Introduction

The Optional Standard Deduction (OSD) is a tax simplification measure provided under Section 34(L) of the National Internal Revenue Code (NIRC) of 1997, as amended by Republic Act No. 10963, also known as the Tax Reform for Acceleration and Inclusion (TRAIN) Law. It allows eligible taxpayers to deduct a fixed percentage—40%—of their gross sales or gross receipts (for corporations) or gross income (for individuals) in lieu of itemizing actual allowable deductions. This option aims to reduce the administrative burden of substantiating expenses, particularly for small and medium-sized enterprises and individual taxpayers with straightforward operations.

However, electing the OSD does not eliminate all tax recording and compliance obligations. Taxpayers must still maintain accurate records to support their gross income, sales, or receipts, as these form the basis for computing the deduction and the taxable income. Failure to comply with these obligations can lead to assessments, penalties, and potential disallowance of the OSD election. This article explores the full scope of tax recording requirements associated with the OSD in the Philippine context, drawing from relevant provisions of the NIRC, Bureau of Internal Revenue (BIR) regulations, and related issuances.

Eligibility for OSD

Before delving into recording obligations, it is essential to understand who can avail of the OSD, as eligibility determines the applicability of associated compliance rules.

For Individuals

Qualified Taxpayers: Resident citizens, non-resident citizens, resident aliens, and taxable estates and trusts engaged in trade, business, or the practice of a profession.
Exclusions: Non-resident aliens engaged in trade or business in the Philippines cannot elect OSD. Similarly, individuals deriving compensation income only (purely employees) are generally not eligible unless they have additional business income. Partners in general professional partnerships (GPPs) may elect OSD for their share in the partnership's income.
Mixed Income Earners: Individuals with both compensation and business income can apply OSD only to their business income, while compensation income remains subject to standard withholding and potential itemized deductions if applicable.

For Corporations

Qualified Entities: Domestic corporations and resident foreign corporations.
Exclusions: Non-resident foreign corporations, proprietary educational institutions, hospitals, and corporations subject to special tax regimes (e.g., those under the Mining Law or Petroleum Service Contracts) are ineligible.
Special Cases: For corporations, the OSD is computed at 40% of gross income, excluding cost of goods sold or services for non-VAT taxpayers.

Eligibility is crucial because only qualified taxpayers can elect OSD, and once elected, they must adhere to specific recording standards to validate their gross figures.

Election Process and Irrevocability

The election of OSD is a critical step that triggers specific recording implications.

How to Elect: The election must be indicated in the taxpayer's first quarterly income tax return (BIR Form 1701Q for individuals or 1702Q for corporations) for the taxable year. If no quarterly return is required (e.g., for individuals with pure business income below certain thresholds), the election is made in the annual income tax return (BIR Form 1701 for individuals or 1702 for corporations).
Irrevocability: Once elected, the OSD is irrevocable for the entire taxable year. Taxpayers cannot switch to itemized deductions mid-year. However, they may change their election in subsequent years.
Implications for Recording: The election shifts the focus of record-keeping from expense substantiation to income verification. Taxpayers must ensure that their books accurately reflect gross sales, receipts, or income, as any discrepancy could invalidate the OSD claim during a BIR audit.

For partnerships, the election is made at the partnership level for GPPs, but individual partners in non-professional partnerships may elect separately.

Tax Recording Obligations Under OSD

While OSD relieves taxpayers from the need to substantiate itemized deductions (e.g., no requirement to keep receipts for advertising, rent, or salaries), it does not absolve them from maintaining proper books of accounts and issuing compliant documents. These obligations stem from Sections 232 to 237 of the NIRC, Revenue Regulations (RR) No. 16-2005 (as amended), RR No. 8-2018, and other BIR issuances. The primary goal is to ensure the integrity of reported gross income, which directly affects tax liability.

Maintenance of Books of Accounts

Requirement for All Taxpayers: All OSD electors must keep books of accounts, regardless of business size. These include journals, ledgers, and subsidiary records, registered with the BIR before use.
Simplified Recording for OSD: Since actual expenses are not deducted, books do not need detailed expense entries. However, they must accurately record:
- Gross sales or receipts (for sellers of goods).
- Gross income (for service providers, including professional fees).
- Cost of goods sold or cost of services (deductible before applying the 40% OSD for certain taxpayers).
Manual vs. Computerized Systems: Taxpayers may use manual books or computerized accounting systems (CAS), but CAS must be registered with the BIR under RR No. 9-2009. Loose-leaf books are allowed if bound and registered annually.
Retention Period: Books must be preserved for at least three years from the last entry, or longer if under audit (Section 235, NIRC). This ensures availability for BIR verification of gross figures.

