1) Why “below the threshold” matters: two separate national taxes

For most Philippine small businesses, “below the threshold” is shorthand for below the VAT registration threshold (generally ₱3,000,000 gross sales/receipts in any 12-month period). Being below that threshold mainly affects business tax on sales/receipts (VAT vs. percentage tax). It does not remove the obligation to pay income tax.

In simplified terms:

Income tax is a tax on taxable income (profit, after allowable deductions), imposed under the National Internal Revenue Code (NIRC) provisions on individuals and corporations.
Business tax is a tax on gross sales/receipts (topline), generally either:
- VAT (value-added tax), or
- Percentage tax (commonly under NIRC, Sec. 116 for non-VAT persons below the VAT threshold), unless a different special percentage tax applies.

A small business below the VAT threshold is usually:

Non-VAT (not registered for VAT), and
Subject to percentage tax (Sec. 116) unless it elects the 8% income tax option (for eligible individuals) or is subject to another type of percentage tax.

2) The VAT threshold: what it is and how it’s tested

2.1 The common threshold rule

Under the NIRC’s VAT provisions, a person is generally required to register as VAT if gross sales/receipts exceed ₱3,000,000 within a 12-month period (or if required/chooses to register). Businesses not exceeding that level are typically treated as VAT-exempt due to threshold and may remain non-VAT.

2.2 How the threshold is monitored in practice

Key points that commonly matter in audits and registration issues:

Gross sales/receipts is a gross measure—not net income.
Testing is typically over a rolling 12-month period, not only calendar-year totals.
Aggregation issues:
- Sales/receipts from branches are generally combined.
- A single taxpayer operating multiple lines of business may still be tested on combined gross sales/receipts, depending on how the taxpayer is registered and invoicing.

2.3 If you exceed the threshold

Once you exceed the threshold, the business is generally expected to update registration to VAT and comply with VAT invoicing and return filing rules. Failure to register on time can trigger deficiency VAT assessments, surcharges, interest, and penalties.

3) If you are non-VAT below the threshold, what business tax applies?

3.1 Default rule: Percentage tax under NIRC, Sec. 116

For many small businesses below the VAT threshold, the default business tax is percentage tax under NIRC, Sec. 116, imposed on persons whose sales/receipts are exempt from VAT due to being below the threshold and who are not VAT-registered.

Tax base: generally gross quarterly sales/receipts
Rate: commonly stated as 3% under Sec. 116 Note: The percentage tax rate has been temporarily adjusted in certain past periods by special laws. For accuracy, always confirm the applicable rate for the quarter being filed, especially for transitional years.

3.2 Filing and payment (typical)

Filed on a quarterly basis using the BIR’s percentage tax quarterly return (commonly BIR Form 2551Q in modern filing).
Deadlines are typically within 25 days after the end of each quarter, though operational rules can change through BIR issuances.

3.3 Who is not covered by Sec. 116 even if “small”

Being below the VAT threshold does not automatically mean Sec. 116 applies. Many activities are subject to other percentage taxes (or other internal revenue taxes) regardless of size, for example:

Certain franchise taxes (depending on the franchise and applicable law)
Banks and non-bank financial intermediaries (gross receipts tax regime)
Certain amusement taxes
Certain carriers and other industries with specific percentage taxes
Excise-tax products (alcohol, tobacco, fuel, etc.)—excise is separate and can apply regardless of threshold

If a specific percentage tax applies to the business, Sec. 116 is generally not the controlling provision.

4) The 8% income tax option: when “below the threshold” can eliminate percentage tax (for eligible individuals)

A major feature for Philippine micro and small businesses is the 8% income tax option, which—when properly elected and applicable—can replace both:

the graduated income tax rates on business/professional income, and
the percentage tax under Sec. 116

4.1 Who can use the 8% option

Generally, the 8% option is available to:

Individuals earning business income (sole proprietors) and/or professional income
Whose gross sales/receipts and other non-operating income do not exceed the VAT threshold (commonly ₱3,000,000)

4.2 Who cannot use it (common exclusions)

The 8% option is generally not available to:

VAT-registered taxpayers (even if later below threshold, while still VAT-registered)
Taxpayers subject to other percentage taxes under the NIRC (not Sec. 116), because the “in lieu of percentage tax” aspect is aimed at Sec. 116
Corporations (including One Person Corporations), partnerships taxed as corporations, and many entities that are not taxed under individual income tax rules

4.3 How the 8% option is computed

For pure business/professional income individuals (no compensation income):

8% is imposed on gross sales/receipts and other non-operating income in excess of ₱250,000.

