We are happy when we have choices. Choices give us the feeling that we are in control. It also gives us a sense of freedom and flexibility, whether it is deciding on the route to take using the options provided by Waze, or the food to pick at a buffet restaurant.
Income taxpayers engaged in business, or professional practice with annual gross sales or receipts not exceeding the value-added tax (VAT) threshold of P3 million, will now have choices affecting their income tax. The recently passed Tax Reform for Acceleration and Inclusion (TRAIN) Law offers the following choices for such taxpayers:
1. 8 percent income tax on gross sales or receipts over P250,000 + zero percentage tax;
2. 0 percent – 35 percent income tax on net taxable income computed based on 40 percent Optional Standard Deduction (OSD) + 3 percent percentage tax, or 12 percent VAT; or
0 percent – 35 percent income tax on net taxable income computed based on itemized deductions + 3 percent percentage tax, or 12 percent VAT.
3. The tax scheme attempts to address the issues for which the old system was criticized: high tax rates and complicated compliance. Under the old regime, net taxable income of P3 million was subject to the 32 percent marginal tax rate. How does one evaluate these options?
For a taxpayer engaged in business or professional practice generating P3 million annually, the 8 percent gross receipts tax (GRT) would result in P220,000 in tax due (P3 million less P250,000 x 8 percent). This new regime addresses both the objectives of simplicity and a low tax rate.
If the taxpayer chooses the graduated rates with the optional standard deductions, their income tax will be P430,000 (P3 million less 40 percent of P3 million x income tax at 30 percent marginal rate), or 14.33 percent of gross revenues. In addition, they have to pay a 3 percent percentage tax of P90,000, pushing the effective tax rate to 17.33 percent.
For some taxpayers, an income tax below P220,000 is likely as well. Someone selling goods is easily in that position. The 8 percent tax on gross sales or receipts is definitely not for those engaged in the sale of goods and incur significant cost of sales. Under the graduated rates and using itemized deduction, a seller of goods with P3 million gross revenues may be exempted from income tax if the profit margin does not exceed 8.3 percent, which would then yield a net income of P250,000 taxable at 0 percent. This particular taxpayer will pay lower income tax than those who will be using the 8 percent GRT, even if the profit margin generated is as much as 26 percent. This already considers that the taxpayer is still liable to the 3 percent percentage tax amounting to P90,000. Under the old regime, a P250,000 net taxable income was at the 25 percent marginal income tax rate.
Under the graduated rates, a self-employed taxpayer below the VAT threshold of P3 million is exempt from the 12 percent VAT and subject only to the 3 percent percentage tax on gross receipts. However, such taxpayer still has the option to register as a VAT taxpayer and be subjected to the 12 percent VAT.
But why would one prefer the 12 percent VAT over the 3 percent percentage tax?
VAT, if implemented properly, shall not affect the taxpayer’s profits. The taxpayer can pass on the 12 percent VAT to customers and recoup any VAT paid on supplies and other expenses as credit against the VAT payable.
The 3 percent percentage tax, on the other hand, is an additional expense to the taxpayer, which can be claimed as a deductible expense. The percentage tax is not fully passed on to the customer. The deductibility, however, will not translate to a benefit if the taxpayer opts for the OSD. Under the itemized deduction scheme, on the other hand, the benefit of paying the percentage tax will only be to the extent of the applicable marginal income tax rate.
Those are the numbers. The decision, however, cannot simply be based on numbers. Each tax regime has its own set of compliance requirements and advantages/disadvantages that should be considered. Just as in choosing the route to take based on the recommendations of Waze, you also consider safety, the quality of roads, and even the view.
The documentation of deductions is not much of a concern for a taxpayer opting to pay the 8 percent tax on gross receipts, or the OSD on graduated rates. In contrast, claiming itemized deductions (which could probably result in the taxpayer being exempt from income tax) has the added burden of maintaining the proper documentation to support the expenses, as well as withholding the correct taxes on income payments.
Between the effectively zero tax burden of VAT and the 3 percent percentage tax, the other consideration is the more stringent compliance and documentation requirements under the VAT regime. How much then would you as a taxpayer be willing to pay in terms of taxes in exchange for these simplifications?
These are some of the considerations that we have to factor in when we have choices. People averse to undergoing such analysis sometimes prefer a “no choice” situation. If these choices are applicable to you as a taxpayer, are you happy that you have these choices?
Lina Figueroa is a principal at the Tax Advisory and Compliance of P&A Grant Thornton. P&A Grant Thornton is one of the leading audit, tax, advisory and outsourcing firms in the Philippines, with 21 partners and over 850 staff members. For your comments, please email firstname.lastname@example.org or PAGrantThornton.email@example.com. For more information about P&A Grant Thornton, visit our website www.grantthornton.com.ph.