You are on page 1of 63

NIVERSITY OF THE PHILIPPINES

COLLEGE OF LAW
Bar Operations 2008

TAXATION LAW




Bar Operations Head
Arianne Reyes

Academics Head
Henry Aguda
Ryan Balisacan

Subject Head
Erwin Matib




Subject Committee
Ryan Romero, Diane Rosacia, Aimee Salamat, Maricon
Maralit, Kate Modesto

Information Management
Committee
Chino Baybay [Head] * Simoun Salinas [Deputy] * Rania Joya
[Design & Lay-out] * Ludee Pulido [Documentations] * Linus
Madamba * Des Mayoralgo * Jillian De Dumo * Mike
Ocampo * Abel Maglanque * Edan Marri R. Caete





1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 2 22 2 of 163 163 163 163
BASIC CONCEPTS TAXATION
Taxation Law 1 Taxation Law 1 Taxation Law 1 Taxation Law 1
TABLE OF CONTENTS TABLE OF CONTENTS TABLE OF CONTENTS TABLE OF CONTENTS

I. I. I. I. Basic Concepts in Income Taxation 3
II. II. II. II. General Classification of Taxpayers General Classification of Taxpayers General Classification of Taxpayers General Classification of Taxpayers 4 44 4
III. III. III. III. Tax on Individuals Tax on Individuals Tax on Individuals Tax on Individuals 5 55 5
IV. IV. IV. IV. Tax on Corporations Tax on Corporations Tax on Corporations Tax on Corporations 1 11 11 11 1
V. V. V. V. Taxation of Fringe Benefits Taxation of Fringe Benefits Taxation of Fringe Benefits Taxation of Fringe Benefits 2 22 21 11 1
VI. VI. VI. VI. T TT Taxation on Partnerships axation on Partnerships axation on Partnerships axation on Partnerships 2 22 23 33 3
VII. VII. VII. VII. Taxation on Estates and Trusts Taxation on Estates and Trusts Taxation on Estates and Trusts Taxation on Estates and Trusts 2 22 24 44 4
VIII. VIII. VIII. VIII. Source of Income Source of Income Source of Income Source of Income 2 22 25 55 5
IX. IX. IX. IX. Gross Income Gross Income Gross Income Gross Income 2 22 28 88 8
X. X. X. X. Exclusions from Gross Income Exclusions from Gross Income Exclusions from Gross Income Exclusions from Gross Income 3 33 30 00 0
XI. XI. XI. XI. Allowable deductions from Gross Income Allowable deductions from Gross Income Allowable deductions from Gross Income Allowable deductions from Gross Income 3 33 32 22 2
XII. XII. XII. XII. Non Non Non Non- -- -deductible expenses deductible expenses deductible expenses deductible expenses 5 55 52 22 2
XIII. XIII. XIII. XIII. Capital Gain Capital Gain Capital Gain Capital Gains and Losses s and Losses s and Losses s and Losses 5 55 52 22 2
XIV. XIV. XIV. XIV. Situs of Taxation Situs of Taxation Situs of Taxation Situs of Taxation 5 55 55 55 5
XV. XV. XV. XV. Installment Basis Installment Basis Installment Basis Installment Basis 5 55 56 66 6
XVI. XVI. XVI. XVI. Returns and Payments of Tax/Withholding Taxes Returns and Payments of Tax/Withholding Taxes Returns and Payments of Tax/Withholding Taxes Returns and Payments of Tax/Withholding Taxes 5 55 57 77 7




1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 3 33 3 of 163 163 163 163
TAXATION LAW 1
I. I. I. I. BASIC CONCEPTS IN INCOME BASIC CONCEPTS IN INCOME BASIC CONCEPTS IN INCOME BASIC CONCEPTS IN INCOME
TAXATION TAXATION TAXATION TAXATION

Income Tax defined as a tax on all yearly
profits arising from property, professions,
trades or offices.
a tax on the net income or the entire
income realized in one taxable year.

Nature of income tax (PED)
DIRECT TAX the tax burden is borne by
the income recipient upon whom the tax
is imposed.
PROGRESSIVE TAX the tax base
increases as the tax rate increases.
EXCISE TAX (privilege tax) a tax on the
right to earn income

Purpose(s) of Income Tax: Fiscal/Non-Fiscal
(ROM)
raise revenue to defray the expenses of the
government;
offset regressive sales and consumption
taxes; and
together with estate tax, mitigate the evils
arising from the inequalities of wealth by a
progressive scheme of taxation which places
the burden on those best able to pay.

Income all wealth which flows to the taxpayer
other than a mere return of capital
It is an amount of money coming to a
person/corporation within a specified time,
whether as payment for services, interest or
profit from investment. Unless otherwise
specified, it means cash or its equivalent.
Income can also be thought of as a flow of
the fruits of one's labor. (Conwi v. Court of
Tax Appeals)
Income includes earnings, lawfully or
unlawfully acquired, without consensual
recognition, express or implied, of an
obligation to repay and without restriction as
their disposition.

Differentiated from Capital
o Capital is a fund; income is a flow. A fund of
property existing at an instant of time is
called capital. A flow of services rendered by
that capital by the payment of money from it
or any other benefit rendered by a fund of
capital in relation to such fund through a
period of time is called income.
o Capital is wealth, while income is the service
of wealth. The Supreme Court of Georgia
expresses the thought in the following
figurative language: "The fact is that property
is a tree, income is the fruit; labor is a tree,
income the fruit; capital is a tree, income the
fruit." A tax on income is not a tax on
property. "Income," as here used, can be
defined as "profits or gains." (Madrigal v.
Rafferty)

Increase in Property Value A mere
increase in the value of property is NOT
INCOME, but merely unrealized increase
in capital. The increase in the value of
property is also known as appraisal
surplus or revaluation increment.

Classification of Income According to Source
1. Income from sources within the Philippines
2. Income from sources without the Philippines
3. Income from sources partly within and
partly without the Philippines

Taxability of Income, Requisites
a. there is income, gain or profit
b. the income, gain or profit is received or
realized during the taxable year
c. the income gain or profit is not exempt from
income tax

Tests to Determine Realization of Income
for Tax Purposes
Realization Test no taxable income until
there is a separation from capital of
something of exchangeable value, thereby
supplying the realization or transmutation
which would result in the receipt of income.
Claim of right doctrine a taxable gain is
conditioned upon the presence of a claim of
right to the alleged gain and the absence of a
definite unconditional obligation to return or
repay that which would otherwise constitute a
gain.
Principle of Constructive Receipt of
Income Income which is credited to the
account of or set apart for a taxpayer and
which may be drawn upon by him at any
time is subject to tax for the year during
which so credited or set apart, although not
then actually reduced to possession. The
income must be credited to the taxpayer
without any substantial limitation or
restriction as to the time or manner of
payment or condition upon which payment
is to be made.
Economic benefit test any economic
benefit to the employee that increases his net
worth is taxable.

Classifications of Income Subject to
Philippine Income Tax
1. Compensation Income derived from
rendering of services under an employer-
employee relationship.
2. Professional Income fees derived from
engaging in an endeavor requiring special
training as professional as a means of
livelihood (e.g. the fees of CPAs, doctors,
lawyers, engineers)
3. Business Income gains or profits derived
from rendering services, selling merchandise,
manufacturing products, farming and long-
term construction contracts
4. Passive Income income in which the
taxpayer merely waits for the amount to
come in (e.g. interest income, royalty
income, dividend income, winnings and
prizes)
5. Capital Gain gain from dealings in capital
assets









1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 4 44 4 of 163 163 163 163
TAXATION LAW 1
II. GENERAL CLASSIFICATION OF TAXPAYERS II. GENERAL CLASSIFICATION OF TAXPAYERS II. GENERAL CLASSIFICATION OF TAXPAYERS II. GENERAL CLASSIFICATION OF TAXPAYERS

Who is a taxpayer?
Under Sec 22(N), a taxpayer is any person subject to [income] tax. Income taxpayers, with distinction
based on the amount of income subject to tax, or the applicable tax rates, or both, are classified as
follows:


Primary
Classification
Sub-Classification(s)
Individuals
Citizens of
the
Philippines
Residents of the Philippines
Not Residents of the Philippines
Aliens
Residents of the Philippines
Not
Residents
of the
Philippines
Engaged in Trade or Business in the Philippines
Not Engaged in Trade or Business in the Philippines
Special
Classes of
Individuals
Individual Employed by Regional or Area Headquarters and Regional
Operating Headquarters of Multinational Companies
Individual Employed by Offshore Banking Units
Individual Employed by a foreign service contractor or by a foreign service
subcontractor engaged in petroleum operations in the Philippines
Estates and
Trusts

Corporations
Domestic Corporations
Foreign
Corporations
Resident Corporations
Non-resident Corporations
Special Classes
of Corporations
Proprietary educational institutions and non-profit hospitals
Domestic Depositary Bank (Foreign Currency Deposit Units)
Resident international carriers
Offshore Banking Units
Resident Depositary Bank (Foreign Currency Deposit Units)
Regional or Area Headquarters and Regional Operating Headquarters
of Multinational Companies
Non-resident cinematographic film owners, lessors or distributors
Non-resident owners or lessors of vessels chartered by Philippine
nationals
Non-resident lessors of aircraft, machinery and other equipment



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 5 55 5 of 163 163 163 163
TAXATION LAW 1
III. TAX ON INDIVIDUALS III. TAX ON INDIVIDUALS III. TAX ON INDIVIDUALS III. TAX ON INDIVIDUALS

A. Classifications of Individual Taxpayers

1. Citizens

RESIDENT a citizen is deemed as a resident of
the Philippines unless he qualifies as a non-
resident under Sec. 22E of the NIRC;
-taxable for income derived from all sources
based on taxable (i.e., net) income

NON-RESIDENT a citizen of the Philippines
who:
(1) establishes to the satisfaction of the
Commissioner the fact of his physical
presence abroad with a definite intention to
reside therein.
(2) Leaves the Philippines during the taxable
year to reside abroad, either as an
immigrant or for employment on a
permanent basis.
(3) Works and derives income from abroad and
whose employment thereat requires him to
be physically present abroad most of the
time during the taxable year.
(4) Has been previously considered as
nonresident citizen and who arrives in the
Philippines at any time during the taxable
year to reside permanently in the Philippines
shall likewise be treated as a non-resident
citizen for the taxable year in which he
arrives in the Philippines with respect to his
income derived from sources abroad UNTIL
the date of his arrival in the Philippines.
taxable for income derived within the
Philippines based on taxable (i.e., net)
income

NOTES:
An OVERSEAS CONTRACT WORKER is taxable
only on income from sources within the
Philippines. (Sec. 23 (c))
o NOTE FURTHER: A seaman who is a
Filipino citizen and who receives
compensation for services rendered abroad
as member of the complement of a vessel
engaged exclusively in international trade is
treated as an overseas contract worker.
Length of stay is indicative of
intention. A citizen of the Philippines who
shall have stayed outside the Philippines for
183 days or more by the end of the year is
a non-resident citizen. His presence
abroad, however, need not be continuous.
[RR1-79]

2. Alien
RESIDENT residence is within the Philippines
and who is not a citizen thereof. An alien actually
present in the Philippines who is not a mere
transient or sojourner is a resident of the
Philippines for income tax purposes. A mere
floating intention, indefinite as to time, to return
to another country is not sufficient to constitute
him a transient.
taxable for income derived within the
Philippines based on taxable (i.e., net)
income

NON-RESIDENT residence is NOT in the
Philippines and who is not a citizen thereof.
Engaged in trade or business in the
Philippines (NRAETB) - is taxable for
income derived within the Philippines based
on taxable (i.e., net) income
Engaged in trade or business in the
Philippines (NRANETB) - is taxable for
income derived within the Philippines based
on gross income
1


NOTES:
What makes an alien a resident or non-resident
alien is his intention with regard to the
length and nature of his stay. Thus:
a. One who comes to the Philippines for a
definite purpose which in its very nature may
be promptly accomplished is not a resident
citizen.
b. One who comes to the Philippines for a
definite purpose which in its very nature
would require an extended stay, and to that
end, makes his home temporarily in the
Philippines, becomes a resident, though it
may be his intention at all times to return to
his domicile abroad when the purpose for
which he came has been consummated or
abandoned. (Sec. 5, RR 2)
Length of stay is indicative of intention.
An alien who shall have stayed in the
Philippines for more than one year by the
end of the taxable year is a resident alien.
NOTE FURTHER: An alien who shall come to
the Philippines and stay for an aggregate
period of more than one hundred eighty
days during a calendar year shall be
considered a non-resident alien in
business, or in the practice of profession, in
the Philippines. [Sec. 25(A)(1)] Thus, if an
alien stays in the Philippines for 180 days or
less during the calendar year, he shall be
deemed a non-resident alien not doing
business in the Philippines, regardless of
whether he owns
1. Stock in trade of the taxpayer, or other
property of a kind which would properly
be included in an inventory of a taxpayer
if on hand at the end of the taxable year
(example: Raw Materials Inventory, Work
in Process Inventory, Office Supplies
Inventory)
2. Property held by the taxpayer primarily
for sale to customers in the ordinary
course of his trade or business (example:
Merchandise Inventory)
3. Property used in the trade or business
which is subject to the allowance for
depreciation (example: Office
Equipment)
actually engages in trade or business
therein. (Mamalateo)


B. Three Kinds of Income

Capital Gains subject to Capital Gains Tax

When the asset sold was held as a capital asset,
the gain or loss is called a capital gain or loss.
When the asset sold was not held as a capital

1
Notwithstanding the general classification of aliens into
resident and non-resident for income tax purposes, note that
there is a special classification of aliens who are taxed
differently. See subsection D.



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 6 66 6 of 163 163 163 163
TAXATION LAW 1
asset (in other words, as an ordinary asset), the
gain or loss is called an ordinary gain or loss.

What are capital assets? those not
considered as ordinary assets!

What are ordinary assets? FOUR
CATEGORIES OF ORDINARY ASSETS are as
follows [Sec. 39]: (RIDS)Real property used in
trade or business of the taxpayer (example:
Building used as a factory)

-Are all sales / dispositions of capital assets
subject to capital gains tax? NO! Only two
kinds of things held as capital assets are subject
to the capital gains tax, as follows:

1. On sale, barter, exchange or other
disposition of shares of stock of a domestic
corporation not listed and traded through
a local stock exchange, held as a capital
asset:

On the net capital gain:

Not over P100,000 = Final Tax of 5%

On any amount in excess of P100,000 =
plus Final Tax of 10% on the excess

Key definitions

Net capital gain selling price less cost

Selling price consideration on the sale OR
fair market value of the shares of stock at the
time of the sale, whichever is HIGHER

Cost original purchase price

2. On sale, exchange, or other disposition of
real property in the Philippines, held as a
capital asset On the gross selling price, or
the current fair market value at the time of
the sale, whichever is higher, a final tax of
6%

-The capital gains tax is applied on the gross
selling price, or the current fair market value
at the time of the sale, whichever is higher.
Any gain or loss on the sale is immaterial
because there is a conclusive presumption
by law that the sale resulted in a gain.

EXCEPTION: When sale of residence is
not liable for capital gains tax?

a. There is a sale or disposition of their
principal residence by natural persons.

b. The proceeds of the sale are fully
utilized in acquiring or
constructing a new principal
residence within 18 calendar
months from the date of sale or
disposition.

The Commissioner shall have been duly
notified by the taxpayer within 30 days
from the date of sale or disposition
through a prescribed return of his
intention to avail of the tax exemption.

A deposit is made of the 6% capital gain
tax otherwise due, in cash or managers
check, in an interest-bearing account with
an Authorized Agent Bank (AAB), under
an Escrow Agreement between the
taxpayer and the Bureau of Internal
Revenue that the same shall be released
to the taxpayer when the proceeds of the
sale shall have been utilized as intended.

The tax exemption can only be availed of
once every 10 years

If there is no full utilization of the
proceeds of sale or disposition, the portion
of the gain presumed to have been
realized from the sale or disposition shall
be subject to capital gains tax (CGT). The
GSP or FMV at the time of sale, whichever
is higher, shall be multiplied by a fraction
which the unutilized amount bears to the
gross selling price in order to determine
the taxable portion.

i.e.,
Unutilized amount x (higher of ) = Taxable
GSP GSP or FMV portion


ALTERNATIVE TAXATION:
In case of a sale or other disposition of
real property to the government or any
of its political subdivisions or agencies or
to government-owned or controlled
corporations, the tax shall be EITHER
the year-end tax of the individual (i.e.,
capital gain to be included in the
computation of income subject to
schedular rates),


OR the capital gain tax of 6%, at the
option of the taxpayer

What is the tax implication of a sale
/ disposition of a capital asset NOT
subject to capital gains tax? The
net capital gain or loss is included in the
computation of net income subject to
schedular rates (5% to 32%).

3. Passive Income subject to Final Tax
Final tax means tax withheld from
source, and the amount received by the
income earner is net of the tax already.
The tax withheld by the income payor is
remitted by him to the BIR. The income
having been tax-paid already, it need not
be included in the income tax return at
the end of the year. These passive
income items are as follows:
Interest Income:
o on any currency bank deposit, yield or
any other monetary benefit from
deposit substitutes, trust funds and
similar arrangements - 20% final tax
o under the expanded foreign currency
deposit system (EFCDS) - 7.5% final
tax for residents, exempt if non-
residents
o on long-term deposit or investment
certificates (LTDIC) in banks (e.g.,
savings, common or individual trust
funds, deposit substitutes, investment



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 7 77 7 of 163 163 163 163
TAXATION LAW 1
management accounts and other
investments, which have maturity of 5
years or more) exempt
Should LTDIC holder pre-terminate
LTDIC before the 5th year, a final
tax shall be imposed on the entire
income based on the remaining
maturity:

4 years to less than 5 years 5%
3 years to less than 4 years 12%
less than 3 years 20%


Dividends
o cash and/or property dividends
2

actually or constructively received by
an individual from
a domestic corporation
a joint stock company
insurance or mutual fund
companies
regional operating headquarters
of multinational companies
o share of an individual in the
distributable net income after tax of a
partnership (except a general
professional partnership) of which he is
a partner
o share of an individual member or co-
venturer in the net income after tax of
an association, a joint account, or a
joint venture or consortium taxable as
a corporation
Rate 10% for residents (RC,
RA) and non-resident citizens (NRC),
20% for NRAETB (non-
resident aliens engaged in trade
or business)

Royalties
o From books, literary works, and
musical compositions 10%
o Other royalties 20%

Winnings, except Philippine Charity
sweepstakes / lotto winnings 20%

Prizes exceeding P10,000 20%
o Prize, differentiated from winnings A
prize is the result of an effort made
(e.g., prize in a beauty contest), while
winnings are the result of a transaction
where the outcome depends upon
chance (e.g., betting).



2
A stock dividend representing the transfer of surplus to
capital account shall not be subject to tax. However, if a
corporation cancels or redeems stock issued as a dividend at
such time and in such manner as to make the distribution and
cancellation or redemption, in whole or in part, essentially
equivalent to the distribution of a taxable dividend, the amount
so distributed in redemption or cancellation of the stock shall be
considered as taxable income to the extent that it represents a
distribution of earnings or profits. (Sec. 73B, NIRC) [In other
words, stock dividends are generally not subject to tax as long
as there are no options in lieu of the shares of stock. On the
other hand, a stock dividend constitutes income if it gives
the shareholder an interest different from that which his
former stockholdings represented.]
4. Other Income subject to Schedular
Tax Rates
3

Income which is neither capital gain with
capital gain tax, nor passive income with
final tax, is other income or residual
income. It may be derived from:
1. Employer-employee relationship,
which is called compensation
income
2. Business or profession
3. Sale or exchange of property which
is not subject to the capital gain tax
4. Incidental sources, such as interest
or dividend, which is not subject to
final tax (i.e., dividend from a
foreign corporation in case of
resident citizens, rent income).
The tax rates on NET ordinary
or other income (schedular
rates)
4
are as follows:
Income
over
But
less
than
Tax Plus of
Excess
over
10,000 5%
10,000 30,000 500 10% 10,000
30,000 70,000 2,500 15% 30,000
70,000 140,000 8,500 20% 70,000
140,000 250,000 22,500 25% 140,000
250,000 500,000 50,000 30% 250,000
500,000 125,000 32% 500,000

Rule for Married Individuals Married
individuals, whether citizens, resident or
nonresident aliens, who do not derive income
purely from compensation, shall file a return for
the taxable year to include the income of both
spouses. [Sec 51(D)]
1. Compute the income tax separately on
their respective incomes.
2. Add the two taxes to arrive at a single
income tax still due and refundable.
3. Income which is clearly joint, or which
cannot be identified as exclusively of one
spouse, will be divided equally. [Sec
24(A)]
o EXCEPTION to the one-return rule:
Where it is impracticable for the
spouses to file one return, each
spouse may file a separate return of
income but the returns so filed shall
be consolidated by the Bureau for
purposes of verification for the taxable
year. [Sec 51(D)]

3
Schedular tax rates apply to all classes of individuals, with the
exception of non-resident aliens not engaged in trade or
business. Should NRANETB earn other income, such is
subject to a 25% final tax.
4
Pro-forma computation of income subject to schedular tax
rates:
Gross Compensation Income P xxx
Less: Personal Exemptions (xxx)
Health Insurance (xxx)
Net Compensation Income P xxx
Add: Net Business Income xxx
Net Professional Income xxx
Other Income
(capital gains, rent, etc.) xxx
Net Income subject to schedular tax rates
P xxx
where Net Business Income and Net Professional Income are
computed as follows:
Gross Business / Professional Income P xxx
Less: Itemized Deductions [OR]
Optional Standard Deduction (xxx)
Net Business / Professional Income P xxx



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 8 88 8 of 163 163 163 163
TAXATION LAW 1

B. Deductions [from Income Subject to
Schedular Tax Rates], In General
The allowable deductions from the gross income
of an individual taxpayer
5
are as follows:

Business Expenses and Expenses from
Practice of Profession deductible only
from business gross income and professional
income, respectively but not from
compensation income.
6
The expenses to be
deducted may either be itemized deductions
OR the optional standard deduction.
7


Special deduction for actual premium
payments for health and/or
hospitalization insurance taken by an
individual taxpayer provided that the
following requisites are met:
a. The taxpayers family gross income
does not exceed P250,000 in a
taxable year.
b. The amount deductible should only
be limited to P2,400 per family or
P200 per month.
In the case of married taxpayers, only
the spouse claiming the additional
exemption for dependents shall be
entitled to this deduction.

Personal Exemptions are arbitrary
amounts allowed by law to be deducted from
income to cover personal, living, or family
expenses of the taxpayer. These deductions
are allowed on the theory that the minimum
requirements of subsistence of a taxpayer
should be free from tax.

Kinds:

1. Basic Personal Exemptions

Kind of Taxpayer Basic Personal
Exemption (BPE)
Single individuals
(includes widow/er)
P20,000
Married individual who
are
judicially decreed as
legally separated,
and
with no qualified
dependents
P20,000
Head of Family P25,000
Each married individual * P32,000

* BUT note Sec 35(A) - In the case of
married individuals where only one of
the spouses is deriving gross income,
only such spouse shall be allowed the
personal exemption.

5
Remember that non-resident aliens not engaged in trade or
business are taxed on gross income. They may not, therefore,
avail of these deductions.
6
Thus, the only deductions that may be claimed by individuals
with compensation income only are personal exemptions and
premium payments on health and/or hospitalization insurance.
7
See Allowable Deductions from Gross Income for the detailed
discussion on itemized deductions and the optional standard
deduction.

Who is a Head of the Family? [Sec 35(A),
NIRC]
1. An unmarried or legally separated man or
woman with dependents who may be
- one or both parents
- one or more brothers or sisters, or
- one or more legitimate, illegitimate or
legally adopted children

Note: Senior Citizen Law (RA 7434 as
amended by 9257) provides in section 4
that senior citizens shall be treated as
dependents provided for in the NIRC, as
amended and as such, individual
taxpayers caring for them, be they be
relatives or not shall be accorded the
privileges granted by the Code insofar as
having dependents are concerned.

2. Such dependent must be living with AND
dependent upon him for chief support

- Chief support principal or main
support given regularly such that
withdrawal will result in destitute life
for dependent; includes situations
where taxpayer is away from home
on business, or dependent is away at
school

more than one-half of the
requirements for support. Hence, if
two children contribute equal
amounts to the support of a parent,
neither of them qualify as head of the
family.

3. Such brothers or sisters or children are
not more than 21 years old
unmarried and
not gainfully employed
OR
regardless of age, are incapable of
self-support because of mental or
physical defect.


2. Additional Exemptions (AE) depends on the
number of qualified dependent children
- Amount allowed as a deduction P8,000 per
dependent child, but not to exceed four children
- Who may claim additional exemptions?
Married Individuals Additional exemptions are
claimed by only one spouse. Generally, the
spouse who is the gross compensation earner is
the claimant of the additional exemptions. Where
the husband and wife are both compensation
income earners, the husband is the proper
claimant of the additional exemptions EXCEPT if
there is an express waiver by the husband in
favor of his wife, as embodied in the withholding
exemption certificate. When the spouses have
business and/or professional income only, either
may claim the additional exemptions at the end
of the year. The wife claims the additional
exemptions in the following instances:
i. husband has no income
ii. husband works abroad
iii. Legally separated spouses Additional
exemptions can be claimed by the spouse with
custody of the child or children (but the total
amount for the spouses shall not exceed the
maximum of four). [Sec 35(B), NIRC]



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 9 99 9 of 163 163 163 163
TAXATION LAW 1

Who is a dependent for purposes of
additional exemptions? A legitimate,
illegitimate or legally adopted child chiefly
dependent upon and living with the taxpayer:
1. not more than 21 years old, unmarried and
not gainfully employed OR
2. regardless of age, is incapable of self-
support because of mental or physical defect

NOTE: Only children may be considered
dependent for purposes of additional
exemptions.

Who may claim personal exemptions?
Citizens (whether resident or non-resident) and
resident aliens are allowed to avail of basic
personal and additional exemptions. Non-
resident aliens engaged in trade or business
are entitled to basic personal exemptions only by
way of reciprocity, but not to additional
exemptions. [Sec. 35, NIRC]
Limit of BPE Allowed to NRAETB: An
amount equal to the exemptions allowed by
the non-resident aliens country to Filipino
citizens not residing therein but deriving
income therefrom, but not to exceed the
amount fixed by NIRC.[In other words,
whichever is LOWER]

Change of Status [Sec 35(C), NIRC]
1. If taxpayer marries during taxable year,
taxpayer may claim the corresponding BPE
in full for such year (i.e., no need to pro-
rate the exemption).
2. If taxpayer should have additional
dependent(s) during taxable year, taxpayer
may claim corresponding AE in full for such
year.
3. If taxpayer dies during taxable year, his
estate may still claim BPE and AE for
himself and his dependent(s) as if he died
at the close of such year.

4. If during the taxable year
a. spouse dies or
b. any of the dependents dies or marries,
turns 21 years old or becomes gainfully
employed, taxpayer may still claim same
exemptions as if the spouse or any of
the dependents died, or married, turned
21 years old or became gainfully
employed at the close of such year.

TIP: When it comes to change of status, the
status beneficial to the taxpayer is used for
purposes of claiming deductions as long as the
taxpayer achieved such status at any time
during the taxable period.

D. Special Classification of Individuals and
Corresponding Tax Treatment [Sec 25(C),
(D), (E)]
1. Alien individuals employed by:
a. Regional or Area Headquarters
(RAHQ) and Regional Operating
Headquarters (ROHQ) established in
the Philippines by multinational
companies
o Multinational company, defined
a foreign firm or entity
engaged in international trade
with affiliates or subsidiaries or
branch offices in the Asia-
Pacific Region and other foreign
markets
b. Offshore Banking Units established
in the Philippines

2. Alien individuals who are permanent
residents of a foreign country but who
are employed and assigned in the
Philippines by a foreign service contractor
or by a foreign service subcontractor
engaged in petroleum operations in
the Philippines

Tax Rate and Base - 15% of gross
income received as salaries, wages,
annuities, compensation, remuneration
and other emoluments, such as
honoraria and allowances
o The same tax treatment shall apply
to Filipinos employed and
occupying the same positions as
those of aliens employed by these
multinational companies, offshore
banking units and petroleum
service contractors and
subcontractors.

Note that the coverage of the special
classification (and the corresponding
tax rate) is limited to income
received as wages. Hence, any
income earned from all other sources
within the Philippines by the alien
employees shall be subject to the
pertinent income tax (example: sale of
real property in the Philippines is
subject to 6% capital gain tax, imposed
on the gross selling price or fair market
value of the property at the time of the
sale, whichever is higher).












