Topic 4 - Tax Schemes Periods Methods and Reporting PDF

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Warning: TT: undefined function: 32 Topic 4: Tax Schemes, Basic Income Tax Patterns, AccountingPeriods, Methods and ReportingIntroductionThis chapter discusses the types of taxation schemes and their scope, basic income tax patterns,concepts of accounting period and its types, concept of accounting ...

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Topic 4: Tax Schemes, Periods, Methods and Reporting

Topic 4: Tax Schemes, Basic Income Tax Patterns, AccountingPeriods, Methods and Reporting Introduction

This chapter discusses the types of taxation schemes and their scope, basic income tax patterns, concepts of accounting period and its types, concept of accounting methods and their accounting procedures , the types of tax returns, their deadline, place of filing and penalties for filing and late payment of taxes.

Learning Objectives

At the end of the topic, students will be able to: • • • • • •

Compare and contrast the three income tax patterns and tax schemes Enumerate the sources and taxability of the income of the different taxpayer Apply the concept of accounting period and accounting methods in taxation Familiarize the different tax returns, when to use and how to use it Learn how to use the eFPS system Learn when to pay taxes and how much is the penalty for non-filing or non-payment or both

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INCOME TAXATION SCHEMES An item of gross income is taxable in any of the three tax schemes as shown in the figure below: these are final taxation, capital gains taxation and regular income taxation. The tax schemes are mutually exclusive. It means that if an income is subjected to one scheme, it will not be taxed by other schemes. Similarly, exempted income in one scheme is not taxable by other schemes.

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Topic 4: Tax Schemes, Periods, Methods and Reporting

1. Final Income Taxation-characterized by final taxes wherein full taxes are withheld by the income payor at source. The recipient income taxpayer receives the net income net of taxes. The payor is the one required by law to remit the tax to the government. Consequently, the recipient income taxpayer does not need to file ITR because the withheld tax constitutes the full tax due and therefore deemed final payments. Final Income tax is applicable only on certain passive income listed by law. Not all passive income is subjected to final income tax. This system of taxation is called final withholding tax system. This will be discussed in detail in Unit 5 2. Capital Gain Taxation-used for the computing the gain on sale,exchange and other disposition of capital assets. These assets are not used in the ordinary course of business or profession. Ordinary assets such as inventory, supplies or property, plant and equipment are not Capital Asset. Capital Gains taxation applies only to two types of capital assets: domestic stocks and real property. This will be discussed in detail in Unit 6. 3. Regular Income Taxation- it is the general rule in income taxation. It covers all other income not taxed by #1 or # 2 above. Items of gross income are accumulated over an accounting period and reported to the government through an income tax return. It makes use of the self- assessment method. Regular Income Taxation will be discussed in detail in Unit 7

THE BASIC INCOME TAX PATTERNS

1. Global Income Tax System- itis a combination of gross compensation and or net income from business, trade or profession to arrive at the total income subject to tabular tax rates. It employs the grouping of similar incomes from all sources and subjecting them to a single tax rate or progressive graduated rates. Examples: a. b. c. d.

Compensation Income; Net Income from business, trade or profession; Passive Income(not subject to final tax); and Capital Gains ( not subjected to capital gains tax)

2. Gross Income Tax System- the taxpayer’s income tax is fixed or computed based on the gross income. The usual allowable deductions are completely disregarded in computing this income tax Examples: a. b. c. d.

Fringe Benefit tax; Passive Income subject to final tax; Capital gains tax on real property (capital asset); Minimum Corporate Income tax

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Topic 4: Tax Schemes, Periods, Methods and Reporting

3. Schedular Income Tax System- income taxes are either computed based on global or gross income system. The filing and payment should be accompanied with separate BIR form as required per category of income. Examples: a. Annual income tax return(for global income tax); b. Capital Gains Tax returns(for sale of property classified as capital asset and shares of stock not traded in the stock market.

