5.3 Income Taxes (PAS 12) and Employee Benefits (PAS 19)
Key Takeaways
Permanent differences, such as interest income already subjected to final tax or non-deductible penalties, never reverse and never create deferred taxes.
Taxable temporary differences create deferred tax liabilities; deductible temporary differences create deferred tax assets only to the extent future taxable profit is probable.
Deferred taxes are measured at enacted or substantively enacted rates, such as the 25% RCIT (20% for qualifying small domestic corporations) under CREATE, and are never discounted.
Defined benefit cost in profit or loss equals service cost (including past service cost) plus net interest on the net defined benefit liability or asset.
Remeasurements, actuarial gains and losses and the return on plan assets excluding net interest, go to OCI and are never reclassified to profit or loss.
Income Taxes (PAS 12) and Employee Benefits (PAS 19)
Income taxes (two FAR items) and employee benefits (one item) are both computation-heavy areas where the board tests the split between profit or loss and other comprehensive income. This section covers accounting profit versus taxable profit, permanent and temporary differences, deferred tax measurement at enacted Philippine rates, intraperiod allocation, and the PAS 19 defined benefit model with service cost, net interest, and remeasurements.
1. PAS 12 Income Taxes
PAS 12 governs the accounting for current and deferred income taxes, implementing the comprehensive balance sheet liability method.
Accounting Income vs. Taxable Income
- Accounting Profit: Profit or loss for a period before deducting tax expense, computed under PFRS.
- Taxable Profit (Tax Loss): The profit or loss for a period determined in accordance with the rules established by the taxation authorities (Bureau of Internal Revenue under the Philippine National Internal Revenue Code - NIRC), upon which income taxes are payable.
Permanent Differences vs. Temporary Differences
1. Permanent Differences
Items that enter into the determination of accounting profit but never enter into taxable profit, or vice-versa. Permanent differences never reverse in future periods and never give rise to deferred taxes:
- Non-taxable Revenues: Interest income on Philippine bank deposits or government securities (subject to final withholding tax), life insurance proceeds where the corporation is the beneficiary, intercorporate dividends from domestic corporations.
- Non-deductible Expenses: Tax penalties and surcharges, interest expense arbitrage limitation under NIRC Section 34(B)(1), life insurance premiums where the corporation is the beneficiary.
2. Temporary Differences
Differences between the carrying amount of an asset or liability in the statement of financial position and its tax base. These differences reverse in one or more future periods:
Temporary Differences
│
┌────────────────────────┴────────────────────────┐
▼ ▼
Taxable Temporary Difference Deductible Temporary Difference
(TTD) (DTD)
│ │
• Carrying Asset > Tax Base • Carrying Asset < Tax Base
• Carrying Liability < Tax Base • Carrying Liability > Tax Base
│ │
▼ ▼
Generates Future Taxable Amounts Generates Future Deductible Amounts
│ │
▼ ▼
Deferred Tax Liability Deferred Tax Asset
(DTL) (DTA)
(Mandatory Recognition) (Recognized if Probable Future
Taxable Profit Exists)
Tax Base Determination
- Tax Base of an Asset: The amount that will be deductible for tax purposes against any taxable economic benefits that will flow to the entity when it recovers the carrying amount. If economic benefits will not be taxable, the tax base equals the carrying amount.
- Tax Base of a Liability: The carrying amount of the liability, less any amount that will be deductible for tax purposes in respect of that liability in future periods. For revenue received in advance, the tax base is the carrying amount less any revenue that will not be taxable in future periods.
Measurement & Applicable Tax Rate
- Deferred tax assets and liabilities are measured at the tax rates enacted or substantively enacted at the end of the reporting period that are expected to apply when the asset is realized or the liability is settled.
- Under the Corporate Recovery and Tax Incentives for Enterprises (CREATE) Act, the standard Regular Corporate Income Tax (RCIT) rate for domestic corporations in the Philippines is 25% (or 20% for corporations with net taxable income not exceeding PHP 5,000,000 and total assets not exceeding PHP 100,000,000, excluding land).
- Prohibition on Discounting: PAS 12 strictly prohibits discounting deferred tax assets and liabilities to present value.
Intra-Period Tax Allocation
Tax expense (or income) must be allocated across the statement of profit or loss and other comprehensive income:
- Profit or Loss: Current and deferred tax relating to items recognized in P&L.
- Other Comprehensive Income (OCI): Tax relating to revaluation surplus, remeasurements of defined benefit plans, and FVOCI investments.
- Directly in Equity: Tax relating to items credited or debited directly to equity (e.g., share issue costs deducted from share premium).
2. PAS 19 Employee Benefits
PAS 19 outlines accounting for all forms of consideration given by an entity in exchange for services rendered by employees.
Classifications of Employee Benefits
- Short-Term Employee Benefits: Expected to be settled wholly before 12 months after the end of the annual reporting period (wages, salaries, paid annual leave, sick leave, profit-sharing bonuses).
- Post-Employment Benefits: Payable after the completion of employment (pensions, post-employment medical care).
- Other Long-Term Employee Benefits: Not expected to be settled wholly within 12 months (long-service leave, jubilee benefits, long-term disability).
- Termination Benefits: Payable as a result of an entity's decision to terminate employment before normal retirement date or an employee's decision to accept voluntary redundancy.
