Income Taxation Dimaampao

BASICAPPf
TO INCOME TJ
JUSTICE JAPAR B. DI
tsA:Sll,; APPROACH
TO
INCOME TAXATION
By
JAPAR B. DIMAAMPAO
Associate Justice, Court of Appeals
Professor of Law, Bar Reviewer
FOURTH EDITION
2011
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856 Nicanor Reyes, Sr. St.

Tel. Nos. 73605-67 73513-64
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Manila, Philippines
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CONTENTS
Chapter 1
Salient Features of the Present Tax System
1: Individual Income System................................. 1

II. Corporate Income Taxation............................... 2
Ill. Common Features ............................................ 2
Chapter 2
Income and Requisites; Income Tax;
Nature and Functions
A. Definitions.......................................................... 4
(1.) Judicial Definitions..................................... 4
(2.) Economist's Definition................................ 4
B. Income, Capital, Revenue, Receipts;
Distinctions................................................. 5
C. Sources of Income............................................ 5
D. Income Tax; Basis, Nature, Functions.............. 7
E. Requisites for Income to be Taxable ......... ....... 8
( 1 . ) Doctrine of Constructive Receipt
of Income............................................ 9
F. Doctrines on Determination of Taxable Income 11
( 1.) Claim of Right Doctrine.............................. 11
(2.) Severance test theory................................ 11
(3.) Control test................................................. 11
Chapter 3
Gross Income
A. General Statutory Definition.............................. 12
xix
B. Broad Definition ................................................. 13 (1.) Other tax implications of condonation
Formula: Gross Income; Net Income; Taxable of indebtedness ......................... 30
Compensation Income; Income Tax Due; (2.) Other tax implications of premiums
Income Tax Payable .................................. 13 paid by employer ....................... 30
Gross Income Taxation and Net Income a.) Convenience of the Employer
Taxation; Distinctions; Advantages and Rule ............................... 31
Disadvantages ........................................... 14 b.) De minim is benefits ..................... 32
Exclusions from Gross Income ......................... 15 E. Special Rules on Fringe Benefits ..................... 33
A. Reasons for Exclusion ...................................... 15 F. Doctrine of Cash Equivalent ............................. 38
B. Exclusions from Gross Income ......................... 15 G. Allowable Deductions from Gross
(1.) Proceeds of life insurance ......................... 15 Compensation Income ............................... 38
(2.) Amount received as return of premium ..... 16 (1.) Personal exemptions ................................. 38
(3.) Gifts, bequests and devises ...................... 17 (2.) Premium Payments on Health and/or
(4.) Compensation for injuries or sickness ....... 17 Hospitalization Insurance ........................... 43
(5.) Income exempt under treaty ...................... 18 Business/Trade/Professional Income
(6.) Retirement benefits, pensions, A. Income Covered
gratuities, etc ...................................... 18 (1.) Income derived by self-employed from
(7.) Miscellaneous items ................................... 21 trade or business (trading,
manufacturing, merchandising,
Chapter 4 farming. and others) ........................... 44
(2.) Income derived by professionals ............... 45
Individual Income Taxation (3.) Gross income of farmers include ............... 46
A. Classification of Individual Taxpayers i.) Interest Income ................................. 46
(1.) Resident citizen .......................................... 25 ii.) Rental Income ................................... 46
(2.) Non-resident citizen ................................... 25 iii.) Dividend Income ............................... 48
(3.) Resident alien ............................................ 25 iv.) Passive Investment Income .............. 50
(4.) Non-resident alien ...................................... 27 (4.) Other Sources ............................................ 51
(5.) Non-resident alien not engaged in
trade or business ................................ 27 Chapter 5
B. General Principles; Sources of Income; Corporate Income Taxation
Tax Base .................................................... 27
A. Definition under the NIRC ................................. 53
C. Categories of Income ........................................ 28
B. Major Groups of Corporation for Income
a. Definition .................................................... 28 Tax Purposes ............................................. 56
b. Basis/Test ................................................... 29 (1.) Domestic Corporations .............................. 56
c. Requisites for Taxability ............................. 29 (2.) Resident Foreign Corporations .................. 57
d. Forms of Compensation ............................ 29 (3.) Non-resident Foreign Corporations ........... 60
xx
xxi
C. Minimum Corporate Income Tax....................... 61 (1.) Distinctions: Deductions, Exclusions and
D. Improperly Accumulated Earnings Tax............. 69 Personal Exemptions.......................... 92
E. Other Corporate Tax Rates............................... 73 Kinds of Allowable Deductions ....... ...... ... .. 92
(1.) Common Tax Rates................................... 73 (1.) Itemized Deductions.................................. 92
(2.) Domestic Corporations ............................. , 73 (2.) Optional Standard Deduction..................... 93
(3.) Resident Foreign Corporations.................. 74 Kinds of Itemized Deductions ... ... ........... ..... ... .. 93
(4.) Non-resident Foreign Corporations........... 75 C. Business Expenses........................................... 93
F. Tax Exempt Corporations Under the NIRC ...... 77 D. Interest Expenses............................................. 106
( 1.) Labor, Agriculture or Horticultural Definition ....... .... .... ... .... ..... ... ...... ...... .......... .. .... . 106
Organization Not Organized E. Taxes................................................................. 110
Principally for Profit............................. 77 Nature and Scope............................................. 110
(2.) Mutual Savings Banks and Cooperative F. Losses............................................................... 113
Banks.................................................. 77 (1.) Definition.................................................... 113
(3.) Fraternal Beneficiary Society, Order (2.) Kinds of Losses ........................... .............. 114
or Association ..... ....... ... ....... .. ..... .... .... 78 (3.) Special Kinds of Losses............................ 115
(4.) Cemetery Companies................................ 79 a.) Wagering losses........................................ 115
(5.) Religious, Charitable, Scientific, Athletic b.) Losses due to voluntary removal
or Cultural Corporations .... ... .... .... ... .. . 80 of building incident to renewal
(6.) Business, Chamber of Commerce, or or replacement........................... 117
Board of Trade.................................... 80 c.) Loss of useful value of capital asset
(7.) Civic League.............................................. 82 due to changes in business
(8.) Non-Stock, Non-Profit Educational condition..................................... 118
(4.) Casualty Losses......................................... 122
Institutions........................................... 83
(5.) Non-deductible Losses.............................. 123
(9.) Government Educational Institution........... 85
(10.) Mutual Fire Insurance Companies G. Bad Debts ..... ..... ... ..... ... .. ... .. ... ... ...... ... ..... ... ...... 126
(1.) Definition.................................................... 126
and Like Organizations....................... 85
(2.) Requisites for deductibility......................... 126
(11.) Farmers, Fruit Growers' or Like
(3.) Measure of Bad Debts deductible............. 129
Association.......................................... 86
H. Depreciation...................................................... 131
Tax-Exempt Corporations under
(1.) Definition.................................................... 131
Special Laws....................................... 90 (2.) Requisites for deductibility......................... 131
I. Depletion........................................................... 134
Chapter 6 (1.) Definition.................................................... 134
Allowable Deductions from Gross Income (2.) Theory and purpose of Depletion
allowance............................................ 134
A. Basic Principles................................................. 91
(3.) Who are entitled......................................... 134
B. The Cohan Rule Principle................................. 91
Essential factors......................................... 135
xx ii xxiii
J. Charitable and Other Contributions ................. . 136 Settled Case on the Tax Situs of Interest
(1.) Kinds ........................................................ .. 136 Income ....................................................... 150
(2.) Entitled ................................... ., ................. . 136 B. Capital Transactions .......................................... 153
(3.) Requisites for deductibility ........................ . 136
(4.) Contributions deductible in full ................. .. 137 Chapter 9
(5.) Contribution subject to limitation ............... . 138
Income Tax Rules on Dealings in Property
(6.) Deductible under Special Laws ................ . 139
K. Research and Development Expenditure ........ . 139
(1.) In General ................................................. . A. Capital Gains from Sale or Other Disposition
139
(2.) Limitations on Deduction .......................... . 140 of Real Property
( 1.) Individual Taxpayers .................................. 164
L. Employer's Contribution to Pension Trust ...... .. 140
(1.) Nature ...................................................... .. (2.) Corporate Taxpayers .................................. 166
140
Gains and Losses from Dealings
(2.) Requisites for Deductibility ....................... . 140
in Property .......................................... 166
(3.) There is no need of special permit from
A. Concept ............................................................. 166
the BIR to put up a pension plan for
the benefit of employees ................... . B. Measure of Income or Loss .............................. 167
141
(4.) Treatment of Income from Pension Plan .. . 141 C. Adjusted Basis or Cost of the Property Sold .... 167
(5.) Deductible payments to pension trusts .... . 141 D. Settled Rules on Sale or Exchange .................. 169
Optional Standard Deduction ................... .. 141 E. Tax-exempt Sales or Exchanges ...................... 170
Special deductions allowed to Insurance F. Gain recognized, loss not recognized Rule ...... 172
Companies ......................................... . 142
Items not deductible .................................. . 143 Chapter 10
Taxpayers Required to File Income Tax Returns
Chapter 7
A. Individuals ......................................................... 173
Estates and Trusts B. Corporations no matter How created or
A. Estate ............................................................... . 146 organized including General Professional
B. Trust ............. .. 147 Partnerships ............................................... 175
(1.) Taxable Trust.. ........................................... . 147 C. Estates and Trusts Engaged in Trade
(2.) Rules on Taxability ................................... .. 147 or Business ................................................ 175
C. Computation of Tax on Estate and Trust.. ...... .. 148
APPENDICES
Chapter 8
Appendix A - Revenue Regulations No. 9-98 ......... 176
Special Topics in Income Taxation Appendix B - Revenue Regulations No. 5-99 ......... 186
A. Determination of Source According to Kind Appendix C - Revenue Regulations No. 13-2000 .. 191
of Income ................................................. .. 149
xx iv xxv
Appendix D - Revenue Regulations No. 2-2001 .... 197
Appendix E - Revenue Regulations No. 25-2002... 204
Appendix F - Revenue Regulations No. 76-2003... 207
Appendix G - Revenue Regulations No. 12-2007.. 211
Appendix H - 2011 Bar Coverage for Taxation....... 220 Chapter 1
Appendix I - Bar Examination Questions
on Taxation................................................. 259 SALIENT FEATURES OF THE PRESENT
INCOME TAX SYSTEM
I. INDIVIDUAL INCOME TAXATION

A. Schedular Tax Treatment
1. It classifies income.
2. It provides different tax rules.
3. It imposes different tax rates.
B. Net Income Taxation
1. Resident citizen (RC)
2. Non-resident citizen (NRC)
3. Resident alien (RA)
4. Non-resident alien engaged in trade or busi-
ness (NRA-ETB)
C. Gross Income Taxation
Non-resident alien not engaged in trade or
business (NRA-NETB)
D. Income Tax Situs
1. Residence RA,RC
2. Place NRA, NRC
3. Citizenship RC
E. Individual taxpayers (compensation earners) except
NRA-NETB are entitled to personal exemptions
xxvi
2 BASIC APPROACH TO INCOME TAXATION CHAPTER 1 3
SALIENT FEATURES OF THE PRESENT INCOME TAX SYSTEM
II. CORPORATE INCOME TAXATION C. Final Withholding Tax System
A. Global Tax Treatment 1. Withholding agent (source) - withholds the

tax and remits the same to the BIR
1. It generally provides for uniform rules.
2. Tax withheld - final settlement of the tax li-
2. It generally imposes uniform tax rate. ability on the income covered
3. It does not generally classify income.
B. Net Income Taxation
1. Domestic Corporation (DC)
2. Resident Foreign Corporation (RFC)
C. Gross Income Taxation
Non-resident Foreign Corporation (NRFC)
D. Income Tax Situs
1. Residence RFC
2. Place NRFC
3. Nationality DC
Ill. COMMON FEATURES

A. Pay as you File System
1. Individuals - upon filing of their income tax
returns
2. Corporations - upon filing of their quarterly
corporate income tax returns and final adjust-
ment corporate returns
B. Creditable Withholding Tax System
1. Withholding agent (source) - withholds the
tax and remits the same to the BIR
2. Tax withheld - creditable against income tax
due
CHAPTER2 5
INCOME AND REQUISITES; INCOME TAX; NATURE AND FUNCTIONS
it cannot be determined by reckoning cash receipts;

other income determining factors: inventories, accounts
receivable, property acquisition and accounts payable
Chapter 2 for expenses incurred.
INCOME AND REQUISITES; INCOME TAX; B. INCOME, CAPITAL, REVENUE, RECEIPTS; DISTINC-
NATURE AND FUNCTIONS TIONS (1995 Bar)
Capital v. Income
Fund Flow
A. DEFINITIONS (1969 Bar)
Wealth Service of wealth
In a broad sense, income means all wealth that
flows into the taxpayer other than as a mere return Tree (property) Fruit (metaphorical
of capital. It includes the forms of income specifically language)
described as gains and profits including gains derived Gross receipt includes receipts which may con-
from the sale or other disposition of capital assets. stitute capital as well as income; therefore, broader in
scope. Income connotes a narrower concept limited only
Judicial definitions to gain derived from labor, capital or property, excluding
gain derived from capital, or from labor, or from both non-income items such as the capital invested, cost of
capital and labor, including the gain derived from the goods sold or those excluded by law from income taxa-
sale or exchange of capital assets (Fisher v. Trinidad, tion.
43 Phil. 973; Eisner v. Macomber, 252 U.S. 189, 40 S. Revenue refers to all funds or income derived by the
Ct. 189, 64 L. Ed. 521 1920). government whether from tax or other sources. Revenue
amount of money coming to a person or corporation is to the government as income is to private persons or
within a specified time, whether as payment for services, corporations.
interest or profit from investment (CONWI v. CTA, 213
C. SOURCES OF INCOME
SCRA83).
Property (capital)
Economist's definition
Labor (service)
money value of the net accretion to one's economic
Sale/Exchange of capital asset and activity
power between two points of time (R.M. Haig, The
Federal Income Tax, Columbia University; Anderson, Source of income is any property, activity or service
Taxation and the American Economy). that produced the income (COM v. BOAC, 149 SCRA
395). It may also be in the form of proceeds from sales
4 of transport documents.
,,,_.-"..,-,,
Under the Tax Code, however, income derived from ~!J/Bad debt r~covery-. must be cl_aimed as deduction
whatever source forms part of the taxpayer's income. -from gross income 1n the preceding year. It assumes
This includes the following: that the taxpayer has a net income, not a net loss
(2005, 2003 Bar).
(1.) Treasure found or punitive damages representing
A!O/ 'f AY.H?t~ 11 ~-" !lei11,;rvi'
profits lost; D. INCOME TAX; BASIS, NATURE, FUNCTIONS
(2.) Amount received by mistake (Javier v. CA, 199
(1.) It is a tax on all yearly profits arising from property,
SCRA 824; Javier v. Com, CTA Case No. 3393, profession, trades or offices or as a tax on a per-
July 27, 1983).
son's income, emoluments, profits and the like.
If a foreign bank erroneously remitted U.S.$1 (2.) It is based on income, either gross or net, realized
million instead of U.S.$1,000.00 and it appears sub-
in one taxable year.
sequently that the recipients spent the difference
of U.S. $999,000 on various purchases of property (3.) Excise tax - it is not levied upon the person or
both here and abroad of their own material benefit, property but upon the right of a person to receive
the said sum constitutes taxable income. income or profits.
It has been held that if a taxpayer receives (4.) Functions of income tax:
earnings under a claim of right without restrictions a.) to provide large amounts of revenues;
as to its disposition, he has received income even
though it may still be claimed that he is not entitled b.) to offset regressive sales and consumption
to retain the money and even though he may still be taxes;
adjudged liable to restore its equivalent. This is an c.) to mitigate the evils arising from the inequalities
exception to the rule that income received through in the distribution of income and wealth which
mistake is not taxable as its receipt is offset by li- are considered deterrents to social progress,
ability to the party making the excessive payment by a progressive scheme of taxation (Report
(North American Consolidated v. Burnet, 286 U.S. of the Tax Commission of the Phil., Vol. II;
417). Madrigal v. Rafferty, 38 Phil. 414 ).
(3.) Cancellation of the taxpayer's indebtedness. (5.) The basis of the right of the government to tax
income emanates from its partnership in the pro-
(4.) Payment of usurious interest.
duction of income by providing the protection,
(5.) Illegal gains - gambling, theft, embezzlement, resources, incentive and proper climate for such
extortion, fraud - income to embezzler if forgiven production (Com. v. Lednicky, 11 SCRA 603). This
by the owner. is called the Partnership Theory which has spawned
(6.) Tax refund - must be claimed as deduction from the following principles:
gross income in the preceding year. It means that a) Protection theory. It dictates that when the
the tax must be a deductible one (2005, 2003 Bar). flow of wealth proceeded from, and occurred
within, Philippine territory, enjoying the protec- dez v. Commissioner of Internal Revenue, 29
tion accorded by the Philippine government, SCRA 553).
the same, in consideration of such protection c.) But if the increase in the net worth of a taxpayer
should share the burden of supporting the is the result of the receipt by it of unreported
government [CIR v. BOAC, 149 SCRA 395, or unexplained taxable income, the correction
407 (2009 Bar)].
is taxable income.
b) Theory offavorable business climate. Domes-
d J Receipt includes constructive receipt.
tic corporations owe their corporate existence
and privilege to do business to the govern- -- - *1[ill Doctrine of Constructive Receipt of
ment. They also benefit from the efforts of the Income - Income which is credited to the
government to improve the financial market account of and lt EIPrt for a J.i:t)(payer and
and to ensure a favorable business climate. It which may be drawn by him at any time is
is therefore fair for the government to require subject to tax for the year during which it was
them to make a reasonable contribution to so credited or set apart although not yet then
the public expenses (CREBA v. Romulo, 614 actually received or reduced to his possession.
SCRA 605, 622). To constitute receipt in such case, the income
@, must be credited to the taxpayer without any
E. REQUISITES FOR INCOME TO BE TAXABLE
substantial limitation or condition upon which
Fr'111.iic:11 (1.) There must be gain or profit, whether in cash or its payment is to be made.
ri.u: -- eq(Jivalent.
Examples of Constructive Receipt:
J.~.) The gain must be realized or received. This implies
i. Matured interest coupons due and de-
that not all economic gains constitute taxable in-
mandable (convertible into cash);
come.
ii. Share in the profits of a partner in a part-
~J Mere increase in the value of property is not
income (unrealized increase in capital). nership;
_tl.1 Increases in the taxpayer's net worth are not iii. Interest credited on savings bank deposit
taxable increases in net worth if they are not (Section 53, Revenue Regulations No.2);
the result of the receipt by it of unreported or iv. Dividends applied by the corporation
unexplained taxable income, but are shown to against the indebtedness of a stockholder
be merely the result of the correction of errors (Section 50, Revenue Regulations No. 2);
in its entries in its books relating to its indebt-
edness to certain creditors, which had been v. Rental payments refused by the lessor
erroneously overstated or listed as outstanding when the lessee tendered payment and
when they had in fact been duly paid (Fernan- the latter made a judicial deposit of the
rental (Limpian Investment Corporation F. DOCTRINES ON DETERMINATION OF TAXABLE

v. Com., 17 SCRA 703). INCOME
vi. Amount credited to shareholders of a (1.)it.\tlaim~~f1"i@l\ff~{!l~frlllfta- illegally acquired income
building and loan association when such constitutes realized gain (Rutkin v. U.S., 343 U.S.
credit passes without restriction to the 130). (2001 Bar)
shareholder. (2. )illlil:e\Uil~al!l:!ils&testtl!life1i\l]iY- separation from capital of
The Doctrine of Constructive Receipt something which is of exchangeable value (Eisner
is designed to prevent the taxpayer using v. Macomber, 252 U.S. 189).
the cash basis from deferring or postpon-
(3. )lk<il1il:tl!Vl!.test11.4- power to procure the payment of
ing the actual receipt of taxable income.
income and enjoy the benefit thereof (Helvering v.
Without the rule, the taxpayer can con-
Horst, 311 U.S. 112).
veniently select the year in which he will
report the income.
., CorJDONA ~ Giil Dl?l!r
In Filipinas Synthetic Fiber Corpo-
- ~d<i(;,,,t. <ffl1U).J!t."~ tn..;.,t<C
ration v. CA [316 SCRA 480, 486], the
{]) ,(,&y,..-l,tcj .-t.t#e-;i;_,
Supreme Court ruled that it is the right
to receive income, and not the actual re- '"'"'''''" , C~lJ.i he Pit
ceipt, that determines when to include the (1) c,,,e, ~ Civ&.k" -
amount in gross income.
'" fl"v-t
For taxpayer using the accrual meth-
od, the determinative question is, when
do the facts present themselves in such a
manner that the taxpayer must recognize
income? The accrual of income is permit-
ted when the all-events test has been met.
This test requires: (1) fixing of a right to
income to pay; and (2) the availability of
the reasonable accurate determination of
such income. [Commissioner of Internal
Revenue v. lsabela Cultural Corporation,
515 SCRA 556, 564-565 (2010 Bar)].
@J The gain must not be excluded by law or treaty from
taxation. This means that not all income is required
to be included in computing the taxable income.
CHAPTER 3 13
GROSS INCOME
B. BROAD DEFINITION
In a broad sense, gross income means income less
income which by statutory definition or otherwise, is
Chapter 3 exempt from the tax imposed by law. Stated otherwise,
gross income means all items of income less exclusions.
GROSS INCOME
FORMULA: GROSS INCOME; NET INCOME; TAXABLE
A. GENERAL STATUTORY DEFINITION COMPENSATION INCOME; INCOME TAX DUE;
INCOME TAX PAYABLE
In a narrow sense, gross income means all income
derived from whatever source, including but not limited
to the following: Gross Income = All income less ex-
clusions (1980,1983
(1.) Compensation for services in whatever form paid
Bar)
including but not limited to fees, salaries, wages,
commissions and similar items; Net or Taxable Income = Gross income less
(2.) Gross income derived from the conduct of trade or allowable deductions
business or the exercise of profession; (1977, 2000 Bar)
(3.) Gains derived from dealings in property; Taxable Compensation Income = Gross compensa-
lion less personal
(4.) Interests; and additional ex-
(5.) Rents; emptions (Individual
Taxpayers)
(6.) Royalties;
Income Tax Due = Taxable ornet income
(7.) Dividends;
multiplied by income
(8.) Annuities; tax rate
(9.) Prizes and winnings; Income Tax Payable = Income Tax due less
creditable withhold-
(10.) Pensions; and
ing tax or tax credit
(11.) Partner's distributive share from the net income of
the general professional partnership.
12
GROSS INCOME
GROSS INCOME TAXATION AND NET INCOME EXCLUSIONS FROM GROSS INCOME
TAXATION; DISTINCTIONS; ADVANTAGES
AND DISADVANTAGES
A. REASONS FOR EXCLUSION
Gross Income Taxation Net Income Taxation (1.) The item ofreceipt does not fall within the definition
Allows no deductions Deductions are allowed of income for income tax purposes.
Grants no exemptions Exemptions are granted Damages recovered in libel and slander suits
Tax base: Gross income Tax base: Net income
Damages recovered for alienation of affection
Damages recovered for breach of promise to
Advantages of Gross Advantages of Net
marry
Income Taxation Income Taxation
Simplifies the income tax Fair and just due to grant of Damages recovered for loss of life of spouse
system deductions Damages recovered in annulment of marriage
Does away with wastage of Tax audit minimizes fraud (2.) A provision of the Tax Code or special law exempts
manpower and supplies
it from income tax.
Substantial reduction in cor- Provides equitable reliefs
ruption and tax evasion - in the form of deductions, B. EXCLUSIONS FROM GROSS INCOME
exercise of discretion to exemptions and tax credits
allow or disallow deductions
(1.) Proceeds of life insurance .(2007, 2005, 2003 Bar)
- received in a single sum or installments - not
dispensed with
taxable-Reason: indemnity ratherthan as gain or
profit. Insurance contract is a contract of indemnity.
Disadvantages of Gross Disadvantages of Net Exception - interest payments s.hall be included in
7
Income Taxation Income Taxation r gross income if such amount is QE)lg,by the insurer j
No deductions and Vulnerable to corruption on \ under the agreement to pay interest thereon.
exemptions allowed account of margin of discre- However, prgceeds of life insurance where the
tion in the grant of deduc- beneficiary is~evocabl~ is subject to estate tax. The
lions exclusion from'mcome taxation applies regardless
Susceptible of fraud in the Confusing and complex of who the beneficiary is, whether a family member,
absence of general audit process of filing income tax or other individual, corporation or partnership.
return
Exclusion applies to group insurance, death
Taxpayers lose interest to Difficult/costly to administer benefits under the Workmen's Compensation Insur-
earn more thereby lessening ance or under health or accident insurance contract
their purchasing capacity having the characteristics of life insurance proceeds
16 BASIC APPROACH TO INCOME TAXATION CHAPTER3 17
GROSS INCOME
by reason of death (El Orients v. Posadas, 56 Phil. Amount other than amount paid by reason of
147). death. Excess of the amounts received over the
Transfer of insurance contract -- amount aggregate premiums or consideration paid is tax-
excludible should only be the amount or value of able. Hence, if a taxpayer took out a P100,000.00
actual consideration paid and the premiums paid endowment policy in which he paid P80,000.00 as
later by the transferee. aggregate premiums and upon maturity he received
P100,000.00, only P20,000.00 is taxable.
Where the consideration and premiums paid
exceed the proceeds, no amount is includible in the (3.) Gifts, bequests and devises
gross income of the transferee. Reason: Not a product of capital nor industry.
other tax implications of life insurance pro- Gifts are subject to donor's tax, whereas be-
ceeds (2003 Bar) quests and devises are subject to estate tax
(1994 Bar).
a.) Included in the gross estate:
CMMnt.<;, But the income from such property is taxable.
P"'r'-tl..i
Third person is revocably designated (, ht1~kt:i- in , If the taxpayer inherits securities, the value of
111
as beneficiary; such securities does not constitute income but
Estate, executor or administrator is the dividends and interest paid on such securi-
designated as beneficiary, revocable ties are taxable.
or irrevocable. Principal paid under a marriage settlement
b.) Excluded from the gross estate: (2007 and alimony or allowance based on separation
Bar) agreement are considered as gifts.
Third person is irrevocably desig- (4.) Compensation for injuries or sickness (2003, 1995,
nated as beneficiary; 1986, 1967, 1964 Bar)
Proceeds of group insurance. Reason: Compensatory; not gain/profit; adds

