. TaxEnd of Depreciation

Accounting Policy

Depreciation of an assetceases the earlier of the datethat the asset is classified as


Taxpayer should cease to claimdepreciation when asset is nolonger used in trade or business.

held for sale and the date thatthe asset is de-recognized.

Accounting vs. Tax

Disposal of Asset

Accounting Policy

Gain or loss from disposal

shall be the differencebetween the considerationand the carrying value (costless accumulateddepreciation and impairmentloss).

An entity cannot classify aspart of the line itemRevenue a gain it realizeson the disposal of PPE.


When the PPE is disposed, gain

or losses arising from the dispositionshall be based on the unadjustedcarrying value (i.e., cost lessdepreciation based on cost)

Notwithstanding the prescribedaccounting treatment, gain from thedisposal of PPE shall be reported astaxable income for MCIT and localbusiness tax purposes.

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Basis for Depreciation and Gain/loss ondisposal

Accounting Tax

Acquisition Cost

Installation, assembly expenses

Estimated dismantling costs

Improvements, additions

Impairment losses

Revaluation increment

PAS 17

Leases

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1.

2.

A. Main Changes

Clarifies the definition of interest rate implicit in thelease.

Distinguishes between the inception of the lease andthe commencement of the lease term.

For lease of land and buildings, the land and buildingelements are considered separately.

Provides additional guidance on accounting for initial

direct costs incurred in negotiating and arranging alease

C.Significant Provisions

Classification of Leases (Accounting)

Finance Lease is a lease that transfers substantially allthe risks and rewards incident to ownership of an asset.

Operating Lease is a lease other than the financelease.

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Definition TAX (RR 19-86)

1. Lease an agreement between the lessor and lesseegiving lessee possession and use of a specific propertyupon payment of rentals over a period of time (CC).

2. Conditional Sale one of the parties obligates himselfo transfer ownership of and deliver a determinate thingwhile the other pays a price certain.(CC)

If true character is not ascertained Commissionermakes a determination. Or request for an advanceruling from BIR.

Compelling Persuasive Factors forConditional sales (RR 19-86)

1. Lessee has option to purchase anytime duringobligatory period of lease

2. Lessee acquires automatic ownership of asset uponpayment of stated rental

3. Portions of periodic rental payments are credited topurchase price

4. Receipt of payments indicate that payment were madepartial or full payment of the asset.

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Leases for GRT purposes - (RR 09-04)

1. Finance Lease mode of extending credit through a non-cancelablelease under which lessor purchases at the instance of lesseeequipment and etc., movable or immovable, in consideration for aperiodic payment by lessee of a fixed amount sufficient to amortizeat least 70% of purchase price including incidental costs and marginof profit of not less than 2 years and bears all the costs of repairsbut with no obligation or option to purchase the leased property atthe end of contract.

A finance lease is a lease that transfers all the risks and rewards

incident to ownership. Title may or may not be eventually transferred

(same as accounting)

2. Operating Lease - lease other than a finance lease of a financing

company (same as accounting)

Comparisons

PAS 21

A lease is a finance leaseif it transferssubstantially all the risksand rewards incidental toownership.

Rev Reg No. 19-86

A contract of sale is anagreement where one ofthe contracting parties(seller or vendor)obligates himself totransfer ownership ofand to deliver a

Rev. Reg No. 09-04

A finance lease is alease that transfers allthe risks and rewardsincident to ownership.Title may or may notbe eventuallytransferred.

determinate thing whilethe other party (buyer orvendee) obligates himselfto pay for said thing aprice certain in money orits equivalent.

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At the inception of the

asset.

Comparisons

PAS 21

Lessee has option to

purchase the asset at aprice that is expectedto be

sufficiently lower than

the fair value.