1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 10 10 10 10 of 163 163 163 163
TAXATION LAW 1
E. Summary of Tax Bases and Tax Rates

QUICK GLANCE


CATEGORY OF INCOME
RESIDENT NON-RESIDENT
CITIZEN ALIEN CITIZEN NRAETB
NRANET
B
All sources
Within the
Philippine
s
Within the
Philippine
s
Within the
Philippine
s
Within the
Philippine
s
1. Compensation / Business /
Profession

2. Prizes of P10,000 or less

3. Proprietary, Educational /
Hospital

4. Cinematographic Film and the
like


Based on Taxable (i.e, Net) Income
Schedular Income Tax Rates (Sec. 24, NIRC)
(i.e, 5% to 32%)
GIW
25%
Not
Applicable

GIW -
25%
GIW
25%
5. Interest from any currency bank
deposit , etc., Royalties (other
than from books, literary works
and musical compositions),
Winnings / Prizes (except prizes
P10,000 and below)

GIW 20% Final Withholding Tax
6. Royalties from books, literary
works, musical compositions

GIW 10% Final Withholding Tax
7. Interest from long-term deposit
or investment certificates, which
have a maturity of 5 years or
more

EXEMPT; However:
In case of pre-termination, with remaining
maturity of:
4 years to less than 5 years 5% on entire
income
3 years to less than 4 years 12% on entire
income
less than 3 years 20% on entire income
8. Cash / Property Dividends from a
domestic corporation, etc., OR
share in the distributable net
income after tax of a partnership
(except a general professional
partnership), etc.

GIW 10% Final Withholding Tax
GIW
20%
9. Interest (Expanded Foreign
Currency Deposit System)

GIW 7.5% Final
Withholding Tax
EXEMPT
10. Winnings on Philippine
Sweepstakes / Lotto

EXEMPT
11. Capital Gains on Sale of Shares
(not traded in a domestic stock
exchange)

Net Capital Gains within:
Not Over P100,000 5% Final Tax
Amount in Excess of P100,000 plus 10% Final Tax on the
excess
12. Capital Gains on Sale of Real
Property in the Philippines

Gross Selling Price or FMV, whichever is higher 6% Final Tax
13. Sale of Shares (traded in a
domestic stock exchange)

of 1% of the Selling Price (Stock Transaction Tax)
Note: Stock Transaction Tax is not an income tax, but a
business (percentage) tax
Legend:
GIW Gross Income within the Philippines
FMV Fair Market Value
C
a
p
i
t
a
l

G
a
i
n
s
,

s
u
b
j
e
c
t

t
o

C
a
p
i
t
a
l

G
a
i
n
s

T
a
x

P
a
s
s
i
v
e

I
n
c
o
m
e

f
r
o
m

d
o
m
e
s
t
i
c

s
o
u
r
c
e
s
,


s
u
b
j
e
c
t

t
o

F
i
n
a
l

T
a
x

O
t
h
e
r

I
n
c
o
m
e

,

s
u
b
j
e
c
t

t
o

G
r
a
d
u
a
t
e
d

T
a
x

R
a
t
e
s
,

e
x
c
e
p
t

f
o
r

N
R
A
N
E
T
B




1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 11 11 11 11 of 163 163 163 163
TAXATION LAW 1
IV. TAX ON CORPORATIONS IV. TAX ON CORPORATIONS IV. TAX ON CORPORATIONS IV. TAX ON CORPORATIONS

A. Coverage of the term Corporation [Sec
22(B)] The term corporation includes
partnerships, no matter how created or
organized, joint-stock companies, joint accounts
(cuentas en participacion), associations, or
insurance companies

It does NOT include:
1. general professional partnerships
(partnerships formed by persons for the
sole purpose of exercising their common
profession, no part of the income of
which is derived from engaging in any
trade or business)
2. joint venture or consortium formed for
the purpose of undertaking construction
projects or engaging in petroleum,
coal, geothermal and other energy
operations pursuant to an operating
consortium agreement under a service
contract with the Government.
8


B. Classification of Corporations

General Types
1. Domestic Corporation (DC) - one
created or organized in the Philippines or
under its laws [Sec 22(C)]
2. Foreign Corporation (FC) one that is
not domestic [Sec 22(D)]
Resident Foreign Corporation (RFC)
- a foreign corporation engaged in
trade or business within the Philippines
[Sec 22(H)]
9

Non-resident foreign corporation
(NRFC) - a foreign corporation not
engaged in trade or business within the
Philippines [Sec 22(I)]

Special Types
1. Proprietary educational institutions and
non-profit hospitals
2. Domestic Depository Bank (Foreign
Currency Deposit Units)
3. Offshore Banking Units
4. Resident Depository Bank (Foreign
Currency Deposit Units)
5. Resident international carrier
6. Non-resident owner or lessor of vessel
7. Non-resident cinematographic film owner,
lessor or distributor
8. Non-resident lessor of aircraft, machinery
and other equipment
9. Regional/Area Headquarters & Regional
Operating Headquarters of Multinational
companies

8
In this case, the joint venture [as an entity] is not subject to
income tax, but each member of the joint venture shall be
taxable on his/its share in the net income of the corporation. On
the other hand, a joint venture constituted for purposes other
than (2) above is treated as a corporation and taxable as such.
9
The qualifier resident in the term resident foreign
corporation should not be equated with the nationality of the
corporation. In determining nationality, the control test is often
invoked and applied, which considers corporate nationality by
the nationality of its controlling shareholders or members.
(Mamalateo, citing Winship v. Philippine Trust Co., 90 Phil 744)
Thus, for income tax purposes, a domestic corporation may be
formed or organized by foreigners (as long as three of them are
residents of the Philippines as per the Corporation
Code),provided that it is organized under the laws of the
Philippines.

C. Scope of Taxation

QUICK GLANCE

Type of
Corporation
Sources of
Taxable
Income
Allowed
Business
Deductions?
Domestic
Corporation (DC)
Within and
without the
Philippines
Yes
Resident Foreign
Corporation (RFC)
Within the
Philippines
Yes
Non-resident
Foreign Corporation
(NRFC)
Within the
Philippines
No*
* - Ergo, non-resident foreign corporations are
taxed on GROSS INCOME.


NOTE: A good example of a resident foreign
corporation is the Philippine branch of a foreign
corporation duly licensed by the Securities and
Exchange Commission. The Philippine branch is
merely an extension of the foreign head office
(i.e., non-resident foreign corporation); hence it
does not have nor issue Philippine shares of
stock. There is only one single entity to speak of.
However, for income tax purposes, only the
income of the Philippine branch from sources
within the Philippines is subject to income tax,
and the income of the Philippine branch as well
as that of the foreign head office from sources
outside the Philippines are exempt from
Philippine income tax.
- NOTE FURTHER: Marubeni Corporation v.
Commissioner (177 SCRA 500) clarified the
single entity concept. As a GENERAL
RULE, the head office of a foreign
corporation is the same juridical entity as its
branch in the Philippines following the single
entity concept. The income from sources
within the Philippines of the foreign
head office shall thus be taxable to the
Philippine branch. BUT when the head
office of a foreign corporation
independently and directly invested in a
domestic corporation without the funds
passing through its Philippine branch, the
taxpayer with respect to the tax on the
dividend income would be the non-
resident foreign corporation itself and the
dividend income shall be subject to the tax
similarly imposed on non-resident foreign
corporations.

D. Tax on Domestic Corporations
Domestic corporations are subject to any or
some of the following:
Capital Gain Tax
Final Tax on Passive Income
Normal Tax [OR] Minimum Corporate
Income Tax (MCIT) [OR] Gross Income Tax
(GIT)
Improperly Accumulated Earnings Tax
(IAET)

1. Capital Gains subject to Capital Gains Tax
a. On sale, barter, exchange or other
disposition of shares of stock of a
domestic corporation not listed and



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 12 12 12 12 of 163 163 163 163
TAXATION LAW 1
traded through a local stock exchange,
held as a capital asset:
On the net capital gain:
Not over P100,000
Final Tax of 5%
On any amount in excess of P100,000
plus 10% Final tax on the excess

b. On the sale, exchange or disposition of
lands and/or buildings which are not
actually used in the business of a
corporation and are treated as capital
assets On the gross selling price, or the
current fair market value at the time of the
sale, whichever is higher, a final tax of
6%
NOTE: Tax treatment is the same as
that of individuals.
The capital gains tax is applied on the
gross selling price, or the current fair
market value at the time of the sale,
whichever is higher. Any gain or loss
on the sale is immaterial because
there is a conclusive presumption
by law that the sale resulted in a
gain.


2. Passive Income Subject to Final Tax
Interest Income:
o on any currency bank deposit, yield or
any other monetary benefit from deposit
substitutes, trust funds and similar
arrangements - 20%
o under the expanded foreign currency
deposit system (EFCDS) - 7.5%

Dividends received from another
domestic corporation (Intercompany
Dividend) - EXEMPT

Royalties (any kind) 20%

3. Income subject to Normal Tax [OR]
Minimum Corporate Income Tax (MCIT)
[OR] Gross Income Tax (GIT)

NORMAL CORPORATE INCOME TAX RATE
35%

of net taxable income
Gross Income Allowable Deductions =
Taxable Income

MINIMUM CORPORATE INCOME TAX
(MCIT) 2% of MCIT Gross Income
Gross Sales Sales Returns Sales
Returns & Allowances Cost of Goods
Sold = MCIT GI

What is cost of goods sold? It includes all
business expenses DIRECTLY incurred to
produce the merchandise to bring them to
their present location and use. [Sec.
27(E)(4)]
MCIT gross income differentiated from the
normal tax gross income the latter would
include other incidental income items, such
as rent income, interest, gain on sale of
assets, certain tax refunds, etc.
When is the MCIT computed? beginning of
the fourth taxable year immediately
following the year in which such corporation
commenced its business operations
What amount of income tax is paid by
the corporation to the BIR? Whichever
is HIGHER between the normal tax and the
minimum corporate income tax.
ILLUSTRATION: E Co., a domestic trading
corporation, in its fourth year of operations
had a gross profit from sales of P300,000 and
net taxable income of P100,000. How much
was the income tax paid by the corporation
for the year?
MCIT (P300,000 x 2%) P6,000
Normal income tax
(P100,000 x 35%) P35,000
Income Tax to be paid for the year
(whichever is higher) P35,000
Excess MCIT carry-forward
Any excess of the minimum corporate income
tax over the normal income tax shall be
carried forward and credited against the
NORMAL TAX for the three (3) immediately
succeeding taxable years. [Sec. 27(E)(2)] In
the year to which carried forward, the normal
tax should be higher than the MCIT.
ILLUSTRATION: A domestic corporation had
the following data on computations of the
normal tax (NT) and the minimum corporate
income tax (MCIT) for five years.
Yr 4 Yr 5 Yr 6 Yr 7 Yr 8
MCIT 80,000 50,000 30,000 40,000 35,000
NT 20,000 30,000 40,000 20,000 70,000

The excess MCIT over NT carry-forward is shown
below:
Year 4 Year 5 Year 6 Year 7 Year 8
MCIT 80,000 50,000 30,000 40,000 35,000
NT 20,000 30,000 40,000 20,000 70,000

NT is
higher
40,000 70,000
Less:
MCIT
carry-
fwd

(40,000)

(20,000)
(20,000)
From
Year 4



From
Year 5


From
Year 7



Tax
Due
80,000 50,000 - 40,000 30,000

-Arrow pointing downward means that the
normal tax is higher so that there can be an excess
MCIT carry-forward against it.

> >
>



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 13 13 13 13 of 163 163 163 163
TAXATION LAW 1
-While only P40,000 out of P60,000 excess
MCIT in Year 4 was used in Year 6, the
unused P20,000 cannot be used in Year 8
because Year 8 was beyond three years
from Year 4.

Relief from MCIT (LLBM) The Secretary of
Finance is authorized to suspend the imposition
of the minimum corporate income tax on any
corporation which suffers LOSSES:
-on account of prolonged labor dispute (losses
from a strike staged by employees that lasts for
more than 6 months and caused the temporary
shutdown of operations), or

-because of force majeure (acts of God and
other calamity; includes armed conflicts like war
or insurgency), or

-because of legitimate business reverses
(substantial losses due to fire, robbery, theft or
other economic reasons).

GROSS INCOME TAX (GIT) The President,
upon the recommendation of the Secretary of
Finance, may allow domestic corporations the
option to be taxed at fifteen percent (15%) of
gross income, after the following conditions have
been satisfied:
Tax effort ratio 20% of
GNP
Ratio of IT collection to
total tax revenue
40%
VAT tax effort 4% of GNP
Ratio of Consolidated
Public Sector Financial
Position (CPSFP) to GNP
0.90%
Ratio of the Corporations
Cost of Sales to Gross
Sales
Does not
exceed
55%

Gross Sales Sales Returns Sales Returns &
Allowances Cost of Goods Sold = GI

The election of the gross income tax option by
the corporation shall be irrevocable for three
(3) consecutive taxable years during which
the corporation is qualified under the scheme.
[Sec. 27(A)]


4. Improperly Accumulated Earnings Tax
(IAET) [Sec. 29, as implemented by RR 2-2001
which prescribes rules governing the imposition
of IAET]

a) Rule There is imposed for each taxable
year, in addition to other taxes, a tax equal to
10% of the improperly accumulated
taxable income of domestic and closely-
held corporations formed or availed of for
the purpose of avoiding the income tax with
respect to its shareholders or the
shareholders of any other corporation, by
permitting the earnings and profits of the
corporation to accumulate instead of dividing
them among or distributing them to the
shareholders.
b) Rationale It is a tax in the nature of a
PENALTY to the corporation for the
improper accumulation of its earnings, and a
DETERRENT to the avoidance of tax upon
shareholders who are supposed to pay
dividends tax on the earnings distributed to
them.
c) Exception The use of undistributed
earnings and profits for the reasonable
needs of the business would not generally
make the accumulated or undistributed
earnings subject to the tax. What is meant by
reasonable needs of the business is
determined by the IMMEDIACY TEST.
Immediacy Test - It states that the
reasonable needs of the business
are the
1) immediate needs of the business;
and
2) reasonably anticipated needs.

How to prove the reasonable needs
of the business The corporation
should prove that there is
1) an immediate need for the
accumulation of the earnings and
profits; or
2) a direct correlation of anticipated
needs to such accumulation of
profits.
d) Composition: The following constitute
accumulation of earnings for the reasonable
needs of the business: (ILL ABE)

1) ALLOWANCE for the increase in the
accumulation of earnings up to 100% of
the paid-up capital of the corporation as
of Balance Sheet date, inclusive of
accumulations taken from other years;

2) Earnings reserved for definite corporate
EXPANSION projects or programs
requiring considerable capital
expenditure as approved by the Board of
Directors or equivalent body;

3) Earnings reserved for BUILDING,
PLANT or EQUIPMENT ACQUISITION
as approved by the Board of Directors or
equivalent body;


4) Earnings reserved for compliance with
any LOAN COVENANT or pre-existing
obligation established under a legitimate
business agreement;

5) Earnings required by LAW or applicable
regulations to be retained by the
corporation or in respect of which there
is legal prohibition against its
distribution;


6) In the case of subsidiaries of foreign
corporations in the Philippines, all
undistributed earnings intended or
reserved for INVESTMENTS WITHIN
THE PHILIPPINES as can be proven by
corporate records and/or relevant
documentary evidence.

e) Covered Corporations Only domestic
and closely-held corporations are liable for
IAET.



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 14 14 14 14 of 163 163 163 163
TAXATION LAW 1

Closely-held corporations are those:
a) at least 50% in value of the outstanding
capital stock; or

b) at least 50% of the total combined
voting power of all classes of stock entitled
to vote
is owned directly or indirectly by or
for not more than 20 individuals.
Domestic corporations not falling
under the aforesaid definition are,
therefore, publicly-held
corporations.

To determine whether the corporation is
closely held corporation, insofar as such
determination is based on stock ownership, the
following RULES shall be applied:

a. Stock Not Owned by Individuals. - Stock
owned directly or indirectly by or for a
corporation, partnership, estate or trust shall
be considered as being owned proportionately
by its shareholders, partners or beneficiaries.

b. Family and Partnership Ownership. - An
individual shall be considered as owning the
stock owned, directly or indirectly, by or for his
family, or by or for his partner. For purposes of
this paragraph, the family of an individual
includes his brothers or sisters (whether by
whole or half-blood), spouse, ancestors and
lineal descendants.

c. Option to Acquire Stocks. - If any person
has an option to acquire stock, such stock shall
be considered as owned by such person. For
purposes of this paragraph, an option to
acquire such an option and each one of a
series of option shall be considered as an
option to acquire such stock.

d. Constructive Ownership as Actual
Ownership. - Stock constructively owned by
reason of the application of (a) or (c) shall, for
purposes of applying (a) or (b), be treated as
actually owned by such person; but stock
constructively owned by the individual by
reason of the application of (b) shall NOT be
treated as owned by him for purposes of again
applying such paragraph in order to make
another the constructive owner of such stock.

BIR Ruling 025-02 The ownership of a
domestic corporation for purposes of determining
whether it is a closely held corporation or a
publicly held corporation is ultimately traced to
the individual shareholders of the parent
company. Where at least 50% of the outstanding
capital stock or at least 50% of the total
combined voting power of all classes of stock
entitled to vote in a corporation is owned directly
or indirectly by at least 21 or more individuals,
the corporation is considered as publicly held
corporation.

f) Exempt Corporations: (BIG-PEN-T)
1. Banks and other non-bank financial
intermediaries;
2. Insurance companies;
3. Publicly-held corporations;
4. Taxable partnerships;
5. General professional partnerships;
6. Non- taxable joint ventures; and
7. Enterprises that are registered:

a. with the Philippine Economic Zone
Authority (PEZA) under R.A. 7916;
b. pursuant to the Bases Conversion and
Development Act of 1992 under R.A.
7227; and
c. under special economic zones declared by
law which enjoy payment of special tax
rate on their registered operations or
activities in lieu of other taxes, national
or local.

Words in regular letters are found in
Sec. 29(B)(2) of the NIRC. Words in
italics are additions made by the
revenue regulation to consolidate Sec.
29 with other pertinent laws.

g) Computation: TI + (ET + EG + FT +
NOLCOD) (TP + D + RN) = IATI
Year's taxable income
P
xx
Add: Income exempt from tax xx

Income excluded from gross
income xx
Income subject to final tax xx
Amount of NOLCO deducted xx
Total P xx
Less: Income tax paid/payable for the
taxable year xx

Dividends actually or
constructively paid from the
applicable year's taxable income xx

Amount reserved for the
reasonable needs of the business
emanating from the covered
year's taxable income xx
Improperly accumulated taxable income P xx
Multiplied by IAET rate 10%
Improperly accumulated earnings(IAET)
tax P xx

Words in regular letters are in the statutory
formula. Words in italics are additions made by
the revenue regulation.

h) Limitation The profit that has been
subjected to IAET shall no longer be
subjected to IAET in later years even if not
declared as dividend. However, profits which
have been subjected to IAET, when declared
as dividends, shall be subject to tax on
dividends except in those instances where the
recipient is not subject thereto.

i) Declaration of Dividends from earnings
For purposes of determining the source of
earnings or profits declared or distributed
from accumulated income, the dividends shall
be deemed to have been paid out of the
most recently accumulated profits or
surplus and shall constitute a part of the
annual income of the distributee for the
year in which received pursuant to Section
73(C) of the Code. But, where the dividends
or portion of the said dividends declared
forms part of the accumulated earnings as of
December 31, 1997, or emanates from
the accumulated income of a particular
year and is therefore an exemption to the



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 15 15 15 15 of 163 163 163 163
TAXATION LAW 1
proceeding statement, such fact must be
supported by a duly executed Board
Resolution to that effect.

j) Period for Payment of Dividend/IAET
The dividends must be declared and paid or
issued not later than one year following
the close of the taxable year, otherwise,
the IAET, if any, should be paid within
fifteen (15) days thereafter.

k) Determination of Purpose to Avoid
Income Tax
1) The fact that a corporation is a mere
holding company or investment
company shall be prima facie evidence
of a purpose to avoid the tax upon its
shareholders or members
A "holding or investment company" is
a corporation having practically no
activities except holding property, and
collecting the income therefrom or
investing the same; and

2) where the earnings or profits of a
corporation are permitted to accumulate
beyond the reasonable needs of the
business.
PRIMA FACIE INSTANCES of
accumulation of profits beyond the
reasonable needs of a business (UBE)
1) Investment of substantial earnings and
profits of the corporation in
UNRELATED BUSINESS or in stock or
securities of unrelated business;
2) Investment in BONDS and other
long-term securities; and
3) Accumulation of earnings IN EXCESS
OF 100% OF PAID-UP CAPITAL, not
otherwise intended for the reasonable
needs of the business.

-The controlling intention of the
taxpayer is that which is manifested at
the time of accumulation. A
speculative and indefinite purpose will
not suffice. The mere recognition of a
future problem or the discussion of
possible and alternative solutions is not
sufficient. Definiteness of plan/s
coupled with action/s taken
towards its consummation is
essential.

ONE LAST NOTE ON THE APPLICABILITY
OF TAX RATES OF DOMESTIC
CORPORATIONS: All corporations,
agencies, or instrumentalities owned or
controlled by the GOVERNMENT are
taxable and shall pay such rate of tax
upon their taxable income as are
imposed on domestic corporations
engaged in a similar business,
industry, or activity.
EXCEPTIONS (i.e, not taxable):
o Government Service Insurance
System (GSIS),
o Social Security System (SSS),
o Philippine Health Insurance
Corporation (PHIC),
o Philippine Charity Sweepstakes Office
(PCSO)
Note: Exemption for PAGCOR was
withdrawn by RA 9337

E. Tax on Resident Foreign Corporations
Resident foreign corporations are subject
to any or some of the following:
Capital Gain Tax
Final Tax on Passive Income
Normal Tax [OR] Minimum Corporate
Income Tax (MCIT) [OR] Gross
Income Tax (GIT)
Branch Profit Remittance Tax

1. Capital Gains subject to Capital Gains
Tax On sale, barter, exchange or other
disposition of shares of stock of a
domestic corporation not listed and
traded through a local stock exchange,
held as a capital asset:
On the net capital gain:
Not over P100,000 Final Tax of 5%
On any amount in excess of P100,000 plus
Final Tax of 10% on the excess

NOTE: Tax treatment is the same as that
of individuals and domestic corporations.
The net taxable income from the sale of
real property realized by the resident
foreign corporation shall be subject to the
normal corporate income tax.

2. Passive Income Subject to Final Tax
Interest Income:
o on any currency bank deposit, yield or
any other monetary benefit from deposit
substitutes, trust funds and similar
arrangements - 20%
o under the expanded foreign currency
deposit system (EFCDS) - 7.5%

Dividends received from a domestic
corporation (Intercompany Dividend) -
EXEMPT

Royalties (any kind) 20%

3. Income subject to Normal Tax [OR]
Minimum Corporate Income Tax (MCIT)
[OR] Gross Income Tax (GIT) The
discussion with respect to this topic (income
subject to normal tax, MCIT, or GIT) under
the subheading of domestic corporations is
equally applicable to resident foreign
corporations, both as to concepts and
computations, except that RFCs are taxed
only on income from sources within the
Philippines.

NORMAL CORPORATE INCOME TAX RATE
35% of net taxable income from sources
within the Philippines

MINIMUM CORPORATE INCOME TAX
(MCIT) 2% of MCIT Gross Income from
sources within the Philippines. The MCIT is
imposed on RFCs under the same conditions
as domestic corporations. [Sec. 28(A)(2)]

GROSS INCOME TAX (GIT) The
President, upon the recommendation of the
Secretary of Finance, may allow resident
foreign corporations the option to be taxed at
fifteen percent (15%) of gross income within



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 16 16 16 16 of 163 163 163 163
TAXATION LAW 1
the Philippines, under the same conditions as
domestic corporations. [Sec. 28(A)(1)]

Branch Profit Remittance Tax [Sec.
28(A)(5)]
Taxable transaction any profit remitted
by a branch to its head office
Tax Rate and Base 15% based on the
total profits applied or earmarked for
remittance without any deduction for the
tax component
Non-taxable activities activities which
are registered with the Philippine
Economic Zone Authority
Income NOT TREATED AS BRANCH
PROFITS unless effectively connected with
the conduct of trade or business in the
Philippines:
i. Interests, dividends, rents,
royalties, including remuneration
for technical services
ii. salaries, wages premiums,
annuities, emoluments
iii. other fixed or determinable
annual, periodic or casual gains,
profits, income
iv. capital gains received during each
taxable year from all sources
within the Philippines
NOTES:
- imposed whether the head office of the
foreign corporation is located in a tax treaty
country, in a tax haven or other non-treaty
country.
- imposed only on the profits remitted by a
Philippine branch to the head office of a
foreign corporation. Should the branch of a
domestic corporation remit profits to its
head office, the transaction is not subject to
the branch profit remittance tax.


F. Tax on Nonresident Foreign Corporations
Non-resident foreign corporations are
subject to any or some of the following:
Capital Gain Tax
Final Tax on Passive Income
Final Tax on [Other] Gross Income
from sources within the Philippines

1. Capital Gains subject to Capital Gains
Tax On sale, barter, exchange or other
disposition of shares of stock of a
domestic corporation not listed and
traded through a local stock exchange,
held as a capital asset:

On the net capital gain:
Not over P100,000 Final Tax of 5%
On any amount in excess of P100,000 plus
Final Tax of 10% on the excess

NOTE: The gross income from the sale
of real property realized by the non-
resident foreign corporation shall be
subject to a 35% final tax imposed on
gross income from sources within the
Philippines.
2. Passive Income Subject to Final Tax
Interest
o on foreign loans contracted on or after
August 1, 1986 20%
o under the expanded foreign currency
deposit system (EFCDS) - EXEMPT

Dividends (cash and/or property)
received from a domestic corporation
(Intercorporate Dividend) 15%, AS LONG
AS the country in which the nonresident
foreign corporation is domiciled allows a
tax credit for taxes deemed paid in the
Philippines equivalent to 20%

20% represents the difference between the
regular income tax of 35% on corporations
and the 15% tax on dividends

If the country within which the NRFC is
domiciled does NOT allow a tax credit, a
final withholding tax at the rate of 35% is
imposed on the dividends received from a
domestic corporation. [In other words, the
dividends are subject to the third kind of
tax: Final Tax on [Other] Gross Income from
sources within the Philippines.]

Final Tax on [Other] Gross Income from
sources within the Philippines 35% of
the gross income

received from all sources
within the Philippines, such as interests,
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 resulting from the sale
of shares of stock of a domestic corporation
not listed and traded through a local stock
exchange, held as a capital asset.

Special Types of Corporations
A. Special Type of Domestic Corporations
1. Proprietary Educational Institutions
and Hospitals (Non-profit)
Tax Rate and Base 10% on net income
(except on income subject to capital gains
tax and passive income subject to final tax)
within and without the Philippines
CAVEAT: If gross income from unrelated
trade or business or other activity exceeds
50% of total gross income derived from all
sources, the tax rate of 35% shall be
imposed on the entire taxable income.
- Unrelated trade, business or other
activity any trade, business or other
activity, the conduct of which is not
substantially related to the exercise or
performance by such educational institution
or hospital of its primary purpose or function.
- Proprietary educational institution any
private school maintained and administered
by private individuals or groups with an
issued permit to operate from the DECS,
CHED or TESDA.

2. Depository Banks (Foreign Currency
Deposit Units) [Sec. 27(D)(3) as
amended by RA 9294 (2004)]
Coverage of the Rule ONLY income
derived by a depository bank under the
expanded foreign currency deposit system
from foreign currency transactions with:
- nonresidents,
- offshore banking units in the Philippines,
- local commercial banks including branches
of foreign banks that may be authorized



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 17 17 17 17 of 163 163 163 163
TAXATION LAW 1
by the Bangko Sentral ng Pilipinas (BSP)
to transact business with foreign currency
deposit system units and
- other depository banks under the
expanded foreign currency deposit system
Tax Rate: Exempt from all taxes,
except net income from such
transactions as may be specified by the
Secretary of Finance, upon recommendation
by the Monetary Board to be subject to the
regular income tax payable by banks

EXCEPTION: Interest
income from foreign currency loans
granted by such depository banks under
said expanded system to residents other
than offshore units in the Philippines or
other depository banks under the
expanded system shall be subject to a
final tax at the rate of 10%.

