TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book PRELIMINARY MATTERS CITIZENSHIP Resident Citizen (RC)

Non-resident Citizen (NRC Resident Alien (RA) Non-resident Alien engaged in trade and business in Phils. Non-resident Alien not engaged in trade and business in Phils. RATES Royalties No. of required days SOURCE INCOME TAX Global income, within and without Income within Income within Income within TAX BASE Net Income (NI) Net Income (NI) Net Income (NI) Net Income (NI) TAX RATE 5-32% 5-32% 5-32% 5-32%

183 days or more/ more than 182 days 12 mos. And 1 day or more/ more than 12 mos. 181 days or more/ more than 180 days 180 days or less

Income within

Gross Income (GI)

25%

Prizes exceeding Php 10,000 (if it is 10,000 or less, it is NOT subject to final tax but the same must be included in other income) Winnings derived from sources within Philippines (except PSCO and Lotto) Interest on Bank Deposits, Deposits Substitutes, Trust Funds and other similar arrangements Dividends received from a domestic corporation Share of a Partner in the NI after tax of a taxable partnership Cash Reward to Informers (sec. 282, NIRC)
Not over P10,000

RC,NRC, RA 20% 10% literary books, and compositions 20%

works, musical

NRA, ETB 20% 10% literary books and compositions 20%

NRA-NETB 25% works, musical 25%

20%

20%

25%

20%

20%

25%

10% 10% 10%

20% 20% 10%

25% 25% 10%

TAXABLE INCOME 5% Over P10,000 but not over P30,000 Over P30,000 but not over P70,000 Over P70,000 but not over P140,000 Over P140,000 but not over P250,000 Over P250,000 but not over P500,000 Over P500,000

INCOME TAX P500+10% of the excess over P10,000 P2,500+15% of the excess over P30,000 P8,500+20% of the excess over P70,000 P22,500+25% of the excess over P140,000 P50,000+30% of the excess over P250,000 P125,000+32% of the excess over P500,000.

8/23/2011 official start So you have discuss the kinds of individual tax payers, understand that there are citizens, resident and non-resident citizens, you know when a citizen is a non-resident. So when a Filipino citizen leaves the country today, will he be liable for income tax for his entire income this year, 2011, will he report his
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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book income until his tax due, yes or no? A Filipino citizen who will leave the country today for another country, earns income in another country for the entire 2011 calendar year, is he obliged to report his January to December 2011 income and pay the tax due? YES. If he leaves the country on May, last May 2011, will he be obliged to pay the tax for the entire year? Only for income within which is the January until May income and any income from May until December for which the situs of the income is here. Let us say for example that you have been hired by a corporation and were given a contract to be assigned abroad for 2 years, your assignment will start today, you leave the country tomorrow, for 2011 thats understood that he is obliged to report the entire income for 2011 because his stay abroad is not more than 183 days. For the next year, is he obliged to pay the income and pay the tax due? Yes or no? His status for 2012 is non-resident citizen. For 2013 from January until he comes back on August 15, 2013 what is his status? Non-resident. So in his income on 2013 be declared for income tax purposes? Yes or no? We said that he is a resident citizen for 2011, contract ends August 16, 2013, 2 year contract, with the income for 2011 will be paid of Philippine income tax whether it is earned abroad or in Philippines, because his status is resident citizen. His income for 2012 will not be paid of Philippine income tax so long as all his income is earned abroad because his status for 2012 is that of a nonresident citizen. How about 2013, when he comes back on Aug. 16, will his income from January to December 2013 be paid of Philippine income tax, yes or no? what is his status for 2013? Non-resident citizen up to the time of his arrival. So he will not be paying any Philippine income tax but for this part of the year, he will be paying income tax. Even if u change this class to May which makes him a nonresident citizen for 2011 full year non-resident on 2012 but for 2013 when he comes back on May as well which is not more than 183 days abroad, he will be considered as non-resident citizen up to the time of his arrival and no Philippine income tax here. There are four types of non-resident citizens. 1st One is a resident abroad who has established his physical presence and residence abroad to the satisfaction of the commissioner; 2nd one who is an immigrant or who works permanently in abroad but not a resident as in the 1 st category; 3rd one whose stay abroad is more than 183 days during a calendar year, its during a calendar year why? Individual tax payers are only considered for tax purposes using the calendar year nor fiscal year; 4th hybrid non-resident citizen, who can be non-resident citizen during time of his arrival. Take not that the requirement for the 4th category as a non-resident citizen at the time of his arrival would require that the prior year he must be considered a non-resident citizen. If he is a resident citizen of the prior year, you do not consider him non-resident citizen in the hybrid category. How about an overseas worker or a seaman? Is he a non-resident citizen? Yes or no? It depends. You have to satisfy the 3rd category that his stay in abroad must be more than 183 days during a calendar period and he must employed in a shipping vessel that is engaged in exclusive international trade otherwise you cannot consider that vessel as an extension of any foreign country. How far have you understood situs of income taxation? Was it a friendly topic? Like interest income, where is the situs? Residence of debtor. Gross income, so you have discussed the different income of an individual taxpayer may earn such as compensation income, rents, royalties, dividends, and not just knowing what type of an income an individual can earn because in so far as Philippine income taxation is concerned, you must know whether the situs is here or not. If situs is not in the Philippines, you cannot as a general rule subject it to Philippine Income Tax except in two cases: the two cases would apply to Individuals and corporations. The exception to the rule, when I say that an income is taxable only when an income in the Philippines would only hold true unless the tax payer is a resident citizen and domestic corporations, you do not consider the situs, wherever the income is earned, its global, wherever income is earned is taxable. Non-resident citizen before prior to the tax code of 1997 which is republic act 8424, non-resident citizen were taxable on income worldwide but beginning 1998 when tax code took effect non-resident citizens are only taxable on income within. Fringe Benefits Tax, an example is housing, so whenever you are provided with a housing allowance, whether it is given in cash or in the form of actual housing, the corporation will be the one to pay the lessor, it is a general rule subject to fringe benefits tax and there are 3 exceptions to the rules when housing benefits are not subject to tax. What are these 3? 1. When the house is within the 50meter distance from company premises 2. When you are assigned on a temporary basis not more than 3 months, like when you are assigned to different branch and you are allowed to stay on a hotel but not more than 3mos. 3. For the convenience of the employer, example if you are a doctor on call, you need your driver and you have your driver stay on an apartment next to your house, you do not really consider that as a benefit to the driver but a benefit to the employer, because it is for the employers convenience. In those instances, those fringe benefits are not subject to fringe benefits tax. Fringe benefits are subject to fringe benefits tax. Is fringe benefit tax an income tax? Yes or no? for those of you who have browse a chapter on income tax in that codal provision, any type of tax that you see whether its named as fringe benefit tax, capital gains tax, whatever tax it is, it is an income tax. It is simply named differently from one tax to the other but its income tax, why? Its under the chapter on income tax.
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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book The reason there is why is it differently named because in some cases, the manner of how it is collected by the government is different, when you say income tax per se as an individual. Withholding tax, Is that income tax? Why is it called withholding tax? So that is actually an income tax because his salary is an income. Its called withholding tax for the simple reason that the employer is designated by the government as a withholding agent for and in its behalf, why? If the government will expect each and every worker or employee to voluntary declare his income at the end of the year when it is required to be declared and pay the tax, do you think workers and employee would truly declare their income and pay the exact tax? NO. number 2, the government requires the withholding of tax in advance, thats simply an income tax that has been withheld by the employer and paid to the government in advanced in behalf of employee to give government revenues in order to shoulder the expenses for the benefits and services that are given to the citizens. Exclusions, so exclusions in gross income. If we look at Sec.32-A, 32-B of tax code, the definition there of gross income is income from whatever source derived, it means to say that any income whether legally made or illegally earned would have to be included in gross income and to be paid out income taxes. The only exception there is that when it falls as an exemption or exclusions. So would you rather memorize inclusions or exclusions? Exclusions of course because you cannot memorize inclusions. Schedular rates, from 5 to 32%, for the 1 st peso you earn, the government has already an inchoate right of 5% of your 1st 1 peso and if you earn income beyond 500,000, 32% of that goes to the government. So that means if you get employed because of course, employers are the most honest taxpayers, why? Because they dont have the leeway, pure compensation earners, because they have no other income except from work. SITUS OF TAXATION The situs of taxation is the place of taxation. The rule is that the State may rightfully levy and collect the tax where the subject being taxed has a situs under its jurisdiction. IMPORTANCE: Determining the situs or incidence or place of taxation leads to the determination on whether the income is taxable or not. TYPE OF INCOME Interest Income Dividend Income from DOMESTIC CORPORATION Dividend Income from FOREIGN CORPORATION SITUS Residence of Debtor Income within a. INCOME WITHIN if 50% or more of the Gross Income of the Foreign Corporation for the preceding 3 years prior to the declaration of the dividend was derived from sources within the Philippines b. INCOME WITHOUT if less than 50% of the Gross Income of the Foreign Corporation for the preceding 3 years prior to the declaration of the dividend was derived from sources within the Philippines (see Illustration below) Place where service is rendered (see CIR case below) Location of Property Place where Intangible Property is used (see Example below) Location of Property Place of Sale Income Within

Service Income Rent Income Royalty Income Gain on Sale of Real Property Gain on Sale of Personal Property Gain on Sale of Domestic Shares of Stocks

