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Internal Flaws of the New Rules on the OSD

(Article published in the May 26, 2010 issue of Manila Standard Today)   

Had Finance Secretary Margarito Teves insisted (and had BIR Commissioner Joel Tan Torres dutifully complied) on conducting a public hearing by way of consultation prior to the issuance of Revenue Regulations No. 2-2010 (Rev. Regs 2-201), he would have been made aware by the affected parties of the intrinsic flaws of said issuance.   

First, on the matter of procedural compliance.  A public hearing would have easily made the good Secretary realize that his asking, in Rev. Regs. No. 2-2010, the affected taxpayers to make their irrevocable choice (of whether to claim itemized deductions or, in lieu thereof, the optional standard deduction, or OSD, of 40%) at the time they file their first quarter returns for the year is contrary to law. 

In contrast, the current provision, Sec. 34(L), of the Tax Code, as well as all its predecessors since 1950, imposes on all income taxpayers the need to so choose at the time of the filing of the return “for the taxable year for which the return is made.”

General professional partnerships, for purposes of computing the distributive share of the partners, compute their net income “in the same manner as a corporation.” A corporation, according to Sections 76 and 77, files for any one year’s income, two kinds of returns: first, it files, for each of the first three quarters, what is known as “a summary declaration of its gross income and deductions on a cumulative basis for the preceding quarter or quarters” and, what is known as a “final adjustment return covering the total taxable income for the preceding calendar or fiscal year.” 


Hence, there is only one return, and that is the “final adjustment return”, that is currently required of corporations to be filed that is for the “taxable year”; all the other returns, i.e. those filed after the first three quarters, covering as they do only the “gross income and deductions on a cumulative basis for the preceding quarter or quarters” are for those less than one year periods and not, repeat “not”, for the taxable year.

Therefore, requiring the taxpayer who is a partner to choose, and choose irrevocably for the year, whether or not to claim the itemized or the OSD, at the first instance when he files a return (which is the return for the first quarter and not for the taxable year) is clearly against the law.  It constrains him by regulation to choose at a time that is not what is identified by law.

Worse than this dissonance between Rev. Regs. No. 2-2010 and the law is attempt to apply the rule, issued in 2010, not only for income that is to be earned after issuance but also for income that was earned in 2009. 

Revenue Memorandum Circular No. 16-2010, on the obligation of taxpayers to indicate their need to disclose their choice of the OSD, provides:

“Taxpayers who are electing to avail of the OSD are required to check the appropriate box in the income tax return filed for the first quarter of the taxable year 2009, regardless of whether such taxpayer is adopting the calendar or fiscal year…The failure to indicate the election to avail of the OSD shall be considered as having availed of the itemized deductions allowed under Section 34 of the Tax Code…”

This rule requiring disclosure of one’s choice “in the income tax return filed for the first quarter of the taxable year 2009” was issued in 26 February of 2010, more than one month after the calendar year 2009 had ended and more than half a year after the return referred to had been filed.  Since the obligation to make the choice in the first return to be filed for 2009 was announced long after the said return had been filed, everyone, in effect, was deprived of the right to make a choice since the inability to take the option is construed as a deliberate choice to itemize one’s  deductions.

This action of the revenue authorities to retroact the application of Rev. Reg. 2-2010 flies in the face of the well-settled rule that issuances of the Commissioner of Internal Revenue cannot be given retroactive application when doing so would be prejudicial to the taxpayers.

Section 246 of the Tax Code clearly states that “any revocation, modification, or reversal of any of the rules and regulations…by the Commissioner shall not be given retroactive effect if the revocation, modification or reversal will be prejudicial to the taxpayers” except in certain instances which clearly do not apply to the subject at hand.

And even if Rev. Reg. No. 2-2010 were not made applicable to income earned before its issuance, the effective revocation of the individual partner’s right to choose constitutes a taking of property without due process of law.

Before the issuance of Rev. Reg. No. 2-2010, the rule, clearly and correctly stated in Rev. Reg. 16-2008, clearly stated that an individual partner may elect either the OSD or itemized deductions independently of how the general professional partnership to which he belongs and in where he earned his distributive share claimed the deductions to determine the partnership’s distributable net income.

This principle has been followed and relied upon since its articulation and the right it recognized cannot be taken away from the individual partner without violating the constitution prohibition against the taking of property without due process of law.  That prohibition is in fact a limitation on the power to tax, and no need for revenues of this departing administration can justify the trampling upon that fundamental creed of constitutional government.