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Publication Detail
TRJ 2009 Vol XXI No 3: Reform Options on the Taxation of Compensation Income Earner and Self-Employed Individuals and Professionals, May - June 2009

he paper discusses and analyzes the income tax treatment between compensation income earners, on one hand, and professionals and self-employed individuals on the other, with the end in view of identifying options to make individual income taxation more equitable. One of the major taxes imposed by the government is the tax on the income of an individual. The taxation of individual income differs depending on the type or source of income an individual has, or on the residence of an individual. If the income of an individual is compensation income which results from an employer-employee relationship, the tax treatment follows the modified gross income taxation scheme, that is, gross compensation income less personal and additional exemptions. On the other hand, if the income originates from the practice of a profession or engagement in business, the net income taxation applies, that is gross income less deductions and personal and additional exemptions. For the period 1998 to 2007, the individual income tax collection grew from P59.0 billion to around P 137.7 billion. Compensation income earners contributed an average of 85% of the collection while individuals engaged in business and practice of professions shared only about 15% of the collection. This scenario may be traced to several factors, among which is the manner by which the individual income tax due is computed. While both groups of individuals are subject to the same tax rate schedule provided under Section 24 of the National Internal Revenue Code (NIRC), the determination of their taxable income differs. For compensation income earners, their gross income is reduced only by personal and additional exemption allowances as provided under Section 35 of the NIRC and premium payments for health and hospitalization insurance as allowed under Section 34(M). For self-employed individuals and professionals, their gross income is reduced not only by the personal and additional exemption allowances enjoyed by compensation income earners but also by the deductible expenses allowed under Section 34 of the NIRC. Thus, self-employed individuals and professionals are able to further reduce their income tax liability. The substantial gap in the tax collection between the two groups of taxpayers can also be traced to the number of taxpayers in each group. Based on the BIR’s 2007 Annual Report, there are around 7.82 million registered compensation earners as of end of CY 2007 while registered self-employed/professionals consist of only around 1.38 million. Based on the 2007 income tax collection from compensation income earners (P120.06 billion) and self-employed and professionals (P17.67 billion), the average income tax paid by the former was around P 15,000.00 while in the case of the latter, it was only around P 13,000.00. Another reason for the disparity in the income tax collection between these groups of individuals is the tax collection mechanism. The individual income tax reporting follows the voluntary assessment method, that is, the taxpayer voluntarily discloses or reports his income subject to tax thereby giving him/her the opportunity not to reveal his/her true income. This significantly contributes to the erosion of the income tax base as most taxpayers, especially the self-employed and professionals, do not accurately report their income. The apparent disparity in the tax treatment between the self-employed individuals and professionals, on one hand, and compensation income earners on the other, gives rise to some possible reform options which may be pursued to enhance equity in the tax treatment of individuals. Some of these are the following: a. Adoption of Simplified Net Income Taxation Scheme (SNITS) for Self-Employed and Professionals - The rationale behind the SNITS is to limit the deductible expenses that may be claimed by this group of taxpayers to just direct expenses in the pursuit of trade, business, or profession in order to broaden the tax base and thus, contribute more to the coffers of the government; b. Subjecting Self-Employed Individuals and Professionals to the Regular Income Tax Rate Applicable to Corporations or to a Different Tax Schedule - The first option is premised on the fact that self-employed and professionals are also enjoying deductions allowed for corporations. Hence, their taxable income should also be subject to the tax rate schedule applicable to corporations. As an alternative, subjecting them to a different tax schedule which could be lower or higher than what is imposed on compensation income earners may also be explored. The problem with a graduated tax schedule is that it encourages manipulation of either taxable income or allowable deductions if only to get a more favorable rate. This problem is deemed minimized if there is just one tax rate as in the case of corporations; c. Prescribing Presumptive Income for Self-Employed Individuals and Professionals - This is to protect the tax base from unwarranted diminutions caused by non-reporting of income or overstatement of claimed deductions. The prescription of benchmark amounts of income for self-employed individuals and professionals that will be the basis of tax computation is designed to improve tax collection from this “hard-to-tax group” of taxpayers. d. Allowing Compensation Income Earners to Claim an Employment Standard Deduction - An employment standard deduction for compensation income earners is conceptually envisioned to be the counterpart of “ordinary and necessary trade, business, or professional expenses” allowed for the self-employed and professionals; e. Removal of Charitable Contributions and Other Donations From the List of Deductions Allowed to Self-Employed and Professionals - As noted, charitable contributions and other donations are not business related, hence, these items of deductions may be removed from the deductions allowed to be claimed by self-employed and professionals to promote equity and fairness in the tax system; and f. Establishing Standard Levels or Percentages of Deductions in Accordance With the Type of Business/Profession Concerned - The concept of a standard level of deduction will remove the opportunity for abuses/leakages in the claim for deductions. The percentage for deduction could be varied by type of business/profession. This, however, may be difficult to establish in the absence of baseline data.

National Tax Research Center
Authors Keywords
National Tax Research Center; taxation; individual income tax; Philippines; income tax; tax collection; tax; compensation tax; self-employed individuals; professionals;
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Published in 2009 and available in the NTRC library or Downloaded 200 times since November 25, 2011
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