nothing to the individual (Lawkins v. Com., 6 B.T.A.
(2.) Amount received as retqm of premium- under life 1032).
insurance, endowment or annuity contracts, either
during the term or at the maturity of the contract.
Through accident or health insurance;
Cash surrender value of the policy is also non- Workmen's Compensation;
taxable. Return of premium means a repayment of
Damages received whether by suit or agree-
a part or the whole of the premiums paid (Com. v. ment on account of such injuries or sickness;
Winslow, 113F [Ed.] 418).
Damages recovered are taxable if the amount
Reason for the exclusion: Return of capital represents loss of anticipated profits; not tax-
GROSS INCOME
able if it represents a return of capital or invest- iii. At least 50 years of age at the time of the
ment (BIR Ruling, September 8, 1954). retirement;
If the recovery represents damages for lost iv. The benefit of exclusion shall be availed of
profits, it is taxable as ordinary income (36 only once. (Santos v. Servier Philippines,
T.C. 1173 [1961], Federal Income Taxation Inc .. 572 SCRA 487, 499)
Third Edition, Rose and Chommie, p. 24)'. Even if the member has attained 50
(2005 Bar)
years of age with at least ten years
Disability benefits paid under life insurance of service, if the employee-member
are also excluded although the law refers to is still on active employment with the
accidents and health insurance (Wong v. Wing company, any and all amounts dis-
Non, 18TC 205, December 18, 1949). tributed from the fund to the private
member over and above his personal
(5.) Income exempt under treaty. This is premised on contributions shall be taxable to the
ou~ adher~nce to the generally accepted principles said employee recipient as wages
of international law. In this category, the following were received before his retirement
items of income are tax exempt: from the service of his employer (BIR
Income derived by the US Consular officials in Ruling 97-86, April 4, 1986).
the Philippines in connection with such consu- An agreement to pay the taxes on the
lar service (USPI Consular Convention). retirement benefits as an incentive
to prospective retirees and for them
Income exempt under tax treaty with foreign
countries. to avail of the optional retirement
scheme is not contrary to law or pub-
(6.) Retirement benefits, pensions, gratuities, etc. lic morals (International Broadcasting
... (2000, 1999, Bar) Corporation v. Amarilla, 505 SCRA
~) Retirement benefits received by officials and
687, 702).
employees of private firms, individuals or cor- b.) Separation benefits due to death, sickness
porations. Requisites for exclusions: or other physical disability or for any cause
beyond the control of the said official or em-
i. Reasonable private plan maintained by ployee.
the employer duly approved by the BIR
for exclusive benefit of the members- em- Any amount received from an employer
ployees; as aresultof separation from service due
to ~icknes~ is exempt from all taxes (BIR
ii. Retiring official or employee who has ren- Ruling1~87, January 9, 1987; Ruling 39-
dered at least 1O years of service; 87, February 10, 1987).
GROSS INCOME
Separation benefits paid to retrenched his connection with his employees and
employees as a consequence of either the who is no longer working (Ibid.) (1996,
sale of the entire business to another cor- 1991 Bar).
poration or the cessation of the employer's.
c.) Social Security benefits; retirement gratuities
business are exempt from income tax (BIR
received by resident or non-resident citizens or
Ruling 130-87, May 14, 1987).
resident aliens from foreign government agen-
Benefits received as a result of voluntary cies and other private or public institutions.
resignation are taxable ( 1984 Bar). Rea- (2007 Bar)
son: It is a cause within the control of the
said official or employee. Pensions received by retirees from foreign
sources (BIR Ruling 72-87, March 12, 1987).
The exemption holds regardless of the
employee's age and length of service d.) Benefits received from US Veterans Adminis-
(1999 Bar). tration (R.A. No. 360) by veterans residing in
the Philippines.
The law does not require that the exclusion
be enjoyed once: e.) Payment of benefits under the Social Security
System in accordance with the provisions of
Separation of employee due to dissolution R.A. No. 8282.
of a law firm is a cause beyond the control
of said employee (BIR Ruling No. 73-85, f.) Benefits received from the GSIS under R.A.
May 20, 1985). No. 8291 including retirement gratuity.
/)l!;l)Uliit,t
Compulsory retirement- cause beyond @~ Miscellaneous items
the control of the employee (Request for ~-''
reconsideration of Atty. Zialcita, 190 SCRA a.) Income received by foreign governments from
851). their investments in the Philippines. Reason:
To lessen the burden of foreign loans inasmuch
Terminal leave pay is excluded from as the interest of these loans are, by contrac-
gross income. Compulsory retirement
tual arrangement, borne by the domestic bor-
may be considered as a cause beyond
rowers. Foreign governments include financing
the control of the said official or employee.
institutions owned, controlled and financed by
Consequently, the amount received by
them and international or regional financing
way of commutation of his accumulated
institutions established by governments.
leave credits as a result thereof falls within
the enumerated exclusion from gross in- To be exempt, the creditor must be the
come. It is not considered compensation foreign government or financing institu-
for services rendered. Reason: It is paid tions owned, controlled and established
when the employer has already severed by it.
GROSS INCOME
Mitsubishi Metal Corporation, a Japanese c.) Prizes and awards under the following condi-
Corporation, borrowed $20 million from tions (2000 Bar):
the Import-Export Bank of Japan (Ex-
i. Received in recognition of religious,
imbank), owned, controlled and financed
charitable, scientific, educational, artistic,
by the Japanese government through a
literary or civic achievement.
consortium of Japanese banks. Mitsubi-
shi used the same amount in extending ii. Recipient was selected without any action
loan to Atlas which agreed to sell copper on his part to enter the contest or proceed-
concentrates to the former. ing.
RULING: Mitsubishi, not Eximbank, iii. Recipient is not required to render sub-
is the sole creditor of Atlas in the contract stantial future services as a condition to
of loan, hence, the interest income of receiving the prize or award.
Mitsubushi is subject to income tax. Ex- d.) Prizes and awards in sports competition grant-
imbank (not party in interest) had nothing ed to athletes whether held in the Philippines or
to do with the sale of the copper concen- abroad and sanctioned by their national sports
trates. When Mitsubishi obtained the loan associations (1996 Bar).
of $20 million from Eximbank of Japan,
said amount ceased to be the property e.) 13th-month pay and other benefits:
of the bank and became the property of i. Other benefits cover productivity incen-
Mitsubishi. Tax exemptions are construed tives and Christmas bonus;
STRICTISSIMI JURIS (Com. v. Mitsubishi
ii. Total exclusion shall not exceed
Metal Corp., 181 SCRA214).
P30,000.00.
Income of foreign government from opera-
f.) GSIS, SSS, Medicare and other contributions.
tion in the Philippines of vessels owned or
chartered by it is taxable (Opinion of the g.) Gains from the sale or exchange of retirement
Secretary of Justice, 40 O.G. 785). of bonds, debentures, or other certificate of
indebtedness with a maturity of more than
b.) Income derived by the Government of the
Philippines or any political subdivision from five (5) years.
any public utility or from the exercise of any h.} Gains from redemption of shares in Mutual
essential governmental function (e.g., income Fund Company.
derived by a municipality from the operation of
a market or an electric power plant) - This is Tax-exempt income under special laws
in recognition of the principle of exemption from i. Prizes received in charity, horse rac-
taxation of government agencies or entities. ing, sweepstakes from the Philippine
24 BASIC APPROACH TO INCOME TAXATION
Charity Sweepstakes Office (R.A. No.

1169).
ii. Salaries and stipend in dollars re- Chapter 4
ceived by non-Filipino citizens serv"
ing as staff of: INDIVIDUAL INCOME TAXATION
International Rice Research In-
stitute (R.A. No. 2707);
A. CLASSIFICATION OF INDIVIDUAL TAXPAYERS
Ford Foundation Grants (R.A.
No. 3538); (1.) Resident citizen (RC) - citizens of the Philippines
who are residing therein (Article IV, Constitution).
Agricultural Department of the
Southeast Asian Fisheries De- (2.) Non,resident citizen (NRG) - citizens of the Phil-
velopment Center (SEAFDEC) ippines who are physically present abroad for an
(P.D. No. 246); uninterrupted period covering an entire taxable
Population Council of New York year. NRC means one who establishes to the sat-
(P.D. No. 246). isfaction of the BIR Commissioner the fact of his
physical presence abroad with definite intention to
iii. Income from bonds and securities: reside therein, either as:
For sale in the international mar- a.) Immigrant;
ket (P.D. No. 81);
b.) Employee on a more or less permanent basis;
Issued by EPZA (P.D. No. 66).
c.) Contract workers whose contracts of employ-
iv. Income derived from the installment ment are renewed from time to time within or
sales of houses to their employees during the taxable year.
and workers or to low-income groups
in housing projects or income derived NRC may be considered RC or NRC depend-
from rentals thereof (P.D. Nos. 745 ing upon his departure and arrival. In this
and 1217- Housing Program of the regard, NRC shall submit proof to the BIR to
government). show his intention of leaving the Philippines to
reside permanently abroad or to return to and
reside in the Philippines for this purpose.
(3.) Resident Alien (RA)- non-citizens who reside in
the Philippines
25
INDIVIDUAL INCOME TAXATION
a.) He must be a resident not mere transient or period exceeding three months as of
sojourner (whether he is a transient or not is and including December 31.
determined by his intention with regard to the
(4.) Non-Resident Alien (NRA) - neither citizen nor
length and nature of his stay).
resident of the Philippines
b.) Alien living in the Philippines and has no defi-
nite intention (floating intention) as to the time a.) NRA-ETB - comes and stays in the Philip-
of return to his country or his stay in the Philip- pines for an aggregate period of more than
pines. 180 days during the calendar year (Section 25
A[1], NIRC, as amended) (2000 Bar).
c.) Those who come to the Philippines and whose
extended stay may be necessary to accomplish b.) ETB - includes the performance of personal
the purpose and to that end they may have the services within the Philippines
intention at any time to return home, when their c.) Foreign technician on a job contract for one
purpose of stay is accomplished/completed. year
BIR regulation provides no fixed or definite (5.) Non-ResidentA/ien Not Engagedin Trade or Busi'-
criterion of determining residency beyond ness- NRA-NETB. In general, his income is taxed
stating that NRA must have no residence at 25% final tax based on gross or entire income.
in the Philippines. The difficulty however, However, NRA-NETB is taxed at special rate of
arises where an alien lives in the Philip- 15% if employed by the following:
pines, though he does not maintain resi-
dence therein. Maintemmce of residence a.) Regional or area headquarters of multi-national
is the test but actual stay is a basic factor corporations;
in determining residency. Therefore, the b.) Offshore banking units established in the Phil-
following must be considered: ippines;
i. Maintenance of residence in the Phil- c.) Petroleum service contractors or sub-contrac-
ippines; tors.
ii. Actual physical residence in the Phil-
B. GENERAL PRINCIPLES: SOURCES OF INCOME;
ippines;
TAX BASE
iii. His temporary stay (with intention to
return) is on an extended stay; Sources of Income Tax Base
iv. Considered resident alien if he RC within and without taxable income
resides for more than one year;
NRC within . taxable income
v. Loses his residence if he stays out-
RA within taxable income
side the Philippines for a continuous
NRA-ETB within taxable income B. BASIS/TEST: Designation/name of the remuneration

upon which it is paid and the manner of payment is IM-
NRA-NETB within gross income
MATERIAL What is important is that it is derived from
employer-employee relationship.
C. CATEGORIES OF INCOME (1967, 1969, 1970 Bar)
However, not every compensation income is includ-
ible under the term gross compensation income.
Compensation for services rendered by an inde-
CATEGORIES OF INCOME pendent contractor does not fall under the legal
Compensation income category of "gross compensation income."
Business income derived by self-employed Amounts paid either as advances or reimburse-
Professional income derived by professionals ment for transportation, representation and other
bona fide ordinary and necessary expenses in-
Passive investment income curred in the performance of his duties - not tax-
Gains derived from dealings in property able compensation income. Only the excess, if any,
over actual expenses is taxable.
Three years back wages shall be taxable to an il-
COMPENSATION INCOME legally separated employee but not attorney's fees
which are not subject to tax (BIR Ruling, 13 July
1992).
A. DEFINITION
Income derived by partner from professional part-
All remuneration for services rendered by an em- nership does not form part of the gross compensa-
ployee for his employer unless specifically excluded tion income.
under the Tax Code (Revenue Regulations 2-98). It
C. REQUISITES FOR TAXABILITY
includes salaries, wages, emoluments, honoraria,
bonuses, allowances (transportation, representation,
---.
(1.) Personal services actually rendered;
entertainment and the like), fringe benefits (monetary
and non-monetary fees) including director's fee, taxable (2.) Payment is for such services rendered;
pensions and retirement pay and other income of similar (3.) Payment is reasonable.
nature including compensation paid in kind.
Income of similar nature - proceeds from property D. FORMS OF COMPENSATION
-....
sharing; COLA, PERA, housing allowance, overtime pay, Form/Kind - Measure of income:
emergency pay, hazard pay, rice and clothing allowance,
medical allowance, grocery allowance. (1.) Cash or in money -Amount of money received.
CHAPTER4 31
30 BASIC APPROACH TO INCOME TAXATION INDIVIDUAL INCOME TAXATION
eficiary designated is the family, executor,

(2.) Property or in kind (Doctrine of Cash Equivalent)
administrator or the estate of the em-
-FMV. ployee (2007, 2004 Bar);
(3.) Price is stipulated - FMV of the compensation in
ii. Employer is not allowed to claim premiums
the absence of contrary evidence. paid as deductible if he is directly or indi-
(4.) Promissory notes or other evidence of indebtedness rectly designated as beneficiary (Section
(not mere security)- Not Discounted: Face Value; 36[A][4]) (1978 Bar).
Discounted: 1.) Year of receipt - Discounted (7.) Income tax paid by employer in consideration of the
value; 2.) Maturity Date - Difference between employee's services rendered - amount of such
Face Value and Fair Market Value tax paid
(5.) Cancellation or forgiveness of indebtedness made (8.) P~rsonal services performed partly within and partly
in consideration of debtor's services rendered - without - apportion on the time basis
amount of debt cancelled
(9.) Tax exempt compensation income (benefits, privi-
Other tax implications of condonation of leges, facilities and the like)
indebtedness:
& Convenience of the Employer Rule (1995
i. If no consideration is given, it amounts to Bar). It grants exemption to benefits which are
taxable donation and therefore subject to given for the exclusive benefit or convenience
donor's tax as far as the creditor (donor) of the employer.
is concerned ( 1997 Bar);
If such quarters and other facilities exceed
ii. It amounts to taxable indirect dividend if the employee's needs, only a ratable part
the creditor is a corporation and the debtor of the value thereof as employee would
is the stockholder. have spent therefor constitutes taxable
(6.) Premiums paid by employer on the life insurance income. The remainder is considered
policy of employee whose family, executor, admin- expense of the employer (Collector v.
Henderson, 1 SCRA 649).
istrator or his estate is the beneficiary - amount
of the premium paid. Lodging quarters furnished to an employ-
ee by or on behalf of the employer shall be
Conversely, premiums are not taxable if the excluded from employee's gross income
beneficiary is the employer whether directly or if the living quarter is situated within the
indirectly designated. business premises of the employer and
Other tax implications of premiums paid by the employee is required to accept such
employer: lodging facility as a condition of his em-
ployment (Revenue Audit Memo. Order
i. Employer may claim the premiums as
No. 1-87, April 23, 1987).
deductible from gross income if the ben-
The value of meal furnished to an em- not more than P1 ,500.00; (2007 Bar; RR
ployee by or on behalf of his employer 5-2008)
shall be excluded from the employee's v. Uniform and clothing allowance not
gross income if the meals are furnished . exceeding P4,000.00 per annum; (RR
in the business premises of the employer 5-2008)
and the meals are for the convenience of
vi. Actual yearly medical benefits not exceed-
the employer (Ibid.}. ing P10,000.00 per annum;
Under Revenue Regulations 3-98, the vii. Laundry allowance not exceeding P300.00
monetary value of housing unit or the per month;
rental value thereof is tax exempt if the
housing unit is situated within the busi- viii. Employee achievement awards, e.g., for
length of service or safety achievement,
ness premises of the employer. In this
which must be in the form of tangible
case, the recipient must be a managerial
personal property other than cash or gift
or supervisory employee.
certificate, with an annual monetary value
JU. De minimis benefits. These refer to facilities not exceeding P10,000.00 received by the
or privileges furnished or offered by an em- employee under an established written
ployer to his employees that are of relatively plan which does not discriminate in favor
small value and are offered or furnished by of highly paid employees;
the employer merely as a means of promoting ix. Gifts given during Christmas and major
health, goodwill, contentment or efficiency anniversary celebrations not exceeding
of his employees. These include only, pursuant P5,000.00 per employee per annum;
to RR 5-2011, the following:
ix. Flowers, fruits, books, or similar items
i. Monetized unused vacation leave credits given to employees under special cir-
of private employees not exceeding ten cumstances, e.g., on account of illness,
(10) days during the year; marriage, birth of a baby, etc.; and
ii. Monetized value of leave creqjts. paid to: . x. Daily meal allowance for overtime work not
government officials and employees;,. : exceeding twenty-five percent (25%) of
iii. Medical cash allowance to dependents the basic minimum wage.
of employees not exceeding P750.00 per E. SPECIAL RULES ON FRINGE BENEFITS
employee per semester or P125.00 per
month; (1.) What is a fringe benefit?
iv. Rice subsidy of P1 ,500.00 or one ( 1) sack Fringe benefits refer to goods, services, or
of 50-kg. rice per month amounting to other benefits furnished or granted by an employer,
~ ,....,,._,,.,, ''"-'"'-'' j IV 11\IVUIVIC 1~1 IUN CHAPTER 4 35
in cash or in kind, in addition to basic salaries, to are involuntarily separated from work are not
managerial or supervisory employees such as, but subject to FBT;
not limited to the following:
b.) Contributions of the employer for the benefit
Housing; of the employee to retirement, insurance and
Expense account; hospitalization benefit plans;
Vehicle of any kind; c.) Benefits given to the rank and file, whether
granted under a collective bargaining agree-
Household personnel, such as maid, driver and ment or not;
others;
d.) De minimis benefits (refer to Tax Exempt Com-
Interest on loan at less than market rate pensation Income, item no. 9[b]);
(benchmark rate of 12%) to the extent of the
difference between the market rate and actual e.) Benefits granted to employee as required by
rate granted; the nature of, or necessary to the trade, busi-
ness or profession of the employer;
Membership fees, dues and other expenses
borne by the employer for the employee in f.) Benefits granted for the convenience of the
social and athletic clubs or other similar or- employer.
ganizations; (3.) Benefits which are considered necessary to the
Expenses for foreign travel;
- business of the employer, or are granted for the
convenience of the employer.
Holiday and vacation expenses;
The following fringe benefits are not subject
Educational assistance to the employee or his to FBT because they are given primarily for the
dependents; and convenience of the employer:
Life or health insurance and other non-life a.) Housing privilege of military officials of the AFP
insurance premiums or similar amounts in located inside or near the military camps;
excess of what the law allows.
b.) A housing unit which is situated inside or at
(2.) Not all benefits given by an employer to his most 50 meters from the perimeter of the busi-
employees are subject to FBT. ness premises;
The following benefits are not subject to FBT: c.) Temporary housing for an employee for 3
a.) Fringe benefits which are authorized and ex- months or less;
empted from income tax under the Code or d.) Expenses of the employee which are reim-
under special law. For instance, separation bursed by the employer if they are supported
benefits which are given to employees who by receipts in the name of the employer and do
not partake the nature of a personal expense The FBT is collected from the employer even
of the employee; if the employer is a tax-exempt corporation, or an
e.) Motor vehicles used for sales, freight, delivery instrumentality of the Philippine government.
service and other non-personal uses; (7.) Why is the FBT collected from the employer?
f.) The use of aircraft (including helicopters) (2003 Bar)
owned and maintained by the employer; Valuation of benefits is easier at the level of the
g.) Business expenses which are paid by the em- firm. The problem of allocating the benefits among
ployer for the foreign travel of his employees individual employees is avoided. Collection of the
in connection with business meetings or con- FBT is also ensured because the FBT is withheld at
ventions. The expenses should be supported source and does not depend on the self-declaration
by documents proving the actual occurrences of the individual.
of the meetings/conventions, or official com- (8.) FBT is not an additional tax on the employer.
munications from business associates.
The FBT is not an additional tax on the em-
(il Nature of Fringe Benefits Tax. ployer. He can claim the fringe benefit and the FBT
The Fringe Benefits Tax is a tax imposed on as a deductible expense from his gross income.
fringe benefits which are granted or are paid by an (]) Benefits subject to the FBT.
employer to an employee occupying a managerial
or supervisory position. The FBT is imposed on fringe benefits given or
furnished to managerial or supervisory employees
(5.) Purpose of the FBT. on or after January 1, 1998. Fringe benefits granted
The FBT is a measure to ensure that an income to rank and file employees are not subject to FBT.
tax is paid on fringe benefits (FBs ). If they were (10.) Who are considered as managers? supervi-
given in cash, an income is automatically with- sors? rank-and-file?
held and collected by government. An additional
compensation which is given in non-cash form is "Managerial employees" refer to those who
virtually untaxed. This situation has caused inequity are given powers or prerogatives to lay down and
in the distribution of the tax burden. The FBT can execute management policies and/or to hire, trans-
enhance the progressiveness and fairness of the fer, suspend, lay-off, recall, discharge, assign or
tax system. discipline employees.
(6.) Who should pay the FBT? (2003 Bar) "Supervisory employees" are those who ef-
fectively recommend such managerial actions if the
The FBTis a tax on the income of an employee exercise of such authority is not merely routinary or
which is paid by the employer on behalf of the em- clerical in nature but requires the use of independ-
ployee. ent judgment.
,i."Rank-and-file employees" mean all em- They are intended to substitute for the disallowance
ployees who are holding neither managerial nor of personal family or living expenses.
supervisory position. Nature: Personal exemptions are the theoretical,
personal, living and family expenses of an individual
F. DOCTRINE OF CASH EQUIVALENT
allowed to be deducted from the gross or net income
It provides that any economic benefit to the em- of an individual taxpayer (Pansacola v. CIR, 507
ployee whatever may have been the mode by which it SCRA81, 87).
is effected is compensation income. In stock option, for
Basis: Principle that the burden of income taxation
instance, the difference between the FMV of the shares
at the time the option is exercised and the option price should be adjusted according to one's capacity to
pay.
constitutes additional compensation income to the em-
ployee (Com. v. Smith, 324 U.S. 177; Com. v. Le Bue, Taxpayers entitled -
1 U. 243). a.) Resident citizen
G. ALLOWABLE DEDUCTIONS FROM GROSS COM- b.) Non-resident citizen
PENSATION INCOME c.) Resident alien
(1.) Personal exemptions: d.) Non-resident alien engaged in trade or busi-
a.) Basic Personal Exemption (R.A. No. 9504) ness on the basis of reciprocity. The reciprocity
Each married individual - P50,000.00 rule applies only to basic personal exemption.
The basic personal exemption that may be al-
Head of family - 50,000.00 lowed must not be more than the aforestated
Single or legally separated individual amounts.
with no dependents - 50,000.00 . Conditions for the grant of basic personal
exemption to NRA-ETB:
b.) Additional exemption for qualified dependent
child - P25,000.00 but not in excess of four His foreign (mother) country has income
(4) or P100,000 (R.A. No. 9504). tax law;
Personal exemptions are arbitrary amounts (they His foreign country allows personal ex-
may not be fully adequate to cover all personal exemptions to citizens of the Philippines not
penses) allowed in the nature of a deduction from residing therein;
gross or net income, for personal, living or family File an accurate return of his income from
expenses. According to the Supreme Court, the all sources within the Philippines on time;
amount has been calculated to be roughly equiva-
lent to the minimum of subsistence (Madrigal v. Amount allowable - not to exceed our
Rafferty, 38 Phil. 414 ). maximum allowable personal exemption.
CHAPTER 4 41
In the case of legally separated spouse, additional Series of 1961. However, Section 35 of

