PART 4 CORPORATE INCOME TAXATION

Part 3
Additional discussion on deductions:
Take note that aside from the itemized deductions, there is also what we call as Special Deductions. These are provided under
special laws if the taxpayer would follow the law. Examples: Adopt-a-School Program, Seniors Citizens Act, Breastfeeding Program
(i.e., whatever expenses that you incur in complying with such laws, such expenditure will be allowed as special deductions).
Tax Rates
Classification
DC
RFC
NRFC
1.

Sources
Within & without
Within
Within

Tax Base
Taxable Income
Taxable Income
Gross Income

Entitled Deduction
Yes
Yes
No

Tax Rate
30%
30%
30%

Rules
General Rule: 30% effective January 1, 2000 (except in special cases) Normal Corporate Income Tax (NCIT)
Optional: Domestic Corporations and Resident Foreign Corporations have the option to be taxed at 15% of gross income,
provided certain conditions are satisfied. This is available to firms whose ratio of cost of sales of gross sales or receipts from all
sources do not exceed 55%. Once elected by the corporation, the option shall be irrevocable for 3 consecutive years.
Note: The Optional 15% Gross Income Tax (GIT) remains to be a provision in the Tax Code because there is no actual implementation
yet. Under the Tax Code, the President, through the recommendation of the Secretary of Finance, will declare if the 15% Optional
Gross Income Tax can be availed of already by corporations. Before the President can declare that the 15% optional gross income
tax is already available, it must first meet the requisites enumerated under item 2.
Example:
Sales
Cost of Goods Sold
Gross Income
Expenses
Taxable Income
Multiply by
Tax Payable

10,000,000
(5,000,000)
5,000,000
(4,000,000)
1,000,000
30%
300,000

x 15% = 750,000

In this case, it is better to avail of the normal income tax rate of

30% because it results to a lower tax payable.

Sales
Cost of Goods Sold
Gross Income
Expenses
Taxable Income
Multiply by
Tax Payable

10,000,000
(5,000,000)
5,000,000
(1,000,000)
4,000,000
30%
1,200,000

x 15% = 750,000

In this case, it is better to avail of the optional 15% gross

income tax, granting that there is already a declaration by
the President allowing corporations to avail of the optional
tax rate.

Take note that in the second example, the ratio of the Cost of Goods Sold to the Sales does not exceed 55%. The Cost of Goods Sold
is only 50% of the amount of Sales (5,000,000 / 10,000,000). Thus, the company can elect to avail of the Optional 15% GIT.
Exception to the General Rule:
a. MCIT - a minimum corporate income tax of 2% of the gross income at the end of the taxable year. It is imposed on a taxable
corporation beginning on the 4 th taxable year immediately following the year in which such corporation commenced its
business operations, when the minimum income tax is greater than the normal income tax. The 30% tax rate may not be
applied if it is lower than the 2% of gross income of such corporate taxpayer.
When we say 4th taxable year following the start of the operations, just add four (4) to the year when it was registered with the
BIR (i.e., the year when it commenced its business operations). However, technically, you can avail of the MCI T only on the 5th
year of operations. Consider the below illustration:
1
2010
x

MCIT (2% of Gross Income)

NCIT (30% of Taxable Income)
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2
2011
x

P A R T

3
2012
x

( E H 4 0 3 )

4
2013
x

5
2014

Take note that the NCIT and the MCIT are mutually exclusive; thus, if you are subject to the NCIT, you are not liable to pay the
MCIT and vice versa.
There are only two instances when a corporation can be held liable to pay MCIT, to wit: (1) if the MCIT is higher than the NCIT;
or (2) if the corporation is operating at a loss; then, automatically, MCIT will apply.
Take note that only the Domestic Corporations and Resident Foreign Corporations can be subjected to pay MCIT provided that
they are liable to pay for the 30% NCIT. Non-Resident Foreign Corporations cannot be subjected to pay MCIT because although
their applicable tax rate is also 30%, it is based on the gross income and not on the net income, unlike for the Domestic and
Resident Foreign Corporations.
b.
2.

