Not everyone’s option

House Bill No. 4157 or the Corporate Income Tax and Incentives Rationalization Act (CITIRA) is on its way to the Senate after being approved on third reading in the House of Representatives.

Of the changes introduced by this Bill — known also as Package 2 of the TRAIN Law — one that would be of interest to many taxpayers is the amendment on Optional Standard Deductions (OSD). The CITIRA Bill proposes to amend the OSD in two ways: (1) change the OSD base for individuals from gross revenue to gross income, and (2) limit the availability of OSD on corporations to those classified as Micro, Small, and Medium Enterprises, or MSMEs.

Currently, all taxpayers, whether individuals or corporations, subject to the regular income tax are allowed to avail of OSD. CITIRA, however, amends this. It retains the qualification of all individual taxpayers, but has provided additional requirements for corporations, i.e., corporate taxpayers must be classified as MSMEs, as determined by the Department of Trade and Industry (DTI).

On the other hand, the change in the base of the 40% OSD to gross income puts both individual and corporate taxpayers on the same footing.

How will these proposed changes affect us?

Under current tax law, OSD gives the taxpayer a choice of computing for tax-deductible expenses at 40% of gross sales or receipts, if the taxpayer is an individual, or on gross income, if a corporation. This is in lieu of itemizing expenses to be claimed as tax deductions.

A choice of OSD means less work since it does away with the listing of expenses and the determination of whether these expenses are allowed deductions of income. Each type of expense has its own elements to be allowed deductions in computing net income subject to tax. And because there is no need to list down the deductions made, the law does not require the attachment of audited financial statements to the income tax return in the case of individuals.

A choice of OSD also benefits the Bureau of Internal Revenue (BIR) in examining the books of taxpayers. Because there is no need to review the expenditures covered by the OSD, examiners can focus on the components of the gross revenue or gross income and determine its completeness and accuracy. In this way, the audit may be completed sooner, and examiners can also increase the number of taxpayers they can review.

Despite the benefits of using OSD, the number of taxpayers availing of the method is still low. Only 22% of individuals engaged in business chose OSD. A higher availment rate of 38% was recorded among taxpayers practicing a profession.

The OSD of 40% for individuals is currently being applied on gross sales or receipts to get the tax due. Based on Revenue Regulations (RR) No. 16-08, “gross sales” and “gross receipts” pertain to total sales or receipts earned by an entity in a taxable period without deducting the cost of the sales or services. To benefit from tax savings under the OSD, a taxpayer must have a profit margin of more than 60%. Hence, taxpayers with much smaller profit margins, usually those engaged in trading or manufacturing, will not choose OSD.

On the other hand, “gross income” is the net amount of gross sales or receipts after deducting sales returns, discounts, allowances, and cost of goods sold or services provided, where the cost of goods sold includes the purchase price or the cost to produce the merchandise, such as direct labor cost, and all expenses directly incurred in bringing the goods to their present location and the use of which could include import duties, freight, and insurance.

Gross income as the OSD base should be fairer and more favorable to individual taxpayers because they can deduct their cost of goods sold and cost of service. The OSD will just be in lieu of administrative and other non-operating expenses.

Will the numbers significantly change for corporations?

Based on the Magna Carta for MSMEs, MSMEs are primarily defined based on their total assets, inclusive of those arising from loans, but exclusive of the land on which the particular business entity’s office, plant, and equipment are situated. They must have value falling under the following categories: micro (not more than P3 million); small (P3,000,001 to P15 million); and medium (P15,000,001 to P100 million).

Based on the Philippine Statistics Authority (PSA), 924,724 business enterprises were operating in the Philippines in 2017, and of this, 99.56% are MSMEs.

Given these, the CITIRA Bill, in providing the option for the MSME sector to avail of the OSD, is upholding the objective of the government to promote, support, strengthen and encourage the growth and development of MSMEs by maintaining a conducive business environment in the form of a deduction option favorable to them in a given taxable year.

Meanwhile, based on the above definition, corporations having assets valued at more than P100 million will have no choice but to itemize their expenses claimed as deductions against income. These large enterprises comprise only 0.44% or just about 4,000 out of the total registered business enterprises.

In all cases, taxpayers must be cautious in exercising their right of choice because, with all the amendments introduced, Congress retains the provision that, once the choice has been made and was signified in the return, the choice is irrevocable for the taxable year for which the return was made.

Let’s Talk Tax is a weekly newspaper column of P&A Grant Thornton that aims to keep the public informed of various developments in taxation. This article is not intended to be a substitute for competent professional advice.

Maria Cecilia Lourdes R. Pilotin is a tax associate of Tax Advisory & Compliance division of P&A Grant Thornton, the Philippine member firm of Grant Thornton International Ltd.

As published in BusinessWorld, dated 24 September 2019