Concept and Purpose of IAET
- A 10% tax imposed annually on improperly accumulated taxable income
- Applies to corporations formed or used to avoid income tax liabilities on shareholders by accumulating earnings instead of distribution
- Serves as a deterrent to avoid shareholder dividend taxation
- Liability depends on the purpose behind accumulation, not merely the fact of accumulation
- Accumulation for reasonable business needs exempts the corporation from IAET
Determination of Reasonable Business Needs
- Accumulation is unreasonable if unnecessary for the business given the circumstances
- Uses the "Immediately Test" from American jurisprudence to assess immediate or reasonably anticipated needs
- Corporation must prove immediate or correlated anticipated needs for accumulation
- Permissible accumulations include:
a) Up to 100% of paid-up capital as allowable accumulation
b) Reserves for corporate expansion projects approved by the Board of Directors
c) Reserves for loan covenants or legitimate business obligations
d) Statutorily required or legally prohibited distribution earnings
e) Investments by subsidiaries reserved for local reinvestment, supported by records
Coverage and Exemptions
- IAET applies to domestic, closely-held corporations earning taxable income starting January 1, 1998
- Closely-held corporation defined as at least 50% owned by 20 or fewer individuals directly or indirectly
- Excluded are banks, insurance companies, publicly-held corporations, partnerships, joint ventures, PEZA registered enterprises, and similar entities enjoying special tax regimes
- Rules provided for constructive stock ownership including family, partnerships, options, and pro-rata stock ownership
- Foreign corporation branches not covered
Tax Base Computation
- Improperly Accumulated Taxable Income includes:
a) Taxable income plus exempt, excluded, final-taxed incomes, and net operating loss carry-over - Reductions include:
a) Income tax paid/payable for the year
b) Dividends declared/paid or constructively paid
c) Reserves for reasonable business needs - Resulting amount multiplied by 10% to determine IAET
- Once IAET is paid, the income is not subject to IAET again even if undistributed
- Dividends from IAET-subjected profits still subject to dividend tax, except as otherwise exempt
- Dividends deemed paid from the most recent profits unless otherwise supported by Board Resolution
Timing for Dividend Declaration and IAET Payment
- Dividends must be declared and paid within one year after the close of the taxable year
- IAET, if applicable, must be paid within 15 days after the dividend declaration deadline
Proof of Purpose to Avoid Income Tax
- Being a holding or investment company is prima facie evidence of tax avoidance intent
- Earnings accumulated beyond reasonable business needs evidences purpose to avoid tax
- Corporations can rebut presumption by clear preponderance of evidence
- Holding or investment company defined as one with minimal activities aside from owning property and investments
- Prima facie indicators include:
a) Investing substantial earnings in unrelated businesses or securities
b) Investment in long-term securities or bonds
c) Accumulations exceeding 100% of paid-up capital without reasonable business justification - Must demonstrate definite and concrete plans for the accumulation, speculative intentions insufficient
Transitory Provisions
- IAET does not apply to improperly accumulated income as of December 31, 1997 (calendar year) or end of fiscal year 1997-1998 (fiscal year taxpayers)
- Dividends declared within one month after effectivity from prior accumulations exempt from IAET
Effectivity
- Effective 15 days after publication
- Covers improperly accumulated taxable income earned from January 1, 1998 onward
- Signed by Secretary of Finance and Commissioner of Internal Revenue on February 12, 2001