TAX ISSUES

1. Observation: The Buenaflor Corporation borrowed P 1 000 000 from a bank which
charges 6% interest and invested the same proceeds to a 6% proceeds to a 6% time
deposit in the same bank.
It erroneously recognized the whole amount of P 60 000 as deductible interest expense.
Thus, tax savings from allowable interest expense is understated by P 12 000.
Criteria: Under NIRC( National Internal Revenue Code), an arbitrage limit is apparently
set in the context of corporate taxpayers. Under the corporate income tax rate, the
arbitrage limiti is (30-20)/30 or 1/3, rounded to 33%.
Recommendation: We recommended the company to appropriately adjust the
deductible interest expense and recognized tax savings as follows:
Gross interest expense

P 60 000

Less : 1/3 x P 60 000 interest income

Deductible interest expense

20 000
P 40 000

Multiply by: regular corporate tax rate

30%

Tax savings from allowable interest expenseP 12 000

2. Observation: The corporation as a VAT taxpayer, is about to pay P 896 000
commission to Mr. Ahente, a VAT registered realty broker. The corporation failed to
deduct the 15% withholding tax on the gross income of Mr. Ahente.
Criteria: Under the BIR Form 1601-E, General Expanded withholding tax rates no.4,
15%- payment to professionals, brokers, agents, entertainers to these persons exceed P
720 000.

Recommendation: The company is recommended to deduct the 15% withholding tax

on gross income of Mr. Ahente. The withholding tax and VAT of the payment shall be
computed as follows:
Gross amount due
Less : Output VAT(P 896 000 x 12/112)
Commission income
Multiply by: Withholding rate for more than P 720 000
Withholding tax

P 896, 000
96 000
P 800 000
15%
P 120 000

The company shall claim the P 800 000 as commission expense and record the P 96
000 as input VAT. The input VAT is a tax credit and is not an expense.

3. Observation: The company fail to collect some value added taxes from customers on
sales of tangible personal property and certain services. And also no remittance monthly
was remitted to the Bureau of Internal Revenue.
Criteria: Under the National Internal Revenue Code, an entity is required to collect
value added taxes from customers on sales of tangible personal property and certain
services. Such value added taxes collected shall be remitted monthly to the Bureau of
Internal Revenue.
Recommendation: We recommended the company to collect value added taxes from
customers because it is required by the NIRC, monthly remittance should also be made
to the BIR.

4. Observation: Pursuant to a plan merger, the Buenaflor Corporation exchanges a vast

track of land with a fair value of P 12 000 000 and tax basis of P 10 000 000 for the
stocks of DEF Company with a fair value of P 12 500 000 and par value of P 11 000 000.
The gain is recognized for the property-for-stock transaction.
For Buenaflor Corporation
Fair value of DEF shares received
Less : Tax basis of the land exchanged
Indicated gain

P 12 500 000
10 000 000
P 2 500 000

Criteria: No gain or loss shall be recognized for the property-for-stock transaction

pursuant to a plan of merger or consolidation. The law does not view this as an incopmegenerating exchange but an investing transaction.
Recommendation: We recommended the company that the basis of DEF shares
received shall be the basis of the land transferred;hence, P 10 000 000. Assuming the
company exchanged its own shares for the shares of DEF Company, no gain or loss
shall likewise be recognized. The tax basis of DEF shares received shall be the tax basis
of the company shares exchanged.

5. Observation: Ms. Denver is a holder of Buenaflor Corporation shares costing P 100

000. She received P 105 000 worth of The basis of Buenaflor shares acquired by King
from Ms. Denver shall be the substituted basis computed using the regulatory formula as
follows:
Fair value of shares exchanged
P 105 000

Add: Cash and other properties exchanged

Tax basis of Buenaflor shares acquired

15 000
P 120 000

The tax basis is overstated by P 5 000 because the lower of the fair value exchanged
and transferor basis shall be used, so P 100 000 should be the amount where cash and
other properties exchanged is deducted.
Criteria: The lower of fair value exchanged and transferor basis rule is intended to
prevent an improper appreciation of tax basis which could create a tax loophole when
additional cost deduction is allowed to the transferee without actual cost in his part.
Recommendation: Thus, the company is recommended to make adjustment based on
the correct computation as follows:
Lower of P 100 000 basis to the transferor and
P 105 000 fair value of shares exchanged
Add: Cash and other properties exchanged
Tax basis of Buenaflor shares acquired

