A.

Income Tax however, the fact that earnings or profits of a

1. Regular Income Tax - A domestic corporation is corporation are permitted to accumulate beyond the
taxable on all income derived from sources within reasonable needs of the business is determinative
and without the Philippines. The general corporate of the purpose to avoid the tax upon its
income tax rate on taxable income is 30%. For shareholders or members unless the corporation,
purposes of computing taxable income, the Tax by clear preponderance of evidence, proves the
Code allows certain deductions. In lieu of an contrary. The phrase “reasonable needs of the
itemized deduction, the Tax Code allows a standard business” includes the reasonably anticipated
deduction of 40% of the gross income. needs of the business.
2. Minimum Corporate Income Tax - Under the
Tax Code, a minimum corporate income tax B. Value-Added Tax Value-added tax (“VAT”) is a
(“MCIT”) of 2% of the gross income of a corporation tax on consumption levied on the sale, barter,
is imposed beginning on the 4th taxable year exchange or lease of goods or properties and
immediately following the corporation’s services in the Philippines and on importation of
commencement of business operations, when such goods into the Philippines. VAT is imposed upon the
MCIT is greater than the tax computed using the seller, who may pass on the same to the buyer,
30% regular or normal tax rate.7 Any excess MCIT transferee or lessee of the goods, properties or
over the regular income tax is carried forward and services.
credited against the regular income tax of the
corporation for the three immediately succeeding C. Donor’s Tax Donor's tax is imposed upon the
taxable years. transfer by any person of property by gift as
provided under Section 98 of the Tax Code. While
3. Final Tax on Passive Income the Tax Code does not define transfer of property by
gift, donation is defined in Article 725 of the Civil
Code as an act of liberality whereby a person
disposes gratuitously of a thing or right in favor of
another, who accepts it. Donation has the following
elements: (a) the reduction of the patrimony of the
donor; (b) the increase in the patrimony of the
donee; and, (c) the intent to do an act of liberality or
animus donandi. In a sale transaction where the
fair market value of the property sold exceeds its
selling price, the excess is considered a donation
even in the absence of animus donandi.