B. Special Types of Resident Foreign
Corporations
1. International Carriers
-Tax Rate and Base 2.5% on Gross Philippine
Billings (GPB)
What is GPB?
In the case of International Air Carriers, GPB
refers to the amount of:

-gross revenue derived from carriage of persons,
excess baggage, cargo and mail originating from
the Philippines in a continuous and uninterrupted
flight, irrespective of the place of sale or issue
and the place of payment of the ticket or passage
document

=gross revenue from tickets revalidated,
exchanged and/or indorsed to another
international airline if the passenger boards a
plane in a port or point in the Philippines

-for flights which originate from the Philippines,
but transshipment of passenger takes place at
any port outside the Philippines on another
airline, the gross revenue consisting of only the
aliquot portion of the cost of the ticket
corresponding to the leg flown from the
Philippines to the point of transshipment [RR
15-2002]

-Air Canada vs. CIR (CTA Case No. 6572)
A foreign airline company selling tickets in the
Philippines through their local agents shall be
considered as resident foreign corporation
engaged in trade or business in the country.
The absence of flight operations within the
Philippine territory cannot alter the fact that the
income received was derived from activities
within the Philippines. The test of taxability is
the source, and the source is that activity which
produced the income.

In the case of International Shipping, GPB
means:
-gross revenue whether for passenger, cargo or
mail originating from the Philippines up to final
destination, regardless of the place of sale or
payments of the passage or freight documents.

2. Offshore Banking Units authorized by the
Bangko Sentral ng Pilipinas (BSP) [Sec.
28(A)(4) as amended by RA 9294 (2004)]

Coverage of the Rule ONLY income derived by
offshore banking units from foreign currency
transactions with:

-nonresidents,
-other offshore banking units
-local commercial banks including branches of
foreign banks that may be authorized by the
Bangko Sentral ng Pilipinas (BSP) to transact
business with offshore banking units

-Tax Rate: Exempt from all taxes, except net
income from such transactions as may be
specified by the Secretary of Finance, upon
recommendation by the Monetary Board to be
subject to the regular income tax payable by
banks

-EXCEPTION: Interest income derived from
foreign currency loans granted to residents other
than offshore banking units or local commercial
banks, including local branches of foreign banks
that may be authorized by the BSP to transact
business with offshore banking units, shall be
subject only to a final tax at the rate of 10%.

3. Resident Depository Bank (Foreign
Currency Deposit Units) [Sec. 28(D)(7)(b)
as amended by RA 9294 (2004)]

-Coverage of the Rule ONLY income derived by
a depository bank under the expanded foreign
currency deposit system from foreign currency
transactions with:

-nonresidents,
-offshore banking units in the Philippines,
-local commercial banks including branches of
foreign banks that may be authorized by the
Bangko Sentral ng Pilipinas (BSP) to transact
business with foreign currency deposit system
units and
-other depository banks under the expanded
foreign currency deposit
system

-Tax Rate: Exempt from all taxes, except net
income from such transactions as may be
specified by the Secretary of Finance, upon
recommendation by the Monetary Board to be
subject to the regular income tax payable by
banks

-EXCEPTION: Interest income from foreign
currency loans granted by such depository banks
under said expanded system to residents other
than offshore units in the Philippines or other
depository banks under the expanded system
shall be subject to a final tax at the rate of 10%.

4. Regional or Area Headquarters and
Regional Operating Headquarters of
multinational Companies

Regional or area headquarters not subject to
income tax

Regional or area headquarters 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,



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 18 18 18 18 of 163 163 163 163
TAXATION LAW 1
subsidiaries, or branches in the Asia-Pacific
Region and other foreign markets.

Regional operating headquarters 10% of their
taxable income
-a branch established in the Philippines by
multinational companies which are engaged in
any of the following services:

(SMART - BAD PPL)
1. general Administration and planning
2. business Planning and coordination
3. sourcing and Procurement of raw materials
and components
4. corporate finance Advisory services
5. Marketing control and sales promotion
6. Training and personnel management
7. Logistic services
8. Research and
development services and product
development
9. technical Support and maintenance
10. Data processing and communications, and
11. Business development.


C. Special Types of Non-resident Foreign
Corporations
1. Non-resident cinematographic film owners,
lessors or distributors 25% of gross
income from all sources within the
Philippines

2. Nonresident Owner or Lessor of Vessels
Chartered by Philippine Nationals 4.5% of
gross rentals, lease or charter fees from
leases or charters to Filipino citizens or
corporations, as approved by the Maritime
Authority

3. Nonresident Owner or Lessor of Aircraft,
Machineries and Other Equipment 7.5% of
gross rentals or fees .



Summary of Tax Bases and Rates of Special Corporations

QUICK GLANCE
Type of Corporation Tax Base
Tax
Rate
Domestic Corporations
Proprietary Educational Institutions and Hospitals (Non-profit) Taxable Income from all sources 10%
Depository Banks (Foreign Currency Deposit Units)
With respect to income derived under the expanded
foreign currency deposit system from certain foreign
currency transactions
With respect to interest income from foreign currency
loans to residents other than offshore units in the
Philippines or other depository banks under the
expanded system

Exempt (except that net income
from such transactions is subject
to the regular income tax payable
by banks)
-
Amount of interest income 10%
Resident Foreign Corporations
International Carriers Gross Philippine Billings 2.5%
Offshore Banking Units
With respect to income derived by offshore banking
units from certain foreign currency transactions

With respect to interest income derived from foreign
currency loans granted to residents other than offshore
banking units or local commercial banks

Exempt (except that net income
from such transactions is subject
to the regular income tax payable
by banks)
-
Amount of interest income 10%
Resident Depository Bank (Foreign Currency Deposit Units)
With respect to income derived under the expanded
foreign currency deposit system from certain foreign
currency transactions
With respect to interest income from foreign currency
loans to residents other than offshore units in the
Philippines or other depository banks under the
expanded system

Exempt (except that net income
from such transactions is subject
to the regular income tax payable
by banks)
-
Amount of interest income 10%
Regional or Area Headquarters Exempt -
Regional Operating Headquarters of Multinational Companies Taxable Income from within the
Philippines
10%
Non-resident Foreign Corporations
Non-resident cinematographic film owners, lessors or
distributors
Gross Income from the Philippines
25%
Nonresident Owner or Lessor of Vessels Chartered by Philippine
Nationals
Gross Rentals, Lease and Charter
Fees from the Philippines
4.5%
Nonresident Owner or Lessor of Aircraft, Machineries and Other
Equipment
Gross Rentals, Charges and Fees
from the Philippines
7.5%



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 19 19 19 19 of 163 163 163 163
TAXATION LAW 1
Exempt Corporations [Sec. 30] (CREB-CLEF-
SMB)
The following organizations shall not be
taxed in respect to income received by them
as such (e.g. membership fees):
1. LABOR, agricultural or horticultural
organization not organized principally for
profit
2. 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
3. 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 non-
stock 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 non-stock corporation or their
dependents
4. CEMETERY company owned and operated
exclusively for the benefit of its members
5. 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
6. 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
7. CIVIC league or organization not organized
for profit but operated exclusively for the
promotion of social welfare
8. A non-stock and nonprofit EDUCATIONAL
institution
9. Government EDUCATIONAL institution
10. 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
11. 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 sales, less the necessary selling
expenses on the basis of the quantity of
produce finished by them;

Notwithstanding the exemptions, income
of whatever kind and character of the
enumerated 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.
Note:
RA 9178 Barangay Micro Business Enterprises
(BMBEs) implemented by DO 17-04, April 20,
2004
BMBEs shall be exempt from income tax for
income arising from the operations of the
enterprise.
BMBE is any business entity or enterprise
engaged in the production, processing or
manufacturing of products or commodities,
including agro-processing trading and
services, whose total assets including those
arising from loans but exclusive of land on
which the particular business entitys office,
plant and equipment are situated, shall not
be more that P3M.



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 20 20 20 20 of 163 163 163 163
TAXATION LAW 1
Summary of Tax Bases, Tax Rates and Applicable Tax Regimes for Corporations

CATEGORY OF INCOME
DOMESTIC RESIDENT NON-RESIDENT
All sources
Within the
Philippines
Within the
Philippines
1. Taxable Income (i.e., income other than
#s 2 to 9)

35% Normal
Tax
35% Normal
Tax
35% of Gross
Income
2. Interest from any currency bank deposit
, etc.

GIW - 20% Final Tax

3. Royalties

GIW - 20% Final Tax

4. Interest (Expanded Foreign Currency
Deposit System)

GIW - 7.5% Final Tax EXEMPT
5. Cash / Property Dividends from a
domestic corporation

EXEMPT
15% or 35%,
whichever is
applicable
6. Capital Gains on Sale of Shares (not
traded in a domestic stock exchange)

Net Capital Gains within:
Not Over P100,000 5% Final Tax
Amount in Excess of P100,000 plus 10% Final Tax on
the excess
7. Capital Gains on Sale of Land and/or
Building

GSP or FMV,
whichever is
higher
6% Final Tax
35% Normal
Tax
35% of Gross
Income
8. Sale of Shares (traded in a domestic
stock exchange)

of 1% of the Selling Price (Stock Transaction Tax)
Note: Stock Transaction Tax is not an income tax,
but a business (percentage) tax

TAX REGIMES APPLICABLE
Normal Tax
YES YES
YES, but based on
Gross Income
Minimum Corporate Income Tax YES YES NO
Gross Income Tax YES YES NO
Improperly Accumulated Earnings Tax YES, if closely-
held
corporation
NO NO
Branch Profit Remittance Tax NO YES Not Applicable
Legend:
GIW - Gross Income within the Philippines
GSP Gross Selling Price
FMV Fair Market Value








1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 21 21 21 21 of 163 163 163 163
TAXATION LAW 1
V. TAXATION OF FRINGE BENEFITS V. TAXATION OF FRINGE BENEFITS V. TAXATION OF FRINGE BENEFITS V. TAXATION OF FRINGE BENEFITS
[Sec. 33 of the NIRC]

A. Definition of Fringe Benefit any good,
service or other benefit furnished or granted in
cash or in kind by an employer to an individual
employee except rank and file employees
(The fringe benefit covered by Sec 33 refers to
those enjoyed by managerial and supervisory
employees.)

Key definitions:
Managerial employee one who is vested with
the powers or prerogatives to lay down and
execute management policies and/or to hire,
transfer, suspend, lay-off, recall, discharge,
assign or discipline employees.

Supervisory employees those who, in the
interest of the employer, effectively recommend
such managerial actions if the exercise of such
authority is not merely routinary or clerical in
nature but requires the use of independent
judgment.

All employees not falling within any of the above
definitions are considered rank-and-file
employees.

Examples of fringe benefits:
1. Housing
2. Expense account
3. Vehicle of any kind
4. Household personnel, such as maid, driver
and others
5. Interest on loan at less than market rate to
the extent of the difference between the
market rate and actual rate granted
6. Membership fees, dues and other expenses
borne by the employer for the employee in
social and athletic clubs or other similar
organizations
7. Expenses for foreign travel
8. Holiday and vacation expenses
9. Educational assistance to the employee or his
dependents
10. Life or health insurance and other non-life
insurance premiums or similar amounts in
excess of what the law allows

B. Tax Rate and Tax Base [Generally] 32% of
the grossed-up monetary value (GMV)
GMV represents the whole amount of income
realized by the employee.

How GMV is determined GMV is determined by
dividing the actual monetary value of the fringe
benefit by 68% [100% - tax rate of 32%]. For
example, the actual monetary value of the fringe
benefit is P1,000. The GMV is equal to P1,470.59
[P1,000 / 0.68]. The fringe benefit tax, therefore,
is P470.59 [P1470.59 x 32%].

Special Cases:
For fringe benefits received by non-resident
alien not engaged in trade of business
(NRANETB), the tax rate is 25% of the
grossed-up monetary value (GMV). The GMV
is determined by dividing the actual monetary
value of the fringe benefit by 75% [100% -
25%].
For fringe benefits received by alien
individuals and Filipino citizens employed by
regional or area headquarters, regional
operating headquarters, offshore banking
units (OBUs), or foreign service contractor,
the tax rate is 15% of the grossed-up
monetary value (GMV). The GMV is
determined by dividing the actual monetary
value of the fringe benefit by 85% [100% -
15%].

What is the tax implication if the employer
gives fringe benefits to rank-and-file
employees? Fringe benefits given to a rank-
and-file employee are treated as part of his
compensation income subject to income tax
and withholding tax on compensation income.

Payor of Fringe Benefit Tax (FBT) the
employer [but the law allows the employer to
deduct such tax as a business expense, in
determining his taxable income]

Fringe Benefits which are not taxable [Sec.
33 of the NIRC, consolidated with Sec. 2.33(C) of
RR 03-98] [RED CNC]
1. Fringe benefits which are authorized and
EXEMPTED from tax under special laws
2. CONTRIBUTIONS of the employer for the
benefit of the employee to retirement,
insurance and hospitalization benefit plans
3. Benefits given to the RANK AND FILE
employees, whether granted under a
collective bargaining agreement or not
4. DE MINIMIS benefits
5. If the grant of fringe benefits to the employee
is required by the nature of, or NECESSARY
to the trade, business, or profession of the
employer
6. If the grant of fringe benefits is for the
CONVENIENCE of the employer
[Convenience of the Employer Rule]

NOTES:
De minimis benefits those which are of
relatively small value are offered by the employer
as a means of promoting health, goodwill,
contentment, or efficiency of his employees, such
as the following: (CLAMMP RUST)
1. Monetized unused vacation leave credits
of private employees not exceeding ten (10)
days during the year and the monetized
value of leave credits paid to government
officials and employees;
2. Medical cash allowance to dependents
of employees not exceeding P750 per
semester or P125 per month;

BIR Ruling 019-02: To be considered de
minimis medical allowance, the following
conditions must concur:
1. The amount given to the EE shall be for
his own medical expense;

2. The amount actually given and actually
spent shall not exceed P10, 000 in any
given calendar year;

3. The EE must fully substantiate with or in
his name the medical allowance to be
granted.

3. Rice subsidy of P350 per month granted
by an employer to his employees;



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 22 22 22 22 of 163 163 163 163
TAXATION LAW 1
4. Uniforms given to employees by the
employer;
5. Medical benefits given to the employees
by the employer;
6. Laundry allowance of P150 per month;
7. Employee achievement awards, e.g. for
length of service or safety achievement,
which must be in the form of a tangible
personal property other than cash or gift
certificate, with an annual monetary value
not exceeding one-half () month of the
basic salary of the employee receiving the
award under an established written plan
which does not discriminate in favor of
highly paid employees;
8. Christmas and major anniversary
celebrations for employees and their
guests;
9. Company picnics and sports
tournaments in the Philippines and are
participated exclusively by employees; and
10. Flowers, fruits, books or similar items
given to employees under special
circumstances, e.g. on account of illness,
marriage, birth of a baby, etc. [as
enumerated in RR 03-98, as amended by
RR 10-00]

Tax implication of de minimis benefits:
EXEMPTED from tax. However, should the
amount of the benefits given be in EXCESS of the
ceilings prescribed, the following rules apply:
-If given to managerial / supervisory employees
The amount in excess of the ceiling prescribed
is taxable as a fringe benefit (i.e., there will be a
32% tax imposed on the grossed-up monetary
value of the residual amount).

-If given to rank-and-file employees The
amount in excess of the ceiling prescribed is
taxable as salary or compensation income.

BIR Ruling 023-02: Meal and food allowance,
although not for overtime work, is considered de
minimis if it does not exceed 25% of the basic
wage. The rules and regulations on de minimis
benefits do not allow aggregation of the amounts
set for each type of benefit.
BIR Ruling 034-02 (Aug 16, 2002):
Representation and Transportation Allowance
(RATA) and Personnel Economic Relief Allowance
(PERA) are not subject to Income Tax and
Withholding Tax. Additional Compensation
Allowance (ACA) is part of other benefits under
Sec. 32(b)(7)(e) of the Tax Code of 1997 which
are excluded from gross compensation income
provided the total amount of such benefits does
not exceed P30,000. It is also not subject to
withholding tax pending its formal integration
into basic pay.
Example of Benefits Necessary to the Trade
/ Business of the Employer: BIR Ruling 013-
02: Outstation Allowance given by the Philippine
Gaming Management Corporation to its
managerial and supervisory employees (who will
be away from the office site for at least 8 hours
to visit the lotto franchise holders for repair
and/or inspection of equipment) intended to
cover meals and trip related expenses is clearly
required by the nature of or necessary to the
trade or business of the employer and hence, not
subject to the fringe benefits tax. It is also not
subject to withholding tax.

Examples of Convenience of the Employer
Rule:
1. The value of the meals given to the employee
is not taxable, if the employer provides the
meals for a substantial non-compensatory
business purpose (generally, when employee
is required to be on duty during the meal
period).
2. Lodging is not taxable if the employee must
accept the lodging on the employers business
premises as a condition of his employment.















































1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 23 23 23 23 of 163 163 163 163
TAXATION LAW 1
VI. TAXATION OF PARTNERSHIPS VI. TAXATION OF PARTNERSHIPS VI. TAXATION OF PARTNERSHIPS VI. TAXATION OF PARTNERSHIPS

A. Classification of Partnerships for Tax
Purposes
1. General Professional Partnerships (GPP)
partnerships formed by persons for the
sole purpose of exercising their
common profession, no part of the
income of which is derived from engaging
in any trade or business
2. Other Partnerships (or General Co-
partnerships) partnerships wherein all
or part of their income is derived from
the conduct of trade or business

B. General Professional Partnerships [Sec
26]
Rules:
1. A GPP as such shall not be subject to
the income tax.
2. The partners shall only be liable for
income tax only in their separate and
individual capacities.
3. For purposes of computing the
distributive share of the partners, the net
income of the GPP shall be computed in
the same manner as a corporation.
4. Each partner shall report as gross income
his distributive share, actually or
constructively received, in the net
income of the partnership.
5. The share of a partner shall be subject
to a creditable withholding income
tax of 15%. (RR 2- 1998)

NOTES:
GPP is not a taxable entity The
partnership is a mere mechanism or a
flow-through entity in the generation of
income by, and the ultimate mechanism
distribution of such income to the
individual partners. (Tan v.
Commissioner [Oct. 3, 1994]) But,
the partnership itself is required to file
income tax returns for the purpose of
furnishing information as to the share in
the gains or profits which each partner
shall include in his individual return.
(RR 2- 1998)

The share of an individual partner in
the net profit of a general professional
partnership is deemed to have been
actually or constructively received
by the partner in the same taxable
year in which such partnership net
income was earned, and shall be
taxed to them in their individual
capacities, whether actually
distributed or not, at the graduated
income tax ranging from 5% to
32%. Thus, the principle of
constructive receipt of income or profit
is being applied to undistributed profits
of GPPs. The payment [to the partners]
of such tax-paid profits in another year
should no longer be liable to income
tax. (Mamalateo)

C. Other Partnerships (or General Co-
partnerships)
Rules:
1. The partnership is subject to the same
rules on corporations (capital gains tax,
final tax on passive income, normal tax,
minimum corporate income tax [MCIT]
and gross income tax [GIT]), but is not
subject to the improperly accumulated
earnings tax [IAET]. The partnership
must file quarterly and year-end income
tax returns.
2. The taxable income of the partnership,
less the normal corporate income tax
thereon, is the distributable net income of
the partnership.
3. The share of a partner in the
partnerships distributable net income of
a year shall be deemed to have been
actually or constructively received by the
partners in the same taxable year and
shall be taxed to them in their individual
capacity, whether actually distributed or
not. [Sec. 73(D)] Such share will be
subjected to a final tax of 10% to be
withheld by the partnership. [Sec.
24(B)(2)]

Co-ownership - There is co-ownership:
1. When two or more heirs inherit and
undivided property from a decedent.
2. When a donor makes a gift of an
undivided property in favor of two or
more donees.

- When Co-ownership is not subject to tax
When the co-ownerships activities are
limited merely to the preservation of the
co-owned property. The co-owners are
only liable for income tax in their
separate and individual capacities.

- When Co-ownership is subject to tax
When the income of the co-
ownership is invested by the co-
owners in business, the co-owners
have in effect constituted themselves
into a partnership. In such a case, the
co-ownership shall be subject to tax as a
corporation.
automatically converted into an
unregistered partnership the moment
the said common properties and/or
the incomes derived from them are
used as a common fund with intent
to produce profits for the heirs in
proportion to their respective shares in
the inheritance as determined in a
project partition either duly executed in
an extrajudicial settlement or approved
by the court in the corresponding testate
or intestate proceeding. [Ona v. CIR,
May, 25 1972]












1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 24 24 24 24 of 163 163 163 163
TAXATION LAW 1
VII. TAX ON ESTATES AND TRUSTS VII. TAX ON ESTATES AND TRUSTS VII. TAX ON ESTATES AND TRUSTS VII. TAX ON ESTATES AND TRUSTS

A. Application of Income Tax
The tax imposed upon individuals shall apply
to the income of estates or of any kind of
property held in trust, including:
1. Income accumulated in trust for the
benefit of unborn or unascertained
person or persons with contingent
interests, and income accumulated or
held for future distribution under the
terms of the will or trust;
2. Income which is to be distributed
currently by the fiduciary to the
beneficiaries, and income collected by a
guardian of an infant which is to be held
or distributed as the court may direct;
3. Income received by estates of deceased
persons during the period of
administration or settlement of the
estate; and
4. Income which, in the discretion of the
fiduciary, may be either distributed to
the beneficiaries or accumulated.

EXCEPTION
The tax shall not apply to employee's
trust which forms part of a pension,
stock bonus or profit-sharing plan of
an employer for the benefit of some or
all of his employees
i. if contributions are made to the trust
by such employer, or employees, or
both for the purpose of distributing to
such employees the earnings and
principal of the fund accumulated by
the trust in accordance with such
plan, and
ii. if under the trust instrument it is
impossible, at any time prior to the
satisfaction of all liabilities with
respect to employees under the trust,
for any part of the corpus or income
to be (within the taxable year or
thereafter) used for, or diverted to,
purposes other than for the exclusive
benefit of his employees.
- NOTE HOWEVER: Any amount
actually distributed to any
employee or distributee shall be
taxable to him in the year in
which so distributed to the
extent that it exceeds the
amount contributed by such
employee or distributee.

B. Computation and Payment of the Tax
The tax shall be computed upon the taxable
income of the estate or trust and shall be
paid by the fiduciary. (GENERAL RULE)

EXCEPTIONS:
1. Revocable Trusts. - Where at any time
the power to revest in the grantor
title to any part of the corpus of the
trust is vested
1. in the grantor either alone or in
conjunction with any person not
having a substantial adverse
interest in the disposition of such
part of the corpus or the income
therefrom, or
2. in any person not having a
substantial adverse interest in the
disposition of such part of the
corpus or the income therefrom,
the income of such part of the trust shall
be included in computing the taxable
income of the grantor.

2. Income for Benefit of Grantor - Where
any part of the income of a trust
i. is, or in the discretion of the
grantor or of any person not
having a substantial adverse
interest in the disposition of such
part of the income may be held or
accumulated for future distribution
to the grantor, or
ii. may, or in the discretion of the
grantor or of any person not
having a substantial adverse
interest in the disposition of such
part of the income, be distributed
to the grantor, or
iii. is, or in the discretion of the
grantor or of any person not
having a substantial adverse
interest in the disposition of such
part of the income may be applied
to the payment of premiums upon
policies of insurance on the life of
the grantor,
such part of the income of the trust shall
be included in computing the taxable
income of the grantor.

NOTE: 'In the discretion of the grantor'
means in the discretion of the grantor,
either alone or in conjunction with any
person not having a substantial adverse
interest in the disposition of the part of
the income in question.

Consolidation of Income of Two or More Trusts
- Where, in the case of two or more trusts,
the creator of the trust in each instance
is the same person, and the beneficiary
in each instance is the same, the
taxable income of all the trusts shall be
consolidated and the tax computed on such
consolidated income, and such proportion
of said tax shall be assessed and
collected from each trustee which the
taxable income of the trust administered by
him bears to the consolidated income of
the several trusts.

C. How Taxable Income of the Estate or
Trust is Computed
[Sec. 61] The taxable income of the estate
or trust shall be computed in the same
manner and on the same basis as in
the case of an individual, EXCEPT that:
(A) There shall be ALLOWED AS A
DEDUCTION in computing the taxable
income of the estate or trust the
amount of the income of the estate or
trust for the taxable year which is to
be distributed currently by the
fiduciary to the beneficiaries, and the
amount of the income collected by a
guardian of an infant which is to be
held or distributed as the court may
direct, BUT the amount so allowed as
a deduction shall be included in



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 25 25 25 25 of 163 163 163 163
TAXATION LAW 1
computing the taxable income of the
beneficiaries, whether distributed to
them or not. Any amount allowed as a
deduction under this Subsection shall
not be allowed as a deduction under
Subsection (B) of this Section in the
same or any succeeding taxable year.

(B) In the case of income received by
estates of deceased persons during
the period of administration or
settlement of the estate, and in the
case of income which, in the discretion
of the fiduciary, may be either
distributed to the beneficiary or
accumulated, there shall be allowed as
an ADDITIONAL DEDUCTION the
amount of the income of the estate or
trust for its taxable year, which is
properly paid or credited during such
year to any legatee, heir or beneficiary
but the amount so allowed as a
deduction shall be included in
computing the taxable income of the
legatee, heir or beneficiary.

(C) In the case of a trust administered in a
foreign country, the deductions
mentioned in Subsections (A) and (B)
of this Section shall not be allowed:
Provided, That the amount of any
income included in the return of said
trust shall not be included in
computing the income of the
beneficiaries.

B. Exemption Allowed to Estates and Trusts
P20,000 from the income of the estate or
trust.

E. Fiduciary Returns
Guardians, trustees, executors,
administrators, receivers, conservators and
all persons or corporations, acting in any
fiduciary capacity, shall:
- render, in duplicate, a return of the
income of the person, trust or estate
for whom or which they act, and
- be subject to all the provisions which
apply to individuals in case such
person, estate or trust has a gross
income of P20,000 or over during the
taxable year.

Such fiduciary or person filing the return
for him or it, shall:
- take OATH that
he has sufficient knowledge of
the affairs of such person, trust
or estate to enable him to make
such return and
that the same is, to the best of
his knowledge and belief, true
and correct, and
- be subject to all the provisions of this
Title which apply to individuals.

A return made by or for one or two or
more joint fiduciaries filed in the province
where such fiduciaries reside, under such
rules and regulations as the Secretary of
Finance shall prescribe, shall be
sufficient compliance.

F. Fiduciaries Indemnified Against Claims
for Taxes Paid
Trustees, executors, administrators and
other fiduciaries are INDEMNIFIED
against the claims or demands of every
beneficiary for all payments of taxes which
they shall be required to make, and they
shall have CREDIT for the amount of such
payments against the beneficiary or
principal in any accounting which they
make as such trustees or other fiduciaries.

VIII. SOURCE OF VIII. SOURCE OF VIII. SOURCE OF VIII. SOURCE OF INCOME INCOME INCOME INCOME [Sec. 42]

A. Classification of Income according to
Source
1. Income derived from sources within the
Philippine
2. Income derived from sources without the
Philippine
3. Income derived from sources partly within
and partly without the Philippines

B. Basic Principles
1. Resident Citizens (RC) and Domestic
Corporations (DC) are taxable on income
derived from within and without the
Philippines
2. Non-resident Citizens (NRC), Non-resident
Aliens (NRA), Resident Foreign
Corporations (RFC) and Non-resident
Foreign Corporations (NRFC) are taxable
only on income derived from within the
Philippines.