exemption may be claimed only by the spouse who the Tax Code excludes them from qualified
has custody of the child or children. The total addi- dependents;
tional exemption claimed by both must not exceed ii. Legally adopted child. There must be a
four (4) or P100,000.00. judicial order by competent court, not
Head of family means an unmarried or legally mere affidavit (BIR Ruling 572, 29 October
1959).
segarated man or womal)lwittfone or bot,h parents
otWith one or more brothers or sisters of't.tith one or d.) Senior eiti:Zen: Uhder Republic Act No. 7432
~d0~~t:cTi~~1~~~~Jtei~ii~X~~:g:~~~~~~;;~~~!e~;~~
as implemented by Revenue Regulations No.
2-94, senior citizen means any resident citizen
him/her for chief support, where such t)rothers or of the Philippinesvat least sixty (60) years old,
sisters or children are not more than twenty-one (21) including those who have retired from both
'years of ageffhnmarried and not gainfully employed governmeJ;;IJ offices and. private enterprises,
or where such children, brothers or sisters, reg9gj- and has ali'income of not more than sixty thou-
less of age are incapable of self-support because of sand pesos (P60,000.00) per annum subject to
mental or physical defect. review by the National Economic and Develop-
ment Authority (NEDA) every three (3) years.
Qualified dependents:
The term head of family includes an
a.) Parents (step parents, parents-in-law are unmarried or legally separated man or
excluded) - Living with the taxpayer and woman who is the benefactor of a quali-
dependent on the taxpayer for chief support. fied senior citizen. Benefactor means
b.) Brothers and sisters (full or half blood): any person whether or not related to the
senior citizen who takes care of the latter
i. Living with and dependent upon the tax-
as a dependent.
payer for chief support;
''Living1with'' does not connote actual or physical
ii. Unmarried and not gainfully employed;
togetherness. It means that taxpayer exercised
iii. Not more than twenty-one (21) years of control based on some moral or legal obligation
age except if incapable of self support and makes the taxpayer's home as his principal
because of physical or mental defect. place of abode. Dependent must be a member of
the taxpayer's family by blood relationship, relation-
c.) Children (legitimate, recognized illegitimate
ship by marriage, or by adoption (Section 11, Rev.
and legally adopted) - Same qualifications
Reg. No. 2, Stanley & Kilcullen).
as brothers and sisters:
a.) Temporary absence from their common resi-
i. Stepchildren are qualified dependents
under BIR Revenue Regulations 235, dence brought about by force of circumstances,
e.g., taxpayer may be away on business or to BIR Rulings:

earn livelihood, or dependent may be boarding (a.) Non-resident Chinese stockholders of a local
elsewhere in the pursuit of education. bank are not entitled to personal exemptions
b.) Children of resident alien residing abroad are granted in accordance with the reciprocity pro-
not considered living with the taxpayer (Section visions of the Tax Code. Reason: The laws of
11, Revenue Regulations No. 2). China do not grant similar exemptions to non-
Chief.support means principal or main support not resident Filipinos (BIR Ruling No. 164, series
just partial support. It must be more than 50% of of1961).
the dependent's need pertaining to food, clothing (b.) Where both husband and wife are employees,
and shelter. the latter can claim additional exemptions for
Rules on change of status (1997 Bar) her two.minor children by her first marriage in
a.) Death of the taxpayer - Estate may claim the their(foinV income tax return (BIR Ruling No.
appropriate personal exemptions. 216, series of 1960).
b.) Death of the dependent - Taxpayer is still (c.) A resident alien supporting his wife and chil-
entitled to additional exemption. dren living abroad is entitled to a personal
exemption corresponding to a married person
c.) Additional dependent -Taxpayer is still enti-
tled to additional exemption. provided that proof of marriage is established
to the satisfaction of the BIR and he is not le-
d.) Dependent becoming more than twenty-one gally separated from his wife. However, he is
(21) years of age - Taxpayer can still claim not allowed to claim an additional exemption
him or her as dependent.
because without necessity, the children con-
e.) Marriage of the taxpayer -Taxpayer is entitled tinuously make their home abroad (BIR Ruling
to full exemption for the particular taxable year. No. 371, series of 1958).
f.) Death of spouse - Surviving spouse may still (d.) Only one exemption is allowed even if taxpayer
claim the full amount of thirty-two thousand received accumulated pension corresponding
(P32,000.00) (2004 Bar). to six years (BIR Ruling No. 203, series of
New rules under Section 35(C): 1960).
g.) Marriage of dependent - Taxpayer can still (2.) Premium Payments on Health and/or Hospitali-
claim him or her as dependent for the particular zation Insurance (2001 Bar).
taxable year.
Conditions:
h.) Gainful employment of dependent-Taxpayer
can still claim him or her as dependent for the a.) Claimant: spouse claiming the additional ex-
particular taxable year. emption for dependents.
b.) Amount allowed: P2,400.00 per annum or Answer: Gross income means the total sales,
P200.00 a month. less the cost of goods sold plus any
c.) Limitation: family gross income must not be income from investments and inci-
more than P250,000.00 for the taxable year. dental operations (Section 48, Rev.
Reg. No. 2).
BUSINESS/TRADE/PROFESSIONAL INCOME
How is income from long-term contracts (build-
A. INCOME COVERED ing installations or construction contracts
covering a period of more than one [1] year)
(1.) Income derived by self-employed from trade or treated for income tax purposes?
- business (trading, manufacturing, merchandis
ing, farming, and others). Answer:
Self-employment income consists of the Percentage of completion basis - gross in-
earnings derived by the individual from the come already earned though not yet received,
practice of profession or conduct of trade based on estimates of architects or engineers
or business carried on by him as a sole duly certified by them is reported in a taxable
proprietor or by a partnership of which he year and all deductions relating to such for the
is a member. taxable year, even if not yet paid, are taken into
Self-employed - means a person account.
engaged in trade or business or performs Completed contract basis - taxpayer reports
services for others for a fee and who derived his income and deductions in the year the con-
personal income from such trade or business tract is finally completed (Section 44, Revenue
or from the performance of such services. The Regulations No. 2).
term includes but is not limited to single pro-
prietorships engaged in trade or business as @] Income derived by professionals from the prac-
manufacturers, traders, market vendors, own- tice of professions.
ers of eateries and farmers as well as owner
Professionals - refer to persons who derive
of service shops, brokers, agents and others
their income from the practice of their profession.
similarly situated.
The term includes lawyers and other persons who
Business is any activity that entails the time, are registered with the PRC such as doctors, den-
attention and effort of an individual or group of tists, CPA's and others similarly situated. It may
individuals for livelihood or profit. also refer to one who pursues an art and makes
In the case of manufacturing, merchandising, living therefrom such as artists, athletes, and others
or mining business, how is the gross income similarly situated.
computed?
GU Gross income of farmers include: marks, patents and natural resources under
a.) Sale of livelihood and farm products received lease.
from the farm; c.) Items considered likewise as rental income
b.) Value of merchandise and other property Obligations of lessor to 3rd parties as-
received from such sales; sumed by the lessee:
c.) Profit from the sale of livestock and other items i. Real estate taxes on leased premis-
purchased;
es;
d.) Gross income from all other sources, rent re-
ii. Insurance premiums paid by lessee
ceived on crop shares, proceeds of income of
on property;
growing crops.
iii. Dividends paid by lessee to stock-
!NTEREST INCOME holders of lessor-corporation;
a.) Definition - amount of compensation paid for iv. Interest paid by lessee to holder of
the use of money or forbearance from such bonds issued by lessor-corporation.
use.
Value of permanent improvements made
b.) Includes such interest arising from indebted- by lessee on leased property that will be-
ness - business or non-business, legal or come the property of the lessor upon the
illegal, usurious or not: expiration of the lease. The lessor shall
i. Interest on government securities - tax- report such an income under any of the
able effective January 1, 1998; following methods ( 1995 Bar):
ii. Interest on savings deposit, time deposits i. Outright method - Fair Market
and deposit substitutes subject to 20% Value of the completed building or
final tax. improvement shall be reported as
additional rent income;
_8.ENTAL INCOME ,
ii. Spread out method -Allocate the
a.) Definition - fixed sum either in cash or prop- depreciated value over the remaining
erty equivalent, to be paid at a definite period term of the lease contract.
for the use or enjoyment of a thing or right.
d.) Are advance rentals taxable?
b.) Scope - all rentals (including royalties) de-
rived from lease of property, whether used in i. Prepaid rentals - taxable if so received
business or not, from real estate or personal under a claim of right and without restric-
property; earnings from copyrights, trade- tion as to its use.
4~ BASIC APPROACH TO INCOME TAXATION CHAPTER4 49
ii. Security deposit- nottaxable. However, are nothing but an enrichment

it is taxable if the lessee violates any provi- through increase in value of
sion of the contract. capital investment (Commis-
iii. Loan - not taxable. sioner v. Court of Appeals, 301
SCRA 152).
-
DIVIDEND INCOME
a.) Definition - corporate profit set aside, de-
Exceptions, however, are as
follows:
clared and distributed by the director of a Change in the stockholder's equity,
corporation to be paid to stockholders on de- right/interest in the net assets of the
mand or at a fixed time. Under the Tax Code, corporation;
any distribution made by a corporation to its
stockholders, whether in money or property Recipient is other than shareholder.
out of its earnings and profit accrued since 1 Stock dividend is taxable to usufructu-
March 1913. ary (Bachrach v. Siefert, 87 Phil. 483);
E:l Kinds of Dividend Cancellation or redemption of shares
of stock (Ibid.);
i. Cash dividend - paid in given sum of
money. Distribution of treasury stocks;
ii. Property dividend - one paid by corpo- Dividends declared in the guise of
ration in securities (not its own stock) or treasury stock dividend to avoid the
other property. effects of income taxation (Com-
missioner v. Manning, 66 SCRA 14)
iii. Stock dividend - one paid by a corpo-
(1994 Bar);
ration with its own stock. It represents
transfer of surplus to capital account. It Different classes of stock were is-
may be of the same kind or different from sued.
that on which it is issued. Illustration of taxability/non-taxability of stock dividend
As a general rule, stock dividends are
not taxable (2003 Bar). Case Authorized Issued & Stock Taxable/Not
C/S Outstanding Dividend Taxable
Reason: They are considered unreal-
ized gain, and ~annot be sub- I Common Common Common Not Taxable
jected to income tax until that II Com & Pref. Common Preferred Not Taxable
gain has been realized. Mere
Ill Com & Pref. Com & Pref. Common Taxable
issuance thereof is not yet
IV Com & Pref. Com & Pref. Preferred Taxable
subject to income tax as they
-
iv.
v.
Scrip Dividend - one that is paid in the
form of promissory notes.
d.) Taxpayer is not required to file ITR if his or her
income consists solely of income subject to
final tax.
Indirect Dividend - one made through the
exercise of right or other means of pay- e.) The tax withheld constitutes final settlement of
ment, e.g., cancellation or condonation of the tax liability on the income.
indebtedness.
f.) Examples of income subject to final tax (2001
vi. Liquidating dividend - one resulting from Bar):
the distribution by a corporation of all its
Interest income from bank deposit;
property or assets in complete liquidation
or dissolution. Taxable income refers to Royalties;
the excess of amount received over cost Dividend received from domestic corpora-
of the share surrendered. tion by individual or non-resident foreign
@> corporation (NRFC);
iK Giver Recipient Taxable (tax rate)/Exempt
Domestic Prizes amounting to more than P10,000.00;
Domestic/RFC tax exempt (2005 Bar)
Domestic Winnings (except sweepstakes and lotto).
RC,NRC,RA 10% - effective taxable
year 2000 Partner's share from the net income after
Domestic tax of business partnership, joint account,
NRA-ETB 20%
joint venture or consortium.
Domestic NRA-NETS 25%
(4.) Other Sources
Domestic NRFC 15% subject to allow- ----
ance for tax credit a) Capital Gain from Sale of Shares of Stock
i. If not listed and traded through stock ex-
/ASSIVE INVESTMENT INCOME change:
a.) It is an income subject to final withholding tax Net capital gain not over P100,000
(2001 Bar). -5%;
b.) The withholding agent withholds the tax and Any amount in excess of P100,000
remits the same to the BIR. -10%.
c.) The recipient is not required to inclu9e the ii. If listed and traded through local stock
income in his gross income. Neither is the exchange - 1/2% of 1% of Gross Selling
taxpayer required to include it in the taxable Price. The tax is in the nature of percent-
income (CIR v. PAL, 504 SCRA 90). age tax not an income tax.
.~) Acquisition and disposition of capital stock

which include sales and retirement of bonds.
_c;) Illegal gains - gambling, betting, lotteries,
extortion or fraud.
Chapter 5
-~) Recovery of damages - taxable - it repre-
sents lost profit/income. CORPORATE INCOME TAXATION
_e) Bad Debts recovery - taxable if it results in
reduction of the taxpayer's tax liability in the
A. DEFINITION UNDER THE NIRC
previous year. "TaxQellefitrl11e" or the "Doc-
trine of equitablebenefit" applies in this case. Corporation includes partnerships, no matter
r It must be claimed as a deduction from how created or organized, joint stock companies, joint
the gross income in the preceding year. accounts, associations or insurance companies except:
.r The reduction results in a tax benefit. Joint construction venture; (2007 Bar)
_f) Tax refund - taxable if it results in reduc- General professional partnership;

tion of the taxpayer's liability in the preceding Joint venture for engaging in petroleum, coal, geo-
year. This means that the tax' refunded must thermal and other energy operations pursuant to a
be prnviollsly claimed as deduction from gross consortium agreement with the government
i!J<,:Qme. J""ax benefit rule likewise applies. -
(1.) Unregistered or registered partnership - taxable
provided that the following requisites concur:
a.) Agreement, oral or writing, to contribute money,
property or industry to a common fund;
b.) Intention to divide the profits.
i. Two sisters purposely created a com-
mon fund without being registered for the
purpose of engaging in a series of trans-
actions for profit - taxable unregistered
partnership is created (Evangelista v.
Commissioner, 102 Phil. 140) .