4. Improperly Accumulated Earnings Tax In

addition to the other taxes imposed on domestic When the donee or beneficiary is a stranger, the tax
corporations, the Tax Code imposes a 10% tax on payable by the donor shall be thirty percent (30%)
“improperly accumulated taxable income” of of the net gifts. For the purpose of donor’s tax, a
corporations formed or availed for the purpose of 'stranger', is a person who is not a: (1) Brother,
avoiding the income tax with respect to its sister (whether by whole or half-blood), spouse,
shareholders or the shareholders of any other ancestor and lineal descendant; or (2) Relative by
corporation by permitting earnings and profits to consanguinity in the collateral line within the fourth
accumulate instead of being divided or distributed. degree of relationship.
This tax, however, does not apply to publicly-held
corporations, banks and other non-bank financial D. Documentary Stamp Tax The documentary
intermediaries and insurance companies. stamp tax (“DST”) is an excise tax levied on
The fact that a corporation is a mere holding documents, instruments, loan agreements and
company or an investment company is prima facie papers evidencing the acceptance, assignment,
evidence of a purpose to avoid the tax upon its sale or transfer of an obligation, rights, or property
shareholders or members. As a general rule, incident thereto.
E. Assessment of National Internal Revenue c. Preliminary Assessment Notice The
Taxes The Philippines follows the pay-as-you-file Assessment Division of the BIR will determine if
system in the enforcement and collection of taxes. there is sufficient basis to issue a deficiency tax
In the pay- as-you-file system, the taxpayer assessment. If there is, a Preliminary Assessment
determines the amount of tax due, files his return Notice (“PAN”) will be issued to the taxpayer, at
and pays the tax based on his own computation. least by registered mail. A PAN informs the
The pay-as-you-file system obliges the taxpayer to taxpayer of the audit findings of the Revenue Officer
conduct self assessment in order to determine and after a review of the said findings.
declare the amount to be used as the basis for the
computation of the tax liability, any deductions d. Formal Letter of Demand and Assessment
therefrom, and finally, the tax to be paid. The tax Notice If the taxpayer fails to respond within 15
due is paid at the time the return is filed. However, days from receipt of the PAN, the taxpayer will be
the BIR is empowered to ascertain the correctness considered in default. A Formal Letter of Demand
of the tax return filed and consequently, the amount (“FLD”) and Assessment Notice will thereafter be
of tax paid. issued by the concerned office. An Assessment
Notice is a declaration of deficiency taxes issued to
1. Prescriptive Period for Assessment The a taxpayer who fails to respond to the PAN or
assessment for national internal revenue taxes whose reply thereto was found not to be
must be made within three years from the last day meritorious. The FLD must state the facts, the law,
provided by law for the filing of tax return. When a rules and regulations or jurisprudence on which the
return is filed beyond the period laid down by law, assessment is based. It must also include a
the period will commence to run on the day the demand for payment of deficiency taxes, otherwise,
return is filed. However, if the return is filed before the FLD and Assessment Notice will be void.
the last day of filing, the three-year period will be
counted on such last day. e. Administrative Protest A taxpayer has 30 days
A “false return” is that which contains wrong from receipt of the FLD and Assessment Notice to
information due to mistake, carelessness or protest the same administratively through either a
ignorance; while a “fraudulent return with intent to request for reconsideration or a request for
evade tax” is a crime involving moral turpitude as it reinvestigation. All the relevant supporting
entails willfulness and fraudulent intent on the part documents to the protest must be submitted within
of the individual. Fraud may be established by the: 60 days from filing of the request for reinvestigation.