ESTATES AND TRUST Estates and trust are also taxable similar with individual taxpayers whatever the income of an estate that is under judicial settlement whether its through an administrator or executor. When we consider as a separate taxable entity treated as an individual allowed to deduct personal exemption to the extent of 20,000. In the year of death of certain person, there will be 2 taxable entities if the estate will be under judicial settlement. If its extrajudicial it is not covered.
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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book If under judicial settlement: 2 Taxable Entities 1. Individual person income from January until date of death And from date of death until end of December 2. Another separate entity which is estate taxable as the income that has been earned during the year from start of its creation which is after death. Expenses are deductible. If its a property held out for lease, It will earn rent income but it will also incur expenses for the maintenance of the unit ,so expenses are deductible. Other deductible items, if there are distributions that are scheduled whether actually or not, if the court says so that it be for distribution, those items, amounts or income that will be distributed are no longer subject to tax in so far as estate is concerned, it will be a deductible item but it will be taxable on the recipient heirs. So at that point government is not losing anything, if its deductible on one entity, its taxable on the other hand. What are trust? Ex. when you create of trust to your child. Income earned in trust is subject to income tax and it is considered as separate entity. But there are trust that are exempt from taxation and these are usually employees trust created by employer for the benefit of the employees. Retirement benefits in exclusion: retirement benefit received by ee from retirement pension plan that is recognized and approved by the Bureau of Internal revenue is exempt from tax so long as retiree reaches age of 50 years old, rendered service for at least 10 years and its his first time to avail of retirement benefit plan. From where does retirement benefit come from? It comes from a pension plan, a trust created by employer. What really happens is that er and ee together contributes money to that fund and allows it to grow. Either held by insurance company or manage by insurance company or bank. So its considered as a separate entity from the corporation that is contributing to that and is separate from employee. Every time that trust or money pulled in earns income, it is exempt from tax probably in labor, for benefit of laborers. CORPORATE INCOME TAX A. INTRODUCTION AND DEFINITION OF TERMS Taxpayers are generally categorized into individual and corporate taxpayers. Corporation includes partnership no matter how created or organized, join account companies, insurance companies and other associations, except. 1. General professional partnership 2. Joint venture for the purpose of undertaking construction projects 3. Joint consortium for the purpose of engaging in petroleum, geothermal and other energy operations pursuant to a consortium agreement with the government Corporation composed of 5 or more stockholders managed by a Board of Directors which primary objective was to obtain profits. The objective of creating a corporation - it is for purposes of generating profits. It is commercial in nature. When 5 or more individuals form an entity wherein their ownership is represented by stocks or shares and the purpose of which is to conduct with regularity commercial transactions or activities, that is corporation in simple terms. Corporation - is an entity that is subject to tax because the purpose is to generate profits and any profit earned is subject to income tax and shareholders because it is represented by shares. You form a corporation and whatever capital you have put and you invested in a building. As 20% owner, can you say you own 1 floor? You cannot. A corporation has a separate and distinct personality from its owners, whether you own 100% or 1% of corporations interest, you cannot say that the assets of corporation is owned by you. You do not own assets of corporation because the corporation owns its own assets. What you own is simply interest. Dividends only pertain to corporation Elements for joint venture or consortium to be not a taxable entity 1. Unincorporated entity (unregistered with SEC) 2. Undertaking construction or energy related project with the government Tax exemption is valid only after completion of construction project, it does not extend to sale or lease.
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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book 3 types of Business 1. Sole proprietorship not subject to corporate income tax of 30% but to graduated income tax 5%-32% because its is represented by owners, natural persons 2. Partnership subject to a flat rate of 30% except GPP 3. Corporations 3 types of partnership 1. General professional partnership 2. Business partnership 3. General co-partnership The latter two are the same in the sense that both are taxable corporations. When two of you agreed to buy and sell RTWs and you form a partnership, thats a taxable partnership. That includes unregistered partnership. The government does not give premium on you for not registering you business. Whether or not registered, taxable so long as you derive income, it will be subject to tax otherwise we will be giving premium to those who does not follow what the law requires. General Co-partnership partnership similar to corporations wherein every partner is treated as a stockholder Individual partners for tax purposes are treated as if they were owners of partnerships and whatever income they received or constructively received are as if they are getting dividends. Dividends are your profit from investment. Dividends only pertain to corporations. Partnership an association of two or more persons where they may contribute money, property, industry to a common fund with the intention of dividing the profits among themselves. The partners are considered as stockholders and therefore, profits distributed to them by the partnership are considered as dividends. Test that will determine whether a partnership exists or not: 1. There must be a contribution to a common fund 2. There must be an intention to divide the profits among themselves For purpose of taxation, this business partnership is taxable irrespective of whether it is orally constituted or in writing, and whether or not it is registered in the Securities and Exchange Commission. Insurance Pool or Clearing House where an insurance pool or cleaning house (composed of 41 non-life insurance corporations) is created, whose role is limited to the principal function of allocation and distributing the risks arising from the original insurance among the signatories to the members of the pool on their ability to absorb the risks ceded as well as the performance of incidental functions and which did not insure/assure any risk in its own name, a partnership or association is created and subject to tax as corporation. Incidental functions: - Records - Maintenance - Collection - Custody of funds Co-ownership as a rule, tax exempt because a co-ownership is not a partnership but one formed and organized not for profit but for common enjoyment of property or for the preservation of the property. - Co-ownership is converted of inherited properties is automatically converted into an unregistered partnership the moment said common properties and/or the incomes derived therefrom are used as a common fund with intent to produce profits for the heirs in proportion to their respective shares. - The character of habituality peculiar to business transactions for the purpose of gain must be present to consider them as unregistered partnership. Where transactions are isolated, in the absence of other circumstances showing contrary intention, the case can only give rise to coownership. Lease of properties under common management where there is series of transaction (i.e. properties lease out to tenants for several years) whose purpose is not limited to the conservation of the common fund or ever acquired properties is formed. The character of habituality peculiar to business transactions engaged in the purpose of gain is present. (evangelista vs collector) General Professional Partnership (GPP) - partnership formed by persons for the sole purpose of exercising their common profession, no part of income of which is derived from engaging in any trade or business.
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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book - Person engaged in business as partners in a GPP shall be liable for income tax only in their separate and individual capacities. - For purposes of computing the distributive share of the partners, the net income of the partnership shall be computed in the same manner as a corporation. - Each partner shall report as gross income his distributive share, actually or constructively received, in the net income of the partnership. - Income of a GPP is deemed constructively received by partners. - Not taxable entity for income tax purposes, partners themselves not the partnership are liable for the payment of income tax in their individual capacity. - Since GPP are thus exempt from income tax, the professional fees paid to it are thus exempt withholding tax - It only refers to partnership that has been registered with SEC - It is exempt from tax - GPP is required to file ITR so that government will determine what income is to be attributed to the taxpayers General Professional Partnerships are not subject to tax. GPP requires the partnership created is for the purpose of enjoying a common profession. Partners in GPP are taxed on their individual income. Joint Consortium - Not automatically exempt, it has to be in agreement with government. Joint Venture - Created when 2 corporations, while registered and operating separately, are placed under one sole management which operated the business affairs of said companies as though they constitute a single entity thereby obtaining substantial economy and profits in the operation Joint account - Created when two persons from or create a common fund and such persons engages in a business for profit. This may result in taxable unregistered association or partnership. Joint Stock Companies - Midway bet. corporation and a partnership, a hybrid personality, somewhat a corporation because this is managed by a BOD and such persons may transfer their shares without the consent of others and somewhat a partnership because it is an association and persons or members of the same contribute fund, money to a common fund. Emergency Operation - May be formed by 2 corporations with separate personalities. - If they form that emergency operation ( it is a special activity) to engaege in a joint venture, corporation 1 may be taxed only from the income derived from such business. - The income derived from such emergency operation should also be included in that taxable income subject to corporate income tax. - In the same way, that corporation 2, has a separate and distinct personality; if its a part of emergency operation, the income derived from such special activity should also be included in the income of that corporation 2, subject to corporate income tax, even if it is not registered with SEC. B. TAXABLE CORPORATIONS 1. Domestic Corporations (DC) Sec. 27 A corporation formed or organized under Philippine laws. It is subject to tax on its net taxable income from sources within and without the Philippines. In Philippine Corporations, owners are at least 60% Filipinos while in Domestic Corporations, regardless of nationality of the owners, the corporation is still domestic as long as it still organized under Philippine laws. Multi-national corporations which are registered in the Philippines having its own set of BOD are still domestic corporations. 2. Resident Foreign Corporation (RFC) Sec. 28A A corporation formed, organized, authorized or existing under the laws of any foreign country, and engaged in trade or business within the Philippines. it is subject to tax on its net taxable income from sources within Philippines. There is no fix criterion as to what constitutes engaged in trade or business. Being engaged in business implies continuity of commercial transaction or dealings continuity of business or continuity of intention to conduct continuous business. 2 types of Resident Foreign Corporations 1. Exempt from income tax because they are not engaged in trade or business in Philippines
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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book 2. Those that are subject to income tax at a. 10% preferential tax rate b. 30% regular corporate income tax rate or 2% minimum corporate income tax rate whichever is higher Philippine branch of a foreign corporation is merely an extension of the foreign corporation in the Philippines. There is only one single entity to speak of. For income taxation purposes, only income of the Philippine branch from sources within the Philippines is subject to Philippine income tax. Branch is an extension of an office. Resident Foreign Corporation need not be registered. all foreign corporations whether registered or not is subject to income tax. 3. Non-Resident Foreign Corporation (NRFC) Sec. 28B A corporation formed, organized, authorized or existing under the laws of any foreign country. It is subject to tax on its gross income from source within Philippines. Such gross income may include interest, dividends, rents, royalties, salaries, premiums (except reinsurance premiums) annuities, emoluments or other fixed or determinable annual, periodic or casual gains, profits and income, and capital gains, EXCEPT capital gains from sale of shares of stock not traded in the stock exchange. NRFC is a foreign corporation not engaged in trade or business within Philippines but deriving income from sources within the Philippines. The term non-resident means not engaged in trade or business in the Philippines Gross income from sources within Philippines paid to a non-resident foreign corporation shall be subject to the 30% final corporate income tax that must be withheld by the Philippine payor of the income and remitted to the BIR

Corporation

DC RFC Net/Gros s Tax Rate Source of Income Example 1: NET 30% Within and Without NET 30% Within

FC NRFC GROSS 30% Within

NRF C bank
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Loan principal

DC Minin g Co

TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book Interest fruit of tree, income out of capital Interest here is paid on a month to month basis, is the interest income subject to tax? YES. Do we categorize it Resident Corp? No. it is still NFRC. You dont look at regularity of payment it is a mode of payment. Sec. 42 interest income, situs is residence of debtor

Example 2: - Hire NRFC to repair equipment in the Philippines C. 1. 2. 3. INCOME TAX EXEMPT ENTITIES, Sec. 30 General Professional Partnerships Special rule in expense deductions Joint venture for the purpose of undertaking construction projects Joint Consortium for the purpose of engaging in petroleum, geothermal and other energy operation pursuant to a consortium agreement under service contract with the government