P 100 000
15 000
P 115 000

6. Observation: Buenaflor Corporation is transferred ownership over a newly acquired

investment property costing P 1 428 000 as residence of its supervisory employee. The
property has zonal value of P 1 700 000.The company use the cost of investment
property in computing the fringe benefit tax expense which is not in accordance with the
NIRC.
Criteria: Under the NIRC, an entity is required to report fringe benefit expense as to the
higher of cost of investment transferred and zonal value.
Recommendation: We recommended the company to use the higher of the zonal value
and cost of property. Thus, fringe benefit should be computed as follows:
Fringe benefit tax expense:

[(P 1.7 M x 32%)/ 68%] =

P 800 000

7. Observation: The company paid or furnished th following in behalf of supervisory

employee for the quarte ended March 2015 :
Membership dues in golf course
One year P 200 000 interest free loan due December 2015
Free vacation sponsored by the company

P 10 000
12 000

The monetary value as to fringe benefit tax reported by the company is only P 22 000
instead of the correct amount which is P 28 000.
Criteria: Under NIRC, the interest foregone by the employer representing the
difference between 12% and the actual interest charge is taxable fringe benefit.
Recommendation: We recommended the company to include the monetary value of P
6 000 as fringe benefit computed as follows:
[(P 200 000 x 12%)/ 4] = P 6 000
8. Observation: The company usually bills its foreign branch at cost; however, it entered
into advanced pricing agreement(APA) with the BIR which fixed its cross-border pricing
to its foreign branch at 150% of cost. The company only includes the gross income
earned within the Philippines which is worth, P 5 300 000. Since it is a domestic
corporation, it violates the transfer pricing rule.
Criteria: Under NIRC notes that the transfer pricing rule is only important in the
measurement of the proper income from foreign sources for purposes of the
computation of the foreign tax credit.
Recommendation: We recommended the company to include gross income of the
company worth P1 500 000 earned outside the Philippines and therefore the company
shall report P 6 800 000 as gross income.
9. Observation: The company received cash dividends from a domestic corporation, and
erroneously reported it as item subject to final tax.
Criteria: Under NIRC, inter-corporate dividends declared by a domestic corporation is
exempted from final tax. Therefore, it is not an item of gross income subject to regular
income tax. This is to minimize double taxation.
Recommendation: Since Buenaflor Corporation is a domestic corporation, the cash
dividends received from the other domestic corporation should not be an item subject to
final tax. Therefore, it is not an item of gross income subject to regular income tax.
10. Observation: The company secured a fire insurance covering the entire P 2 000 000
fair value of its office building. The building was completely destroyed by fire when the
depreciated cost of the building was P 1 800 000. The company recovered the P 2 000
000 insurance proceeds. The tax basis is not deducted by the company to the total
proceeds.
Criteria: Under NIRC, the proceeds of property insurance contracts in excess of the tax
basis of the property lost or destroyed is a taxable return on capital.

Recommendation: The company is recommended that the proceeds should be

analyzed as follows:
Total proceeds

P 2 000 000

Less: Basis of property destroyed (return of capital)

Return on Capital (item of gross income)

1 800 000
P

200 000

11. Observation: The company declare net loss for the year. In line with this, the company
did not used the minimum corporate income tax as the basis for their income tax return.
Criteria: Under the NIRC, the higher of the REQUIRED COPORATE INCOME TAX
and MINIMUM CORPORATE INCOME TAX is the basis for income tax return of
corporate taxpayers. RCIT is computed as net income for the year multiplied by 30%
and MCIT computed as 2% multiply by the total gross income subject to regular income
tax.
Recommendation: We recommended the company to use the MCIT as the basis for
their income tax to be as follows:
Total gross income

P 3 000 000

Multiply by:
MCIT

2%
P

60 000

Net loss is (P 100 000), therefore RCIT is 0. Thus, higher between the two which is the
MCIT should be the income tax of the corporation.

12. Observation: The company erroneously carry over the capital loss of the previous year
to the current year.
Criteria: Under NIRC, the net capital loss carry over is only applicable to invidual
taxpayers.
Recommendation: We recommended the company to adjust the balance of net income
recognized for the year by excluding the capital loss carry over for the current year.

