Year-end adjustments under OSD
Year-end adjustments under Optional Standard Deduction
By Lina P. Figueroa
For many business entities, particularly those whose fiscal year coincides with the calendar year, yearends are busy periods, since there are numerous adjustments and reconciliations that have to be made for tax purposes.
These entities also have to comply with reportorial requirements pertaining to operations during the year.
For the purposes of the company’s withholding liabilities with respect to the compensation income paid to employees, there is an annualization process that allows the company to comply with the requirement to zero-out the tax liabilities of their employees at yearend on the basis of the tax status information provided to them.
On the corporate income tax side, there are decisions on when to accrue income and expenses and which of such income and expenses should be properly reported in the income tax return.
The Optional Standard Deduction (OSD) for corporations under Republic Act No. 9504, which should have become effective beginning last July, could further complicate the year-end adjustments that have to be undertaken by corporations, depending on how the OSD will apply on 2008 income.
The OSD refers to an option to compute the corporation’s taxable income by taking a standard deduction equivalent to 40% of the computed gross income. This is in lieu of taking as tax deduction the total of all the operating expenses actually incurred by the company that qualify as allowable deductions under the Tax Code and the regulations.
The primary consideration in choosing between the OSD and the itemized deduction will depend on which system will give the company more tax benefits considering the company’s cost structure.
The implementing regulations have not been issued yet. It is hoped that the regulations on the implementation of the OSD will be issued before the year ends.
Pending this, however, taxpayers have to anticipate what the rules will be and plan for the closing of their books. Several other considerations may be surmised under some possible scenarios.
Considering the manner by which the Bureau of Internal Revenue (BIR) implemented the new income tax rules applicable to individuals, it is unlikely that the OSD will be allowed to apply for the whole year of 2008. Hence, the OSD will most likely commence to be an option on July 2008. Thus, there are two possible scenarios:
- BIR would allow corporations to compute their taxable income from July to December using the OSD, while the itemized deductions apply on income from January to June; or
- BIR will require that only one system be applied throughout the year.
If the BIR allows the combination of OSD and itemized deductions for 2008, the corporation may have some evaluations to make if it will opt to avail of the OSD for the last two quarters.
Has it properly reported all its income and expenses from January to June in the first- and second-quarter income tax returns? Were there operating expenses that should have been properly claimed in the first two quarters but were not yet reported and will be taken only in the fourth quarter?
Under the OSD, such operating expenses will not have any additional tax benefit because the computation of the taxable income using the OSD stops at the level of the gross income.
With the OSD, the corporate income tax is effectively computed on gross income, at a lower effective rate of 21% under a 35% regular corporate income tax.
Would the company still have an opportunity to amend its first and second quarterly returns to include these expenses where they can enjoy tax benefits under the itemized system of claiming deductions?
At this point, the company may also be better off reviewing whether it is correctly computing its gross income. If there are expenses that should have been properly classified as cost of goods sold or cost of service, but were instead claimed as operating expenses, such expenses will not yield tax benefi
ts under the OSD.
Remember, any expense that does not impact on gross income will not impact on the level of taxable income and tax due under the OSD.
The introduction of the OSD this year may also affect the deferred income taxes (DIT) that have to be set up for expenses at the end of the year. To be able to properly set up the DIT, the company must evaluate whether it is inclined to avail of the OSD or the itemized deductions in the tax year when these deferred expenses will be reported as deductible expenses for the purpose of the corporate income tax.
A deferred tax asset may or may not be an asset depending on whether it is an expense classifiable as cost of sale or operating expense and whether the company will opt to avail of the OSD or the itemized deductions.
As with any new system, the impact of the OSD and required adjustments should be carefully examined to be able to evaluate whether it is something that the company would choose to apply and how.
For additional information on OSD, we invite you to attend the P&A Tax Seminar on yearend adjustments and updates ("Withholding on compensation, the corporate income tax and the OSD") this November 26 at the Renaissance Makati City Hotel. For details, please contact Marge Antonio at 886-5511 local 519, or visit our Web site www.punongbayan-araullo.com.
(The author is a tax director at Punongbayan & Araullo, a member firm within Grant Thornton International Ltd. For comments and inquiries, please e-mail Lina.Figueroa@pna.ph or call 886-5511.)