Special Rates

Conditions to be satisfied to avail of the 15% optional corporate tax:

a. A tax effort ration of 20% of the Gross National Product (GNP)
b. A ration of 40% of income tax collection to total tax revenues
c. A VAT tax effort ratio of 4% of the GNP
d. A 0.9% ratio of the Consolidated Public Sector Financial Position to GNP
It is the Secretary of Finance who will determine if the above conditions have been met and subsequently make the necessary
recommendation to the President.

3.

2% Minimum corporate Income Tax

The minimum corporate income tax rate of 2% of gross income means that the corporate taxpayer must pay corporate income
tax not lower than 2% of its gross income. If the actual corporate income tax is lower than the 2% tax that is supposed to be paid,
it is the 2% minimum.
Take note that there are exceptions to MCIT, as follows:
a. Domestic Corporation
i.
Proprietary Educational Institutions those educational institutions that are not non-stock and non-profit

As a rule, they enjoy a preferential rate of 10% if their gross income from unrelated activities does not exceed 50%.
If the gross income from unrelated activities exceed 50%, they will now be subject to the 30% NCIT; consequently,
they can also be liable to pay the 2% MCIT.

You apply the Predominance Test based on the gross income and not the net income. For example, if University of
Cebu is earning income from tuition fees amounting to 100M and rental income amounting to 50M or a total gross
income of 150M, the entire gross income of 150M will be subject to 10% because the rental income is only 33% of
the total gross income.
ii. Non-Profit Hospital

Same rationale or condition with the Proprietary Educational Institutions

iii. Depositary Banks under the Foreign Currency Depositary System (FCDS)

Subject to special rates and not to the 30% NCIT

b. Resident Foreign Corporation
i.
Offshore Banking Units (OBU)

Subject to special rates

ii. Regional Operating Headquarters (ROHQ)

Subject to a special rate of only 10%

iii. Entities Registered in PEZA or Economic Zones

They can opt to be subjected to 5% of the gross income or 30% of the taxable income. If they opted the 5% tax rate,
then they will be exempted from MCIT; however, if they opted the 30% tax rate, then they will also be subject to
MCIT.
iv. International Carriers

Whose flights are originating here in the Philippines in a continuous and uninterrupted manner and who can avail of
the special tax rate of 2.5% of their gross Philippine billings

If they have no flights originating in the Philippines or if the flights are not in a continuous or uninterrupted manner,
they can be subjected to the 30% NCIT.

Definition of Terms

Gross income derived from business shall be equivalent to gross sales less sales returns, discounts and allowances and cost of goods
sold. (Section 27A and 27E)

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Gross Sales
Less: Sales Returns
Less: Sales Allowances
Less: Sales Discounts
Net Sales
Less: Cost of Goods Manufactured and Sold or Cost of Sales
Gross Income

xx
xx
xx
xx
xx
xx
xx

Sales Returns refer to those goods which have been sold and delivered to the customers but subsequently returned
because of defect.
Sales Allowances refer to the reserves for possible defects or breakage, as the case may be, depending on the nature of
the business.
Sales Discounts refer to the cash discounts.
The term Cost of Sales is usually used if the business is into trading or into the buying and selling of properties; while, Cost
of Goods Manufacturing Sold is usually used if the business is into manufacturing or in the conversion of raw materials
into finished products.

For taxpayers engaged in sale of service, gross income means gross receipt less sales returns, allowances and discounts.
(Section 27A)

For taxpayers engaged in sale of service, gross income means gross receipts less sales returns, allowances, discounts and cost
of services. (Section 27E)
Take note that the definition in Section 27(A) pertains to the optional 15% gross income tax; while, the definition in Section
27(E) pertains to the minimum corporate income tax. Therefore, for MCIT purposes, you consider the cost of services.
Question: What is the difference between Gross Sales and Gross Receipts? Gross Sales is used if the nature of your business is
manufacturing or trading; while, Gross Receipts is used if you are into service enterprises. However, conceptually, they are the
same.