SEC. 30. Exemptions from Tax on Corporations. - The following organizations shall not be taxed under this Title in respect to income received by them as such: 4. Labor, agricultural or horticultural organization not organized principally for profit - May derive income from such business as long as it is merely incidental (organization is still exempt) it is important that in the articles of incorporation of this tax exempt organization, it must be clearly provided that it is not formed or organized for profit. 5. Mutual savings bank not having a capital stock represented by shares, and cooperative bank without capital stock organized and operated for mutual purposes and without profit; Requisites: a. No capital stock represented by shares b. Earnings, less only expenses of operating are distributable whoolly among depositors c. Operated for mutual purposes and without profit 6. A beneficiary society, order or association, operating for the exclusive benefit of the members such as a fraternal organization operating under the lodge system, or mutual aid association or a nonstock corporation organized by employees providing for the payment of life, sickness, accident, or other benefits exclusively to the members of such society, order, or association, or nonstock corporation or their dependents; 7. Cemetery company owned and operated exclusively for the benefit of its members; Requisites: a. Owned and operated exclusively for the benefit of its owners b. Not operated for profits 8. Non-stock corporation or association organized and operated exclusively for religious, charitable, scientific, athletic, or cultural purposes, or for the rehabilitation of veterans, no part of its net income or asset shall belong to or inures to the benefit of any member, organizer, officer or any specific person; Requisites: a. Organized and operated for one or more of the specified purposes b. No part of its net income must inure to the benefit of private stockholders or individuals 9. Business league chamber of commerce, or board of trade, not organized for profit and no part of the net income of which inures to the benefit of any private stock-holder, or individual; Requisites: a. Association of persons having some common business interest b. Limited its activities to work for such common interest c. Not engaged in a regular business for profit d. No part of net income inures to the benefit of any private stockholder 10. Civic league or organization not organized for profit but operated exclusively for the promotion of social welfare; Requisites: a. Not organized for profit but operated exclusively for purposes beneficial to the community as a whole. In general, organizations engaged in promoting the welfare of mankind b. Sworn affidavit with BIR showing character of league, purpose for which it was organized, actual activities, sources of income and disposition there and all facts relating to the operation of the organization which affects its right to exemption. 11. Farmers' or other mutual typhoon or fire insurance company, mutual ditch or irrigation company, mutual or cooperative telephone company, or like organization of a purely local character, the income of which consists solely of assessments, dues, and fees collected from members for the sole purpose of meeting its expenses; and Requisites: a. Income derived solely from assessments, dues and fees collected from members b. Fees collected from members are for sole purpose of meeting its expenses 12. Farmers', fruit growers', or like association organized and operated as a sales agent for the purpose of marketing the products of its members and turning back to them the proceeds of
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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book sales, less the necessary selling expenses on the basis of the quantity of produce finished by them; Requisites: a. Formed and organized as sales agent for the purpose of marketing the product of its members b. No net income to the members c. Proceeds of the sale shall be turned over to them less necessary selling expenses on the basis of the quantity of produce finished by them. 13. Government educational institution; 14. A nonstock and nonprofit educational institution; - GR: all corporations, agencies or instrumentalities owned or controlled by the government shall pay as such rate of tax upon their taxable income as are imposed upon corporations or associations engaged in similar business, industry or activity. - Exceptions: 15. GSIS (Government Service Insurance System 16. SSS (Social Security System) 17. PHIC (Philippine Health Insurance Corporation) 18. PCSO (Philippine Charity Sweepstakes Office) 19. LWD (Local Water District) RA 10026 20. NAPOCOR (special law) Caveat: Notwithstanding the provisions in the preceding paragraphs, the income of whatever kind and character of the foregoing organizations from any of their properties, real or personal, or from any of their activities conducted for profit regardless of the disposition made of such income, shall be subject to tax imposed under this Code. - The phrase any of their activities conducted for profit does not qualify the word properties. This makes income from the property of the organization taxable, regardless of how that income is used, whether for profit or for lofty non-profit purposes. - Exceptions to Exempt Entities under Sec.30 1. Income from the use of properties, real or personal, whether profitable or not 2. Income from activities conducted for profit What is meaning of the term 'regional or area headquarters'? it shall mean a branch established in the Philippines by multinational companies and which headquarters do not earn or derive income from the Philippines and which act as supervisory, communications and coordinating center for their affiliates, subsidiaries, or branches in the Asia-Pacific Region and other foreign markets. While the term 'regional operating headquarters' shall mean a branch established in the Philippines by multinational companies which are engaged in any of the following services: general administration and planning; business planning and coordination; sourcing and procurement of raw materials and components; corporate finance advisory services; marketing control and sales promotion; training and personnel management; logistic services; research and development services and product development; technical support and maintenance; data processing and communications; and business development. Which of the two is taxable? The regional operating headquarters because it generates income. D. TYPES/CLASSIFICATION OF INCOME 1. Gross Income, Inclusions a. Compensation for Services Requisites for Taxability: a1. Personal services actually rendered a2. Payment is for such services rendered a3. Payment is reasonable b. Gross income from trade or business or the exercise of a profession c. Gains derived from dealings with property d. Interest amount of compensation paid for the use of money or forbearance from such use May or may not be subject to final withholding tax - Interest on bank deposit/deposit substitutes/trust fund and similar arrangement 20% - Interest from lending/interest income from bonds - Interest on foreign bonds/government bonds - Interest on treasury bills - Interest earned from deposits maintained under FCDU system 7.5% - Interest income of pawnshop operators e. Rents Definition: Fixed sum either in cash or property equivalent to be paid at a definite period for the use and enjoyment of a thing or right. Operating Lease a contract under which the asset is not wholly amortized during the primary period of the lease and where the lessor does not rely solely on the rentals during the primary period for his profits but looks for the recovery of the balance of his costs and for

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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book the rest of his profits from the sale or the re-lease of the returned assets at the end of the primary lease period (LEASE IN ORDINARY SENSE) Financial lease also called the full pay-out lease, a contract involving payment over an obligatory period (also called primary or basic period) of specified rental amounts for the use of a lessors property, sufficient in total to amortize the capital outlay of the lessor and to provide for the lessors borrowing costs and profits. Obligatory period is the primary noncancellable period of the lease which in no case shall be less than 730 days. Lessee exercises choice over the asset. (LEASE TO OWN) f. Royalties 20% Definition: payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, or films or tapes used for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process or for use or the right to use, industrial commercial, or scientific equipment or for information concerning industrial, commercial or industrial experience. g. Dividends Any distribution made by a corporation to its shareholders out of its earnings on profits and payable to its shareholders, whether in money or in other property. Requirements for dividend declaration, in general: 1. Unrestricted retained earnings 2. Board of Directors declaration 3. Absence of prohibition in any loan agreement Kinds of Dividend Income 1. Stock Dividend GR: Stock Dividend representing the transfer of surplus to capital account shall not be subject to tax. Exception: a. Taxable if subsequently cancelled or redeemed by corporation b. Taxable if it leads to a substantial alteration in the proportion of tax ownership in a corporation 2. Disguised Dividend These are payments which are equivalent to dividend distribution. In the case of excessive payments by corporations, if such payments correspond or bear a close relationship to stockholdings, and are found to be a distribution of earnings or profits, the excessive payments will be treated as dividends. 3. Property Dividend These are dividends paid in securities or other property, in which the earnings of a corporation have been invested are income to the recipients to the amount of the full market value of such property when receivable by individual stockholders. NOTE: A dividend paid in stock of another corporation is not a stock dividend, even though the stock distributed was acquired through the transfer by the corporation declaring the dividends of property to the corporation the stock of which is distributed as a dividend. 4. Liquidating dividend It occurs where a corporation distributes all its assets in complete liquidation or dissolution. The gain realized or loss sustained by the stockholder, whether individual or corporation is a taxable income or deductible loss. h. Annuities i. Prizes and Winnings (except prizes amounting to 10,000 or less) and other winnings (except Philipine Charity Sweepstakes Office and lotto winnings) from source within Philippines shall be subject to 20% final withholding tax, if received by a citizen, resident alien or non-resident alien engaged in trade or business in the Philippines. If recipient is NRA-NETB, prizes and other winnings shall be subject to 25% final withholding tax. If recipient is a corporation (domestic or foreign) prizes and winnings are added to the corporations operating income and the net income is subject to 30% corporate income tax. j. Pensions k. Partners distributive share from the net income of the general professional partnership l. Others 2. Gross Income Exclusions, refer to Outline 1.

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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book E. DEDUCTIONS FORMULA: Sales/Revenues Less: Cost directly related to Sales Revenues GROSS INCOME Less: Deductions - Itemized; OR - Optional Standard deduction TAXABLE (NET) INCOME X Tax Rate 30% TAX DUE Less: Tax Credit Tax Payable Gross income know where the situs of income is. In Domestic Corporation - taxable within or without In Resident Corporation situs is important. Situs rules apply to both individual. 1. Fundamental Principles in Deductions a) The taxpayer must prove that there is a law authorizing deductions b) The tax payer must prove that he is entitled to deduction 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 Not allowed to claim deductions (Tax Base: Gross Income) a. NRA-NETB b. NRFC 2. Entitlement to Deductions a) Domestic Corporations (includes private educational institutions, non-profit hospital, government-owned and controlled corporations) entitled to deductions, tax base is taxable income. b) Resident Foreign Corporations entitled to deductions, tax base is taxable income c) Non-resident Foreign Corporations not entitled to deductions, tax base is gross income. 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 computing the taxpayers taxable income bearing heavily against taxpayer whose inexactitude is of his own making. 3. Allowable Deductions a) Itemized Deductions i. Expenses ii. Interest iii. Taxes iv. Losses v. Bad Debts vi. Depreciation vii. Depletion of oil gas, wells and mines viii.Charitable Contributions ix. Research and Development x. Contribution to Pension Trust b) Optional Standard Deduction A standard deduction available to corporation, except non-resident, in an amount not exceeding forty percent (40%) of the gross income, in lieu of itemized deductions. Unless the taxpayer signifies in its intention to elect the optional standard deduction, it shall be considered as having availed of the itemized deductions. Such election when made in the return shall be irrevocable for the taxable year in which the return is made. A taxpayer who is entitled to and claimed for the optional standard deduction shall not be required to submit with its tax return such financial statements otherwise required in the Tax Code. See: Rule for general professional partnerships and its partners 4. Additional Requirement for Deductibility of Certain Payments Any amount paid or payable which is otherwise deductible from, or taken into account in computing gross income or for which depreciation or amortization may be allowed, shall be allowed as a deduction only if it is shown that the tax required to be deducted and withheld therefrom has been paid to the BIR. (Section 34) F. ITEMIZED DEDUCTIONS 1. Expenses Definition of Terms:
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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book Business Expense vs Capital Expense Business Expense refer to all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on or which are directly attributable to the development, management, operation and/or conduct of the trade, business or the exercise of a profession. Capital Expense are expenditures for the extraordinary repairs which are capitalized and subject to depreciation. These are expenses which tend to increase the value or prolong the life of the taxpayers property Ordinary & Necessary Expenses Ordinary Expenses refers to the expenses which are normal, usual or common to the business, trade or profession of the taxpayer. An expense is ordinary when it is commonly incurred in the trade or business of the taxpayer as distinguish from capital expenditures. The payments, however, need not be normal or habitual in the sense that the taxpayer will have to make them often. The payment may be unique or non-recurring to the particular taxpayer affected. Necessary Expense one which is useful and appropriate in the conduct of the taxpayers trade or profession. Extra-Ordinary Expenses these are amortized or depreciated a) Common Requisites for Deductibility of Ordinary and Necessary Expenses i. The expenses must be ordinary and necessary ii. It must be paid or incurred during the taxable year Exception: net operating loss carry-over iii. It must be paid or incurred in connection with the trade, business or profession of the taxpayer iv. It must be reasonable in amount reasonableness depends on the type of business, there are various factors. There must be direct relation to the amount and extent of services. Ex. If you give a janitor a compensation of 50,000, is it reasonable? NO. it violates reasonableness. v. It must be substantiated by sufficient evidence such as official receipts and other official records and official receipts. Must receipt be at all times? Example: export of furnitures. Official receipts Adequate Records Amount of Expense being deducted Date and Place where such expense is paid or incurred Nature of expense direct connection or relation of the expense being deducted to the development, management, operation and/or conduct of the trade, business or profession of the taxpayer vi. It must not be against law, morals, public policy or public order Expense Deduction 1. For it to be deductible, there must be a law to be deductible 2. Taxpayer interested must prove he is qualified 3. For expenses required withheld, otherwise it is considered as non-deductible Business Expense depends on the nature of business, it has to be business related Expense Deductions construed strictly against taxpayer What is Business Expense? Ther are ordinary and necessary in trade, business or profession. a. Ordinary normal, usual and common. It does not have to be regularly incurred. It can be even if incurred one time during the year. Regularly incurred example: in a law firm, you normally incur paying salary of secretary of security Not regularly incurred example: paying salary of a provider of data base of new jurisprudence. Both are ordinary expenses. b. Necessary useful and appropriate Capital expenditures prolong life of an asset to more than a year. It will benefit not only current year but also future years. Types of income: a. Ordinary income there is ordinary expense b. Capital income there is capital expense. Not deductible in the year of payment. Exc. Sec. 34-A Ex. Apartment units 10M payable in 20 years. Cost is spread 500K per year. But if Private Educational Institution will purchase real property and stands to be useful, school can choose to have it as: a. Capital expenditure 500k per year b. Deductible immediately it will distort NET income of school because during 10M will be offset by tuition fees. Sec. 30-A institution are exempt from taxes educational institutions, otherwise it is subject to 10%.
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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book Requirements for Deductibility 1. Must be ordinary or necessary 2. Must be reasonable in amount reasonableness depends on the type of business. 3. Must be paid or incurred during taxable year - Incurred means obligation or transaction is completed within the year. Cash out is not necessary so long as there is already a liability. 4. Must be paid in connection in trade, business, profession 5. Must not be contrary to law, morals, public policy not kickbacks, not bribes - On income taxation, all types of income whether legal or illegal are taxable, opposite in deduction. Like expense payment must not be contrary to law, public morals or public policy otherwise deductible. - Ex. Hiring of GROs from KTV 6. Must be withheld of tax otherwise non-deductible 7. Must be substantiated with official receipts or official records in absence of sufficient evidence or if there are no invoices or sales receipts, acknowledgments receipts may suffice. In Sec. 34-A, which is withheld of tax? Compensation of employee as the easiest. In case employer pays off salaries of employees without tax, salaries expenses not deductible to corporation If tax is not withheld then it is not deductible. On part of income recipient, what is the effect of taxes has been withheld? If one pays or incurs expenses, another party earns income. Receipt is already net income. Even if you are being paid of NET, your entire income is the whole payment including amount deducted. If you fail to withhold, you cannot deduct the expense, you will be assessed of taxes that should have been withheld. b) Kinds i. ii. iii. iv. v. vi. vii. of Ordinary and Necessary Expenses Compensation for services rendered Advertising and promotional expenses Rent expenses Traveling expenses Entertainment expenses Repairs and maintenance expenses Supplies and materials