C. Gross Income From Sources Within the
Philippines (RIDIC - within)
The following items of gross income shall
be treated as gross income from
sources WITHIN the Philippines:
1. Interests derived from sources within the
Philippines, and interests on bonds, notes
or other interest-bearing obligation of
residents
2. Dividends received:
a. from a domestic corporation; and
b. from a foreign corporation, UNLESS less
than 50% of its gross income for the
previous 3-year period was derived
from sources within the Philippines [in
which case it will be treated as income
partly from within and partly from
without]. The income which is
considered as derived from within the
Philippines is obtained by using the
following formula:


NOTE: * of the corporation giving the
dividend

3. Compensation for labor or personal
services performed in the Philippines
4. Rentals and royalties from property
located in the Philippines or from any
interest in such property, including rentals
or royalties for (stackem)
a. The use of or the right or privilege to
use in the Philippines any copyright,
patent, design or model, plan, secret
formula or process, goodwill,
Philippine Gross Income* x Dividend = Income Within
Worldwide Gross Income*



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 26 26 26 26 of 163 163 163 163
TAXATION LAW 1
trademark, trade brand or other like
property or right;
b. The use of, or the right to use in the
Philippines any industrial, commercial
or scientific equipment;
c. The supply of scientific, technical,
industrial or commercial knowledge or
information;
d. The supply of any assistance that is
ancillary and subsidiary to, and is
furnished as a means of enabling the
application or enjoyment of, any such
property or right as is mentioned in (a),
any such equipment as is mentioned in
(b) or any such knowledge or
information as is mentioned in (c);
e. The supply of services by a
nonresident person or his employee in
connection with the use of property or
rights belonging to, or the installation
or operation of any brand, machinery or
other apparatus purchased from such
nonresident person;
f. Technical advice, assistance or
services rendered in connection with
technical management or
administration of any scientific,
industrial or commercial undertaking,
venture, project or scheme; and
g. The use of or the right to use:
(i) Motion picture films;
(ii) Films or video tapes for use in
connection with television; and
(iii) Tapes for use in connection with
radio broadcasting.

5. Gains, profits and Income from the sale
of real property located in the
Philippines

6. GENERAL RULE: Gains, profits and
income from the sale of personal
property, subject to the following rules:
Place of
PURCHASE
Place of
SALE
Treatment**
Philippines Abroad Income from
Without
Abroad Philippines Income from
Within
** in other words, treated as income from
the country in which sold

EXCEPTIONS:
1. Gain from the sale of shares of
stock in a domestic corporation
treated as derived entirely from
sources within the Philippines
regardless of where the said shares
are sold.
2. Gains from the sale of
(manufactured) personal property:
a. produced (in whole or in part)
by the taxpayer within and
sold without the Philippines,
or
b. produced (in whole or in part)
by the taxpayer without and
sold within the Philippines
treated as derived partly from
sources within and partly from
sources without the Philippines.

Place of
PRODUCTION
Place of
SALE
Treatment
Philippines Abroad Partly within,
partly without
Abroad Philippines Partly within,
partly without

Allowable Deductions from Gross
Income From Sources Within the
Philippines
GENERAL RULE:
From the items of gross income above,
the following are allowed as deductions:
a. expenses, losses and other
deductions properly allocated to
items of gross income
b. ratable part of expenses, interests,
losses and other deductions
effectively connected with the
business or trade conducted
exclusively within the Philippines
which cannot definitely be allocated
to some items of gross income

Formula for (b):


EXCEPTION:
No DEDUCTIONS FOR INTEREST paid
or incurred abroad shall be allowed from
the item of gross income unless
indebtedness was actually incurred
to provide funds for use in
connection with the conduct or
operation of trade or business in the
Philippines.

D. Gross Income From Sources Without the
Philippines (RIDIC - without)
The following items of gross income shall
be treated as income from sources without
the Philippines:
1. Interests other than those derived
from sources within the Philippines
2. Dividends other than those derived
from sources within the Philippines
3. Compensation for labor or personal
services performed without the
Philippines
4. Rentals or royalties from property
located without the Philippines or
from any interest in such property
5. Gains, profits and Income from
the sale of real property located
without the Philippines

Allowable Deductions to Gross Income
From Sources Without the Philippines
1. expenses, losses, and other
deductions properly apportioned to
items of gross income
2. ratable part of any expense, loss or
other deduction which cannot
definitely be allocated to some items
or classes of gross income
e.g.:
Gross Income from Expenses
Without the Philippines x Unallocated = allocated
Worldwide Gross Income Expenses to income
from
without

Expenses
Philippine Gross Income x Unallocated = allocated
Worldwide Gross Income Expenses to income
from within



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 27 27 27 27 of 163 163 163 163
TAXATION LAW 1


C. QUICK GLANCE

Item of Income Test of Source of Income
Interest Residence of the debtor
Income from Services Place of performance
10

Rental Location of the property
Royalty Place of use of the intangible
Gain on Sale of Real Property Location of the property sold
Gain on Sale of Personal Property (EXCEPT:
- Shares of a domestic corporation
- Personal property produced (in whole or in
part) by the taxpayer within and sold without
the Philippines [or vice versa])
Place of sale
Gain on Sale of Domestic Shares Always income from within
Gain on sale of personal property produced (in
whole or in part) by the taxpayer within and sold
without the Philippines [or vice versa]
Partly from without and partly from within
Dividends
a. From Domestic Corporation

Income from within
b. From Foreign Corporation Income from WITHIN, IF at least 50% of its gross
income for the previous 3-year period was derived
from sources within the Philippines. [entire income
considered as income from within]

HOWEVER, if less than 50% of its gross income
for the previous 3-year period was derived from
sources within the Philippines, considered as
partly within and partly without. Income within
computed using this formula:

Philippine Gross Income* x Dividend= Income
Within
Worldwide Gross Income*

NOTE: * of the corporation giving the dividend

10
Regardless of the residence of the payor, of the place in which the contract for service was made, or of the place of payment.



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 28 28 28 28 of 163 163 163 163

TAXATION LAW 1
Taxable = Ordinary + net capital
net income net income gains
IX. GROSS INCOME IX. GROSS INCOME IX. GROSS INCOME IX. GROSS INCOME

A. Basic Principles
Gross Income means all income derived
from whatever source
11
, including (but not
limited to) the following items: (TRIP CARD
GPP)
1. Gross income derived from the conduct of
TRADE or business or the exercise of
a profession
2. RENTS
3. INTERESTS
4. PRIZES and winnings
5. COMPENSATION for services in
whatever form paid, including, but not
limited to fees, salaries, wages,
commissions, and similar items
6. ANNUITIES
7. ROYALTIES
8. DIVIDENDS
9. GAINS derived from dealings in property
10. PENSIONS
11. PARTNER'S distributive share from the
net income of the general professional
partnership (GPP)

The term gross income whenever used
without qualification, is comprehensive, as
defined above, and is different from the
limited meaning of gross income for
purposes of minimum corporate income tax
or the gross income tax of corporations.

B. Supplementary Discussion on Some
Items Included in Gross Income

1. Compensation Income
a. income arising from an ER-EE relationship.
It means all remuneration for services
performed by an EE for his ER, including
the cash value of all remuneration paid in
any medium other than cash. [Sec. 78(A)]
It includes:
1. Salaries and wages
2. Commissions
3. Tips
4. Allowances
5. Bonuses
6. Fringe Benefits of rank and file EEs

b. It does NOT include remuneration paid:
For agricultural labor paid entirely in
products of the farm where the labor is
performed, or
For domestic service in a private home,
or
For casual labor not in the course of the
employer's trade or business, or
For services by a citizen or resident of the
Philippines for a foreign govt or an intl
organization. [Sec. 78(A)]

Withholding Tax on Compensation Income
The income recipient (i.e., EE) is the
person liable to pay the tax income, yet
to improve the collection of
compensation income of EEs, the State
requires the ER to withhold the tax upon
payment of the compensation income.


11
It does not include income excluded or exempted by law.
Fringe Benefits of Rank and File EEs
Basic Rule:
Convenience of the ER Rule
If meals, living quarters, and other facilities
and privileges are furnished to an employee
for the convenience of the employer, and
incidental to the requirement of the
employees work or position, the value of
that privilege need not be included as
compensation.

2. Gains Derived From Dealings In
Property Dealings in property such as
sales or exchanges may result in gain or
loss. The kind of property involved (i.e.,
whether the property is a capital asset or
an ordinary asset) determines the tax
implication and income tax treatment, as
follows:

ORDINARY
ASSET
CAPITAL
ASSET***
Gain from
sale or
exchange
Ordinary Gain
Capital
Gain
Loss from
sale or
exchange
Ordinary Loss
Capital
Loss
Excess of
Gains over
the Losses
[goes into
computation
of]
Ordinary Net
Income
Net
Capital
Gain

*** (except shares of stock not listed nor
traded in a local stock exchange and real
property subject to capital gains tax)




If the asset involved is classified as
ordinary, the entire amount of the gain
from the transaction shall be included in
the computation of gross income [Sec
32(A)], and the entire amount of the
loss shall be deductible from gross
income. [Sec 34(D)]. (See XI. Allowable
Deductions from Gross Income -
Losses)
If the property sold is a capital asset
(except shares of stock not listed nor
traded in a local stock exchange and
real property subject to capital gains
tax), the rules on capital gains and
losses apply in the determination of the
amount to be included in gross income.
(See XIII Capital Gains and Losses)

Computation of Gain or Loss [Sec.
40(A)]:


Note: Amount realized from sale or
other disposition of property = sum of
money received + fair market value of
the property (other than money)
received

Amount realized from sale or other
disposition of property
Less: basis or adjusted basis_____ ____
GAIN (LOSS)



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 29 29 29 29 of 163 163 163 163

TAXATION LAW 1
In computing the gain or loss from the
sale or other disposition of property,
the BASIS shall be as follows:
1. Property acquired by purchase
its cost, i.e., the purchase price
plus expenses of acquisition.
2. Property which should be included
in the inventory its latest
inventory value [RR-2 sec 136]
3. Property acquired by devise,
bequest or inheritance its fair
market price or value as of the
date of acquisition
4. Property acquired by gift or
donation the same as if it would
be in the hands of the donor or at
last preceding owner by whom it
was not acquired by gift, EXCEPT
that if such basis is greater than
the FMV of the property at the
time of the gift then, for the
purpose of determining loss, the
basis shall be such FMV
5. Property (other than capital asset)
acquired for less than an adequate
consideration in moneys worth
a) the amount paid by the
transferee for the property; or b)
the transferors adjusted basis at
the time of the transfer whichever
is greater
6. Property acquired in a transaction
where gain or loss not recognized
The basis shall be the same as it
would have been in the hands of
the transferor increased by the
amount of gain recognized by the
transferor on the transfer.

3. Interest Income e.g., Interest income
from government securities such as
Treasury Bills

4. Rental Income
Actual rent itself included in gross
income (taxable)
Payments by lessee of obligations
of lessor to third persons
considered as additional rent income of
the lessor, and therefore included in
gross income (taxable).
Advance Rentals Receipt of
advance rentals by the lessor may or
may not constitute taxable income to
him depending on the true nature of
the so-called advance rentals.
o If the advance rental is in the
nature of prepaid rent (for the
lessee), received by the lessor
under a claim of right and without
restriction as to use, the entire
amount is taxable income of the
lessor in the year received.
o If the amount received is in the
nature of a security deposit for the
faithful compliance by the lessee of
the terms of the contract, there is
no income to the lessor unless the
conditions which make the security
deposit the property of the lessor
occur (i.e., the lessee violates the
terms of the lease agreement)

5. Dividends Any dividend which is not
exempt from income tax, or which is not
subject to final tax, is taxable dividend
included in the computation of the taxable
income (gross income) in the income tax
return at the end of the year.

NOTE: Liquidating Dividend distribution
of all the property of a corporation. It is
strictly not dividend income, but rather a
sale of shares of stock resulting in capital
gain or loss.

6. Annuities income derived from a capital
amount paid to an insurance company.

7. Pensions paid for past employment
services rendered.

8. Cancellation of debt The cancellation or
forgiveness of indebtedness may have any
of three possible consequences:
1. It may amount to payment of income.
If, for example, an individual performs
services to or for a creditor, who, in
consideration thereof, cancels the debt,
income in that amount is realized by
the debtor as compensation for
personal services.
2. It may amount to a gift. If a creditor
wishes merely to benefit the debtor,
and without any consideration
therefore, cancels the debt, the amount
of the debt is a gift to the debtor and
need not be included in the latters
report of income.
3. It may amount to a capital transaction.
If a corporation to which a stockholder
is indebted forgives the debt, the
transaction has the effect of a payment
of dividend.

9. Prizes and Awards Contest prizes and
awards received are generally taxable.
Such payment constitutes gain derived
from labor. The EXCEPTIONS are as
follows:

Prizes and awards received in
recognition of religious, charitable,
scientific, educational, artistic, literary
or civic achievements are EXCLUSIONS
from gross income if:
a. The recipient was selected without
any action on his part to enter a
contest or proceedings; and
b. The recipient is not required to
render substantial future services
as a condition to receiving the
prize or award.
Prizes and awards granted to athletes
in local and intl sports competitions
and tournaments held in the Philippines
and abroad and sanctioned by their
national associations shall be EXEMPT
from income tax.

10. Damage recovery
Compensatory damages, as constituting
returns of capital, are not taxable.
Thus, amounts received as moral
damages for personal actions (such as
alienation of affection, libel, slander or



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 30 30 30 30 of 163 163 163 163

TAXATION LAW 1
breach of promise to marry) are not
taxable.
Recovered damages representing
recoveries of lost profits are taxable,
just as profits are taxable in the regular
course of business. Thus, damages
recovered in patent infringement suits
are taxable.

11. Bad Debt Recovery
Tax Benefit Rule Bad debts claimed as
a deduction in the preceding year(s) but
subsequently recovered shall be included
as part of the taxpayers gross income in
the year of such recovery to the extent of
the income tax benefit of said deduction.
There is an income tax benefit when the
deduction of the bad debt in the prior year
resulted in lesser income and hence tax
savings for the company. (Sec. 4, RR 5-
99)

Illustration:

Case A Case B Case C
Year 1
Gross Income
500,000

400,000

500,000
Less: Allowable
Deductions
(before write-off
of Uncollectible
Accounts/Debts)

(200,000)

(480,000)

(495,000)
Taxable Income
(Net Loss)
before write-off

300,000

(60,000)

5,000
Deduction for
Accounts
Receivable
written off

(2,000)

(2,000)

(6,000)
Taxable Income
(Net Loss) after
write-off

298,000

(62,000)

(1,000)

Year 2
Recovery of
Amounts
Written Off

2,000

2,000

6,000

Taxable
Income on the
Recovery
2,000 - 5,000
Explanation:
In Case A, the entire amount recovered
(P2,000) is included in the computation
of gross income in Year 2 because the
taxpayer benefited by the same extent.
Prior to the write-off, the taxable income
was P300,000; after the write-off, the
taxable income was reduced to
P298,000.
In Case B, none of the P2,000 recovered
would be recognized as gross income in
Year 2. Note that even without the write-
off, the taxpayer would not have paid
any income tax anyway. The taxable
income before the write-off was actually
a net loss.
In Case C, only P5,000 of the P6,000
recovered would be recognized as gross
income in Year 2. It was only to this
extent that the taxpayer benefited from
the write-off. The taxpayer did not
benefit from the extra P1,000 because at
this point, the P1,000 was already a net
loss.

12. Tax Refund As a general rule, a refund
of a tax related to the business or the
practice of profession, is taxable income
(e.g., refund of fringe benefit tax) in the
year of receipt to the extent of the income
tax benefit of said deduction (i.e., the tax
benefit rule applies). However, the
following tax refunds are not to be included
in the computation of gross income:
(EXCEPTIONS) (CAPIFFEDVAT)
1. Philippine income tax, except the
fringe benefit tax
2. Income tax imposed by authority of
any foreign country, if the taxpayer
claimed a credit for such tax in the
year it was paid or incurred.
3. Estate and donors taxes
4. Taxes assessed against local benefits
of a kind tending to increase the value
of the property assessed (Special
assessments)
5. Value Added Tax
6. Fines and penalties due to late
payment of tax
7. Final taxes
8. Capital Gains Tax

The enumeration of tax refunds that are
not taxable (income) is derived from an
enumeration of tax payments that are not
deductible from gross income. If a tax is
not an allowable deduction from gross
income when paid (no reduction of taxable
income, hence no tax benefit), the refund
is not taxable.

X. EXCLUSIONS FROM GROSS X. EXCLUSIONS FROM GROSS X. EXCLUSIONS FROM GROSS X. EXCLUSIONS FROM GROSS
INCOME INCOME INCOME INCOME [Sec. 32(B)]

The following are excluded from gross income:
(GIRL CRM)

1. LIFE Insurance
General rule: The proceeds of life
insurance policies paid to heirs or
beneficiaries upon the death of the insured
- Reason: Insurance is a contract of
indemnity; hence, the proceeds should
be treated as indemnity and not as
gain or income.

Exception: If such amounts are held by
the insurer under an agreement to pay
interest thereon, the interest payments
shall be included in gross income.

2. Amount Received by Insured as
RETURN of Premium
General rule: The amount received by the
insured, as a return of premiums paid by
him under life insurance, endowment, or
annuity contracts, either during the term or
at the maturity of the term mentioned in
the contract or upon surrender of the
contract
- Reason: This is a return of capital and
not income.

Exception: If the amounts received by the
insured (when added to the amounts
already received before the taxable year
under such contract) exceed the aggregate



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 31 31 31 31 of 163 163 163 163

TAXATION LAW 1
premiums or considerations paid (whether
or not paid during the taxable year), then
the excess shall be included in gross
income. (source unknown)

3. GIFTS, Bequests, and Devises
General rule: The value of property
acquired by gift, bequest, devise, or
descent.
- Reason: These transactions are
subject to transfer taxes estate or
donors taxes.

Exception: Income from such property, as
well as gift, bequest, devise or descent of
income from any property, in cases of
transfers of divided interest, shall be
included in gross income.

4. COMPENSATION for Injuries or
Sickness
The amounts received as compensation for
personal injuries or sickness, plus the
amounts of any damages received, whether
by suit or agreement, on account of such
injuries or sickness.

5. INCOME Exempt under Treaty
Income of any kind, to the extent required
by any treaty obligation binding upon the
Government of the Philippines.

6. RETIREMENT Benefits, Pensions,
Gratuities, etc.-
a. Retirement benefits received under
RA 7641 and those received by officials
and employees of private firms in
accordance with a reasonable private
benefit plan maintained by the
employer.

o REQUISITES:
i. The retiring employee has been in
the service of the same employer
for at least 10 years.
ii. The retiring employee is not less
than 50 years of age at the time
of his retirement
iii. The benefits shall be availed of by
an employee only once.
iv. That there be a reasonable
private benefit plan as defined
below.

o A 'reasonable private benefit
plan' means
a pension, gratuity, stock bonus
or profit-sharing plan
maintained by an employer for
the benefit of some or all of his
employees
wherein contributions are made
by such employer for the
employees
for the purpose of distributing to
such employees the earnings
and principal of the fund thus
accumulated and
wherein it is provided in the plan
that at no time shall any part of
the corpus or income of the fund
be used for, or be diverted to,
any purpose other than for the
exclusive benefit of the said
officials and employees.

b. Any amount received by an employee
or by his heirs from the employer as a
consequence of separation of such
official or employee from the service of
the employer because of
o death
o sickness
o other physical disability or
o for any cause beyond the
control of the employee (i.e., the
separation of the employee must
be involuntary and not initiated by
him)

c. The social security benefits,
retirement gratuities, pensions and
other similar benefits received by
resident or nonresident citizens of the
Philippines or aliens who come to reside
permanently in the Philippines from
foreign government agencies and other
institutions

d. Payments of benefits due or to become
due to any person residing in the
Philippines under the laws of the United
States administered by the United
States Veterans Administration

e. Benefits received from or enjoyed
under the Social Security System

f. Benefits received from the GSIS,
including retirement gratuity received
by government officials and employees

CASE LAW:
BIR Ruling 125-98:
The phrase "shall not have availed of
the privilege under a retirement benefit
plan of the same or another employer"
found in Sec. 32 (B) (6) (a) of the Tax
Code means that the retiring official or
employee must not have previously
received retirement benefits from
the same or another employer who
has a qualified retirement benefit
plan.

BIR Ruling 143-98:
The terminal leave pay of
government employees whose
employment is coterminous is
exempt since it falls within the
meaning of the phrase "for any cause
beyond the control of the said official or
employee" found in Sec. 32(B).

7. MISCELLANEOUS Items
a. Income Derived by Foreign
Government
Income derived from (1) investments in
the Philippines in domestic securities
(loans, stocks, bonds, etc.) or from (2)
interest on deposits in banks in the
Philippines by
i. foreign governments
ii. financing institutions owned,
controlled, or enjoying
refinancing from foreign
governments, and



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 32 32 32 32 of 163 163 163 163

TAXATION LAW 1
iii. international or regional financial
institutions established by foreign
governments.

b. Income Derived by the Government
or its Political Subdivisions
Income derived from any public utility
or from the exercise of any essential
governmental function accruing to the
Government of the Philippines or to any
political subdivision thereof.

c. Prizes and Awards
Prizes and awards made primarily in
recognition of religious, charitable,
scientific, educational, artistic, literary,
or civic achievement but only if:
i. recipient was selected without
any action on his part to enter
the contest or proceeding and
ii. recipient is not required to render
substantial future services as a
condition to receiving the prize or
award

d. Prizes and Awards in Sports
Competition
All prizes and awards granted to
athletes (1) in local and international
sports competitions and (2) sanctioned
by their national sports associations.

e. 13th Month Pay and Other Benefits
Gross benefits received by employees
of public and private entities provided
that the total exclusion shall not
exceed P30,000 which shall cover:
i. Benefits received by government
employees under RA 6686
ii. Benefits received by employees
pursuant to PD 851 (13
th
Month
Pay Decree)
iii. Benefits received by employees
not covered by PD 851 as
amended by Memorandum Order
No. 28 and
iv. Other benefits such as
productivity incentives and
Christmas bonus

What happens if the benefits
exceed P30,000? The amount in
excess of P30,000 will be considered as
compensation income.

f. GSIS, SSS, Medicare and Other
Contributions
GSIS, SSS, Medicare and Pag-ibig
contributions, and union dues of
individuals

g. Gains from the Sale of Bonds,
Debentures or other Certificate of
Indebtedness
Gains realized from the sale or
exchange or retirement of bonds,
debentures or other certificate of
indebtedness with a maturity of more
than 5 years.

h. Gains from Redemption of Shares in
Mutual Fund
Gains realized by the investor upon
redemption of shares of stock in a
mutual fund company


XI. ALLOWABLE DEDUCTIONS FROM XI. ALLOWABLE DEDUCTIONS FROM XI. ALLOWABLE DEDUCTIONS FROM XI. ALLOWABLE DEDUCTIONS FROM
GROSS INCOME GROSS INCOME GROSS INCOME GROSS INCOME

The term taxable income means the pertinent
items of gross income specified in the National
Internal Revenue Code [Sec. 32], less the
deductions [Sec. 34] and/or personal and
additional exemptions [Sec. 35], if appropriate,
authorized for such types of income by the Code
or other special laws. [Sec. 31]

A. Basic Principles Governing Tax
Deductions
He who claims it must point to the specific
provision of the statute authorizing it, and
he must be able to prove that he is
entitled to it.
If the exemption is not expressly stated in
the law, the taxpayer must at least be
within the purview of the exemption by
clear legislative intent. However, if there
is an express mention in the law or if the
taxpayer falls within the purview of the
exemption by clear legislative intent, the
rule on strict construction against the
taxpayer-claimant will not apply.
Unlike gross income, there is no catch-all
provision for deductions.
Deductions must comply with the
substantiation requirement.

B. Kinds of Deductions
1. Itemized Deductions business (or
professional) expenses which are ordinary
and necessary in the conduct of business
(or in the exercise of profession)

2. Optional Standard Deduction (OSD)
may be taken by an individual, in lieu of
itemized deductions [Section 34(L)]
REQUISITES:
a. Available only to citizens and resident
aliens
b. The standard deduction is optional;
i.e., unless the taxpayer signifies in his
return his intention to elect this
deduction, he is considered as having
availed of the itemized deductions.
c. Such election, when made by the
qualified taxpayer, is irrevocable for
the year in which made; however, he
can change to itemized deductions in
succeeding years.

*Since an individual in business or in
the practice of profession is required
to file quarterly income tax returns,
can he choose the OSD in his quarterly
returns and then choose the itemized
deductions in his annual income tax
return, or vice versa? YES, the OSD or
Itemized Deductions is against the
gross income of the year. Quarterly
income tax returns are only interim
computations on the taxable income
for the year.




1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 33 33 33 33 of 163 163 163 163

TAXATION LAW 1
d. The amount of standard deduction is
limited to ten percent (10%) of the
taxpayers gross income. [However,
OSD is not available against
compensation income arising out of
an employer-employee relationship.
(Sec. 34, 1
st
par.)]
*NOTE: The Gross Income base of
OSD is
For an individual in a
manufacturing or merchandising
concern: gross income (or profit)
from sales [i.e., sales less cost of
sales], and incidental income, if
any
For an individual whose income is
from the sale of services: gross
income (or profit) from sale of
services [i.e., gross receipts less
direct cost of services], and
incidental income, if any

e. Proof of actual expenses is not
required, but the taxpayer should
keep records pertaining to his gross
income during the taxable year.

C. Who can avail of deductions?
GENERAL RULE: All taxpayers
EXCEPTION: Those earning compensation
income arising from personal services
rendered under an employer-employee
relationship

Rules:
1. Compensation income earners can avail
themselves only of the deduction in Sec.
34 (M), i.e., premium payments on health
and/or hospitalization insurance (in
addition to the appropriate personal
exemption).
2. The following can claim ITEMIZED
deductions:
a. Corporations, whether domestic or
(resident) foreign
b. General Professional Partnerships
c. Individuals engaged in trade,
profession or business (citizen,
resident alien, non-resident alien
doing business in the Philippines)
d. Estates and trusts engaged in trade
or business
e. Proprietary educational institutions
and hospitals (non-profit)
f. Government-owned or controlled
corporations
3. Only individuals, EXCEPT non-resident
aliens, can elect between itemized
deductions and OPTIONAL STANDARD
DEDUCTION.

QUICK GLANCE

The following are the deductions from gross
income:
For individuals with gross
compensation income only:
- Premium payments on health and/or
hospitalization insurance (if requisites
are complied with)
- Personal Exemptions
For individuals with gross income
from business or practice of
profession:
- Optional Standard Deduction [OR]
Itemized Deductions
- Premium payments on health and/or
hospitalization insurance (if requisites
are complied with)
- Personal Exemptions
For corporations, general professional
partnerships, estates and trusts
engaged in business, proprietary
educational institutions and hospitals
(non-profit), and government-owned
or controlled corporations
- Itemized Deductions

D. Kinds of Itemized Deductions (BELT DID
CPR)
1. Expenses
2. Interest
3. Taxes
4. Losses
5. Bad debts
6. Depreciation
7. Depletion
8. Charitable and Other Contributions
9. Research and Development
10. Pension Trust

E. Expenses [Sec. 34(A)]
Only deduction allowable Ordinary and
necessary trade, business or professional
expenses

REQUISITES: (SPOD RYN)
1. It must be ORDINARY AND
necessary.
Ordinary - expense which is
normal in relation to the taxpayers
business and the surrounding
circumstances. The expense need
not be recurring.
Necessary where the
expenditure is appropriate or
helpful in the development of the
taxpayers business or that the
same is proper for the purpose of
realizing a profit or minimizing a
loss.
The TWO CONDITIONS MUST
CONCUR. A court may decide on
when an expense is, or is not,
ordinary, but as much as possible,
it will refuse to substitute its
judgment for that of the taxpayer
on the necessity of an expense.
2. It must be paid or incurred during
the taxable YEAR.
3. It must be paid or incurred in carrying
on or which are DIRECTLY
attributable to, the development,
management, operation and/or
conduct of the trade, business or
exercise of a profession.
4. The amount must be REASONABLE.
5. It must be SUBSTANTIATED with
sufficient evidence, such as official
receipts or other adequate records,
showing:
i. the amount of the expense being
deducted, and
ii. the direct connection or relation of
the expense being deducted to the
development, management,
operation and/or conduct of the



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 34 34 34 34 of 163 163 163 163

TAXATION LAW 1
trade, business or profession of the
taxpayer.
6. It is NOT CONTRARY to law, public
policy or morals.
7. The tax required to be withheld on
the amount paid or payable must
have been PAID to the BIR by the
taxpayer, who is constituted as a
withholding agent of the government
(for instance, withholding tax on
compensation income paid to
employees, fringe benefit tax on fringe
benefits given to managerial and
supervisory employees, etc.). (Sec.
2.58.5, RR 2-98 as amended by Sec.
6, RR 14-2002)

EXAMPLES: (CERT)
1. Salaries, wages, and other forms of
compensation for personal services
actually rendered, including the
grossed-up monetary value (GMV) of
fringe benefit furnished by the
employer to the employee
2. Travel expenses, here and abroad,
while away from home in the pursuit
of trade, business or profession
3. Rentals and/or other payments which
are required as a condition for the
continued use or possession, for
purposes of the trade, business or
profession, of property to which the
taxpayer has not taken or is not taking
title or in which he has no equity other
than that of a lessee, user or
possessor
4. Entertainment, amusement and
recreation expenses that are 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 exercise of
a profession

Representation Expenses [Sec. 2,
RR 10-2002] incurred by a
taxpayer in connection with the
conduct of his trade, business or
exercise of profession, in
entertaining, providing amusement
and recreation to, or meeting with,
a guest or guests at a dining place,
place of amusement, country club,
theater, concert, play, sporting
event, and similar events or
places.