SUMMARY OF GROUPS OF INCOME 1. Gross Income Subject to Regular Income Taxation 2. Gross Income Subject to Final Income Taxation 3. Gross Income Subject to Capital Gain Taxation

Compensation Income Subject to Regular

Business Income Income

Taxation

Subject to Regular Income

Passive Income

Capital Gain

**Subject to Final Taxation

Subject to Capital

Taxation

*Subject to Regular

Gain Taxation

taxation

Salaries

Income from Trading

Interest Income

Holiday pay

Income from merchandising

Royalties

Sick leave pay

Income from manufacturing

Dividends

Vacation Leave Pay Per Diem

Professional Income Income from Farming Rent Income Income from Construction Contract

Prizes Winnings

Wages

Honorarium Night Shift

Sale of Capital Assets (not an inventory/not in used in business) Sale of Real property (capital asset) Sale of Share of stock (sold outside stock exchange)

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Differential Hazard Pay Commission Allowances Tips Bonus 13th month pay Retirement pay Terminal Pay Pension

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Topic 4: Tax Schemes, Periods, Methods and Reporting

ACCOUNTING PERIODS

Accounting periodrefers to the fixed time period during which all accounting transactions are recorded for financial statement. It is the basis of which the taxable income is computed and the income tax imposed. Two kinds of accounting period 1. Regular Accounting Period- 12 months length

a. Calendar Year. A period of 12 months beginning January 1 and ending December 31, of every year b. Fiscal Year. A period of 12 months ending on the last day of any month other than December. The taxable income shall be computed upon the basis of the taxpayer’s annual accounting period (fiscal or calendar year) in accordance with the method of accounting regularly employed in keeping the books of the taxpayer. Individuals, estates or trusts and general professional partnerships are required to compute their taxable income on the basis of the calendar year only. While corporations may employ either calendar year or fiscal year as a basis for filing annual income tax return. **If the latter does not have an accounting period or does not keep books, it is required to file returns on the calendar year basis. 2. Short Accounting Period- less than 12 months Instances of short accounting period 1. Newly commenced business- The accounting period covers the date of start of business until the year-end of the business. Ex. TT started business operation on July 1, 2019 and opted to use calendar year. TT should file its first income tax return for July 1- December 31,2019 on or before April 15,2020.

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Topic 4: Tax Schemes, Periods, Methods and Reporting

2. Dissolution of business- The accounting period covers the start of the current year until the date of dissolution. Ex. Star Bucks is on the fiscal year of accounting period ending every May 31. It ceased operation on August 15,2019. Star Bucks should file its last income tax return covering April 1 to August 15, 2019 on or before September 15, 2019. **Under the Old NIRC, dissolving corporations shall file their return within 30 days from the cessation of activities or 30days from the approval of merger by the Securities and Exchange Commission. 3. Change of accounting period by corporate taxpayers- The accounting period covers the start of the previous period up to the designated year- end of the new accounting period. Example 1: Effective February 2019, S Corporation changed its calendar accounting period to a fiscal year ending every June 30. S Corporation shall file an adjustment return covering the income from January 1 to June 30, 2019 on or before October 15, 2019. . Example 2: Effective August 2019, S Corporation changed its fiscal accounting period to a calendar ending every June 30. S Corporation shall file an adjustment return covering the income from July 1 to December 31, 2019 on or before April 15, 2020. ** BIR approval is required in changing an accounting period. It is not automatic 4. Death of the taxpayer - The accounting period covers the start of the calendar year until the death of the taxpayer. 5. Termination of the accounting period of the taxpayer by the commissioner of Internal Revenue- The accounting period covers the start of the current year until the date of the termination of the accounting period. Ex. The accounting period of a taxpayer under the calendar year basis was terminated by the CIR on August 2, 2019. The taxpayer must file an income tax return covering January 1 to August 2, 2019. The income tax return and tax shall be due and payable immediately.

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Topic 4: Tax Schemes, Periods, Methods and Reporting

ACCOUNTING METHODS  Accounting techniques used to measure income Types of Accounting Methods 1. The general methods a. Accrual b. Cash basis 2. 3. 4. 5.

Installment and deferred payment method Percentage of Completion Method Outright and Spread Out Method(Leasehold improvement) Crop Year Basis ( agricultural or farming income)

1. General Methods for Income from sale of goods or service a.Cash Basis-income is recognized when received and expense is recognized when paid. b. Accrual Basis- income is recognized when earned regardless of when received. Expense is recognized when incurred regardless of when paid. Tax and Accounting concepts of accrual and cash basis distinguished The financial accounting concepts of accrual basis and cash basis are similar to their tax counter parts except only for the following tax rules: 1. Advanced income is taxable upon receipt-income received in advance is taxable upon receipt pursuant to the Lifeblood Doctrine and the Ability to Pay Theory. This rule is applicable only to sale of services not on goods. 2. Prepaid expense is non-deductible- these are not deductible against the gross income in the year paid.They are deducted against income in the future period they expire or are used in the business, trade or profession of the taxpayer. This contradicts the Lifeblood Doctrine. 3. Special Tax accounting must be followed – there are cases where the tax law itself provides for a specific accounting treatment of an income tax expense. The specified method must be observed even if it departs from the basis regularly employed by the taxpayer in keeping his books.

