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Chapter 4-Income Tax Schemes, Accounting Periods, Methods, and Reporting

CHAPTER 4

INCOME TAX SCHEMES, ACCOUNTING PERIODS, ACCOUNTING METHODS, AND

REPORTING

Chapter Overview and Objectives

This chapter provides an overview of the income tax schemes under

After this chapter, readers are expected to gain familiarization and mastery of the following:

a. Types of taxation schemes and their scope

b. Concept of accounting period and its types

c. Concept of accounting methods and their accounting procedures

d. Types of tax returns, their deadline and place of filing

INCOME TAXATION SCHEMES There are three income taxation schemes under the NIRC:

a. Final income taxation

b. Capital gains taxation
c. Regular income taxation

An item of gross income is taxable in any of these tax schemes,

Item of gross income

Taxable to any one of

Final Income Taxation Capital Gains Regular Income

Taxation Taxation

Mutually exclusive coverage

The tax schemes are mutually exclusive. An item of gross income that is subject tax in one
scheme will not be taxed by the other schemes. Similarly, item income that are exempted in one
scheme are not taxable by the other schemes
CLASSIFICATION OF ITEMS OF GROSS INCOME

Because of the different tax schemes, items of gross income can be classified as follows:

1. Gross income subject to final tax

2. Gross income subject to capital gains tax
3. Gross income subject to regular tax

Readers are advised to master the coverage of both final income tax and capital gain tax. A
thorough understanding of these exceptional tax treatments is very essential to your mastery of
Income Taxation

FINAL INCOME TAXATION

Final income taxation is characterized by final taxes wherein full taxes are withheld by the
income payor at source. The recipient income taxpayer receives the 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 Home Las returns because the withheld tax constitutes
the full tax due and are therefore deemed final payments. This system of taxation is referred to
as the final withholding tax system.

Final taxation is applicable only on certain passive income listed by the law. Not

All items of passive income are subject to final tax.

Passive income vs. active income

Passive incomes are earned with very minimal or even without active involvement of the
taxpayer in the earning process.

Examples of passive income:

1. Interest income from banks

2. Dividends from domestic corporations
3. Royalties

Active or regular income arises from transactions requiring a considerable degree of effort or
undertaking from the taxpayer. It is the direct opposite of passive income

Examples of passive income:

1. Compensation income
2. Business income
3. Professional income
Chapter 4-Income Tax Schemes, Accounting Periods, Methods, and Reporting

CAPITAL GAINS TAXATION

Capital gains tax is imposed on the gain realized on the sale, exchange and other dispositions
of certain capital assets.

Capital assets are assets not used in business, trade or profession. Capital as are the opposites
of ordinary assets. Ordinary assets are assets used in business trade or profession such as
inventory, supplies or property, plant and equipment

Also, not all capital gains are subject to capital gains tax. Most of them are subject to regular
income tax.

The NIRC identifies capital gains tax as a final tax but they are hybrid forin final taxes since it
also employs self-assessment method. The taxpayer still capital gains tax returns to report the
gain and pay the tax to the government Capital gains taxation applies only to two types of
capital assets-domestic stocks and real property.

Capital gains taxation will be discussed in detail in Chapter 6.

REGULAR INCOME TAXATION

The regular income tax is the general rule in income taxation and covers all other income such
as:

1. Active income

2. Other income

a. Gains from dealings in properties, not subject to capital gains tax

b. Other passive income not subject to final tax

Items of gross income from these sources are valued or measured using all accounting
methods, accumulated over an accounting period, and reported to the government through an
income tax return. Regular income taxation makes use of the self-assessment method.

ACCOUNTING PERIOD

Accounting period is the length of time over which income is measured and reported.
Types of Accounting Periods

1. Regular accounting period - 12 months in length

a. Calendar

b. Fiscal

2. Short accounting period less than 12 months

Calendar year

The calendar accounting period starts from January 1 and ends December 31. This accounting
period is available to both corporate taxpayers and Individual taxpayers.

Under the NIRC, the calendar year shall be used when the:
1. Taxpayer’s annual accounting period is other than a fiscal year (i.e. longer than 12
months in length)
2. Taxpayer has no annual accounting period (i.e. less than 12 months in length)
3. Taxpayer does not keep books
4. Taxpayer is an

individual Fiscal year

A fiscal accounting period is any 12-month period that ends on any day other than December
31. The fiscal accounting period is available only to corporate income taxpayers and is not
allowed to individual income taxpayers.

Deadline of Filing the Income Tax Return

Under the NIRC, the return is due for filing on the fifteenth day of the fourth month following the
close of the taxable year of the taxpayer. The regular tax due is payable upon filing of the
income tax return.

