IMPROPER ACCUMULATED EARNINGS TAX

Report By : Rebecca A. MacaraegGroup 1

Overview of IAET

• IAET imposed upon every corporation formed or availed for the purpose of avoiding the income tax with respect to its shareholders or the shareholders of any other corporation, by permitting earnings and earnings and profits to accumulate instead of being divided or distributed. Hereunder are its feature to picture out:

Imposed as a penalty tax to recover lost revenue

• IAET is a penalty tax upon a corporate taxpayer for accumulating so much net income after tax beyond the reasonable needs of the business. Section 43 of the Corporation Code of the Philippines in effect prohibits a stock corporation to maintain a retained earnings more than 100% of its paid-up capitalization.

In a corporate set-up, stockholders-owners get their share in the earnings in the corporation through the dividends from retained earnings. Dividend declaration is dependent upon the will of the Board of Directors and upon declaration cash and /or property dividend to resident individual stockholder is subject to 10% final tax on dividends. No dividend declaration by the Board of Directors means that the government will lose revenue from dividend tax. As such, IAET in the Philippines is imposed to recover the revenue it should have earned. Aside from the 10% IAET, SEC likewise provides a penalty for such excess.

Tax rate is 10% based on improperly accumulated

earnings

• As a mechanism to recover lost revenue, the tax rate is patterned after the rate the government should have earned. Since tax on dividends to residents individual is 10%, then, the tax rate imposed is the same. Thus, Section 29 of the National Revenue Code of the Philippines imposes a 10% improperly accumulated earnings tax.

Imposition is not outright upon the mere improper accumulation

• The mere fact that the retained earnings exceed 100% of the paid up capitalization at the end of a taxable year does not mean and outright tax liability for IAET. What is being tax is the improper accumulation and not the mere accumulation. Improper means the unjustifiable accumulation beyond the reasonable needs of the business. In determining the reasonable needs, the amount of paid up capitalization is considered, but does not include additional paid-up capital under RMC no. 35-2011.

As a rule, the corporate taxpayer has within one (1) year or twelve months from the end of the taxable year within which to dispose of or remedy the excess retained earnings. Under the rules of the SEC such corporate taxpayer must come up with a concrete plan as to the disposition of such excess. It is the failure to dispose of such excess upon the lapse of one(1) year that is being penalized and subjected to improperly accumulated earnings tax.

One simple approach is to appropriate part of retained earnings for some future use through a Board Resolution- e.g. appropriations for business expansion, redemption of a long term obligation, and more. But mere appropriation of retained earnings without implementation may not be safe. Another approach is a cash or property or stock dividend declaration securing a notation with the SEC. Another is increasing authorized capitalization with SEC either by cash infusion, stock dividend declaration, tax-free transfer, and more.

Imposed upon improperly accumulated earnings on holistic

view

• Taxable net income is subjected to 30% income tax. Net income after income tax is allowed to accumulated beyond 100% of paid-up capitalization is the tax based of improperly accumulated earnings tax. Improperly accumulated taxable income as a tax base of the 10% improperly accumulated earnings tax is further adjusted by the following:

• Income exempt from tax; • Income excluded from gross

income;• Income subject to final tax;• The amount of net operating loss carry-over deducted

In short, the improperly accumulated earnings as a tax base is the entire income of the corporation because it includes all income it earned during the year, regardless of whether or not it was subjected to 30% normal income tax. It is however reduced by the amount of dividends actually or constructively paid.

No duplication of the tax

• Normally, this tax type is being paid during tax assessments . Once the 10% improperly accumulated earnings tax has been paid, such amount could no longer be subjected to IAET in the subsequent year. To do so would be a direct duplicate taxation tantamount to a violation of equal protection clause. Nevertheless, is still suggested to dispose of the excess free retained earnings. Remember, it is always better to prevent an issued with the tax authority (BIR), than to defend one.

Does not apply to the following

Not all corporate taxpayers are subject to the 10% improperly accumulated earnings tax . The following are exempted, to wit:• Publicly held corporations; • Banks and other non-bank financial intermediaries;• Insurance companies;• Taxable Partnership;• General professional partnerships;• Tax-exempt joint ventures;• Economic Zone (Eco zones) under special tax rates ; and,• Philippines branch of a multinational company

SEC scale of fines of Section 43 of Corporation Code of the Philippines

Excess in Retained Earnings

Stock Corporations are prohibited from retaining surplus profits in excess of one hundred percent (100%) of their paid in capital:• First offense - Retained Earnings

less paid-up capital x .001 or a minimum of P1,000

• Second offense - Retained Earnings less paid-up capital x .001 or a minimum of P1,000

• Third offense - Retained Earnings less paid-up capital x .001 or a minimum of P1,000