Ceiling [Sec. 5, RR 10-2002]
The amount of actual
entertainment, amusement and
recreation expense paid or
incurred within the taxable year by
the taxpayer, but in no case shall
such deduction exceed:
- For taxpayers engaged in sale of
goods or properties: 0.5% of net
sales (i.e., gross sales less sales
returns/allowances and sales
discounts)
- For taxpayers engaged in sale of
services, including exercise of
profession and use or lease of
properties: 1.0% of net revenue
(i.e., gross revenue less discounts)

Bribes, Kickbacks and Other Similar
Payments No deduction shall be
allowed for any payment made, directly or
indirectly, to an official or employee of the
national or local government,
government-owned or -controlled
corporation, or foreign government, or to
a private corporation, general professional
partnership, or a similar entity, if the
payment constitutes a bribe or kickback.

SPECIAL CASE: Expenses Allowable to
Private Educational Institutions [Sec.
34(2), RR 10-2002] In addition to the
expenses allowable as deductions, a
private educational institution may at its
option elect either:
1. to deduct expenditures otherwise
considered as capital outlays of
depreciable assets incurred during
the taxable year for the expansion of
school facilities, or
2. to deduct allowance for depreciation
thereof.

F. Interest [Sec 34(B)]
Deduction Allowable The amount of
interest paid or incurred within a taxable
year on indebtedness in connection with
the taxpayer's profession, trade or
business shall be allowed as deduction
from gross income.

REQUISITES (Sec. 34(B) as
implemented by Sec. 6, RR 13-2000):
(WITTY CReP DL)
1. There is an INDEBTEDNESS.
2. The indebtedness is that of the
TAXPAYER.
3. The indebtedness is connected with
the taxpayers TRADE, profession,
or business.
4. The interest must be legally DUE.
5. The interest must be stipulated in
WRITING.
6. The taxpayer is LIABLE to pay
interest on the indebtedness.
7. The indebtedness must have been
paid or accrued during the taxable
YEAR.
8. The interest payment arrangement
must not be between ReLATED
taxpayers as mandated in Sec.
34(B)(2)(b), in relation to Sec. 36(B),
both of the Tax Code of 1997.
9. The interest must not be incurred to
finance PETROLEUM operations.
10. In case of interest incurred to acquire
property used in trade, business or
exercise of profession, the same was
not treated as a CAPITAL
expenditure,

LIMITATION: The taxpayer's allowable
deduction for interest expense shall be
reduced by an amount equal to 42% of
the interest income subjected to final tax;



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 35 35 35 35 of 163 163 163 163

TAXATION LAW 1
provided, that effective January 1, 2009,
the percentage shall be 33%.
12

Purpose: To prevent tax arbitrage or the use
of back- to-back loans to take advantage
of the difference between the tax rate on
interest income (20% final tax) and the
rate of savings caused by the deduction of
interest expense (35%-corporate rate)

ILLUSTRATION:
On Jan. 1, 2007, A Corp borrowed P100,000
from B Bank at a rate of 10% per annum.
On the same day A Corp. deposited the
same amount to C Bank at 10% interest p.a.
By the end of the year A Corp would have
P10,000 interest income from C Bank, and
P10,000 interest expense payable to B Bank.
If not for the 42% limitation, the 2
transactions would result in tax savings for A
Corp as
follows:
Tax savings from deduction
of interest expense (P10,000
x 35%
3,500
Less: Final tax on interest
income (P10,000 x 20%)
2,000
Net Tax savings 1,500

Applying the limit, A corp.s deductible
interest expense would be:
Actual interest expense 10,000
Less: 42% of interest
income
4,200
Deductible interest
expense
5,800

Due to the limitation, the tax savings will be
reduced from P 1,500 to P 30:
Tax savings on interest
expense deduction (P
5,800 x 35%)
2,030
Less: Final Tax on interest
income
2,000
Net Tax Savings 30


When is the limitation not
applicable? Interest incurred or paid
by the taxpayer on all its business
related taxes shall be fully deductible
from gross income unpaid and shall not
be subject to the limitation on
deduction. Thus, such interest expense
incurred or paid shall not be diminished
by the percentage of interest income
earned which had been subjected to
final withholding tax. (Sec. 4(c), RR 13-
2000)


NON-DEDUCTIBLE INTEREST (Sec.
34(B)(2)(b) as implemented by Sec. 4(d),
RR 13-2000)
1. Interest paid in advance by the
taxpayer who reports income on cash
basis
When allowed as deduction: in the
year the indebtedness is paid.
If the indebtedness is payable in
periodic amortizations, the amount of

12
As amended by RA 9337
interest which corresponds to the
amount of the principal amortized or
paid during the year shall be allowed
as deduction in such taxable year.
2. Interest payments made: (between
related taxpayers [persons specified
under Section 36 (B), see discussion
on losses below-Subsection H]
3. Interest on indebtedness incurred to
finance petroleum exploration

OPTIONAL TREATMENT OF INTEREST
EXPENSE: At the option of the taxpayer,
interest incurred to acquire property used
in trade, business or exercise of a
profession may be either (1) allowed as a
DEDUCTION or (2) treated as a CAPITAL
EXPENDITURE.

ILLUSTRATION:
Mr. A wanted to acquire a delivery van
worth P1,000,000 for his business. To
finance this, he borrowed P1,000,000
from ABC Bank on January 1, 2005. The
loan bears interest of 10%, and both the
interest and principal are payable on
December 31, 2005. For income tax
purposes, how should Mr. A account for
his interest expense in 2005?

ANSWER: Mr. A has two options. First, he
may choose to treat the P100,000 (10%
of P1,000,000) interest expense As
amended by RA 9337
as an outright deduction from his gross
income in 2005 (which deduction shall be
subject to the limitation that it be reduced
by an amount equal to 42% of the
taxpayers interest income subjected to
final tax). Alternatively, he may choose to
capitalize the interest expense by
incorporating its amount to the cost of the
vehicle obtained for his business. In this
case, the vehicle will be recorded in his
books at a cost of P1,100,000 (purchase
price of P1,000,000 plus the interest
expense of P100,000). The total cost of
the vehicle will then be gradually allowed
as deduction from the gross income of the
succeeding taxable years as depreciation
expense.

G. Taxes [Sec. 34(C)]
Definition: The word taxes means taxes
proper and no deduction should be
allowed for amounts representing interest,
surcharge, or penalties incident to
delinquency. (Sec. 80, RR-2)

GENERAL RULE: All taxes, national or
local, paid or incurred during the taxable
year in connection with the taxpayer's
profession, trade or business, are
deductible from gross income

EXCEPTIONS:
Philippine income tax, except the
fringe benefit tax
Income tax imposed by authority of
any foreign country
Except when the taxpayer does
NOT signify his desire to avail of
the tax credit for taxes of foreign
countries, in which case the



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 36 36 36 36 of 163 163 163 163

TAXATION LAW 1
amount may be allowed as a
deduction subject to the limitations
set forth by law. (Note that a
taxpayer qualified to take tax
credits for foreign income taxes
paid or incurred may alternatively
claim them as deductions from
gross income.)
Estate and donors taxes
Taxes assessed against local benefits
of a kind tending to increase the value
of the property assessed (Special
Assessments)
Value Added Tax
Fines and penalties due to late
payment of tax
Final taxes
Capital Gains Tax

REQUISITES: (TEDY)
1. It must be paid or incurred within the
taxable YEAR.
2. It must be paid or incurred in
connection with the taxpayers
TRADE, profession or business.
3. It must be imposed DIRECTLY on
the taxpayer.
4. It must not be specifically
EXCLUDED by law from being
deducted from the taxpayers gross
income.

EXAMPLES:
Import duties
Business taxes
Occupation taxes
Privilege and license taxes
Excise taxes
Documentary stamp taxes
Automobile registration fees
Real property taxes

LIMITATION: In the case of a
nonresident alien individual engaged in
trade or business (NRAETB) and a
resident foreign corporation (RFC), the
deductions for taxes shall be allowed only
if and to the extent that they are
connected with income from sources
within the Philippines.

Special Treatment of Foreign Income
Tax: A taxpayer qualified to take tax
credits for foreign income taxes paid or
incurred may alternatively claim them as
deductions from gross income.

What is tax credit? A credit for
foreign income tax paid or incurred
reduces the Philippine income tax that
should be paid. Tax credit is given to a
taxpayer in order to provide relief
from too onerous a burden of taxation
where the same income is subject to
both foreign income tax and the
Philippine income tax. In determining
the tax credit that may be allowed a
taxpayer, the foreign income tax
should be understood to mean tax
proper only; no credit shall be taken
for any amount paid or incurred to the
foreign country which represents
interest, surcharge or penalty incident
to delinquency on the payment of the
tax. In taking a tax credit:

Tax credit is taken for

The foreign
income tax
Tax credit is taken
against
The
Philippine
income tax

Who can claim a tax credit, and in
what amount
13
?
1. The amount of income taxes paid
or incurred during the taxable year
to any foreign country
a. Citizens
b. Domestic corporations
2. The taxpayers proportionate share
of such taxes of the general
professional partnership/estate or
trust paid or incurred during the
taxable year to a foreign country,
if his distributive share of the
income of such partnership/estate
or trust is reported for taxation
a. Members of general
professional partnerships
b. Beneficiaries of estates or
trusts

Who may NOT claim a tax credit?
1. Alien individuals
2. Foreign corporations

Substantiation requirements: The
tax credits shall be allowed only if the
taxpayer establishes to the
satisfaction of the Commissioner the
following:
1. The total amount of income
derived from sources without the
Philippines;
2. The amount of income derived
from each country, the tax paid
or incurred to which is claimed as
a credit under said paragraph,
such amount to be determined
under rules and regulations
prescribed by the Secretary of
Finance; and
3. All other information necessary
for the verification and
computation of such credits.
Limitations: The amount of tax credit
allowed is equivalent to the tax paid or
incurred to a foreign country during
the taxable year but not to exceed the
following limits:
1. [Per Country Limit] The amount
of tax credit shall not exceed the
same proportion of the tax against
which such credit is taken, which
the taxpayer's taxable income
from sources within such country
bears to his entire taxable income
for the same taxable year; and
2. [Worldwide Limit] The total
amount of the credit shall not
exceed the same proportion of the
tax against which such credit is
taken, which the taxpayer's
taxable income from sources

13
Amounts are subject to the limitations (per country and
overall) set forth by law.



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 37 37 37 37 of 163 163 163 163

TAXATION LAW 1
without the Philippines taxable
bears to his entire taxable income
for the same taxable year.

i.e.:



NOTE: The second limitation
applies where the taxpayer derives
income from more than one
foreign country.

ILLUSTRATION:
D Co., a domestic corporation, had the
following data for a year on taxable income
and income taxes paid:


Taxable Income, Country A P200,000
Taxable Income, Country B P100,000
Taxable Income, Philippines P700,000
Income Tax Paid Country
A
P 60,000
Income Tax Paid Country
B
P 38,000

What is the Philippine income tax still due,
after credit for foreign income taxes?
Should D Co. choose to treat income taxes
paid to foreign countries as deductions
from gross income, what is its Philippine
income tax?

Answer:
Scenario A: Tax Credit option is chosen.

Step 1: Compute for total taxable
income and Philippine income tax

Taxable Income, Country A 200,000
Taxable Income, Country B 100,000
Taxable Income, Philippines 700,000
Total Taxable Income from
sources within and without
the Phils 1,000,000

Philippine Income Tax (P1Mx
35%)
350,000

Step 2: Compute for Limitation A (Per
Country Basis).
To get tax credit per country under
Limitation A, this formula is followed:



The result after applying the formula above
is compared to the tax actually paid for each
foreign country. The lower of the two
amounts for each foreign country will be
added to get the total tax credit allowed
under Limitation A.
Amount
Allowed
(Whichever
is Lower)
Country A
Limitation A 70,000 60,000
(200/1000 x
350,000)

Actually paid to
Country A
60,000
Country B
Limitation B 35,000 35,000
(100/1000 x
350,000)

Actually paid to
Country B
38,000
Tax credit
allowed under
Limitation A
95,000

Step 3: Compute for Limitation B
(Overall Basis).
To get tax credit (overall basis) under
Limitation B, this formula is followed:



The result after applying the formula above
is compared to the tax actually paid in total
to foreign countries. The lower of the two
amounts will be added to get the total tax
credit allowed under Limitation B.

Amount
Allowed
(Whichever
is Lower)
Overall
Limit:

300/1000
x 350,000
105,000
Total
foreign
income
taxes paid
98,000
Tax credit
allowed
under
Limitation
B
98,000


Step 4: Compare the respective tax credits
allowed under Limitation A and Limitation B.
The lower of the two amounts is the final
allowable tax credit. In this case, the
amount computed under Limitation A
(P95,000) is lower, thus it becomes the final
allowable tax credit.

Step 5: Compute for the income tax still
due.
Philippine Income tax 350,000
Less: Allowable Tax Credit 95,000
Philippine Income Tax still due 255,000



Taxable Income from
sources outside the Phils x Phil. income = tax
Taxable Income tax credit
from all sources
Taxable Income
from Foreign Country x Phil. income = tax
Taxable Income tax credit
from all sources
2. Taxable Income for
all Foreign Countries x Phil. income = limit
Worldwide tax
Taxable Income

1. Taxable Income
per Foreign Country x Phil. income = limit
Worldwide tax
Taxable Income




1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 38 38 38 38 of 163 163 163 163

TAXATION LAW 1
Scenario B: Deduction option is chosen.

Taxable Income,
Country A
P 200,000
Taxable Income,
Country B
100,000
Taxable Income, Phils. 700,000
Total Taxable Income
(before deduction
for foreign income
tax)

P1,000,000
Less: Deductions for
Foreign Income Taxes
Paid
Country A
P60,000
Country B
P38,000

(98,000)
Net Taxable Income P 902,000

Philippine Income Tax
(902,000 x 35%)

P 315,700

H. Losses [Sec. 34(D)]
Losses actually sustained during the
taxable year and not compensated for by
insurance or other forms of indemnity
shall be allowed as deductions:
If incurred in trade, profession or
business;
Of property connected with the trade,
business or profession, if the loss
arises from fires, storms, shipwreck,
or other casualties, or from robbery,
theft or embezzlement.

REQUISITES: (CATT DID)
1. The loss must be that of the
TAXPAYER.
-The loss is personal to the taxpayer
and is not transferable or usable by
another. The loss of a predecessor
partnership is not deductible by a
successor corporation. The loss of the
parent company may not be
deducted by its subsidiary.
2. The loss must be ACTUALLY
sustained and charged off within
the taxable year.
-However, if the loss is compensated
by insurance or otherwise, the loss is
postponed to a subsequent year in
which it appears that no
compensation at all can be had, or
there is a remaining net loss (or
there is no full compensation).
Deduction will be denied if there is a
measurable right to compensation for
the loss, with ultimate collection
reasonably clear. So where there is
reasonable ground for
reimbursement, the taxpayer must
seek his redress and may not secure
a loss deduction until he establishes
that no recovery may be had. In
other words, the taxpayer must first
exhaust his remedies to recover or
reduce his loss. (Plaridel Surety and
Insurance Co. v. Collector, 21 SCRA
1187)

3. The loss is evidenced by a CLOSED
and completed transaction.
There should be an identifiable
event that fixes the loss. For
instance, when a loss results from
a sale, the consummation of the
sale is the identifiable event that
fixes the loss, and the deduction
should be claimed in the year that
the sale was consummated. A
sale is consummated only when
there is delivery.
4. The loss is not claimed as a
DEDUCTION for estate tax
purposes.
5. The loss must not be compensated
by INSURANCE or other forms of
indemnity.
6. The loss must be connected with
the taxpayers TRADE, business or
profession.
7. In the case of casualty loss,
declaration of loss (Sworn
DECLARATION of Loss) must be
filed within 45 days from the
occurrence of the casualty loss. (RR
12-77)

Despite concurrence of
requisites, when is loss
nonetheless NOT deductible?
In computing net income, no
deductions shall in any case be
allowed in respect of losses from
sales or exchanges of property
directly or indirectly [between related
taxpayers (Sec. 36 (B) ]
1. Between members of a family
- Family -includes brothers and
sisters (whole and half-blood),
spouse, ancestors, and lineal
descendants
2. Between an individual and
corporation more than fifty
percent (50%) in value of the
outstanding stock of which is
owned, directly or indirectly, by
or for such individual; or
3. Between two corporations more
than fifty percent (50%) in value
of the outstanding stock of which
is owned, directly or indirectly, by
or for the same individual;
4. Between the grantor and a
fiduciary of any trust;
5. Between the fiduciary of a trust
and the fiduciary of another trust
if the same person is a grantor
with respect to each trust;
6. Between a fiduciary of a trust and
beneficiary of such trust.

Obsolescence and worthlessness;
when deductible
Obsolescence: when the property has
to be discarded permanently because
its usefulness is suddenly terminated.
Worthlessness: when it can be
satisfactorily shown that the property
had indeed become valueless.

Other Types of Losses Recognized by
the Tax Code
Shrinkage in Value of Stocks (Sec.
99, RR-2) no loss can be deducted
from a mere shrinkage in value of



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 39 39 39 39 of 1 11 163 63 63 63

TAXATION LAW 1
such stock through fluctuation of the
market. The loss allowable in such
case is that actually suffered when
the stock is disposed of. If stock of a
corporation becomes worthless, its
cost or other basis determined in
accordance with Revenue Regulation
2-98 may be deducted by the owner
in the taxable year in which the stock
became worthless, provided a
satisfactory showing of its
worthlessness be made, as in the
case of bad debts.

Wagering Losses [Sec. 34 (D)(6)]
Wagering losses are deductible only
to the extent of wagering gains.
Therefore, if there are no wagering
gains, wagering loss cannot be
deducted. [Wagering gains and
losses - gains and losses from
transactions where the outcome
depends upon chance.]

Loss from Wash Sales of Stocks or
Securities [Sec. 38] A loss from a
wash sale of stock or securities is
generally not deductible from gross
income. A wash sale is a sale under
the following circumstances:
1. There was a sale or other
disposition of stock or securities
at a loss.
2. Within a period beginning thirty
days before, and ending thirty
days after, the date of sale or
disposition (known as the sixty-
one day period), there was an
acquisition of shares or securities
(or option to acquire shares or
securities).
i.e.:

---------------- x ----------------




3. The acquisition, or option,
should be a purchase or
exchange upon which gain or
loss is recognized under the
income tax law.
4. The stock or securities acquired
were substantially the same as
those disposed of.
5. The taxpayer is NOT a dealer in
securities.


INCOME TAX RULE: On the
shares sold at a loss with
covering acquisitions, NO LOSS
shall be recognized. On the
shares sold at a loss with no
covering acquisitions, CAPITAL
LOSS shall be recognized (See
XIII. Capital Gains and Losses,
for the income tax treatment).
The loss not recognized shall be
adjusted into (i.e., added to) the
basis of the shares acquired
within the sixty-one day period.

ILLUSTRATION:
S Co., not a dealer in securities,
on December 27, 2000, sold for
P90,000, 1,000 shares of
common stock of ZZ Company,
that it acquired on January 20,
2000 for P110,000. On January 5,
2001, or nine days after the sale,
it acquired 900 shares of common
stock of the same company for
P90,000. On June 10, 2001, the
latest acquisition was sold for
P120,000.

INCOME TAX IMPLICATIONS:
There would have been a loss
not recognized of P18,000 on
the sale of December 27,
2000.
There would have been a gain
of P12,000 on the sale of June
10, 2001.

SUPPORTING SOLUTION:
a. Determine if the sale is a
wash sale YES, because
nine days after the December
27, 2000 sale (or within the
sixty-one day period), S. Co.
(which is not a dealer in
securities) acquired shares of
stock which were the same as
those disposed of.

b. Computation of loss not
recognized

Acquisition Cost P110,000
Less: Selling Price 90,000
Total Loss P 20,000

No. of shares sold at a loss 1,000
Less: Number of shares
acquired within the 61-day
period
900
No. of shares acquired with
no matching acquisition
100

Loss on a wash sale, not
recognized

(900/1,000 * 20,000) P18,000
Capital Loss recognized
(100/1,000 * 20,000) P2,000

c. Computation of basis of the
shares acquired on January 5,
2001 (i.e., adjusted cost).
Acquisition Cost P 90,000
Add: Loss not
recognized
18,000
Basis of the shares
acquired on January
5, 2001


P108,000

d. Computation of the gain on
the sale of June 10, 2001
Selling Price P120,000
Less: Adjusted
Basis
108,000
Gain on the Sale 12,000
30 days PRIOR OR 30 days AFTER
to the sale the sale

Date of sale
Acquisition
occurred
EITHER:



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 40 40 40 40 of 163 163 163 163

TAXATION LAW 1

What if the taxpayer is a dealer
in securities, and the transaction
from which the loss resulted, was
made in the ordinary course of
the business of such dealer?
The loss is deductible in full.

Corporate readjustment: Merger or
Consolidation
14
[Sec. 40(C)]
A merger or consolidation has income
tax consequences to the corporation
which is a party to the merger or
consolidation, to its stockholders, and
to its security holders. To the
corporation, or to its stockholders, or
to its security holders, loss is not
recognized from the merger or
consolidation.

ILLUSTRATION:
Y Co. was merged into Z Co. Y Co.
transferred its properties with a book
value of P2,000,000 to Z Co., for
which it received shares of stock of Z
Co. with a fair market value of
P1,800,000. Mr. AA was a
stockholder of Y Co., and he was
asked to surrender his shares in Y
Co. (which he acquired at a cost of
P200,000) to the company (Y Co.),
and received in return for the shares
surrendered, shares of stock of Z Co.
with a fair market value of P180,000.
The merger had the following tax
consequences:


To Y Co.
Fair Market Value of shares of
Z Co. received
P1,800,000
Less: Book Value of properties
transferred
2,000,000
Loss not recognized P 200,000

To Mr. AA:
Fair Market Value of Z Co.
shares received

P 180,000
Less: Cost of Y Co. shares
surrendered

200,000
Loss not recognized P18,000

Suppose a merger or
consolidation resulted in a GAIN
to the corporation, or
stockholder, or security holder,
will the gain be recognized?

14
No gain or loss shall be recognized if in pursuance of a plan
of merger or consolidation -
(a) A corporation, which is a party to a merger or
consolidation, exchanges property solely for stock in a
corporation, which is a party to the merger or
consolidation; [property for stock] or
(b) A shareholder exchanges stock in a corporation, which
is a party to the merger or consolidation, solely for the
stock of another corporation also a party to the merger
or consolidation; [stock for stock ] or
(c) A security holder of a corporation, which is a party to
the merger or consolidation, exchanges his securities in
such corporation, solely for stock or securities in such
corporation, a party to the merger or consolidation.
[securities for securities]
Gain will be recognized only if, on
the exchange under the merger or
consolidation, the taxpayer received
cash or property. The gain to be
recognized should not exceed the
sum of money and the fair market
value of the property received.


Corporate readjustment: Transfer to
Controlled Corporation [Sec. 40(C)]
When a taxpayer transfers property
to a corporation, in consideration of
stock received for the transfer, as a
result of which transfer, the taxpayer
(alone or together with others not
exceeding four [or a total of five])
gains control of the corporation
15
, no
loss is recognized on the transfer of
property.


Suppose the transfer resulted in
a GAIN to the transferor, will the
gain be recognized?
Gain will be recognized only if on
the transfer, the taxpayer received
cash or property in addition to the
shares received. The gain to be
recognized shall not exceed the sum
of money and fair market value of
the property received.


If before the transfer to the
corporation, the transferor
already had control over the
corporation, the gain or loss on
the transfer will be recognized.

ILLUSTRATION:
Mr. II transferred property to JJ Co.,
of which he had control. The property
had a basis to him of P500,000. JJ
Co. paid him with shares of stock
with a fair market value of P450,000.
Will there be a loss to recognize?
Yes. This transfer does not qualify as
a corporate readjustment.

BIR Ruling 383-87 (Nov. 25,
1987): Requirements for
deductibility
1. Plan of reorganization should be
adopted by each of the corporation
shown by acts of its duly
constituted officers
o Copy of the plan
o Complete statement of the
cost or other basis of all
property
o Statement of the amount of
stock or securities and other
property or money received
from the exchange, including
a statement of all
distributions or other
dispositions made thereof
o Statement of the amount and
nature of any liabilities
assumed upon the exchange.

15
Previous to the transfer there was no control, and it was the
transfer that resulted in control.



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 41 41 41 41 of 163 163 163 163

TAXATION LAW 1
2. Taxpayer (other than the
corporation party to the
reorganization) who received
stocks or securities and other
property shall be incorporated in
his ITR for the taxable year in
which the exchanges takes place a
complete statement of facts
pertinent to the non-recognition of
gain or loss including:
o Statement of the cost or
other basis of the stock or
securities transferred in the
exchange
o Statement in full amount of
the stocks, securities, other
property, and money
including liabilities assumed
upon the exchange.

Capital Losses (See XIII. Capital
Gains and Losses)

Abandonment Losses [Sec. 34(D)(7)]
In the event a contract area where
petroleum operations are
undertaken is partially or wholly
abandoned, ALL accumulated
exploration and development
expenditures pertaining thereto
shall be allowed as a deduction:
o Provided, That accumulated
expenditures incurred in that
area prior to January 1, 1979
shall be allowed as a
deduction only from any
income derived from the same
contract area.
o In all cases, notices of
abandonment shall be filed
with the Commissioner.

In case a producing well is
subsequently abandoned, the
unamortized costs thereof, as
well as the undepreciated costs
of equipment directly used
therein, shall be allowed as a
deduction in the year such well,
equipment or facility is abandoned
by the contractor:
o Provided, That if such
abandoned well is reentered
and production is resumed, or
if such equipment or facility is
restored into service, the said
costs shall be included as
part of gross income in the
year of resumption or
restoration and shall be
amortized or depreciated, as
the case may be.

Net Operating Loss Carry-Over
(NOLCO) [Sec. 34(D)(3)]
The net operating loss
16
of the
business for any taxable year
immediately preceding the current
taxable year, which had not been
previously offset as deduction from
gross income shall be carried over as

16
Net operating loss is the excess of allowable deductions over
gross income (as defined in Sec. 32(A) of the NIRC).
a deduction from gross income for
the next three (3) consecutive
taxable years
17
immediately
following the year of such loss.

REQUISITES:
1. Any net loss incurred in a taxable
year during which the taxpayer
was exempt from income tax
shall not be allowed as a
deduction.
2. A net operating loss carry-over
(NOLCO) shall be allowed only if
there has been NO SUBSTANTIAL
CHANGE in the ownership of the
business or enterprise.
There is no substantial change
when:
a. 75% or more in nominal
value of outstanding issued
shares, if the business is in
the name of the corporation,
is held by or on behalf of the
same persons; or
b. 75% or more of the paid up
capital of the corporation, if
the business is in the name
of the corporation, is held by
or on behalf of the same
persons.

Applicability of the 75% interest
rule
o The 75% equity, ownership or
interest rule shall only apply to a
transfer or assignment of the
taxpayer's net operating losses as a
result of or arising from the said
taxpayer's merger or consolidation or
business combination with another
person. In case the transfer or
assignment of the taxpayer's net
operating losses arises from the said
taxpayer's merger, consolidation or
combination with another person, the
transferee or assignee shall NOT be
entitled to claim the same as
deduction from gross income
UNLESS, as a result of the said
merger, consolidation or
combination, the shareholders of
the transferor/assignor, or the
transferor (in case of other business
combinations) gains control of at
least 75% or more in nominal
value of the outstanding issued
shares or paid up capital of the
transferee/assignee (in case the
transferee/assignee is a corporation)
or 75% or more interest in the
business of the transferee/assignee
(in case the transferee/assignee is

17
Exception to the Three-Year Rule For mines other
than oil and gas wells, a net operating loss without the benefit
of incentives provided for under the Omnibus Investments Code
of 1987, incurred in any of the first ten (10) years of operation
may be carried over as a deduction from taxable income for the
next five (5) years immediately following the year of such loss.
The entire amount of the loss shall be carried over to the first of
the five (5) taxable years following the loss, and any portion of
such loss which exceeds, the taxable income of such first year
shall be deducted in like manner form the taxable income of the
next remaining four (4) years.



