Improperly accumulated earnings tax (IAET)

Have you paid all the taxes? Not yet! You should pay more because your retained earning is "IMPROPER".

National Internal Revenue Code (NIRC) of 1997, as amended, imposes Improperly Accumulated Earnings Tax (IAET) on corporations for each taxable year on the improperly accumulated taxable income of such corporations. The term “improperly accumulated taxable income” means the taxable income adjusted by income exempt from tax, income excluded from gross income, income subject to final tax, and the amount of net operating loss carry-over deducted and reduced by the sum of  dividends actually or constructively paid and income tax paid for the taxable year.

It is equal to 10 percent of the improperly accumulated taxable income.

The IAET is imposed to discourage tax avoidance through corporate surplus accumulation. When corporations do not declare dividends, income taxes are not paid on the undeclared dividends received by the shareholders. Based on Section 6 of Revenue Regulations (RR) 2-2001, the dividends must be declared and paid or issued not later than one year following the close of the taxable year, otherwise, the IAET, if any, should be paid within 15 days thereafter.

The IAET does not apply to 

(a) Publicly held corporations, 

(b) Banks and other nonbank financial intermediaries, and 

(c) Insurance companies. 

(d) RR 2-2001 likewise included taxable partnerships, general professional partnerships, nontaxable joint ventures and enterprises duly registered under special economic zones as exempt from the coverage of IAET.

If the failure to pay dividends is due to some other causes, such as the use of undistributed earnings and profits for the reasonable needs of the business, such purpose would not generally make the accumulated or undistributed earnings subject to IAET. However, if there is a determination that a corporation has accumulated income beyond the reasonable needs of the business, the 10-percent improperly accumulated earnings tax shall be imposed.

According to BIR RR 2-2001, the following constitute accumulation of earnings for the reasonable needs of the business: 

a) Allowance for the increase in the accumulation of earnings up to 100 percent of the paid-up capital of the corporation as of Balance Sheet date, inclusive of accumulations taken from other years;

b) Earnings reserved for definite corporate expansion projects or programs requiring considerable capital expenditure as approved by the Board of Directors or equivalent body;

c) Earnings reserved for building, plants or equipment acquisition as approved by the Board of Directors or equivalent body;

d) Earnings reserved for compliance with any loan covenant or pre-existing obligation established under a legitimate business agreement;

e) Earnings required by law or applicable regulations to be retained by the corporation or in respect of which there is legal prohibition against its distribution;

f) In the case of subsidiaries of foreign corporations in the Philippines, all undistributed earnings intended or reserved for investments within the Philippines as can be proven by corporate records and/or relevant documentary evidence.