Cost of goods shall include all business expenses directly incurred to produce the merchandise to bring them to their present
location and use. (Section 27A and 27E)

For trading concerns, Cost of goods sold shall include the invoice cost of the goods sold, plus import duties, freight in
transporting the goods to the place where the goods are actually sold, including insurance while the goods are in transit.
(Section 27A and 27E)
The invoice cost is the original cost less any cash discount that you availed. For example, if you are into buying and selling veils.
You purchase veils from your supplier at 100/piece and you are given a 10% discount by your supplier; thus, you only pay
90/piece. In this case, the invoice cost is the 90/piece and not 100/piece.
Freight In vs. Freight Out
Freight In means the freight expenses incurred in the purchase of the goods; while, Freight Out refers to the freight
expenses incurred in the selling of the goods. In terms of the cost of goods sold, you consider the Freight In since it
relates to the production. However, this will apply only for manufacturing concerns and not to trading concerns.
The term freight in is what is referred to in the Tax Code as cost incurred to bring the raw materials to the
factory/warehouse. Thus, it forms part of your cost of goods manufactured and sold.
For trading concerns, included in the cost of goods sold is the freight or transportation cost incurred in bringing the goods
to the place where they are sold.
For manufacturing concerns, you purchase raw materials and then convert them into finished products. The cost that you
will consider as the cost of goods sold will only be the costs incurred in bringing the raw materials to the factory/warehouse
and the cost in converting them into finished products. That is why you dont consider the freight out expense because
you have already producing the finished product and you only incur the freight out expense in selling the finished product.
However, for trading concerns, you are only into buying and selling the product. That is why you consider the freight out
expense in transporting the goods where the goods are actually sold.
Example: Production and selling of sardines

Transportation cost from the fishermen/market to the factory of 555 Company (a manufacturing company):
recorded as freight in, as far as 555 Company is concerned, and considered as part of the cost of goods sold of the
sardines

Transportation cost from the factory of 555 Company to Gaisano supermarket the cost being shouldered by 555
Company: recorded as freight out, as far as 555 Company is concerned, and considered as selling expense

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Transportation cost from the factory of 555 Company to Gaisano supermarket the cost being shouldered by
Gaisano Supermarket: recorded as freight in, as far as Gaisano supermarket is concerned, and considered as cost of
goods sold in its trading business

For a manufacturing concern: Cost of goods manufactured and sold shall include all costs of production of finished goods,
such as raw materials used, direct labor and manufacturing overhead, freight cost, insurance and other costs incurred to bring
the raw materials to the factory/ warehouse. (Section 27A and 27E)

For a service concern: Cost of services shall mean all direct costs and expenses necessarily incurred to provide the services
required by the customers and clients including (A) salaries and employee benefits of personnel, Consultants and specialists
directly rendering the service and (B) cost of facilities directly utilized in providing the service such as depreciation or rental of
equipment used and cost of supplies. Provided, however, that in case of banks, cost of services shall include interest expense.
For service enterprises, the question that you need to ask is If you will not incur the expense, can you still render or provide
the service? If the answer is YES, then expense is considered as an indirect cost; on the other hand, if the answer is NO, then
that is considered as a direct cost and will be included as part of the cost of services.
Example: In an accounting firm, the salaries of the security guards are considered as indirect costs; while, salaries of the
associates are considered as direct costs.

Carry Forward of Excess Minimum Tax

Any excess of the minimum corporate income tax over the normal income tax shall be carried forward and credited against the
normal income tax for the 3 immediately succeeding taxable years.
Example: X Corp. started its operations on 2010 with the following results of the business operations for the subsequent years 2013

2014

2015

2016

10,000,000
(8,000,000)
2,000,000
(3,000,000)
(1,000,000)
30%
-0-

10,000,000
(8,000,000)
2,000,000
(1,900,000)
100,000
30%
30,000

5,000,000
(2,000,000)
3,000,000
(2,900,000)
100,000
30%
30,000

8,000,000
(4,000,000)
4,000,000
(2,000,000)
2,000,000
30%
600,000

MCIT (2% x Gross Income)

-0-

40,000

60,000

80,000

Tax Payable (MCIT vs. NCIT)

-0-

40,000

60,000

600,000

Excess (MCIT NCIT)

-0-

10,000

30,000

-0-

Excess MCIT Carried Over

-0-

-0-

-0-

(40,000)

Tax Payable

-0-

40,000

60,000

560,000

Sales
Cost of Goods Sold
Gross Income
Expenses
Income/(Loss)
Multiply by
NCIT (30% x Taxable Income)

For the year 2013, the corporation is still not be liable to pay MCIT since it is still on its 4 th year of operations. It is also not liable
to pay NCIT because it incurred a loss.