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 42 42 42 42 of 163 163 163 163

TAXATION LAW 1
other than a corporation). (Sec. 2.4,
RR 14-2001)

o BIR Ruling 011-02, March
27, 2002
The 75% equity, ownership
or interest rule does not apply
in this case, since the transfer
of the shares by the previous
stockholders were through
straight purchase and sale
and not through merger,
consolidation or business
combination, such transfer did
not cause a substantial
change in ownership.

Time of Determination of
Substantial Change in the
Ownership of the Business
the
end of the taxable year when NOLCO
is to be claimed as deduction (e.g., in
the case of merger or consolidation
of two or more corporations, such
change shall be determined based on
the ownership of the outstanding
shares of stock issued or based on
paid-up capital as of the end of the
taxable year, and as a result of or
arising from the said merger or
consolidation). (Sec. 5, RR 14-2001)


By or on Behalf of the Same
Persons
o refers to the maintenance of
ownership despite change as when:

No actual change in ownership is
involved in case the transfer involves
change from direct ownership to
indirect ownership, or vice versa.

ILLUSTRATION:
Facts: P Corporation owns Q
Corporation that has NOLCO. P
Corporation transfers Q
Corporation's shares to R
Corporation in exchange for 100%
of R Corporation shares.
Held: Q Corporation's NOLCO is
retained because Q Corporation's
shares are held "by" R Corporation
"on behalf of" P Corporation, the
original owner.

No actual change in ownership is
involved as in the case of merger of
the subsidiary into the parent
company.

ILLUSTRATION:
Facts: X Corporation owns 100%
of Y Corporation. Y Corporation
owns 100% of Z Corporation. Z
Corporation has NOLCO. Z
Corporation is merged into Y
Corporation.
Held: Z Corporation's NOLCO
should be retained and transferred
to Y Corporation. Prior to the
merger, X Corporation already
indirectly owned Z Corporation,
i.e., Z Corporation's shares were
held "by" Y Corporation "on behalf
of" X Corporation. After the
merger, X now directly owns Z
Corporation [absorbed corporation]
which continues to exist in Y
Corporation.

Taxpayers Entitled to Deduct
NOLCO from Gross Income.
1) Any individual (including estates
and trusts) engaged in trade or
business or in the exercise of his
profession
-Special Rule: An individual
who claims the 10% optional
standard deduction shall not
simultaneously claim deduction
of the NOLCO. Further, the
three-year reglementary period
shall continue to run
notwithstanding the fact that
the aforesaid individual availed
of the 10% optional standard
deduction during the said
period.

2) Domestic and resident foreign
corporations subject to the normal
income tax (e.g., manufacturers
and traders) or preferential tax
rates under the Code (e.g., private
educational institutions, hospitals,
and regional operating
headquarters)
-Special Rule: Corporations
cannot enjoy the benefit of
NOLCO for as long as it is
subject to MCIT in any taxable
year. The three-year
reglementary period on the
carry-over of NOLCO shall
continue to run
notwithstanding the fact that
the corporation paid its income
tax under the "Minimum
Corporate Income Tax"
computation.

EXCEPTIONS (Who are not entitled
to deduct NOLCO): (bob-pie)
1. Offshore Banking Unit (OBU) of
a foreign banking corporation, and
Foreign Currency Deposit Unit
(FCDU) of a domestic or foreign
banking corporation, duly
authorized as such by the Bangko
Sentral ng Pilipinas (BSP);

2. An enterprise registered with
the Board of Investments
(BOI) with respect to its BOI-
registered activity enjoying the
Income Tax Holiday incentive.
Its accumulated net operating
losses incurred or sustained during
the period of such Income Tax
Holiday shall not qualify for
purposes of the NOLCO;

3. An enterprise registered with
the Philippine Economic Zone
Authority (PEZA), pursuant to
R.A. No. 7916, as amended, with



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 43 43 43 43 of 163 163 163 163

TAXATION LAW 1
respect to its PEZA-registered
business activity. Its accumulated
net operating losses incurred or
sustained during the period of its
PEZA registration shall not qualify
for purposes of the NOLCO;

4. An enterprise registered under
R.A. No. 7227, otherwise known as
the Bases Conversion and Devt
Act of 1992, e.g., SBMA-registered
enterprises, with respect to its
registered business activity. Its
accumulated net operating losses
incurred or sustained during the
period of its said registered
operation shall not qualify for
purposes of the NOLCO;

5. Foreign corporations engaged in
international shipping or air
carriage business in the
Philippines; and

6. In general, any person, natural or
juridical, enjoying exemption
from income tax, pursuant to the
provisions of the Code or any
special law, with respect to its
operation during the period for
which the aforesaid exemption is
applicable. Its accumulated net
operating losses incurred or
sustained during the said period
shall not qualify for purposes of
the NOLCO.

ILLUSTRATION OF NOLCO:
(In Pesos) 2000 2001 2002 2003 2004
Gross Income 500,000 600,000 700,000 500,000 800,000
Less: Deductions 900,000 500,000 750,000 420,000 450,000
Net Loss [OR] (400,000) (50,000)
Net Income before NOLCO* 100,000 80,000 350,000
Less: NOLCO

From 2000 (100,000) (80,000)


From 2002

(50,000)
Taxable Income 0 0 0 0 300,000
* - whichever is applicable

Explanation:
The unused net operating loss of P220,000 (400,000 100,000 80,000) of the year 2000 could
not be carried over beyond 2003. The net operating loss of 2002 could be carried over to 2004,
since it is within the three-year period.

Q: As of yearend of 2004, what amount of NOLCO is available to the company for offsetting against
(potential) gross income of succeeding taxable years?

Answer: None. While there was an unused portion of the 2000 NOLCO, such had already expired
by yearend of 2003. The 2002 NOLCO (P50,000) was completely used up in 2004. There is,
therefore, no NOLCO available to the company for year 2005 and thereafter.



I. Bad Debts [Sec. 34(E)]
Definition: debts resulting from the
worthlessness or uncollectibility, in whole or
in part, of amounts due the taxpayer by
others, arising from money lent or from
uncollectible amounts of income from goods
sold or services rendered. (Sec. 2, RR 5-99
as amended by RR 25-2002)

Deduction Allowed: Debts due to the
taxpayer actually ascertained to be
worthless and charged off within the taxable
year

Actually ascertained to be worthless
In general, a debt is not worthless simply
because it is of doubtful value or difficult to
collect. Worthlessness is not determined by
an inflexible formula or slide rule calculation
but upon the exercise of sound business
judgment. The determination of
worthlessness in a given case must depend
upon the particular facts and the
circumstances of the case. A taxpayer may
not postpone a bad debt deduction on the
basis of a mere hope of ultimate collection
or because of a continuance of attempts to
collect notes which have long become
overdue, and where there is no showing
that the surrounding circumstances differ
from those relating to other notes which
were charged off in a prior year. While a
> >
>




1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 44 44 44 44 of 163 163 163 163

TAXATION LAW 1
mere hope probably will not justify
postponement of the deduction, a
reasonable possibility of recovery will
permit the account to be carried along
notwithstanding that the probabilities are
that the debt may not be collected at all.

Good faith is not enough. Taxpayer
must show also that he had
reasonably investigated the relevant
facts and had drawn a reasonable
inference from the information thus
obtained by him. Where a taxpayer
has failed to attach to his tax returns a
statement showing the propriety of the
deductions therein made for alleged bad
debts, the account written off will be
disallowed. (Collector v. Goodrich
International Rubber Co., 21 SCRA
1336)

What does good faith require? The
taxpayer may strike a middle course
between pessimism and optimism and
determine debts to be worthless in the
exercise of sound business
judgment based upon as complete
information as is reasonably
ascertainable. The taxpayer need not
have perfect discernment. (Sec. 2, RR 5-
99 as amended by RR 25-02)

"Actually charged off from the
taxpayers books of accounts"
means that the said receivable has been
cancelled and written-off from the said
taxpayer's books of account. In no case
may any bad debt deduction be allowed
unless the facts pertaining to the money or
property lent and its cancellation or write-
off from the taxpayer's accounting records,
after having been determined that the same
has actually become worthless, have been
complied with by the taxpayer. (Sec. 2, RR
5-99 as amended by RR 25-02)

EXCEPTIONS:
The following are not deductible as bad debts:
1. debts not connected with profession,
trade or business
2. debts sustained in a transaction entered
into between family members or related
taxpayers [see Sec. 36(B) or discussion
on Losses above-Subsection H]

REQUISITES: (PICU)
1. There must be an existing
INDEBTEDNESS due to the taxpayer,
which must be valid and legally
demandable.
2. The debt must be connected with
PROFESSION, trade or business.
3. The debt must be actually ascertained
to be worthless or UNCOLLECTIBLE.
(e.g., bankrupt debtor)

Determining uncollectibility
Before a taxpayer may charge off
and deduct a debt, he must ascertain
and must be able to demonstrate with
reasonable degree of certainty the
uncollectibility of the debt. The
Commissioner of Internal Revenue
will consider ALL PERTINENT
EVIDENCE, including

the value of the collateral, if
any, securing the debt and the
financial condition of the
debtor in determining whether a
debt is worthless, or the
assigning of the case for
collection to an independent
collection lawyer who is not
under the employ of the taxpayer
and who shall issue a statement
under oath showing the propriety
of the deductions thereon made
for alleged bad debts. (Sec. 3, RR
5-99 as amended by RR 25-2002)

Other factors
The flight or disappearance of the
debtor, the insolvency of the debtor, or
the death of the debtor with insufficient
properties to pay creditors, may
indicate worthlessness of the debt.

Note: A creditor cannot deduct the
debt of an insolvent debtor as long as it
is possible to proceed against the
guarantor or surety who is insolvent.
All efforts must be exhausted to collect
from the guarantor or surety.

4. The debt must be actually CHARGED
OFF the books of accounts of the
taxpayer as of the end of the taxable
year.

NOTE: The debts due a taxpayer may arise
out of securities held. But in a case where
securities are ascertained to be worthless
and charged off within the taxable year, and
are capital assets, the loss to the taxpayer
(other than a bank or trust company
incorporated under the laws of the
Philippines a substantial part of whose
business is the receipt of deposits) will not
be treated as bad debts, but as capital loss
on the last day of the taxable year (See
XIII. Capital Gains and Losses for the
income tax treatment). The date that the
securities were written off is immaterial.
[Sec. 34(E)(2)]
18


GENERAL RULE: The determination by the
Commissioner of Internal Revenue as to the
worthlessness of bad debt is adequate.

EXCEPTIONS: Who are required to submit
additional documents or to secure approval
from their regulatory agencies before they
are allowed to deduct bad debts from gross
income?


18
ILLUSTRATION: Mr. A purchased bonds of B Co. on March 10,
2000 for P100,000 and held them as capital assets. On February
2, 2001, B Co. was declared by the Court as insolvent, and the
bonds were totally worthless. Mr. A wrote off the bonds from his
books of accounts on February 4, 2001. There is no bad debt for
Mr. A. He would be considered to have a capital loss of P100,000
for the year 2001. The holding period of the bonds was from
March 10, 2000 to December 31 2001, or more than 12 months.
The capital loss would be considered at 50%, or at P50,000. (See
XIII. Capital Gains and Losses for the detailed explanation on
income tax treatment of capital asset transactions.)



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 45 45 45 45 of 163 163 163 163

TAXATION LAW 1
1. Banks: Without prejudice to the
Commissioners determination of the
worthlessness and uncollectibility of
debts, the taxpayer shall submit a
Bangko Sentral ng Pilipinas (BSP) /
Monetary Board written approval of the
writing off of the indebtedness from the
banks' books of accounts at the end of
the taxable year.
Requirements for deductibility (RR
5-99)
Bad debts uncollected for 6 months
Resolution by the BOD of the bank
Approval by the monetary board

2. In no case may a receivable from an
insurance or surety company be
written-off from the taxpayer's books
and claimed as bad debts deduction
unless such company has been
declared closed due to insolvency or for
any such similar reason by the
Insurance Commissioner.

Recovery of Bad Debts Previously
Deducted (Tax Benefit Rule) (Sec. 4, RR
5-99)
The recovery of bad debts previously
allowed as deduction in the preceding year
or years shall be included as part of the
taxpayer's gross income in the year of such
recovery to the extent of the income tax
benefit of said deduction.

J. Depreciation [Sec. 34(F)]
Definition: Depreciation is the gradual
diminution of the useful value of tangible
property resulting from wear and tear and
normal obsolescence. The term is also
applied to amortization of the value of
intangible assets (i.e., patents), the use of
which in the trade or business is definitely
limited in duration.

Deduction Allowable: There shall be allowed
as a depreciation deduction a reasonable
allowance for the exhaustion, wear and tear
(including reasonable allowance for
obsolescence) of property used in the trade
or business. The rationale for this is that
property gradually approaches a point
where its usefulness is exhausted.

What if the property is used in
business and for personal purposes?
The depreciation expense must be pro-
rated; only the portion attributable to
business use is deductible.
e.g., the car of the petitioner was
used more for business than for
personal purposes. He was a law
practitioner, a law professor and
engaged in business. He had only
one car. Consequently, of the
value of the depreciation of the car
may be considered as business
related, while thereof represents
non-deductible personal expense.
(Jamir v. Collector, CTA Case No.
443, November 28, 1959)

Who may take depreciation: The person
who sustains an economic loss from the
decrease in property value due to
depreciation gets the deduction. Ordinarily,
this is the person who owns and has a
capital investment in the property.

When to deduct depreciation: The period of
depreciation starts when the asset is placed
in service. It ends when the asset is
disposed of, or its usefulness exhausted.

REQUISITES: (TRUCE)
1. The allowance for depreciation must be
for property used in the TRADE or
business, or those not being used
temporarily during the year (Conwell
Bros. Co. v. Collector, CTA Case No.
411).
2. The asset must have a limited USEFUL
life.
3. The allowance for depreciation must be
REASONABLE.
4. The allowance must be CHARGED off
during the taxable year from the
taxpayers books of accounts.
5. The total allowances must not EXCEED
the cost of the property.

What is the appropriate useful life of the
property? What rate of depreciation must be
applied?

Generally, the estimated useful life is
determined by the taxpayer himself.
HOWEVER, where the taxpayer and the
Commissioner have entered into an
agreement in writing specifically dealing
with the useful life and rate of depreciation
of any 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.

General Rule: Any change in the
agreed rate and useful life of the
depreciable property as specified in the
agreement shall not be effective for
taxable years prior to the taxable year
in which notice in writing by certified
mail or registered mail is served by the
party initiating such change to the
other party to the agreement.

Exception: Where the taxpayer has
adopted such useful life and
depreciation rate for any depreciable
property and claimed the depreciation
expenses as deduction from his gross
income, without any written
objection on the part of the
Commissioner or his duly authorized
representatives, the aforesaid useful
life and depreciation rate so adopted by
the taxpayer for the depreciable asset.


Methods and Rates of Depreciation
1. Straight-line method



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 46 46 46 46 of 163 163 163 163

TAXATION LAW 1
The depreciation expense deductible in
each of the years of the propertys
estimated useful life is constant.



ILLUSTRATION:
H Co. acquired a machine at a cost of
P380,000. It has no scrap (or salvage)
value, and the useful life is estimated at
25 years. The depreciation expense per
year is P15,000, computed as follows:



2. Declining-balance method, using a rate
not exceeding twice the rate for straight
line method
Under this method, the depreciation
allowance per year varies. Depreciation
is largest in the first year and continually
decreases towards the end of the useful
life of the property. The depreciation
rate under the straight-line method is
first computed, and the result is
multiplied with the rate relative to the
straight-line method rate. The product
(the declining balance rate) is then
multiplied to the yearly declining
balance of the property (i.e., book value
of the property at the start of the
current year, which is equal to its
original cost minus its accumulated
depreciation) to determine the deduction
for depreciation for the current year.
However, in the last year of the assets
estimated life, the depreciation is equal
to the book value of the property at the
start of that year (i.e., the amount of
depreciation must be just enough to
reduce the propertys book value to
zero). Note that the salvage value is
ignored in the declining balance
method.

ILLUSTRATION:
P Company acquired a machine on
January 1, 2002 at a cost of P400,000.
It had a scrap value of P50,000, and a
useful life of 4 years. The company uses
the declining balance method, at a rate
of one and a half that of the straight line
method. Determine the depreciation
chargeable in years 2002, 2003, 2004
and 2005.

Step 1: Compute for the
depreciation rate under the straight-
line method.



Step 2: Compute for the Declining
Balance Rate (DBR).



Step 3: Apply the Declining Balance
Rate to the book value of the
property at the start of the current
year.

Year 2002:
Book value of the
property ***
P400,000
Multiplied by: DBR 37.5%
Deduction for
Depreciation

P150,000

*** Since this is the year of the
acquisition, the book value of the
property at the start of the year is
equal to its original cost.

Year 2003:
Original Cost P 400,000
Less:
Accumulated
Depreciation
150,000
Book Value of the
Property,
start of
current year


P 250,000
Multiplied by:
DBR
37.5%
Deduction for
Depreciation

P 93,750

Year 2004:
Original Cost P 400,000
Less:
Accumulated
Depreciation
Year 2002
P150,000
Year 2003
P93,750






243,750
Book Value of
the Property,
start of
current year



P 156,250
Multiplied by:
DBR
37.5%
Deduction for
Depreciation

P58,593.75






Declining = Straight Line Rate Relative to
Balance Rate Depreciation Rate x the Straight Line
Depreciation Rate

= x 1.5
= 37.5%

Straight Line = 1 _ _
Depreciation Rate Estimated Useful Life

= , or 25%
Depreciation = [(380,000 0) / 25]
Expense [OR]
= (1/25) x (380,000 0)

Formula:
Deduction = Cost Salvage Value__
for Depreciation Estimated Useful Life
of the Property

NOTE: (Cost Salvage Value) is known as the
depreciable cost.

Alternative Method:
Depreciation = 1 _ _
Rate Estimated Useful Life
of the Property

Deduction for = Depreciation x (Cost Salvage Value)
Depreciation Rate




1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 47 47 47 47 of 163 163 163 163

TAXATION LAW 1
Year 2005:
Original Cost P 400,000
Less: Accumulated
Depreciation
Year 2002
P150,000
Year 2003
P93,750
Year 2004
P58,593.75




302,343.75
Book Value of the
Property, start
of current year

P 97,656.25

Deduction for
Depreciation ***

P97,656.25

*** The deduction for depreciation in
2005 is equal to the book value of the
property at the start of the year
because the machine had a useful life
of 4 years, which ended in 2005.

3. Sum-of-the-years-digit method
Under this method, the annual
depreciation is computed by applying a
changing fraction to the depreciable cost
of the property (original cost reduced by
the salvage value). In the fraction, the
numerator is the number of remaining
years of the estimated useful life of the
property and the denominator is the
sum of the numbers representing the
years of the propertys life.

ILLUSTRATION: On January 1, 2001, J
Company acquired a machine at a cost
of P105,000. It had a salvage value of
P5,000, and an estimated useful life of 5
years. The company uses the sum-of-
the-years method in determining
depreciation. Determine the depreciation
chargeable in years 2001, 2002, 2003,
2004 and 2005.

Step 1: Compute for the sum of the
numbers representing the years of
the propertys life.
The property has an estimated useful
life of 5 years. The sum, therefore, is 15
(5 + 4 + 3 + 2 + 1). This sum will be
used as the denominator in the fraction.

Step 2: Compute for the depreciable
cost of the property.
The depreciable cost is P100,000
(P105,000 P5,000).

Step 3: Compute for the yearly
deduction for depreciation (Column
D).













A B
(A/15)
C D
(= B x C)
Year Remainin
g Useful
Life
(Reckoni
ng Point:
Start of
the Year)
Resulti
ng
Fractio
n
Depreciabl
e Cost
Deduction
for
Depreciati
on
2001 5 5/15 P105,000 P35,000
2002 4 4/15 P105,000 P28,000
2003 3 3/15 P105,000 P21,000
2004 2 2/15 P105,000 P14,000
2005 1 1/15 P105,000 P7,000


4. Any other method which may be
prescribed by the Secretary of Finance
upon recommendation of the
Commissioner

Special Rules:
Depreciation of Properties Used in
Petroleum Operations
An allowance for depreciation in
respect of all properties DIRECTLY
related to production of petroleum
shall be allowed under the straight-
line or declining-balance method of
depreciation at the option of the
service contractor. However, if the
service contractor initially elects the
declining-balance method, it may
shift to the straight-line method.
The useful life of properties used in
or related to production of
petroleum shall be ten (10) years
or such shorter life as may be
permitted by the Commissioner.
Properties NOT USED DIRECTLY
in the production of petroleum shall
be depreciated under the straight-
line method on the basis of an
estimated useful life of 5 years.

Depreciation of Properties Used in
Mining Operations
An allowance for depreciation in
respect of all properties used in mining
operations other than petroleum
operations, shall be computed as
follows:
At the normal rate of depreciation if
the expected life is ten (10) years
or less; or
Depreciated over any number of
years between five (5) years and
the expected life if the latter is
more than ten (10) years, and the
depreciation thereon allowed as
deduction from taxable income:
Provided, That the contractor
notifies the Commissioner at the
beginning of the depreciation period
which depreciation rate allowed will
be used.

Depreciation Deductible by Nonresident
Aliens Engaged in Trade or Business
(NRAETB) or Resident Foreign
Corporations (RFC)



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 48 48 48 48 of 163 163 163 163

TAXATION LAW 1
- A reasonable allowance for the
deterioration of property arising out of
its use or employment or its non-use in
the business, trade or profession shall
be permitted only when such property is
located in the Philippines.


K. Depletion of Oil and Gas Wells and
Mines [Sec. 34(G)]

Definition: Depletion is the exhaustion of natural
resources due to production. It is the reduction of
cost or value of natural resources such as oil and
gas wells and mines as the resources are converted
into inventories.

Limitation: A reasonable allowance for depletion
computed using the cost-depletion method shall be
granted provided that the allowance for depletion
shall not exceed the capital invested.

ILLUSTRATION:
Land containing natural resources was purchased
for P100,900,000. It was estimated that the land,
after exploitation of its natural resources, will have
a value of P900,000. It was estimated that the
natural resource supply was 5,000,000 tons. If
withdrawal of resources from the land in 2005 was
500,000 tons, how much was the deduction for the
year?

Purchase Price P100,900,000
Less: Residual Value of the Land
900,000
Depletion Base P100,000,000
Divided by: Estimated Resource
Supply, in tons

5,000,000
Depletion Base per ton P20
Multiplied by: Withdrawal of
Resources in 2005, in tons

500,000
Depletion Expense, 2005 P 10,000,000

Allowable Deduction for a Nonresident Alien
individual Engaged in Trade or Business or a
Resident Foreign Corporation Allowance for
depletion of oil and gas wells or mines shall be
authorized only in respect to oil and gas wells or
mines located within the Philippines.

L. Charitable and Other Contributions [Sec.
34(H)]

REQUISITES: (TEE / BE)
1. The charitable contribution must actually be
paid or made to the ENTITIES specified by
law (i.e., Philippine government or any political
subdivision thereof exclusively for public
purposes, or any of the accredited domestic
corporations or associations specified in the
NIRC).

1. It must be made within the TAXABLE year.
2. It must be EVIDENCED by adequate
receipts or records.
3. Additional Requisite for Contributions Other
than Money: The amount of charitable
contribution of property other than money
shall be BASED on the acquisition cost of
the property (i.e., not the fair market value
at the time of the contribution).
4. Additional Requisite for Contributions subject
to the statutory limitation: It must not
EXCEED 10% (individual) or 5%
(corporation) of the taxpayers taxable
income before charitable contributions.

Kinds of Contributions:
1. Contributions deductible in full
2. Contributions subject to the statutory limit

Contributions Deductible in Full: (FoNG)
1. Donations to the Government - Donations to
the Government of the Philippines or to any of
its agencies or political subdivisions, including
fully-owned government corporations,
exclusively to finance, to provide for, or to be
used in undertaking PRIORITY ACTIVITIES
in:
education,
health,
youth and sports development,
human settlements,
science and culture, and
in economic development,according to
a National Priority Plan determined by
the National Economic and Development
Authority (NEDA), in consultation with
appropriate government agencies, including
its regional development councils and private
philanthropic persons and institutions.
Any donation which is made to the
Government or to any of its agencies or
political subdivisions not in accordance with
the said annual priority plan shall be
considered a contribution subject to the
statutory limit.

2. Donations to Certain Foreign Institutions
or International Organizations - Donations
to foreign institutions or international
organizations which are fully deductible in
pursuance of or in compliance with
agreements, treaties, or commitments
entered into by the Government of the
Philippines and the foreign institutions or
international organizations or in pursuance of
special laws;

3. Donations to Accredited Non-government
Organizations - The term "non-government
organization" means a non-profit domestic
corporation:
Organized and operated exclusively for:
(CRWSH Cys ChE Com)
-Scientific,
-Research,
-Educational,
-Character-building and youth and sports
development,
-Health,
-social Welfare,
-Cultural or
-CHaritable purposes, or
-a COMbination thereof,
no part of the net income of which
inures to the benefit of any private
individual;

Which, not later than the 15th day of the
third month after the close of the
accredited non-government organizations
taxable year in which contributions are
received, makes utilization directly for
the active conduct of the activities
constituting the purpose or function for
which it is organized and operated,



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 49 49 49 49 of 163 163 163 163

TAXATION LAW 1
-UNLESS an extended period is
granted by the Secretary of Finance;

The level of administrative expense shall,
on an annual basis, not exceed thirty
percent (30%) of the total expenses;
(Sec. 1, RR 13-1998) and

The assets of which, in the event of
dissolution, would be distributed to
-another nonprofit domestic corporation
organized for similar purpose or purposes, or
-to the state for public
purpose, or
-would be distributed by a court to another
organization to be used in such manner as in
the judgment of said court shall best
accomplish the general purpose for which the
dissolved organization was organized.

All the members of the Board of Trustees of
the non-stock, non-profit corporation,
organization or NGO do not receive
compensation or remuneration for their
service to the aforementioned organization.
(added by Sec. 3, RR 13-1998)

Utilization means:
a. Any amount, including admin expenses, paid or
utilized by an accredited NGO to accomplish
one or more of its purposes
b. Any amount paid to acquire an asset used
directly in carrying out one or more purposes
for which the accredited NGO was created or
organized; or
c. Any amount set aside for a specific project
which comes within the NGOs purpose/s, but
the NGO has to establish that the amount will
be utilized within at least five (5) years, and
that the project will be better accomplished by
setting aside such amount than by immediate
payments of funds
d. Any amount in cash or in kind invested in any
activity related to the purpose for which the
NGO was created
e. Any amount invested in capital sustaining and
generating activities. Provided that, any
income derived from those investments shall be
exclusively used in activities directly related to
one or more of its purposes (Sec. 1, RR 13-
1998)

Contributions subject to the Statutory Limit
(DNGS)
1. Contributions made to the Government or any
of its agencies or political subdivisions
exclusively for public purposes
(contributions for non-priority activities)

2. Contributions made to accredited domestic
corporation or associations
Organized exclusively for
o religious,
o charitable,
o scientific,
o youth and sports development,
o cultural or
o educational purposes or
o for the rehabilitation of veterans

3. Contributions to social welfare institutions

4. Contributions to non-government
organizations
no part of the net income of which inures to
the benefit of any private stockholder or
individual

Statutory Limit: Amount deductible must
not be in excess of:
10% in the case of an individual, and
5% in the case of a corporation,
of the taxpayer's taxable income derived
from trade, business or profession before the
deduction for contributions and donations.
In other words, the amount deductible is
the actual contribution or the statutory limit
computed, whichever is lower.

ILLUSTRATION:
N Co. had a gross income from business of
P1,000,000 and allowable deductions (except
deductions for contributions) of P400,000. It made
during the year a contribution that is fully
deductible of P10,000 and contributions subject to
limitation of P50,000. Compute for the total
deduction for contributions and the taxable income
of the company.

ANSWER: The total deduction for contributions is
P40,000, and the taxable income is P560,000.