Rev Reg No. 19-86

The lessee is given the

option to purchase theasset at anytime duringthe obligatory period ofthe lease,notwithstanding that the

Rev. Reg No. 09-04

Consideration of the

periodic payment by thelessee of a fixed amountof money sufficient toamortize at leastseventy percent (70%)

option price isequivalent to or higher

lease the present value than the current fair

of the minimum lease market value of thepayments amounts toat least substantiallyall of the fair value ofthe leased asset.

Comparisons

of the purchase price oracquisition cost,including any incidentalexpenses and a margin

of profit

PAS 21

The lease term is for

the major part of theeconomic life of theasset even if title

is not transferred

Rev Reg No. 19-86 Rev. Reg No. 09-04

Obligatory period of

not less than two (2)years during which thelessee has the right tohold and use theleased property

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C. Classification of Lease

When is the lease classification made?

Accounting: Inception of the lease

- is the earlier of the date of the leaseagreement or of a commitment by theparties to the principal provisions of thelease.

Tax: Beginning of Contract

D. Accounting for Leases OperatingLease

Lessee - lease payments are recognized as expense forthe period on a straight-line basis over the leaseterm

- no assets or obligations are recorded other thansecurity deposits, advance rentals andunamortized balanced of initial direct costs

Lessor - lease income are recognized as an income for

the period on a straight-line basis over the leaseterm

- report assets in accordance with the nature ofthe asset (Depreciation policy and subject toimpairment)

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D. Accounting for Leases Operating Lease

Situation - Lease with rent-free period

Lease term (inclusive of rent-free period)

Annual rent

4 yrs

P1,000

Rent-free period

Total rental (P1,000 x 3.5 yrs)

Ave. annual rent (P3,500 / 4 yrs)

6 months

P3,500

P875


Situation Lease with rent-free period

Accounting entry upon receipt/payment of rent: Year 1

Lessors Books Lessees Books

Dr. Cash P500 Dr. Rent Expense P875

Dr. Receivable

Cr. Rent Income

375

P875

Cr. Cash

Cr. Payable

P500

375

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Situation Lease with rent-free period

Accounting entry upon receipt/payment of rent: Years 2 and 3

Lessors Books

Year 2 One year

Dr. Cash P1,000

Lessees Books

Dr. Rent Expense P875

Cr. Receivable

Cr. Rent Income

P125

875

Dr. Payable

Cr. Cash

125

P1,000

Year 3 One year

Dr. Cash P1,000 Dr. Rent Expense P875

Cr. Receivable

Cr. Rent Income

P125

875

Dr. Payable

Cr. Cash

125

P1,000

Accounting vs. Tax

Accounting Policy

Operating lease: Lessee

Lease payments shall be recognized

as an expense on a straight-line basisover the lease term unless anothersystematic basis is morerepresentative of the time pattern ofthe users benefit.

In the example: P 875 for 3 yrs.


The lessee may deduct the

amount of rent paid or legallypayable during the year.

In BIR Ruling No. 3-00, theincome to be reported by thelessor is just the rent actuallyearned. Conversely, on the part

of the lessee, only the rentactually incurred will be allowedas deduction.

In the example: Yr.1 500; Yr. 2,3 P1000

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Accounting vs. Tax

Accounting Policy

Operating Lease: Lessor

Initial direct costs incurred by

lessors in negotiating andarranging an operating lease shallbe added to the carrying amount ofthe leased asset and recognized asexpense over the lease term on the

same basis as the lease income.


Costs incurred by lessors in

negotiating and arranging anoperating leases are treated asexpense in the period incurred.

Costs incurred by lessee which

are properly payable by the lessor

is deemed received as a rentalincome of lessor. Example: RealProperty Taxes

Accounting vs. Tax

Accounting Policy

Operating Lease: Lessor

Lease income from operating leases

shall be recognized as income on astraight-line basis over the lease term,even if the receipts are not on such a


In BIR Ruling No. 3-00, theincome to be reported by thelessor is just the rent actuallyearned.

basis.

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D.

(1)

(2)

D.

Accounting for Leases Finance Lease

Lessee Finance LeaseTransaction is treated as a purchase of assets.