13. Observation: The company included the interest income from short term interest
deposit in BPI in the regular income tax. The said interest income should be part of the
final tax and not subject to regular tax.

Criteria: Under the NIRC, the interest income from short term deposits of Domestic
Corporation should be subject to final tax of 20%.
Recommendation: The company is recommended to report the interest income from
the short term deposit as part of final tax.

14. Observation: The company erroneously included the interest income in foreign loans
as part of items subject to final tax.
Criteria: Under the NIRC, the interest income from foreign loans of Domestic
Corporation is not subject to final tax but instead subject to regular income tax.
Recommendation: The company is recommended to report the interest income from
foreign loans to be part of items subject to regular income tax and not to final tax.
15. Observation: The company received prize worth P 100 000 from a non-government
agency and erroneously included it on the items subject to final tax.
Criteria: Under the NIRC, the prizes received by domestic and resident foreign
corporation regardless of the amount should be included in the items subject to regular
income tax.
Recommendation: We recommended the company to exclude the amount of prize in
the items subject to final tax and include it in the items subject to regular income tax.

16. Observation: The company changed its fiscal year accounting period ending every
June 30 to the calendar year. The company fail to file an adjustment return to the BIR,
covering July 1 to December 31, 2015 on or before April 15, 2016.
Criteria: Under NIRC, the accounting period covers the start of the previous accounting
period up to the designated year-end of the new accounting period with the BIR
approval.
Recommendation: We recommended the company to file adjustment return covering
July 1 to December 30,2015 on or before April 15,2016.

17. Observation: Buenaflor Corporation issued 10 000 P 10 par ordinary shares in

exchange for a vacant lot owned by KIT, Inc. The vacant lot has a fair value of P 500
000. It is computed and erroneously included in the capital gains tax.
Criteria: Under the NIRC, Domestic Corporation should not include issuance of its own
shares as subject to capital gains tax.

Recommendation: We recommended the company that shares should not be an item

subject to capital gains tax. The transaction involves issue by the company by its own
shares of stocks. These stocks do not represent investment in the shares of another
corporation. The share premium of P 300 000, [P 500 000-(10 000 x P 10)], is part of the
corporate capital, not an income. Hence, it is not subject to capital gains tax.

18. Observation: Buenaflor Corporation, assigned receivable to the bank without recourse
at a loss of P 200 000. During the year, it disposed an old building at a gain of P 800 000
and its investment in foreign securities at a gain of P 350 000. All assets were held for
more than one year.
The company did not recognized capital gain of P 150 000 for the current year. Thus
capital gains tax is also understated.
Criteria: Under the NIRC, Capital gains and capital loss of corporations are recognized
at their full amounts without regard to the holding period.
Recommendation: We recommended the company to compute and recognize for the
net capital gain as follows:
Sale of foreign securities( P 350 000 x 100 %)
Assignment of receivables[ (P 200 000) x 100%)]
Net capital gain

P 350 000
200 000
P 150 000

The gain on sale of building is not included as it is an ordinary gain.

19. Observation: The company incurred a net operating loss during the previous year:
Gross income
P 1 500 000
Less : Regular Itemized deductions
P 1 200 000
Special deductions under the NIRC
700 000
Deduction incentive unders under special laws
300 000
2 200 000
Net operating loss
(P 700 000)
The company fail to recognize Net operating loss carry over for the current year.
Criteria: Under the NIRC, all taxpayers subject to tax on taxable income whether
regular income tax or at preferential tax rate can deduct NOLCO. Taxpayers who are
exempt, enjoying a tax holiday, subject to tax on gross income, or subject to final income
tax, cannot deduct NOLCO.
Recommendation: We recommended the company to deduct the NOLCO for the three
consecutive taxable years to arrive the correct amount of net income in the consecutive
years.
20. Observation: The company receive royalties worth P 100 000 from cinematographic
films they own. The company did not report the royalties as part of items subject to final
tax.

Criteria: Under the NIRC, domestic corporation should report the passive royalties as
part of the items subject to final tax of 10%.
Recommendation: We recommended the company to report a P 10 000 final tax for the
royalties recived from cinematographic films computed as ( P 100 000 x 10%).