SUPPORTING SOLUTION:
Gross Income P1,000,000
Less: Allowable Deductions (except deduction for
contributions)

400,000
Taxable Income before deduction for contributions P
600,000
Multiplied by: Statutory Limit (%)
5%
Statutory Limit (in Pesos) P 30,000

Actual Contributions made (subject to limitation) P 50,000

Allowable Deduction for Contributions subject to limitation
(whichever is lower)
P 30,000

Taxable Income before deduction for contributions P 600,000
Less: Allowable Deduction for Contributions

40,000
Deductible in Full
Allowable Deduction for Contributions subject to
limitation
P 10,000

30,000
Taxable Income P 560,000



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 50 50 50 50 of 163 163 163 163

TAXATION LAW 1
M. Research and Development [Sec. 34(L)]
Definition: R&D costs are for improvements of
processes and formulas as well as the development
of improved or new products. As a general rule,
R&D only extends from the laboratory or drawing
board to prototype status; i.e., so long as an
activity still contains an element of
uncertainty/technical risk, it is within the realm of
R&D.
Quality control, routine product testing, data
collection, efficiency surveys, management
studies, market research and sales promotion
are NORMALLY NOT CONSIDERED R&D
ACTIVITIES.

Tax Treatment: R&D expenditures which are paid
or incurred by a taxpayer during the taxable year
in connection with his trade, business or profession
may be treated EITHER as:
1. Ordinary and necessary expenses allowed
as deduction during the taxable year when paid
or incurred (i.e., as an outright deduction for
the full expenditure), or
2. Deferred asset (or deferred expense) which is
periodically subject to amortization

At the election of the taxpayer, the following R&D
expenditures may be treated as deferred assets:
1. Those paid or incurred by the taxpayer in
connection with his trade, business or
profession.
2. Those not treated as expenses.
3. Those chargeable to capital account but not
chargeable to depreciable property.

In computing taxable income, such deferred
expenses shall be allowed as deduction ratably
distributed over a period of not less than sixty (60)
months as may be elected by the taxpayer
(beginning with the month in which the taxpayer
first realizes benefits from such expenditures).
-The taxpayer may elect this alternative not later
than the time prescribed by law for filing the return
for such taxable year (April 15). The method so
elected, and the period selected by the taxpayer,
shall be adhered to in computing taxable income
for the taxable year for which the election is made
and for all subsequent taxable years UNLESS with
the approval of the Commissioner, a change to a
different method is authorized with respect to a
part or all of such expenditures.
-The election shall not apply to any expenditure
paid or incurred during any taxable year prior to
the taxable year for which the taxpayer makes the
election.

Limitations on Deduction: The above tax
treatment of R&D expenses does NOT apply to:
1. Any expenditure for the acquisition or
improvement of land or the improvement of
depreciable property, used in connection with
research and development.
2. Any expenditure incurred in ascertaining the
existence, location, extent, or quality of any
deposit of ore or other mineral, including oil or
gas.
NOTE: Cost of acquisition or improvements of
property subject to depreciation or depletion used
in research and development becomes part of the
cost of the asset, and deduction from it is by
way of depreciation or depletion, as the case
may be.

ILLUSTRATION:
Q Co., a manufacturer of food seasoning, is
continuously conducting research and development
on its product lines. In early January 2004, it
completed the extension and improvement of its
research and development building at a cost of
P1,000,000. The extension has an estimated useful
life of 25 years. The company also incurred an
aggregate of P1,800,000 for other research and
development costs. Determine the tax treatment of
the various expenditures.

ANSWER:-The P1,000,000 cost of expansion of the
building cannot be deducted as research and
development costs in 2004. However, depreciation
of P40,000 may be recognized yearly for 25 years
(P1,000,000 / 25 years).
-The other costs of P1,800,000 may be either:
a. An outright deduction from gross income for
P1,800,000 in 2004; [OR]
b. A deferred expense of P1,800,000, from which
there shall be a monthly deduction of P1,800,000
divided by 60 months (cannot be shorter, but can
be longer), or P30,000 per month, beginning with
the first month from which benefits were acquired
from the expenditure. The aggregate of monthly
deductions for a given taxable year is then
deductible from that years gross income.

N. Pension Trusts [Sec. 34(J)]
Deduction Allowable: An employer establishing or
maintaining a pension trust to provide for the
payment of reasonable pensions to his employees
shall be allowed as a deduction (in addition to the
contributions to such trust during the taxable year
to cover the pension liability accruing during the
year, allowed as a deduction under Sec. 34(A)(1)
[Ordinary and Necessary Expenses]) a reasonable
amount transferred or paid into such trust during
the taxable year in excess of such contributions

REQUISTES: Such reasonable amount will only be
allowed as a deduction if it:
1. has not theretofore been allowed as a
deduction, and
2. is apportioned in equal parts over a period of
ten (10) consecutive years beginning with the
year in which the transfer or payment is made.

Background Concepts: The rules in the law on
deduction for pension payments to employees
apply to a pension plan that is funded. An employer
does not provide for pension for his employees in
his initial years of operations. A pension plan is
usually set up after some years of operations have
gone by, when the employer is already financially
capable of providing benefits to his employees.
Since the benefits from any pension plan consider
the length of service of the employee, the plan
should take into account the services of the
employees who were already with the employer
even before the plan was set up. Such past
services will require a lump sum payment to the
pension fund; this is called past-service cost.
For each year after the pension plan was set up,
there should be payment to the fund for pension
for the services rendered during the year by the
employees. This is called present service cost.
Present service cost deductible in full in the
year transferred or paid into the trust; covered
by Sec. 34(A)(1) [Ordinary and Necessary
Expenses]
Past-service cost amount so transferred is
apportioned and deductible in equal parts over
a period of ten (10) consecutive years



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 51 51 51 51 of 163 163 163 163

TAXATION LAW 1
beginning with the year in which the transfer or
payment is made; covered by Sec. 34(J)
[Pension Trusts]

ILLUSTRATION:
F Co. established a pension trust in 2001,
transferring thereto a lump sum payment of
P500,000 to cover past services rendered by its
employees. Additionally, the terms of the trust are
such that P20,000 in pension liability would accrue
yearly, covering services rendered during the year
by its employees. Determine the total deduction on
account of the pension trust allowed to F Co. from
2001 onwards.

Year Yearly
Amortization
of
Past Service
Cost
(= 1/10 of
P500,000)
[covered by
Sec. 34(J)]
Current
Liability /
Present
Service
Cost

[covered
by Sec.
34(A)(1)]
TOTAL
2001 P50,000 P20,000 P70,000
2002 P50,000 P20,000 P70,000
2003 P50,000 P20,000 P70,000
2004 P50,000 P20,000 P70,000
2005 P50,000 P20,000 P70,000
2006 P50,000 P20,000 P70,000
2007 P50,000 P20,000 P70,000
2008 P50,000 P20,000 P70,000
2009 P50,000 P20,000 P70,000
2010 P50,000 P20,000 P70,000
2011
onwards
- P20,000 P20,000

O. Special Provisions Regarding Income
and Deductions of Insurance Companies,
Whether Domestic or Foreign [Sec. 37]
Special Deduction Allowed to Insurance Companies.
- In the case of insurance companies, whether
domestic or foreign doing business in the
Philippines, the net additions, if any, required by
law to be made within the year to reserve funds
and the sums other than dividends paid within the
year on policy and annuity contracts may be
deducted from their gross income. However, the
released reserve should be treated as income for
the year of release.

Mutual Insurance Companies. - In the case of
mutual fire and mutual employers' liability and
mutual workmen's compensation and mutual
casualty insurance companies requiring their
members to make premium deposits to provide for
losses and expenses, said companies shall not
return as income any portion of the premium
deposits returned to their policyholders, but shall
return as taxable income all income received by
them from all other sources plus such portion of
the premium deposits as are retained by the
companies for purposes other than the payment of
losses and expenses and reinsurance reserves.

Mutual Marine Insurance Companies. - Mutual
marine insurance companies shall include in their
return of gross income, gross premiums collected
and received by them less amounts paid to
policyholders on account of premiums previously
paid by them and interest paid upon those amounts
between the ascertainment and payment thereof.

Assessment Insurance Companies. - Assessment
insurance companies, whether domestic or foreign,
may deduct from their gross income the actual
deposit of sums with the officers of the
Government of the Philippines pursuant to law, as
additions to guarantee or reserve funds.

Allocation of Income and Deductions [Sec. 50]
- In the case of two or more organizations, trades
or businesses (whether or not incorporated and
whether or not organized in the Philippines) owned
and controlled directly or indirectly by the same
interests, the Commissioner is authorized to
distribute, apportion or allocate gross income or
deductions between or among such organization,
trade or business, if he determines that such
distribution, apportionment or allocation is
necessary in order: (a) to prevent evasion of taxes;
or (b) to clearly reflect the income of any such
organizations, trades or businesses.




1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 52 52 52 52 of 163 163 163 163

TAXATION LAW 1
XII. NON XII. NON XII. NON XII. NON- -- -DEDUCTIBLE EXPENSES DEDUCTIBLE EXPENSES DEDUCTIBLE EXPENSES DEDUCTIBLE EXPENSES [Sec.
36]

GENERAL RULE: In computing net income, no
deduction shall be allowed in respect to: (PIRI)
1. Personal, living or family expenses
Rationale: not related to conduct of trade or
business
2. Any amount paid out for new buildings or for
permanent improvements, or betterments
made to increase the value of any property or
estate
EXCEPTION: Intangible drilling and
development costs incurred in petroleum
operations which are deductible under Sec.
34(G)(1)
3. Any amount expended in restoring property or
in making good the exhaustion thereof for
which an allowance [for depreciation or
depletion] is or has been made (i.e., Major
Repairs)

NOTE: Nos. (2) and (3) are capital
expenditures. Examples are:
a. The cost of defending or perfecting title to
property constitutes a part of the cost of the
property and is not a deductible expense.
b. The amount expended for architects
services is part of the cost of the building
c. Expenditures to promote the sales of
additional capital stock or the cost,
commissions and fees for obtaining stock
subscriptions are capital expenses. (Atlas
Consolidated Mining Co. v. Commissioner,
102 SCRA 246)
4. Premiums paid on any life insurance policy
covering the life of any officer, employee, or
person financially interested in the trade or
business carried on by the taxpayer, when the
taxpayer is directly or indirectly a beneficiary
under such policy.
A person is said to be financially
interested in the taxpayers business, if
he is a stockholder thereof or he is to
receive as his compensation a share of the
profits of the business.

ILLUSTRATION:
CASE 1 CASE 2
Insured
Officer,
employee, or
person
financially
interested in the
taxpayers trade
or business
Officer,
employee, or
person financially
interested in the
taxpayers trade
or business
Beneficiary
of Life
Insurance
Policy
Company
Officer,
employee, or
person financially
interested in the
taxpayers trade
or business
Premium a
deductible
expense?
NO (covered by
Sec. 36)
YES (Premium is
likewise a fringe
benefit on the
part of the
beneficiary.)

XIII. CAPITAL GAINS AND XIII. CAPITAL GAINS AND XIII. CAPITAL GAINS AND XIII. CAPITAL GAINS AND LOSSES LOSSES LOSSES LOSSES [Sec.
39]

Definitions:
Net Capital Gain the excess of the gains from
sales or exchanges of capital assets over the losses
from such sales or exchanges

Net Capital Loss means the excess of the losses
from sales or exchanges of capital assets over the
gains from such sales or exchanges

Holding Period the length of time the asset was
held by the taxpayer

Meaning of sale or exchange requirements
for capital gain
Gain or loss is recognized in a sale or exchange
of property if the following conditions are
satisfied:
1. The property received in exchange is
essentially different from the property
disposed of;
2. The property received has a market value

Sale a delivery of goods for money
Exchange a delivery of goods for goods received.

HOWEVER, there are transactions which the law
considers sales or exchanges though they do not
meet the definitions given. These are:
1. Retirement of bonds, etc.
2. Short sales of properties
19

3. Failure to exercise a privilege or option to buy
or sell property;
4. Securities becoming worthless.
5. Receipt of a liquidating dividend


Percentage taken into account (Long-term /
Short term) by taxpayers:
Taxpayers Other than a Corporation (i.e.,
individual taxpayers and taxpayers treated as
individuals, such as estates and trusts)
- 100% if the capital asset was held for not
more than 12 months
- 50% if the capital asset has been held for
more than 12 months
NOTE:
o GENERAL RULE: For purposes of
computing capital loss and capital gain, the
actual holding period is taken into
account.
o EXCEPTION: If securities become
worthless during the taxable year and are
capital assets, the loss resulting therefrom
shall be considered as a loss from the sale
or exchange, on the last day of such
taxable year, of capital assets. [Sec.
34(D)(4)(b)]
Corporate Taxpayers 100% of the capital
gain or loss, regardless of the holding period

Limitation on Capital Losses
GENERAL RULE: Losses from sales or exchanges
of capital assets shall be allowed only to the extent
of the gains from such sales or exchanges.


19
A transaction in which a speculator sells securities which he
does not own in anticipation of a decline in its price. The seller
intends to cover the sale by purchasing the securities when the
price declines, in which case he will make a profit.



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 53 53 53 53 of 163 163 163 163

TAXATION LAW 1
SPECIAL RULE FOR BANKS AND TRUST
COMPANIES: If a bank or trust company
incorporated under the laws of the Philippines, a
substantial part of whose business is the receipt of
deposits or the sale of bond, debenture, note,
certificate or other evidence of indebtedness, any
loss resulting from such sale shall not be subject to
the foregoing limitation and shall not be included in
determining the applicability of such limitation to
other losses.
Rationale: The securities mentioned are
ordinary assets of the bank or trust company.

Formula: (Sec. 134, RR2)
Taxable net income = Ordinary net income +
net taxable capital gains
Net taxable capital gains =
Gains of sales of capital assets, or 50%
thereof Losses from sales of capital assets,
or 50% thereof

Net Capital Loss Carry-over: If an individual
taxpayer sustains a net capital loss in a taxable
year, such loss (in an amount not in excess of the
net income
20
for such year) shall be treated in the
succeeding taxable year as a loss from the sale or
exchange of a capital asset held for not more than
12 months (100% deduction).

ILLUSTRATIONS: Mr. O, a citizen of the Philippines,
single, had the following data for 2001 and 2002:

2001 2002
Net Income, Business 80,000 90,000
Interest Income from notes
of clients
4,000 2,000
Capital Gain on assets:
50,000



70,000
Shares of foreign
corporations, held for 3
years
Jewelry, held for 10
months
Capital Loss on bonds, held
for 4 months
120,000 -


20
Net Income should be understood as taxable income
(Executive Order No. 37)



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 54 54 54 54 of 163 163 163 163

TAXATION LAW 1
Mr. Os taxable income for 2001 was P64,000, and for 2002 was P78,000, computed as follows:


2001 2002
Net Income, Business P 80,000 P 90,000
Interest Income 4,000 2,000
Ordinary Net Income P84,000 P92,000
Capital Gain (50%) P25,000
Capital Gain (100%) P70,000
Capital Loss (100%) (120,000)

Net Capital Loss

(P95,000)



Net Capital Loss Carry-Over from 2001



(64,000)

Net Capital Gain [70,000 64,000] 6,000
Total P98,000
Less: Basic Personal Exemption (20,000) (20,000)
Taxable Income

P64,000 P78,000

Legend:




P Co., a domestic corporation, had the following results of operations for a taxable year:
Ordinary Net Income P52,000
Gain on sale of capital asset, held for ten months 2,000
Gain on sale of capital asset, held for eighteen months 2,000
Loss on sale of capital asset, held for six months 1,100
Loss on sale of capital asset, held for twenty months 2,000

and in the preceding year it had a net capital loss of P1,500 and a taxable income of P60,000. The taxable
income of the corporation for the year is computed as follows***:
Ordinary net income P52,000
Gain on sale of capital asset, held for ten months (100%) P2,000
Gain on sale of capital asset, held for eighteen months
(100%)
2,000
Total Capital Gains P4,000
Loss on sale of capital asset, held for six months (100%) P1,100
Loss on sale of capital asset, held for twenty months (100%) 2,000
Total Capital Loss 3,100
Net Capital Gain 900
Taxable Income P52,900
*** For corporations, capital gains and losses are always considered at 100%, and there is
no net capital loss carry-over.


SUMMARY OF RULES
For Corporations:
1. Corporations shall recognize 100% of the capital gain or loss, regardless of the holding period.
2. Corporations cannot carry-over net capital loss.
3. Losses from sales or exchanges of capital assets shall be allowed only to the extent of the gains from
such sales or exchanges.

For Individuals, and Taxpayers Treated as Individuals:
1. The holding period is relevant in determining the percentage of capital gains and losses to be taken into
account, as follows:
- 100% if the capital asset was held for not more than 12 months
- 50% if the capital asset was held for more than 12 months
2. Net capital loss (in an amount not in excess of the net income for such year) shall be treated in the
succeeding taxable year as a loss from the sale or exchange of a capital asset held for not more than
12 months (100% deduction)
3. 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 Carry-Over from the previous year
To determine the maximum that may be carried over to the next year: Taxable Income



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 55 55 55 55 of 163 163 163 163

TAXATION LAW 1
XIV. SITUS OF TAXATION XIV. SITUS OF TAXATION XIV. SITUS OF TAXATION XIV. SITUS OF TAXATION [Sec. 42]

A. Gross Income From Sources Within the
Philippines
Interests derived from sources within the
Philippines, and interest on bonds, notes or other
interest-bearing obligations of residents,
corporate or otherwise
Dividends
Compensation for labor or personal services
performed in the Philippines
Rentals and royalties from property located in
the Philippines or from any interest in such
property, including rentals or royalties for:
(a) The use of or the right or privilege to use
in the Philippines any copyright, patent, design
or model, plan, secret formula or process,
goodwill, trademark, trade brand or other like
property or right;
(b) The use of, or the right to use in the
Philippines any industrial, commercial or
scientific equipment;
(c) The supply of scientific, technical,
industrial or commercial knowledge or
information;
(d) The supply of any assistance that is
ancillary and subsidiary to, and is furnished as
a means of enabling the application or
enjoyment of, any such property or right as is
mentioned in paragraph (a), any such
equipment as is mentioned in paragraph (b) or
any such knowledge or information as is
mentioned in paragraph (c);
(e) The supply of services by a nonresident
person or his employee in connection with the
use of property or rights belonging to, or the
installation or operation of any brand,
machinery or other apparatus purchased from
such nonresident person;
(f) Technical advice, assistance or services
rendered in connection with technical
management or administration of any
scientific, industrial or commercial
undertaking, venture, project or scheme; and
(g) The use of or the right to use:
(i) Motion picture films;
(ii) Films or video tapes for use in
connection with television; and
(iii) Tapes for use in connection with radio
broadcasting.
Gains, profits and income from the sale of real
property located in the Philippines
Gains; profits and income from the sale of
personal property

B. Taxable Income From Sources Within the
Philippines
GENERAL RULE. Deduct the expenses, losses and
other deductions properly allocated thereto and a
ratable part of expenses, interests, losses and
other deductions effectively connected with the
business or trade conducted exclusively within the
Philippines which cannot definitely be allocated to
some items or class of gross income: Provided,
That such items of deductions shall be allowed only
if fully substantiated by all the information
necessary for its calculation. The remainder, if any,
shall be treated in full as taxable income from
sources within the Philippines.
EXCEPTION. - No deductions for interest paid or
incurred abroad shall be allowed unless
indebtedness was actually incurred to provide
funds for use in connection with the conduct or
operation of trade or business in the Philippines.

C. Gross Income From Sources Without the
Philippines.
(1) Interests other than those derived from
sources within the Philippines as provided in A.
(2) Dividends other than those derived from
sources within the Philippines as provided in A.
(3) Compensation for labor or personal services
performed without the Philippines;
(4) Rentals or royalties from property located
without the Philippines or from any interest in
such property including rentals or royalties for
the use of or for the privilege of using without
the Philippines, patents, copyrights, secret
processes and formulas,
goodwill, trademarks, trade brands,
franchises and other like properties; and
(5) Gains, profits and income from the sale of
real property located without the Philippines.

D. Taxable Income From Sources Without the
Philippines. - Deduct from the gross income
from sources without the Philippines
(a) the expenses, losses, and other deductions
properly apportioned or allocated thereto
and
(b) a ratable part of any expense, loss or other
deduction which cannot definitely be
allocated to some items or classes of gross
income.
The remainder, if any, shall be treated in full as
taxable income from sources without the
Philippines.

E. Income From Sources Partly Within and
Partly Without the Philippines.
Allocated or apportioned to sources within or
without the Philippines, under the rules and
regulations prescribed by the Secretary of
Finance, upon recommendation of the
Commissioner
For the purpose of computing the taxable
income therefrom, where items of gross income
are separately allocated to sources within the
Philippines, there shall be deducted:
(a) the expenses, losses and other deductions
properly apportioned or allocated thereto,
and
(b) a ratable part of other expenses, losses or
other deductions which cannot definitely be
allocated to some items or classes of gross
income.
The remainder, if any, shall be included in full
as taxable income from sources within the
Philippines.

In the case of gross income derived from
sources partly within and partly without the
Philippines, the taxable income may first be
computed by deducting the expenses, losses or
other deductions apportioned or allocated
thereto and a ratable part of any expense, loss
or other deduction which cannot definitely be
allocated to some items or classes of gross
income; and the portion of such taxable income
attributable to sources within the Philippines
may be determined by processes or formulas of
general apportionment prescribed by the
Secretary of Finance.

Gains, profits and income from the sale of
personal property



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 56 56 56 56 of 163 163 163 163

TAXATION LAW 1
(a) produced (in whole or in part) by the
taxpayer within and sold without the
Philippines, or
(b) produced (in whole or in part) by the
taxpayer without and sold within the
Philippines,
shall be treated as derived partly from sources
within and partly from sources without the
Philippines.

F. Gains, profits and income derived:
(a) from the purchase of personal property within
and its sale without the Philippines, or
(b) from the purchase of personal property without
and its sale within the Philippines
shall be treated as derived entirely form sources
within the country in which sold: Provided,
however, That gain from the sale of shares of stock
in a domestic corporation shall be treated as
derived entirely form sources within the Philippines
regardless of where the said shares are sold.
The transfer by a nonresident alien or a foreign
corporation to anyone of any share of stock issued
by a domestic corporation shall not be effected or
made in its book unless:
the transferor has filed with the Commissioner
a bond conditioned upon the future payment by
him of any income tax that may be due on the
gains derived from such transfer, or
the Commissioner has certified that the taxes, if
any, imposed in this Title and due on the gain
realized from such sale or transfer have been
paid. It shall be the duty of the transferor and
the corporation the shares of which are sold or
transferred, to advise the transferee of this
requirement.

Definition of Royalties - Philamlife vs. CTA
[CA GR SP 31283 April 25, 1995]
The CTA ruled that it is not the presence of any
property from which one derives rentals and
royalties that is controlling, but rather it
includes royalties for the supply of scientific,
technical, industrial, or commercial knowledge
or information .
XV. INSTALLMENT BASIS XV. INSTALLMENT BASIS XV. INSTALLMENT BASIS XV. INSTALLMENT BASIS [Sec. 49]

A. Sales of Dealers in Personal Property A
person who regularly sells or otherwise
disposes of personal property on the installment
plan may return as income therefrom in any
taxable year that proportion of the installment
payments actually received that year, which the
gross profit realized or to be realized when
payment is completed, bears to the total
contract price.


B. Sales of Realty and Casual Sales of
Personal Property
1. A casual sale or other casual disposition of
personal property (other than property of a kind
which would properly be included in the
inventory of the taxpayer if on hand at the
close of the taxable year) for a price
exceeding One thousand pesos (P1000); or
2. A sale or other disposition of real property

In either case the initial payments must
NOT exceed 25% of the selling price
'Initial payments' means the payment received in
cash or property other than evidences of
indebtedness of the purchaser during the taxable
period in which the sale or other disposition is
made.

Income Tax Treatment: Income may be
returned on the same basis as sales of dealers in
personal property (see section A)
C. Sales of Real Property Considered as
Capital Asset by Individuals An individual
who sells or disposes of real property,
considered as capital asset, and is otherwise
qualified to report the gain therefrom under
Subsection (B) may pay the capital gains tax in
installments.

D. Tax Evasion vs. Tax Avoidance [CIR vs.
Estate of Toda (Sept, 14, 2004)]

Tax Evasion Tax Avoidance
a scheme used
outside of those lawful
means and when
availed of, it usually
subjects the taxpayer
to further or additional
civil or criminal
liabilities
tax saving device
within the means
sanctioned by law,
used by the
taxpayer in good
faith and at arms
length

FORMULA:

Gross Profit Installment payments Income to be
---------------------- X actually received = reported for
Contract price the year



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 57 57 57 57 of 163 163 163 163

TAXATION LAW 1
XVI. RETURNS AND PAYMENTS OF XVI. RETURNS AND PAYMENTS OF XVI. RETURNS AND PAYMENTS OF XVI. RETURNS AND PAYMENTS OF
TAX / WI TAX / WI TAX / WI TAX / WITHHOLDING TAXES THHOLDING TAXES THHOLDING TAXES THHOLDING TAXES

A. Returns and Payment of Tax
1. Individual Return (Sec. 51, NIRC)
a. Who are required to file
(a) Every Filipino citizen residing in the
Philippines;
(b) Every Filipino citizen residing outside the
Philippines, on his income from sources
within the Philippines;
(c) Every alien residing in the Philippines, on
income derived from sources within the
Philippines; and
(d) Every nonresident alien engaged in trade
or business or in the exercise of
profession in the Philippines.

b. Those not required to file
The following individuals shall not be required to
file an income tax return:

a. An individual whose gross income does not
exceed his total personal and additional
exemptions for dependents under Section 35
Exception: That a citizen of the Philippines and
any alien individual engaged in business or
practice of profession within the Philippines shall
file an income tax return, regardless of the
amount of gross income;

b. An individual with respect to pure
compensation income, as defined in Section 32
(A)(1), derived from sources within the
Philippines, the income tax on which has been
correctly withheld under the provisions of
Section 79 of this Code
Exceptions:
i. an individual deriving compensation
concurrently from two or more employers at any
time during the taxable year
ii. an individual whose compensation income
derived from sources within the Philippines
exceeds Sixty thousand pesos (P60,000)

c. An individual whose sole income has been
subjected to final withholding tax pursuant to
Section 57(A) of this Code

d. An individual who is exempt from income tax
pursuant to the provisions of this Code and other
laws, general or special.

Any individual not required to file an income tax
return may nevertheless be required to file an
information return pursuant to rules and
regulations prescribed by the Secretary of Finance,
upon recommendation of the Commissioner.

SPECIAL RULES:
1. Husband and Wife Married individuals,
whether citizens, resident or nonresident aliens,
who do not derive income purely from
compensation, shall file a return for the taxable
year to include the income of both spouses,
but where it is impracticable for the spouses to file
one return, each spouse may file a separate return
of income but the returns so filed shall be
consolidated by the Bureau for purposes of
verification for the taxable year.

2. Return of Parent to Include Income of
Children The income of unmarried minors
derived from property received from a living parent
shall be included in the return of the parent, except

o when the donor's tax has been paid on such
property, or
o when the transfer of such property is exempt
from donor's tax.

3. Persons Under Disability If the taxpayer is
unable to make his own return, the return may be
made by his duly authorized agent or
representative or by the guardian or other
person charged with the care of his person or
property, the principal and his representative or
guardian assuming the responsibility of making the
return and incurring penalties provided for
erroneous, false or fraudulent returns.

Signature Presumed The fact that an
individual's name is signed to a filed return shall be
prima facie evidence for all purposes that the return
was actually signed by him.

c. Where to file
Except in cases where the Commissioner
otherwise permits, the return shall be filed:
If person has legal residence or place of
business in the Philippines - with an authorized
agent bank, Revenue District Officer,
Collection Agent or duly authorized
Treasurer of the city or municipality in which
such person has his legal residence or principal
place of business in the Philippines

If there be no legal residence or place of
business in the Philippines - with the Office of
the Commissioner.

d. When to file - The return of any individual
specified above shall be filed on or before the
fifteenth (15th) day of April of each year
covering income for the preceding taxable year.

e. Where to pay (Sec. 56, NIRC)
The total amount of tax imposed by this Title
shall be paid by the person subject thereto at
the time the return is filed.

When the tax due is in excess of Two thousand
pesos (P2,000), the taxpayer other than a
corporation may elect to pay the tax in two (2)
equal installments in which case:
1. the first installment shall be paid at the time
the return is filed and
2. the second installment, on or before July 15
following the close of the calendar year
3. if any installment is not paid on or before the
date fixed for its payment, the whole amount
of the tax unpaid becomes due and payable,
together with the delinquency penalties.

f. Capital gains on shares of stocks and real
estate
FILING A RETURN
Individuals subject to tax on capital gains:
(a) From the sale or exchange of shares of stock
not traded thru a local stock exchange as
prescribed under Section 24(c) shall file a
return within thirty (30) days after each
transaction and a final consolidated return on
or before April 15 of each year covering all
stock transactions of the preceding taxable
year; and



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 58 58 58 58 of 163 163 163 163

TAXATION LAW 1
(b) From the sale or disposition of real property
under Section 24(D) shall file a return within
thirty (30) days following each sale or other
disposition.