Illustration. Due date of the annual income return

1. Taxpayers under the calendar year must file their annual income tax return for the current
period not later than April 15 of the following year.

2. A corporate taxpayer with fiscal year ending June 30, 2021 must file its annual Income tax
return not later than October 15, 2021
INSTANCES OF SHORT ACCOUNTING PERIOD

1. Newly commenced business-The accounting period covers the date of the start of the
business until the designated year-end of the business.

Illustration

Palawan Inc. started business operation on June 30 2021 and opted to use the calendar year
accounting period.

Palawan should file its first income tax return covering June 30 to December 31. … for the year
2021. The return must be filed on or before April 15, 2022.

2. Dissolution of business- The accounting period covers the start of the current year to the
date of dissolution of the business.

Illustration
Tawi-Tawi Inc is in the fiscal year accounting period ending every March 31. It ceased business
operations on August 15, 2021.

Tawi-tawi should file its last income tax return covering April I to August 15

Under the old NIRC, dissolving corporations shall file their return within from the cessation of
activities or 30 days from the approval of merger Securities and Exchange Commission in the
case of merger. (BPI vs. C 144653, August 26, 2011). Hence, the return shall be filled on or
before September 15, 2021.

For individuals, the return shall be due on or before April 15, 2022. There is requirement for
early filling under the NIRC.

Change of accounting period by corporate taxpayers- The accounting period covers the start of
the previous accounting period up to the designated year-end of the new accounting period.
Note that BIR approval is required changing an accounting period. It is not automatic.

Illustration 1

Effective February, 2021, Sulu Corporation changed its calendar accounting period to a fiscal
year ending every June 30.

Sulu Corporation shall file an adjustment return covering the income from Janu to June 30, 2021
on or before October 15, 2021.
Illustration 2

Effective August 2021, Zamboanga Company changed its fiscal year accounting period ending
every June 30 to the calendar year.

Zamboanga Company should file on adjustment return covering July 1 to December 31, 2021
on or before April 15, 2022.

Death of the taxpayer- The accounting period covers the start of the calendar year until the
death of the taxpayer.

Illustration

Mr. Regonald died on November 2, 2021

The heirs of Mr. Reponald or his estate administrators or executors shall file his final Income
tax return covering his income from January 1 to November 2, 2021. There is no requirement for
early filling in case of death of taxpayers. Hence, the income tax return shall be filed on or
before the usual deadline, April 15, 2022

It must be noted that cut af of income must be made at date point of death because properties
such as income accruing before death are part of the estate of the decedent in Estate Taxation
while those income accruing after death are not part thereof, Hence it is in mandatory for the
accounting period of the taxpayer to the terminated exactly at the date of death

Income Tax Schemes, Accounting Periods, Methods, and Reporting

4. 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.

Illustration

The accounting period of a taxpayer under the calendar year basis was terminated by the CIR
on August 2, 2021.

The taxpayer must file an income tax return covering January 1 to August 2, 2021.
The income tax return and the tax shall be due and payable immediately.
ACCOUNTING METHODS

Accounting methods are accounting techniques used to measure income.

Types of Accounting Methods

1. The general methods a. Accrual basis

b. Cash basis

2. Installment and deferred payment method

3. Percentage of completion method

4. Outright and spread-out method

5. Drop year basis

The tax accrual basis income is determined as follows:

Cash income P xxx, xxx

Accrued (uncollected) income P xxx, xxx
Advanced income P xxx, xxx
Gross income P xxx, xxx

The tax accrual basis expense is determined by as follows:

Cash expenses P xxx, xxx

Accrued (unpaid) expense P xxx, xxx
Amortization of prepayment and
Depreciation of capital expenditures P xxx, xxx
Deductions P xxx, xxx

The tax cash basis income is determined as follows:

Cash expense P xxx, xxx

Amortization of prepayments P xxx. xxx
and depreciation of capital
expenditures
Deductions P xxx, xxx

The tax cash basis expense is determined as follows:

Cash expense P xxx, xxx

Amortization of prepayments and P xxx, xxx
depreciation of capital expenditures
Deductions P xxx, xxx
Illustration
A taxpayer providing services reported the following in 2021 and 2022
2021 2022
Collections from services rendered P 500,000 P 800,000
Accrued income from services rendered 500,000 400,000
Collection from accrued income of 2021 - 470,000
Collection from services not yet rendered 300,000 200,000
Payment for expenses of current period 400,000 600,000
Accrued expenses 100,000 150,000
Payment of accrued expenses of 2021 - 100,000
Payment for expenses of the following year 200,000 300,000

Tax Accrual Basis

2021 2022
Cash Income P 500,000 P 800,000
Accrued income 500,000 400.000
Collection for future services - advances 300,000 200,000
Total gross income P 1,300,000 P 1,400,000
Less: Deductions
Cash expenses P 400,000 P 600,000
Accrued expenses 100,000 150,000
Amortization of 2021 prepaid expense - 200,000
Total Deductions P 500,000 P 950,000
Net income P 800,000 P 450,000

Points to consider in converting GAAP Accrual Basis to Tax Accrual Basis

1. In accounting accrual basis income is recognized when earned even if not yet received.
Advanced income is inherently not included in net income. For purposes of taxation,
advanced income is taxable. Hence, it must be added to accrual basis gross income.
2. In accounting, expense is recognized when accrued even if not yet paid. Prepaid
expenses are inherently not deducted. Hence, no adjustment for prepayments is
necessary under accrual basis.