(a) intentional and substantial understatement of tax Otherwise, the assessment will become final,
liability by the taxpayer; (b) intentional and executory and demandable.
substantial overstatement of deductions or
exemptions; or (c) the recurrence of the foregoing f. Appeal to the Court of Tax Appeals
circumstances. As for “failure to file a return,” the If the BIR denies the protest, in whole or in part, the
mere omission is already a violation regardless of taxpayer may appeal to the Court of Tax Appeals
the fraudulent intent or willfulness of the individual. (“CTA”) Division within 30 days from the receipt of
the decision by filing a petition for review.
2. Procedure in the Issuance of Deficiency Tax Otherwise, the decision will become final and
Assessment demandable.
a. Letter of Authority The BIR has the power to
issue a Letter of Authority (“LOA”) against a g. Appeal to the Supreme Court The decision of
taxpayer pursuant to Section 5 of the Tax Code the CTA En Banc can be questioned before the
which shall authorize the BIR, in ascertaining the Supreme Court by filing a Petition for Review within
correctness of any entry in the tax return, or in 15 days from receipt of the decision.
making a return where none has been filed, or in
ascertaining the liability of any person for internal F. Collection of National Internal Revenue Taxes
revenue taxes, or in collecting tax liability or in Once the assessment becomes final, executory,
determining tax compliance. and demandable by failure to protest the same
administratively and/or judicially, or the protest or
b. Notice of Informal Conference After the appeal is denied or decided against the taxpayer,
examination of the taxpayer’s books of accounts the government may avail of the following remedies
and accounting records pursuant to the LOA, a to collect deficiency taxes: (a) distraint of personal
notice of informal conference, informing the property; (b) levy of real property; (c) civil action;
taxpayer that the findings of the audit indicate that and (d) criminal action. Revenue Memorandum
deficiency taxes has to be paid, must be issued to Order (“RMO”) No. 39-200755 authorizes the
the taxpayer. immediate issuance and service of warrants of
distraint and garnishment and/or levy upon the from the date of assessment by administrative or
issuance of the final decision. judicial action.
III. Real Property Tax The Local Government Code
II. Local Business Taxes The provisions on local authorizes provinces to levy real property tax on
business taxes are codified in the Local real property such as land, building, machinery and
Government Code of 1991 (the “Local Government other improvements at the rate not exceeding 1% of
Code”). Under Section 129 of the Local the assessed value of the said property annually
Government Code, each local government unit while for cities
(“LGU”) has the power to create its own sources of
revenue and to levy taxes, fees and charges. LGUs A. Collection of Real Property Tax Real property
usually have their own Revenue Code levying tax must be collected within five years from the date
taxes, fees and charges which must not contravene they become due. In case of fraud or intent to
the Local Government Code. evade the payment of taxes, fees, or charges, the
action for collection must be instituted within ten
A. Community Tax Every corporation is required to years from discovery of the fraud or intent to evade
pay annually not later than the last day of February payment.
a basic community tax of PhP500.00 and an
additional tax which in no case shall exceed B. Protest of Real Property Tax Generally, a
PhP10,000.00, depending on the amount of gross protest can only be entertained if the taxpayer pays
receipts or earnings during the preceding year. The the real property tax. The words “paid under
community tax must be paid in the place where the protest” must be annotated on the tax receipts for
principal office of the juridical entity is located. In payment of real property tax. The protest must be
determining the gross receipts or earnings for filed within 30 days from payment of the real
purposes of this additional tax, dividends received property tax to the provincial, city treasurer or
from another corporation are included. municipal treasurer.

