Tax savings tip

9 Ways Small Businesses Can Lower Income Tax in the Philippines

May 21, 2023 | 3:01 pm

If there’s one common headache among small business owners, it’s managing and paying income taxes. You need to make timely, accurate payments and know how to lower the taxable income to save money legally.

Luckily, we have nine tips to reduce your income tax in the Philippines and prepare you for the next tax season. With these tips, you’ll be able to save money and time while still being a diligent taxpayer.

However, not all small businesses can similarly apply for these tax deductions or exemptions. In this guide, we elaborate on how to lower your taxable income so you can pay less taxes.

How to Reduce Your Income Tax

9 allowable deductions to help small businesses lower income tax

Lower taxes also mean more money you can put back into your business! Here are nine tips to remember to reduce your income tax:

Tip #1: Deduct your interest expense

Small business owners typically borrow funds from banks or financing institutions as business loans. If you’ve done so, you can deduct the interest expense you pay from your gross income.

Good news, right? Especially if you usually borrow funds to invest in your business’ growth and development. You may also deposit these funds in a bank to steadily earn interest income.

Since interest income is subject to final withholding tax, which is lower than the income tax rate, business owners enjoy double tax benefits. That is a reduced income tax because of the interest expense deduction and lower tax liability on the interest income.

To neutralize this tax arbitrage, the Philippine Tax Code limited the use of interest expense as a deductible expense.

Suppose you earned interest income using the money from bank loans. In that case, the allowable deduction for interest expense is only up to 20% of the interest income subjected to final withholding tax.

Tip #2: List down your utility expenses

If your business has a physical presence or an office, then utility bills are part of your regular expenses.

Start writing off these utility expenses to reduce your taxable income. These include payments for your electricity, water, and communication bills. Costs like wifi and phone subscription plans also fall into the communication category as long as these are used for the business only.

Note that official receipts must be under the company’s name to claim the amount paid for utilities as deductible expenses. It’s also a good habit to always keep your receipts as proof to avoid penalties in case of an audit.

Even working from home, you can deduct utility expenses from your business income if adequately documented. Consider the portion of bills consumed by your home office only, not the whole house, as this falls under personal expenditures.

Tip #3: Pay your employees’ government contributions

As employers, you must pay your employees’ monthly contributions to SSS, Pag-IBIG, and PhilHealth as part of the mandatory benefits required by the Labor Code of the Philippines.

Luckily, government contributions to SSS, Pag-IBIG, and PhilHealth are deductible expenses you can use to lower your income tax liability.

The first step is registering your business and becoming eligible employer members of these agencies. Once done, you must remit both the employee and employer share of these contributions.

The share amount taken from the employee and the employer varies from agency to agency. Always check the updated contribution rates for each to ensure you’re making the correct payments.

Since you are taking the employee share directly from their salary, you can only use the employer share expense as a deductible for your income tax.

Tip #4: Give your employees more benefits

Aside from the mandatory benefits, giving your employees additional perks or fringe benefits can also reduce your income tax.

Fringe benefits are benefits added to your employees’ compensation, including holiday bonuses, educational allowance, housing assistance, club memberships, subsidized cars, and more.

The monetary value of these added perks can be treated as a business expense, which you can deduct from your gross income.

However, note that fringe benefits granted to managerial or supervisory employees are subjected to fringe benefits tax, which is 35% of the benefit’s monetary value. Some exceptions are benefits related to health and retirement and those given to rank-and-file employees.

If you end up paying fringe benefits tax, worry not because this tax expense is also an additional deductible from your gross income, further lowering your income tax.

Aside from the tax advantage, giving additional benefits to your employees reduces your turnover rate, which is another win for your business.

These benefits will also show how much you value your employees by improving their quality of life and the way they do their work.

Tip #5: Claim representation and entertainment expenses

Having someone represent your company in meetings, conferences, or travels is also typical in business. These representation expenses include flight tickets, hotel bookings, and meal expenses during the event.