c) Compensation for Services Rendered Special Requisites for Deductibility of these Expenses: i. This must be reasonable, meaning, this must not be ostensible and ii. This are, in fact, payments for personal services actually rendered Special Requisites for Deductibility of Bonuses to Employees: i. The bonuses are made in good faith ii. They are given for personal services actually rendered and iii. They do not exceed a reasonable compensation for the services rendered, when added to the stipulated salaries, measured by the amount and quality of services performed in relation to the taxpayers business. Bonuses must be given in good faith and in determining whether bonuses will form part of the compensation for services rendered, you have to consider the (1) nature of business, (2) the financial capacity of the taxpayer and (3) the extent of the services rendered Bonuses are given in addition to salaries. It must be given in good faith otherwise nondeductible. There are 5 instances in a year where bonuses are given. d) Advertising and Promotional Expenses It must be reasonable. Expenses for goodwill, although not deductible in the year, it should be amortized over the number of years that such expenses are expected to benefit the company. e) Rental Expenses i. The rental payment is required as a condition for continued use of possession ii. The purpose is for trade, business or profession iii. The taxpayer must not be the owner of the property or he has no equitable title over the property. The taxpayer must not be taking title to the property iv. This is subject to withholding tax f) Traveling Expense Special Requisites for Deductibility of Travelling Expenses i. The expense must be reasonable and necessary ii. They must be incurred or paid while away from home and Home does not refer to your residence but to that station assignment or post/principal place of business. iii. They must be paid or incurred in the conduct of trade or business
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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book g) Entertainment, Amusement and Recreation Expenses Special Requisites for Deductibility of EAR Expenses i. Reasonable in amount ii. Incurred during taxable period iii. Directly connected to the development, management and operation of the trade, business or profession of the taxpayer or that are directly related to or in furtherance of the conduct of his or its trade, business or profession iv. Not to exceed such ceiling as the Secretary of Finance may by rules and regulations, prescribe and of 1% of net sales for sellers of goods 1% of net sales for sellers of services v. Any expense incurred for entertainment, amusement or recreation which is contrary to law, morals, public policy or public order shall in no case be allowed as a deduction In representation expense, we cannot arbitrarily deduct them, only to the extent of which exceeded. If in a corporation: 1% in sale of services of 1% in goods If both sale of goods of and services, it has to be determined pro rata. h) Repairs and Maintenance Expenses Expenses for repairs are deductible if such repairs are incidental or ordinary, that is, made to keep the property used in trade or business of the taxpayer in an ordinarily efficient operating condition. Repairs in the nature of replacement to the extent that they arrest deterioration and prolong the life of the property are capital expenditures and should be debited against the corresponding allowance for depreciation. Note: If the cost of the repair increases the life of an asset for a period of more than one (1) year, that amount is considered extra-ordinary repair. Otherwise, it is considered ordinary repair. i) j) Supplies and Materials This must be actually consumed during the taxable year Litigation Expenses Litigation expenses defrayed by a taxpayer to collect apartment rentals and to eject delinquent tenants are ordinary and necessary expenses in pursuing his business However, litigation expenses that are incurred in the defense or protection of title are capital in nature and not deductible. Ex. credit or financing company, for them litigation expense is very ordinary and necessary to collect revenues.

k) Option to Private Educational Institution In addition to the allowable deductions, a private educational institution may, at its option, elect either: i. Deduct expenditures otherwise considered as capital outlays of depreciable assets incurred during the taxable year for the expansion of school facilities ii. To deduct allowance for depreciation thereof 2. Interest - pay for the use or forbearance for someone elses money The amount of interest paid or incurred within taxable year on indebtedness in connection with taxpayers profession, trade or business shall be allowed as deduction from gross income. a) Arbitrage Rule The taxpayers allowable deduction for interest expenses shall be reduced by an amount equal to 33% (effective January 1, 2009) of the interest income earned by him which has been subjected to final tax. Interest may be an expense. If we have a corporation and you obtained a loan from your sister company and were charged with interest and pay such an annual basis on 1milion. Is 1 M interest expense deductible? Interest allowed to be deducted shall be reduced to the extent of 33% of interest income subjected to final tax. INTEREST EXPENSE Interest can be deductible if one is personal holding company. Observation of Arbitrage Rule: Corp 403 extended a 10M loan by Corp 404. Interest income is 1M while Interest expense is 1M. Is the full 1M deductible? NO. Since 1M interest income is subject to 20% final tax. 1M
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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book 20% 800K Therefore, 33% of 800 is 330K. And so 1M interest expense less 330K is 670K. Interest expense is deductible but it shall be reduced to 33% of income subject to final tax pursuant to arbitrage rule. This rule avoids the 10% benefit. 30% benefit less 20% tax on income. If 1M is not subject to final tax, will it reduced interest expense? Law provides interest expense is fully deductible. If not subject to final tax, not benefit to the company. Example of a type of interest income is not subject to final tax: corporation extending loans to employees. Considering you are not a bank, no issue of final tax. What is 200K is the interest expense? 33% of 1M interest income is higher than interest expense then ZERO interest expense. b) Requisites for Deductibility - For it to be deductible, there are special requirements: i. This must be paid or incurred during taxable year ii. This must be incurred in connection with trade, business or profession of the taxpayer iii. There must be an obligation which is valid and subsisting iv. There must be an agreement in writing to pay interest v. This must observe the limitation under the arbitrage rule and vi. This must not be between related taxpayers There must be a valid and existing indebtedness, there must be a stipulation to pay interest, absence stipulation, would corporation liable? Civil Code, interest must be stipulated in writing. Tax Code also provides interest be in writing. If not in writing, it is not deductible. c) Delinquency Interest on Tax Payments Revenue Reg.2 provides that penalties are not deductible. It is because there is a recognized indebtedness in the government. Deficiency tax should also be deductible. Not subject to arbitrage rule. d) Interest Expenses which are Non-Deductible i. Interest expense on preferred stock As a rule, interest on preferred stock is not deductible because there is no obligation to speak of. It is in effect an interest on dividend. Reason: the payment is dependent upon profits of the corporation. It will only be paid if the corporation earns profits. BUT if it is not dependent upon corporate profits or earnings, it is deductible. If it is payable on a particular date or maturity without regard to the corporate profits, it is deductible. If you are a shareholder in a corporation, there are two shares: Common shares ordinary shares Preferred shares you have preference in shares in receiving dividends. When you invest in a corporation, it is not liable to you until there are profits. Your investment may produce dividends or it may not. If the declaration on dividends on preferred shares is dependent simply on profits, the any interest given is not deductible. But if declaration is a requirement every year, regardless of profit, interest is considered is deductible if not dependent upon profits. ii. iii. When there is no agreement in writing to pay interest Interest expenses on loan entered into between related taxpayers Related taxpayers: a. Members of same family which includes a.1. spouses a.2 brothers and sisters a.3. descendants and ascendants How about grandfather or grandmother? They are considered as family. How about great grandchildren? It does not matter as to degree, as long as lineal, it is part of the family. First degree cousin is no longer family because it is collateral not direct line. b. between 2 corporations owned or controlled by one individual. He must have a controlling interest over these 2 corporations. OR if one corporation is considered as personal holding company of another corp. c. between a corporation and an individual; that individual owns or controls more than 50% of the outstanding capital stock of such corporation d. parties to a trust d.1. grant or fiduciary

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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book d.2 fiduciary of one trust and fiduciary of another trust but there is only one grantor d.3 beneficiary and fiduciary iv. interest paid or cancelled for cost-keeping purposes v. interest paid in advance through discount or otherwise by an individual taxpayer reporting income on the cash basis. Such interest shall be allowed as a deduction in the year the indebtedness is paid vi. interest on obligation to finance petroleum exploration vii. interest on unclaimed salaries of the employees viii. 33% of the interest income subjected to final tax e) Theoretical Interest An interest which is computed or calculated, not paid or incurred, for the purposes of determining the opportunity cost of investing in a business, this does not arise from legally demandable interest-bearing obligation. This is not a deductible interest. It is a paper interest. How about imputed interest? SEC. 50 gives BIR, to determine at any time the true taxable income between two taxpayers. Theoretical Interest not deductible Imputed Interest - government imputes 12% interest income pursuant to Sec. 50 when no interest is shown. For BIR to impute is discretionary. 40 3 40 10M loan 4 no interest

