Improperly Accumulated Earnings Tax
Section
29 of the National Internal Revenue Code (NIRC) of 1997, as amended, imposes
Improperly Accumulated Earnings Tax (IAET) on corporations for each taxable
year on the improperly accumulated taxable income of such corporations. It is
equal to 10 percent of the improperly accumulated taxable income.
This
tax applies to every corporation which is formed or availed of for the purpose
of avoiding the imposition of income tax on the income received by shareholders
of the corporation, by permitting its earnings or profits to accumulate,
instead of being divided or distributed. Based on Section 6 of Revenue
Regulations (RR) 2-2001, the
dividends must be declared and paid or issued not later than one year following
the close of the taxable year, otherwise, the IAET, if any, should be paid
within 15 days thereafter.
The
IAET is imposed to discourage tax avoidance through corporate surplus
accumulation. When corporations do not declare dividends, income taxes are not
paid on the undeclared dividends received by the shareholders. The tax on
improper accumulation of surplus is essentially a penalty tax designed to
compel corporations to distribute earnings so that the said earnings by
shareholders could, in turn, be taxed (GR 108067. January 20, 2000).
There
are instances when IAET does not apply despite accumulation of earnings and
profits of a corporation. The IAET does not apply to (a) Publicly held
corporations, (b) Banks and other nonbank financial intermediaries, and (c)
Insurance companies. RR 2-2001 likewise included taxable partnerships, general
professional partnerships, nontaxable joint ventures and enterprises duly
registered under special economic zones as exempt from the coverage of IAET.
Further,
if the failure to pay dividends is due to some other causes, such as the use of
undistributed earnings and profits for the reasonable needs of the business,
such purpose would not generally make the accumulated or undistributed earnings
subject to IAET. However, if there is a determination that a corporation has
accumulated income beyond the reasonable needs of the business, the 10-percent
improperly accumulated earnings tax shall be imposed.
While
there appears to be no clear-cut definition of the phrase “reasonable needs of
the business,” Section 29(E) of the Tax Code defines it to include the
reasonably anticipated needs of the business. RR 2-2001 defines the same as the
immediate needs of the business, including reasonably anticipated needs. In
either case, the corporation should be able to prove an immediate need for the
accumulation of the earnings and profits, or the direct correlation of
anticipated needs to such accumulation of profits. The computation of the
improperly accumulated earnings under Section 29 of the Tax Code, as amended,
excludes the earnings and profits of a corporation set aside for the reasonable
needs of the business (CTA Case 8295, May 15, 2015).
Under
Section 3 of RR 2-2001, the following constitute accumulation of earnings for
the reasonable needs of the business:
1.
a) Allowance for the increase in the accumulation of earnings up
to 100 percent of the paid-up capital of the corporation as of Balance Sheet
date, inclusive of accumulations taken from other years;
2.
b) Earnings reserved for definite corporate expansion projects
or programs requiring considerable capital expenditure as approved by the Board
of Directors or equivalent body;
3.
c) Earnings reserved for building, plants or equipment
acquisition as approved by the Board of Directors or equivalent body;
4.
d) Earnings reserved for compliance with any loan covenant or
pre-existing obligation established under a legitimate business agreement;
5.
e) Earnings required by law or applicable regulations to be
retained by the corporation or in respect of which there is legal prohibition
against its distribution;
6.
f) In the case of subsidiaries of foreign corporations in the
Philippines, all undistributed earnings intended or reserved for investments
within the Philippines as can be proven by corporate records and/or relevant
documentary evidence.
Thus,
if a company can justify the accumulation of its earnings as within the
reasonable needs of business, it is exempt from the imposition of IAET.
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