For mixed income earners (compensation + business/professional):

The ₱250,000 “excess” rule is typically not applied to the business income side (because the compensation income already uses the graduated rate structure where the ₱250,000 bracket is effectively accounted for). In practice, the 8% applies to gross business/professional receipts (subject to the applicable rules for that tax year).

4.4 The tradeoff: simplicity vs. deductions

The 8% option is attractive because:

it can be simpler, and
it removes the Sec. 116 percentage tax.

But it can be costly if:

your profit margin is thin,
you have large costs and expenses, or
you would otherwise benefit from itemized deductions or the Optional Standard Deduction (OSD).

5) Income tax still applies below the threshold: what rate and what return depends on your taxpayer type

5.1 If you are an individual (sole proprietor or professional)

You generally choose one of these for your business/professional income:

A) Graduated income tax rates (plus percentage tax if non-VAT)

You compute net taxable income = gross income − allowable deductions.
Then apply the graduated tax rates for individuals.
If you are non-VAT below the threshold and did not choose 8%, you typically also pay percentage tax under Sec. 116.

Deductions under the graduated system:

Itemized deductions (substantiated expenses), or
Optional Standard Deduction (OSD) (commonly 40% of gross sales/receipts for eligible individuals, subject to conditions and documentation rules)

B) 8% income tax option (in lieu of graduated rates and Sec. 116)

Compute 8% on the applicable gross base (as discussed above).
Generally no need to file/pay Sec. 116 percentage tax for quarters covered by a valid 8% election.

Common compliance note for individuals

Even if you use the 8% option, you may still have obligations as a withholding agent if you:

have employees (withholding on compensation), or
pay suppliers/landlords/contractors subject to withholding tax.

Those are separate from your own income tax.

5.2 If you are a corporation (including an OPC)

Being below the VAT threshold does not change that corporations pay corporate income tax on taxable income.

Corporate income tax (CIT)

Under the CREATE-era framework, the general CIT rate is:

25% for most domestic corporations
20% for qualifying smaller domestic corporations that meet both:
- Net taxable income not over a statutory ceiling (commonly ₱5,000,000), and
- Total assets not over a statutory ceiling (commonly ₱100,000,000), excluding the land on which the office/plant sits (Exact qualification requires careful reading of the applicable law and the corporation’s audited statements.)

Minimum Corporate Income Tax (MCIT)

Corporations can also be subject to MCIT (a minimum tax based on gross income) beginning on a specified year of operations, with rates and suspensions that have changed in past periods under special laws.

Business tax for a non-VAT corporation below threshold

A corporation that is not VAT-registered and is below the VAT threshold is typically subject to:

percentage tax under Sec. 116 (unless a different special percentage tax applies), or
it may voluntarily register as VAT if advantageous (with a lock-in period rule historically applied to VAT registration changes).

5.3 Partnerships and similar arrangements (brief but important distinctions)

General Professional Partnerships (GPPs) are typically treated as pass-through for income tax: the partnership itself is not taxed like a corporation on net income; instead, partners are taxed on their distributive shares. However, the partnership may still have business tax and withholding obligations depending on its activities and registration.
Ordinary partnerships can be taxed similarly to corporations under the NIRC, depending on structure and classification.

Because partnership taxation can be fact-specific, classification should be confirmed against the entity’s registration and governing agreements.

6) Practical guide: “What taxes apply to me?” (Below VAT threshold)

Scenario 1: Individual sole proprietor, non-VAT, gross sales ≤ ₱3,000,000, chooses graduated rates

You generally pay:

Income tax (graduated rates) on net taxable income, and
Percentage tax (Sec. 116) on gross sales/receipts, plus
Any withholding taxes you must remit if you have employees or pay suppliers subject to withholding.

Scenario 2: Individual professional/sole proprietor, non-VAT, gross receipts ≤ ₱3,000,000, chooses 8%

You generally pay:

8% income tax on the applicable gross base, and
No Sec. 116 percentage tax (for periods covered by a valid election), plus
Any withholding taxes you must remit as a withholding agent.