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Topic 4: Tax Schemes, Periods, Methods and Reporting

Relevant formula

Deductions

Deductions

Example: A taxpayer providing services reported the following in 2018 and 2019

2018 P250,000 250,000

Collections from services rendered Accrued income from services rendered Collection from accrued income of 2018 Collection for services not yet rendered Payment of expenses of current period Accrued expenses Payment of accrued expenses of 2018 Payment for expenses of the following year Solution: Tax Accrual BasisTax Cash Basis

2019 400,000 200,000 235,000 100,000 300,000 75,000 50,000 150,000

150,000 200,000 50,000 100,000

2018

2019

2018

2019

Collections from services rendered P250,000 P400,000 P250,000 *635,000 Accrued Income from services rendered 250,000 200,000 Collection for services not yet rendered 150,000 100,000 150,000 100,000 Total Gross Income P650,000 P700,000 P400,000 P735,000 Less: Deductions Payment of expenses for the current 200,000 300,000 200,000 *350,000 Accrued expense 50,000 75,000 Amortization of 2018 prepaid expense 100,000 100,000 Total Deductions P 250,000 P475,000 P200,000 P450,000 Net Income P 400,000P 225,000 P200,000P285,000 **400,000+235.000=P635, 000 **300,000+ 50,000= P 350,000 7

Topic 4: Tax Schemes, Periods, Methods and Reporting

**Points to consider in converting GAAP Accrual Basis to Tax Accrual Basis 1. In Accrual basis income is recognized when earned, not of when received. Advanced income is not included in the net income. For taxation purposes, advanced income is taxable. Hence it must be added to accrual basis gross income. 2. Expense is recognized when incurred and not when it is paid, prepaid expenses are not deducted. Hence, no adjustment is necessary under accrual basis. ****Points to consider in converting GAAP Cash Basis to Tax Cash Basis 1. In Cash basis income is recognized when received, not of when earned. Advanced income is included in income. Hence, no adjustment is necessary. 2. Expense is deducted when paid including prepaid expense. hence, the deducted prepaid expenses must be reversed for purposes of taxation Sellers of Goods The gross income of taxpayers selling goods is determined as: Sales Less: Cost of Sales Gross Income

P xxx xxx P xxx

Cost of Sales is computed using the periodic inventory method.

Hybrid basis A combination of accrual basis, cash basis and or other methods. It is used when the taxpayer has several businesses which employ different accounting methods. Example: Miss A has two business: a service business which use cash basis and a trading business which uses accrual basis. **The gross income determined from service business using cash basis is simply added to the gross income in trading business using the accrual basis. There is no requirement to measure the income of different method under a single accounting method. Sale of Goods with Extended Payment Terms 1. Accrual Basis- already discussed 2. Installment method 3. Deferred payment method 2.1 Installment Method Gross income is recognized and reported in proportion to the collection from the installment sales. Installment method is used by: • Dealers of personal property on the sale of properties they regularly sell • Dealers of real properties only if the initial payment does not exceed 25% of the selling price. • Casual Sale of non-dealers in property, real or personal, when their selling price exceeds P1, 000 and their initial payment does not exceed 25% of the selling price.

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Topic 4: Tax Schemes, Periods, Methods and Reporting

Initial Payment The total payments made by the buyer in cash or property in a taxable year the sale was made. Initial payment is downpayment plus installment payments in the year of sale.

Selling Price It is the total amount for which the buyer is obligated to pay to the seller.