Points to consider in converting GAAP cash basis to Tax cash basis

1. Under the accounting cash basis, income is recognized when received, not when paid.
Advanced income is inherently recognized as Income. Hence, no adjustment is need for
income.

2. Under accounting cash basis, expense is deducted when paid including prepaid
expense. Hence, the deducted prepaid expenses must be reversed for purposes of
taxation.
 Tax Cash Basis
2021 2022
Collection from services rendered P 500,000 P *1,270,000
Collection for future services - advanced 300,000 200,000
Total gross income P 800,000 P 1,470,000
Less: Deductions
Payments of expenses P 400,000 P **700,000
Amortization of 2021 prepayments - 200,000
Total deductions P 400,000 P 900,000
Net Income P 400,000 P 570,000

Note: P800,000 + P470,000 = P*1,270,000*; P600,000 + 100,000 = P700,000**

Sellers of goods

The gross income of taxpayers selling goods is determined as follows:

Sales P xxx, xxx

Less: Cost of goods sold xxx, xxx

Gross income Pxxx, xxxx

The cost of sales is computed using the inventory method:

Beginning inventory. Pxxx, xxx

Add: Purchases xxx, xxx

Total goods available for sale. P xxx, xxx

Loss Ending inventory xxx, xxx

Cost of goods sold. Pxxx, xxx

The expensing of the purchase cost of goods does not properly and fairly reflected income of
the taxpayer particularly when there are significant fluctuations in inventory levels between
accounting periods. This could expose the taxpayer to file for BIR assessment. The use of the
accrual method is suggested but of course subject to practical and cost considerations.

Hybrid basis

The hybrid basis is any combination of accrual basis, cash basis, and/or for methods of
accounting. It is used when the taxpayer has several businesses who employ different
accounting methods.
Illustration

Mr. Roxas has two proprietorship businesses: a service business which uses cash … and a
trading business which uses accrual basis.

The gross income as determined by cash basis in the service business and the gross income as
determined by the accrual basis in the trading business are simply combined. There is no
requirement to measure the income of different businesses under … accounting method

Sale of goods with extended payment terms

The sale of goods with extended payment terms may be reported using the accrual basis,
installment method, or deferred payment method.

Installment method
Under the installment method, gross income is recognized and reported in proportion to the
collection from the installment sales.

Installment method is available to the following taxpayers:

1. Dealers of personal property on the sale of properties they regularly sell

2. Dealers of real properties, only if their initial payment does not exceed 25% of The
selling price sale
3. Casual sale of non-dealers in property, real or personal, when their selling exceeds
P1,000 and their initial payment does not exceed 25% of the selling price

Initial payment
Initial payment means total payments by the buyer, in cash or property, in the taxable year the
sale was made. The term "initial payment" is broader than downpayment. It also includes the
installment payments in the year of sale.

Selling Price

Selling price means the entire amount for which the buyer is obligated to the seller. It is
computed as follows:

Cash received and/or receivable. P xxx, xxx

Fair market value of property received
or receivable xxx, xxx
Mortgage or any indebtedness assumed
by the buyer xxx, xxx
Selling price. P xxx, xxx
Contract Price

The contract price is the amount receivable in cash or other property from the buyer. It is usually
the selling price in the absence of an agreement whereby the debtor assumes indebtedness on
the property.

Comprehensive Illustration

Malaybay Company, a car dealer, sold a machine with a tax basis of P1,200,000 on installment
on January 3, 2021. Malaybay received a P200.000 cash down payment and a P1,000,000
promissory note for the balance payable in six installments of P300,000 after July 1 and January
3 thereafter.

The selling price and gross profit on the sale is computed as follows:

Cash downpayments. P 200,000

Note receivables. 1,800,000
Selling price. P2,000,000
Less: Taxbasis of machine sold. (P1,200,000)
Gross Profit P800,000

Accrual Basis
Under the accrual basis, the entire P800,000 gross profit shall be reported as gross income in
2021, the year of sale.