12% 1.2M X 30% Tax 360 K

imputed interest income of 12%

In a contract of loan between 404 and 403, no interest is due, zero interest bearing transaction. 404 gave 10M to 403. BIR imputed interest income. If they were unrelated taxpayers, 404 should earn interest income. But since they are related taxpayers, 404 did not earn interest income but BIR imputed saying 404 should be paying 30% on imputed interest income, meaning government imputed interest that has been earned income by 404. In the other side of story, can 403 claim if at all 404 is obligated to pay tax on imputed interest, ,meaning it was assessed and eventually paid tax on interest income. Is 403 allowed to claim interest expense since 404 declared interest income forcibly? No. So there is also no imputed interest expense that is deductible. Ex, if loan is 10M and legal rate is 12%, what is 12% of 1M? 1.2 so 403 will not be collecting 1.2 M and 404 will not be paying 1.2M but the problem with Sec.50, BIR can imputed that there should have been interest 1.2, so therefore it will be assessed 30% of 1.2 which is 360K tax. It imputes income on such transaction. But this is favorable to the government, on 404s side. But on 403s side, it will not be a deductible interest expense because it violates all requirements, like no stipulation in writing, related taxpayer and this is not an actual interest payment incurred. No interest bearing between 2 related taxpayers, it is presumed it is in favor of one but is not 100% all the time, it is only when BIR wishes to impute. To impute is discretionary on the part of BIR. Common stocks - they cannot demand to be paid of dividends if there is no profits. There are various types of preferred stockholders. There are those which command payment even when during a year no profit is made. At all times, there should be unrestricted retainers. Another example: Your corporation 403 obtained a loan from 404, your not related taxpayers and you obtained a loan of 10M. instead of giving you a full or entire 10M, it already deducted in advance, the entire interest that is due from transaction. It is a 5 year loan, charged interest, therefore you are only given 9M instead of 10M, because 1M is the entire interest for 1 year, can you deduct this year, the 1M interest expense? NO. since the loan is more than 5 years, proceed stands to benefit future years and the interest is for the entire 5 years, it cannot be deducted in the year that it has been charged against your corporation for the next 5 years, its actually an interest paid in advance. Penalties are not deductible because there is a recognized indebtedness to government.

f) Optional Treatment on Interest Expense At the option of the taxpayer, interest incurred to acquire property used in trade, business or exercise of a profession may be allowed as a deduction or treated as a capital expenditure.
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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book 3. Taxes General Rule: All taxes, national or local, paid or incurred within taxable year in connection with the taxpayers trade, business or profession are deductible from gross income. Exception: i. Special Assessment on real properties tax imposed on the improvement of parcel of land. Special levy levy imposed against landowners of land specially benefited by government projects. Who is the collecting agency? Local government units ii. Income Tax Philippine and Foreign income tax Philippine income non-deductible. Foreign income tax Deductible? Philippine Income Tax X Foreign Income Tax RC and DC (check /) All others X iii. iv. v. Taxes which are not connected with trades, business or profession of the taxpayer Transfer Taxes Estate Tax and Donors Tax corporation will not die. If corporation donates property it is not deductible because business should not be in the habit of donating properties. Value-Added Tax not deductible on the part of the corporation. If a corporation sells a particular property, the burden of paying tax is shifted to consumer. Therefore it is not really an expense of the corporation. It did not deprive the corporation of its income therefore non-deductible. Electric Energy Consumption Tax (BP No. 36)

vi.

If at all there is foreign income tax, it can be availed of as a tax credit or tax deduction. Taxes under Sec.34-C only refers to tax proper. Taxes are deductible as a general rule so long as the common requisites have been met. Taxes that are not deductible: 1. Special assessment or special levy 2. VAT 3. Estated or Donors Tax 4. Final withholding tax 5. Electric Energy Consumption Tax 6. Philippine Income Tax 7. Foreign Income tax if granted tax credit a) Requisites for Deductibility i. This must be paid or incurred during taxable year and ii. This must be taxes paid or incurred in connection with trade, business or profession of the taxpayer b) Tax Deductions vs Tax Credit Taxes, as deduction, include those taxes which are paid or incurred in connection with the trade, business or profession of the taxpayer. However, the source of a tax credit is foreign income tax paid, war profit tax, excess profit tax paid to the foreign country. Taxes, as deductions, may be claimed as deductions from gross income in computing the net income WHILE tax credit is a deduction from Philippine Income Tax. The foreign income tax paid to the foreign country is not always the amount that may be claimed as tax credit because under the limitation provided under the Tax Code, it must not be more than the ratio of foreign income to the total income multiplied by the Philippine income tax. TAX RATE Philippine 1,000,000 30% = PHILIPPINE BIR Income 1,800,000 Country A 2,000,000 25% = 500,000 1.7 M income Country B 3,000,000 40% = income 1,200,000 What is more beneficial? Tax credit Tax Deduction from gross income Tax Credit automatic, entire 1.7 is 100% deductible if you do not know the limitation c) Who may claim tax credits for taxes of foreign countries? i. Citizens ii. Domestic Corporations iii. Members of GPPs
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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book iv. Beneficiaries of Estates and Trusts Limitations on deductions for NRA-ETB and RFC: In the case of a NRA-NETB in the Philippines and a RFC, deductions for taxes shall be allowed only if and to the extent that they are connected with income from sources within the Philippines. d) Limitations of Credit The amount of the credit taken shall be subject to each of the following limitations: i. Per Country Limitations the amount of the credit in respect to the tax paid or incurred to any country shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayers taxable income from sources within such country bears to his entire taxable income for the same taxable year and TAX RATE Philippine 1,000,000 30% = PHILIPPINE BIR Income 1,800,000 Country A 2,000,000 25% = 500,000 1.7 M income Country B 3,000,000 40% = income 1,200,000 LIMITATIONS IN TAX CREDIT: a. PER COUNTRY LIMITATIONS LIMIT Country A 2/6 x = 600,000 1,800,000 Country B 3/6 x = 900,000 1,800,000

ACTUAL 500,000 1,200,000

CLAIM 500,000 900,000 = 1,400,000 TAX CREDIT 1,800,000 1,400,000 (FIT) 400,000

Philippine Income tax not deductible Foreign Income Tax that has been paid is it deductible? it would depend on the type of taxpayer. Resident Citizens and Domestic Corporations, it is deductible. All others meaning NRC, RA, NRA and foreign corporations, is it deductible? NOT. Because being taxable on income within, all other taxpayers apart from RC and Domestic Corporations, cannot at all times deduct foreign income taxes paid abroad, because they are not taxable on foreign income tax. But in so far as this taxpayer RC and Domestic Corporation are concerned, Is it safe to say, that they can deduct foreign income tax paid at all times so long as they declare the foreign source income? The law provides 2 alternate treatments that a foreign i.ncome tax that is paid by a RC or Dom Corp, the options are not applicable to all others, only to RC and Dom Corps which says that if at all that there is Foreign Income tax that has been paid, such foreign income tax may be availed as a tax credit or availed of as tax deduction. When we say tax deduction, it can be claimed as expense offset against Gross Income meaning deductible expense. Meaning RC and Dom, Corps can actually claims as expense the foreign income tax but this becomes an X, it cannot be claimed as an expense deduction if it is claimed as a tax credit. What is tax credit? If a tax deduction is an expense against gross income, a tax credit is a deduction from Philippine Income tax. So if you pay a foreign income tax of 1M abroad, the 1M can be offset against Philippine Income tax? Generall, when you talk of taxes under Sec, 34C, it only refers to taxes proper, you do not talk about surcharges or interest that goes with it if ever there is assessment made by govt. GR: taxes are deductible so long as requisites met plus special requisite that tax must be imposed pursuant to a law. But taxes that are not deductible are S.I.T.T.V.E., Philippine income tax and Foreign Income tax if a tax credit has been claimed. What is the limitation? Ex. The Philippine government may collect 1.8 and country A and B internal revenue will collect theirs. Since it is a domestic corporation, 30% will be based for entire 6M.

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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book

What shall be paid supposedly to the government? Its 1.8M. Will the government allow domestic corp X, claim the entire 500,000 and 1.2M such that since this is 1.7, such it will only pay the Philippine Government 1.7 as tax credit? Tax deduction, every Dom corp has the option to either claim this foreign income taxes as expense against gross income or as tax credit against the Philippine income tax. What is more beneficial? Tax deduction or tax credit? Tax credit. Although it depends if you really know, for those who do not know its better to have it tax credit because it automatically comes to mind full amount is deductible, its the bottom line figure na, while if you claim this 1.7 as tax deduction, its against gross income, youre actual benefit is only 30% of 1.7 because that is only the extent that will reduce your income tax whereas if its tax credit, your 1.7 is entirely deductible if you do not know the limitation. Limitations: Can you convince the BIR you are only liable for 100,000 since you want to avail of tax credit and you paid foreign government 1.7M in all? Simple, how much are you liable to Philippine gov? 1.8M. in that 1.8 M can you say that that is the tax available only to Philippine source income? No. Because 1.8 million is actually based on global income, entire worldwide income, therefore a portion of this entire 1.8 M is a tax on your country A income, a portion 1.8M is a tax of your Country B income. The government allows you a limitation to the extent of the pro rata of tax applicable of Country A income and Country B income. Lets separate 1.8, for country A you earned 1/3 coz 2/6 is 1/3 Country B, 3M of 6M, so government although collecting 1.8M from you recognizes that half of it pertains to income that you have generated from Country B so this is tbe limitation. So you can claim only upto 600,000 on country A, 900,000 for country B. what is actual? How much can you claim as tax credit? CA 500 CB 900 Law has set limit that your tax credit shall not exceed the proportion of tax that is due from the foreign income vis a vis your worldwide income. So that proportion of your 1/3 of Phippine income tax pertains to limit of 600,000 in country a but since only 500, the law is in favor of Gov. which is lower is the amount that you can claim as credit. In Country B its, the lower of 900,000 against 1.2 a total of 1.4M. so your due to government is only? How much are you paying Philippine Gov. its the 1.8M less 1.4M foreign income tax. Actually this is favorable than tax deduction. Had you claim tax deduction, what is 30% of 1.7M? only 500,000 that is way below than 1.4M. While global limitation is simpler. What is the formula?

ii. Global Limitation the total amount of the credit shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayers taxable income from sources within the Philippines taxable under this Title bears to his entire income for the same taxable year. b. GLOBAL LIMITATION Simple, combine all income outside Philippine
You combine all your income outside Philippines that;s 5M over global income. Thats 5/6 x Phillippine Income tax meaning you want to get the component in 1.8M that pertains to the recognized tax of Country A and B. 5/6 of 1.8 is 1.5M. you divide 1.8M is 6parts multiplied by 5. 1 part each is 300,000 times 5. So can you deduct 1.5 million? Not as yet. You do not stop, know first Global Limitation, since the global limitation is higher than the per country limitation, you follow the 1.4M whichever is lower.

