Written by Karen Andrea D. Torres, 29 May 2008
It has been a common misconception that tax and accounting are worlds apart. Whereas present accounting standards are already leaning towards valuation at fair market values, tax, on the other hand, is generally construed to be at cash and historical cost basis.
The confusion seems to have stemmed from the fact that, once upon a time, cash-basis accounting was generally accepted and assets were valued at their acquisition cost, without any reference to their markets.
Despite the introduction of accounting standards limiting the usage of cash-basis accounting to small entities, and historical cost accounting to assets without any active market, the view on taxation vis-a-vis accounting has not changed.
Perhaps what should be made clear is that tax generally follows accounting.
Though accounting standards are principles-based, meaning there is leeway for judgment, and tax is embodied in laws wherein strict adherence is required, the Tax Code itself states that, generally, the taxable income of an entity shall be computed upon the basis of the taxpayer’s method of accounting it regularly employs in keeping its books.
What the law only requires is that this method of accounting should clearly reflect and represent the true income of the taxpayer, and that this method is consistently applied. Only in such circumstances when the method employed is unfaithful to the taxpayer’s veritable income that the tax regulations step-in and impose what they deem to be more appropriate.
As early as Revenue Regulations No. 2, it has been laid down that income and expenditure need not be in the form of cash. It is sufficient that these items can be appraised in terms of money and are actually realized in a close and completed transaction.
The same rule was adopted under the present Philippine Financial Reporting Standards (PFRS) which require that items of income/expenditure must (1) have been actually earned/ incurred, i.e., economic benefits are probable to flow in/out of the entity; and (2) are capable of reasonable estimate.
Let me cite a few examples of common areas of confusion for better a understanding of our readers.
One is how assets that are marked-to-market for accounting purposes are treated for tax purposes, e.g., investment securities that are held with the intention of short-term profiteering, and are carried in the books at their fair value.
From an accounting perspective, fluctuations in the value of these assets are treated as other gains and losses.
On the other hand, Section 34(4)(b) of the Tax Code provides that loss resulting from securities (that are capital assets) becoming worthless during the year shall be considered deducible upon the sale or exchange of the capital assets.
Another source of perplexity for taxpayers is the tax treatment of changes in the valuation of property, plant and equipment (PPE). Under the 2005 PFRS, companies have the option to carry their PPE either at cost or at revalued amount.
While revaluation is not allowed for tax purposes, the Bureau of Internal Revenue (BIR) has issued a controversial ruling allowing a company to use and reflect in their books the appraisal fair market values of their PPE used in business as determined and reported by an independent appraiser and to depreciate the same based on their remaining useful life as re-estimated in the light of the changes in the business and economic conditions surrounding the PPE.
As to impairment of PPE, for accounting purposes, the same is recognized as a loss item in the income statement even without actual disposal.
However, for tax purposes, impairment of PPE is generally allowed as a deductible loss provided there is actual sale or any form of disposal of the asset. In the case of building and machinery, impairment in value is deductible only if there is actual removal, demolition or scrapping of the building or machinery.
An exception to the close and completed rule is the deductibility of a loss arising from the decline in value of capital goods due to obsolescence.
Loss is deductible even if there is no actual sale or disposition if there are changes in business conditions such that the taxpayer discontinues the business or discards such assets permanently from use in the business. In such instances, decline in the value of the building is allowed as deduction if it is permanently abandoned or devoted to a radically different use, and in the case of machinery, if permanently abandoned.
A last example would be in regard to impairment in the valuation of inventories, such as when the inventories become unsalable at normal prices or unusable in the normal way because of damage, imperfections, shop wear, changes of style, or other similar causes.
For accounting purposes impairment of inventories under these circumstances is already a recognizable loss. The same rule applies for tax provided the inventories are valued at their "bona fide" selling prices. However, a temporary decline in the market value of inventories shall only be allowed as a deductible expense upon actual sale/disposal of the inventories.
Notwithstanding the general rule that deductions shall be recognized only upon a completed and settled transaction, the Supreme Court (SC) has ruled in one case that accruals are allowed as taxable items as long as they meet the "all-events test," consistent with accounting principles.
The SC explained that the "all-events test" requires that the liability to pay be fixed, and the amount due can be determined with reasonable accuracy.
The test, however, does not demand that the amount of liability be known absolutely. It is sufficient that the taxpayer has the information necessary to compute the amount with reasonable accuracy and that its basis is unchangeable.
Given the differences in the accounting and tax treatments of certain transactions, securing a clarificatory ruling from the BIR might seem to be a prudent approach on the part of the taxpayer.
Although there is no guarantee that all confusion will be resolved, much less eliminated — for there have been several rulings issued by the BIR that are questionable, if not controversial — a ruling can give the taxpayer a certain level of comfort in the tax treatment of its transactions.
