CRC-ACE REVIEW SCHOOL

The Professional CPA Review School

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TAXATION

RE Hermosilla

IMPROPERLY ACCUMULATED EARNINGS TAX

(For Closely Held Corporations)
Imposition of improperly accumulated earnings tax
In addition to other taxes imposed, there is imposed for each taxable year
on the improperly accumulated taxable income of each corporation an
improperly accumulated earnings tax equal to 10% of the improperly
accumulated taxable income.
Not
(a)
(b)
(c)
(d)
(e)
(f)
(g)

subject to improperly accumulated earnings tax

Publicly-held corporations;
Banks and other nonbank financial intermediaries;
Insurance companies.
Taxable partnerships
General professional partnerships
Non-taxable joint ventures; and
Enterprises registered with PEZA and under Bases Conversion and
Development Act, special
economic zones.

Holding Company or investment company

The fact that any corporation is a mere holding company or investment
company shall be prima facie evidence of a purpose to avoid the tax upon its
shareholders or members.
Earnings or profits of a corporation are permitted to accumulate beyond the
reasonable needs
The fact that the earnings or profits of a corporation are permitted to
accumulate beyond the reasonable needs of a business shall be
determinative of the purpose to avoid the tax upon its shareholders or
member, unless the corporation, by clear preponderance of evidence, shall
prove to the contrary.
Evidence of Purpose to Avoid Income Tax.
(1) Prima Facie Evidence. - the fact that any corporation is a mere holding
company or investment company shall be prima facie evidence of a
purpose to avoid the tax
upon its shareholders or members.
(2) Evidence Determinative 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 the
clear preponderance of evidence, shall prove to the contrary.
(3) Circumstances indicative of improper accumulation of profits
1. Withdrawals by stockholders disguised as loans.
2. Expenditures by the corp. for the personal benefit of the
stockholders.
3. Investments in unrelated business.
4. Radical change of business when large profits have been
accumulated.
5. Yearly substantial advances made to stockholders-officers.
Reasonable need of the business

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Reasonable needs of the business include the reasonably anticipated needs
of the business.
Circumstances considered proper accumulation of profits
1. Additional working capital purposes.
2. Purchase of long-life assets reasonably required by the business.
3. Obligation in a contract to set aside funds in a sinking fund to settle debt.
Profits subjected to IAET not declared as dividends
Once the profits have been subjected to IAET, the same shall no longer be
subjected to IAET in later years even if not declared as dividends.
Profits subjected to IAET still subject to tax on dividends
Profits which have been subjected to IAET when finally declared as
dividends shall be subject to tax on dividends
Declaration of dividend to avoid IAET
The dividend must be declared and paid or issued not later than one (1)
year following the close of the taxable year
Payment of IAET
Improperly accumulated earnings tax shall be paid within 15 days after one
year following the close of the taxable year if dividends are not declared and
paid or issued.
Pro forma computation of improperly accumulated taxable income
Taxable income
xxx
Add: Income exempt from tax
xxx
Income excluded from gross income
xxx
Income subject to final tax
xxx
The amount of net operating loss
carry-over deducted
xxx xxx
Total
xxx
Less: Dividends actually or constructively paid
xxx
Income tax paid for the whole year
xxx
Amount reserved for the reasonable needs
of the business
xxx xxx
Improperly accumulated taxable income
xxx
Problems:
1. A penalty and a form of deterrent to the avoidance of tax upon
shareholders who are supposed to pay dividends tax on the earnings
distributed to them by their corporation
a. Minimum corporate income tax
c. Improperly accumulated earnings
tax
b. Fringe benefit tax
d. Gross income tax
2. Improperly accumulated earnings tax is
a. 10% of taxable income.
c. 10% of improperly accumulated
income.
b. 10% of net income.
d. 10% of gross income.
3. The following, except one, give rise to the presumption that a corporation
is improperly accumulating profits. Identify the exception:
a. The corporation is a mere holding company.
b. The corporation is an investment company.
c. The corporation permits its profits to accumulate beyond the
reasonable needs of the business.
d. The corporation is a service enterprise.

