Deferred income tax complications under CITIRA

Almost two years after the enactment of the Tax Reform for Acceleration and Inclusion (TRAIN) law, corporations are gearing up for the second package in the government’s ongoing tax reform program. House Bill (HB) No. 4157, or the Corporate Income Tax and Incentives Rationalization Act (CITIRA), was approved by the House of Representatives on 13 September. It aims to gradually lower the corporate income tax rate and rationalize corporate tax incentives.

Currently, CITIRA is undergoing deliberations at the Senate and is expected to take effect beginning 1 January.

What are the changes in the income tax rates?

Currently, the regular corporate income tax (RCIT) rate is 30%. Entities with special registrations enjoy a gross income tax (GIT) rate of 5% or a special income tax rate of 10%.

Under CITIRA, the RCIT rate shall be reduced by one percentage point every year beginning 1 January, until 1 Janyuary, 2029, thereby reducing the rate to 20% from 30%. Aside from regular corporate taxpayers, the rate shall also apply to offshore banking units (OBUs) and regional operating headquarters (ROHQs) that are currently taxed at 10%, with the ROHQ being given a two-year transition period.

On the other hand, registered activities under the Strategic Investment Priority Plan will enjoy an Income Tax Holiday (ITH) incentive for three to six years depending on the business location. When the ITH incentive expires, they will be subject to a preferential income tax rate (PITR) or enhanced deductions for two to four years. The PITR is 18% commencing 1 January, but shall be reduced by one percentage point every two years beginning 1 January 2022, until 1 January 2030, bringing the rate down to 13% from 18%. The PITR shall apply to taxable income, calculated as gross income less deductions (such as direct costs, operating expenses, and other expenses).

A registered enterprise that opts to apply RCIT after the expiration of the ITH may avail of the enhanced deductions, which include:

• Depreciation allowance for qualified capital expenditure;
• Up to 50% additional deduction on direct labor expense and domestic input expense;
• Up to 100% additional deduction on research and development, training costs, and infrastructure development;
• Reinvestment allowance to manufacturing industry; and 
• Enhanced net operating loss carryover.

For existing registered activities under ITH, the transitory provision provides a five-year maximum period to avail of the combined remaining ITH period and 5% GIT incentive. For existing activities under 5% GIT, the transitory provision covers the following periods: two years (for activities enjoying the incentives for more than 10 years), three years (for those with incentives between five to 10 years), and five years (for incentives below five years).

After the end of the incentive period, registered enterprises shall be subject to RCIT.

How do changes in the rates affect both current and deferred income tax (DIT)?

For accounting purposes, the DIT assets or liabilities shall be determined using the tax rates that have been enacted or substantially enacted at the financial reporting date and are expected to apply when the related DIT assets are realized, or DIT liabilities are settled.

Let us assume that the entity has unrealized foreign exchange losses amounting to PHP100,000, as at 31 December 2019. Based on management evaluation, the unrealized foreign exchange losses will be realized in the next three years. The DIT asset shall be computed as follows:

For a registered enterprise enjoying tax incentives for 10 years and will be subject to PITR of 17% beginning 1 January 2022, the DIT asset shall be calculated as follows:

Based on the current rules, realized foreign exchange losses are not deductible from gross income for GIT calculation; hence, no DIT asset may be declared for 2020 and 2021. However, in the CITIRA, realized foreign exchange losses are recognized as a deductible expense; thus, the DIT asset will be calculated in the year when the entity shifts to the new PITR.

For companies with a fiscal year-end other than 31 December, the taxable income shall be computed without regard to the specific date when sales, purchases, and other transactions occur. The income and expenses for the fiscal year shall be deemed to have been earned and spent equally for each month of the period. In case the entity’s fiscal year-end is 31 March 2020, the taxable income from 1 April to 31 December, 2019, shall be subject to 30% while the taxable income from 1 January to 31 March 2020, shall be subject to 29%.

Using the same assumptions earlier and using a fiscal year-end of 31 March 2020, the calculations of the DIT asset become more complex, as follows:

More complicated calculations are expected for a registered entity with a fiscal year-end.

The same detailed calculations shall be performed for all other temporary differences.

Temporary differences are differences between the carrying amount of an asset or liability in the statement of financial position and its tax basis. These are deductible or taxable in determining the taxable profit or loss of future periods when the carrying amount of asset or liability is recovered or settled.

With barely two months before the year ends, companies should now start analyzing the impact of CITIRA in their tax compliance and financial reporting. Due to the complexities of income tax calculations that CITIRA may create, management should maintain orderly documentation to support their tax calculations and efficiently time the realization of deferred taxes.