Defined Contribution Plans vs. Defined Benefit Plans
| Feature | Defined Contribution Plan (DCP) | Defined Benefit Plan (DBP) |
|---|---|---|
| Obligation | Entity pays fixed contributions into a separate fund | Entity is obligated to pay agreed post-employment benefits to employees |
| Actuarial / Investment Risk | Borne entirely by the employee | Borne entirely by the employer (entity) |
| Accounting Mechanics | Expense recognized equals contribution payable for period | Requires actuarial assumptions via Projected Unit Credit Method |
| Balance Sheet Item | Accrued or prepaid contribution | Net Defined Benefit Liability or Asset (Funded Status) |
Accounting for Defined Benefit Plans
1. The Funded Status
At the end of each reporting period, the entity determines the net amount recognized on the statement of financial position:
- If : Recognized as a Net Defined Benefit Liability (Deficit).
- If : Recognized as a Net Defined Benefit Asset (Surplus), subject to the Asset Ceiling (the present value of any economic benefits available in the form of refunds from the plan or reductions in future contributions).
2. Components of Defined Benefit Cost
Under PAS 19, the components of defined benefit cost are strictly bifurcated between profit or loss and Other Comprehensive Income (OCI):
Components of Defined Benefit Cost
│
┌─────────────────────────┴─────────────────────────┐
▼ ▼
Profit or Loss Other Comprehensive Income
┌─────────────┴─────────────┐ (OCI)
▼ ▼ │
Service Cost Net Interest ▼
• Current Service Cost • Net Interest Expense / Remeasurements
• Past Service Cost Income • Actuarial Gains & Losses
(Plan Amendments) • Net Defined Benefit on DBO
• Gain/Loss on Non- Liability (Asset) x • Actual Return on Plan
Routine Settlements Discount Rate Assets less Interest Income
• Changes in Asset Ceiling
│
▼
Strictly NEVER Recycled
to Profit or Loss
-
Service Cost (Profit or Loss):
- Current Service Cost: Increase in present value of DBO resulting from employee service in the current period.
- Past Service Cost: Change in present value of DBO resulting from plan amendments (introducing or changing benefits) or curtailments (significant reduction in employee numbers). Under PAS 19, past service cost is recognized immediately as an expense in profit or loss at the earlier of when amendment occurs or when related restructuring/termination costs are recognized. Amortization over remaining vesting periods is prohibited.
- Gain or Loss on Settlement: Difference between present value of DBO settled and the settlement consideration paid.
-
Net Interest on Net Defined Benefit Liability / Asset (Profit or Loss):
- The discount rate must be determined by reference to market yields at the end of the reporting period on high quality corporate bonds (or government bonds if deep corporate bond market lacks).
- This single net interest calculation replaces the older historical approach of calculating interest cost on DBO and expected return on plan assets separately.
-
Remeasurements (Other Comprehensive Income - Non-Recyclable):
- Actuarial Gains and Losses on DBO: Arising from experience adjustments (differences between previous actuarial assumptions and what actually occurred) and effects of changes in actuarial assumptions (demographic or financial).
- Return on Plan Assets (Excluding Net Interest): The difference between actual return on plan assets and interest income on plan assets included in net interest.
- Changes in Effect of Asset Ceiling (excluding interest).
- Accounting Treatment: Remeasurements are recognized immediately in OCI and accumulated in equity (retained earnings or a separate reserve). They are strictly prohibited from being recycled to profit or loss in any subsequent period.
Zamboanga Corporation reported accounting income before tax of PHP 4,000,000 for the year ended December 31, 2026. The tax rate is 25%. Examination of transactions revealed the following differences: (1) Interest income on Philippine bank deposits (subject to final tax) of PHP 150,000; (2) Fines and surcharges paid to the BIR of PHP 50,000; (3) Warranty expense recognized on an accrual basis of PHP 400,000, while actual warranty costs paid during the year were PHP 100,000; (4) Tax depreciation exceeded accounting depreciation by PHP 300,000. There were no beginning deferred tax balances. What is the total current income tax expense for 2026, and what is the net deferred tax balance on December 31, 2026?
Current tax expense PHP 975,000; Net deferred tax liability PHP 25,000
Current tax expense PHP 1,025,000; Net deferred tax asset PHP 75,000
Current tax expense PHP 975,000; Net deferred tax asset PHP 25,000
Current tax expense PHP 975,000; Net deferred tax balance PHP 0
At the start of 2026, Palawan Enterprises reported a Defined Benefit Obligation (DBO) of PHP 8,000,000 and Plan Assets at fair value of PHP 6,500,000 (Net Defined Benefit Liability of PHP 1,500,000). The market discount rate on high quality corporate bonds was 8%. During 2026, current service cost was PHP 700,000; past service cost due to a plan amendment was PHP 200,000; employer contributions paid to the fund were PHP 600,000; and benefits paid to retirees were PHP 400,000. The actual return on plan assets was PHP 620,000, and actuarial losses on DBO due to changes in financial assumptions were PHP 150,000. Under PAS 19, what total defined benefit cost should be recognized in profit or loss for 2026?
PHP 1,020,000
PHP 1,070,000
PHP 820,000
PHP 1,170,000
Sections you finish are checked off in the contents.