Saturday, October 25, 2014

Improperly Accumulated Earnings Tax (Closely held Corporations)

Revenue Memorandum Circular (RMC) No. 35-2011 has issued by the bureau for the clarification of issues concerning the Imposition of Improperly Accumulated Earnings Tax Pursuant to Section 29 of the Tax Code of 1997, in relation to Revenue Regulations No. 2-2001.

1. In addition to other taxes imposed, there is imposed for each year on the improperly accumulated taxable income of each corporation an improperly accumulated earnings tax equal to 10% of the improperly accumulated taxable income. The objective of imposing improperly accumulated earnings tax is to force corporations to distribute dividends to shareholders in order that related tax in dividends will be collected.

2. Improperly accumulated earnings tax is imposed on improperly accumulated taxable income earned starting January 1, 1998 by domestic corporations as defined under the Tax Code and which are classified as closely held corporations. The improperly accumulated earnings tax shall NOT APPLY TO:

a. Publicly held corporation;

b. Banks and other non-bank financial intermediaries;

c. Insurance companies;

d. Taxable partnerships;

e. General professional partnerships;

f. Non-taxable joint venture; and

g. Enterprises registered with PEZA and under Bases Conversion and Development Act, special economic zones.

Closely held corporations are those corporations at least 50% in value of the outstanding capital stock or at least 50% of the total combined voting power of all classes of stock entitled to vote is owned directly or indirectly by or for not more than 20 individuals. Domestic corporations not falling under the aforementioned definition are, therefore, publicly-held corporations.

Certain Circumstances indicating Improper accumulation of profits:

1. Substantial changes to corporate officers who are stockholders at the same time/Personal loans.

2. Radical change in the nature of business after a considerable surplus has been accumulated.

3. Investment is unrelated business or activity.

4. Substantial expenditures of corporations for the personal benefit of stockholders only.
                       

PRESUMPTIONS of Improper Accumulation
a. The fact that any corporation is a mere holding company; or investment company shall be prima facie evidence of a purpose to avoid the tax upon its shareholders or members.

“Holding or Investment Company” shall refer to a corporation having practically NO ACTIVITIES except holding property, and collecting the income therefrom or investing the same

b. The fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of a business shall be determinable of the purpose to avoid the tax upon its shareholders or members, unless the corporation, by clear preponderance of evidence, shall prove to the contrary.

When is accumulation of profits Unreasonable?

If it is not required for legitimate business purposes, considering all circumstances of the case. 

The following are considered LEGITIMATE BUSINESS PURPOSES.

a. For additional working capital needed by the business.

b. For plant expansion of the business.

c. If, in accordance with contractual obligations, placed to the credit of a sinking fund for the purpose of retiring bonds issued by the corporation.

3. EFFECT of IAET: Once the profit has been subjected to IAET, the same shall no longer be subjected to IAET in later years, even if not declared as dividends. Notwithstanding the imposition of the IAET, profits which have been subjected to IAET, when finally declared as dividends, shall nevertheless be subject to tax on dividends under the Tax Code, except in those circumstances where the recipient is not subject thereto.

4. Proforma computations of improperly accumulated taxable income.

Taxable Income for the year (e. g., 2010)                                                     P xxx
Add:
 (a) Income subjected to Final Tax                           P xxx
 (b) Income exempt from tax                                       xxx
 (c) Income excluded from gross income                    xxx
 (d) NOLCO                                                                 xxx                                 xxx

Less: 
Dividends, actually or constructively paid                   xxx 
Income tax paid for the whole year                              xxx                                 xxx
Total                                                                                                                    xxx  
Add: Retained Earnings from prior years
Accumulated Earnings as of December 31, 2010
Less: Amount that may be Retained
          (100% of Paid-Up Capital as of December 31, 2010)
          or Amount reserved for the reasonable needs for the business                  xxx 
Improperly accumulated earnings or
Improperly Accumulated Taxable Income                                                 P   xxx

Multiply by: Tax Rate                                                                                          10%

Improperly accumulated earnings tax                                                         P  xxx

5. Reasonable needs of the business include the reasonably anticipated needs of the business.

6. The IAET is not computed and applied by the corporation on itself in its income tax return for a taxable year. The BIR makes the computation on its allegation of improper accumulation of profits by the corporation. The BIR makes a computation a year or years after the improper accumulation shall have taken place.

SOURCE: http://www.bir.gov.ph/images/bir_files/old_files/pdf/59678RMC%20No%2035-2011.pdf and http://www.bir.gov.ph/images/bir_files/old_files/pdf/rr02_01.pdf

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