PAYMENT
The total amount of tax imposed and prescribed
shall be paid on the date the return prescribed is
filed by the person liable.
If the seller submits proof of his intention to
avail himself of the benefit of exemption of
capital gains under existing special laws, no
such payments shall be required.
o In case of failure to qualify for exemption
under such special laws and implementing
rules and regulations, the tax due on the
gains realized from the original transaction
shall immediately become due and payable.
o If the seller, having paid the tax, submits
such proof of intent within six (6) months
from the registration of the document
transferring the real property, he shall be
entitled to a refund of such tax upon
verification of his compliance with the
requirements for such exemption.
o In case the taxpayer elects and is qualified to
report the gain by installments, the tax due
from each installment payment shall be paid
within (30) days from the receipt of such
payments.

g. Quarterly declaration of income tax (Sec.
74, NIRC)
Every individual subject to income tax under
Sections 24 and 25(A) of this Title, who is
receiving self-employment income, whether it
constitutes the sole source of his income or in
combination with salaries, wages and other fixed
or determinable income, shall make and file a
declaration of his estimated income for the
current taxable year on or before April 15 of the
same taxable year.

In general, self-employment income consists of
the earnings derived by the individual from the
practice of profession or conduct of trade or
business carried on by him as a sole proprietor
or by a partnership of which he is a member.
1. Nonresident Filipino citizens, with respect to
income from without the Philippines, and
nonresident aliens not engaged in trade or
business in the Philippines, are not required
to render a declaration of estimated income
tax.
2. The declaration shall contain such pertinent
information as the Secretary of Finance, upon
recommendation of the Commissioner, may,
by rules and regulations prescribe. An
individual may make amendments of a
declaration filed during the taxable year
under the rules and regulations prescribed by
the Secretary of Finance, upon
recommendation of the Commissioner.

Estimated tax means the amount which the
individual declared as income tax in his final
adjusted and annual income tax return for the
preceding taxable year minus the sum of the
credits allowed under this Title against the said tax.
If, during the current taxable year, the taxpayer
reasonably expects to pay a bigger income tax, he
shall file an amended declaration during any
interval of installment payment dates.

Return and Payment of Estimated Income Tax
by Individuals: The amount of estimated income
with respect to which a declaration is required shall
be paid in four (4) installments:
o 1
st
installment - at the time of the declaration
o 2
nd
installment - on August 15 of the current
year
o 3
rd
installment on November 15 of the
current year
o 4
th
installment - on or before April 15 of the
following calendar year when the final
adjusted income tax return is due to be filed

h. Substituted filing for ITR of Salaried
Individuals
RR 19-2002
Certificate of Compensation Payment/Tax
Withheld (BIR Form No. 2316). In general,
every employer required to deduct and withhold
the tax on compensation including fringe benefits
given to rank and file employees, shall furnish
every employee the Certificate of Compensation
Payment/Tax Withheld (BIR Form No. 2316), on
or before January 31 of the succeeding calendar
year, or if the employment is terminated before
the close of such calendar year, on the day on
which the last payment of compensation is
made. Failure to furnish the same shall be a
ground for the mandatory audit of payors
income tax liabilities (including withholding tax)
upon verified complaint of the payee.

The Certificate of Compensation Payment/Tax
Withheld (BIR Form No. 2316) shall contain a
certification to the effect that the employers
filing of BIR Form No. 1604-CF shall be
considered as a substituted filing of the
employees income tax return to the extent
that the amount of compensation and tax
withheld appearing in BIR Form No. 1604-CF as
filed with BIR is consistent with the
corresponding amounts indicated in BIR Form
No. 2316. It shall be signed by both the
employee and employer attesting to the fact that
the information stated therein has been verified
and is true and correct to the best of their
knowledge. Withholding agents/employers are
required to retain copies of the duly signed BIR
Form No. 2316 for a period of three (3) years.

The employee who is qualified for substituted
filing of income tax return under these
regulations, shall no longer be required to file
income tax return (BIR Form No. 1700) since
BIR Form No. 1604-CF shall be considered a
substituted return filed by the employer. BIR
Form No. 2316, duly certified by both employee
and employer, shall serve the same purpose as if
a BIR Form No. 1700 had been filed, such as
proof of financial capacity for purposes of loan,
credit card, or other applications, or for the
purpose of availing tax credit in the employees
home country and for other purposes with
various government agencies. This may also be
used for purposes of securing travel tax
exemption, when necessary.

However, information referring to the
certification, appearing at the bottom of BIR
Form No. 2316, shall not be signed by both the
employer and the employee if the latter is not
qualified for substituted filing. In which case, BIR
Form No. 2316 furnished by the employer to the
employee shall be attached to the employees



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 59 59 59 59 of 163 163 163 163

TAXATION LAW 1
Income Tax Return (BIR Form No. 1700) to be
filed on or before April 15 of the following year.

i. Modes of Payment of Taxes Through
Banks
RR 16-2002
SECTION 3. Modes Of Payment To
Authorized Agent Banks. Aside from the
electronic payment system currently used by
some taxpayers in paying their BIR taxes, the
rest shall pay their tax liabilities through any of
the following modes:
a) "Overthecounter cash payment" -
payment of taxes to an authorized agent
bank in the currencies that are legal tender
in the Philippines. The maximum amount
allowed per tax payment shall not exceed
ten thousand pesos (P10,000.00)
b) "Bank debit system" - taxpayer, through
a bank debit memo/advice, authorizes
withdrawals from his bank accounts for
payment of tax liabilities.
c) "Checks" refers to a bill of exchange or
Order Instrument drawn on a bank payable
on demand.

The following checks are, however, NOT
acceptable as check payments for internal
revenue taxes: (SUESAP)
1. Accommodation checks checks issued or
drawn by a party other than the taxpayer
making the payment;
2. Second endorsed checks checks issued to
the taxpayer as payee who indorses the
same as payment for taxes;
3. Stale checks checks dated more than six
(6) months prior to presentation to the
authorized agent bank;
4. Postdated checks checks dated a day or
several days after the date of presentation
to the authorized agent bank;
5. Unsigned checks
6. Checks with alterations/Erasures.

AABs accepting checks as payment must see to
it that the check covers one tax type for one
return period only. Second indorsement of
checks which are payable to the BIR or
Commissioner of Internal Revenue is absolutely
prohibited

2. Corporation Regular Returns
a. Quarterly Income Tax (Sec. 75, NIRC)
Every corporation shall file in duplicate a
quarterly summary declaration of its gross
income and deductions on a cumulative basis
for the preceding quarter or quarters upon which
the income tax, shall be levied, collected and
paid.

The tax so computed shall be decreased by
the amount of tax previously paid or
assessed during the preceding quarters and
shall be paid not later than sixty (60) days from
the close of each of the first three (3) quarters of
the taxable year, whether calendar or fiscal year.

b. Final Adjustment Return (Sec. 76,
NIRC)
Every corporation liable to tax shall file a final
adjustment return covering the total taxable
income for the preceding calendar or fiscal
year. If the sum of the quarterly tax payments
made during the said taxable year is not equal to
the total tax due on the entire taxable income of
that year, the corporation shall either:
(A) Pay the balance of tax still due; or
(B) Carry-over the excess credit; or
(C) Be credited or refunded with the excess
amount paid, as the case may be.

In case the corporation is entitled to a tax credit
or refund of the excess estimated quarterly
income taxes paid, the excess amount shown on
its final adjustment return may be carried over
and credited against the estimated quarterly
income tax liabilities for the taxable quarters of
the succeeding taxable years. Once the option to
carry-over and apply the excess quarterly
income tax against income tax due for the
taxable quarters of the succeeding taxable years
has been made, such option shall be
considered irrevocable for that taxable
period and no application for cash refund or
issuance of a tax credit certificate shall be
allowed.

c. When to File (Sec. 77, NIRC)
Quarterly declaration shall be filed within
sixty (60) days following the close of each of the
first three (3) quarters of the taxable year.

The final adjustment return shall be filed on
or before the fifteenth (15
th
) day of April, or on
or before the fifteenth (15
th
) day of the fourth
(4
th
) month following the close of the fiscal year,
as the case may be.

Extension of Time to File Returns The
Commissioner may, in meritorious cases, grant a
reasonable extension of time for filing returns of
income (or final and adjustment returns in case
of corporations)

d. Where to File (Sec. 77, NIRC)
Except as the Commissioner otherwise permits,
the quarterly income tax declaration required in
Section 75 and the final adjustment return
required in Section 76 shall be filed with:
o the authorized agent banks or
o Revenue District Officer or
o Collection Agent or
o duly authorized Treasurer of the city or
municipality having jurisdiction over the
location of the principal office of the
corporation filing the return or place where
its main books of accounts and other data
from which the return is prepared are
kept.

e. When to Pay (Sec. 77, NIRC)
The income tax due on the corporate quarterly
returns and the final adjustment income tax shall
be paid at the time the declaration or return is
filed in a manner prescribed by the
Commissioner.

f. Capital Gains on Shares of Stock
Every corporation deriving capital gains from the
sale or exchange of shares of stock not traded
thru a local stock exchange as prescribed under
Sections 24 (c), 25 (A)(3), 27 (E)(2),
28(A)(8)(c) and 28 (B)(5)(c), shall file a return
within thirty (30) days after each transaction and
a final consolidated return of all transactions
during the taxable year on or before the fifteenth
(15th) day of the fourth (4th) month following
the close of the taxable year.



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 60 60 60 60 of 163 163 163 163

TAXATION LAW 1

g. Return of Corporations Contemplating
Dissolution / Reorganization
Every corporation shall, within thirty (30) days
after the adoption by the corporation of a
resolution or plan for its dissolution, or for the
liquidation of the whole or any part of its capital
stock, including a corporation which has been
notified of possible involuntary dissolution by the
Securities and Exchange Commission, or for its
reorganization, render a correct return to the
Commissioner, verified under oath, setting forth
the terms of such resolution or plan and such
other information as the Secretary of Finance,
upon recommendation of the commissioner,
shall, by rules and regulations, prescribe.

The dissolving or reorganizing corporation shall,
prior to the issuance by the Securities and
Exchange Commission of the Certificate of
Dissolution or Reorganization, as may be defined
by rules and regulations prescribed by the
Secretary of Finance, upon recommendation of
the Commissioner, secure a certificate of tax
clearance from the Bureau of Internal Revenue
which certificate shall be submitted to the
Securities and Exchange Commission.

Sec. 244. RR-2
All corporations, partnerships, joint accounts and
associations, contemplating dissolution or
retiring from business without formal dissolution,
shall, within 30 days after the approval of such
resolution authorizing their dissolution, and
within the same period after their retirement
from business, file their IT returns covering the
profit earned or business done by them from the
beginning of the year up to the date of such
dissolution or retirement and pay the
corresponding IT due thereon upon demand of
the Commissioner. In addition to the IT return,
they shall also submit within the same period the
following:
(a) a copy of the resolution authorizing such
dissolution;
(b) balance sheet at the date of dissolution or
retirement and a profit and loss statement
covering the period from the beginning of the
taxable year to the date of dissolution or
retirement;
(c) in the case of a corporation, the names and
addresses of the shareholders and the
number and par value of the shares held by
each; and in case of a partnership, joint
account or association, the name of the
partners or members and the capital
contributed by each;
(d) the value and a description of the assets
received in liquidation by each shareholder;
(e) the name and address of each individual or
corporation, other than shareholders, if any,
receiving assets at the time of dissolution
together with a description and the value of
the assets received by such individuals or
corporations and the consideration if any,
paid by each of them for the assets received.

B. WITHHOLDING TAX
1. Final Withholding Tax at Source
Sec. 57. NIRC
Subject to rules and regulations the Secretary of
Finance may promulgate, upon the
recommendation of the Commissioner, requiring
the filing of income tax return by certain income
payees, the tax imposed or prescribed by
Sections 24(B)(1), 24(B)(2), 24(C), 24(D)(1);
25(A)(2), 25(A)(3), 25(B), 25(C), 25(D), 25(E),
27(D)(1), 27(D)(2), 27(D)(3), 27(D)(5), 28
(A)(4), 28(A)(5), 28(A)(7)(a), 28(A)(7)(b),
28(A)(7)(c), 28(B)(1), 28(B)(2), 28(B)(3),
28(B)(4), 28(B)(5)(a), 28(B)(5)(b), 28(B)(5)(c);
33; and 282 of the NIRC on specified items of
income shall be withheld by payor-corporation
and/or person and paid in the same manner and
subject to the same conditions as provided in
Section 58 of the NIRC.

Withholding of Creditable Tax at Source. -
The Secretary of Finance may, upon the
recommendation of the Commissioner, require
the withholding of a tax on the items of income
payable to natural or juridical persons, residing
in the Philippines, by payor-corporation/persons
as provided for by law, at the rate of not less
than one percent (1%) but not more than thirty-
two percent (32%) thereof, which shall be
credited against the income tax liability of the
taxpayer for the taxable year.

Tax-free Covenant Bonds. - In any case where
bonds, mortgages, deeds of trust or other similar
obligations of domestic or resident foreign
corporations, contain a contract or provisions by
which the obligor agrees to pay any portion of
the tax imposed in this Title upon the obligee or
to reimburse the obligee for any portion of the
tax or to pay the interest without deduction for
any tax which the obligor may be required or
permitted to pay thereon or to retain therefrom
under any law of the Philippines, or any state or
country, the obligor shall deduct bonds,
mortgages, deeds of trust or other obligations,
whether the interest or other payments are
payable annually or at shorter or longer periods,
and whether the bonds, securities or obligations
had been or will be issued or marketed, and the
interest or other payment thereon paid, within or
without the Philippines, if the interest or other
payment is payable to a nonresident alien or to a
citizen or resident of the Philippines.

2. Withholding of Creditable Tax
RR 2-98
Under the creditable withholding tax system,
taxes withheld on certain income payments are
intended to equal or at least approximate the tax
due of the payee on said income.
The income recipient is still required to file an
income tax return, to report the income and/or
pay the difference between the tax withheld and
the tax due on the income.

Taxes withheld on income payments covered by
the expanded withholding tax and compensation
income are creditable in nature.

RR 12-2001
The amounts subject to withholding tax under
this paragraph shall include not only fees but
also per diems, allowances and any other form of
income payments not subject to withholding tax
on compensation.
In the case of professional entertainers,
professional athletes, directors involved in
movies, stage, radio, television and musical
productions and other recipients of talent fees,
the amounts subject to withholding tax shall also



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 61 61 61 61 of 163 163 163 163

TAXATION LAW 1
include amounts paid to them in consideration
for the use of their names or pictures in print,
broadcast, or other media or for public
appearances, for purposes of advertisements or
sales proportion.

Furthermore, in order to determine the
applicable tax rate (10% or 20%) to be
applied/withheld by the withholding agent, every
professional entertainer, professional athlete,
director involved in movies, stage, radio,
television and musical productions and other
recipients of talent fees shall annually disclose
his gross income for the current year to the BIR,
by submitting a notarized sworn declaration
thereof, copy furnished all the current payors of
the declaration duly stamped received by the
BIR. The disclosure should be filed on June 30 of
each year or within fifteen (15) days after the
end of the month the talent's income reaches
P720,000, whichever comes earlier. In case his
total gross income is less than P720,000 as of
June 30, he/she shall submit a second disclosure
within fifteen (15) days after the end of the
month that his/her gross income for the current
year to date reaches P720,000. The initial
disclosure after the effectivity of these
Regulations shall be filed on or before September
30, 2001 or within fifteen (15) days after the
effectivity of these Regulations, whichever comes
later. In case of failure to submit the annual
declaration/disclosure to the BIR, the payor shall
withhold the tax at the rate of 20%.

If an individual recipient receives talent fees in
addition to salaries from the same payor, the
said talent fees shall be considered as
supplemental compensation and, thus, be
subject to the withholding tax on compensation."

3. Return and Payment of Tax
Sec. 58
Quarterly Returns and Payments of Taxes
Withheld. - Taxes deducted and withheld under
Section 57 by withholding agents shall be
covered by a return and paid to, except in cases
where the Commissioner otherwise permits, an
authorized Treasurer of the city or municipality
where the withholding agent has his legal
residence or principal place of business, or,
where the withholding agent is a corporation,
where the principal office is located.

The taxes deducted and withheld by the
withholding agent shall be held as a special fund
in trust for the government until paid to the
collecting officers.

The return for final withholding tax shall be filed
and the payment made within twenty-five
(25) days from the close of each calendar
quarter, while the return for creditable
withholding taxes shall be filed and the payment
made not later than the last day of the
month following the close of the quarter
during which withholding was made:
Provided, That the Commissioner, with the
approval of the Secretary of Finance, may
require these withholding agents to pay or
deposit the taxes deducted or withheld at more
frequent intervals when necessary to protect the
interest of the government.

Statement of Income Payments Made and
Taxes Withheld. - Every withholding agent
required to deduct and withhold taxes under
Section 57 shall furnish each recipient, in respect
to his or its receipts during the calendar quarter
or year, a written statement showing the income
or other payments made by the withholding
agent during such quarter or year, and the
amount of the tax deducted and withheld
therefrom, simultaneously upon payment at the
request of the payee, but not later than the
twentieth (20th) day following the close of
the quarter in the case of corporate payee,
or not later than March 1 of the following
year in the case of individual payee for
creditable withholding taxes. For final
withholding taxes, the statement should be
given to the payee on or before January 31
of the succeeding year.

Annual Information Return. - Every
withholding agent required to deduct and
withhold taxes under Section 57 shall submit to
the Commissioner an annual information return
containing the list of payees and income
payments, amount of taxes withheld from each
payee and such other pertinent information as
may be required by the Commissioner. In the
case of final withholding taxes, the return shall
be filed on or before January 31 of the
succeeding year, and for creditable
withholding taxes, not later than March 1 of
the year following the year for which the
annual report is being submitted. This
return, if made and filed in accordance with the
rules and regulations approved by the Secretary
of Finance, upon recommendation of the
Commissioner, shall be sufficient compliance
with the requirements of Section 68 of the NIRC
in respect to the income payments.

The Commissioner may, by rules and
regulations, grant to any withholding agent a
reasonable extension of time to furnish and
submit the return required in this Subsection.

Income of Recipient. - Income upon which any
creditable tax is required to be withheld at
source under Section 57 shall be included in the
return of its recipient but the excess of the
amount of tax so withheld over the tax due on
his return shall be refunded to him subject to the
provisions of Section 204; if the income tax
collected at source is less than the tax due on his
return, the difference shall be paid in accordance
with the provisions of Section 56.

All taxes withheld pursuant to the provisions of
this Code and its implementing rules and
regulations are hereby considered trust funds
and shall be maintained in a separate account
and not commingled with any other funds of the
withholding agent.

Registration with Register of Deeds. - No
registration of any document transferring real
property shall be effected by the Register of
Deeds unless the Commissioner or his duly
authorized representative has certified that such
transfer has been reported, and the capital gains
or creditable withholding tax, if any, has been
paid: Provided, however, That the information as
may be required by rules and regulations to be
prescribed by the Secretary of Finance, upon



1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 62 62 62 62 of 163 163 163 163

TAXATION LAW 1
recommendation of the Commissioner, shall be
annotated by the Register of Deeds in the
Transfer Certificate of Title or Condominium
Certificate of Title: Provided, further, That in
cases of transfer of property to a corporation,
pursuant to a merger, consolidation or
reorganization, and where the law allows
deferred recognition of income in accordance
with Section 40, the information as may be
required by rules and regulations to be
prescribed by the Secretary of Finance, upon
recommendation of the Commissioner, shall be
annotated by the Register of Deeds at the back
of the Transfer Certificate of Title or
Condominium Certificate of Title of the real
property involved: Provided, finally, That any
violation of this provision by the Register of
Deeds shall be subject to the penalties imposed
under Section 269 of this Code.

C. Withholding on Wages
Sec. 78. Definitions.
Wages - The term 'wages' means all remuneration
(other than fees paid to a public official) for
services performed by an employee for his
employer, including the cash value of all
remuneration paid in any medium other than cash,
except that such term shall not include
remuneration paid:

(1) For agricultural labor paid entirely in products
of the farm where the labor is performed, or
(2) For domestic service in a private home, or
(3) For casual labor not in the course of the
employer's trade or business, or
(4) For services by a citizen or resident of the
Philippines for a foreign government or an
international organization.

If the remuneration paid by an employer to an
employee for services performed during one-half
(1/2) or more of any payroll period of not more
than thirty-one (31) consecutive days constitutes
wages, all the remuneration paid by such employer
to such employee for such period shall be deemed
to be wages; but if the remuneration paid by an
employer to an employee for services performed
during more than one-half (1/2) of any such payroll
period does not constitute wages, then none of the
remuneration paid by such employer to such
employee for such period shall be deemed to be
wages.

Payroll Period - a period for which payment of
wages is ordinarily made to the employee by his
employer, and the term "miscellaneous payroll
period" means a payroll period other than, a daily,
weekly, biweekly, semi-monthly, monthly,
quarterly, semi-annual, or annual period.

Employee - any individual who is the recipient of
wages and includes an officer, employee or elected
official of the Government of the Philippines or any
political subdivision, agency or instrumentality
thereof. The term "employee" also includes an
officer of a corporation.

Employer - means the person for whom an
individual performs or performed any service, of
whatever nature, as the employee of such person,
except that:
(1) If the person for whom the individual performs
or performed any service does not have
control of the payment of the wages for such
services, the term "employer" (except for the
purpose of Subsection (A)) means the person
having control of the payment of such wages;
and
(2) In the case of a person paying wages on
behalf of a nonresident alien individual, foreign
partnership or foreign corporation not engaged
in trade or business within the Philippines, the
term "employer" (except for the purpose of
Subsection (A)) means such person.

Sec. 79. Income Tax Collected at Source
Requirement of Withholding - Every employer
making payment of wages shall deduct and
withhold upon such wages a tax determined in
accordance with the rules and regulations to be
prescribed by the Secretary of Finance, upon
recommendation of the Commissioner: Provided,
however, That no withholding of a tax shall be
required where the total compensation income of
an individual does not exceed the statutory
minimum wage, or five thousand pesos
(P5,000.00) per month, whichever is higher.

Tax Paid by Recipient - If the employer, in
violation of the provisions of this Chapter, fails to
deduct and withhold the tax as required under this
Chapter, and thereafter the tax against which such
tax may be credited is paid, the tax so required to
be deducted and withheld shall not be collected
from the employer; but this Subsection shall in no
case relieve the employer from liability for any
penalty or addition to the tax otherwise applicable
in respect of such failure to deduct and withhold.

Refunds or Credits -
(1) Employer. - When there has been an
overpayment of tax under this Section, refund
or credit shall be made to the employer only
to the extent that the amount of such
overpayment was not deducted and withheld
hereunder by the employer.

(2) Employees. - The amount deducted and
withheld under this Chapter during any
calendar year shall be allowed as a credit to
the recipient of such income against the tax
imposed under Section 24(A) of this Title.
Refunds and credits in cases of excessive
withholding shall be granted under rules and
regulations promulgated by the Secretary of
Finance, upon recommendation of the
Commissioner.

Any excess of the taxes withheld over the tax due
from the taxpayer shall be returned or credited
within three (3) months from the fifteenth (15
th
)
day of April. Refunds or credits made after such
time shall earn interest at the rate of six percent
(6%) per annum, starting after the lapse of the
three-month period to the date the refund of credit
is made.

Refunds shall be made upon warrants drawn by the
Commissioner or by his duly authorized
representative without the necessity of counter-
signature by the Chairman, Commission on Audit or
the latter's duly authorized representative as an
exception to the requirement prescribed by Section
49, Chapter 8, Subtitle B, Title 1 of Book V of
Executive Order No. 292, otherwise known as the
Administrative Code of 1987.





1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W 1 0 0 % U P L A W U P B A R O P S 2 0 0 8 Page 63 63 63 63 of 163 163 163 163

TAXATION LAW 1
Personal Exemptions -
In General. - Unless otherwise provided by this
Chapter, the personal and additional exemptions
applicable under this Chapter shall be determined
in accordance with the main provisions of this Title.

Exemption Certificate. -
(a) When to File. - On or before the date of
commencement of employment with an
employer, the employee shall furnish the
employer with a signed withholding exemption
certificate relating to the personal and
additional exemptions to which he is entitled.
(b) Change of Status. - In case of change of
status of an employee as a result of which he
would be entitled to a lesser or greater
amount of exemption, the employee shall,
within ten (10) days from such change, file
with the employer a new withholding
exemption certificate reflecting the change.
(c) Use of Certificates. - The certificates filed
hereunder shall be used by the employer in
the determination of the amount of taxes to
be withheld.
(d) Failure to Furnish Certificate. - Where an
employee, in violation of this Chapter, either
fails or refuses to file a withholding exemption
certificate, the employer shall withhold the
taxes prescribed under the schedule for zero
exemption of the withholding tax table
determined pursuant to Subsection (A) hereof.

Withholding on Basis of Average Wages - The
Commissioner may, under rules and regulations
promulgated by the Secretary of Finance, authorize
employers to:
(1) estimate the wages which will be paid to an
employee in any quarter of the calendar year;
(2) determine the amount to be deducted and
withheld upon each payment of wages to such
employee during such quarter as if the
appropriate average of the wages so
estimated constituted the actual wages paid;
and
(3) deduct and withhold upon any payment of
wages to such employee during such quarter
such amount as may be required to be
deducted and withheld during such quarter
without regard to this Subsection.

Husband and Wife - When a husband and wife
each are recipients of wages, whether from the
same or from different employers, taxes to be
withheld shall be determined on the following
bases:
(1) The husband shall be deemed the head of
the family and proper claimant of the additional
exemption in respect to any dependent children,
unless he explicitly waives his right in favor of his
wife in the withholding exemption certificate.
(2) Taxes shall be withheld from the wages of
the wife in accordance with the schedule for zero
exemption of the withholding tax table prescribed
in Subsection (D)(2)(d) hereof.

Nonresident Aliens - Wages paid to nonresident
alien individuals engaged in trade or business in
the Philippines shall be subject to the provisions of
this Chapter.

Year-End Adjustment - On or before the end of
the calendar year but prior to the payment of the
compensation for the last payroll period, the
employer shall determine the tax due from each
employee on taxable compensation income for the
entire taxable year in accordance with Section
24(A). The difference between the tax due from the
employee for the entire year and the sum of taxes
withheld from January to November shall either be
withheld from his salary in December of the current
calendar year or refunded to the employee not
later than January 25 of the succeeding year.

Sec. 79. Liability for Tax
Employer - The employer shall be liable for the
withholding and remittance of the correct amount
of tax required to be deducted and withheld under
this Chapter. If the employer fails to withhold and
remit the correct amount of tax as required to be
withheld under the provision of this Chapter, such
tax shall be collected from the employer together
with the penalties or additions to the tax otherwise
applicable in respect to such failure to withhold and
remit.

Employee - Where an employee fails or refuses to
file the withholding exemption certificate or willfully
supplies false or inaccurate information thereunder,
the tax otherwise required to be withheld by the
employer shall be collected from him including
penalties or additions to the tax from the due date
of remittance until the date of payment. On the
other hand, excess taxes withheld made by the
employer due to:
(1) failure or refusal to file the withholding
exemption certificate; or
(2) false and inaccurate information shall not be
refunded to the employee but shall be
forfeited in favor of the Government.

Sec. 81. Filing of Return and Payment of
Taxes Withheld
Except as the Commissioner otherwise permits,
taxes deducted and withheld by the employer on
wages of employees shall be covered by a return
and paid to an authorized agent bank, Collection
Agent, or the duly authorized Treasurer of the city
or municipality where the employer has his legal
residence or principal place of business, or in case
the employer is a corporation, where the principal
office is located.

The return shall be filed and the payment made
within twenty-five (25) days from the close of each
calendar quarter: Provided, however, That the
Commissioner may, with the approval of the
Secretary of Finance, require the employers to pay
or deposit the taxes deducted and withheld at more
frequent intervals, in cases where such
requirement is deemed necessary to protect the
interest of the Government.

The taxes deducted and withheld by employers
shall be held in a special fund in trust for the
Government until the same are paid to the said
collecting officers.