Rule: whichever is lower, the lesser the amount of tax credit, the more favorable to the government. How do you prove foreign income tax payment? Net income directly used for tax computations

e) Proof of Credits (Tax Credits) The credits shall be allowed only if the taxpayer establishes to the satisfaction of the Commissioner the following: i. The total amount of income from sources without the Philippines ii. The amount of income derived from each country, the tax paid or incurred to which is claimed as a credit and iii. All other information necessary for the verification and computation of such credits f) Tax Subsequently Refunded or Credited Taxes previously allowed as deductions, when refunded or credited, shall be included as part of gross income in the year of receipt to the extent of the income tax benefit of said deduction. TAX REFUND 2011 1,000,000 T? YES
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2009 GI 10,000,000 EXP 9,000,000 PTX 1,000,000

2010 10,000,000 9,500,000 1,000,000

TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book -030% -0-030% -0-

Let us say that you have paid value added tax of your consumers, and realizes a year later that it was more than what is due so you filed a refund and eventually you were refunded. So for example the tax that you claimed for refund was 1M, you were given 1M by the government miraculously. Should you pay income tax on the refunded tax? Otherwise stated, should that tax refunded form part of the gross income for which you pay taxes? That taxes subsequently refunded are at all times taxable as long as the corporation benefited. When can you say that the corporation benefited from tax? Are you basing the word benefit from the word tax or on its prior event? Valued added tax, was it considered as a deductible item in the first place? No therefore it was subsequently collected, can you say that there is a tax benefit? Was there really a tax benefit on the part of the corporation when it remitted to the government 1.2 Million and the reality is that its only liable vat of 1M, it over paid 200,000. Subsequently the 200,000 was refunded. Is the equation in balance? Value added tax is not deductible. Not being deductible the corporation was never benefited by its overpayment and therefore if its not a deductible tax and its subsequently refunded because you have overpaid, there was no tax benefit in the prior years not being an expense deduction, any refund is also not taxable. If its a deductible tax and subsequently refunded, then it may be taxable if in the year of deduction, it reduced your taxable income. Cause and effect again. So if its a valued added tax that has never form part of this equation subsequently refunded, dont even talk of this situation again because it is not an income it is not an expense. The government simply returned the 200,000 to you. But if its a deductible tax. Sec.21 deductible taxes it list types of taxes.Like value added tax, sales tax, percentage tax. Percentage tax is deducted. Assuming you have a gross income of 10M, you have expenses of 9M and you have a percentage tax of 1M. which brings down your taxable income to? 0. How much is your tax due? O, this is year 2008. In 2011 you realize that this 1M should not have been paid because you are not liable for percentage tax because its not a registered activity, not a registered tax type. So you filed a claim for refund and government refunded. Is the 1M refund in 2011 taxable? Yes. Because Corporation benefited and benefit is to the extent of reducing taxable income. In the year that you incur and paid percentage tax it reduced your taxable income eventually you are not paying any tax. How much of the 1M is taxable in 2011? Entire year. Let us say your expense in 2009 is 9.5 million plus percentage tax of 1M in 2010. How much is net income? Still 0. In 2011 you were refunded on entire px tax, is the person refunded in 2011 subject to tax, the income tax of 30%? Yes. Subject to income tax. Is it the full amount of 1M? no. only 500,000 because in the year when you paid the percentage tax as a deduction, you were only benefited to the extent of 500,000. Assuming there is no percentage tax on 2010, your income, your net income is only 500,000 and you will only pay 30% of 500,000 and because you have percentage tax, you are only benefited by 30% of the difference of this one, meaning your percentage tax reduced your taxable income only to the extent of 500,000. When youre subsequently refunded of this amount, the entire 1M is not exactly taxable. Why? Your actual benefit in the year of expense deduction was only 500,000. If this is 9.6, how much is taxable? If the expense is 9.6 how much is taxable if there is a subsequent refund? It is 400,000. Because the 400,000 net income that you should have been paid was strip off because of your 1M so you benefited from this not from the entire 1million. If your expense prior to percentage tax is 10M, when you are subsequently refunded in 2011, is the 1M subject to income tax? No. whether or not you had this one, you have zero income tax due. So therefore if this was subsequently refunded you would not be paying any tax on this one because in the year of expense deduction you are not even be liable to tax in first place. 4. Losses a) Classification of Losses i. Ordinary Losses losses sustained in the course of trade, business or profession of the taxpayer Net Operating Loss the excess allowable deduction over gross income of the business in a taxable year Net Operationg Loss Carry Over (NOLCO) shall be carried over as a deduction from the gross income for the next 3 consecutive taxable years immediately following the year of loss. Such loss shall be allowed as a deduction if it had not been previously offset as deduction from gross income. However, any net loss incurred in a taxable year during
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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book which the taxpayer was exempt from income tax shall not be allowed as a deduction. NOLCO shall be allowed only if there has been to substantial change in the ownership of the business or enterprise. There is no substantial change when: Ia. Not less than 75% in nominal value of outstanding issued shares, if the business is in the name of a corporation, is held by or on behalf of the same persons or Ib. Not less than 75% of the paid up capital of the corporation, if the business is in the name of corporation is held by or on behalf of the same persons. Discussion: What are capital assets? Under Sec. 39 negative definition of what capital assets are. It enumerates what are the ordinary assets, outside are capital assets Ordinary assets are used on trade business or profession, capital asset not used in trade, business or profession. Ordinary transaction which produces ordinary gain or loss Capital transaction capital gains or capital loss Special Requisites for Deductibility of loss: Losses must be that of a corporation It must be sustained and not anticipated losses Charged off during taxable year Not compensated by insurance but if there is, that which is not compensated is deductible Not have been deducted for estate If it is a casualty loss, there must be a sworn declaration within 45 from date of occurrence or loss from discovery if it is discovered later than occurrence. In so far as determining expenses deductible from gross income. If its a calendar year or fiscal year, it does not matter. Report loss to BIR within 45 from loss or discovery. Content of declaration? - The property subject of loss - Nature of event - If there is insurance If property insurance, always should not exceed face value of property Details as to how loss is estimated or calculated Failure to report it within 45, then not deductible. Failure to record in the books of the corporation is a valid proof that you are not interested in claiming it as deductible. If loss occurred this year and discovery in the subsequent next year, in what year will the loss be deducted? Assuming it was not insured, embezzlement took place this year. You have already filed ITR, should you retrieve and amend your ITR and seek for refund? NOLCO does not apply to capital transaction (ex. cash a capital asset a casualty). When you lose something that is not an ordinary asset, example cash and it was embezzled, Is cash an ordinary asset of corporation? Normally not, its not a merchandise, its actually a casualty loss. If embezzlement occurred December and discovery was on May, can you go back to December and ask for deduction. If its robbery theft embezzlement, general rule, losses must be actually sustained GR is that losses must actually be sustained during taxable year of when you intend to deduct but exception is NOLCO and another which only arises in cases if when discovery was made the subsequent year, simply consider the relationship between corporation employer and one who stole the money under creditor or debtor relationship which now becomes a bad debt expense, taken from the coverage of losses just to make it a deductible loss. Like Sulpicio Lines and princess of the stars, can you discovery is made the succeeding year? Assuming settlement with insurance is not made feasible, can you consider loss sustained or discovery was made subsequent year? The sinking of vessel is public knowledge so there is no reason why you have to put off discovery report it within45 days in the subsequent year in the insurance settlement was made. But as to how much the insurance co is willing to consider as compensation is another matter. NOLCO or Net Operating Loss Carry Over what type of transaction will produce NOLCO? Its a loss sustained in regular operations of business while NCLCO from capital transactions. NOLCO applies to individuals and corporation. When can a corporation which is into business recognized NOLCO as deductible expense? NOLCO is actually a result where allowable deductible expenses of a corporation or even an individual exceed that of gross income. Remember formula sales less direct cost of sales equals gross income, after GI, a taxpayer is allowed to deduct itemized deductions or optional standard deduction. It can include as part of itemized deduction, net operating loss of the previous years because once current expenses of a corporation exceeds that of GI, you will arrive at a loss. Any loss sustained during this year, will be carried over as deductible expense in the succeeding years and thats 3 consecutive years.
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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book Ex. your corporation, you are a president of a subsidiary of a multinational corporation, you invested in a country multimillion dollars and as fiscal incentive granted by government, you were given income tax holiday for 4 years. During the 4 years, you are exempt from income tax during 1 st 4 years. If you sustained losses on the 4th year, can you use losses sustained in the 4 th year as NOLCO against your gross income in your 5th 6th and 7th year? NO. Any losses during the year in which the company is not subject to income tax or exempt from tax is not available for NOLCO. It cannot be carried over as a loss on the subsequent 3 consecutive years. If a corporation opts for itemized deduction, EX: Gross sales 10M Direct cost 5M Gross Income 5M If you opt for optional standard deduction, are you allowed to claim NOLCO as deductible loss? Meaning you have previously used NOLCO. All you have to do is whether deduct it in the year where you opted for OSD or whether its not deductible. It is allowed even if the corporation, remember that there is a separate identity between the current year where you opted OSD and the previous year wherein you generated losses from choosing itemized deduction. OSD can never produce NOLCO because OSD can only be to the extent of 40% of your GI. What type of expense deduction that can produce NOLCO? It is only itemized deductions wherein your expenses may overshoot that of your gross income. If in previous year, you have chosen itemized deduction and you created NOLCO out of that choice and in the current year, your transaction is favorable to government mea ning you have generated so much income wherein expenses are unsupported you chose OSD, what can you do with your NOLCO in the previous year? you can still use it in the subsequent years even in the year where you chose to deduct OSD. It still applies. Same goes for those corporations which are not liable to the 30% but are liable for 2% minimum corporate income tax. When you are liable for 2% mcit in your gross income, you are still subject to income tax, its just that your income tax of 30% is lower than you should pay. Gross income is multiplied at 2% and net income x 30%, thats the reason why there is a big discrepancy in the rate but nonetheless, NOLCO can still be deducted against the corporations operation even it has chosen OSD during the taxable year or even if mcit is its liability. Illustration: (refer to your notes, taas au explanation DMD ) Sales/Receipts Less: Cost of Sales Gross income 5,000,000 5,000,000 5,000,000 5,000,000 Less: itemized deduction exp. 6,000,000 4,000,000 9,000,000 4,000,000 4,000,000 5,000,000 Osd Net Taxable Income (1,000,000) 1,000,000 4,000,000 1,000,000 1,000,000 4,500,000 X 30% -0(1,000,000) (1,000,000) -0NOLCO In year no, 5 cam you use this loss as deduction? Under income tax, corporation is still not exempt. In year no.5 you have to pay income tax of 300,000. 1,000,000 x 30% In year no. 6 it is a NOLCO because How much should you pay to the government? There is net operating loss. There is a zero liability. Corporation a came into an agreement to merge with Corporation B. can the surviving entity claim the NOLCO of Corp A when there was still no merger? YES. NOLCO may be claimed by entity so long as there is no substantial change in ownership. No substantial change in ownership means at least 75% or 75% or more owning both corporations. If thisnis not respected, corporations can easily evade taxes by simply merging. If less than 75%, NOLCO cannot be claimed. Capital transcations usually have a subject of transactions. ii. Capital Loss - governed by rules on loss from the sale or exchange of capital assets. Losses from sales or exchanges of capital assets shall be allowed only to the extent of the gains from such sales or exchanges. Net Capital Loss the excess of capital loss over capital gains Net Capital Loss Carry Over (NOLCO) not available to corporate taxpayers Capital Losses include the following: Iia. Loss arising from failure to exercise privilege to sell or buy property Iib. Securities becoming worthless Iic. Abandonment losses in the case of natural resources
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4th