53
CORPORATE INCOME TAXATION
ii. Taxable partnership is formed where fif- (Article 1769, NCC) (Pascual and Dragon
teen (15) persons contributed money to v. Commissioner, 166 SCRA 560).
purchase sweepstakes tickets for the sole
vi. On 2 March 1973, Joe Obillos, Sr. trans-
purpose of dividing among themselves the
ferred his rights under contract with Orti-
prize.
gas Co. to this four (4) children to enable
iii. Two persons entered into agreement to them to build residences on the lots. TCTs
operate cockpit under which one was to were issued. Instead of building houses,
contribute his services and the other to the Obillos children sold them after one
provide the capital - taxable partnership (1) year to Walled City Securities Corpora-
is formed (Rallos v. Rallos, 2 Phil. 509). tion and Olga Cruz Canda. The Supreme
iv. As a rule, co-ownership is tax-exempt. It Court held that the Obillos children are
becomes taxable if it is converted into an co-owners. It is an isolated act which
unregistered partnership. Converted into shows no intention to form a partnership.
partnership if the properties and income It appears that they decided to sell it after
are used as common fund with intention they found it expensive to build houses
to produce profits. If after partition, the (Obillos, Sr. v. Commissioner, 139 SCRA
shares of the heirs are held under a single 436).
management for profit making, unregis- (2.) Joint accounts or joint ventures formed for profits.
tered partnership is formed (1997 Bar)
Joint Emergency Operation - (no legal per-
(Ona, et al. v. Commissioner, 45 SCRA
sonality) operates the business affairs of the two
74).
companies as though they constitute a single entity
v. Pascual and Dragon bought two (2) par- thereby obtaining substantial economy and profit in
cels of land from Bernardino and three operation - taxable (Collector v. Batangas Co., 54
(3) from Roque. Thereafter, the first two OG 6724).
(2) were sold to Meirenir Development (3.) Joint Stock Companies-generally classified as a
Corporation at a profit of P165,224. 70 partnership possessing some of the characteristics
and the three (3) to Reyes and Samson of a corporation. They appear to be like corporations
for a profit of P60,000. They divided the to the extent that they have capital stock but when
profits between the two (2) of them. RUL- capital is divided or made transferable even without
ING: There was no partnership formed. the consent of the co-partner, they partake of the
The sharing of returns does not in itself nature of partnership (Brocki v. American Express
establish a partnership whether or not
Company, CA Michigan, 279F 2d 785, 787).
the persons sharing therein have a joint
or common right or interest in the property
B. MAJOR GROUPS OF CORPORATION FOR INCOME canteen, cafeteria, dormitory and book-
TAX PURPOSES (Sources, tax base, tax rate) store within the school premises (BIR
Ruling 237-87, 16 December 1987).
(1.) DOMESTIC CORPORATIONS
b.) Non-profit hospital
Source: Within and without
Same rules as private educational institu-
Tax base: Taxable income
tion.
Tax rate: 35% effective July 01, 2005; 30% effec-
Unrelated trade, business, or other activity
tive January 1, 2009 (R.A. No. 9337)
- the conduct of which is not substantially
Special domestic corporations: related to the exercise or performance by
such hospital of its primary purpose or
a.) Private Educational Institution - function.
Subject to ten percent (10%) on their tax- (2.) RESIDENT FOREIGN CORPORATIONS
able income provided that its gross income
from unrelated trade, business or other Source: Within
activity does not exceed fifty percent Tax base: Taxable income
(50%) of the total income. Conversely, it Tax rate: 35% effective July 01, 2005; 30% effec-
is subject to thirty-five percent (35%) if its tive January 01, 2009 (R.A. No. 9337)
income from unrelated trade or business
exceeds fifty percent (50%) of the total Special Resident Foreign Corporations:
(gross) income.
a.) International Carriers - within - Gross Phil.
Private educational Institution - is any Billings - 2.5%;
"private school" maintained and admin-
b.) Offshore banking unit - within - Gross on-
istered by private individuals or groups
issued a permit to operate by Secretary shore income - 10%;
of DECS in accordance with existing laws c.) Foreign currency deposit unit-within - Gross
and regulations. onshore income - 10%.
Unrelated trade, business, orotheractivity Transacting business - means continuity of
-the conduct of which is not substantially commercial dealings and arrangements (Far East
related to the exercise or performance by Import-Export Corp. v. Nankai Kogyo Co., Ltd., Int'!.,
such educational institution of its educa- No. L-13525, 30 November 1962, 6 SCRA 725).
tional purpose or function.
Gross Philippine Billings -- refers to the
Related activities include income derived amount of gross revenue realized from carriage of
from auxiliary activities - ~chool owned persons, excess baggage, cargo and mail original-
ing from the Philippines in a continuous and uninter- language to do so; but the legislature did not. Thus,
rupted flight, irrespective of the place of sale or the logical interpretation of such provisions is that, if
issue and the place of payment of the ticket or Sec. 28(A)(3)(a) is applicable to a taxpayer, then the
passage document. (2005 Bar) general rule under Sec. 28(A)( 1) would not apply.
FOREIGN AIRLINE COMPANIES WITH If, however, Sec. 28(A)(3)(a) does not apply, a resi-
OUT FLIGHTS STARTING FROM OR PASSING dent foreign corporation, whether an international
THROUGH ANY POINT IN THE PHILIPPINES - air carrier or not, would be liable for the tax under
An off-line airline having a branch office or a sales Sec. 28(A)(1 ).
agent in the Philippines which sells passage docu- Clearly, no difference exists between British
ments for compensation or commission to cover off- Overseas Airways and South African Airways.
line flights of its principal or head office, or for other The findings therein that an off-line carrier is doing
airlines covering flights originating from Philippine business in the Philippines and that income from
ports or off-line flights, is not considered engaged the sale of passage documents here is Philippine-
in business as an international air carrier in source income must be upheld.
the Philippines and is, therefore, not subject
to Gross Philippine Billings Tax provided for in The general rule is that resident foreign corpo-
Section 28(A)[3][a] of the Code nor to the three rations shall be liable for a 32% (now 30%) income
percent (3%) common carrier's tax under Sec- tax on their income from within the Philippines,
tion 118(A) of the same Code. (2005 Bar) This except for resident foreign corporations that are
provision is without prejudice to classifying such international carriers that derive income "from car-
taxpayer under a different category pursuant to a riage of persons, excess baggage, cargo and mail
separate provision of the same Code (Rev. Reg. originating from the Philippines" which shall be
No. 15-2002). taxed at 2 1/2% of their Gross Philippine Billings.
South African Airways, being an international carrier
/ International Air Carrier and International
with no flights originating from the Philippines, does
Shipping - shall be taxed on the basis of their
not fall under the exception. As such, petitioner must
Gross Philippine Billings.
fall under the general rule. This principle is embod-
/Off-line international airline is subject to ied in the Latin maxim, exception firmat regu/am
corporate income tax in casibus non exceptis, which means, a thing not
Sec. 28(A)(3)(a) of the 1997 NIRC does not, being excepted must be regarded as coming within
in any categorical term, exempt all international air the purview of the general rule.
carriers from the coverage of Sec. 28(A)(1) of the To reiterate, the correct interpretation of the
1997 NIRC. Certainly, had legislature's intentions above provisions is that, if an international air car-
been to completely exclude all international air carrier maintains flights to and from the Philippines,
riers from the application of the general rule under it shall be taxed at the rate of 2 1/2% of its Gross
Sec. 28(A)(1 ), it would have used the appropriate Philippines Billings, while international air carriers
60 BASIC APPROACH TO INCOME TAXATION CHAPTERS 61
that do not have flights to and from the Philippines C. MINIMUM CORPORATE INCOME TAX (Sections
but nonetheless earn income from other activities 27[E], 28A[2] /mp/emented by Revenue Regulations
in the country will be taxed at the rate of 32% (now No. 9-98 as amended by Revenue Regulations 12-
30%) of such income. [see South African Airways 2007)
v. Commissioner of Internal Revenue, 612 SCRA
665, 675-676, 678 (201 O)] (1) Concept and Rationale of the MCIT
The MCIT on domestic corporations is a new
(3.) NON-RESIDENT FOREIGN CORPORATIONS
concept introduced by RA 8424 to the Philippine
Source: Within taxation system. It came about as a result of the
Tax base: Gross income perceived inadequacy of the self-assessment sys-
tem in capturing the true income of corporations.
Tax rate: 35% effective July 01, 2005; 30% effec- ft was devised as a relatively simple and effective
tive January 01, 2009 (R.A. No. 9337)
revenue-raising instrument compared to the normal
Special Non-Resident Foreign Corporations: income tax which is more difficult to control and
enforce. It is a means to ensure that everyone will
a.) NR-lessorof cinematographicfilm-within make some minimum contribution to the support of
- Gross income - 25% final tax; the public sector. x x x
b.) NR - owner or lessor of vessels chartered Domestic corporations owe their corporate
by Phil. Nationals - within - Gross rental existence and their privilege to do business to the
- 4.5% final tax; government. They also benefit from the efforts of the
c.) NR- owner or lessor of aircraft, machinery & government to improve the financial market and to
equipment-within - Gross rental - 7.5% ensure a favorable business climate. It is therefore
final tax. fair for the government to require them to make a
reasonable contribution to the public expenses.
Two vessels of V. Reederji Amsterdam
called on Philippine ports twice to unload car- Congress intended to put a stop to the
goes for foreign destination. It has no office in practice of corporations which, while having large
the Philippines. The fees were collected by its turn-overs, report minimal or negative net income
husbanding agent, Royal International Ocean resulting in minimal or zero income taxes year in
Lines. The Supreme Court held that the corpo- and year out, through under-declaration of income
ration is considered non-resident foreign cor- or over-deduction of expenses otherwise called tax
poration. Casual activity as in this case, does shelters. x x x
not amount to engaging in trade or business
The primary purpose of any legitimate busi-
in the Philippines (N.V. Reederji Amsterdam
ness is to earn a profit. Continued and repeated
v. Com., L-460229, 23 June 1988, 162 SCRA
487). losses after operations of a corporation or con-
sistent reports of minimal net income render its ~)Purpose of MCIT (2001 Bar)
financial statements and its tax payments suspect. The imposition of the MCIT is designed to
For sure, certain tax avoidance schemes resorted forestall the prevailing practice of corporations of
to by corporations are allowed in our jurisdiction over claiming deductions in order to reduce their
The MCIT serves to put a cap on such tax shelters. income tax payments.
As a tax on gross income, it prevents tax evasion
and minimizes tax avoidance schemes achieved (3.) Nature of minimum corporate income tax (MCIT)
through sophisticated and artful manipulations of The MCIT is an estimate of the income tax that
deductions and other stratagems. Since the tax is due from a firm. It is equal to two percent (2%)
base was broader, the tax rate was lowered. of the gross income of a corporation at the close of
each taxable quarter.
To further emphasize the corrective nature of
the MCIT, the following safeguards were incorpo- Being a minimum income tax, a corporation
rated into the law. should pay the MCITwhenever its regular (normal)
income tax is lower than the MCIT, or when the firm
First, recognizing the birth pangs of businesses
reports a net loss in its tax return. Conversely, the
and the reality of the need to recoup initial major
regular income tax is paid when it is higher than the
capital expenditures, the imposition of the MCIT
MCIT.
commences only on the fourth taxable year imme-
diately following the year in which the corporation (4.) MCIT is not an additional tax to the regular or
commenced its operations. This grace period al- normal income tax
lows a new business to stabilize first and make its
At the end of the taxable quarter, the MCIT is
ventures viable before it is subjected to the MCIT.
compared with the regular income tax which is due
Second, the law allows the carrying forward from a corporation. If the regular income is higher
of any excess of the MCIT paid over the normal in- than the MCIT, then the corporation does not pay
come tax which shall be credited against the normal the MCIT.
income tax for the three immediately succeeding Newly established firms, or those which are on
years. their first three years of operations are not covered
Third, since certain businesses may be incur- by the MCIT.
ring genuine repeated losses, the law authorizes jfr.J"coverage of the MCIT (2001 Bar)
the Secretary of Finance.Jo suspend the imposition
of MCIT if a corporation suffers losses due to pro- The MCIT covers domestic and resident for-
longed labor dispute, force majeure and legitimate eign corporations which are subject to the regular
business reverses. [CREBA v. Romulo, 614 SCRA income tax. The term "regular income tax" refers to
605, 622-624 (2010)] the regular income tax rates under the Tax Code.
The tax rate is 33% for 1999, 32% for 2000, 35% The period of reckoning the start of its business
effective July 01, 2005 and 30% effective January operations is the year when the corporation was
01, 2009. Thus, corporations which are subject to registered with the BIR. This rule will apply regard-
a special corporate tax system do not fall within the . less of whether the corporation is using the calen-
coverage of the MCIT. These are as follows: dar year or fiscal year as its taxable year (Manila
/: Schools, hospitals, and income of Offshore Banking Corporation v. CIR, 499 SCRA 782, 788).
Banking Units (OBUs), and Foreign Currency Firms that were registered in 1994 and earlier
Deposit Unit (FCDU) from foreign currency years are covered by the MCIT beginning Janu-
transactions; ary 1, 1998.
Regional operating headquarters; Firms which were registered with the BIR in
The incomes of these corporations are any month in 1998 will be covered by the MCIT
subject to a ten percent (10%) preferential tax after the lapse of three calendar years, i.e., 2002.
rate; (~ Suspension of the payment of MCIT
Firms under a special income tax regime such The Secretary of Finance, upon the recom-
as those under the PEZA law and the Bases mendation of the BIR Commissioner, may suspend
Conversion Development Act; the imposition of the MCIT on a corporation in any
International carriers subject to tax at 2 1/2% of the following cases:
of their Gross Philippine Billings. Sustained losses from prolonged labor dispute;
For corporations whose operations or activi- Force majeure;
ties are partly covered by the regular income tax
system and partly covered under a special income Legitimate business reverses.
tax system, the MCIT shall apply on operations "Sustained losses from a prolonged labor
covered by the regular income tax system. dispute" means losses arising from a strike staged
For example, the MCIT does not cover an activ- by employees which lasted for more than six (6)
ity of a firm which is registered with the Board of months within a taxable period and which has
Investments (BOI) and is granted an income tax caused the temporary shutdown of business opera-
holiday. The MCIT shall cover its other activities tions.
which are not covered by the SOI tax incentives. "Force majeure" means a cause due to an
(9,) When does a corporation start to be covered by irresistible force as by "Act of God" like lightning,
the MCIT? ~ earthquake, storm, flood and other natural calami-
A corporation starts to be covered by the MCIT ties. This term would also include armed conflicts
on the fourth (4th) year of its business operations. like war or insurgency.
"Legitimate business reverses" shall include services required by the customers and clients
substantial losses due to fire, robbery, theft or including:
embezzlement, or for other economic reason as
Salaries and employee benefits of personnel,
determined by the Secretary of Finance.
consultants and specialists directly rendering
(8.) How is the MCIT computed? the service;
--~~
The MCIT is equal to two percent (2%) of the Cost of facilities directly utilized in providing
gross income of the corporation at the end of the the service such as depreciation or rental of
taxable year. equipment used;
~< "Gross income" means gross sales less Cost of supplies.
. sales returns, discounts and allowances and cost Interest expense is not included as part of cost
of goods sold. It will also include all items of gross of service, except in the case of banks and other
income enumerated under Section 32(A) of the Tax financial institutions.
Code, as amended, except income exempt from
income tax and income subject to final withholding The term "gross receipts" means amounts ac-
tax. tually or constructively received during the taxable
year. However, for taxpayers employing the accrual
Cost of goods sold include all business expens-
basis of accounting, it means amounts earned as
es directly incurred to produce the merchandise to - - -- '.,.,- '-- --., '"'""""> -- ,,M
gross income.
bring them to their present location and use.
(9.) When is the MCIT reported and paid?
For a trading or merchandising concern, cost
of goods sold means the invoice cost of goods sold, The MCIT shall be paid in the same manner
plus import duties, freight in transporting the goods prescribed for the payment of the normal corporate
to the place where the goods are actually sold, income tax which is on a quarterly and on a yearly
including insurance while the goods are in transit. basis.
For a manufacturing concern, cost of goods The taxpayer shall pay the MCIT whenever
manufactured and sold means all costs of produc- it is greater than the regular or normal corporate
tion of finished goods such as raw materials used, income tax which is imposed under Section 27(A)
direct labor and manufacturing overhead, freight and Section 28(A)(1) of the Code.
cost, insurance premiums and other costs incurred
Thus, in the computation of the tax due for the
to bring the raw materials to the factory or ware-
taxable quarter, if the computed quarterly MCIT is
house.
higher than the quarterly normal income tax, the tax
For sale of services, gross income'means gross due to be paid for such taxable quarter and the time
receipts less sales returns, allowances, discounts of filing the quarterly corporate income tax return
and cost of services which cover all direct costs shall be the MCITwhich is two percent (2%) of the
and expenses necessarily incurred to provide the gross income as of the end of the taxable quarter.
The final comparison between the normal The taxpayer is required to pay the MCIT
income tax payable by the corporation and the whenever it is_QJE:llf than the reg[Jlar income
MCIT shall be made at the end of the taxable year tax. Thus, in 2000, the taxpayer will pay MCIT
and the payable or excess payment in the Annual of P75,000 since this is greater than the normal
Income Tax Return shall be computed taking into income tax of P50,000.
consideration corporate income tax payment made
at the time of filing of quarterly corporate income In 2001, the taxpayer will pay MCIT of
tax return whether this be MCIT or normal income P100,000 because its MCIT in 2001 is still
tax. higherthan the regular income tax. The excess
MCIT of P25,000 in 2000 (or the difference
(10.) Can the company claim the MCIT it paid as a between the MCIT and the regular income tax
deduction from gross income? ,,.---""'
in 2000)E'3_~!19tlbe used in this instance.
Since the MCIT is an estimate of the normal
income tax, it cannot be claimed as deduction. In 2002, )!l{hf?~ the rmJ1,1l9rii:ic;Qrne t9x of
P100,000 is(b_ig_h~wthan the MCIT of P60,000,
(11.) What is the carry-forward provision under the the taxpayer is allowed to claim as credit the
- MCIT? excess MCIT of P25,000 and P40,000 for
Any excess of the MCIT over the normal in- 2000 and 2001 respectively, or a total crE!di!
come tax may be carried forward on an annual basis of P65,000. Hence, the taxpayer will pa~(only
and be credited against the normal income tax for P35,000 (P100,000- P65,000). ~-- .
the three immediately succeeding taxable years.

0.-- IMPROPERLY ACCUMULATED EARNINGS TAX (Sec-
Illustration: tion 29 as Implemented by Rev. Reg. No. 2-2001)
2000 2001 2002 (1.) Rationale of improperly accumulated earnings
Normal income tax 50,000 60,000 100,000 tax of 10%
MCIT 75,000 100,000 60,000 If the earnings and profits were distributed, the
shareholders would then be liable to income tax
Amount of tax to be paid 75,000 100,000 100,000
thereon, whereas if the distribution were not made
Less: Excess MCIT to them, they would incur no tax in respect to the
2000- 25,000 undistributed earnings and profits of the corpora-
lion. Thus, a tax is being imposed in the nature of
2001 - 40,000 65,000 a penalty to the corporation for the improper accu-
mulation of its earnings, and as a form of deterrent
Net amount of tax payable 75,000 100,000 35,000
to the avoidance of tax on shareholders who are
CHAPTER 5 71
supposed to pay dividends tax on the earnings able capital expenditure as approved by the
distributed to them by the corporation. Board of Directors or equivalent body;
(2.) What is the touchstone of the liability? c.) Earnings reserved for building, plants or equip-
ment acquisition as approved by the Board of
It is the purpose behind the accumulation ofthe
Directors or equivalent body;
income and not the consequences of the accumula-
tion. Thus, if the failure to pay dividends is due to d.) Earnings reserved for compliance with any loan
some other causes, such as the use of undistributed covenant or pre-existing obligation established
earnings and profits for the reasonable needs of the under a legitimate business agreement;
business, such purpose would not generally make e.) Earnings required by law or applicable regu-
the accumulated or.undistributed earnings subject
lations to be retained by the corporation or
to the tax. However, if there is a determination that
in respect of which there is legal prohibition
a corporation has accumulated income beyond the
against its distribution;
reasonable needs of the business, 10% improperly
accumulated earnings tax shall be imposed. f.) In the case of subsidiaries of foreign corpo-
rations in the Philippines, all undistributed
(3.) Determination of reasonable needs of the busi-
earnings intended or reserved for investments
ness
within the Philippines as can be proven by cor-
An accumulation of earnings or profits (includ- porate records and/or relevant documentary
ing undistributed earning or profits of prior years) is evidence.
reasonable if it is necessary for the purpose of the
business, considering all the circumstances of the To determine the 'reasonable needs' of
case. The term "reasonable needs of the business" the business in order to justify an accu-
are hereby construed to mean the immediate needs mulation of earnings, the Courts of the
of the business, including reasonably anticipated United States have invented the so-called
needs. "Immediacy Test" which construed the
words 'reasonable needs of the business'
(~J What constitute accumulation of earnings for to mean the immediate needs of the busi-
- the reasonable needs of the business? ness, and it was generally held that if the
a.) Allowance for the increase in the accumulation corporation did not prove an immediate
of earnings up to 100% of the paid-up capital need for the accumulation of earnings and
of the corporation as of Balance Sheet date, profits, the accumulation was not for the
inclusive of accumulations taken from other reasonable needs of the business, and the
years; penalty tax would apply [Mertens, Law of
b.) Earnings reserved for definite corporate expan- Federal Income Taxation, Vol. 7, Chapter
sion projects or programs requiring consider- 39, p. 103]. (2010 Bar)
[
72 BASIC APPROACH TO INCOME TAXATION I CHAPTER 5 73
I CORPORATE INCOME TAXATION
(5.) Coverage of IAET

The 10% Improperly Accumulated Earnings
I
'
Investment of substantial earnings and profits
of the corporation in unrelated business or in
stock or securities of unrelated business;
Tax (IAET) is imposed on improperly accumulated
taxable income earned starting January 1, 1998 by Investment in bonds and other long-term se-
domestic corporation as defined under the Tax Code curities;
and which are classified as closely held corpora- 1' Accumulation of earnings in excess of 100%
tions. of paid-up capital, not otherwise intended for
(6-) What are closely-held corporations? the reasonable needs of the business.
Closely-held corporations are those corpora- E. OTHER CORPORATE TAX RATES
tions at least fifty percent (50%) in value of the out-
standing capital stock or at least fifty percent (50%) (1.) Common Tax Rates
i
of the total combined voting power of all classes of a.) Capital gain from sale of share of stock.
stock entitled to vote is owned directly or indirectly
by not more than twenty (20) individuals.
I i. If not listed and traded through stock ex-
change:
(7) Corporations not subject to IAET:
Banks and other non-bank financial interme-
diaries;
I

Net capital gain not over P100,000
-5%;
Any amount in excess of P100,000
,, Insurance companies; -10%.
Publicly-held corporations; ii. If listed and traded through local stock
exchange - 1/2% of 1% of Gross Selling
Taxable partnerships; Price (not income tax).
General professional partnerships; (2.) Domestic Corporations
Non-taxable joint ventures; a.) Corporations have the option to be taxed at
Enterprises duly registered with the Philippine fifteen percent (15%) of gross income. In this
Economic Zone Authority (PEZA) under R.A. regard, the President may, upon the recom-
No. 7916, and enterprises registered pursuant mendation of the Secretary of Finance, effec-
to the Bases Conversion and Development Act tive 1 January 2000, allow corporations the
of 1992 under R.A. No. 7227. option to be taxed at fifteen percent (15%) of
gross income, after the following conditions
(8.) Prima facie instances of accumulation of profits have been satisfied:
beyond the reasonable needs of a business are
indicative of purpose to avoid income tax upon i. A tax effort ratio of twenty percent (20%)
shareholders: of Gross National Product (GNP);
74 BASIC APPROACH TO INCOME TAXATION iI CHAPTER 5
75
!
f; Tax base: Profits applied or ear-
ii. A ratio of forty percent (40%) of income !
tax collection to total tax revenues; t marked for remittance. This took ef-
I
iii. A VAT tax effort of four percent (4%) of 'I'

fect on 1 January 1998.
GNP; and Tax rate: 15% final tax.
iv. A 0.9 percent (0.9%) ratio of the Con-
I
Condition: Branch profits are effec-
solidated Public Sector Financial Position I tively connected with the conduct of
(CPSFP) to GNP. I its trade or business in the Philippines
The option to be taxed based on (1999 Bar).
gross income shall be available only r The dividend income remitted to
I
to firms whose ratio of cost of sales
to gross sales or receipts from all
II Marubeni Corporation of Japan aris-
ing from its equity investments in
sources does not exceed fifty-five

percent (55%).
The election of the gross income tax
'
!
II.
'
Atlantic, Gulf and Pacific Company
of Manila is considered separate and
distinct income from the branch of-
fice in the Philippines. There can be
option by the corporation shall be ir-
revocable for three (3) consecutive no other logical conclusion that the
taxable years during which the corpo- investment was made for purposes
ration is qualified under the scheme. peculiarly germane to the conduct
of the corporate affairs of Marubeni,
The term "gross income" derived Japan, but certainly not of the branch
from business shall be equivalent to in the Philippines (Commissioner v.
gross sales less sales returns, dis-
counts and allowances and cost of II
Marubeni, 177 SCRA 500).
Exempt profits remitted: Derived
goods sold. "Cost of goods sold" '
shall include all business expenses from activities registered with the
directly incurred to produce the Philippine Economic Zone Authority
merchandise to bring them to their (PEZA).
present location and use. (4.) Non-Resident Foreign Corporations
b.) Interest on currency deposit and royalties a.) Interest on foreign loan - 20% Final Tax.
derived from sources within the Philippines -
b.) Dividend received from domestic corporation.
20% Final Tax.
This is known as the tax sparing credit rule
(3.) Resident Foreign Corporations (Section 28 B 5[b), NIRC).
a.) Branch Profit Remittance Tax Tax rate: 15% final tax.
Condition: foreign government shall provision or revenue regula-

allow a credit against the tax due from tion requiring "Actual Grant."
the foreign corporation taxes deemed to Therefore, the phrase "deemed
have been paid. paid" "tax credit" does not imply
Tax credit allowed: 20% effective July 1, tax credit actually granted by
2005; 15% effective January 1, 2005 (R.A. the foreign government.
No. 9337). Purpose of Tax Sparing Credit: To

Issues: encourage foreign investments and to
attract foreign investors.
May a subsidiary corporation (withholding
agent) file an action for refund? F. TAX EXEMPT CORPORATIONS UNDER THE NIRC
Answer: Procter and Gamble Philip- (1.) Labor, Agriculture, or Horticultural Organization
pines, subsidiary corporation Not Organized Principally for Profit
of P & G-USA is properly re,
a.) Provincial fairs and like associations of a quasi-
garded as a "taxpayer" within
public character designed to encourage devel-
the meaning of Section 309,
NIRC [now Section 22(N)] and opment of better agricultural and horticultural
therefore, authorized to file re- products through a system of awards, prizes
fund. Withholding agent is tech- or premiums and whose income derived from
nically considered as taxpayer. gate receipts, entry fees, donations, etc. is
Reason: It is also an agent of used exclusively to meet necessary expenses
the taxpayer in reporting such of upkeep and operation are thus exempt.
an income (Com. v. Procter, 204 b.) On the other hand, the holding of periodical
SCRA377). race meets by associations, the profits from
Does the phrase "deemed paid" tax credit which inure to the benefit of their stockholder
mean tax credit actually granted by the are not tax-exempt. Similarly, corporations
foreign country? engaged in growing agricultural or horticultural
Answer: The Tax Code merely requires products or raising livestock or similar products
that the foreign country (USA) for profit are subject to tax (Section 25, Rev.
shall allow a credit against Reg. No. 2).
the tax due from Procter and (2.) Mutual Savings Banks and Cooperative Banks
Gamble-USA for taxes deemed
to have been paid in the Phil- a.) Requisites for exemption:
ippines. There is no statutory i. No capital stock represented by shares;
ii. Earnings, less only the expenses of oper- c.) Mutual protective societies not operating un-
ating are distributable wholly among the der the lodge system and traveler's associa-
depositors (Section 26, Rev. Reg. No. 2); tion providing for fixed death benefits to the
iii. Operated for mutual purposes and without beneficiaries or members are not tax exempt
profit. (Commercial Travelers Life and Accident As-
sociation v. Radway, 235 Fed. 370).
b.) Exemption applies to foreign as well as domes-
tic banks (4.) Cemetery Companies
c.) Not qualified as mutual savings bank if deposits a.) Requisites for exemption:
are made compulsory under contracts between
i. Owned and operated exclusively for the
the bank and depositors and is operated for
benefit of its owners;
speculation rather than for savings (C.C. 262;
C.B. 111-2, 248; Mateus, ibid., Vol. 6, p. 7). ii. Not operated for profit.
(3.) Fraternal Beneficiary Society, Order or Associa~ b.) Any cemetery corporation chartered solely
ti on r for burial purposes and not permitted by its
a.) Requisites for exemption: I charter to engage in any business not neces-
sarily incident to that purpose, is exempt from
i. Operated under lodge system or for the income, provided that no part of its net earnings
exclusive benefit of the members of a inures to the benefit of any private shareholder
society - they have parent and local or individual.
organizations which are active (Western
Funeral Benefit Association v. Hellmich, c.) Cemetery company which fulfills the other
2F, [2d] 367); requirements of the Statute may be exempt,
even though it issues preferred stock entitling
ii. Established system of payment to its the holders to dividend at a fixed rate, provided
members or their dependents of life, sick, that its articles of incorporation require:
accident, or other benefits (Section 27,
Rev. Reg. No. 2); i. that the preferred stock shall be retired
at par as soon as the sufficient funds are
iii. No part of the net income inures to the realized from sales; and
benefit of the stockholders or members.
ii. that all funds not required for the payment
b.) A grand lodge established for the care of the
of dividends upon or for the retirement of
members, their dependents, and members of
preferred stock shall be used by the com-
an affiliated lodge unable to earn a livelihood
pany for the care and improvement of the
by reason of the infirmities of age was held tax
cemetery/property.
exempt.
d.) Cemetery having a capital stock represented i a.) Requisites for exemption:
by shares, or which is operated for profit or for r i. Association of persons having some com-
the benefit of persons other than its members, ! mon business interest;
does not come within the exempted class (Sec-
tion 29, Rev. Reg. No. 2).
(5.) Religious, Charitable, Scientific, Athletic or
'I
~- ii. Limited its activities to work for such com-
mon interests;
Cultural Corporations ! iii. Not engaged in a regular business for