B. Business Taxes Corporations also have to pay CHAPTER 2: THE SAVANT FRAMEWORK
the annual business tax and other fees imposed by SAVANT stands for Strategy, Anticipation,
the LGU having jurisdiction over the corporation. Value-adding, Negotiating and Transforming.
These local taxes and fees must be paid within the
first 20 days of January each year. They may also STRATEGY Tax management should strive to
be paid in four quarterly installments. enhance the firm’s strategy and should not cause
For manufacturers, assemblers, contractors, the firm to engage in tax-minimizing transactions
producers and exporters with factories, project illegally that deter it from its strategic plan.
offices, plants and plantations, the following sales ANTICIPATION As the firm curves out its strategy,
allocation must be followed in determining the they should also anticipate actions that may be
amount of business taxes due for each LGU: done by their competitors, markets and even the
(a) 30% of all sales recorded in the principal office government.
is taxable by the LGU where the principal office is VALUE ADDING Every goal of an effective tax
located; and management for each transaction should at least
(b) 70% of all sales recorded in the principal office add value. Financial Statement analysis, together
is taxable by the city or municipality where the with others, is one which the management can
factory, project, office, plant or plantation is located. derive if there’s value-adding.
NEGOTIATING Negotiating tax benefits and costs
Where the plantation is located at a place other is a function with the other who has also control on
than the place where the factory is located, the 70% their functions. That is to say, contracting with
mentioned in the preceding sentence will be divided another which is not a governmental authority
as follows: TRANSFORMING Tax management should
(a) 60% to the LGU where the factory is located; effectively think of ways how to transform certain
(b) 40% to the LGU where the plantation is located tax types to another. Like for instance, a
non-deductible expense to a deductible one, a
C. Assessment of Local Business Taxes taxable income to a gain and expenses into losses.
1. Prescription of Local Business Taxes- Local
taxes, fees or charges must be assessed within five CHAPTER 3: CHOOSING A LEGAL ENTITY, RISK
years from the date they became due. MANAGEMENT, RAISING CAPITAL AND TAX
2. Procedure Governing Protest of Assessment MANAGEMENT
D. Collection of Local Business Tax Local
business taxes may be collected within five years
Capital Raising Raising capital essentially means Value-Adding A key aspect of debt financing is
getting the money you need to grow your business leverage. Debt adds value when debt increases
from investors. Raising capital is another way of operating cash flows in excess of the required
talking about financing your business. You can raise periodic payments of interest and repayments of
capital through investors, or you can take out debts, principal.
like loans or credit cards, to finance your business Negotiating Tax benefits from losses suffered by
venture. start-up companies are good negotiating tool.
Management Control Unlike in a sole Businesses that suffer operating losses can get
proprietorship which he has the sole control of the immediate tax benefits by carrying those losses
business, the other type of business such as back to offset profits.
partnership and corporation invites more decision Anticipation The company should anticipate
makers that will make judgment on the firm’s macroeconomic changes that will affect interest
venture. rates or taxlaw changes affecting interest
Anticipation and Timing Issues In a corporate deductions or tax rates on investors.
setting, it can control the timing of income to its Effect of Clienteles The optimal choice for capital
shareholders. For example, a corporation normally structure is highly influenced by the tax status of
can choose not to pay dividends investors in a firm’s debt or equity. This is
particularly the case where the investor clientele
CHAPTER 4: FINANCING A NEW VENTURE includes those who do not pay tax at all. For
INTERNAL FINANCING A company may use this example, dividends received from a domestic
strategy when it has available retained earnings to corporation are tax-exempt. There are certain
finance a firm’s growth. However, as part of its exempt corporations under Section 30 of the NIRC.
long-run planning, an organization may plan to These are
transition from external to internal financing 1. Labor, agricultural or horticultural organization –
eventually. non-profit
Strategy Retained earnings are not generally 2. Mutual savings bank or cooperative bank –
subject to payout and control restrictions compared non-stock, non-profit, operated for mutual purposes
to external financing. Debt financing requires 3. Beneficiary society, order, or association –
periodic payment of interest. Equity financing will operating for the exclusive benefits of their
dilute earnings per shares as well as control. members; includes fraternal organization operating
Anticipation Anticipated tax law changes affect under the lodge system; or mutual aid association
internal financing choice. or a nonstock corporation organized by employees
Value-Adding The value added through internal providing life, sickness, accident, or other benefits
financing is potentially higher than from external exclusively to the members
financing. This is because neither the enhanced 4. Cemetery company – owned and operated
cash flows nor the increased value of the firm is exclusively for the benefit of its members
shared with anyone other than the original owners. 5. Non-stock corporation or association organized
Negotiation Negotiation of tax benefits is not really and operated exclusively for religious, charitable,
affected by the use of internal financing, but, as also scientific, athletic, or cultural purposes or for the
discussed later, it is an important factor in rehabilitation of veterans, provided that no part of its
structuring debt financing. income or asset belong to or inure to the benefit of
Transforming While there are no direct any individual
transforming advantages to internal financing, there 6. Business league, chamber of commerce, or
is a definite advantage in the absence of transaction board of trade – Non-profit; no part of net income
costs (as discussed in the next section). However, inures to the benefit of an individual
increases in firm value are not usually taxed until 7. Civic league or organization – Non-profit;
there is an exchange transaction, such as a sale of operating exclusively for the promotion of social
corporate stock. welfare
EXTERNAL FINANCING: DEBT VERSUS EQUITY 8. Non-stock and non-profit educational institutions
Debt may be in the form of short-term debt or 9. Government educational institutions
long-term debt. Short term debts are expected to be 10. Organizations of a purely local character whose
settled within a year. It is characterized overall by income consists solely of assessment, duties and
higher interest rates than long-term debt but can be fees collected from their members to meet
interest free. expenses; includes farmers’ or other mutual
Strategy Managers search for an optimal capital typhoon or fire insurance company, mutual ditch or
structure in the long run. The optimal capital irrigation company and mutual or cooperative
structure depends on the objective of the telephone company
organization.
11. Farmers’, fruit growers’, and like association – CHAPTER 6: ATTRACTING AND MOTIVATING
whose primary function is to market the product of EMPLOYEES AND MANAGERS: COMPANY AND
their members EMPLOYEE TAX PLANNING