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4. One of the following statements is wrong. Identify. The improperly

accumulated earnings tax imposed on corporations:
a. Is calculated to force corporations to pay out dividends.
b. Is computed on improperly accumulated income over several years.
c. Is based on the net income per books after income tax.
d. Is based on a statutory formula for improperly accumulated income.
5.

All of the following, except one, are additions to taxable income after
income tax for purposes of computing improperly accumulated income
a. Income subject to final taxes.
c. Income excluded from gross income.
b. Reserved for reasonable needs of d. NOLCO deducted in computing
the business.
taxable income.

6. A domestic corporation had the following data for 2005, the accumulated
earnings for which year the Bureau of Internal Revenue considered to be
improper:
Sales
P6,000,0
00
Cost of sales
2,000,000
Business expenses
1,000,000
Interest on Philippine currency bank deposit
50,000
Capital gain on sale directly to buyer of shares of 120,000
domestic corporation
Dividend income from domestic corporation
60,000
Dividend declared and paid during the year
500,000
The improperly accumulated earnings tax is:
a. P175,300
b. P221,000
c. P171,000
d. P166,300
For Items 7 & 8
The records of a closely-held domestic corporation show the following
data for 2005:
Gross income (gross of WT of 1%)
P1,500,00
0
Business expenses
600,000
Gain on sale of business asset
60,000
Interest on deposit with Metrobank, net 5,000
of tax
Sale of shares of stocks, not listed and
traded:
Selling price
150,000
Cost
115,000
Dividends from Victory Corporation, 35,000
domestic
Dividends paid during the year
120,000
Reserved for building acquisition
300,000
In 2004, the corporation suffered an operating loss of P130,000. This
amount was carried forward and claimed as deduction from gross income
in 2005.
7. The income tax due in 2005 is
a. P250,600
b. P265,600

c. P292,200

8. The improperly accumulated earnings tax is

a. P64,415
b. P34,765
c. P250,600

d. P290,500
d. P32,275

9. All, except one, of the following, are not subject to the improperly
accumulated earnings tax. Which is the exception?
a. Publicly-held corporations.
c. Insurance companies.

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b. Banks and nonbank financial d. Service enterprises.
intermediaries.
10. In 2005, Linux Corporation, a domestic corporation, had a net income
of P2,000,000. It paid a corporate tax of 35% leaving a distributable
income of P1,300,000. If a dividend is declared by the corporation and
received by the following stockholders, which of the following statements
is false?
a. Nonresident aliens engaged in trade or business are liable to pay 30%
dividend tax.
b. Nonresident aliens not engaged in trade or business are liable to pay
25% dividend tax.
c. Resident citizens are liable to pay 10% dividend tax.
d. Resident foreign corporations are exempt from the payment of
dividend tax.
For items 11 & 12
Lotte Corporation, a domestic corp. had the following data for taxable year
2000:
Sales
5,000,000
P
Cost of goods sold
2,000,000
Gen. Selling and administrative
500,000
expenses
Interest income from Phil. Bank
100,000
deposit
Rental
income
(net
of
5%
190,000
withholding tax)
Dividend Income:
From domestic corporation
60,000
From foreign corporation
50,000
Winnings from charity sweepstakes
1,000,000
Capital gains from sale of domestic
shares of stock sold directly to buyer
75,000
Dividends declared and paid during
500,000
the year
Retained earnings, beg. of the year
(subjected
1,000,000
to IAE tax last year)
Note: The board of directors approved a resolution reserving P1,500,000
of its net profit for the year for plant expansion.
11. The income tax due after credit if any is:
a. P880,000
b. P870,000
c. P899,200

d. P952,500

12. Based on the foregoing problems, the IAE tax if any is:
a. P208,125
b. P108,125
c. P207,125
d. P99,875