Installment Basis
Malaybay cannot readily use the installment method because it is a dealer of (?) rather than a
dealer of machineries. The sale of properties of which the seller is (?) dealer is referred to as
“casual sale”. Hence, the ratio of initial payment shall (?) tested first.

The initial payment of Malaybay can be computed as follows:

Cash downpayment (January 3, 2021) P 200,000

First installment (July 3, 2021) 300,000
Initial payment P 500,000

Ratio of initial payment (500,000/2,000,000) 25%

Malaybay can use the installment method. The contract price or the amount due shall be
determined next. Since there is no mortgage assumed by the buyer, the selling price is the
contract price.

The gross profit will be reported in gross income throughout the installment period (?)
the formula: (Collection/Contract price)x Gross profit
Malaybay shall recognized the following gross income:

At the date of sale: (P200K/2M x P800,000) P 80,000

Upon every installment: (P300K/P2M x P800,000) P 120,000

If Malaybay is a dealer in machinery, it can avail of the installment method even if the ratio of its
initial payment over selling price exceeds 25% so as long as the selling price on the installment
sale exceeds P1,000.

With indebtedness assumed by the buyer

The application of the installment method will slightly vary when the buyer assumes
indebtedness on the property sold.

In this case, the selling price is no longer the contract price. The contrac t price is the residual
amount after deducting the mortgage from the selling price. Thus,

Selling price P xxx,xxx

Less: Mortgage assumed by buyer xxx,xxx
Contract price P xxx,xxx

Illustration
On January 3,2021, Tagaytay, Inc,., a real property dealer, sold a lot costing P1,400,000 (?)
P2,000,000. The lot was encumbered by a P1,000,000 mortgage which was assumed by the
buyer. The buyer paid P200,000 downpayment. The balance is due (?) four installments of
P200,000 every July 3 and January 3 thereafter.

The gross profit can be computed as follows:

Selling price P 2,000,000

Less: Tax basis of lot sold 1,400,000
Gross profit P 600,000

Note that dealers of real properties are subject to limitation on the use of installment method.
The ratio of initial payment shall be determined first.

January 3, 2021 cash downpayment P 200,000

July 3, 2021 installment 200,000
Initial payment P 400,000
Ratio of initial payment (400,000/2,000,000) 20%
Tagaytay is qualified to use the installment method. The contract price should be determined
next.

Selling price P 2,000,000

Less: Mortgage assumed by buyer 1,000,000
Contract price P 1,000,000

Alternatively, the contract price can be computed directly as follows:

Cash downpayment P 200,000

Collectible balance (200,000 x 4 installments) 800,000
Contract price P 1,000,000

Tagaytay shall recognize the following gross income:

At the date of sale: (P200K/P1M x 600,000) P 120,000

Upon every installment (P200K/P1M x 600,000) P 120,000

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 downpayment which must
be added as part of the contract price and the initial payment. Note also that under this
condition, all collection from the contract including the excess mortgage is a collection of
income.
The contract price shall be computed as follows:

Selling price P xxx,xxx

Less: Mortgage assumed by buyer xxx,xxx
Cash Collectible P xxx,xxx
Add: Excess indebtedness - constructive receipt xxx,xxx
Contract price P xxx,xxx

The initial payment shall be computed as follows:

Downpayment P xxx,xxx
Installment in the year of sale xxx,xxx
Excess of mortgage over tax basis xxx,xxx
Initial payment P xxx,xxx

Illustration
On July 1, 2021, a taxpayer made a casual sale of property with a tax basis of P1,300,000 for
P2,000,000. The property was subject to a P1,500,000 mortgage which was agreed to be
assumed by the buyer. The buyer paid a P100,000 down payment with the balance due in two
installments of P200,000 on December 31, 2021 and July 1, 2022

The gross profit on the sale is determined as follows:

Selling price P 2,000,000

Less: Tax basis of the property sold 1,300,000
Gross profit P 700,000

The initial payment shall be determined first:

Downpayment P 100,000
December 31,2021 installment 200,000

Excess mortgage (P1,500,000 - P1,300,000) 200,000

Initial payment P 500,000

Ratio of initial payment (P500K/P2,000,000) 25%

The contract shall be computed as:

Selling price P 2,000,000

Less: Mortgage assumed by buyer 1,500,000
Cash Collectible P 500,000
Excess mortgage (P1,500,000 - P1,300,000) 200,000
Contract price P 700,000
Note that the gross profit on the sale is the same as the contract price. Hence, any collection
from the contract including the excess mortgage shall be recognized as gross income upon
collection.

(?) shall recognized the following gross income:

At the date of sale (P200K down + P100K excess) P 300,000

Upon the receipt of first installment - 12/31/2021 200,000
Upon the receipt of second installment - 7/1/2022 200,000
Total gross profit of the contract P 700,000

Deferred payment method

The deferred payment method is a variant of the accrual basis and is used in the reporting
income when a non-interest bearing note is received as consideration in a sale.