Transaction Cost Effects on Value-Adding Debt EXECUTIVE/MANAGERS COMPENSATION:

offerings typically are cheaper than equity (5% Schemes for compensating executives/managers
versus 10%, depending on circumstances). have become important in many companies’
Because these costs are present at each offering, it strategic plans. This may be because
makes sense for the firm to try to anticipate future executive/managerial talent has become
capital needs in order to minimize the number of increasingly scarce as firms have become more
issuances. complex, causing firms to compete for talent at the
Transforming By issuing stock or securities that top by offering lucrative compensation packages.
are convertible to equity, firms can enable either The results of surveys like these can vary because
themselves or their investors to transform ordinary compensation packages for managers differ widely.
income into capital gains or taxable income into They often consist of a mix of factors thought to
nontaxable income. match both employees’ and employers’ varying
needs. The array of factors can be generalized,
CHAPTER 5: NEW PRODUCTS: DEVELOPMENT, however, into six basic components:
PROMOTION, AND ADVERTISING 1. Annual base wages
2. Year-end bonuses
NEW PRODUCTS AND PRODUCT 3. Long-term equity participation
IMPROVEMENT The typical product/process 4. Deferred compensation
development process typically consists of research 5. Fringe benefits
and development, then, promotion and advertising. 6. Employment security arrangements

For Philippine employees, Employers must observe

a range of payroll compliance regulations, which
include monthly withholding obligations. The three
main statutory contributions deducted from
employee salaries each month are:
• Social Security: General social insurance
Anticipation To evaluate potential tax benefits from covering sickness, disability, maternity and old age.
new product development, actions by competitors • PhilHealth: The Philippine Health Insurance
and governments should be anticipated. Tax rate Corporation scheme aims to provide access to
and rule changes also should be considered in the quality medical and health care services for all
planning process. employees.
Value-Adding Like any other investment, product • Home Development Mutual Fund: A housing
development must pass the value-adding test. program designed to provide short term loans and
Negotiating Like other areas of taxation, promotion access to housing programmes for all workers in
involves interaction with other parties in which tax the Philippines.
benefits can be part of the negotiations. Employee Leasing One way to reduce
Transforming There are few opportunities for the employment and transaction costs related to
firm to convert sales income into tax-favored capital employment is through employee leasing. Here a
gains. However, if a new product turns out to be company hires whomever it wants, but leases the
unsellable, all costs of unsold inventory, supplies, employees from a company that specializes in
and equipment can be written off as ordinary leasing employees
losses.
SAVANT AND RESEARCH AND DEVELOPMENT CHAPTER 7: MARKET PENETRATION:
Because R&D is risky, managers sometimes like to OPERATING IN DIFFERENT AREAS
separate it into a separate entity (such as a GENERAL PRINCIPLES OF STATE AND LOCAL
subsidiary corporation or an LLC). This can get the TAXATION States impose these major taxes on
R&D off the parent company’s financial statements, businesses
which may also be useful for hiding R&D from 1: ■ Income taxes
competitors. ■ Property taxes
■ Payroll taxes
■ Other taxes significant in the aggregate:
document, capital stock/net worth, real estate
transfer
Income Tax Savings through Restructuring Anticipation When the firm decides to go
Restructuring can be done by combining entities. overseas, it predicts implicitly whether tax rates will
This is useful when one entity operates at a loss change over time. If the firm is offered a tax holiday
and the other has a profit. for a fixed period of time, it must anticipate the
amount of tax increase that will occur at the
Taxation of Electronic Commerce Whether you expiration time. Similarly, firms should forecast the
have a traditional “bricks and mortar” business with extent to which existing general tax rates and
physical premises or an online business, tax treaties will change.
compliance is a must. Persons doing online
business transactions are required to pay taxes Anticipation and Timing. If the firm anticipates a
under the Tax Code, as amended. change in foreign tax rates or rules, it may want to
adjust the timing of its investments. Timing also
Registering an online business with the BIR affects ongoing transactions.
1. File a Certificate of Registration BIR registration
may require submission of the following Anticipation and Time Value. Regarding
documentation: organizational form, time value is most salient for
• DTI Certificate of Registration (if applicable) corporate subsidiaries. In corporate setting,
• Occupational Tax Receipt or Professional Tax payment of dividends can be postponed almost
Receipt from City Hall or Municipal Hall (if infinitely, such that their net present value (NPV)
applicable) can be nearly zero.
• Barangay Clearance
• Proof of Address, e.g. Lease Contract or Land Value-Adding Related to strategy is the
Title Certificate • Valid identification fundamental idea that the pretax economics of
• To register, individuals (e.g. freelancers) must overseas investment must be sound. Accordingly,
complete and submit BIR Form 1901. Partnerships foreign tax incentives should influence location
and corporations must complete and submit BIR choice only at the margin. If a planned operation is
Form 1903. A BIR registration fee of P500 profitable solely because of tax benefits, it should
be avoided.
Standard taxes filed by online businesses The
Certificate of Registration issued to each taxpayer Adjusting Value-Adding for Risk. Foreign
will confirm what type of taxes the particular ventures pose additional risk management
business must pay. problems for the firm. Part of this is mitigated by
The following are just some of the taxes online entity choice. Direct export involves minimal risk;
businesses will pay: joint ventures and partnerships provide local
• Monthly and Quarterly Value Added Tax (required risk-sharing partners. Branches and subsidiaries put
for all businesses earning more than P3 Million in a more of the firm’s operations at risk.
taxable year)
• Quarterly Percentage Tax (businesses earning P3 Value-Adding and Transactions Costs. Legal and
Million or less annually not subject to VAT) accounting costs are higher for the corporate form
• Withholding Tax on Compensation and lowest for direct exports. These costs vary by
• Expanded Withholding Tax/Creditable Withholding country and size of operation. In addition to import
Tax and export duties, there are other transaction taxes
• Quarterly and Annual Income Tax Returns to consider.

