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Retroactivity of OSD rules to 2009

Retroactivity of OSD rules to 2009 by: Roy N. Relato

The deadline for the filing of the annual income tax return (ITR) for taxpayers using the calendar year method for the taxable year 2009 is in less than a month.

As we all know, taxpayers have the option to use either the itemized deduction scheme or the Optional Standard Deduction (OSD) in computing the taxable income in the annual ITR. Whereas there are no limits on the amounts of deductible ordinary and necessary expenses in the itemized deduction scheme, the OSD is limited to only 40 percent of an individual’s gross sales or receipts, or 40 percent of a corporation’s gross income.
Moreover, unlike in the itemized deduction scheme, a taxpayer under the OSD regime is not required to substantiate the amount of deduction with official receipts and other adequate records.

The Bureau of Internal Revenue (BIR) recently issued Revenue Regulations (RR) No. 02-2010 which amended the rules laid down under RR 16-2008 on the election to claim the OSD or the itemized deductions. Under RR 16-2008, a taxpayer may use either the itemized deduction or the OSD in the quarterly ITR, and the taxpayer’s choice must be indicated in the annual ITR. Under RR 02-2010, however, the election to use either the OSD or the itemized deductions must be signified in the ITR filed for the 1st quarter of the taxable year. Once the election is made, the same type of deduction must be consistently applied for all the succeeding quarterly ITRs and in the annual ITR. Failure to indicate the election to avail of the OSD in the 1st quarter ITR or failure to file the 1st quarter ITR shall mean that the taxpayer chose to avail of the itemized deductions for the taxable year.

Subsequently, the BIR issued Revenue Memorandum Circular (RMC) No. 16-2010 which prescribes the rules for the disclosure of the taxpayer’s election to avail of the OSD for the taxable year 2009. Under RMC 16-2010, taxpayers electing to avail of the OSD are required to check the appropriate box in the 1st quarter ITR (BIR Form No. 1702Q) of the taxable year 2009, regardless of whether such taxpayer is adopting the calendar or fiscal year method of reporting. Failure to indicate the election to avail of the OSD in the 1st quarter ITR or failure to file such return shall mean that the taxpayer chose to avail of the itemized deduction for the taxable year 2009. The election to avail of the OSD or itemized deduction is irrevocable for the taxable year 2009 and such irrevocability is not affected by any amendment by the taxpayer of his 1st quarter ITR.

The main issue that needs to be resolved in the issuance of the RMC is whether RR 02-2010 may be given retroactive application for the taxable year 2009. In general, any revocation, modification, or reversal of any of the rules and regulations or any rulings or circulars promulgated by the Commissioner of the BIR shall not be given retroactive application if the revocation, modification or reversal will be prejudicial to the taxpayers (Section 246, Tax Code). As previously mentioned, the RMC requires that the election to use the OSD already be made known by the taxpayer in his 1st quarter ITR for the taxable year 2009. It must be noted, however, that at the time the RMC was issued, most of the taxpayers have already filed their 1st quarter ITR since under the Tax Code, the deadline for filing the said return is 60 days from the close of the taxable quarter.  This means that for taxpayer’s using the calendar year as accounting period, the last day for filing was last June 1, 2009. Thus, it would be impossible to comply with the RMC since the taxpayers have already filed the 1st quarter ITR.  

Hence, the retroactive application of the RMC to the 1st quarter ITR of taxable year 2009 should not be allowed because it would be prejudicial to taxpayers.

Moreover, the RMC provides that even if the taxpayers file an amended ITR for the 1st quarter o f taxable year 2009, such amendment will not change the irrevocability of the decision of the taxpayer in the originally filed return. In effect, the RMC does not give the taxpayers a chance to exercise their right to avail of the OSD and instead deprives them of such right by judging their choice of method of deduction on the basis of a return filed prior to the release of the RMC. Such provision runs counter with the due process clause of our Constitution. Hence, in addition to being prejudicial to taxpayers, the validity of the RMC should also be challenged because it violates the taxpayer’s right to due process.

Then, what should the taxpayers do in the meantime? Taxpayers who failed to elect the use of the OSD in the 1st quarter ITR for 2009 have the option to either question the validity of the RMC before the courts or simply accept the RMC.  On the other hand, since the 1st quarter of the current year is about to end this March, it would be prudent for taxpayers to evaluate the method of deduction that is beneficial to them and to signify their decision in the 2010 1st quarter ITR.