Falcon Waterfree Philippines, Inc.

Income Taxation Practice Set

A Partial Requirement for the Subject:

Income Taxation (TAX 1: TX511Ax)

AY 2017-2018

Submitted by:

Camille Joy Dava

Madelle Q. Pradas
Maryl Joyce D. Tabaniag

Submitted to:

Crisfolo S. Montareal, CPA

October 21, 2017

Computation of Tax:

Net Sales 9,500,000

Less: Cost of Sales (schedule 1) 6,500,000
Gross Income from Operation 3,000,000
Add: Other Taxable Income Not Subjected to Final Tax (schedule 2) 1,020,000
Total Gross Income 4,020,000
Less: Total Itemized Deductions (schedule 3) 3,256,708
Net Taxable Income 763,292
Income Tax Rate 30%
Income Tax Due 228,988
Less: Total Tax Credits (schedule 4) 209,147
Net Tax Payable 19,841

Schedules and Analyses:

Schedule 1: Cost of Sales

Merchandise Inventory – beginning 3,000,000

Add: Purchases of Merchandise 5,000,000
Total Goods Available for Sale 8,000,000
Less: Merchandise Inventory – ending 1,500,000
Cost of Sales 6,500,000

Schedule 2: Other Taxable Income Not Subjected to Final Tax

Rental Income 145,000

Interest Income 20,500
Dividend Income 30,000
Gain on Sale of Real Estate 800,000
Income from Bad Debt Recovery 9,500
Income from Tax Refund 15,000
Total 1,020,000
 The corporation owns a lot in Manila which is being leased to Unique International Corporation at a
monthly rental of 10,000. Under the contract of lease, the lessee is to erect a building on the lot. The building was
finished on December 31 of the previous year at a cost of 5,000,000 with an estimated useful life of 50 years. The
term of the lease is for 40 years effective January of the current year.

Rental Income refers to earnings derived from leasing real estate as well as personal property. Aside from
the regular amount of payment using the property, rental income also includes all other obligations assumed to be
paid by the lessee to the third party in behalf of the lessor. (Sec. 2.01, Rev. Reg. 19-86)

When the lessee erected or built permanent improvements on the leased property which will become the
property of the lessor upon the expiration of the lease, the value of the improvements should be reported as
income of the lessor using either outright method or spread out method. (Sec. 49, Rev. Reg. No. 2)

Thus:

Cost of the Building 5,000,000

Less: Accumulated Depreciation at the end of the lease
[(5,000,000/50 years) x 4 years] 4,000,000
Book Value of Improvement at the End of the Lease 1,000,000
Divide by: Term of Lease in Years 40 years
Annual Income on Leasehold Improvement 25,000
Add: Annual Rental 120,000
Total Rental Income to be Reported 145,000

The schedule of interest income is shown below:

Nature Name and Address of Payor Principal Rate Tax Withheld Interest Earned
Savings Account BDO – Libertad 80,000 5% 800 4,000
Mandaluyong
Time Deposit BPO – Ayala 120,000 9% 2,000 10,000
Treasury Bill and PNB – Makati 120,000 14% 3,300 16,500
Time Deposit
Time Deposit - 50,000 3% - 2,000
DBP Treasury Bills DBP – Makati 80,000 9% - 4,500
Loan Vicente Dos, Dasmarinas, 100,000 18% - 14,000
Makati

Interest income on deposits made in banking institutions is a passive income which is usually subjected to
final withholding tax of 20%. Thus, out of the total 51,000 interest income, only 37,000 is subject to regular income
tax and the rest are subjected to the 20% final tax. The time deposit and DBP treasury bills were considered
subjected to regular tax since no corresponding tax has been withheld and they have been received in their total
amount.
 During the year, the corporation received the following dividends:

Ayala Land Corporation, a domestic corporation – Cash Dividend 20,000

Motor Corp., a US corporation – Cash Dividend 30,000
San Miguel Corp., a domestic corporation – Stock Dividend 50,000
Meralco, a domestic corporation – Property Dividend 50,000

Under the nontaxable inter-corporate principle, when dividends are received by a domestic or resident
corporation from a domestic corporation subject to tax, such dividend is tax-exempt. Pure stock dividends are also
tax-exempt. Thus, out of these dividends, only the 30,000 cash dividend received by a US corporation is subject to
regular income tax.

The gain on sale of real estate has been considered as part of the other taxable income since the creditable
withholding tax of 100,000 has been made.

The following recoveries were credited to allowance for bad debts:

Allowed as deduction by BIR when bad debts were written off 9,500
Not allowed as deduction by BIR when bad debts were written off 50,000

Tax benefit rule is a general principle in taxation which states than if a taxpayer deducted an item on his
income tax return and enjoyed a tax benefit, thereby in a subsequent year recovers all or part of that item he will
recognize gross income in the year the deducted item is recovered. (Dobson v. Commissioner, 320 U.S. 489)

When a written off receivable has been recovered in the succeeding year, the recovered amount must be
included in the gross income during the taxable year of recovery. However, under the doctrine of equitable
benefit, the amount recovered is only taxable to the extent of the tax benefit in the year the account was written
off. (Sec. 34E, NIRC)

Thus, only the recovery of 9,500 is included in the computation of regular income tax since the corporation
did not receive tax benefit out of the 50,000 recovery of written off bad debts.

