Time flies so fast. It’s now March, and the first quarter of 2018 is about to end. For some, this is just another quarter of the year, but for companies in this country, this means their tax and other regulatory filing deadlines are fast approaching.
As company accountants and auditors find themselves busy during this time of year, it would be good to look back on common accounting and tax differences that companies and practitioners typically miss when finalizing financial statements and income tax returns. One important point that we all need to be reminded of is that tax does not always follow accounting. If you recognize expenses in your financials, it does not necessarily follow that all those expenses are deductible for purposes of your annual income tax calculation. Some of the usual differences are as follows:
- Bad debts written off. Claims that remain outstanding after quite some time are usually written off by companies and charged as expense on the year when the management has concluded that the receivables are no longer collectible. Such expense will be tax deductible, but only if the company is able to demonstrate with certainty that the accounts are, indeed, uncollectible, with sufficient proof that all efforts to collect have been exhausted.
- Pension. Pension expense is usually accounted for based on an estimation made by an actuary, using assumptions such as, average working lives of employees, expected increase in salaries, discount rates, etc. For tax purposes, employer pension contributions are deductible only to the extent of the normal employee retirement or current employee cost for the year. Any excess of contributions over current/normal cost should be amortized over a period of 10 consecutive years for tax deductibility.
- Donations. Donation expense is recognized upon actual payment of money/transfer of goods, or upon having an irrevocable commitment to donate to an organization. Donation expense would only be tax deductible (whether in full or subject to limitation) if extended to specific types of organizations. For example, donations to accredited non-government organizations can be fully deductible, provided this is supported by a certificate of donation and a notice of donation for those amounting to at least P50,000.
- Sales discounts and rebates. Estimation or accrual of sales discounts and rebates is allowed in accounting, provided that the estimation is supported by a reasonable basis of calculation, which is usually established from past experiences of customer claims from the company. However, only actual sales discounts and rebates extended to or used by customers during the taxable period are considered allowable deductions from gross sales for tax purposes.
- Depreciation. The most common method of accounting for depreciation expense is the straight-line method, or amortization of an asset cost over its estimated useful life. This is also an acceptable method for tax, for as long as the identified useful lives of properties represent a reasonable estimation of the asset’s wear and tear. However, we should also be mindful that if a company uses the fair value method of accounting for its properties, only the depreciation expense related to the original cost of the property is deductible for income tax purposes. The depreciation charge related to any increase in value of the property, as a result of revaluation, should be considered a temporary tax difference, and can only be treated as tax deductible on the year of actual realization (upon sale or disposal) of the asset.
- Rent. Rent payments under an operating lease arrangement are recognized as expense on a straight-line basis over the lease term. Even if there are rent-free periods, rent expense is still recognized in the financials. For tax, only the actual rent due for payment or paid for the period is allowable for deduction.
- Gains and losses. Gains are recognized in the period earned, and losses are recognized in the period incurred. Accounting does not allow net presentation of gains and losses, unless the gains and losses are results of a similar transaction. For purposes of taxability of gains and deductibility of losses, only realized gains and losses during the period are taxable and deductible. Therefore, companies should be able to properly monitor actual or realized gains and losses of the company’s transactions. For example, foreign currency exchange (FOREX) gains/losses from collection of receivables and payment of liabilities are considered realized and are considered taxable gains/deductible losses since these are considered completed transactions, but FOREX gains/losses resulting from year-end conversion of foreign-currency denominated receivables and payables are considered unrealized gains/losses and should be treated as a temporary tax difference.
The points summarized above are just a few of the more common accounting and tax differences in operating companies in the country. We expect more tax and accounting differences to arise when companies adopt the new accounting standards on revenue in 2018, and on leases in 2019.
Meanwhile, as the government aims to improve the ease of doing business in the country, let’s remain hopeful that local regulators would be able to eventually work on a convergence project to align the provisions of accounting and tax. When this happens, finalizing financials and tax filings would just be a breeze for all.