Taxation Philippines: Leasehold Improvements

INCOME on Leasehold Improvements

ANGELITO C. DESCALZO, CPA  ICAEW IFRS IFRS Certified 

Leasehold Improvements - Definition

• Alterations made to rental premises in order to customize it for the specific needs of a tenant. • Leasehold improvements include construction of  building, fencing, painting, installing partitions, changing the flooring, putting in customized light fixtures, etc. • Leasehold improvements can either be undertaken by landlords (lessors), who may offer to do so to increase the marketability of their rental units, or by the tenants (lessees) themselves.

When the lessee makes useful improvement to the leased property, the following rules shall apply if no reimbursements are made by the lessor:

1. The lessor may report income under the: a. Outright method – based on fair market va ue

o mprovemen s n

e year o

completion b. Spread-out method – book value (BV) of  improvements are spread over the remaining term of the lease

Rules on Leasehold Improvement (continued):

2. Lessee may claim depreciation of the improvements over the remaining term of the lease or life of the improvements, whichever is shorter. . , lessor should report income based on the BV upon termination less amount already reported as income. 4. The lessor shall apply cash method on prepayment of rental even if it is using accrual accounting.

Leasehold Improvements  Note:

• If leased property (land and building) is being used actually, directly and exclusive for   educational purpose, t e essee s a e exempt rom pay ng rea estate tax. • All assessments or reassessments made after the 1 st day of January of any year shall take effect on the 1 st day of January of the succeeding year  (Sec. 221, Local  Government Code of 1991).

Illustration – – Leasehold Improvement • Mr. A leased a land to Mr. B for a period of 20 years starting January 2, 2012 at a monthly rental of P50,000. • The Lease contract provides that Mr. B will construct a school house on the lot. • The contract also provides that the improvement shall become property of the lessor at the end of the lease. • The school house was completed on June 30, 2014 at a cost of  2,000,000. • The estimated life of the leasehold improvement is 25 years. • Mr. B agreed to pay the real estate tax on the land assessed at P34,567 annually. • Mr. B paid Mr. A an equivalent of 2 years rent on January 3, 2012.

Q1 – – What is the income to be reported by the lessor in 2012?

Cash received (P50,000 x 24) Tax aid b lessee Income to be reported in 2012

1,200,000 34 567 1,234,567

Q2 – – What is the income to be reported by the lessor in 2013?

Tax paid by lessee

34,567

Income to be re orted in 2013

34 567

Q3 – – What is the income to be reported by the lessor in 2014 under the outright method?

Rent income (50,000 x 12) Leasehold improvement Tax paid by lessee Income to be reported in 2014 under outright method

600,000 2,000,000 34,567 2,634,567

Q4 – – What is the income to be reported by the lessor in 2014 under the spreadspread -out method? Rent income (P50,000 x 12) Tax paid by lessee Cost Less: Accumulated amortization (2,000,000/25 x 17.5) Book value, end of lease Computation: (600,000/17.5) x 6/12 Income to be reported in 2014 under spread-out method

600,000 34,567 2,000,000 1,400,000 600,000 17,143 651,710

Q5 – – What is the income to be reported by the lessor in 2015 under the spreadspread -out method? Rent income (P50,000 x 12) Income on Leasehold improvement:

600,000 ,

Less: Accumulated amortization (2,000,000/25 x 17.5) Book value, end of lease Computation: (600,000/17.5) Income to be reported in 2015 under spread-out method

,

1,400,000 600,000 34,286 634,286

Q6 – – Assuming the lease contract was terminated on March 31, 2018 due to lessee’s fault, how much income should Mr. A report in 2018 under the spreadspread-out method?

Cash received (50,000 x 3) Leasehold improvement: Cost ess: ccumu a e eprec a on (2,000,000/25 x 3.75) Book value upon termination Less: Amount declared as income 2014 2015 2016 2017 Income to be reported in 2018

150,000 2,000,000 300,000 1,700,000 17,143 34,286 34,286 34,286

120,001 1,579,999 1,729,999

Q7 – – How much deductible expenses can the lessee report in 2014?

Rent expense (P50,000 x 12) Tax De reciation on LHI 2,000,000/17.5 x 6/12 Expenses to be reported in 2014

600,000 34,567 57,143 691,710

Q8 – – How much deductible expenses can the lessee report in 2015?

Rent expense (P50,000 x 12) Depreciation on LHI , , . Expenses to be reported in 2015

600,000 , 714,286

Q9 – – How much deductible expenses can the lessee report in 2018?

Rent expense (P50,000 x 3) Depreciation on LHI , , . Expenses to be reported in 2018  Note: Remaining book value of leasehold improvement shall be treated as other loss by the lessee

150,000 , 178,571

GROSS INCOME from Manufacturing, Merchandising or  Mining business Computation of Gross income: Total sales Less: Cost of Goods Sold Gross Profit  Add: Other Income Gross Income

Pxxx xx Pxxx xx Pxxx

GROSS INCOME from Farming

Farm includes livestock, dairy, poultry, fruit and truck farms, plantations, ranches, and all land used for  farming operations. Methods of reporting gross income: a. Cash basis – no inventory is used to determine profits b. Accrual basis – an inventory account is used to determine profits c. Crop basis – used when crops take more a year  to gather and dispose of from the time of planting.