At the commencement of the lease, lessee recognizesassets for the leased property and liabilities for the rentalspayable at an amount equal to the lower of:

the fair value of the leased property, orthe present value of minimumlease payments.

The capitalized asset and the related liability arepresented in the lessees balance sheet.


Lessee Finance LeaseThe capitalized asset is depreciated applying thedepreciation policy that used for depreciable assetswhich are owned. Depreciation period is the shorter ofthe lease term or the useful life if title does not transferto the lessee. The asset is also subjected toimpairment assessment.

Lease payments are apportioned between the financecharge and the reduction of the outstanding liability.

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D.

-

-

-

-

-

-

D.

-

-

-

-

-


Situation 4 - Finance Lease with Fixed Annual Rental(direct financing lease type)

Assumptions:

Lease term

Carrying value

Annual rental

Implicit interest rate

PV of annuity

PV

5 years

P500

P132

10%

3.791

P500



Lease Liability Balance:

Start of lease term

End of year 1

End of year 2

End of year 3

End of year 4

P500

418

327.8

228.6

119.5

End of year 5 - 0

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D.

-

-

-

-

-



Interest on Outstanding Liability:

Year 1

Year 2

Year 3

Year 4

Year 5

Total

Annual deprecation

P 50

41.8

32.8

22.9

12.5

P 160

P 100


Situation Finance Leases with Fixed Annual Rental (Direct Financing Lease)

To record the finance lease at commencement date


Dr. Lease receivable

Cr. EquipmentCr. Unearned interest

P660

500160

Dr. Equipment

Cr. Lease liability

P500

P500

income

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D. Accounting for Leases Finance LeaseTo record receipt/payment Years 1 to 3

Year 1


Dr. Cash P132Dr. Lease liability P82

Cr. Lease receivableDr. Unearned int. income

Cr. Interest income

P50132

50

Dr. Interest expense

Cr. Cash

50

P132

Year 2Dr. Cash P132

Cr. Lease receivable

Dr. Unearned int. income

Cr. Interest income

P41.8

132

41.8

Dr. Lease liability


Cr. Cash

P90.2

41.8

P132

Year 3Dr. Cash

Cr. Lease receivable

Dr. Unearned int. income

Cr. Interest income

P132

P32.8

132

32.8

Dr. Lease liability


Cr. Cash

P99.2

32.8

P132

D. Accounting for Leases Finance Lease

Accounting entry for annual depreciation

Lessors Books

Annual Depreciation

Lessees Books

Dr. Depreciation exp. P100

No entry Cr. Accum. depreciation 100

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Accounting vs. Tax

Accounting Policy

Finance Lease: Lessee- Initial

recognition

Lessees shall recognize finance

leases as assets and liabilities intheir balance sheets at amountsequal to the fair value of theleased property, or if lower, the

present value of the minimumlease payments each determinedat the inception of the lease.


If lease is actually a conditional sale-

Lessees recognizes as assets andliabilities. The cost of the asset willbe the difference between the totalpayments and the interest. (in effectPV) (RR 19-86)

Hence, the amount at which the

asset is recognized in the books maybe different from the amount paid.

Accounting vs. Tax

Accounting Policy

Finance Lease: Lessee -

Subsequent Payments

A finance lease gives rise to

depreciation expense fordepreciable assets as well asfinance expenses for each

accounting period.


If lease is actually a conditional

sale-

Deduction for tax purposes shall

be the depreciation amount andinterest unless interest iscapitalized. (Taxpayer has option to

expense or capitalize interest).

ISSUE: Rule on interest expensedeductibility: If the lease contractdoes not explicitly provide for theinterest rate, is the interest expensedeductible?

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Accounting vs. Tax

Accounting Policy

The discount rate to be used in

calculating the present value ofthe minimum lease payments isthe interest rate implicit in thelease, if this is practicable todetermine; if not, the lesseesincremental borrowing rate shallbe used.


