Overview of Improperly Accumulated Earnings Tax in the Philippines

By: Garry S. Pagaspas

Improperly accumulated earnings tax (IAET) in the Philippines is imposed upon every corporation formed or availed for the purpose of avoiding the income tax with respect to its shareholders or the shareholders of any other corporation, by permitting earnings and earnings and profits to accumulate instead of being divided or distributed. I pity those who are being paid this tax because with proper education and awareness, these could be avoided. You would not want to waste your hard earned business profits from the effects of simple lapses, or worst, ignorance.  Hereunder are its simple features to picture out how it works:

Imposed as a penalty tax to recover lost revenue

In simple and plain language, improperly accumulated earnings tax is a penalty tax upon a corporate taxpayer for accumulating so much net income after tax  beyond the reasonable needs of the business. Section 43 of the Corporation Code of the Philippines in effect prohibits a stock corporation to maintain a retained earnings more than 100% of its paid-up capitalization.

In a corporate set-up, stockholder-owners gets their share in the earnings of the corporation through the dividends from the retained earnings. Dividend declaration is dependent upon the will of the Board of Directors and upon declaration cash and/or property dividend to resident individual stockholder is subject to 10% final tax on dividends. No dividend declaration by the Board of Directors means that the government will lose the revenue from the dividend tax. As such, improperly accumulated earnings tax in the Philippines is imposed to recover the revenue it should have earned. Aside from the 10% IAET, Securities and Exchange Commission (SEC) likewise provides a penalty for such an excess.

Tax rate is 10% based on improperly accumulated earnings

As a mechanism to recover lost revenue, the tax rate is patterned after the rate that the government should have earned.  Since tax on dividends to resident individuals is 10%, then, the tax rate imposed is the same. Thus, Section 29 of the National Internal Revenue Code of the Philippines imposes a 10% improperly accumulated earnings tax.

Imposition is not outright upon the mere improper accumulation

The mere fact that the retained earnings exceed 100% of the paid up capitalization at the end of a taxable year does not mean an outright tax liability for IAET. What is being taxed is the improper accumulation and not the mere accumulation. Improper means the unjustifiable accumulation beyond the reasonable needs of the business. In determining the reasonable needs, the amount of paid up capitalization is considered, but does not include additional paid-up capital under Revenue memorandum Circular no. 35-2011.

As a rule, the corporate taxpayer has within one (1) year or twelve months from the end of the taxable year within which to dispose of or remedy the excess retained earnings. Under the rules of the Securities and Exchange Commission (SEC), such corporate taxpayer must come up with a concrete plan as to the disposition of such excess. It is the failure to dispose of such excess upon the the lapse of one (1) year that is being penalized and subjected to improperly accumulated earnings tax in the Philippines.

One simple approach is to appropriate part of retained earnings for some future use through a Board Resolution – e.g. appropriations for business expansion, redemption of a long term obligation, and more. But mere appropriation of retained earnings without an implementation may not be safe. Another approach is a cash or property or stock dividend declaration securing a notation with the SEC. Another is increasing authorized capitalization with the Securities and Exchange Commission (SEC) either by cash infusion, stock dividend declaration, tax-free transfer, and more.

Imposed upon improperly accumulated earnings on holistic view

Taxable net income is subjected to 30% income tax. Net income after income tax that is allowed to accumulate beyond 100% of the paid-up capitalization is the tax base of improperly accumulated earnings tax in the Philippines. Improperly accumulated taxable income as a tax base of the 10% improperly accumulated earnings tax is further adjusted by the following:

  • Income exempt from tax;
  • Income excluded from gross income;
  • Income subject to final tax;
  • The amount of net operating loss carry-over deducted
In short, the improperly accumulated earnings as a tax base is the entire income of the corporation because it includes all income it earned during the year, regardless ow whether or not it was subjected to 30% normal income tax. It is however reduced by the amount of dividends actually or constructively paid.

No duplication of the tax

Normally, this tax type is being paid during tax assessments in the Philippines. Once the 10% improperly accumulated earnings tax has been paid, such amount could no longer be subjected to IAET in the subsequent year. To do so would be a direct duplicate taxation tantamount to a violation of equal protection clause. Nevertheless, is is still suggested to dispose of the excess free retained earnings. Remember, it is always better to prevent an issued with the tax authority (BIR), than to defend one.

Does not apply to the following

Suffice it to say, not all corporate taxpayers are subject to the 10% improperly accumulated earnings tax in the Philippines. The following are exempted, to wit:

  • Publicly held corporations;
  • Banks and other non-bank financial intermediaries;
  • Insurance companies;
  • Taxable partnerships;
  • General professional partnerships;
  • Tax-exempt joint ventures;
  • Economic Zone (Ecozones) under special tax rate; and,
  • Philippine branch of a multinational company

I hope the above would give you a bigger picture of how the 10% improperly accumulated earnings tax in the Philippines would apply. As mentioned above, this could be avoided legally and I suggest you do not waste you hard earned business profits on this tax type.


Disclaimer: This article is for general conceptual guidance only and is not a substitute for an expert opinion. Please consult your preferred tax and/or legal consultant for the specific details applicable to your circumstances. You can send your comments and feedback at info@taxacctgcenter.org.


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