You may even offer entertainment or recreational activities like parties, team-building activities, or dinner events to show your clients and employees appreciation, which also means higher spending.

The good thing is these representation and entertainment expenses are deductions you can use to lower your tax liability.

Just like the other deductions, remember to properly document these expenses and ensure they are within a reasonable amount.

As per BIR regulations, you should note that this deduction is capped at 0.5% of net sales if you sell goods or 1% of net revenue if you sell services.

Tip #6: Bad debts

There may come a time when you get a customer who can no longer pay what they owe to your business. Some reasons for this could be bankruptcy, unforeseen emergency, or your customer suddenly becoming unreachable.

Once uncollectible, the amount that the customer owes is now considered bad debt. Since this is a loss on your end, you can use this as a deductible expense for your tax.

But before doing so, you should first exhaust all your options in trying to collect the debt. You can repeatedly send invoices, contact customers, send demand letters, and even file a collection case.

If the debt remains unpaid after all these efforts, you can now prove it as uncollectible and deduct it from your income.

Tip #7: Consider the depreciation of your assets

Another way to lower your taxable income is by treating asset depreciation as an expense. Typically, you can use a straight-line method to compute depreciation.

However, to accelerate depreciation in the early years of the life of an asset, a recommended method is the double-declining balance (DDB) method. Lower your taxable income during the first business years through the DDB method, especially for assets that quickly depreciate, like cars.

You can also use charitable donations as another tax deduction to lower your tax liability. Generally, this deduction is only 5% of your net income.

However, 100% of your donations can be deducted if you donate to non-government organizations accredited by the BIR as a donee institution. Here is a list of accredited NGOs along with the validity of their BIR donee status.

Donating to the government or its priority projects also means a full deduction from your gross income. The priority projects are those under the National Priority Plan determined by the National Economic Development Authority (NEDA).

On top of reducing your income tax, you’ll also help out communities and support different advocacies.

Just note that a 6% donor’s tax may be imposed when you exceed the ₱250,000 donation amount for each taxable year.

Bonus Tip #9: Register your business as BMBE

If you’re only starting or growing your business and have less than ₱3 million in assets, you can register your business as a Barangay Micro Business Enterprise (BMBE). You can enjoy exemption or reduced local taxes or fees depending on your local government.

By becoming a BMBE, you can enjoy different perks, such as being exempt from paying income tax. Other advantages are being exempted from the Minimum Wage Law, being prioritized for a particular credit window, and receiving training and assistance from different agencies.

Being a BMBE is valid for two years and can be renewed if you follow the eligibility requirements, including the ₱3 million limitation in assets.

While exempt from paying income tax as a BMBE, you must still file your annual income tax return with zero payment due.

What is CREATE Act for small businesses?

In addition to these money-saving tips, small business owners like you can also enjoy lower corporate income tax rates, thanks to the CREATE Act.

The newly-passed Comprehensive Recovery and Tax Incentives for Enterprises (CREATE) Act implements the reduced corporate income tax rates applied to your net income.

If you own a domestic corporation, your tax rate is reduced to 20% or 25%. Meanwhile, foreign corporations can enjoy a 25% tax rate, which was lowered from 30%.

On the other hand, the minimum corporate income tax (MCIT) rate is temporarily at 1% from July 1, 2020 to June 30, 2023. MCIT applies to corporations whose 25% tax on net income is lower than the 2% MCIT on gross income.

Aside from CREATE Act, there are other recent changes in tax rules and regulations you should know. These include lower personal income tax rates and reduced frequency of VAT payments.

Improve income tax with proper tax planning

Keeping tabs on the different tax deductions through proper tax planning is one of the best ways to save money and lower your corporate income tax.

With the help of OneCFO PH, you can plan expenditures and strategize well to ensure you are on time in paying taxes and paying the proper taxes after exhausting all deductions applicable to your business.

Subscribe to OneCFO PH’s reliable services now to worry less about your taxes and focus more on growing your business.

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