Clarifying income tax: for self-employed individuals & professionals

If you’re a Filipino or you live in the Philippines, we are sure you are well aware of the so-called TRAIN Law. The Tax Reform for Acceleration and Inclusion (TRAIN) overhauls the Internal Revenue Code of the country. Implemented in January 2018, TRAIN simplifies tax filings and lessens income tax for most Filipinos. It also aimed at reducing taxation for self-employed individuals and professionals. As the bill passed quite late last year, there was still some uncertainty about how it would be implemented – how to avail of the 8% tax rate and who would have the option. Since then, the Bureau of Internal Revenue has released several Revenue Memorandum Orders to clarify its process and applicability throughout the year  RMO 9-2018, RMO 14-2018 and RMO 23-2018.

As these can all be quite confusing, here is a simple infographic and simulation, which will help you navigate the TRAIN Law regulations so you could define which computation would be best for you.

Infographic | what are your options?

When to chose the 8% Income Tax Rate?

The infographic helps you determine if you can opt for the 8% Income Tax Rate, but it may not necessarily tell you which option would be more beneficial. The answer is not as simple, and would depend on several variables such as your annual gross income, how much expenses related to your professional activity do you incur, etc. To help you solve this question, we have prepared several scenarios for you.

Scenario 1: a case for the 8% Income Tax Rate

Christy operates an online retail store and works as a freelancer providing digital marketing services. This year she plans on earning PHP 1,200,000 from her retail activity and PHP 700,000 from her freelancing work. Her cost of sales for the retail activity is PHP 650,000 on top of other operating expenses amounting to PHP 230,000.

If Christy opts for the for the 8% Income Tax Rate her tax due for the year would be PHP 132,000, computed as follows.

+ Gross sales – Online retail sales1,200,000
+ Gross receipts – Digital marketing services700,000
= Total sales & receipts1,900,000
–  PHP250k annual deduction250,000
= Taxable income1,650,000
Tax due at 8% income tax rate132,000
If Christy had opted for the graduated income tax her income tax for the year would have been higher at PHP 196,000.
+ Gross sales – Online retail sales1,200,000
+ Gross receipts – Digital marketing services700,000
= Total sales & receipts1,900,000
– Cost of sales650,000
= Gross Profit1,250,000
– Operating expenses230,000
= Taxable income1,020,000
Tax due196,000

Referring to the Graduated Income Tax Rate table below, the tax due is computed as follows:
130,000 + (1,020,000 – 800,000) x 30% = 196,000

Graduated Income Tax Rates

Annual salaryTax rate under TRAIN
Between P10,000 and P250,0000%
> P250,000 and <= P400,00020% of the excess over P250,000
>P400,000 and <= P800,000P30,000 + 25% of the excess over P400,000
>> P800,000 and <= P2 millionP130,000 + 30% of the excess over P800,000
> P2 million and <= P8 millionP490,000 + 32% of the excess P2 million
> P8 millionP2,410,000 + 35% of the excess over P8 million

In this case, the 8% Income Tax Rate proved to be more beneficial, but it may not always be the case.

Scenario 2: a case for the Graduated Income Tax table

Let’s revisit Christy’s scenario but assume that her operating expenses amounted to PHP 530,000 for the year. She would have paid the same amount of PHP 132,000 under the 8% Income Tax Rate. However in this case, Christy’s tax due would be lower under the Graduated Tax Rate.

+ Gross sales – Online retail sales1,200,000
+ Gross receipts – Digital marketing services700,000
+ Gross receipts – Digital marketing services700,000
= Total sales & receipts1,900,000
–  Cost of sales650,000
= Gross Profit1,250,000
–  Operating expenses530,000
= Taxable income720,000
Tax due (30,000 + (720,000 – 400,000) x 25%)110,000

Why is it important to understand all these?

As a self-employed professional, you would want to minimise your annual income tax, RIGHT? Then, it helps to try and forecast your taxable income under both scenarios to evaluate which option would be best for you. In this way, familiarizing yourself with the TRAIN Law regulations will prove beneficial.

Frequently Asked Questions

  1. Q: When can I select between the Graduated Income Rate and the 8% Income Tax Rate

    A: You can opt for the 8% income tax rate upon registration (form 1905) at the start of the year, upon filing your 1st quarterly income tax or percentage tax for the year.

  2. Q: What if I do not select either of the two options?

    A: If you fail to opt for the 8% Income Tax Rate, you will automatically be subjected to the Graduated Income Tax Rate.

  3. Q: Can I change my mind during the year?

    A: No. Your selection for a particular tax year is irrevocable.

  4. Q: What happens if in the course of the year, my gross sales exceed PHP 3 million?

    A: Once your gross sales for the year exceed PHP3 million, you would automatically be taxed under the Graduated Income Tax Rate for that particular year. Any income tax paid under the 8% Income Tax Rate will be used as a tax credit against your next tax payment, which will already be under the Graduated Income Tax Rate computation.

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