The following refunds were credited to retained earnings:

Percentage tax refund 15,000

Income tax refund 10,000

Also under the tax benefit rule, refunds from taxes paid are taxable except those which are not deductible
from gross income. Thus, only the percentage tax refund of 15,000 is subject to regular income tax.
Schedule 3: Total Itemized Deductions

Advertising and Promotions 40,000

Bad Debts ¹ 130,000
Charitable Contributions ² 120,173
Commissions 300,000
Communication, Light and Water ³ 135,000
Depreciation 127,000
Insurance 10,000
Interest ⁴ 489,935
Losses ⁵ 421,000
Office Supplies 30,000
Professional Fees 60,000
Rental 100,000
Repairs and Maintenance 20,000
Representation and Entertainment ⁶ 47,500
Salaries and Allowances ⁷ 1,100,000
SSS, GSIS, Philhealth, HDMF and Other Contributions ⁸ 43,500
Taxes and Licenses ⁹ 32,600
Transportation and Travel 50,000
Total 3,256,708

(1) To be deductible, the claim must be ascertained worthless and the corresponding receivable should have
been written off within the taxable year. (Sec. 34E, NIRC; Sec. 102, Rev. Regs. No. 2) Thus, the bad debts of 130,000
is derived from the actual write off of bad accounts for the year.

(2) Under Sec. 34H of the NIRC, contributions to a science foundation is deductible in full while contributions
to churches is subject to the limit of 5% of the taxable income before contributions. Whereas;

Contributions to NCBA Science Foundation 76,000

Contributions to Catholic Church (883,465 x 5%) 44,173
Total 120,173

(3) The total amount of communication, light and water is computed as follows:

Light, power and water 120,000

Telephone, telegram and cable 15,000
Total 135,000
(4) If the taxpayer has interest income subjected to 20% final tax and at the same time incurred an interest
expense during the taxable year, the interest expense shall be reduced by thirty-three percent (33%)
effective January 1, 2009 as amended by R.A. 9337. Thus, the computation of the deductible interest
expense is computed as follows:

Interest Expense 500,000

Less: Tax Differential (30,500 x 33%) 10,065
Deductible Interest Expense 489,935

(5) The total amount of losses is computed as follows:

Loss from robbery 419,000

Loss from sale of transport equipment 2,000
Total 421,000

(6) Under Revenue Regulations No. 10-2002, representation and entertainment expenses of taxpayers
engaged in the sale of goods are subject to the ceiling of 0.05% of their net sales. Thus the amount of
47,500 is derived from multiplying the net sales of 9,500,000 by 0.05%.

(7) The total amount of salaries and allowances is computed as follows:

Salaries and Wages 900,000

Bonuses 200,000
Total 1,100,000

(8) The total amount of SSS, GSIS, Philhealth, HDMF and other contributions is derived by adding together the
SSS contributions and the pension trust contributions. Section 34J of the tax code provides that the
allowable deduction as pension trust is equal to the provision for the payment of reasonable pension to
employees or actual contribution to the plan whichever is lower, and the excess of actual contribution
over the actuarial valuation is to be amortized over the period of 10 years. The computation is as follows:

SSS Contributions 6,000

Pension Trust Fund Contribution
Actual Contribution 25,000
Amortization of Excess Contribution [(150,000 - 25,000) / 10 years] 12,500 37,500
Total 43,500
 (9) As a general rule under Section 80 of the Revenue Regulation No. 2, taxes are allowed as deduction when
paid or incurred within the taxable year in connection with the taxpayer’s profession, trade or business.
However there are some taxes that are not deductible. The following taxes and licenses are deductible
from gross income:

Graduated Fixed Tax 9,000

Community Tax 1,000
Municipal Tax on Business 15,000
US Income Tax on Dividend* 6,100
Other Taxes and Licenses 1,500
Total 32,600

*Under 34C of the NIRC, the income tax paid to foreign countries may be treated as an item of
deduction or tax credit at the option of the taxpayer.

Schedule 4: Total Tax Credits

Income Tax Payments under Regular Rate from Previous Quarters 103,147
Creditable Tax Withheld from Previous Quarters 4,500
Creditable Tax Withheld for the 4th Quarter 101,500
Total Tax Credits 209,147

Further computation of the total tax credits is shown below:

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

Gross Income 987,000 892,500 1,002,500 1,129,500
Less: Itemized Deductions 863,617.65 767,000 892,558.82 699,323.53
Net Income, this quarter 123,382.35 125,500 109,941.18 430,176.47
Net Income, prior quarters - 123,382.35 248,882.35 358,823.53
Taxable Income 123,382.35 248,882.35 358,823.53 789,000
Tax Rate 30% 30% 30% 30%
Income Tax Due 37,014.71 74,664.71 107,647.06 236,700
Less: Tax Credits
CWT, this quarter 1,500 1,500 1,500 101,500
CWT, prior quarters - 1,500 3,000 4,500
Total Credits 1,500 3,000 4,500 106,000
Difference 35,514.71 71,664,71 103,147.06 130,700
Less: Estimated Tax Paid, prior quarters - 35,514.71 71,664.71 103,147.06
Quarterly Tax Payable 35,514.71 36,150 31,482.35 27,552.94