For the year 2014, the corporation can already be liable to pay MCIT because it is on its 5 th year of operations. The corporation
is liable to pay the MCIT because it is higher than the NCIT. The excess of 10,000 can be availed of and credited by the
corporation against its NCIT for three (3) immediately taxable years or until year 2017.

For the year 2015, the corporation is liable to pay the MCIT since it is higher than the NCIT. However, it cannot carry over the
excess of 10,000 in year 2013 since the excess should be credited against the NCIT and not the MCIT. As of the year 2015, the
accumulated MCIT is 40,000 (10,000 + 30,000). The excess of 30,000 can be availed of and credited by the corporation against
its NCIT for three (3) immediately taxable years or until year 2018.

For the year 2016, you will consider the NCIT since it is higher than the MCIT. In this case, you can already carry over or credit
against the NCIT the accumulated excess MCIT from year 2014 and 2015 (note that you need to apply the First In First Out
or FIFO method in applying the excess MCIT).

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Using the same example from year 2013 to 2015; however, on year 2016, the company incurred a loss:
2016

2017

2018

8,000,000
(4,000,000)
4,000,000
(5,000,000)
(1,000,000)
30%
-0-

5,000,000
(3,000,000)
2,000,000
(1,900,000)
100,000
30%
30,000

4,000,000
(2,000,000)
2,000,000
(1,000,000)
1,000,000
30%
300,000

MCIT (2% x Gross Income)

80,000

40,000

40,000

Tax Payable (MCIT vs. NCIT)

80,000

40,000

300,000

Excess (MCIT NCIT)

80,000

10,000

-0-

-0-

-0-

(120,000)

80,000

40,000

180,000

Sales
Cost of Goods Sold
Gross Income
Expenses
Income/(Loss)
Multiply by
NCIT (30% x Taxable Income)

Excess MCIT Carried Over

Tax Payable

For the year 2016, there is an excess MCIT of 80,000 which can be availed of until year 2019. As of the end of this year, the
accumulated excess MCIT amounts to 120,000 (10,000 from year 2014 + 30,000 from year 2015 + 80,000 from year 2016).

For the year 2017, you will apply the MCIT since it is higher than the NCIT. The excess MCIT of 10,000 can be availed of until
year 2020.

For the year 2018, the NCIT should be applied since it is higher than the MCIT. However, you can deduct against the NCIT the
excess MCIT from year 2015 to 2017 (30,000 + 80,000 + 10,000). You can no longer deduct the excess MCIT from year 2014
because it already expired (i.e., it can only be availed of until year 2017).

Question: In year 2018, what if the NCIT is only 100,000? How much excess MCIT should be deducted? You should only deduct
the 30,000 excess from year 2015 and a partial 70,000 excess from year 2016, just enough to zero out your tax payable. The
following year, in 2019, if the NCIT is still greater than the MCIT, you can still carry over the remaining 10,000 excess from year
2016 (80,000 70,000) and the 10,000 excess in year 2017.

Relief from MCIT under certain conditions

The Secretary of Finance may suspend the imposition of the MCIT on any corporation which suffers losses on account of (1)
prolonged labor dispute; (2) force majeure; and (3) legitimate business reverses.

4.

Special Rules
a.

Special Domestic Corporations

1. Proprietary Educational Institution

Sources
Within and without

Tax Base
Taxable Income

Tax Rate
10% or 30%

Proprietary Educational Institution - any private school maintained and administered by private individual or group with an
issued permit to operate from DepEd (if you are offering primary and secondary education) or CHED (if you are also offering
tertiary courses) or TESDA (if you are offering vocational courses), as the case may be.
Tax rates:

10% if its income derived from unrelated trade, business or activity does not exceed 50% of its gross total income.

30% ordinary tax rate if its income from unrelated trade, business or activity exceeds 50% of its gross income.
Sources
2. Non-Profit Hospital
Within and without
*Same principle (10% or 30%) applied in proprietary institution

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Tax Base
Taxable Income

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Tax Rate
10% or 30% *

b.