RR 19-86 allows interest to be

computed using either the Annuity orthe Sum-of-the-Years method. Iftaxpayer opts to use the Sum-of-the-Years method, the interest rate to bereported for tax purposes is differentfrom that recognized for financialreporting purposes.

If it shifts to Annuity Method, thenthis involves a change in accountingmethod for which BIR approval isrequired to be secured.

Accounting vs. Tax

Accounting Policy

Finance Lease: Lessee -Subsequent Payments

The depreciation is allocated to

each accounting period during theperiod of expected use.



Depreciation per books and per taxmay be different if the amounts atwhich the asset was recognized aredifferent.

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PAS 17: Finance Lease

Accounting Policy

Finance Lease: Lessee - Impairmentof Assets

Determination shall be made

whether the leased asset hasbecome impaired, based on IAS 36.


If lease is actually a conditionalsale-

Depreciation shall remain the

same based on the originalcarrying cost (no adjustment for

impairment loss.)

Such impairment evaluation mayreduce the carrying value of theleased asset. The same will be thebasis of subsequent depreciation.

Accounting vs. Tax

Finance Lease: Lessor Recognition.

Accounting Policy

Lessor shall recognize assets held

under a finance lease in their balancesheets and present them as areceivable at an amount equal to thenet investment in the lease.

Gain from the disposition of the asset

shall be the difference between thetotal lease payments receivable,minus the interest charges, and thecarrying value of the asset (net ofdepreciation and impairment losses.



For tax, the lessor shall recognize again on the sale of the asset anddeferred interest income.

Gain from the disposition of the assetshall be the difference between the totallease payments receivable, minus theinterest charges, and the unadjustedcarrying value of the asset (net only ofdepreciation).

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Accounting vs. Tax

Accounting Policy

Lessor Recognition.

Interest income shall be arrived

at using the implicit interestrate.



For tax purposes, interest is computed

using either the Sum-of-the-Years orthe Annuity method. If taxpayer uses

the Sum-of-the-Years method, interestincome recognized for tax purposeswill be different from that recognized

for financial reporting purposes.

E. Sale and Leaseback Transactions

Parties Involved

Party A Party B

Vendor

Lessee

Sale

Leaseback

Buyer

Lessor

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E. Sale and Leaseback Transactions

Benefits(a)The seller-lessee benefits from the higher price because

of:- the gain on the sale of the property

- the deductibility of the lease payments which areusually larger than the previous depreciation.

(b) The buyer-lessor benefits both from the higher rentalpayments and the larger depreciable base.

Accounting Treatment

Depends on the type of the leaseback same rules onoperating lease and finance lease applies.

Accounting vs. TaxSale/leaseback transactions

Accounting Policy

If the transaction results in a finance

lease, any excess of sales proceedsover the carrying amount shall bedeferred and amortized over the leaseterm.

If the sales price is below fair market

value, any profit or loss shall be

recognized immediately except that, ifthe loss is compensated for by futurelease payments at below marketprice, it shall be deferred andamortized in proportion to the leasepayments over the period for whichthe asset is expected to be used.


For tax, gain from the sale

shall already be taxed. Similar toordinary sale.

For tax, loss shall berecognized, regardless of the

impact of future lease payments.

The leaseback shall be taxed

depending on whether it will beconsidered a finance lease oroperating lease.

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PAS 19Employee BenefitsSupersedes SFAS 24, RetirementBenefit Costs

SCOPE

Applies to:

Wages and salaries

Compensated absences (paid vacation and sick leave)

Profit sharing plans

Bonuses

Medical and life insurance benefits during employment

Housing benefits

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=

SCOPE

Applies to (contd.):

Free or subsidized goods or services given to employees

Pension benefits

Post employment medical and life insurance benefits

Long-service or sabbatical leave, anniversary benefits

Deferred compensation programs

Termination benefits

BASIC PRINCIPLE

Emp

picpa income tax pas tax2

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