t profit;
a.) Requisites for exemption:
!I iv. No part of the net income inures to the
i. Organized and operated for one or more benefit of any private stockholder or indi-
of the specified purposes; I
f
f
vidual.
ii. No part of its net income must inure to the t b.) Ceases to be tax exempt if it engages in a
benefit of private stockholders or individu- I regular business for profit even if it conducts
business on a cooperative basis or produces
als. i only sufficient income to be self-assessing.
b.) In the case of religious activities, income from !
the conduct of strictly religious activities, such I c.) An association engaged in furnishing informa-
as fees received for administering baptismal, I tion to prospective investors, to enable them to
make sound investment, is not exempt, since
solemnizing marriages, attending burials, hold-
ing masses, and other like income is exempt
(Section 30, Rev. Reg. No. 2).
I its members have no common business inter-
ests even though all its income is devoted to
the purpose stated.
c.) Charitable corporation includes association
for the relief of the families of clergymen, even d.) A clearing house association, not organized for
though the latter make contributions to the fund profit, no part of the net income of which inures
established for this purpose, or for furnishing to the benefit of any private shareholder or
individual, is exempt provided its activities are
the series of trained nurses to persons unable
limited to the exchange of checks and similar
to pay for them or for aiding the general body
work for the common benefit of its member.
of litigants by improving the efficient adminis-
tration of justice (Ibid.). e.) An association of persons who are engaged in
the transportation business whether by land or
d.) Scientific corporation includes an association
water, which is designed to promote the legiti-
for the scientific study of law with a view to
mate objects of such business, and all of the
improving its administration (Ibid.).
income of which is derived from membership
(6.) Business, Chamber of Commerce, or Board of fee dues and is expended for office expenses
Trade is exempt (Section 31, Rev. Reg. No. 2).
f.) Makati Stock Exchange is not a business the community welfare, of the residents of
league, chamber of commerce, or board of the place which is a contiguous community
trade within the purview of Section 30(f) of the of property owners and residents within an
Tax Code, as amended, and must pay income area, its source of income coming from dues
tax on its taxable income. Earnings inure to the assessed against the members on the basis
benefit of its members (BIR Ruling No. 64-027). of their relative holding in said place, and no
part of such income inures to the benefit of any
(7.) Civic League
private stockholder or individual is exempt from
a.) Requisites for exemption: the payment of income (BIR Ruling, 31 March
1959).
i. Not organized for profit but operated ex-
clusively for purposes beneficial to the c.) An association organized for maintaining sani-
community as a whole. In general, organi- tation, to afford community police protection,
zations engaged in promoting the welfare fire prevention as well as the beautification and
of mankind (Section 32, Rev. Reg. No. 2); uniformity of the surrounding premises of the
occupants of a subdivision is exempt from in-
ii. Sworn affidavit with the BIR showing the come tax (BIR Ruling No. 520, series of 1959).
following:
(8.) Non-Stock, Non-Profit Educational Institutions
Character of the league or organiza- (Revenue Memorandum Circular No. 76-2003)
tion;
a.) The exemption of non-stock, non-profit edu-
Purpose for which it was organized; cational institutions refers to internal revenue
Actual activities; taxes imposed by the National Government
on all revenues and assets used actually, di-
Sources of income and disposition rectly and exclusively for educational purposes
there; (Paragraph 3, Section 4, Article XIV of the
All facts relating to the operation of Constitution).
the organization which affects its right b.) Furthermore, revenues derived from assets
to exemption. used in the operation of cafeterias/canteens
iii. The copy of articles of incorporation, by- and bookstores are exempt from taxation
laws and financial statements should be provided they are owned and operated by the
attached to the sworn affidavit (BIR Ruling educational institution as ancillary activities
No. 21, January 23, 1961). and the same are located within the school
premises.
b.) Activities which consist in the doing of acts
and things designed to promote the best in- c.) However, they shall be subject to internal
terests and well-being, as well as to safeguard revenue taxes on income from trade, busi-
ness or other activity, the conduct of which struction and/or improvement of school
is not related to the exercise or perform- buildings and facilities, acquisition of
ance by such educational institutions of equipment, books and the like) to be
their educational purposes or functions funded out of the money deposited in
(Sec. 2, Finance Department Order No. 137-. banks or placed in money markets, on or
87 as amended by Finance Department Order before the 14th day of the fourth month
No. 92-88) i.e., rental payment from their following the end of its taxable year (Sec.
building/premises. 3, Finance Department Order No. 137-87).
d.} Unlike non-stock, non-profit corporations, their e.) Finally, the exemption does not cover with-
interest income from currency bank deposits holding taxes. As an educational institution,
and yield from deposit substitute instruments they are constituted as withholding agents for
used actually, directly and exclusively in pur- the government required to withhold the tax
suance of their purposes as an educational on compensation income of their employees,
institution, are exempt from the 20% final tax or the withholding tax on income payments to
and 7 1/2% tax on interest income under the persons subject to tax pursuant to Section 57
expanded foreign currency deposit system of the Tax Code of 1997.
imposed under Section 27(D)[1] of the Tax
Code of 1997, subject to compliance with the (9.) Government Educational Institution
conditions that as a tax-exempt educational a.) UP (Act No. 1870, as amended) is subject to
institution, they shall on annual basis submit 20% final tax. Other government educational
to the Revenue District Office concerned an institutions are likewise subject thereto. Rea-
annual information return and duly audited
financial statement together with the following:
i. Certification from their depository banks as
I
f
t
son: Income from properties, real or personal
or from any of their activities conducted for
profit, regardless of the disposition made of
to the amount of interest income earned f such income shall be subject to tax (BIR Ruling
from passive investment not subject to the [- 21-90, 28 February 1990).
20% final withholding tax and 7 1/2% tax
on interest income under the expanded
foreign currency deposit system imposed
[ (10.) Mutual Fire Insurance Companies and Like Or-
ganizations
by Section 27(D)[1] of the Tax Code of It a.) Requisites for exemption:
1997;
ii. Certification of actual utilization of the said
income; and
I
{
i. Income is derived solely from assess-
ments, dues and fees collected from
members;
!
iii. Board Resolution by the school admin- ii. Fees collected from members are for the
istration on proposed projects (i.e., con- sole purpose of meeting its expenses.
b.) Receipt which is a mere incident of the business b.) Cooperative dairy companies which are en-
of the company does not prevent exemption. gaged in collecting milk and disposing of it,
Thus, receipt or the proceeds of the sale of or the products thereof and distributing the
badges, office supplies, or equipment will not proceeds less necessary operating expenses
defeat the exemption. The same holds true among the members upon the basis of the
with the receipt of interest upon government quantity of the milk or of butter fat in the milk
bonds. are exemptfrom the tax (Section 35, Rev. Reg.
c.) However, where such bonds are bought as No. 2).
permanent investment, the receipt of interest c.) If the proceeds of the business are distributed
destroys the exemption. in any other way other than on such proportion-
ate basis, the company will be subject to tax
d.) Receipt of entrance fee (premium) does not
render the company taxable. (Ibid.).
d.) Farmers association is not tax exempt, if it
EXCEPTION: Issuing policies for stipulated deducts more than the necessary selling ex-
cash premiums or requiring advance deposits penses incurred in accounting the proceeds to
to cover the cost of insurance and maintaining the farmers (Ibid.).
investment from which income is derived - no
longer exempt (Section 34, Rev. Reg. No. 2). e.) Cooperative associations acting as purchasing
agents are not expressly exempt from tax, but
e.) Advance assessment for the sole purpose of rebates made to purchases, whether or not
meeting losses and expenses - tax exempt member of the association, in proportion to
(Ibid.). their purchases may be excluded from gross
( 11.) Farmers, Fruit Growers' or Like Association income, any profits made from non-members
and distributed to members in the guise of
a.) Requisites for exemption: rebates are, of course, subject to tax (Ibid.).
i. Formed and organized as sales agent for f.) "Like associations" is construed as referring
the purpose of marketing the product of only to association whose activities are similar
its members; to farming and fruit growing (Garden House Co.
ii. No net income to the members; v. Com., 64 F [2d] 953). Credit Union which is a
non-stock corporation organized and operated
iii. Proceeds of the sale shall be turned over for mutual purposes without profit, its activi-
to them less necessary selling expenses ties being confined to the members thereof, is
on the basis of the quantity of produce exempt from income business and residence
finished by them. taxes (BIR Ruling No. 605, 13October1958).
COMMON REQUISITES: ii. Young Men's Christian Association of the

a.) Not organized and operated principally for Philippines, Inc. (YMCA) established as "a
profit; welfare educational and charitable non-profit
corporation" is subject to income tax on the
b.) No part of the net income inures to the benefif rental income derived from the lease of its
of any member or individual;
properties, real or personal, and is therefore
c.) No capital represented by shares of stock; not exempt from income taxation, even if such
d.) Educational or instructive in character. income is exclusively used for the accomplish-
ment of its objectives. The exemption claimed
Objectives: betterment of the conditions by the YMCA is expressly disallowed by the
engaged in such pursuits, the improvement of very wording of the last paragraph of then
the grade of their product and the development Section 26 (now last paragraph of Section
of a higher degree of efficiency in their respec- 30) of the NIRC which mandates that income
tive occupations.
of exempt organizations (such as the YMCA)
COMMON LIMITATIONS: from any of their properties, real or personal,
be subject to the tax imposed by the same
The income of whatever kind and character of Code. Because the last paragraph of said
the foregoing organizations from any of their proper- section unequivocally subjects to tax the rent
ties, real or personal or from any of their activities income of the YMCA from its real property, the
conducted for profit, regardless of the disposition Court is duty-bound to abide strictly by its literal
made of such income shall be subject to tax (2002 meaning and to refrain from resorting to any
Bar).
convoluted attempt at construction (Commis-
i. The income of such organizations which is sioner of Internal Revenue v. Court of Appeals,
considered as income from their properties, 298 SCRA 83).
real or personal, generally consists of income
from corporate dividend, rentals received from Tax exempt government-owned and con-
their properties, interests from Philippine cur- trolled corporations (GOCC) (Sec. 27[c] as
rency bank deposits or capital loaned to other amended by R.A. No. 9337
persons, income from agricultural lands, owned i. Government Service Insurance System;
by such corporations, profits from the sale of
property, real or personal and other similar ii. Social Security System;
income are taxable. iii. Philippine Health Insurance Corporation;
EXCEPTION: When earned by a non-stock, iv. Philippine Charity Sweepstakes Office.
non-profit educational institution (Article XIV,
Section 4[3], 1987 Constitution).
Tax-exempt corporations under special laws

( 1.) Cooperatives are exempted from taxes subject to
certain conditions under Republic Act No. 6938
(Rev. Memo. Circular 48-91 ). Chapter 6
(2.) Foundation created for scientific advancement is ALLOWABLE DEDUCTIONS FROM
exempt from tax under Section 24 of Republic Act GROSS INCOME
No. 2067.
A. BASIC PRINCIPLES:
( 1.) The taxpayer must point to some specific provisions
of the statute authorizing the deduction; and
(2.) He must be able to prove that he is entitled to the
deduction authorized or allowed (1955 Ph. Fed.
Tax Course, par. 1801; Atlas Consolidated Mining
v. Com., 102 SCRA 246).
If a taxpayer fails to deduct certain expenses
for the taxable year, he cannot deduct them
from the income of the next or any succeeding
year (Section 76, Rev. Reg. No. 2).
Not allowed to claim deductions (Tax base:
Gross Income):
i. NRA- NETB
ii. NRFC
B. THE COHAN RULE PRINCIPLE: If there is showing
that expenses have been incurred but the exact amount
thereof cannot be ascertained due to the absence of
documentary evidence, it is the duty of the BIR to make
an estimate of deduction that may be allowed in com-
puting the taxpayer's taxable income bearing heavily
against the taxpayer whose inexactitude is of his own
91
r CHAPTER 6
ALLOWABLE DEDUCTIONS FROM GROSS INCOME
93
making. A disallowance of 50% of the taxpayer's claimed j.) Pension trust contribution
deduction is valid (Rev. Memo. Circular No. 23-2000).
2. Optional Standard Deduction (OSD)
Deductions v. Exclusions (2001 Bar)
amounts deducted amounts/items KINDS OF ITEMIZED DEDUCTIONS
from gross income to exempt from tax by
arrive at net income C. BUSINESS EXPENSES
virtue of the Tax Code
or special law Requisites for deductibility (1968 Bar)
Deductions v. Personal Exemptions ( 1.) The expense must be ordinary and necessary.
(2001 Bar) There is no hard and fast rule on the matter.
business expenses personal expenses It depends upon particular facts such as, the
represent cost of doing cover personal, type of business (custom), intention of the tax-
business living or family payer, time, place and prevailing circumstanc-
expenses es. The Supreme Court has never attempted
both individual and to define with precision the terms ordinary and
only individual is
corporate taxpayers necessary.
entitled
may claim However, Section 34(A)[1a] of the NIRC, as
amended by R.A. 8424, provides that expens-
es are considered "ordinary and necessary" if
KINDS OF ALLOWABLE DEDUCTIONS
they are directly attributable to development,
1. Itemized deductions management, operation, and or conduct of
a.) Business expenses the trade or business of the taxpayer, or in the
exercise of the taxpayer's profession.
b.) Interest
Guiding principles:
c.) Taxes
Ordinary, when it is normal (common or usual) in
d.) Losses relation to the business of the taxpayer and the
e.) Bad debts surrounding circumstances. Need not be recurring,
e.g., lawyer's fee to prosecute infringement suit. It is
f.) Depreciation called ordinary in most cases to distinguish it from
g.) Depletion a capital expenditure (1955 CCH Fed. Tax Course,
par. 403).
h.) Charitable and other contributions
Recapitalization and reorganization expenses
i.) Research and development expenditure are capital expenditure as well as cost of
r CHAPTER 6 95
obtaining stock subscription and promotion

! c.) Mere holding of investments cannot be con-
expenses (Atlas Consolidated Mining and I sidered engaging in business so that the
Development Corp. v. Com., 120 SCRA246). expenses in managing the investments are
Necessary, where it is appropriate and helpful in not considered ordinary and necessary in the
the development of the taxpayer's business. It is pursuit of a trade or business (Hospital De San
intended to realize a profit or to minimize a loss Juan De Dias v. Com., G.R. No. 311305, 10
(Visayan Cebu Terminal Co. v. Collector, CTA Case May 1990).
No. 28, 29 June 1957). d.) Margin fees of P340,822.04 paid to the Central
Ransom money paid to secure the return of an Bank by ESSO, a foreign corporation doing
individual is not deductible as it has nothing to business in the Philippines, on its profit remit-
do with profit-making (Teodoro and De Leon, tances to its New York head office are not
op. cit., pp. 64-65). ordinary and necessary expenses. REASON:
The fees were paid not in the production of
Payment of the debts of bankrupt company to
income, but in the disposition of said income
which the taxpayer was an officer to establish
after it had already been earned. Hence, it is
his credit is, according to U.S. Supreme Court
an expense properly attributable to the head
not ordinary (Welch v. Helvering, 290 U.S. 11
[1933]). office and not in the carrying on of its trade or
business in the Philippines (ESSO Standard
(2.) The expenses must be incurred in trade or busi- Eastern, Inc. v. Com., 175 SCRA 158-159).
ness carried on by the taxpayer - This means
that the same is not incurred in the trade or business (3.) The expenses must be substantiated by proof
of another. a.) It is incumbent upon the taxpayer to establish
a.) Stockholder's expense in connection with the proximate relation (logical link or nexus) be-
acquisition of additional stock in order to sell it tween the expense and the taxpayer's busi-
to certain company executives in furtherance of ness (Atlas Consolidated v. Com., 102 SCRA
a management incentive plan of the company 246, 256).
- not incurred in connection with the trade or b.) Receipts are the best proof. Burden of proof
business of the company (Stanly and Kilcullen, lies upon the taxpayer. In certain cases, this
pp. 63-64). rule is relaxed.
b.) Fees paid by the taxpayer to recover its lost as- Even if no records/receipts are available, the
sets occasioned by the war and to rehabilitate oral testimony of a CPA, if not contradicted by
its business - business connected expenses
the government is sufficient (Basilan Estates v.
(Collector v. Phil. Education Co., G.R. No.
Com., G.R. No. L-22494, 5September1967).
L-8505, 30 May 1953).
(4.) The expenses must be reasonable be/a Cultural Corporation [515 SCRA 566-
a.) Promotional expenses incurred or paid by Phil. 567], that the professional fees of SGV &
Sugar Estate Development Co. to Algue Inc. Co., for auditing the financial statements
amounting to P125,000.00 was reasonable of ICC for the year 1985 cannot be validly
in the light of the efforts exerted in inducing claimed as expense deductions in 1986.
investors and prominent businessman to ven- Reason: ICC failed to present evidence
ture in a experimental enterprise (Vegetable showing that even with only "reasonable
Oil Investment Corp.), and to invest in a new accuracy, it cannot determine the profes-
business involving millions of pesos (Com. v. sional fees which said company could
Algue, 158SCRA11). charge for its services."
(5.) Paid or incurred during the taxable year (6.) Expenses must not be against public policy,
a.) Cash basis method - deducts expenses in public moral or law
the year in which they are paid.
a.) Fines and penalties - against public policy.
b.) Accrual basis method-recognizes expenses
in the year they accrue. b.) Attorney's fee incurred in defending civil action
based on illegal act - deductible provided it
The propriety of an accrual must be is business connected.
judged by the facts that a taxpayer knew,
or could reasonably be expected to have c.) Even though the defense is unsuccessful - as
known, at the closing of its books for the long as it is business connected - deductible.
taxable year. Accrual method of account-
d.) Entertainment expenses incurred by officer of
ing presents largely a question of fact;
such that the taxpayer bears the burden a corporation to entertain certain government
of proof of establishing the accrual of an officials to discuss transactions/dealings at
item of deduction. Manila Hotel - against public policy (Nava v.
Collector, CTANo. 568, 25September1961).
The all-events test requires that the liability
be fixed, and the amount of such liability e.) The purchase price of political influence to ob-
be determined with reasonable accuracy. tain or hold public contracts; dollar allocations
The amount of liability does not have to be from the Central Bank; import control licenses;
determined exactly; it must be determined payments in excess of the maximum amount
with reasonable accuracy (something authorized by law - against public policy.
less than an exact or complete accurate Reason: To permit a violator to gain a tax
amount). advantage through deductions would in effect
Applying the all-events test, the Supreme lessen the degree of punishment intended, or
Court ruled in the recent case of CIR v. Isa- would frustrate the purpose and effectiveness
c~~ffiB w
of the public policy that has been violated ( 1955 including contribution under SSS
PH Fed. Taxes, pars. 11, 1235, 11, 237). Act;
f.) Bribe to obtain protection from arrest or pros- other forms of compensation for
ecution - against public policy. services actually rendered.
(7.) If subject to withholding tax, proof of payment
to BIR must be shown Factors/tests which determine whether compen-
sation paid for services rendered is deductible
Professional expenses - 10% or not
Rent expense -10% (Rev. Reg. No. 6-85, 2 Any amount paid in the form of compensation
May 1985) which does not partake of the purchase price
of services is not deductible.
KINDS OF BUSINESS EXPENSES
Example: 1) Ostensible salary paid by a corpo-
(1.) Compensation for personal services ration may be treated as distribution of dividend
Requisites: upon stock.
a) Personal services actually rendered; This is likely to occur in the case of a cor-
poration having few stockholders, practically
b) Compensation is for such services rendered;
all of whom drew salaries. Reasonable amount
c) Reasonable. - deductible from gross income; Excess over
What are included in compensation for serv- reasonable amount - not deductible.
ices which are allowed as deductions from gross Example: 2) An ostensible salary may be in part
income? (1968 Bar) payment for property - Partnership sells out
to a corporation; the former partners agreeing
Answer: wages, salaries, etc.;
to continue in the service of the corporation.
bonuses in good faith; The salaries are not merely for services but
commissions, professional fees, payment for the transfer of their business (Sec-
vacation-leave pay, retirement pay; tion 70, Rev. Reg. No. 2; Alhambra v. Collector
105, 106 Phil. 355).
management expenses;
premiums and compensation for The form or method of fixing compensation
injuries if not compensated for by is not decisive as to deductibility. Contingent
insurance or otherwise; compensation may be deductible as long as
it is not influenced by any consideration other
contribution to pension trust created than securing fair and advantageous terms
for the benefit of the employees, (Reyes v. CTA No. 4, 30 September 1957).
CHAPTER6 101
Bonuses are deductible under the following Other forms of compensation:

conditions:
a.) Housing and meals;
a.) Paid in good faith as additional compensa-
tion for services rendered; b.) Courtesy discounts;
b.) Reasonable amount. To hold otherwise c.) Entertainment and gifts to company of-
would open the gate to rampant tax eva- ficers during Christmas and major anni-
sion (Kuenzle & Strife, Inc. v. Collector, versary, sports tournament and company
106 Phil. 355); picnics (Rev. Audit Memo Order 1-87, 23
April 1987);
c.) Not to exceed reasonable compensation
when added to stipulated salaries. d.) Legitimate expenses (salaries and miscel-
laneous expenses) of an illegitimate busi-
Suggested tests: (Consider the date when ness are deductible based on the theory
the contract for services was made, not at the date that the income tax is not a tax on gross
when the contract is questioned) income even if such income is earned from
a.) good faith; an illegal business (1.T. 2581, 1942-2 Com
Bell 88).
b.) character of business;
(2.) Travelling expenses - include transportation
c.) salary policy of the corporation;
expenses and meals and lodging (Sections 65 and
d.) type and extent of services; 66, Rev. Reg. No. 2).
e.) employee's qualification and contribution; Requisites for deductibility:
f.) general economic conditions (C.M.
a.) Paid or incurred while "away from home."
Hoskins & Co. v. Com., L-24059, 28 No-
vember 1969). i. Transportation expenses from main office
to branch, from branch office to main office
Bonuses granted to corporate officers for the
- deductible.
successful sale of a piece of land effected
through broker - no services rendered - ii. Transportation expenses from office to
not deductible as reasonable and necessary home; home to office - not deductible.
expenses (Aguinaldo Industries Corp. v. Com., iii. If a company car is utilized both for busi-
L-29790, 25 February 1982). ness and personal use - proportion to
It is immaterial whether bonuses are paid in the use.
cash or in kind or partly in cash and partly in b.) Paid or incurred in the conduct of trade or busi-
kind. ness.
CHAPTER 6 103
c.) Reasonable and necessary expenses.

being no hard and fast rule on the matter,
(3.) Representation and Entertainment expenses the right to a deduction depends on a
number of factors such as but not limited
Requisites for deductibility:
to: the type and size of business in which
a.) Subject to the rule of substantiation - receipt the taxpayer is engaged; the volume and
or adequate records, amount of expense, date amount of its net earnings; the nature of
and place of expense, purpose of expense the expenditure itself; the intention of the
and professional or business relationship of taxpayer and the general economic condi-
expense; tions. It is the interplay of these, among
b.) Paid or incurred in the pursuit of trade or busi- other factors and properly weighed, that
ness; will yield a proper evaluation.
c.) Paid or incurred in the taxable year; Advertising is generally of two kinds:
(1) advertising to stimulate the current
d.) Not contrary to law, morals and public policy;
sale of merchandise or use of services
e.) Reasonable. and (2) advertising designed to stimulate
Dues paid to social, athletic, or sporting the future sale of merchandise or use of
club or organization per officer; to professional services. The second type involves ex-
or business organization (Lions, Kiwanis) - penditures incurred, in whole or in part, to
deductible. create or maintain some form of goodwill
for the taxpayer's trade or business or for
Purchase of propriety shares and playing the industry or profession of which the tax-
rights - not deductible. payer is a member. If the expenditures are
(4.) Advertising and Promotional Expenses for the advertising of the first kind, then,
except as to the question of the reasona-
a.) Must be substantiated. bleness of amount, there is no doubt such
b.) All payments for the purchase of promotional expenditures are deductible as business
give-aways, contest prizes or similar material expenses. If, however, the expenditures
must be properly receipted. are for advertising of the second kind, then
normally they should be spread out over
All payments for services such as radio
a reasonable period of time.
and TV time, print ads, advertising expense
must be subjected to withholding tax. The protection of brand franchise is
analogous to the maintenance of goodwill
There is yet to be a clear-cut criteria or
or title to one's property. This is a capital
fixed test for determining the reasonable-
expenditure which should be spread out
ness of an advertising expense. There
over a reasonable period of time. Cor-
CHAPTER6 105
104 BASIC APPROACH TO INCOME TAXATION ALLOWABLE DEDUCTIONS FROM GROSS INCOME
(7.) Repairs
porate taxpayer's venture to protect its
brand franchise was tantamount to efforts Rules on deductibility
to establish a reputation. [Commissioner a.) Incidental or ordinary repairs - keeps the as-
of Internal Revenue v. General Foods set in its ordinary working condition (does not
(Phils.), Inc., 401 SCRA 545 (2003) 2009 add material value to the property or prolong
Bar] its life as distinguished from extra-ordinary
Expenses incurred or paid to promote sale repairs).
of capital stock for acquisition of additional i. Expense for the maintenance and repair
capital is not deductible from taxable in- of fishponds - deductible - It keeps the
come. Efforts to establish reputation are fishponds in an ordinary efficient operat-
akin to acquisition of capital assets and, ing condition (Villegas v. Com., CTA case
therefore, expenses related thereto are dated 7 October 1963).
not business expense but capital expen-
ditures. [Welch v. Helvering, 290 U.S. 111, ii. Repairs on the second floor of plant to
78 L Ed. 212, 545 Ct. 8 (1933)) strengthen it and avoid danger of col-
lapse - deductible (Kerotest Mfg. Co.,
(5.) Rent Expense (Rev. Reg. No. 8-90 dated 15 Oc- BTA Mamo Op., 25 November 1941 ).
tober 1990)
b.) Extraordinary repairs are not deductible -
a.) Business property- at least P500 - 5%. they are capital expenditures.
b.) Non-business/residential property - at least i. Expenses necessitated by radical chang-
P10,000.00- 5%. es in design made during construction are
(6.) Cost of material and supplies - deductible only not deductible - part of the cost of the
to the amount actually consumed or used in opera- project (Dirscoll v. Com., 1477 [2d) 493).
tion. ii. Expenses of repairs to walls and roof of a
Methods utilized to determine materials used: building to prevent leakage - deductible
(Buckland v. U.S. D.C. Com., 9 May 1946).
a.) Actual consumption method (inventory meth-
od); iii. Cost of demolishing building and erecting
a new one is a capital expenditure (Law of
b.) Direct purchase method. Federal Income Taxation, Merters, Vol. 4,
Taxpayer purchases materials but has no p. 372).
record of consumption - deductible provided Organization costs are amortized
the net income is clearly reflected by this over the life of the corporation.
method (Section 67, Rev. Reg. No. 2).
Private or proprietary educational institution may, Interest paid for late payment of
at its option, elect either: donor's tax is deductible (Com.
a) To deduct expenditure otherwise considered as v. Prieto, L-13912, 30 September
capital outlets of depreciable assets incurred 1960).
during the taxable year for the expansion of What are included in the term "indebt-
school facilities, or edness" interest of which is deduct-
b) Deduct allowance for depreciation therefrom. ible? (1968 Bar)
Gifts when proven to be bonafide
D. INTEREST EXPENSES loans
(1.) Definition - amount which one has contracted Taxes
to pay for the use of borrowed money (Old Colony
Bay Co., 284 U.S. 552) or amount of compensation Obligations of joint obligor
paid for the use of money or forbearance from such Discount on notes issued to bank for
use. loan
Requisites for deductibility: b.) Incurred in connection with taxpayer's trade or
a.) There must be an indebtedness: business
i. no indebtedness -- no deduction; c.) Indebtedness must be that of the taxpayer:
ii. Indebtedness- unconditional and legally i. Corporation was allowed interest deduc-
enforceable obligation for payment of a tion for payments made on loans obtained
sum certain in money; in its corporate capacity, using corporate
iii. Embraces not only contractual debts but assets as security, through borrowed
also interest accruing as a result of delin- funds were subsequently loaned to a
quency for payment of the tax. However, stockholder.
penalties (civil or criminal) are excluded; ii. Interest on income tax deficiency on prop-
iv. Distinction between taxes and debts are, erty after transfer to transferee (Arcale
on account of their nature and in certain Realty Co., Inc., 35 TC 256).
cases, inconsequential (Sambrano v. CTA, iii. Interest on mortgage by legal or equitable
L-8652, 30 March 1957). owner not directly liable upon indebted-
Correspondingly: ness (Section 8, Rev. Reg. No. 2).
Interest on delinquent tax liabilities d.) The interest must have been stipulated in writ-
is deductible (Com. v. Palanca, 18 ing in consonance with Article 1956, New Civil
SCRA496); Code which provides that no interest shall be
108 BASIC APPROACH TO INCOME TAXATION 109
CHAPTER6
due unless it has been expressly stipulated in (6.) Interest on indebtedness paid in advance through
writing. discount or otherwise (cash basis). Deductible in the
e.) Paid or accrued within the taxable year. year the indebtedness was paid, not when interest
was paid in advance.
Cash basis - deductible in the year it is .
actually paid. (7.) Interest between related taxpayers.
Accrual basis - deductible in the year it a.) Members of a family - brothers and sisters
is accrued even if not actually paid. (full or half), spouse, ancestors and lineal de-
scendants.
Deductible interest expenses b.) Individual and corporate - individual owns
a.) Interest on taxes. Reason: Taxes for this pur- directly or indirectly more than 50% of the
pose are indebtedness. Fines, penalties and outstanding stock.
surcharges on taxes are not deductible. c.) Between corporations - more than 50% of
b.) Interest paid by corporation on scrip dividends. the outstanding stock both owned directly or
indirectly by the same individual.
c.) Interest on deposits paid by authorized bank
of the Central Bank. d.) Grantor and fiduciary (trustee) of any trust.
d.) Interest paid by legal or equitable owner on e.) Fiduciary and another fiduciary - the same
mortgage of real property. granter.
f.) Fiduciary and beneficiary or such trust.
Some non-deductible interest expenses
Theoretical interest is not deductible as it
(1.) Interest on preferred stock which is considered is merely computed or calculated. It does
interest on capital by virtue of RMC 17-71 dated not arise from interest bearing obligation
12 July 1971 (1999 Bar). (PICOP v. CA, 250 SCRA 434 ).
(2.) Interest on undrawn salaries and bonuses (Keunzle Optional treatment of interest expense
& Streiff, Inc. v. Collector, 106 Phil. 355). on capital expenditure. At the option of
the taxpayer, interest expense on a capital
(3.) Interest on capital for cost keeping. Reason: No
expenditure incurred to acquire property
indebtedness.
used in trade, business or exercise of a
(4.) Interest paid where parties provide no stipulation profession may be allowed as a: ( 1) de-
to pay interest in writing. duction in full in the year when incurred,
(5.) Interest on indebtedness if incurred to finance pe- the provisions of Section 36 (A)[2] and [3]
of the Tax Code of 1997 to the contrary
troleum exploration.
notwithstanding; or may be treated as a (2)
CHAPTER 6 1
No deductions are allowed for amounts