Scenario 3: Corporation/OPC, non-VAT, gross sales ≤ ₱3,000,000

You generally pay:

Corporate income tax (and possibly MCIT, depending on year/status), and
Percentage tax (Sec. 116) unless another special percentage tax applies or you register as VAT, plus
Withholding taxes if applicable.

Scenario 4: Small business in an industry with a special percentage tax

Even if small, you may be subject to:

a specific percentage tax regime instead of Sec. 116, and
income tax rules appropriate to your taxpayer type.

7) Choosing between (a) non-VAT + percentage tax, (b) 8%, and (c) VAT registration

7.1 Non-VAT + percentage tax (default small taxpayer route)

Often makes sense if:

customers are mostly end-consumers who do not care about VAT invoices, and
you want simpler compliance than VAT, and
you are not eligible for (or do not prefer) the 8% option.

7.2 8% option (eligible individuals only)

Often makes sense if:

your profit margin is high (low expenses relative to receipts), and
you value compliance simplicity, and
your receipts are comfortably within the threshold, and
you are not subject to a special percentage tax.

7.3 Voluntary VAT registration

Sometimes makes sense if:

your clients are VAT-registered and prefer VAT invoices, or
you have significant input VAT on purchases and want input VAT credits, or
you anticipate exceeding the threshold soon and want a smoother transition.

But VAT registration brings:

stricter invoicing requirements,
periodic VAT returns, and
potential lock-in rules on cancellation of VAT registration.

8) Related taxes and obligations that frequently apply even to “small” businesses

Even when the focus is income tax and percentage tax, small businesses often encounter these obligations:

8.1 Withholding taxes (as a withholding agent)

If you pay:

employees (compensation), or
rent, professional fees, contractors, commissions, certain suppliers, etc.,

you may need to withhold and remit taxes and file withholding returns. This obligation is separate from your own income tax and percentage tax.

8.2 Registration, invoicing, and bookkeeping

Small taxpayers generally must:

register with the BIR and secure a Certificate of Registration (COR),
maintain books of accounts as required,
issue compliant invoices/receipts,
keep records supporting deductions (if under graduated rates with itemized deductions).

The Ease of Paying Taxes Act and related reforms have affected invoicing/receipting and administrative requirements in recent years, so the exact implementation details for a specific taxable year should be checked against the then-effective BIR rules.

8.3 Local government taxes

Cities/municipalities typically impose:

local business tax, permits, and regulatory fees under the Local Government Code, which are separate from national BIR taxes and apply regardless of VAT threshold.

8.4 Special law incentives (e.g., BMBE)

If registered as a Barangay Micro Business Enterprise (BMBE) under RA 9178, a business may enjoy income tax exemption on income from operations, but it is commonly still required to:

register with the BIR,
comply with invoicing and recordkeeping, and
comply with other taxes/withholding obligations not expressly exempted by the law.

9) Penalties: why correct classification matters

Common exposures for below-threshold businesses include:

Failure to register as VAT after exceeding the threshold (leading to deficiency VAT, surcharge, interest)
Wrong tax type filed (e.g., filing Sec. 116 when subject to a special percentage tax, or claiming 8% when ineligible)
Non-issuance of compliant invoices/receipts
Withholding tax noncompliance (often a high-risk audit area)

Penalties under the NIRC can include:

surcharge, interest, and
compromise penalties and potential criminal liability for willful cases, depending on facts.

10) Quick checklist for small businesses below the VAT threshold

Confirm your taxpayer type: individual, corporation/OPC, partnership/GPP.
Confirm whether you are VAT-registered or non-VAT.
If non-VAT, determine whether you are under:
- Sec. 116 percentage tax, or
- a special percentage tax regime.
If an individual under Sec. 116, evaluate if the 8% option is available and beneficial.
Track gross sales/receipts against the ₱3,000,000 rolling threshold.
Ensure correct returns and deadlines for:
- income tax (quarterly/annual as applicable),
- percentage tax (quarterly, if applicable),
- withholding taxes (if applicable).
Ensure compliant invoicing/receipting and recordkeeping for the tax year.