Issuance of Official Receipts and Invoices

Mandatory for All Transactions: Every sale, barter, exchange, or lease must be documented with a BIR-registered official receipt (OR) or sales invoice (SI).
- VAT Taxpayers: Must issue VAT invoices or receipts compliant with RR No. 16-2005, including details like taxpayer's name, TIN, business address, date, quantity, description, unit cost, and VAT amount.
- Non-VAT Taxpayers: Issue non-VAT ORs or SIs with similar details but without VAT breakdown.
Electronic Invoicing: Under the Ease of Paying Taxes (EOPT) Act (RA 11976), electronic invoicing is encouraged, and taxpayers must comply with BIR's electronic reporting requirements.
Impact of OSD: Even with OSD, improper invoicing can lead to penalties and questions on gross income validity. For instance, unreported sales discovered through third-party matching could adjust the OSD base.

Registration and Reporting Requirements

Annual Registration: Taxpayers must update their registration (BIR Form 1905) if electing OSD, especially if it changes their accounting method.
Quarterly and Annual Returns: OSD electors file the same returns as others but compute taxable income as gross income minus 40% OSD (after deducting cost of sales where applicable).
Summary Lists: VAT-registered OSD users must submit quarterly Summary List of Sales/Purchases (SLSP) under RR No. 1-2012, detailing transactions above certain thresholds.
Inventory Lists: For sellers of goods, annual inventory lists must be submitted if gross sales exceed PHP 3 million, even under OSD.

Special Considerations for Professionals and Service Providers

Professionals (e.g., lawyers, doctors) electing OSD must still maintain client ledgers or records of services rendered to support gross receipts.
No need for expense vouchers, but income logs are essential for audit defense.

Audit and Verification

During BIR audits, the focus shifts to verifying gross income through bank deposits, third-party information (e.g., from customers), or cash flow analysis.
Taxpayers must provide access to books and records upon request (Section 6, NIRC). Non-compliance can result in jeopardy assessments.

Compliance Monitoring and Penalties

The BIR monitors OSD compliance through its Large Taxpayers Service, Revenue District Offices, and data-matching programs.

Common Violations:
- Failure to keep registered books.
- Non-issuance or improper issuance of receipts/invoices (penalty: PHP 1,000 to PHP 50,000 per violation, plus potential criminal charges).
- Underdeclaration of gross income (leads to deficiency taxes plus 25% surcharge, 12% interest, and 50% fraud penalty if willful).
Civil Penalties: Under Section 257, failure to keep books incurs fines from PHP 1,000 to PHP 50,000.
Criminal Penalties: Willful neglect can lead to imprisonment (Section 255).
Disallowance Risk: If records are inadequate, the BIR may disallow OSD and require itemized deductions, potentially increasing tax liability.

To mitigate risks, taxpayers should undergo voluntary compliance programs like the BIR's Tax Compliance Verification Drive.

Interaction with Other Tax Rules

Withholding Taxes: OSD does not affect withholding obligations. Taxpayers must withhold and remit taxes on payments (e.g., expanded withholding tax on professional fees).
Value-Added Tax (VAT): OSD applies only to income tax; VAT recording remains unchanged, requiring detailed sales and input tax records.
Percentage Tax: For non-VAT taxpayers, percentage tax returns must still be filed with supporting sales records.
Local Business Taxes: Local government units may require separate records for business permits, but OSD does not directly impact these.

Best Practices and Recommendations

To ensure full compliance:

Engage a certified public accountant (CPA) for book registration and return preparation.
Use accounting software compliant with BIR standards.
Conduct regular internal audits of income records.
Stay updated with BIR issuances, such as Revenue Memorandum Circulars (RMCs) clarifying OSD applications.

Conclusion

The OSD offers significant relief from the rigors of itemizing deductions, but it mandates rigorous recording of income-related data to uphold tax integrity. By maintaining registered books, issuing compliant documents, and fulfilling reporting duties, taxpayers can fully benefit from this option while avoiding penalties. Understanding these obligations is vital for sustainable tax compliance in the Philippines, promoting both efficiency and accountability in the tax system.