Special Resident Foreign Corporations

Sources
Tax Base
Tax Rate
1. International Air Carrier
Within
Gross Phil. Billings
2.5%
2. International Sea Carrier
Within
Gross Phil. Billings
2.5%
For purposes of International Air Carrier, Gross Philippines Billings refer to the amount of gross revenue derived from the
carriage of persons, excess baggage, cargo and mail originating from the Philippines in a continuous and uninterrupted
flight irrespective of the place of sale or issue, and the place of payment of the ticket or passage document. Tickets
revalidated, exchanged and/ or endorsed to another international airline form part of the Gross Philippine Billings of the
passenger boards a plane in a port or point in the Philippines.
For example, Korea Airlines flight from Cebu to Singapore then from Singapore to USA: the computation of the Gross
Philippine Billings will only pertain to the first flight; the second flight will be subjected to the 30% NCIT.
For purposes of International Sea Carrier **, Gross Philippine Billings means gross revenue whether from passenger,
cargo or mail originating from the Philippines up to final destination, regardless of the place of sale or payments of the
passage or freight documents.
Note: Revenue Regulation No. 15-2013, dated September 20, 2013
** Indicated as International Shipping in the Tax Code
3. Offshore Banking Units
Within

Income derived from

foreign currency
transactions with nonresidents, offshore
banking units in the
Philippines, local
commercial banks, inc.,
branches of foreign
banks that may be
authorized by the BSP to
transact business with
OBUS,

Exempt

10%
Income derived from
foreign currency loans
granted to residents
Exempt
Income of nonresidents
(individual/ corporation
from OBUs)
An Offshore Banking Unit is considered or is treated as an extension of a foreign bank. These are classified as RFC;
consequently, they are taxable for income earned within the Philippines. Thus, for the income under the first and third
enumeration, they are exempt from income tax because they are considered as income derived outside of the Philippines.
But if the income is derived from foreign currency loans granted to residents, it is subject to 10% income tax because the
interest income has its situs in the place of the debtor; thus, it is considered as earned within the Philippines.
4. Tax on Branch Profits Remittances
Total profits applied or
15%
earmarked for
remittance, without
deduction for the tax
components thereof
The phrase without deduction for the tax components thereof means that you did not not deduct it in advance but you
included it in the computation of the 15%.
The Branch Profits Remittance Tax (BPRT) is not applicable to Domestic Corporations. It applies only to Resident Foreign
Corporations in a home office-branch relationship wherein the home office is located abroad or in the foreign country and
the branch is located here in the Philippines. The branch will remit a portion of its profit to its home office abroad; such
remittance will be subject to 15% BPRT.
Illustration: NRFC located in the USA. The NRFC has two options in doing business here in the Philippines: establish either a
subsidiary or a branch.
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Sources
Tax Base
Tax Rate
The NRFC, for it to have an operation here in the Philippines, will establish a Domestic Corporation, which can be owned
99% by the NRFC. The relationship between the NRFC and the DC is a parent-subsidiary relationship. In this case, the NRFC
is the parent company and the DC is the subsidiary company. Being a DC, it means to say that the corporation has its
separate set of shareholders, one of which is the NRFC. The advantage is that whatever liability incurred by the DC will not
be a liability of the NRFC because they are separate entities. If it earns profit, the DC will declare dividends to its
shareholders, including the NRFC. This will be subject to either 15% or 30% tax.
The other option of the NRFC is to establish a branch here in the Philippines, which will be considered as a RFC. The
relationship will no longer be parent-subsidiary but it becomes home office-branch relationship. In this type of
arrangement, the branch is considered merely as an extension of the NRFC (note that the branch does not have a separate
set of shareholders). Meaning to say, whatever liability the RFC or branch incurred will also be considered as a liability of
the NRFC. The advantage is that it involves lesser requirements in establishing a branch. If it earns profit, it will remit the
profit to the NRFC. It is at this point when we compute the BPRT equivalent to 15% (which is the least income tax that will
be subjected to the dividends paid by the DC to the NRFC in the first scenario). The basis is the amount earmarked or the
remittance itself.
General rule: 15% BPRT
Exception: If the RFC is PEZA-registered or registered in an economic zone which is duly recognized by the government and
it availed of the 5% tax rate in lieu of all taxes; then, you will be subjected to 5% BPRT instead of 15%.
5. RAHQs
N/A
Exempt
6. ROHQs
Within
Taxable Income
10%
Regional Area Headquarters (RAHQs) are not subject to income tax because they do not have operations here in the
Philippines, unlike Regional Operating Headquarters (ROHQs).
c.