5th 10,000,000 5,000,000 5,000,000 5,000,000

6th

7th

8th

9th

TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book Iid. Loss from wash sale ot stock securities Wash Sale occurs where it appears that within a period beginning 30days before the date of the sale or disposition of share of stock or securities and ending 30 days after such date, the taxpayer has acquire, substantially identical stock or securities. No deduction for loss shall be allowed for wash sales unless the claim is made by a dealer in stock or securities and with respect to a transaction made in the ordinary course of the business of such dealer. CAPITAL LOSSES Generated from capital transactions. Capital transactions involves: Capital assets capital gain or capital loss What types are considered capital assets? Capital transactions are not normally made in the course of trade and business. Ex. jewelry business any income from selling of vehicles. Capital income, will it be taxable? Will it form part of income tax return? Subject to capital gains tax: 1. Real property situated in Philippines, 6% of gross selling price or fmv whichever is higher pursuant to sec.6 2. Shares of stock not listed and traded in stock exchange or those listed but not traded 3. All others not shares, not property, so long as not considered as ordinary assets Since the law does not provide with all others, we use tax rate as a specific taxpayer. 5-32% any income of all other is still subject to 5-32%. You have to identify which is an ordinary income or capital. Loss generated from a capital transaction NCLCO. Loss generated from capital transaction carried over to the next year. By all? NO. Not available to corporations. You cannot combine NOLCO and NCLCO. It cannot be offset. It maintains separate identity. Example of capital transaction of a corporation? Capital loss of corporations cannot be carried over and assuming it is a capital income, it is subjected to 30%. Would a loss of sale of securities made today against of income of 5days prior, the same? NO. Why losses on wash sales are not deductible? Is gain from wash sales taxable? It is taxable. Income from whatever source is taxable. Loss of such sale is generally not taxable because it is as if a simulated sale. Wash sale - 0days after sale of, it has acquired substantially similar securities. When is loss from wash sales deductible? It is incurred in the course of trade and business. Failure to exercise an option, who will sell to your corporation a parcel of land. You ask 2 weeks within which to decide, in return he REQUIRED you give an option money of 100,000. Within 2 weeks you failed to purchase land, will you recognize as an expense? It is deductible as a capital loss but any loss cannot be carried over as a net capital loss for the simple reason that it is a corporation. But capital loss can only be offset against capital income of corporation including the year coporation did not generate income, the 100,000 loss cannot be offset against income. iii. Wagering or Gambling losses the amount that is deductible must not exceed the gains. Wagering losses are they deductible? Any net generating income is subject to tax. iv. Casualty Losses include losses from fire, storm, shipwreck, other casualty losses, robbery, embezzlement and theft v. Abandonment Losses In the event a contract after where petroleum operations are undertaken is partially or wholly abandoned, all accumulated exploration and development expenditures pertaining thereto shall be allowed as deduction. vi. Special Losses Eg. Loss arising from voluntary removal of buildings as an incident to renewal or replacement b) Common Requisites for Deductibility of Losses i. The loss must be incurred by the taxpayer in the course of his trade, business or profession ii. Losses must be actually sustained and charged off within the taxable year and not mere anticipated losses iii. Must be evidenced by a closed and completed transaction iv. Must not be compensated only the amount not compensated by insurance is deductible v. The loss is not claimed as a deduction for estate tax purposes vi. If it is a casualty loss, the taxpayer has filed a sworn declaration of loss within 45 days after the date of discovery of the casualty or robbery, theft or embezzlement.
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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book 5. Bad Debts These are debts due to the taxpayer which are usually ascertained to be worthless and charged off within the taxable year. a) Requisites for Deductibility of Bad Debts i. Must be valid and subsisting indebtedness ii. Must be ascertained to be worthless iii. Must be charged off and uncollectible within the taxable year iv. Must be uncollectible in the near future and v. Must arise from trade, business, or profession of taxpayer b) Steps i. ii. iii. iv. v. to Prove the Worthlessness There must be a statement of account sent to the debtor A collection letter If he failed to pay, refer the case to a lawyer If lawyer may send a demand letter to the debtor and If the debtor still fails to pay the same, file an action in court for collection

c) Bad Debts Charged Off Subsequently Collected If the recovery of bad debts, resulted in a tax benefit to the taxpayer, that is taxable. If it did not result in any tax benefit to the taxpayer, that is not taxable. Bad debts An indebtedness due to taxpayer but ascertained to be worthless. What are the requisites for a bad debt to deductible? 1. There must be a valid and subsisting indebtedness which must be valid and demandable 2. Connected with taxpayers trade, business or profession 3. Must be ascertained to be worthless 4. Debt must be written off or charged off during the taxable year Can it be between related taxpayers? Can we say that a debt between related taxpayer, fall within the ambit of valid and legally demandable indebtedness? As a general rule, bad debts suffered in a transaction between taxpayers would have the same rate as interest between a loan in related taxpayers. Therefore, If you are not paid by your sister company or affiliate where controlling interest is in one and same person, it will not be deductible bad debt. Third it must be ascertained to be worthless. Debt is an asset of the company, its a receivable. When 1. 2. 3. 4. 5. can you say that a debt is worthless? Statement of account A collection letter If he failed to pay, refer the case to the debtor If lawyer may send a demand letter to the debtor If the debtor still fails to pay the same, file an action in court for collection

If it is ascertained to be worthless this year, it has to be charged off within year. So long as you have ascertained that you have extended to an entity to be worthless, meaning when it ascertained to worthless, it should be charged off within the taxable year. Its in the year of being ascertained, If it is ascertained to be worthless this year, it has to be charged off within year. So long as you determine to be not collectible or uncollectible in the future. If you have a receivable from insurance company where insurance co delayed release of face value, can you consider 5 years of delay as coming within the ambit of worthless within the year or near future? In so far as insurance company is concerned, policy holder cannot consider any receivable from any insurance company as a bad debt. The only time where indebtedness from insurance company to consider as bad debt is when company is due for bankruptcy or insolvency. When can you consider bad debts are taxable when bad debts are considered as taxable expense? If a debt is paid it is no longer considered as bad, if subsequently a bad debt has been deducted in the books of corporation. Any subsequent recover made by creditor shall be considered as taxable income for extent of benefit in the year of payment. Tax Benefit Rule (Section 34.E) Taxes previously allowed as deduction when refunded or credited, shall be included as part of Gross income in the year of receipt to the extent of the income tax benefit of said deduction. 6. Depreciation The gradual diminution of the useful value of the property used in trade, business or profession of the taxpayer, arising from wear & tear or natural obsolescence. The term is also
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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book applied to amortizations of the value of intangible assets, the use of which in trade or business is definitely limited in duration. a) Requisites for Deductibility of Depriciation i. The property must be used in trade, business or profession of the taxpayer ii. There must be depreciable properties The non-depreciable properties are iia. Personal property not used in trade, business or profession of the taxpayer iib. Inventoriable stock and securities iic. Land iid. Mining and other natural resources iii. The allowance for depreciation must be reasonable iv. This must be charged off during the taxable year v. A statement on the allowance must be attached to the return and vi. The method in computing the allowance for depreciation must be in accordance with the method prescribed by the Secretary of Finance upon the recommendation of the BIR Commissioner This prescribed method includes: via. Declining balance method vib. Sum of the years digit method vic. Straight line method vid. Any other method as may be prescribed by Secretary of Finance upon recommendation of the BIR Commissioner. b) Agreement as to Useful Life on which Depreciation Rate is based Where the taxpayer and the CIR have entered into an agreement in writing specifically dealing with the useful life and rate of depreciation of the property, the rate so agreed upon shall be binding on both the taxpayer and the National Government in the absence of facts and circumstances not taken into consideration during the adoption of such agreement. The responsibility of establishing the existence of such facts and circumstances shall rest with the party initiating the modification. c) Deduction for Obsolescence If the whole or any portion of physical property is clearly shown by the taxpayer as being affected by economic conditions that will result in its being abandoned at a future date prior to the end of its natural life, so that depreciation deductions alone would be insufficient to return the cost at the end of its economic terms of usefulness, a reasonable deduction for obsolescence, in addition depreciation, may be allowed. d) Depreciation of Patent or Copyright In computing a depreciation allowance in the case of a patent or copyright, the capital sum to be replaced is the cost or other basis of the patent or copyright over the life of the patent or copyright since its grant or since its acquisition by the taxpayer or since March 1, 1913 as the case may be. What is depreciation? Gradual diminution On wear and tear deduct on depreciation rate Obsolescence extent of property where it has been rendered Can he deduct the depreciation expense? No because it is not related to ordinary course - allowance for depreciation must be reasonable. For an 1. 2. 3. 4. allowance to be reasonable, we follow depreciation methods: Declining balance method Sum of the year digit Straight line method Others: double declining method so long as recognized by sec. of finance as recommended by BIR.