CHAPTER 8: MARKET PENETRATION: Negotiating Often local officials, especially in

COMPANY AND EMPLOYEE TAX PLANNING developing countries, can be negotiated with. This
FOR OPERATING IN FOREIGN COUNTRIES is particularly true with regard to property taxes and
other localized fees.
Strategy The firm’s decision to do business in
foreign countries should be consonant with its Transforming By utilizing a foreign subsidiary, a
strategic plan. Once the firm has decided to go Philippine parent effectively transforms taxable
international, an important strategic decision is income into nontaxable income by deferral. Income
entity choice. That is, what legal form (e.g., a of foreign subsidiary is not taxable in the
corporation, a partnership). Philippines, unless it is declared dividends.
On Competitive Strategy. A recurrent theme
throughout the text is that by effectively managing
taxes, a firm’s costs decrease, and it can then
afford to lower prices and win more market share.
CHAPTER 9: OPERATIONS MANAGEMENT one-half (1/2) of the rates prescribed for
manufacturers, wholesalers and retailers of other
Production Design and Process Selection products.
Businesses need to design the products that d. Contractors and other independent contractors.
consumers demand. A good marketing department e. Retailers.
can tell the organization what consumers want, and f. Banks and other financial institutions at a rate not
even convince consumers that they want it. exceeding 50% of 1% of the gross receipts of the
preceding calendar year derived from interest,
Under the Local Government Code, local commissions and discounts from lending activities,
government units are empowered to impose the income from financial leasing, dividends, rentals, on
following taxes: property and profit from exchange or sale of
1. Provinces property, insurance premium.
a. Tax on business of printing and publication at a 3. Cities
rate not exceeding 50% of 1% of the gross annual The city government may impose and collect any of
receipts for the preceding calendar year. In case of the taxes, fees and charges imposed by the
newly started business, the tax shall not exceed province or municipality. The rates of taxes may
1/20 of 1% of the capital investment. exceed the maximum rates allowed for the province
b. Tax on a business enjoying franchise at a rate not or municipality by not more than 50% except the
exceeding50% of 1% of the gross annual receipts rates of professional and amusement taxes which
for the preceding calendar year. In case of a newly are alreadyfixed.
started business, the tax shall not exceed 1/20 of 4. Barangays
1% of the capital investment. The barangay may impose a tax on stores or
c. Tax on sand, gravel and other quarry resources retailers with fixed business establishments with
at a rate not exceeding 10% of the fair market value annual gross sales or receipts of PhP50,000.00 or
in the locality per cubic meter of ordinary stones, less in the case of cities; and PhP30,000.00 or less,
sand, gravel, earth, and other quarry resources, as in the case of municipalities, at a rate not exceeding
defined under the National Internal Revenue Code 1% of gross sales or receipts.
(NIRC), as amended, extracte drom public lands or
from the beds of seas, lakes, rivers, streams, CHAPTER 10: FINANCING ONGOING
creeks, and other public waters within its territorial OPERATIONS AND TAX PLANNING
jurisdiction.
d. Professional tax on each person engaged in the Operating Earnings Operating earnings, after
exercise or practice of his/her profession requiring payment of taxes, add to retained earnings.
government examination at a rate not exceeding However, accumulation of earnings without
PhP300.00. legitimate business purpose are subject to
e. Amusement tax payable by proprietors, lessees, improperly accumulated earnings tax.