Cash received and/or receivable Fair market value of property received or receivable Mortgage or any indebtedness assumed by the buyer Selling PriceP xxx

P xxx xxx xxx

Contract Price (CP) It is usually the selling price without agreement that the debtor assumes indebtedness on the property. If there is any, the contract price is the selling price less the amount of debt assumed. Comprehensive Example: Carlub Company, a car dealer, sold a machine with tax basis of P 600, 000 on installment basis on Feb 3, 2020. Carlub received a P100, 000 cash down payment and a P 900,000 promissory note for the balance payable in six instalments of P150, 000 every August 3 and Feb 3 thereafter. The selling price and gross profit on the sale is computed as follows: Cash Down payment Notes Receivable Selling Price Less: Tax basis of machine sold Gross Profit

P100, 000 900,000 P1, 000,000 600,000 P 400,000

Accrual basis ** The total amount of P400, 000 computed above shall be reported as gross income in 2020, the year of sale. Installment Method Carlub cannot readily use the installment method because it is a dealer of cars rather than dealer of machineries. The sale of properties of which the seller is not a dealer is referred to as a “ casual sale”. Hence, the ratio of initial payment shall be tested first. Initial payment Cash downpayment (Feb 3, 2020) P 100,000 First installment (August 3, 2020) 150,000 P 250,000 initial payment (250,000/1,000,000)= 25% Carlub can use the installment method. The gross profit will be reported in the gross income throughout the installment period using the formula (Collection/Contract Price) x Gross Profit Carlub shall recognize the following gross income:

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Topic 4: Tax Schemes, Periods, Methods and Reporting

At the date of sale: (100,000/1,000,000) x 400,000= Upon every installment : (150,000/ 1,000,000)x 400,000=

P 40,000 P60,000

What if Carlub is a dealer in machinery, it can avail the installment method even if the ratio of initial payment over selling price exceeds 25% so long as the selling price on the installment sale exceeds P1, 000. with indebtedness assumed by the buyer In this case the selling price is no longer the contract price. The contract price is the residual amount after deducting the mortgage from the selling price. Selling price Less: mortgage assume by buyerxxxxxx Contract Price P xxxxxx

P xxxxxx

Example: On February 5, 2020, Batangas Inc., a real property dealer sold a lot costing P 700,000 for P1,000,000. . The lot was encumbered by a P 500,000 mortgage which was assumed by the buyer. The buyer paid P 100,000 downpayment. The balance is due over four instalments of P 100,000 every August 5 and January 5 thereafter. Selling price P 1,000,000 Less: Tax basis 700,000 Gross Profit P 300,000 ** Dealers of real properties are subject to limitation on the use of installment method. The ratio of initial payment shall be determined first.

February 5, 2020 cash downpayment August 5, 2020 installment 100,000 Initial payment Ratio of initial payment(200,000/1,000,000)

P100, 000 P200,000 20%

Batangas is qualified to use the installment method. The contract price should be determined next. Selling price P 1,000,000 Cash dowpayment P100, 000 Less: mortgage assume by buyer 500,000 or Collectible balance (100,000 x 4) 400,000 Contract Price P 500,000 Contract PriceP 500,000 Batangas shall recognize the following gross income: At the date of sale: (100,000/1000,000 x P300,000) Upon every installment : (100,000/1,000,000 x 300,000)

P60,000 P 60,000

Indebtedness assumed exceeds tax basis of property sold When the indebtedness assumed by the buyer exceeds the tax basis of the property sold, the excess is an indirect receipt realized by the seller. This is an indirect down payment. Which must be added as part of the contract price and the initial payment?Note also that under this 10

Topic 4: Tax Schemes, Periods, Methods and Reporting

condition, all collection from the contract including the excess mortgage is a collection of income. Selling Price Pxxx,xxx Less: Mortgage assumed by buyer xxx,xxx Cash CollectiblePxxx,xxx Add: Excess indebtedness- constructive receipt xxx,xxx Contract PriceP xxx,xxx DownpaymentPxxx,xxx Installment in the year of sale Excess of mortgage over tax basis Initial Payment

xxx,xxx xxx,xxx Pxxx,xxx

Example: On July 1,2020, a taxpayer made a casual sale of property with a tax basis of P 650,000 for P1, 000,000. The property was subject to a P750, 000mortgages which was agreed to be assumed by the buyer. The buyer paid a P 50,000 down payment with the balance due in two instalments of P200, 000 on December 31, 2020 and July 1, 2021. How much is the gross profit? Initial payment?contract price? Selling Price Less: Tax basis of property sold Gross Profit

P 1,000,000 650,000 P 350,000

Downpayment P 50,000 Dec...