Under the deferred payment method, the gross income is computed based on the present value
(discounted value) of a note receivable from the contract. The discount interest on the note is
amortized (i.e,. spread) as interest income over the installment term.

Illustration
On December 31, 2021, a taxpayer sold an office building costing P1,400,000 for P2,000,000.
The buyer made a P1,000,000 downpayment and the balance, evidenced by a note, is due in 2
annual installments of P500,000 every December 31 starting December 31, 2022.

Note that the installment method cannot be allowed since the ratio of initial payment is already
50% (P1,000,000/P2,000,000).

Assume the note is non-interest bearing but can be discounted at a local bank for P900,000.
Under the deferred payment method, the reportable gross income for each year shall be:

2021 2022 2023

Cash downpayment P 1,000,000
Present value of the note 900,000
Selling price P 1,900,000
Less: Tax basis of the property 1,400,000
Gross income P 500,000
Interest Income (P1,000,000-P900,000) P 50,000 P 50,000

Note:
1. The difference between the face value and the present value of the note, known as
discount, will not be recognized in gross income at the date of sale but will be deferred
and recognized as interest income.
 2. The discount is amortized as interest income upon every collection on the balance of the
note as follows: P500,000 installment/P1,000,000 total note balance x P100,000
discount

In the case of interest-bearing notes, the use of the deferred payment method will bear the
same result as the accrual basis of accounting.

The Percentage of Completion Method for Construction Contracts

Under the percentage method of completion method, the estimated gross income of the
construction is reported based on the percentage of completion of the construction project.
There are several methods of estimating project completion in practice but the output method
based on engineering survey id prescribed by the NIRC.
Illustration
In 2021, Cagayan De Oro Construction Company accepted a P5,000,000 fixed-price
construction contract. The following shows the details of its construction activities.
2021 2022
Contract price P 5,000,000 P 5,000,000
Multiply by: % of completion 70% 100%
Construction revenue P 3,500,000 P 5,000,000
Less: Construction revenue in prior year - 3,500,000
Construction revenue this year P 3,500,000 P
1,500,000
Less: Expense during the year P 3,000,000 P 1,200,000
Construction gross income P 500,000 P 300,000
Income from Leasehold Improvement
Leasehold improvement are tangible improvements made by the lessee to the property of the
lessor. Improvements will benefit the lessor when their useful extends beyond the lease term.
This benefit is referred to as income from leasehold improvement.
Under Revenue Regulations No. 2, the income from the leasehold improvement can be can be
reported using either of the following method at the option of the taxpayer:
1. Outright method
The lessor may report as income the fair market value of such buildings on improvements
subject to the lease at the time when such buildings on improvement are completed.
2. Spread-out method
The lessor may spread over the life of the lease the estimated depreciate value of such
buildings or improvements at the termination of the lease and report as an income for each year
of the lease an aliquot part thereof.
The depreciated value of the leasehold improvement is computed as:
Cost of improvement x Excess useful life over lease term
Useful life of the improvement
Illustration
On January 1, 2021, Ivan leased a vacant lot to Greg under a 20_year lease contract. Greg
immediately constructed a building on the lot at a total cost of P4,500,000. The building has
useful life of 30 years.
Outright Method
Under the plain wordings of Section 49 of Revenue Regulations No. 2, Ivan shall recognize the
entire P4,500,000 fair value of the improvement as gross income upon completion of the
improvement in 2021. This is not income in its totality, but this is the amount referred by the
regulation.

Spread-out Method
The depreciated value of the property at the termination of the lease is the value of the years of
usage of the lessor. This can be computed by splitting the value of the improvement as follows:

Years of
User usage Allocation Cost
Lessee 20 20/30 x P4,500,000 P 3,000,000
Lessee 10 10/30 x P4,500,000 1,500,000
Total 30
P 4,500,000
The P1,500,000 depreciated value of the improvement at the termination of the lease is an
income from leasehold improvement by the lessor.
Under the spread-out method, Anderson shall spread the P1,500,000 income over 20periods or
recognize an annual income of P75,000 from the leasehold improvement from Year 2021 to
Year 2040.
Note to Readers
It should be pointed out that this rule exists only in the regulation and is absent in the NIRC.
Some taxpayers are questioning its validity pointing out lack of legal basis. However, it is fairly
proper to consider the depreciated value of the improvement that remains to the lessor. These
are, in effect, additional rental consideration in kind.
However, the treatment specified by the outright method is perceived as unjust and abusive,
and is an improper introduction of legislation.
The depreciated value of the improvement at the termination of the lease should be the proper
value to be recognized as gross income under the outright method.
This view is supported by the fact that the spread-out method could not have an option if the
outright method intended to the tax the entire fair value of the improvement considering the
huge disproportion in the reportable gross income under the two options.
The outright method mandated by the regulation will best apply in cases when leases pay the
lessor rentals in the form of leasehold improvements or when leasehold improvements made by
lessee are treated as reduction to cash rentals. In such cases, the fair value of the leasehold
improvements upon completion is unquestionably income to the lessor for taxation purposes.
Agricultural or Farming Income
Farming is commonly measured using the cash basis or accrual basis such as in the following:
a. animal husbandry
B. Short-term crops
Illustration
Northern barn have the following details of its agricultural activity during the year
Total sale of fattened pigs, P 1,000,000 on credit P 12,000,000
Increase in fair value of pig herd compared last year 2,700,000
Total cost of farm of feeds and supplies bought 7,000,000
Total cost of farm of feeds and supplies used 6,800,000
Administrative and selling expense 1,200,000
Northern Barn shall compute its net income using either method as follows:
Accrual method Cash basis
Sales P 12,000,000 P 11,000,000
Direct farm cost 6,800,000 6,800,000
Gross profit from operations P 5,200,000 P
5,200,000
Less: administrative and selling expense 1,200,000
1,200,000
Net income P 5,000,000
P 4,000,000
The accounting for long-term crops depends on the harvesting frequency:
a. Perennial crops- that yield harvest through years
b. One-time crops- those that are harvested once after several years

The initial farm development costs of perennial crops like mangoes, mangosteens, coconut and
banana are capitalized and amortized over the expected years of harvest. The harvests are
accounted for using cash basis or accrual basis. One-time crops are accounted for using the crop
year basis.

Crop year basis

Under the crop year basis, farming income is recognized as the difference between the proceeds
of harvest and expenses of the particular crop harvested. The expenses of each crop are
accumulated and deducted upon the harvest of the crop.

Illustration
Juan de la Cruz, a farmer, plants a certain crop that takes more than a year to harvest. Juan had
the following data on his farming operations:

2021 2022 2023

Process of harvest P - P 750,000 P 1,000,000
1st cropping expenses 400,000 200,000 -
2nd cropping expense - 500,000 300,000
The reportable farming income using crop year method would be:

2021 2022 2023

Process of harvest P - P 750,000 P 1,000,000
Less: cropping expenses
Incurred last year 400,000 500,000
Incurred this year 200,000 300,000
Farming gross income P 150,000 P 200,000

Crop year basis is an accounting method and is not an accounting period.

Use of different accounting methods

Taxpayers with more than one type of business using different accounting methods can
consolidate the income reported using the different methods. There is no need to restate the
income to a common accounting method. However, the methods applied to each business should
be applied consistently from period to period.

Change in accounting period

The change of accounting period requires prior BIR notice. The following documentations are
required:
1. A letter of request addressed to the RDO having jurisdiction over the place of the business of
the taxpayer showing
a. The original and the proposed new accounting period
b. The reason for desiring to change the accounting period
2. Certified true copy of the SEC approved amended by-laws showing change in accounting period
3. Sworn statement of "non-forum shopping stating that such request have been previously
acted upon by the BIR National Office
4. Duly filled up BIR Form 1905
5. A sworn undertaking by an officer of the taxpayer to file a separate adjustment return for the
period between the close of the original accounting period and the date designated as the close
of the new accounting period

The request for approval of the change in accounting period shall be filed on time not less than
60 days prior to the beginning of the new accounting period. The certification approving the
adoption of a new accounting period must be released within 30 days from the date of receipt of
the complete documents and requirements.

TAX REPORTING

Types of Returns to the Government

1. Income tax returns- provide details of the taxpayer's income, expense, tax due, tax credit and
tax still due the government.
2. Withholding Tax returns- provide reports of income payments subjected to withholding tax by
the taxpayer-withholding agent
3. Information returns
 Information Returns

Certain taxpayers are also required to file information returns. Information returns do not involve
any payment or withholding of tax but are essential to the government in its tax mapping efforts
and in its evaluation of tax compliance

The non-filing of income tax returns, withholding tax returns, or information returns is subject to
penalties, fines, and or imprisonment.

MODE OF FILING INCOME TAX RETURNS

1. Manual Filing System

The traditional manual system of filing income tax return is by paper documents where
taxpayers fill up BIR forms to report income, expenses, or any declaration required to be filed
with the BIR

Under the NIRC, the income tax return shall be filed to the following. It is a descending order of
priority, within the revenue district office where the taxpayer is registered or required to register.