Special Non- Resident Foreign Corporations

1. Non Resident Cinematographic Film

Owner, Lessor or Distributor
2. Non Resident Owner or Lessor of
Vessels Chartered to Filipino Nationals
or Corporations
The Charter Agreement of which is
approved by MARINA
3. Non Resident Owner or Lessor or
Aircraft, Machinery and Equipment
5.

Sources
Within

Tax Base
Gross income

Tax Rate
25%

Within

Gross Rentals, Lease or

Charter Fees

4.5%

Within

Gross Rentals or Fees

7.5%

Passive income (The income must be derived from the Philippines)

1. Interest Income on Bank Deposit

2. Interest Income on Bank Deposit Under the

Expanded Foreign Currency Deposit System
3. Royalties Derived Within the Philippines
4. Capital Gains Derived From its Sales of Shares of
Stock
a. If it is listed and traded thru local stock
exchange: of 1% of the GSP
b. If it is not listed or traded thru local stock
exchange:
Not over P100,000: 5%
Over P100,000: 10%
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DC
20%

RFC
20%

7.5%

7.5%

NRFC
This should be included in its
gross income subject to 30%
tax. But in the case of interest
on loans which have been
made on or after August 1,
1986, the same is subject to
20% final tax.
Tax Exempt

20%

20%

30%

This rule applies BOTH to corporate and individual taxpayers.

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5. Capital Gains Derived from the Sale of Real

Property which is not Used in Trade or Business

6. Branch Profit Remitted by a Branch Office

7. Dividends Received from Domestic Corporation

DC
6% of the Gross
Selling Price or
Zonal Value
whichever is higher
N/A

Exempt

RFC
NRFC
Should be treated as OTHER INCOME SUBJECT to
30%

Subject to Branch
Profit Remittance
Tax of 15%, the
basis of the tax is
the amount
applied for or
earmarked or
remittance
Exempt

N/A

These dividends received from

DC by NRFC is subject to 15%
Final Tax IF: the foreign corp.
allows a tax credit at least
15% of the taxes deemed paid
in the Philippines by NRFC.

Dividends from DC to:

NRFC: 30% or 15% using the Tax Sparing Rule

RFC: Exempt

DC: Exempt

Natural Persons: 10% / 20% / 25%

The reason why dividends from DC to RFC or DC are exempted is because they are considered as temporary transfers. They are
considered to be within the jurisdiction of the Philippines.

Although the dividends from the DC to the RFC are exempted, the remittance of the RFC to its home office NRFC abroad will be
subject to 15% BPRT. On the other hand, even if the dividends from the DC to the DC are exempted, the subsequent dividends
issued by the recipient DC to its shareholders who are natural persons will now be subject to tax.

The dividends to NRFC are subject to tax because they are no longer considered to be within the jurisdiction of the taxing
authority because it was already transmitted abroad.

Tax Sparing Credit [Section 288(5)b]- 15%

Purpose: To attract investors in the Philippines
There is no statutory provision that requires actual grant of tax credit by the foreign government. Neither is there a Revenue Regulation
requiring actual grant. It is clear that the provision of the law says allows. So, it is enough to prove that the foreign government allows
a tax credit. It is not incumbent upon the foreign government to prove the amount actually granted.
Tax on Improperly Accumulated Earning
(Section 29, Tax Code)
1.

Coverage
For corporations using the calendar basis, the accumulated earnings tax shall not apply on improperly accumulated income as of
December 31, 1997.
For corporations adopting the fiscal year accounting period, the improperly accumulated income not subject to this tax shall be
reckoned as of the end of the month comprising the 12- month period of FY 1997- 98.

2.

Corporations Subject to IAET

The IAET shall apply to every corporation formed or availed for the purpose of avoiding the income tax with respect to shareholders
or the shareholders of any other corporation, by permitting earnings and profits to accumulate instead of being distributed or
divided.
Purpose: To declare the net profit to the shareholders if it is not reserved or appropriated for a specific purpose.