Straight value - acquisition cost. In the books of corporation, you can actually determine the actual spending of corporation, there is actually revenue regulation. If and when you want to change depreciation method how? File for an approval before BIR otherwise no change and cannot be deductible as an expense. Can you change the estimated useful life of property to 10 years without any BIR approval? As a rule you dont need any prior approval as to how many years it is useful, it depends on administration. If ever there has been a prior approval with BIR then that would be the instance where any change in the useful life would be requiring prior approval of BIR.
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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book Assuming that you have a machinery that depreciated in 10 years. How much is depreciation value in every year? At the end of 5th year, the value of property is only 500,000. If you realized at end of 6 th year, it will be considered as obsolete. How much depreciation value will you recognized in year 6? How much is your expense? Your depreciation expense? Obsolescence value? Expense is 500,000. Another instance: Using the straight line method of 10 years, if during the 6 th year it was appraised at 1M still, How much is the depreciation expense in year 6 assuming that the 1M has been recognized. It is still 100,000. Where did you get the 100,000, is it from the acquisition of property. You have not incurred any amount in order for the machinery to be appraised, so the difference between the 500,000 value and the 10million versus appraisal amount of 1M will not allow company to depreciate the whole value its only to the extent of the remaining tax. The appraisal increase there for purposes of presenting the value of machinery in case it will subsequently be sold by corporation. 7. Depletion Depletion is the exhaustion of natural resources like mines and oil and gas wells as a result of production or severance from such mines or wells. These are non-replaceable assets. a) Requisites for Deductibility of Depreciation Same as that of depreciation, except that the properties involved are natural resources Depletion vs Depreciation Depletion and depreciation are predicated on the same basic premise of avoiding a tax on credit. Depletion is based upon the concept of the exhaustion of property, not otherwise a natural resource, used in trade or business or held for the production of income. Thus, depletion and depreciation are made applicable to different types of assets. b) Determination of Amount of Depletion Cost Essential factors: i. The basis of the property ii. The estimated total recoverable units in the property and iii. The number of units recovered during the taxable year c) Intangible Cost in Petroleum Operations Any cost incurred in petroleum operations which in itself has no salvage value and which is incidental to and necessary for the drilling of wells and preparation of wells for the production of petroleum. DEPLETION Can it be used for machineries and equipment? No. What are recognized depreciation methods used in depletion? Factors to determine what should be depleted during the current year: - Basis of property, - Estimated total recoverable units in the property and - Number of units recovered during the taxable year. Since when you purchase a parcel of land where you believe that it is producing only minerals. The parcel of land cannot be depreciated. The parcel of land will be there till the end of time unless there would be armagedon. So if and when you estimate that there will be 10 truckloads of diamond for the entire lifetime of that parcel of land, and during this year you only produced 1 truckload? How much will be the depreciation rate? Estimate of production is 10 truckloads while actual production is 1 truckload, what is the depreciation rate? If the value that is to be depleted is 1M. Estimate usually is peg at 100%. If you get it all. Thats 1 over 10 truckload, depreciation rate is 10%. So during the year, depletion expense is 100,000 which is 10% of the property to be depleted. Property would only refer to natural resources the work is derived because in property once the production is made such natural resources is not easily restored. AMORTIZATION OF INTANGIBLE ASSETS What expense do you recognized when you incur intangible assets? When you spend out intangible assets such as patent, how do you call that expense? Amortization expense. But you cannot amortized intangible properties under Intellectual property code if you have not actually spent for it. 8. Charitable and other Contribution a) Kinds of Charitable Contribution i. Ordinary those which are subject to limitations as to the amount deductible from gross income Limitations: it must not exceed 10% in the case of an individual and 5% in the case of a corporation of the taxpayers taxable income (except where the donation is deductible in full) to be determined without the benefit of the contribution ii. Special those which are deductible in full from gross income
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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book b) Requisites for Deductibility of Charitable and Other Contributions i. The contribution must actually be paid or made to the Philippine government or any political subdivision or to any of the domestic corporations or associations specified by the Tax Code ii. No part of the net income of the beneficiary must inure to the benefit of any private stockholder or individual iii. It must be made within the taxable year iv. It must not exceed 10% in the case of an individual and 5% in the case of a corporation of the taxpayers taxable income (except where the donation is deductible in full) to be determined without the benefit of the contribution and v. It must be evidenced by adequate records or receipts. c) Charitable and Other Contributions which are Fully Deductible If the contributions are given to the following: i. Government or to any of its agencies or political subdivisions, including GOCCs, exclusively to finance, to provide for or to be used in undertaking priority projects Ia. Sports development, science and invention Ib. Health and human settlement Ic. Educational and economic development ii. Foreign government or institution and international which are formed and organizes for any of the following purposes: Iiia. Research Iib. Health Iic. Education Iid. Charitable, cultural, charater building Iie. Sports development and social welfare CHARITABLE CONTRIBUTIONS May a corporation donating property be allowed to deduct the cost of property donated? Assuming that you are a corporation, if this is the data and you made 50,000 contribution, can you reduced the taxable income? Yes. In full? It depends. There are two types of deduction in so far as donation is concerned: 1. Special deductions/Special contributions deductible in full 2. Ordinary type it is subject to some limitation Deductible in Full: what are the requirements? In syllabus. If donor is an individual and donations is worth 2M, it can be deducted against its business income to the extent of 10% of 2M which 200,000. So it can incur as donation expense the extent of 200,000 deductible item. When you say deductible in full what are the 3 entities for which contributions will be recognized as special? Who are the recipients? 1. Government 2. Foreign Institutions 3. Accredited NGOs Assuming its for sports development donated to NGO, can you say that the contribution is fully deductible on the part of donee? It depends if accredited or not. Can donations be contributed to GOCCs? Yes. If its donated to national government, political subdivisions, does that mean it is fully deductible? Who accredits NGO? It will be accredited by respective agencies of the government. So if its a school to whom its donated, it will be accredited by CHED or DSWD. Donation to a non-accredited NGO is not fully deductible. If donation is to NGO duly accredited for sports development purposes but it appears that individual stockholders are receiving profits from regular dividends, is donation deductible? No. donation must not inure to a private stockholder. Charitable contributions and donations are guided by strict requirements because it is very easy to abuse such provision of law. Therefore this are the rules, you distinguish between an ordinary charitable contribution from a special contributions. The difference is that when you have ordinary contributions you have guided by the rules of 5 or 10% but if donation is used to those 3 recipients who are considered as special recipients, it is deductible in full whether or not it exceeds 5 or 10%.
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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book So for purposes of ordinary contribution, if the donor the giving is an individual, it must not exceed of his net taxable income. If the donor is a corporation it must not exceed the 10% of his taxable income, prior to considering donation as an expense. 9. Research and Development Program Research and development expenditures which are paid or incurred by a taxpayer during the taxable year in connection with its trade, business or profession may be treated as ordinary and necessary expenses which are not chargeable to capital account. The expenditures so treated shall be allowed as deduction during the taxable year when paid or incurred. a) Amortization of Certain Research and Development Expenditures The taxpayer may also elect the following research and development expenditures as deferred expenses: i. Paid or incurred by the taxpayer in connection with his trade, business, or profession ii. Not treated as expense iii. Chargeable to capital account but not chargeable to property of a character which is subject to depreciation or depletion b) Non-deductible Research and Develoment Expenditures i. Amount spent for the acquisition or improvements of land for the improvement or development of natural resources ii. Amount paid or incurred for the purposes of ascertaining the existence, location, extent, quality of any natural resources like deposits or one or other minerals oil or gas. RESEARCH AND DEVELOPMENT Is it deductible expense? What is the nature of that expense? Research and development are outright deducted so long as it is in the course of business or trade of taxpayer such as making sample models of a particular product. Outright deduct except? When a research development cost is attached to real property considered as capital asset, it will not be expense outright in the year it has incurred but rather it will be charged with the capital account and it will expense throughout the life of the capital account. In some cases, you are given the option of amortizing the research developments cost whenever its not chargeable to a capital property. In some cases research and development cost are amortized over 60 months or 5 years if 1. It has not been charged as an expense 2. If its not chargeable to a capital account and 3. if its not related to business if not chargeable to capital account, it will be chargeable to the normal ordinary expense which is not capitalized over its useful life. Also it has not been treated as an expense because it has not been deducted because you wish to amortize for 5 years. 10.Contribution to Pension Trusts a) Contributions i. Current year the contribution is considered as ordinary and necessary expenses full deductible ii. Past years if it refers to the services rendered for the past 10 years, the contribution is deductible but apportioned over the next 10 years. (ie. 1/10 deductible every year) b) Requisites for Deductibility of Contributions to Pension Trust i. There must be a pensions or retirement plan established by the employer ii. The pension must be reasonable and actually sound iii. Contribution must be given by the employer to that pension plan iv. The amount contributed must no longer be subject to the control or disposition of the employer v. The payment has not yet been allowed as a deduction vi. This must be for the benefit of the employees vii. The deduction is apportioned in equal parts over a period of (10) consecutive years beginning with the year in which the transfer or payment is made.

CONTRIBUTIONS TO PENSION TRUSTS You are well aware that whatever amount given to an employee pursuant to a retirment plan or pension trust is not taxable so long as it meets the requisites.

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TAX 2011 PRE-FINALS *black = syllabus; red = discussions & book What about the contributions made by the corporations to that retirement plan? It requires regular contributions to make the money grow and adress the future retirEment of its employees. It will be managed by an insurance company or a bank/ When you say it is deductible in full if it is for current year of service and deductible over of 10 years for the past year There is a certain company that has not established a trust for the previous 5 years of its operation. What it did is just to set aside funds in trust account for which any retirement in the future will be addressed by such fund. Meaning 5 years from now, if someone retires, the company will get the payment from such separate fund. If contribution is made annually for 10 years, there is no lapse of 1M contribution every year. Is the 1M contribution deductible? NO. There is no payment here yet. The law says that following certain requirements, any contribution for the current year of service and any contribution for the past year of service is fully deductible and deductible over a period of 10 years. So if and when there is a certain requirement any contribution to the fund is not deductible. If a corporation sets up its own fund for retirement, is it deductible? NO. Because it violates the requirement that it must not be under the control of the corporation but solely for the benefit of the employee. If you put in a fund wherein anytime the corporation can withdraw and address it for some future retirement, youre still having control over the pension fund/retirement plan. Whatever is not taxaable has to satisfy the following conditions: (Requisites for Deductibility of Contributions to Pension Trusts) 1. There must be a pension or retirement plan established by the employer. 2. It must be reasonable and actuarially sound must be reasonable in amount. 3. Contributions must be given by the employer to that pension plan. 4. The amount contributed must no longer be subject to the control or disposition of the employer. 5. The payment has not yet been allowed a deduction. 6. This must be for the benefit of the employees; and 7. The deduction apportioned in equal parts over a period of 10 consecutive years beginning with the year in which the transfer or payment is made. The labor code provides that there must be a retirement plan otherwise the law still guarantees receive retirement payments which are tax free. If on the 6 th year, after establishing no pension/retirement plan, it hired an actuarial (persons who determine what is due to the person years from now), and its approved by the BIR. Deductble. If the contribution made by ER is for the current year of service (the annual for year 6) 1M every year. So in year 6, the corp has to pay 1M for this current year of service of the entire pool of employees. Since they have already rendered service for the past 5 years, there must be computation of their service for the past years of service. Usually when you retire, its of 1months salaray according to the number of years of service. So there must be due contributon for the 5 years of past service to the company. Following the common requisites that expenses must be charged off or payed during the taxable year, only the current contribution for current services will be deductible fully. As for the contributions for the past 5 years, its deductible but since it is for the past years of service, it does not satisfy the requirement of during the year, but there is due recognition because its for labor, its deductible over the period of the next 10 years. GOD BLESS

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