1. An authorized agent bank (AAB)

2. Revenue Collection Officer

3. Duly authorized city or municipal treasurer, if there is no BIR office in the locality

2. e-BIR Forms

The BIR introduced the e-BIR Forms with an offline or online version. Taxpayers fill up their
income tax returns in electronic spreadsheets without the need of writing on paper returns. The
system ensures completeness of data on the return and is capable of online submission. If there
are no penalties that require BIR assessments, taxpayers would have to print a hard copy of the
filled tax returns and proceed directly to the bank for payment.

3. Electronic Filing and Payment System (eFPS)

The eFPS is a paperless tax filing system developed and maintained by the BIR. Taxpayers file
tax returns including attachments in electronic format and pay the tax through the Internet.
Taxpayers mandated to use the eFPS

1. Large taxpayers duly notified by the BIR

2. Top 20,000 private corporations duly notified by the BIR

3. Top 5.000 individual taxpayers duly notified by the BIR

4. Taxpayers who wish to enter into contracts with government offices

5. Corporations with paid-up capital of P10,000,000
6. PEZA- registered entities and those located within Special Economic Zones
7. Government offices in so far as remittance of withheld VAT and business tax are
concerned
8. Taxpayers included in the Taxpayer Account Management Program [TAMP]
9. Accredited Importers, including prospective importers required to secure the Importers
Clearance Certificate (ICC) and Custom brokers Clearance Certificate (BCC)

In case of unavailability of the eFPS during maintenance or instances of technical errors, eFPS
enrolled taxpayers may file manually.

Grouping of Taxpayers under EFPS

1. Group A

a. Banking institutions

b. Insurance and pension funding

c. Non-bank financial intermediation

d. Activities auxiliary to financial intermediation

e. Construction

f. Water transport

g. Hotels and restaurants

h. Land transport
2. Group B

a. Manufacture and repair of furniture

b. Manufacture of basic metals
c. Manufacture of chemicals, and chemical products
d. Manufacture of coke, refined petroleum, and fuel products
e. Manufacture of electrical machinery, and apparatus NEC
f. Manufacture of fabricated metal products
g. Manufacture of foods, products, and beverages
h. Manufacture of machineries, and equipment NEC
i. Manufacture of medical, precision, and optical Instruments
j. Manufacture of motor vehicles, trailers and semi-trailers
k. Manufacture of office, accounting, and computing machineries
l. Manufacture of other non-metallic mineral products
m. Manufacture of other transport equipment IL n. Manufacture of other wearing apparel
o. Manufacture of papers, and paper products
p. Manufacture of radio, TV, and communication equipment, and apparatus
q. Manufacture of rubber and plastic products
r. Manufacture of textiles
s. Manufacture of tobacco products
t. Manufacture of wood and wood products
u. Manufacturing N.E.C.
v. Metallic ore mining
w. Non-metallic mining and quarrying

3. Group C
a. Retail sale
b. Wholesale trade and commission trade
c. Sale, maintenance, repair of motor vehicle, and sale of automotive fuel
d. Collection, purification, and distribution of water
e. Computer and related activities
f. Real estate activities

4. Group D
a. Air transport
b. Electricity, gas, steam, and hot water supply
c. Postal and telecommunications
d. Publishing printing, and reproduction of recorded media
e. Recreational, cultural, and sporting activities
f. Recycling
g. Renting out of goods and equipment
h. Supporting and auxiliary transport activities
Group E
a. Activities of membership organizations Inc.
b. Health and social work
c. Private educational services
d. Public administration and defense compulsory social security
e. Public educational services
f. Research and development
g. Agriculture, hunting and forestry
h. Farming of animals
i. Fishing
j. Other service activities
k. Miscellaneous business activities
l. Unclassified activities

PAYMENT OF INCOME TAXES

The general rule is “pay as you file”. The capital gains tax and regular income tax are paid as the
taxpayer files his return. Installment payment of income tax is allowed on certain conditions.

Taxpayers under the eFPS system shall e-pay their tax online through internet banking service. The
account of the taxpayer will be auto-debited for the amount of taxes to be paid.

BASIC COMPARISON OF FILING AND PAYMENT SYSTEMS

Manual e-BIR Forms eFPS
Data entry Manual Electronic Electronic
Filing/Submission Manual Electronic Electronic
Tax payment Manual Manual Electronic

PENALTIES FOR LATE FILING OR PAYMENT OF TAX

The late filing and payment of taxes is subject to the following additional charges:
1. Surcharge-
a. 25% of the basic tax for failure to file or pay deficiency tax on time
b. 50% for willful neglect to file and pay taxes

The non-filing is considered ‘willful neglect’ if the BIR discovered the non-filing first. This is the
case when the taxpayer received a notice from the BIR to file return prior to his actual filing. If the
taxpayer filed a return before the receipt of such notice, the same is considered simple neglect
subject to the 25% surcharge.