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Under the Corporation Code, there is a requirement that a corporation must not maintain unrestricted retained earnings by more
than 100% of its paid up capital.
3.

Exceptions to IAET
This IAET shall not apply to:
a) Publicly held corporations
Publicly held corporations are those that are not closely held. A publicly held corporation is not necessarily publicly listed (i.e.,
it is listed in the local stock exchange).
Note: A publicly listed corporation is necessarily a publicly held corporation.
A closely held corporation pertains to a corporation at least 50% in value of the outstanding capital stock OR at least 50% of
the total combined voting power of all classes of stocks entitled to vote is owned directly or indirectly by not more than 20
persons. Meaning to say, if more than 50% is owned directly or indirectly by more than 20 individuals, it is considered as a
publicly held corporation; thus, exempted from the rule on IAET.
Examples:
50% is owned by 20 individuals; 50% is owned by 1 individual closely held corporation
55% is owned by 21 individuals; 45% is owned by 1 individual publicly held corporation
55% is owned by 1 individual; 45% is owned by 21 individuals closely held corporation
Note: A closely held corporation is not necessarily a family corporation; however, a family corporation is necessarily a closely
held corporation because the moment that the family corporation offers its shares to the public, it becomes a publicly held
corporation.
b)
c)
d)

e)
f)
g)
h)

Banks and other non-bank financial intermediaries

They are required to maintain a certain liquidity level.

Insurance companies

They are required to maintain a certain liquidity level and they are monitored closely by the Insurance Commission
Revenue Regulation No. 2-01

This gives us an enumeration instances when a corporation is allowed to accumulate earnings (e.g., if reserved for definite
corporate projects or expenditures must be supported by a Board Resolution and the funds must be reclassified as
Appropriated or Restricted Retained Earnings).
PEZA-registered companies
Foreign corporations
Taxable business partnerships or general co- partnerships
General professional partnerships

Take note that in a recently concluded case, the SC ruled that to ascertain if an income has been improperly accumulated, aside from
determining if it is reasonable, you also have to apply the Immediacy Test. Meaning to say, if you need to immediately use it the
following taxable year, then you are allowed to accumulate the retained earnings.
4.

Evidence of Purpose to Avoid Income Tax

Prima Facie Evidence: The fact that any corporation is a mere holding company or investment company
Other prima facie evidence:

If the corporation makes investments of its substantial earnings or profits to unrelated business or stock securities of unrelated
business

If there are investments in bonds and other long-term securities

If the earnings accumulated are already in excess of 100% of the paid up capital (example: if your paid up capital is only 1M
but your unrestricted accumulated retained earnings is already 19M).
Note: When you earn profits and you do not return it to your shareholders, you recognize it in your financial statement, specifically
in your Balance Sheet, under the Retained Earnings account. There are two types of Retained Earnings: (1) Appropriated or Restricted
Retained Earnings, which is already reserved or appropriated for a specific purpose; and (2) Unappropriated or Unrestricted Retained
Earnings, those that are not reserved for a specific purpose. In determining if there is a prima facie evidence of IAET, you consider
the Unrestricted or Unappropriated Retained Earnings only.

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Evidence Determination of Purpose: The fact that the earnings or profits of a corporation are permitted to accumulate beyond the
reasonable needs of the business shall be determinative of the purpose to avoid the tax upon its shareholders or members unless
the corporation, by clear preponderance of evidence, shall prove to the contrary. The term reasonable needs of the business
includes the reasonably anticipated needs of the business.
5.

Computation of IAET income

Taxable Income adjusted by:
a) Income exempt from tax
b) Income excluded from gross income
c) Income subject to final tax
d) Amount of NOLCO deducted
And reduced by the sum of:
a) Dividends actually or constructively paid (i.e., if there is dividends declaration); and
b) Income tax paid for the taxable year.
If the result is positive, then there is Improperly Accumulated Earnings which should be subject to IAET of 10%.
The nature of the IAET is a penalty for failure of the corporation to distribute the income to its rightful owners.
Question: If you paid IAET in the previous year and distributed dividends in the succeeding year, will you still be liable for the tax on
the dividends paid the succeeding year? Yes. There is no double taxation because the purpose of the IAET and the tax on the dividends
are different.
ooOOoo END ooOOoo

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