Q: It is tax season once again and I am preparing to file for income tax this week. I understand that one way to lower income payments is by increasing expenses. I have prepared list of expenses but I am not sure if these are acceptable. What are the expense items that I should review before I submit to the BIR (Bureau of Internal Revenue)? – Veron, by email
A: With the deadline for income tax filing fast approaching, one of the tasks you should be doing now is to review your income tax returns. Determine how your income tax has been computed and see if your revenues and expenses have been properly recognized and declared.
So how do you get started?
One way to check your income tax is to look closely at your expenses. For tax computation purposes, BIR does not allow every business expense that you incur to be deducted from your taxable income.
For example, you might have included business expenses in your income statement that the BIR may not recognize unless they are supported by official receipts. There are also some expenses that must be documented properly to establish a direct connection between them and your business. These expenses, if disallowed by the BIR, could translate into substantial taxes especially if they contribute a large portion of your operating expenses.
There are some entrepreneurs who claim personal expenses as official expenses of the business. As a rule, personal or living expenses are not allowed by the BIR as business expenses.
This practice sometimes goes unnoticed by the tax agency. However, red flags are raised if the amount involved is large, especially when the amount is classified as representation expense. The BIR defines representation expenses as necessary expenses incurred in providing entertainment, amusement, or recreation to clients.
Among the personal expenses that are typically passed off as representation expenses are eating out, going to a country club, watching movies and concerts, and similar recreational activities. Under BIR rules, a service company can claim only up to 1% of the total net sales of the business as representation expense. On the other hand, a business engaged in selling goods and properties can claim only up to 0.5% of its total net sales as representation expense.
For example, if the total net sales of your food business is P1 million ($21,701.38), the maximum representation expense that you can claim would be only P5,000 ($108.41).
The next item you should review is your compensation expenses. Even if you already withhold taxes on your employees’ salaries and incur other payroll-related deductions, you also need to look at other compensation expenses.
For instance, do you provide your managers with car plans or housing as incentives? Do you provide your manager expense accounts? Do you give special financial assistance to some of your employees? If so, then you need to pay additional taxes, one of which is the fringe benefit tax.
The fringe benefit tax is computed by dividing the monthly expense amount by 68%, and then multiplying the quotient by 32%; the result of this 2-step process is the fringe benefit tax.
For example, if you provide your manager a housing allowance of P15,000 ($325.24) a month, you will need to pay a fringe benefit tax of P7,058 ($153.04) on top of the expense.
Other items that you need to check are expenses that require you to withhold a certain amount from the payee: an amount that you yourself must remit to the tax agency.
In essence, you are advancing to the BIR the income taxes of those receiving the payments from you. These include rental expenses, professional fees, and commission expenses. The tax rates differ according to the type of expense.
For example, if you pay a rental fee of P25,000 ($542.07) a month, you are required to withhold 5% of the amount in behalf of the BIR so you pay your landlord only P23,750 ($514.97).
If you pay a commission to your contractor, you need to withhold 10% of the payment. Failing to withhold taxes due these payments could lead to penalties for your business.
To minimize your taxable income, look for ways to increase your expenses legally. One way to do this is by depreciating newly acquired assets used in the business. To maximize your depreciation expenses, select the most appropriate depreciation methods and accurately estimate the useful life of the property.
If you borrowed money from a financing institution to acquire an asset, you have the option to classify the interest costs on that loan as an expense so you can lower your taxable income.
You can also check your accounts receivable, or money owed to you by a customer for products or services provided on credit you might find in them some bad accounts that need to be written off.
Once you have determined that the account is no longer collectible, you can charge it under expenses. These are some of the things that you need to consider when reviewing your expenses for your tax payments. Being aware of tax regulations and their implications will help structure your business properly and minimize taxes legally.
Henry Ong, CMC, is president of Business Sense Financial Advisors. You can follow him at @henryong888 or email hong[at]businesssense.com.ph.
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