2. Interest- Double of the legal interest rate for loans or forbearance of any money in the absence
of any express stipulation

Since the legal interest is currently set at 6%, the interest penalty is therefore 12% per annum
effective January 1, 2018. Note that NIRC imposed an interest penalty of 20% per annum until
December 31, 2017.
Under the new rules established by RR21-2018, the interest period shall be computed based on
actual days divided 365 days. The additional day in February during a leap year will be
counted. The yearly-monthly-daily counting method established in prior regulations is already
abandoned.

A month normally has 30 days except the following:

31-day months January, March, May, July, August, October, December
28 or 29-day month February

The best way to put this in mind is that 31-day months alternating from January to July, but the
sequence is reset in August. Also in mind that February is a 28-day month, except on a leap year.

How to identify a leap year?

A year divisible by 4 with a whole number quotient without a decimal is a leap year. Years 2016,
2020, 2024, 2028 and so on and so forth. Leap year has 29 days in February hence the actual
number of days in a leap year is 366days the usual 365. This id due to the fact that our planet
revolves around the sun in 365 ¼ days. Hence, there is an extra one complete day in every four
calendar years.

Under the illustrative guidelines in RR21-2018, the new day accounting system for the interest
penalty will be implemented for tax assessments effective January 1, 2018. This means it will be
applied even if the tax assessment pertains to 2017 and prior years.

Illustration 1: Basic procedure

The tax return of the tax payer was due on April 15, 2021 but was filed on August 3, 2021. The
tax due per return of the taxpayer amounts to P100,000.

The number of days would be counted as follows:

Period Days
April 15-30 15
May 31
June 30
July 31
August 3
Total days 110

The interest penalty shall be computed as P 100,000 x 12% x 110/365 = P3,616.44

Illustration 2: Interest in a leap year

A taxpayer-withholding agent failed to file his withholding tax return and failed to remit the
P50,000 withholding tax thereon April 30,2019. The taxpayer filed the return on July 16, 2020.

The number of days would be counted as follows:

Period Days
April 30, 2019 to April 30, 2020 366
May 2020 31
June 2020 30
July 2020 16
Total days 443
The interest penalty shall be computed as P50,000 x 12% x 443/365=P728.19

Illustration 3: Interest in transition years

An individual taxpayer has a tax due of P40,000 for taxable year 2016 due on April 15, 2017. The
taxpayer settled his tax on February 10,2018.

The interest in 2017 shall be computed using the old 20% interest penalty rate while the interest in
2018 shall be computed using the 12% interest penalty rate.

April 16, 2017 to December 31, 2017 is 260 days. January 1, 2018 to February 10, 2018 is
41days. Hence, the interest shall computed as follows:

2017 interest (P40,000 x 20% x 260/365) P 5,698.63

2018 interest (P40,000 x 12% x 41/365) 539.18
Interest penalty P 6,237.81

3. Compromise penalty-
Compromise penalty is an amount paid in lieu of criminal prosecution over a tax violation.

The schedules of compromise penalty related to income taxes are included in Appendix 4 for your
reference.

INTERGRATIVE ILLUSTRATION
An individual taxpayer filed his 2020 income tax return with a computed tax due of P100,000 on
July 15, 2021. A total of P20,000 creditable withholding taxes was deducted by various income
payors from his gross income.

The total amount to be paid by the taxpayer including penalties should be:

Tax due P 100,000

Less: Tax credits (creditable withholding tax) 20,000
Net tax due P 80,000
Plus: penalties
Surcharge (P80,000 x 25%) 20,000
Interest (P80,000 x 12% x 91/365) 2,393
Compromise penalty* 15,000
Total tax due P 117,393

Note:
1. The deadline of the 2020 income tax return is April 15, 2021. April 15, 2021 to July 15, 2021 is
a 91-day period.
2. Interest is computed from the net amount of tax due before the 25% surcharge. Imposition
of interest upon the surcharge is illegal.
3. The compromise penalty is taken form the table of compromise penalties for failure to file and
or pay internal revenue tax at the time or times required by law, as follows:

If the amount of tax unpaid

Exceeds But not exceed Compromise is
… … …
 P 20,000 P 50,000 P 10,000
50,000 100,000 15,000
100,000 500,000 20,000

You may check the schedule of compromise penalty for late payment of income tax in Appendix 4
for your reference.

PENALTIES FOR NON-FILING OF LATE FILING OF INFORMATION RETURN

For each failure to file a separate information returns, statement or list, or keep book record, or
supply any information required by the Code of Commissions on the date prescribe therefor,
unless it is shown that such failure is due to reasonable cause not to willful neglect, shall be
subjected to penalty off P1,000 for each such failure. Provided that the amount imposed for all
such failure during calendar year shall not exceed P25,000.