or operators of theaters, cinemas, concert halls, Sale of Operating Assets Gains (losses) on the
circuses, boxing stadia, and other places of sale of ordinary assets generally are taxable (tax
amusement at a rate of not more than 10% of the deductible). Losses on the sale of operating assets
gross receipts from admission fees. usually are treated as ordinary losses and are fully
f. Annual fixed tax not exceeding PhP500.00 for deductible. Losses between related parties are not
every delivery truck or van used by manufacturers, tax deductible. Note that depreciation previously
producers, wholesalers, dealers or retailers in the taken reduces an asset’s basis.
delivery or distribution of distilled spirits, fermented Sale of Investments If the asset is not used in
liquors, soft drinks, cigars and cigarettes, to sales business or is considered as capital asset, the
outlets, or consumers, whether directly or indirectly, resulting difference between the sales price and the
within the province. cost basis is considered capital gain or loss.
2. Municipalities
a. Manufacturers, assemblers, repackers, Short-Term Borrowing Proceeds from and
processors, brewers, distillers, rectifiers, and payment of borrowings are not taxable. Interest
compounders of liquors, distilled spirits, and wines expenses are tax deductible. However, Interest
or manufacturers of any article of commerce of payments on short-term debt (such as bank notes)
whatever kind or nature. are usually higher than those on long-term debts.
b. Wholesalers, distributors, or dealers in any article
of commerce of whatever kind or nature. Accounts Receivable Offering discounts for early
c. Exporters, and manufacturers, millers, producers, payment (e.g., 2/10 net 30) may affect the timing of
wholesalers, distributors, dealers or retailers of cash flows, but the timing of taxable income
essential commodities are subject to not more than recognition is usually unaffected. This is because
taxable income is already recognized under the The long-term investment is generally considered
accrual method for most firms. under capital budgeting. This step helps in
monitoring the performance of an individual
Decrease in Dividends Firms can increase internal investment.
cash flows by decreasing dividend payments to Implementation: After the apportioning of the
shareholders. All other things being equal, long-term investment, the company comes into
shareholders should not mind a lack of dividends, action for the execution of its decision. To avoid
as long as the firm can invest the money and complications and excess time-consumption, the
receive at least as great a return as the shareholder management should lay out a detailed plan of the
would have received when investing it project in advance.
Performance Review: The last but the most crucial
Stock Dividends Stock dividends and increase in step is the follow-up and analysis of the project’s
the value of shares are not considered as income, performance. While the company’s operations are
hence, not subject to income tax. steady, the management needs to measure and
correlate the actual performance with that of the
Stock Buybacks When the shares are retired, the estimated one to figure out the deviation and take
capital gain or loss derived by the holder shall be corrective actions for the same.
subject to regular income tax rates. The capital gain
or loss is the difference between the amount Capital Budgeting Decisions The organization’s
received and the cost of the shares all capital budgeting decisions can be broadly
categorized under the following three types:
Receipt of Dividends from Subsidiaries
Dividends paid by a domestic stock corporation to
another domestic stock corporation or resident
foreign corporation are not subject to tax. Likewise,
dividends are not tax deductible.