capital expenditure for which the taxpayer representing: (1) interest; (2) surcharges;
may claim only as a deduction the periodic and (3) fines or penalties incident to de-
amortization of such expenditure (Section linquency (Par. 2, Section 80, Rev. Reg.
34(8)[3] as implemented by Rev. Reg. No. No. 2).
13-2000). Postage is not a tax. Automobile registra-

Arbitrage rule on deductible interest. tion fees are not considered taxes (Section
The percentage by which the taxpayer's 80, Rev. Reg. 2).
otherwise allowable deduction for inter-
Under Section 4(a), R.A. No. 9257
est expense shall be reduced, has been
(Expanded Senior Citizens Act), the
increased from 38% to 42% of the inter-
twenty percent (20%) discount granted
est income subjected to final tax effective
to senior citizens shall be allowed as tax
July 1, 2005. It shall be reduced to 33%
deduction from gross income for the same
effective January 1, 2009 (Section 34[8],
taxable year that the discount is granted.
as amended by R.A. No. 9337).
E. TAXES Requisites for deductibility:

(1.) Paid or incurred within the taxable year;
(1.) NATURE AND SCOPE -All taxes, whether na-
tional or local, paid or accrued, within the taxable (2.) Paid or incurred in connection with taxpayer's busi-
year in connection with the taxpayer's trade or ness;
business, except:
(3.) Deductible only by the person upon whom the tax
a.) Philippine income tax; is imposed by law (VAT is deductible only by seller).
b.) Income, war profit, and excess profit taxes
EXCEPTIONS:
imposed by the authority of any foreign country
provided the taxpayer chooses to take a tax a.) Taxes of shareholder upon his interest as such
credit (If a taxpayer is qualified to take a tax and paid by the corporation without reimburse-
credit for income, war profits and excess profits ment from him can be claimed by the corpora-
taxes paid or accrued to a foreign country such tion as deduction.
taxes, when not taken as tax credit, may be
b.) A corporation paying the tax for the holder of its
claimed as deductions from gross income);
bond or other obligations containing a tax-free
c.) Estate and donor's tax; covenant clause cannot claim deduction for
d.) Special assessment tax; such taxes paid by it pursuant to such covenant
(Sec. 80, Rev. Reg. No. 2).
e.) Taxes paid for commodity not connected with
the taxpayer's business:
CHAPTER 6 113
When may deduction for taxes be claimed?
the taxpayer's taxable income from
Answer: Year paid or incurred in general. sources without the Philippines bears to
However, in the case of contingent tax liability, the his entire taxable income for the same
obligation to deduct arises only when the liability is taxable year.
finally determined.
Tax Credit- amount allowed by law to reduce Tax Deduction v. Tax Credit
the Philippine income tax due on account of income
war-profit tax, excess profit tax, paid or accrued to' Deductible from gross in- Deductible from Phil.
a foreign country. come income tax
Only domestic corporations are entitled to avail Sources: Deductible taxes Sources: Foreign income
of the tax credit. such as business tax, excise war-profits and excess
tax, percentage tax and other profit tax
Reason/Purpose: To lessen the harshness business-connected taxes
of taxation in cases where an income is subject to
both foreign tax and Philippine income tax.
Tax deduction reduces taxable income while
The taxpayer has the option either to claim tax credit reduces the taxpayer's liability (CIR
foreign income taxes paid as deduction from v. Bicolandia Drug Corporation, 496 SCRA 176,
gross income or tax credit against the Philip- 182).
pine income tax. If claimed as tax credit, it is
Administrative conditions for allowance of
no longer deductible from gross income.
credit for foreign taxes:
If claimed as tax credit, the allowable tax credit (1.) The taxpayer must signify in his income tax
is subject to the following limitations:
return his desire to claim tax credit;
a.) The amount of the credit with respect to (2.) The return must be accompanied by the ap-
the tax paid or incurred to any country propriate form prescribed by the BIR Commis-
shall not exceed the same proportion of sioner, signed and sworn, carefully filled up and
the tax against which such credit is taken, containing the information required.
which the taxpayer's taxable income from
sources within such country bears to his If credit is sought for taxes already paid, receipt for pay-
entire taxable income for the same taxable ment must be attached.
year; and
F. LOSSES
b.) The total amount of the credit shall not
(1.) DEFINITION
exceed the same proportion of the tax
against which such credit is taken, which The term implies an unintentional parting with
something of value. It is used in the income tax law
in a very broad sense to comprehend all losses is due to a fluctuation in the market price or to
which are not general or natural to the ordinary other similar cause, the amount of loss is not
course of business and are not covered under some deductible until it is disposed of (Sec. 99, Rev.
other heading such as bad debts, inventory tosses; Reg. No. 2).
depreciation, etc. (1955 CCH Test Tax Course, Par.
598). b.) Must be claimed in the year the worthlessness
occurs. The law requires that it must be con-
Treatment of losses depends upon: sidered as a loss from the sale or exchange
a.) Class of taxpayers; of capital assets on the last day of the taxable
year in which it occurred.
b.) Nature of losses.
e.) Losses from short sale of property.
(2.) KINDS OF LOSSES:
f.) Losses due to failure to exercise privilege or
a.) Ordinary losses those incurred in trade or option to buy or sell property.
business.
g.) Abandonment losses (oil exploration).
b.) Those incurred in any transaction entered for
i.) All accumulated exploration and develop-
profit though not connected with the trade or
business. ' ment expenditures pertaining to partially
or fully abandoned petroleum operations
c.) Casualty Losses those incurred by property shall be allowed as deduction. In all cases,
connected with the trade or business, if the notices of abandonment shall be filed with
loss arises from fire, storm, shipwreck, or other the BIR.
casualties or from robbery, theft or embezzle-
ment. ii.) Subsequently abandoned producing well
- the unarmortized costs and undepre-
d.) Capital losses deductible only to the extent ciated costs of equipment directly used
of capital gains: shall be allowed as deduction. If the well
Losses from sale or exchange of capital is reentered and production resumed, or
assets; if such equipment or facility is restored
into service - the costs shall be included
Losses resulting from securities becoming as part of the gross income and shall be
worthless which are capital assets. amortized or depreciated, as the case may
Two important requisites: be.
a.) It becomes worthless upon the happening of an (3.) SPECIAL KINDS OF LOSSES:
identifiable event which evidences destruction a.) Wagering losses - deductible only to the
of value. However, when the decline in value extent of gain or winning:
l
CHAPTER 6 117
set against gains from a legal transaction

Illustrations: (Section 96, Rev. Reg. No. 2).
Gambling winning 1,000.00
! b.) losses due to voluntary removal of building
Gambling loss 500.00 incident to renewal or replacement (1968
500.00 Bar).
Deductible loss
Gambling winning 500.00 Tax Code does not provide for the deduct-
ibility of losses arising from voluntary removal
Gambling loss 1,000.00
of old building, or scrapping of machinery
Deductible loss 500.00 or equipment. Rev. Reg. No. 2, Section 87
Gambling winning 0 granted the deductibility of losses sustained if
building, machinery or equipment is old, and
Gambling loss 1,000.00
the demolition or scrapping thereof is made ,
Deductible loss 0 incident to removals or replacements. This
i. Thus, a taxpayer whose gambling transac- presupposes that the building is already exist-
tions resulted in losses of P500 and gains ing on the lot owned by the taxpayer before the
of P400 in another gambling game, would demolition.
be obliged to report the gain of P400 in With respect to the building existing at the
order to obtain a deduction of the loss time of purchase of the lot upon which the said
for P500. The excess of the loss over the building is erected, the rules are the following:
gain is not deductible. On the other hand,
i.) When a taxpayer buys a real estate upon
the excess of the gain over loss is taxable which a building is built, the cost to build
(Humpreyv. Com., 35AFTR, 1572; Fran- another building and the cost of removal
cis M. Cronon, 33 BTA 668). of the old building is not deductible. The
ii. The cost of the unsold tickets of a sweep- value of the real estate, exclusive of old
stakes agent constitutes his investment in improvements, being presumably equal to
a wagering transaction. Losses he may in- the purchase price of the land and build-
cur therefrom can be allowed as deduction ing plus the cost of removing the useless
only up to the extent of the gains realized. building.
But, R.A. No. 1169 exempts sweepstakes ii.) However, if the removal of the building
winnings from taxation, it follows that no was required by the authorities because
losses incurred therefrom can be allowed the building was a fire hazard, the value of
as deductions from gross income (BIR the building and the cost of its removal will
Ruling No. 62-006, 26 January 1962). be deductible as losses (Com. v. Prescilla
Losses from an illegal transaction are Estate, Inc., et al., 11 SCRA 130 ).
not deductible and they cannot be off-
I
I
CHAPTER 6
119
I
c.) Loss of useful value of capital asset due to Foreign Corporations - Losses actually sus-
changes in business condition. tained:
i.) When taxpayer discontinues the business a.) In business or trade conducted in the Philip-
or discards such assets permanently from
use in such business, he may claim as
I pines;
b.) In transaction entered into for profit in the Phil-
deduction the actual loss sustained. In de- ippines;
termining the amount of loss, adjustment
must be made, however, for improve- c.) Not compensated for by insurance or other-
ments, depreciation and salvage value of wise.
the property. This is an exception to the Requisites for deductibility (In general):
rule requiring a sale or other disposition of
a.) The loss claimed as deduction must be that of
property in order to establish a loss (Sec-
a taxpayer.
tion 98, Rev. Reg. No. 2).
i. The taxpayer must prove that the loss was
ii.) Proof required to establish loss of useful suffered by said taxpayer.
value (Unforeseen causes):
Where a taxpayer operates two
Increase in the cost or change in the phases of industry, one exempt from
manufacture of any product; income tax pursuant to RA. No. 901
New legislation directly makes the and the other taxable, losses sus-
continued profitable use of the prop- tained in the tax-exempt operation
erty impossible. cannot be deducted from income of
the taxable industry (Marcelo Steel
iii.) Non-deductible loss due to loss of useful Corp. v. Collector, G.R. No. L-12401,
value: 31 October 1960).
Useful life of property terminates If the taxpayer is engaged in several
solely as a result of those gradual businesses such that its gross income
processes for which depreciation is arises from operations of two or more
authorized; businesses, loss sustained in one
Inventories (Section 98, Rev. Reg. line of business cannot be claimed
No. 2). as a deduction or be offset from the
income of its other line of businesses
Domestic Corporations - All losses actually (BIR Ruling No. 123-87, 4 May 1987).
sustained and charged off within the taxable year
and not compensated for by insurance. If a taxpayer derived income from
manufacturing and at the same time
I CHAPTER 6 121
I ALLOWABLE DEDUCTIONS FROM GROSS INCOME
was engaged in the business of If the receipt of the recoup men! fixed the
farming, but its farming expenses
exceeded its farming income, the amount of the net loss (Section 96, Rev.
taxpayer cannot offset its net loss r Reg. No. 2).
from farming against its manufactur-
ing income (BIR Ruling No. 31-84, 9
I There should be an identifiable cause
February 1994). I ii.

which fixed the loss.
Loss from sale. Consumption of the sale is
b.) The loss must have been sustained during the the identifiable event which fixes the loss.
taxable year.
iii. Building, worth P500,000.00, insured for
A taxpayer is not allowed to defer the
P500,000.00; burned in the year 2000. The
deduction to some other time other than the
insurer refused to acknowledge its'liability;
year in which the loss was actually sustained
action was brought in court by the insured.
(Com. v. Asturias Sugar Central, Inc., G.R. No.
In the year 2001, the parties agreed to com-
L-15013, 31August1961)
promise the case - P400,000.00. Loss
War losses due to enemy attacks and sus- deductible (P500,000.00 - 400,000.00)
tained subsequent to 6 December 1941, = P100,000.00 in the year 2001 when
but not later than 1 July 1942 - deduct- the insurance recovery is definitely es-
ible in the year when the taxpayer was tablished and not 2000. Closed and com-
advised by the War Damage Commission pleted transaction - final settlement and
(Philippine Sugar Estate Development determination of the insurance recovery,
Company v. Posadas, 68 Phil. 216). event which took place in 2001 (1955 PH
c.) Loss evidenced by a closed and completed Fed. Tax Course, par. 2207).
transaction. d.) Loss not compensated by insurance or other-
i. The phrase "closed and completed trans- wise.
action" means that the loss is fixed by an i. Not indemnified by insurance or other
identifiable event occurring in the taxable forms of indemnification.
year in which, under the surrounding
facts and circumstances, the basis of an ii. Insurance or otherwise. Otherwise means
immediate recoupment is not present in other ways - refers to compensation
(Louisville Trust Co. v. Glenn, 25 AFTR due under a title analogous or similar to
464 ). Consequently, where the fact would insurance (ejusdem generis; noscitur a
indicate substantial basis for recoupment sociis) inasmuch as the latter is a contract
and reasonably recognized as such, the establishing a legal obligation, namely:
matter is not a closed transaction until law, contract, quasi-contract, torts or
crime.
Included - insurance created by c.) Proof of the elements of the loss claimed, such
operation of law such as the War Damage as the actual nature and occurrence of the
Corporation Act of the United States event and the amount of the loss.
(Com. v.Asturias Sugar Central, Inc., G.R.
No. L-15013, 31August1961). i.) Casualty loss - documentary proof of
costs, photograph showing extent of dam-
Excluded (Income Tax Law) - age, condition or value of the property
hope, or even moral certainty, proposed after it was repaired, restored or replaced.
legislation - authorizing payment of an
indemnity, not due either the general ii.) Robbery, theft or embezzlement losses -
principles of law, or under any particular amount of loss. Police report is necessary
statute - would eventually be approved although not conclusive proof of the loss
(Cu Unjieng Sons, Inc. v. BTA, G.R. No. arising therefrom.
L-6296, 29 September 1956). (5.) NON-DEDUCTIBLE LOSSES
(4.) CASUALTY LOSSES (fire, storms, robbery, theft (1.) Losses in dealings between related taxpayers
or embezzlement) (except in case of distribution in liquidation)
Requisites for deductibility (Rev. Reg. No.12-77) a.) Members of a family. Family means tax-
payer's brothers and sisters (whether by
a.) Sworn declaration of loss must be filed with
whole or by half blood), spouse, ancestors
the BIR.
and lineal descendants.
i.) Nature of the event giving rise to loss and
time of its occurrence; i. Loss on a bonafide sale to a son-in-
law of the taxpayer's brother - de-
ii.) Description of the damaged property and ductible.
its location;
ii. Prohibition applies to indirect sale or
iii.) Items needed to compute the loss such exchange. Consequently, if the tax-
as cost or other basis of the property, payer seeks to deduct a net operating
depreciation allowed if any, value of the loss, the prohibition does not apply
property before and after the event, cost (AnyderSons Co. v. Comm., G.AFTR
of repair; 2d. 875).
iv.) Amount of insurance or other compensa-
b.) Between an individual and corporation.
tion received or receivable.
More than 50% of the outstanding stock
b.) Filed through the nearest RDO within 45 days of the corporation is owned directly or
after the date of the occurrence. indirectly by the individual.
CHAPTER6 125
applies to acquisition through a taxable

c.) Between two corporations:
exchange and the making of an option
i. One or both of the corporations is a contract;
personal holding company preceding
e.) The seller is not dealer in securities.
the date of the sale or exchange;
Reasons for non-deductibility of loss from
ii. More than 50% in value of the stock
wash sale:
of each corporation is owned directly
or indirectly by the same indvidual; i. Prevent deduction of losses on
sales of stock or securities that were
iii. However, the limitation does not ap-
replaced by substantially identical
ply where the individual owning more
stocks or securities.
than 50% of the stock of the purchas-
ing corporation owned less than 50% ii. Loss is added to the cost of the sub-
of the stock of the selling corporation sequently acquired securities/stock.
(Shelder Land Co., 42 BTA 498). Hence, a mere artificial loss.
d.) Between parties to a trust: (3.) Loss due to removal of building if purchased
(not existing and not incident to renewal)
i. Grantor and fiduciary (trustee);
Net operating loss carry over (NOLCO)
ii. Fiduciary of a trust and fiduciary of
another trust - the same grantor; i. Applies to individual and corporate.
iii. Fiduciary and beneficiary. ii. Can be carried over in the next three
consecutive taxable years.
(2.) Losses on wash sale (61-day sale)
iii. Taxpayer is not exempt from income
Points to be considered: tax.
a.) Taxpayer must have bought or sold stocks iv. No substantial change in the owner-
or securities; ship of the business or enterprise in
b.) Substantially identical stock or securities that not less than 75% in nominal val-
are acquired within a period beginning 30 ue of the outstanding issued shares
days before the date of sale and ending or paid up capital of the corporation
30 days after such date; is held by or on behalf of the same
person.
c.) There must have been sale or disposition
of stocks or securities; v. Mines other than oil and gas wells
may carry over net operating losses
d.) Not limited to situations where the replace-
as deduction in the next five years.
ment is acquired by purchase. It also
I
CHAPTER 6 127
G. BAD DEBTS
L) Worthlessness is not determined by an
(1.) DEFINITION inflexible formula but upon the exercise
Debts due to the taxpayer which are actually of sound business judgment Mere uncer-
ascertained to be worthless and charged off within tainty of collection or investigation that the
the taxable year. debtor is in an unsatisfactory financial con-
dition and that the collection of the debt is
(2.) REQUISITES FOR DEDUCTIBILITY:
doubtful will not suffice. All pertinent facts
a.) Existence of a valid debt and subsisting debt and evidence must be considered. The
(legal and factual). burden of proof to show worthlessness is
L) A debt is valid if there exists the relation- on the taxpayer.
ship of a debtor and creditor. It is not Illustration: If the creditor could show
necessary that the debt shall be due in the that during the years he at-
sense that it is then collectible. It must be tempted to collect the debt,
an outstanding obligation, which if not due the debtor had property the
at the time, will certainly become due at title of which was in dispute
some future date (Budsboro Steel Foundry but which would enable him
& Machine Co. v. U.S., 12AFTR 1948). to pay his debts when the
iL) Where the debt, however, is subject to title was cleared, the credi-
a contingency and such contingency did tor would be entitled to defer
not occur, there is no valid subsisting debt the deduction on the ground
(Evans Clark, 18TC 780). that there was no genuine
ascertainment of worthless-
iii.) Repayment of the debt is essential for the
ness.
existence of the debt Understanding that
the payment of the alleged debt would iL) Factors affecting the worthlessness of a
never be demanded - there is no debt debt (2004 Bar):
within the contemplation of the law. ii.a. Bankruptcy or insolvency of the
Exception: Even ifthe debt be uncollect- debtor;
ible from its inception, it is the right of the iLb. Insufficiency of the collateral;
endorser or guarantor to deduct payment
iLc Statute of limitation;
which he is required to make upon default
of the primary debtor. ii.d. Death of the debtor leaving no as-
sets;
b.) Debts must be actually ascertained to be worth-
less. ii.e. Injury of the debtor making it impos-
sible for him to earn a living (Section
102, Rev. Reg. No. 2; 1955 CCH Non-resident Foreign Corporation

Fed. Tax Course, par. 502); - not entitled.
ii.f. Meager amount involved; d.) Debt arises from business or trade.
ii.g. Improbability of success of judicial e.) Does not arise from transactions between
collection; related taxpayers.
ii.h. Destruction by fire of original in- f.) Additionally, before a debt can be ascer-
voices evidencing the indebtedness tained to be worthless, the taxpayer must
(Goodwill International Rubber Co. also show that it is indeed uncollectible in
v. Collector, CTA Case No. 468, 8 the future.
June 1963).
Furthermore, there are steps outlined
c.) Debt must be charged off within the year of to be undertaken by the taxpayer to prove
worthlessness. that he exerted efforts to collect the debts
A taxpayer may not defer deduction to viz: (1) sending of statements of accounts'
a later year of a bad debt. If the charge off (2) sending of collection letters; (3) giving'
is made in a later year, the deduction will be the account to a lawyer for collection; and
disallowed (Collector v. Goodrich International (4) filing a collection case in court (PRC v.
Rubber Co., 21 SCRA 1336, 1314). Commissioner, 256 SCRA 667).
Loss from theft or embezzlement In the case of banks, they shall submit
i. Deductible in the year in which it was a Bangko Sentraf ng Pifipinas/Monetary
sustained. Board written approval of the writing off of
the indebtedness from the bank's books
ii. No means of determining the actual date
of embezzlement - year of discovery of accounts at the end of the taxable year
(Rev. Reg. No. 25-2002).
(Boston Consolidated Gas Co. v. Comm.,
126F [2d] 437). As regards insurance or surety company,
iii. Modified by the application of the bad writing off of a receivable from the books
debt theory which holds that since the and claimed as bad debts deduction
embezzlement of funds creates a debtor- requires declaration of closure due to
creditor relationship the loss is deductible insolvency or for any such similar reason
as BAD DEBT in the year when the right by the Insurance Commissioner. (Ibid).
of recovery become worthless. (3.) MEASURE OF BAD DEBTS DEDUCTIBLE
Deductible bad debts of Domestic and a.) Generally the entire amount of the bad debt.
Resident Foreign Corporations - only
business debts. b.) Not necessarily so in the following instances:
i. Unpaid wages paid in promissory note - of PS0,000.00 or the amount absolved if

amount deductible is the value of the note the debtor is insolvent.
and not the amount of the unpaid salary
viii. Unpaid wages, salaries, rents and other
or wages;
similar income, deductible in full provided
ii. Distribution of the decedent's assets - the same is returned as income.
only the difference between creditor's
claim and property received from the H. DEPRECIATION
estate; (1.) DEFINITION (1996 Bar)
iii. Account receivable becoming worthless Gradual diminution in the useful (service) value
in the hands of the purchaser - only the of tangible property used in trade, profession or
amount which represents the purchase business resulting from exhaustion, wear and tear,
price and not the face value of the note. and obsolescence. It applies also to the amortiza-
iv. Foreclosure of mortgages: tion of the value of intangible assets, the use of
which in trade or business is definitely limited in
iv.a. Only the difference between the
duration (Basilan Estates, Inc. v. Com., 21 SCRA
debt and the proceeds of the sale is
17, 5September1967).
generally deductible as bad debts;
Necessity of depreciation allowance --
iv.b. If no foreclosure occurs and the certain property used in the business gradually ap-
debtor surrenders the property to proaches a point where its usefulness is exhausted.
the creditor - difference between By using the property, a gradual sale is made of it,
the basis of the debt and FMV of the and the depreciation change is the measure of the
property is deductible (Section 103, cost which has been sold (Ibid.).
Rev. Reg. No. 2).
(2.) REQUISITES FOR DEDUCTIBILITY:
v. If creditor buys the mortgaged property
and credits the debt with the purchase a.) The allowance for depreciation must be rea-
price even if such price is Jess than the sonable (Bacolod-Murcia Milling Co., Inc. v.
indebtedness - no deductible bad debt, Com., CTACase No. 1402, 31October1969).
the security taking the place of the debt. Depreciation is a question of fact and is not
measured by theoretical yardstick. Reasona-
vii. Debt partially secured by a mortgage is
bleness of a claim depends upon the conditions
deductible only to the extent not covered
known to exist at the end of the period for which
by mortgage.
the return is made (Section 109, Rev. Reg. No.
vii. A debt, say for P100,000, compromised 2). It must be in accordance with a reasonable
for PS0,000.00 is deductible to the extent consistent plan.
CHAPTER 6 133
The Tax Code, provides for the use of the
following methods of depreciation, viz: e.) Building and furnitures for personal use;
i. Straight line method; f.) Intangibles - use is unlimited

'
ii. Declining balance method; g.) Personal effects and clothing.
iii. Sum of the years digit method; Property kept in repair - subject to de-
preciation
iv. Any other method which may be pre-
scribed by the Secretary of Finance upon Properties and costumes used exclusively in busi-
recommendation of the BIR Commission- ness such as theatrical business, may be subject to
er. The BIR and the taxpayer may agree deprec1at1on (Section 106, Rev. Reg. No. 2).
in writing on the useful life of the property Rules on the depreciation of properties used in
to be depreciated. The agreed rate may petroleum operation:
be modified if justified by facts or circum-
( 1.) Depreciation is allowed - straight line or declining
stances. The change shall not be effective
balance method at the option of the service contrac-
before the taxable year on which notice in tor;
writing by registered mail or certified mail
is sent by the party initiating. (2.) Shift from declining to straight line is allowed;
b.) It must be for property used in trade or business (3.) Useful life of properties used - ten (10) years or
or profession (depreciable assets). such shorter life as may be permitted by the BIR;
Depreciable assets: (4.) Properties not used indirectly in petroleum operation

5 years.
a.) Tangible property used in trade or business -
allowance; Depreciation deduction is not allowed:
b.) Intangible property like patent, copyrights and ( 1.) Property amortized to its scrap value and no longer
franchises (Section 107, Rev. Reg. No. 2)- in use (Section 108, Rev. Reg. No. 2);
amortization. (2.) Beyond the capital investment in the assets being
depreciated (Gutierrez v. Com., L-19587, 20 May
Non-depreciable assets:
1965), otherwise some profit will be made. These
a.) Inventories or stock; deductions are privileges not matter of right.
b.) Land and improvements; In the case of NRA and RFC - only properties
c.) Bodies of minerals subject to depletion; located in the Philippines.
d.) Automobiles or transportation equipment for In the case of property held by one person for life
personal use (residence); with remainder to another person (usufruct or feidi-
commissarv substitution) - life tenant mav c.IFiim
CHAPTER 6 135
(2.) Charged off within the taxable year.

the deduction as if he were the absolute owner of
the property. (3.) Allowance for depletion is computed in accordance
with the cost depletion method.
Property held in trust - apportion between or
among the beneficiaries and trustees in accordance Essential Factors:
with the trust instrument.
a.) Basis of the property;
I. DEPLETION b.) Estimated total recoverable units in the prop-
erty;
(1.) DEFINITION
c.) Number of units recovered during the taxable
It is the exhaustion of natural resources like
year.
mines and oil and gas wells as a result of a produc-
tion or severance from such mines or wells (1965 (4.) Depletion deductible:
CCH Fed. Tax Course, par. 1201 ). a.) Domestic Corp. - oil, gas wells or mines lo-
(2.) THEORY AND PURPOSE OF DEPLETION AL- cated within and without;
LOWANCE - as the product of the mine is sold, a b.) Resident Corp. - gas wells and mines located
gradual sale is being made of the taxpayer's capital in the Philippines.
interest in the property. The purpose is, then, to
enable him to recover that capital interest free of (5.) May the taxpayer deduct exploration and devel-
income tax at its cost or on some other basis. opment expenditures paid or incurred during the
taxable year?
(3.) WHO ARE ENTITLED - only persons having an
economic interest in a mineral land or oil or gas YES. At taxpayer's option, he may deduct explora-
wells. To acquire an economic interest, the taxpayer tion and development expenditures (mines) pro-
must have a capital investment in the property and vided that it shall not exceed 25% of the taxable
not mere economic disadvantage. The taxpayer income from mining operations computed without
must have acquired at least, by investment, any in- the benefit of any tax incentives under existing
terest in oil or gas, or mineral in place, and services, laws.
by any form of legal relationship, income derived NO. With respect to improvements of property
from the extraction of the oil, gas or mineral to which subject to allowance for depreciation (expenditure)
he must look for a return of his capital (Gen. Cir. and those paid or incurred for the exploration and
No. V-332, 6 January 1961 ). development of oil and gas
Requisites for deductibility Depreciation v. Depletion
(1.) Depletible asset- natural resources - mines, gas Depreciable assets Natural resources
and oil wells.
CHAPTERS 137
J. CHARITABLE AND OTHER CONTRIBUTIONS his right to prove his contribution in accordance
with the rules of evidence (Ramirez v. Com.,
(1.) KINDS: CTA Case No. 544, 14 September 1959).
(a.) Ordinary- subject to limitation; b.) Must be given to the organization specified by
(b.) Special - deductible in full. Tax Code or special law.
c.) The net income of the institution must not inure
(2.) ENTITLED: to the benefit of any member or individual.
a.) Corporate taxpayer except NRFC - 5% of the
Net Income before Charitable Contribution; (4.) CONTRIBUTIONS DEDUCTIBLE IN FULL
b.) Individual taxpayer except NRA-NETB - 10% a.) Donations to the government or political sub-
of the Net Income before Charitable Contribu- division including fully-owned government cor-
tion. poration to be used exclusively in undertaking
priority activities in:
(3.) REQUISITES FOR DEDUCTIBILITY
i. education;
a.) Contribution or gift must be actually paid during
ii. health;
the taxable year.
Requirements/conditions (to be stated in the iii. youth and sports development;
return): iv. human settlement;
i. Name and address of organization; v. science and culture;
ii. Approximate date and amount of the gift; vi. economic development.
iii. If not in money, FMV of the gift; b.) Donations to international organizations or
foreign institutions in compliance with agree-
iv. Signed by the responsible officer of the
ments or treaties.
corporation.
c.) Donations to accredited non-government or-
Question - May the deduction of contribution ganizations (NGO).
be allowed even in the absence of supporting
receipts? i. Exclusively for:
a. scientific;
Answer - YES. Attachment of receipts for
contribution to the return is merely an admin- b. research;.
istrative device for the convenience and facility c. character building;
of the BIR in verifying the income tax return and
the requirement cannot deprive the taxpayer of d. youth and sports development;
1 Jti BASIC APPROACH TO INCOME TAXATION CHAPTER6 139
e. health; vi. rehabilitation of veteran;

f. social welfare; vii. social welfare.
g. cultural; (6.) DEDUCTIBLE UNDER SPECIAL LAWS (IN FULL)

h. charitable; a.) IBP (P.O. 1810)
i. any combination thereof. b.) Development Academy of the Philippines (P.O.
ii. Utilized not later than 15th day of the 3rd 205)
month following the close of its taxable c.) Agricultural Department of Southeast Asian
year. Fisheries Development Center (P.O. 292)
iii. Administrative expense must not exceed d.) National Social Action Council (P.O. 294)
30% of total expenses.
e.) Task Force on Human Settlement
iv. Upon dissolution, assets must be dis- f.) National Museum, Library & Archives (P.O.
tributed to another non-profit domestic 373)
corporation or to the state.
g.) Ministry of Youth & Sports Development (P.O.
(5.) CONTRIBUTION SUBJECT TO LIMITATION (5% 604)
or 10% of Net Income before Charitable Contri- h.) Social Welfare, Cultural & Charitable Institution
bution) (P.O. 507)
a.) Not in accordance with priority plan.
i.) Museum of Philippine Costumes (P.O. 1388)
b.) Conditions are not complied with.
j.) lntramuros Administration (P.O. 1616)
c.) Donation to the government of the Philippines
k.) Lungsod ng Kabataan (P.O. 1631)
or political subdivision exclusive for public
purposes. Contributions to International Lions Club
not Deductible (BIR Ruling, 16 July 1955).
d.) Donations to domestic corporations organized
exclusively for: K. RESEARCH AND DEVELOPMENT EXPENDITURE
i. religious;
(1.) IN GENERAL - A taxpayer may treat research
ii. charitable; or development expenditures which are paid or in-
curred by him during the taxable year in connection
iii. scientific;
with his trade, business or profession as ordinary
iv. cultural; and necessary expenses which are not chargeable
v. educational; to capital account. The expenditures so treated shall
be allowed as deduction during the taxable year (3.) There is no need of special permit from the BIR to
when paid or incurred. put up a pension plan for the benefit of employees.
However, the provision of Section 118 of Rev. Reg.
(2.) LIMITATIONS ON DEDUCTION-The following No. 2 must be complied with (BIR Ruling, 26 July
expenditures are not deductible: 1956).
a.) Any expenditure for the acquisition or improve- (4.) TREATMENT OF INCOME FROM PENSION PLAN
ment of land, or for the improvement of property
a.) Not taxable to the employee (BIR Ruling, 20
to be used in connection with research and
November 1956).
development of a character which is subject
to depreciation; and b.) In case any portion of the funds is reverted
back to the employer, said fund forms part of
b.) Any expenditure paid or incurred for the pur-
the income of the employer during the taxable
pose of ascertaining the existence, location,
year of reversion (BIR Ruling, 3 April 1959).
extent, or quality of any deposit of ore or other
mineral, including oil or gas. (5.) DEDUCTIBLE PAYMENTS TO PENSION TRUSTS
a.) Employer's current liability- amount contrib-
L. EMPLOYER'S CONTRIBUTION TO PENSION TRUST uted during the taxable year - ordinary and
(1.) NATURE - applicable only to the employer on necessary expenses.
account of its contribution to a private pension plan b.) Employer's liability for past services - one-
for the benefit of its employee. Purely business in tenth (1/10) of the reasonable amount paid
character. b~ the employer to cover pension liability ap-
plicable to the preceding 1Oyears - payment
(2.) REQUISITES FOR DEDUCTIBILITY: to pension trust.
a.) Employer must have established a pension or
OPTIONAL STANDARD DEDUCTION (OSD)
retirement plan for the payment of reasonable
as amended by R.A. No. 9504
pension to its employees;
a.) Individual Taxpayers Entitled: Resident
b.) Pension plan is reasonable and actuarially
Citizen (RC), Non-resident Citizen (NRC),
sound (Section 118, Rev. Reg. No. 2);
Resident Alien (RA).
c.) Funded by the employer (employer contributes
b.) Individual Taxpayers Not Entitled: Non-
cash);
Resident alien whether engaged in trade
d.) Amount contributed must no longer be subject or business (NRA-ETB & NRA-NETB).
to control of the employer;
c.) Corporate Taxpayers Entitled: Domestic
e.) Payment has not yet been allowed as deduc- Corporation (DC) and Resident Foreign
tion. Corporation (RFC).
d.) Limitation: 40% of: a.) Portion of the premium deposits returned to
d. 1) Gross income - DC and RFC the policy holders;
d.2) Gross sales or receipts-RC, NRC, b.) Portion of the premium deposits retained for
RA . payment of losses, expenses and reinsurance
reserve.
e.) Option/Election. Taxpayer entitled must
signify his intention in his income tax (4.) Assessment insurance (domestic or foreign).
return which shall be irrevocable for the a.) Amount actually deposited with officers of the
taxable year for which the return is made. government of the Philippines pursuant to law
(2009 Bar)
as addition to guarantee or reserve funds.
SPECIAL DEDUCTIONS ALLOWED TO
ITEMS NOT DEDUCTIBLE
INSURANCE COMPANIES
(1.) Items not deductible:
(1.) Non-life insurance (domestic or foreign doing busi-
ness in the Philippine). a.) Personal, living or family expenses.
a.) Net additions, if any, required by law to be Reason: Non-business expenses.

made within the year to reserve funds;
b.) Amounts paid out for new buildings or for per-
b.) Sums other than dividends paid within the year manent improvements, or betterment made to
on policy and annuity contracts provided that increase the value of any property or estate.
the released reserve be treated as income for
the year released. Exception: Intangible drilling and development
cost incurred in petroleum operations.
(2.) Mutual marine insurance companies (Gross income
from gross premiums less reinsurance): Reason: Capital expenditure - that results in
obtaining benefits of a permanent nature such
a.) Amounts repaid to policy holders on account
as land, buildings, and machinery (Encyclope-
of premiums previously paid by them;
dia Dictionary of Business, p. 127).
b.) Interest paid upon those amounts between
Examples of Capital Expenditures (Rev. Reg.
the date of ascertainment and the date of its
payment No. 2):
i. Cost of defending or perfecting title to
(3.) Mutual insurance (other than mutual marine and
property;
mutual life) - mutual fire and mutual employer's
liability and mutual workmen's compensation and ii. Architects fee - part of the cost of build-
mutual casualty insurance companies: ing;
CHAPTER 6 145
iii. Commissions paid in selling securities - Reason/Purpose:

part of the cost;
i. Members of the same Family - to pre-
iv. Expenses of the administrator of the estate
vent avoidance of income tax by means of
-Attorney's fee and Executor's commis-
purported or simulated sale or exchange.
sion - charge to the corpus of the estate;
ii. Others -the law presumes that the trans-
v. Corporate expenses for reorganization
actions are devoid of free bargain between
such as incorporation fees, attorney's fee
the seller and the buyer. It is immaterial
and accountant charge - amortize.
whether the sale or exchange is bona fide
c.) Amount expended in restoring property or in or not (Lake Irrigation Co., Inc. v. Com.,
making good the exhaustion thereof for which 128F [2], 418).
an allowance has been made.
Reason: Capital Expenditure

d.) Premiums paid on a life insurance policy cov-
ering the life of any officer or employee, or of
any person financially interested in any trade or
business carried on by the taxpayer, individual
or corporate, when the taxpayer is directly or
indirectly a beneficiary under such policy.
i. Premiums paid by a family corporation
on the life insurance policy covering the
life of its president where the wife is the
beneficiary - Not deductible, corpora-
tion being indirectly beneficiary under the
policy (BIR Ruling, 10 November 1960).
ii. Premiums paid by a corporation on life
insurance policies covering the lives of two
executives naming each other beneficiary
- deductible because the corporation is
not directly and indirectly the beneficiary
of the policies (BIR Ruling, 27May1953).
e.) Losses from sales or exchanges of property
between related taxpayers.
CHAPTER 7 147
ESTATES AND TRUSTS
after tax, is no longer taxable on the part

of its recipient (BIR Ruling No. 233-86, 7
November 1986).
Chapter 7
B. TRUST- right to the property, whether real or personal,
ESTATES AND TRUSTS held by one person for the benefit of another
(1.) Taxable trusts:
A. ESTATE - refers to the mass of properties left by a a.) Trust, the income of which is to be accumu-
deceased person. lated;
(1.) Taxable estate entity- estate under administration b.) Trust, in which the fiduciary may, at his discre-
or judicial settlement. tion, either distribute or accumulate the income.
(2.) Hence, if not under judicial testamentary or intestate (2.) Rules on taxability:
proceedings, it is not taxable entity. The income a.) Taxable to the beneficiary- income of the trust
thereof is taxable directly to the heir or beneficiary. for the taxable year which is to be distributed
(3.) Subject to income tax in the same manner as indi- to the beneficiaries;
viduals. Its own status is dependent on the status b.) Taxable to trustee or fiduciary- income of the
of the decedent immediately prior to his death. trust which is to be accumulated or held for fu-
a.) Personal exemption - P20,000.00 ture distribution, whether consisting of ordinary
income or gain from sale of assets included in
i. If the taxpayer should die during the tax-
the "corpus" of the estate (revocable trust).
able year, his estate may still claim the
personal and additional exemptions for Exceptions:
himself.
i. Revocable trust - taxable to granter or
ii. Distribution to the heirs during the taxable trustee;
year is deductible from estate income
ii. Income is held for the benefit of the granter
which distributed share would then form
- taxable to the granter.
part of the recipient heirs' respective
income. Where no such distribution to "The income of the trust shall be included in comput-
the heirs is made during the taxable year ing the taxable income of the granter where the power
that the income is earned, which is then to revest title to any part of the corpus of the trust is
subject to income tax payment by the es- vested:
tate, the subsequent distribution thereof (1.) In the granter, either alone or in conjunction with
146
any person not having a substantial adverse inter-
est in the disposition of the corpus or the income

therefrom; or
(2.) In any person not having a substantial adverse in- Chapter 8
terest in the disposition of the corpus or the income
therefrom." SPECIAL TOPICS IN INCOME TAXATION
C. COMPUTATION OF TAX ON ESTATE AND TRUST

A. DETERMINATION OF SOURCE ACCORDING TO
( 1.) Allowable deductions same as individual. KIND OF INCOME
(2.) Special deductions.
Kinds of Income Source (Tax Situs)
a.) Personal exemption - P20,000.00.
1.) Service or compensa- Place of performance of
b.) Amount of income which is to be distributed tion income service
currently to the beneficiaries.
2.) Rent Location of property (real
c.) Amount of income collected by a guardian of or personal)
an infant which is to be held or distributed as 3.) Royalties (copyright, Place of use of intangibles
the court may direct. However, the amount patent, design trade-
so allowed as deduction shall be included in mark, etc.)
computing the net income of the heir, legatee Place of sale
4.) Merchandising
or beneficiary.
Trust administered in foreign country-deduc- 5.) Gain on sale of per- Place of sale
tions in (a) (b) and (c) are not allowed. sonal property
6.) Gain on sale of real Location of property
Formula:
property
Consolidated gross income Pxxxx
7.) Mining income Location of the mines
Less: Consolidated deduction xxxx
8.) Farming income Place of farming activities
Consolidated net income Pxxxx
9.) Gain on sale of domes- Income within the Philip-
Less: Personal exemption P20,000 xx xx tic stock pines
Taxable income of several trusts Pxxxx 10.) Interest Residence of the debtor
Apply 5-32% (year 2000)
Tax due Pxxxx
149
CHAPTERS 151
SPECIAL TOPICS IN INCOME TAXATION
Tax situs of three possible sources of income interest paid even in Tokyo by NOC to the ship builders
Income from labor (services)-the place where the is considered as income from the Philippines (NOC v.
labor is done; Com., 151 SCRA 472).
Income from capital - the place where the capital (11.) Gain on sale of transport document - Place of
is employed; activity that produces income
Income from the sale of capital assets - the place The source of an income is the property, activity
where the sale is made. or service that produced the income. For the income
to be considered as coming from the Philippines, it
[8 Mertens, Law of Federal Income Taxation, Sec-
is sufficient that the income is derived from activity
tion 45.27 (1957)]
within the Philippines. In Commissioner v. BOAC,
Settled Case on the Tax Situs of Interest Income 149 SCRA395, the sale of tickets in the Philippines
(1989 Bar) is the activity that produced the income. The tickets
exchanged hands here and payments for fares
FACTS: National Development Corporation (NOC) were also made here in the Philippine currency. The
entered into contracts in Tokyo with Japanese building flow of wealth proceeded from and, occurred within
companies for the construction of 12 ocean-going ves- Philippine territory, enjoying the protection accorded
sels. Initial payments were in cash and irrevocable letters by the Philippine government. In consideration of
of credit. The balance was secured by promissory notes such protection, the flow of wealth should share the
guaranteed by the Republic of the Philippines. The ves- burden of supporting the government.
sels were completed and delivered to the NOC in Tokyo.
The promissory notes and interest therein were paid by The absence of flight operations to and from
NOC. the Philippines is not determinative of the source of
income or the situs of income taxation. Admittedly,
ISSUE: Is interest on the promissory notes to be treated BOAC was an off-line international airline at the time
income from the Philippines considering that all the pertinent to this case. The test of taxability is the
elements of the main transaction, i.e., construction and "source" and the source of an income is that activity
delivery of vessels, were all performed in Japan? (sale of airline tickets) which produced the income.
HELD: The interest is considered income from the Phil- Unfortunately, the passage documents were sold
ippines. According to Section 36 [now Section 42A(1 )] in the Philippines and the revenue therefrom was
of the NIRC as amended, xxx interest on bonds or other derived from a business activity regularly pursued
interest bearing obligations of residents, corporate or within the Philippines xxx. The word "source" con-
otherwise, is considered income from the Philippines. veys one essential idea, that of origin, and the origin
The law does not speak of the activity which gave rise to of the income herein is the Philippines (Ibid.).
the obligation, but solely of the residence of the obligor. However, Rev. Reg. No. 15-2002, implement-
NOC is undoubtedly resident of the Philippines. Hence, ing Section 28A(3), provides that in computing for
CHAPTER 8 153
"Gross Philippine Billings," there shall be included

c.) Foreign corporation
the total amount of gross revenue derived from
passage of persons, excess baggage, cargo and/or If for the 3-year period preceding the declaration
mail, originating from the Philippines in a continuous of such dividend, the ratio of such corporation's
and uninterrupted flight, irrespective of the place Philippine income to the world (total) income was:
of sale or issue and the place of payment of the a) Less than 50% - Entirely without
passage documents. (2005 Bar)
b) 50% to 85% - Proportionate
(12.) Manufacturing
c) More than 85% - Entirely within (Phil.)
a.) Produced in whole within and sold within -
Income purely within FORMULA (PROPORTIONATE - 50% TO 85%)
Phil. Gross Income
b.) Produced in whole without and sold without
- Income purely without
x Dividend received Income =
Entire Gross Income within (Phil.)
c.) Produced within and sold without - Income
partly within and Income partly without B. CAPITAL TRANSACTIONS (2003, 1998 Bar)
d.) Produced without and sold within - Income (1.) Definition of capital asset. The NIRC (Section
partly within and Income partly without 39) defines capital assets by exclusion. There is no
From the income partly within and partly without, concrete definition. The term "capital asset" means
income purely within is derived as follows: property held by the taxpayer (whether or not con-
nected with his trade or business), but does not
Net Income x Value of property within include the following (these are ordinary assets).
= Pxxxx a.) Stock in trade of the taxpayer or other property
2 Value of property within of a kind which would properly be included
and without in the inventory if on hand at the close of the
taxable year (raw materials, work in process,
Add:
finished goods, supplies);
Net Income x Gross sales within
b.) Property held by the taxpayer primarily for sale
= Pxxxx
to customers in the ordinary course of trade
2 Gross sales within
or business.
and without
Requisites:
Income purely within =
i. Property must be held primarily for sale.
(13.) Dividend income from:
a.) Domestic corporation - Income within (Phil.) ii. Property must be held for sale to custom-
ers.
A sale by dealer in securities is an Account receivable;