CHAPTER 11: CAPITAL BUDGETING

Definition: Capital budgeting is the method of

determining and estimating the potential of
long-term investment options involving enormous
capital expenditure. It is all about the company’s
FIXED ASSETS ACQUISITIONS Managers are
strategic decision making, which acts as a
frequently faced with decision making on purchase
milestone in the business.
of additional fixed assets and replacement of old
equipment. As with other projects, they should have
Capital Budgeting Process Capital budgeting, as
expected net cash flows with positive net present
we know, is a decision making process. It involves
value.
the following six steps:
Year End Tax Planning with Fixed Assets One
aspect of tax planning for a business is how to
Identifying Potential Investment Opportunities:
account for fixed asset purchases in the most tax
The company has various options for capital
efficient manner. There are several methods to plan
employment on a long-term basis. In the initial
with fixed assets including the use of various
stage, the management needs to analyze the
depreciation methods , section 34 of RA 8424 (Tax
strengths and weaknesses of every project for
Code), in expensing and the timing of an assets
foreseeing the potential of each option.
placed in service date.
Evaluating and Assembling Investment
Allowed Depreciation under Section 34 of RA
Proposals: In the next step, the management
8424 Depreciation expense is a tax deduction
assembles and compiles all the investment
coming from the fixed assets to reduce the taxable
proposals on the grounds of cost, risk involvement,
income of a taxpayer. The deduction is allowed on
future profits, return on investment, etc.
acquisition of new fixed assets.
Decision Making: Now, the company needs to
decide as to which investment option it may select
Placed in Service Date An asset is placed in
to suit its pocket and yield a high profit for the
service generally when it begins to be used in a
company in the long run.
trade or business. The company can purchase an
Capital Budgeting and Apportionment: The next
asset and not use it in the trade or business right
step is to classify the investment as per its duration.
away.
Business tax on Purchases of Fixed Assets
(VAT at 12%) In most fixed asset acquisitions,
capital acquisitions (such as machinery and
equipment) are subject to business taxes, known as
value-added tax (VAT).Most vendor of fixed assets
are VAT registered and imposes 12% VAT to buyers
or companies

Property Taxes If the capital expansion involves

realty, there will be an increase in property taxes. If
the expansion (or new site) is significant enough,
the firm can negotiate with local officials for tax
relief. If the expansion involves a combined
purchase of personalty and realty, the firm can try to
allocate the purchase price so that all taxes are
minimized.

CAPITAL BUDGETING AND PLANT CAPACITY If

the firm needs to expand plant capacity, it may do
so by expanding the current plant or by building
additional, separate facilities. Because of the
interrelationship of federal, international, and state
and local taxes in many businesses, it is important
to consider all of the taxes in Exhibit 11.4

RISK CONSIDERATIONS Because capital

budgeting involves longer-run horizons, there is
inherently more risk that cash flows may vary from
projections. (Note that the depreciation tax shield,
absent a change in the firm’s effective tax rate, is
invariant.) Because income taxes decrease with
decreased revenues, they act as a variance (and
hence risk) reduction mechanism