ordinary transaction (BIR Ruling, 27
Securities held as investments;
February 1954).
Goodwill.
iii. Property must be sold in the ordinary
course of taxpayer's trade or business. Reason: Not included in the four catego-
ries of ordinary assets.
Trade of business - that which oc-
cupies the time, attention, and labor ii. Sale of a business to a corporation - Or-
of men for the purpose of livelihood or dinary and capital assets. Consider the
profit (Flint v. Storne Tracy Company, assets involved in the sale.
220 U.S. 107, 31 S. Ct. 342, 55 L. Ed.
iii. Sale of partner's interest in a partnership
389; Kackler v. Commissioner, 133F
- capital asset.
[2d] 509).
Reason:Not included in the category of
"Ordinary course" indicates signifi-
ordinary assets
cance of the transaction and, there-
fore, excluded are those sales which iv. Car used in trade or business and for
are effected by the taxpayer merely personal purpose -
incidentally or accidentally to his busi- One half of the value - ordinary as-
ness. Hence, isolated transactions set - used in business.
would not be in the ordinary course
of trade of business (Alfonso Zobel One half of the value - capital asset
vs. Com., CTACase No. 622, 29April - not used in business.
1961) (2) The statutory definition of capital assets is
c.) Property used in trade or business of a char- negative in nature. If the asset is not among the
acter which is subject to the allowance for exceptions, it is a capital asset; conversely, assets
depreciation. falling within the exceptions are ordinary assets.
And necessarily, any gain resulting from the sale or
i. Depreciable personal properties such as
furnitures, equipment, and machineries exchange of an asset is a capital gain or an ordinary
used in trade or business. gain depending on the kind of asset involved in the
transaction.
d.) Real properly used in trade or business of the
taxpayer. However, there is no rigid rule or fixed formula
by which it can be determined with finality whether
i. Properties used or connected with trade property sold by a taxpayer was held primarily for
or business which are considered capital sale to customers in the ordinary course of his trade
assets: or business or whether it was sold as a capital as-
set. Although several factors or indices have been d.) If conducted through a supervision over the
recognized as helpful guides in making a determina- agent;
tion none of these is decisive; neither is the pres-
' . e.) Extent and nature of the taxpayer's efforts to
ence nor the absence of these factors conclusive.
sell (Smith v. Dunn, 224 F. [2d] 353, 47 A.F.T.R
Each case must in the last analysis rest upon its
1419; Tuazon v. Lingad, 58 SCRA 170; Blake
own peculiar facts and circumstances. [Calasanz v. Ravanagh, 107 R. 179).
v. CIR, 144 SCRA 664, 669-670 (1986)]
Also a property initially classified as a capital (5.) Guidelines in determining whether a particular
asset may thereafter be treated as an ordinary asset real property is a capital asset or ordinary asset
(Rev. Reg. No. 7-2003).
if a combination of the factors indubitably tend to
show that the activity was in furtherance of or in the a.) Taxpayers engaged in the real estate busi-
course of the taxpayer's trade or business. Thus, a ness. - Real property shall be classified with
sale of inherited real property usually gives capital respect to taxpayers engaged in the real estate
gain or loss even though the property has to be business as follows:
subdivided or improved or both to make it salable.
i. Real Estate Dealer. -All real properties
However, if the inherited property is substantially acquired by the real estate dealer shall be
improved or very actively sold or both it may be considered as ordinary assets.
treated as held primarily for sale to customers in
the ordinary course of the heir's business. [34 Am ii. Real Estate Developer. -All real proper-
Jur 2d., p. 92] ties acquired by the real estate developer,
whether developed or undeveloped as of
(3.) Construction and interpretation of capital assets the time of acquisition, and all real prop-
- The general rule has been laid down that the erties which are held by the real estate
coda! definition of a capital asset must be narrowly developer primarily for sale or for lease
construed while the exclusions from such definitions to customers in the ordinary course of
must be interpreted broadly (Tuazon v. Lingad, 58 his trade or business or which would
SCRA 176). properly be included in the inventory of
(4.) Factors/tests determinative of capital or ordinary the taxpayer if on hand at the close of the
asset: taxable year and all real properties used in
the trade or business, whether in the form
a.) Nature and character of the taxpayer's title to
of land, building, or other improvements,
the property;
shall be considered as ordinary assets.
b.) Reason, purpose and interest of requisition,
iii. Real Estate Lessor. -All real properties
as well as its period of duration;
of the real estate lessor, whether land and/
c.) Taxpayer's vocation, extent of activities; or improvements, which are for lease/rent
or being offered for lease/rent, or other- nally registered to be engaged in the real estate
wise for use or being used in the trade or business, all real properties originally acquired
business shall likewise be considered as by it shall continue to be treated as ordinary
ordinary assets. assets.
iv. Taxpayers habitually engaged in the e.) Treatment of abandoned and idle real prop-
real estate business. -All real proper- erties. - Real properties formerly forming part
ties acquired in the course of trade or bu~i of the stock in trade of a taxpayer engaged in
ness by a taxpayer habitually engaged 1n
the real estate business, or formerly being used
the sale of real estate shall be considered
in the trade or business of a taxpayer engaged
as ordinary assets. or not engaged in the real estate business,
b.) Taxpayer not engaged in the real estatet which were later on abandoned and became
business. - In the case of a taxpayer no idle, shall continue to be treated as ordinary
engaged in the real estate .business, real assets.
properties, whether land, bu1ld1ng, .or other
improvements, which are used.or being used
f.) Treatment of real property subject of invol-
or have been previously used 1n the trade or untary transfer. - In the case of involuntary
business of the taxpayer shall be considered transfers of properties, including expropriation
as ordinary assets. or foreclosure sale, the involuntariness of such
sale shall have no effect on the classification
c.) Taxpayer changing business from re_af es- of such real property in the hands of the invol-
tate business to non-real estate business. untary seller, either as capital asset or ordinary
- In the case of a taxpayer who changed its asset, as the case may be.
real estate business to a non-real estate busi-
ness, or who amended its Articles of Incorpora- Rules on capital gains and losses. Two
tion from a real estate business to a non-real conditions must concur: a) There must be a
estate business, such as a holding company, sale or exchange, and b) what is sold or ex-
manufacturing company, trading company, change is a capital asset.
etc., the change of business or amendment
(6.) Special Rules on Capital Transactions
of the primary purpose of the business shall
not result in the re-classification of real INDIVIDUAL CORPORATE
property held by it from ordinary asset to
a.) HOLDING PERIOD I x
capital asset.
RULE
d.) Taxpayers originally regist~red to bf.e _e nd-
gaged in the real estate business but at1e b.) LOSS LIMITATION I except
to subsequently operate. - In the case. ~f RULE trust company
subsequent non-operation by taxpayers ong1- and bank
BASIC APPROACH TO INCOME TAXATION CHAPTER 8 161
160
c.) NET CAPITAL LOSS I x *** Net capital loss (carry over)-shall be treated in
CARRYOVER the succeeding taxable year as loss from the sale
or exchange of capital asset held for not more than
Percentage of gain or loss recognized 12 months.
100% if the asset was held for not more than 12 Limitation - not in excess of the taxable (net)
months income in the preceding year or the lower amount
50% if the asset was held for more than 12 months between the net income and the capital loss.
Holding period - the length of time the asset was The foregoing rules are not applicable to sale
held by the taxpayer. It covers the period from the of shares of stock & real property.
date of acquisition of the assets to the date of sale. (7.) Special capital transactions
In computing the period, the day on which the prop- a.) Short sale. A transaction in which a speculator
erty was acquired is excluded, the day on which sells securities which he does not own in an-
it was disposed of is included (1955 PH Fed. Tax ticipation of a decline in its price. It represents
Course, Par. 1604). a debt contracted in goods rather than cash.
Loss limitation rule - capital losses are allowed Should the price of the securities decline, the
**
only to the extent of capital gains. Therefore, capi- seller makes profit. If the price goes up, he
incurs the loss
tal losses are not deductible from ordinary gains.
Reason: To ensure the matching of costs against b.) Securities becoming worthless.
revenues consistent with the rule that only business
Requisites:
expenses are deductible from gross income. Capital
loss is not a business expense (2003 Bar). i. Ascertained to be worthless and charged
off within the taxable year;
Settled rules:
ii. Worthlessness occurred during the tax-
a.) Ordinary loss is deductible from ordinary gain;
able year;
b.) Capital loss is deductible from capital gain;
iii. Deductible on the last day of the taxable
c.) Capital loss is not deductible from ordinary year.
gain;
If the loss is due to fluctuation of price
d.) Ordinary loss is deductible from capital gain. in market, the loss is not deductible
Net capital gain - excess of capital gain over until finally disposed of.
capital loss. c.) Failure to exercise privileges or option to
Net capital loss - excess of capital loss over capital buy or sell property. A sale of the option itself
under allowable covenants would constitute
gain.
sale or exchange of a capital assets. In fine, Amount received from corp. p xxx
the law considers an option or privilege as the
capital asset itself and the failure to exercise Less: Cost of shares surrendered xxx
the same as transaction. If the option is not Capital gain or loss p xxx
exercised, it is deemed to have been sold or
exchanged as of the day the option expires. g.) An equity investment is a capital, not ordinary,
asset of the investor the sale or exchange of
d.) Retirement of bonds. Amounts received by
which results in either a capital gain or a capital
the holder upon retirement of bonds, deben- loss (China Banking Corporation v. CA, 236
tures, notes or certificates or other evidence SCRA 178, 181).
of indebtedness issued by any corporation
(including those issued by a government or (8.) Expenses of acquisition and disposition of
capital assets
political subdivision thereof) with interest cou-
pons or in registered form, shall be considered a.) Expenses of acquisition (purchase) should be
as amounts received in exchange therefrom. capitalized together with the cost of acquisition;
e.) Readjustment of interest in a tax-exempt part- b.) Expenses of disposition (sale) such as com-
nership (Section 142, Rev. Reg. No. 2). Where mission and other selling expenses should be
a partner retires from a tax-exempt partnership, considered as reduction from the selling price.
or the partnership is dissolved, the partner (9.) Exemption of capital gain from income tax -tax
realizes gain or suffers a loss determined as avoidance (both for individual and corporation)
follows:
a.) Under the Investment Incentives Act, the capi-
Price received for his interest tal gain realized from the sale of capital asset
in the partnership p xxx shall be exempt from income tax under the
following conditions:
Less: Cost of interest
partnership p xxx i. Investment in new issues of capital stock
of BO! registered enterprise within six
Add: Share in any undistributed months from the date the gains were real-
partnership net income since ized;
becoming partner xxx xxx
ii. Sale and investment of the proceeds
Capital gain or loss p xxx should be registered with the BOI and BIR.
iii. Investment must not be disposed of:
f.) Receipt of liquidating dividend. If the stock was
held as a capital asset, gain or loss is deter- 3 years - pioneer industry;
mined as follows: 5 years - non-pioneer industry.
CHAPTER 9 165
INCOME TAX RULES ON DEALINGS IN PROPERTY
Principal residence shall refer to the

dwelling house, including the land on
Chapter 9 which it is situated, where the husband
and wife or an unmarried individual
INCOME TAX RULES ON DEALINGS whether or not qualified as head of family:
IN PROPERTY and members of his family reside. Actual
occupancy of such principal residence
shall not be considered interrupted or
A. CAPITAL GAINS FROM SALE OR OTHER DISPOSI- abandoned by reason of the individual's
TION OF REAL PROPERTY temporary absence therefrom due to travel
or studies or work abroad or such other
TRANSACTION COVERED similar circumstances. Such principal
Sale, exchange or other disposition of real property residence must be characterized by per-
located in the Philippines classified as capital assets, manency in that it must be the dwelling
including pacto de retro sales and other forms of con- house to which, whenever absent, the said
ditional sales. individual intends to return (Rev. Reg. No.
13-99).
(1.) INDIVIDUAL TAXPAYERS (Section 24[0])
ii. BIR should be notified of the intention to
a.) Final tax rate: 6%
avail of the exemption within thirty (30)
b.) Basis: Gross Selling Price or zonal value (cur- days from the date of sale or disposition;
rent fair market value), whichever is higher.
iii. Acquisition or construction of new principal
c.) Taxpayer covered: Citizen or resident alien. residence must be made within eighteen
d.) Option: Apply the tax rates under Section 24(A) (18) months from the date of sale or dis-
- 5% to 32% if the buyer is the government or position;
any of its political subdivisions or agencies or iv. The tax exemption can only be availed of
government-owned or -controlled corporations. once every ten (10) years;
e.) Payment: Thirty (30) days after the sale. v. The buyer/transferee must withhold from
f.) Tax avoidance scheme: the seller and deduct from the selling price
the 6% capital gains tax which must be
i. The proceeds of the sale must be fully deposited in cash or manager's check with
utilized in acquiring or constructing a new an Authorized Agent Bank (AAB) under an
principal residence; ESCROW Agreement between the Rev-
enue District Officer, the seller, transferee
164
and theAAB.
Definition of ESCROW Agreement - refers to Answer:

a scroll, writing or deed, delivered by the grantor, It includes all income derived from the disposition
promisor or obligor into the hands of a third per- of property whether real or personal, or mixed, for
son, to be held by the latter until the happening of money (sale) or for other property (exchange) or for
a contingency or performance of a condition, and a combination of both, which results in gain (loss)
then by him delivered to the grantee, promisee or because of the difference between the taxpayer's
obligee (Rev. Reg. No. 17-2003). investment in what the disposed of and the value
vi. After depositing the 6% capital gains tax, the buyer/ in what he received (1955 PH Fed. Handbook, par.
transferee and the seller shall jointly file, within 30 1401 ),
days from the date of the sale or disposition of the
B. MEASURE OF INCOME OR LOSS
principal residence, the Final Capital Gains Tax
Return (Ibid). Selling Price p xxx
(2.) CORPORATE TAXPAYERS Less: Cost xxx
a.) Only domestic corporation is subject to 6% of Gain (loss) p xxx
the gross selling price or zonal value (fair mar-
ket value) whichever is higher (Section 27[D] Two conditions:
[5]),
(1.) The property received in exchange is essentially
b.) Real property: lands and/or buildings which are different from the property disposed of;
not actually used in the business.
(2.) The property received has a market value (Section
c.) Payment: thirty (30) days following the sale or 140, Rev. Reg. No. 2).
disposition.
C. ADJUSTED BASIS OR COST OF THE PROPERTY
GAINS AND LOSSES FROM DEALINGS SOLD. It depends primarily on the manner in which the
IN PROPERTY taxpayer acquired the property.
(1.) By purchase:
A. CONCEPT
a.) acquired beifore 1 March 1913- FMV on such
Include all gains or losses derived from the disposition date;
of property (real, personal or mixed) for MONEY in case
of SALE, or for PROPERTY in case of EXCHANGE, or b.) acquired on or after 1 March 1913 - Cost
from a combination of both sale and exchange. plus exp~nses of acquisition (Section 136,
Rev. Reg: No. 2).
Under the legal definition of gross income, what is
included in gross income derived from dealings in (2.) Included in the inventory - its latest inventory
property? value (Section 36, Rev. Reg. No. 2).
(3.) By devise, bequest or inheritance - FMV or value The same basis as it would be in the hands
of such property at the time of the acquisition - of transferor increased by the amount of the gain
death of the decedent (Section 139, Rev. Reg. recognized to the transferor on the transfer.
No. 2).
D. SETTLED RULES ON SALE OR EXCHANGE
(4.) By gift - the same basis as if it would be in the
hands of the donor or the last preceding owner by (1.) Distribution in complete liquidation has been held
whom it was acquired by gift, except that if such to be an "exchange" for the purpose of determining
basis is greater than the fair market value of the whether or not gain or loss has been realized or
property at the time of the gift, then for the purpose sustained within the provisions pertinent (Helvering
of determining the loss, the basis shall be such fair v. Chester N. Weaver Co., 305 U.S. 293).
market value. (2.) Conveyance of property in consideration of the
(5.) Acquired (other than capital assets) for less than transferee's assumption of accrued taxes for
an adequate consideration in money or money's which the transferor was personally liable, as a
worth - amount paid by the transferee. compromise of the tax liability on other realty, has
been construed to be a sale or exchange within the
(6.) Stock or security property received ifthe exchange
meaning of the law (Philipps v. Com., 112 F (2d]
is one where gain or loss may be recognized -
721; C.L. Gransder & Co. v. Com., 117 [2d] 80).
The same as the basis of the stock, or security
or property given in exchange. (3.) The words "sales or exchanges" have been inter-
preted quite liberally. Thus, forced sales such as
(7.) Stock or security received if the exchange is one
foreclosure sales and tax sale, have been held to be
where the gain, if any, but not the loss is to be
embraced within the meaning of the law (Helve ring
recognized -
v. Hommel, 311 U.S. 504).
Basis of the property, stock or security given in (4.) A sale or exchange will ordinarily be held to occur on
exchange- the date the transfer of title over the asset is effected
Less: Cash and FMV of property given in ex- or when ownership is terminated in the hands of the
change transferor. In other words, it is the consummation
thereof not the perfection of the contract that is
Add: Dividend and/or gain recognized generally taken into account (American Fork & Hoe
Basis of stock or security received Co., T.C. Memo Op. Dkt. 108334, 22 September
1943; U.S. Industrial Alcohol Co. v. Helvering, 137
(8.) Property transferred in the hands of the transferee F.[2d]511).
if exchange is one where the gain, if any, but not (5.) In condemnation proceedings, the sale occurs at the
the loss is to be recognized. time of taking of the property rather than when the
170 BASIC APPROACH TO INCOME TAXATION t.;HAt-'I t:K 8 111
proceeds of the judgment are received (Kiesel back acquisition by one corporation of all or
v. Com., 317 U.S. 399, 87 L. Ed. 358, 63 S. Ct. substantially all the properties of another
303). It is essential that the right of condemnation corporation solely for stock.
be legally recognized. (4.) Transfer or exchange of property for stock result-
ing in acquisition of corporate control (PROPERTY
E. TAX-EXEMPT SALES OR EXCHANGES "NO GAIN,
FOR STOCK).
NO LOSS RECOGNIZED" (Section 40{C)[2]) - Ex-
ceptions to the rule that the entire amount of gain or loss No gain or loss shall be recognized if property
shall be recognized: is transferred to a corporation by a person in
exchange for stock in such corporation of which
(1.) Between corporation which are parties to the merg-
as a result of such exchange said person, alone
er or consolidation (PROPERTY FOR STOCK).
or together with other, not exceeding four per-
A corporation which is a party to a merger or sons, gains control of said corporation. Stocks
consolidation exchanges property solely for issued for services shall not be considered as
stock in a corporation which is a party to the issued in return of property. However, the BIR
merger or consolidation. ruled that the law would apply even when the
(2.) Between a stockholder of a corporation party to a exchanger or exchangers already had control
merger or consolidation and the other party corpo- of the corporation at the time of the exchange
ration (STOCK FOR STOCK). (BIR Rulings Nos. 04987, 27 February 1987;
06087, 9 March 19987; 09887, 6 April 1987).
A shareholder exchanges stock in a corporation
which is a party to the merger or consolidation, The term control shall mean ownership of
solely for the stock of another corporation also stocks in a corporation possessing at least
a party to the merger or consolidation. fifty-one percent (51 %) of the total voting
power of all classes of stocks entitled to
(3.) Between a security holder of a corporation party to vote.
the merger or consolidation and the other corpora-
tion (SECURITIES FOR SECURITIES OR STOCK). In the foregoing cases, if the taxpayer
receives stocks (or securities) and, as a
A security holder of a corporation which is a part of the consideration, another party
party to the merger or consolidation exchanges to the exchange assumes a liability of the
his securities in such corporation solely for taxpayer, or acquires from the taxpayer
stock or securities in another corporation, a property subject to a liability, then such
party to the merger or consolidation. assumption or acquisition shall not be
The term merger or consolidation shall treated as money/or property, and it shall
be understood to mean: i.) The ordi- not prevent the exchange from being ex-
nary merger or consolidation, or ii.) the empt.
F. "GAIN RECOGNIZED, LOSS NOT RECOGNIZED

RULE" APPLIES TO THE FOLLOWING TRANSAC-
TIONS:
( 1.) Transactions not solely in kind (Exchanges of prop-
Chapter 10
erty, stocks or securities plus cash or money); TAXPAYERS REQUIRED TO FILE INCOME
(2.) Illegal transactions (2001 Bar); TAX RETURNS
(3.) Transaction between related taxpayers:
a.) Members of a family; A. INDIVIDUALS
b.) Corporation and individual - Individual owned
(1.) Resident citizens receiving income from sources
more than fifty percent (50%) of the outstand-
within or outside the Philippines:
ing capital stock of the corporation;
c.) Two (2) corporations - more than fifty percent a.) Individuals deriving compensation income from
(50%) of the outstanding capital stock is owned 2 or more employers, concurrently or succes-
by the same individual; sively at anytime during the taxable year;
d.) Parties to a trust-truster, trustee, beneficiary b.) Employees deriving compensation income
and fiduciary. regardless of the amount, whether from a
single or several employers during the calendar
(4.) Wash sale transaction (61-day sale). year, the income tax of which has not been
Purchase of substantially identical stock or withheld correctly (i.e., tax due is not equal
securities beginning thirty (30) days before to the tax withheld) resulting to collectible or
the date of sale and ending thirty (30) days refundable return;
thereafter. c.) Employees whose monthly gross compensa-
Seller must not be a dealer in securities or tion income does not exceed P5,000 or the
stock. statutory minimum wage, whichever is higher,
It covers acquisition through a taxable ex- and opted for non-withholding of tax on said
change and the making of an option contract. income;
d.) Individuals deriving other non-business non-
professional related income in additi,on to
compensation income not otherwise subject
to a final tax;
173

Income Taxation Dimaampao

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BASICAPPf

'* ;~iei~~k Sd;~re

856 Nicanor Reyes, Sr. St.

1: Individual Income System................................. 1

I. INDIVIDUAL INCOME TAXATION

II. CORPORATE INCOME TAXATION C. Final Withholding Tax System

A. Global Tax Treatment 1. Withholding agent (source) - withholds the

Ill. COMMON FEATURES

it cannot be determined by reckoning cash receipts;

rental (Limpian Investment Corporation F. DOCTRINES ON DETERMINATION OF TAXABLE

Proceeds of group insurance. Reason: Compensatory; not gain/profit; adds

Charity Sweepstakes Office (R.A. No.

NRA-ETB within taxable income B. BASIS/TEST: Designation/name of the remuneration

eficiary designated is the family, executor,

e.g., taxpayer may be away on business or to BIR Rulings:

ii. Security deposit- nottaxable. However, are nothing but an enrichment

.~) Acquisition and disposition of capital stock

_f) Tax refund - taxable if it results in reduc- General professional partnership;

the three immediately succeeding taxable years.

(5.) Coverage of IAET

iii. A VAT tax effort of four percent (4%) of 'I'

Condition: foreign government shall provision or revenue regula-

Cultural Corporations ! iii. Not engaged in a regular business for

COMMON REQUISITES: ii. Young Men's Christian Association of the

Tax-exempt corporations under special laws

obtaining stock subscription and promotion

Bonuses are deductible under the following Other forms of compensation:

c.) Reasonable and necessary expenses.

No deductions are allowed for amounts

E. TAXES Requisites for deductibility:

set against gains from a legal transaction

February 1994). I ii.

applies to acquisition through a taxable

102, Rev. Reg. No. 2; 1955 CCH Non-resident Foreign Corporation

i. Unpaid wages paid in promissory note - of PS0,000.00 or the amount absolved if

i. Straight line method; f.) Intangibles - use is unlimited

Depreciable assets: (4.) Properties not used indirectly in petroleum operation

(2.) Charged off within the taxable year.

e. health; vi. rehabilitation of veteran;

g. cultural; (6.) DEDUCTIBLE UNDER SPECIAL LAWS (IN FULL)

a.) Net additions, if any, required by law to be Reason: Non-business expenses.

iii. Commissions paid in selling securities - Reason/Purpose:

Reason: Capital Expenditure

after tax, is no longer taxable on the part

est in the disposition of the corpus or the income

C. COMPUTATION OF TAX ON ESTATE AND TRUST

"Gross Philippine Billings," there shall be included

A sale by dealer in securities is an Account receivable;

Principal residence shall refer to the

Definition of ESCROW Agreement - refers to Answer:

F. "GAIN RECOGNIZED, LOSS NOT RECOGNIZED

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