Income Tax Notes

Statutory Inclusions!
!
SEC. 32 Gross Income. -!
(A) General Definition. - Except when otherwise provided in this Title, gross income means all
income derived from whatever source, including (but not limited to) the following items:!
(1) Compensation for services in whatever form paid, including, but not limited to fees, salaries,
wages, commissions, and similar items; !
(2) Gross income derived from the conduct of trade or business or the exercise of a profession; !
(3) Gains derived from dealings in property; !
(4) Interests; !
(5) Rents; !
(6) Royalties; !
(7) Dividends; !
(8) Annuities; !
(9) Prizes and winnings; !
(10) Pensions; and !
(11) Partner's distributive share from the net income of the general professional partnership.!
!
SEC. 78. Definitions. - As used in this Chapter:!
(A) 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.!
!
Old Colony Trust Co. v. CIR!
- Petitioners are executors of the will of William M. Wood, deceased!
- Before Wood died, CIR notified him by registered mail of determination of a deficiency in income
tax for years 1919 and 1920!
- An appeal was taken to the BTA but the latter approved the action of the Commissioner!
- Wood was president of the American Woolen Company in 1918, 1919, 1920.!
- In 1916 the American Woolen Company adopted a resolution stating that the company shall pay
any and all income taxes, state and federal, that may be due and payable upon the salaries of
all the officers of the company so the officers shall receive their salaries in full without deduction
on account of income taxes!
- American Woolen Company then paid to the CIR Mr. Woods federal income tax due to salary
and commissions paid by the company.!
- The BTA decided that the income taxes paid by the American Woolen Company for Mr. Wood
were additional income to him.!
- ISSUE: WHETHER THE PAYMENT BY THE EMPLOYER OF THE INCOME TAX ASSESSABLE
AGAINST THE EMPLOYEE CONSTITUTE ADDITIONAL TAXABLE INCOME TO SUCH
EMPLOYEE.!
- A taxpayer, having induced a third person to pay his income tax or having acquiesced in such
payment as made in discharge of an obligation to him, may not avoid the making of a return
thereof and the payment of a corresponding tax.!
- Payment of tax by the employers was in consideration of the services rendered by the employee
and was derived by the employee from his labor.!
Income Tax Notes
- It is immaterial that the taxes were directly paid over to the government.!
- The discharge by a third person of an obligation to him is equivalent to receipt by the person
taxed.!
- Taxes were paid upon a valuable consideration - the services rendered by the employee and as
part of the compensation therefor.!
- Payment of the tax is also not a gift. Payment for services, even though entirely voluntary, was
nevertheless compensation within the statute.!
- Noel v. Parrott: A gratuitous appropriation equal in amount to $3 per share cannot be regarded
as a gift. It was either compensation for services rendered or a gain or profit derived from the
sale of the stock of the corporation, or both, and in any view, it was taxable as income.!
- Is the result tax upon a tax? NOT A QUESTION BEFORE THE CIRCUIT COURT OF APPEALS
AND NOT CERTIFIED TO THE SC.!
- The bottomline is the payment by the employer of the income taxes assessable against the
employee constitute additional taxable income to such employee.!
!
Helvering v. Bruun!
- On July 1, 1915, the respondent, as owner, leased a lot of land and the building thereon for a
term of 99 years.!
- Lease provided that the lessee might at any time, upon giving bond to secure rentals accruing in
the two ensuing years, remove or tear down any building on the land, provided that no building
should be removed or torn down after the lease became forfeited, or during the last three and
one-half years of the term. The lessee was to surrender the land, upon termination of the lease,
with all buildings and improvements thereon.!
- In 1929, the tenant demolished and removed the existing building and constructed a new one
which had a useful life of not more than 50 years!
- In 1922, the lease was cancelled for default in payment of rent and taxes and respondent
regained possession of the land and building!
- Helvering determined that in 1933, Bruun realized a net gain on the building.The Board
overruled and the Circuit Court of Appeals affirmed the Board.!
- The course of administrative practice and judicial decision in respect of the question has not
been uniform.!
- 1917: Treasury ruled that the adjusted value of improvements installed upon leased premises is
income to the lessor upon the termination of the lease!
- Incorporated in 2 succeeding editions of the Treasury Regulations!
- 1919: Circuit Court of Appeals for the 9th Circuit (Miller v. Gearin) held that the regulation was
invalid, as the gain, if taxable at all, must be taxed as of the year when the improvements were
completed.!
- Regulations were accordingly amended to impose a tax upon the gain in the year of completion
of the improvements, measured by their anticipated value at the termination of the lease and
discounted for the duration of the lease.!
- Regulations then permitted the lessor to spread the depreciated value of the improvements over
the remaining life of the lease reporting an aliquot part each year with provision that upon
premature termination, a tax should be imposed upon the excess of the then value of the
improvements over the amount theretofore returned.!
- 1935: Circuit Court of Appeals for Second Circuit (Hewitt Realty v. Commissioner) held that a
landlord received no taxable income in a year, during the term of the lease, in which his tenant
erected a building on the leased land. No taxable gain because the improvement was not
portable or detachable from the land and if removed, would be worthless except as bricks, iron,
and mortar. INVALIDATED REGULATIONS IN FORCE.!
- 1938: SC decided M.E. Blatt Co. v. US: Any enhancement in the value of the realty in the tax
year was not income realized by the lessor within the Revenue Act.!
- ISSUE: WHETHER OR NOT HELVERING WAS CORRECT IN ASSESSING THE GAIN
REALIZED IN 1933.!
- Bruun insists that the realty, a capital asset at the date of the execution of the lease, remained
such throughout the term and after its expiration; that improvements affixed to the soil became
part of the realty indistinguishably blended in the capital asset; that such improvements cannot
Income Tax Notes
be separately valued or treated as received in exchange for improvements which were on the
land at the date of the execution.!
- Bruun further argues that the added value can be considered capital gain only upon the owners
disposition of the asset.!
- HELVERING WAS RIGHT IN ASSESSING THE GAIN AS REALIZED IN 1933.!
- The correctness of the Commissioners determination has not been overborne.!
- Bruun cannot successfully contend that the definition of gross income in the Revenue Act is not
broad enough to embrace the gain in question.!
- Bruun also asserted that the improvement must be capable of being separated from the land
and capable of realizing separate gain, relying on the Hewitt case. However, that definition
distinguishes ordinary and stock dividends thus not controlling in the case at bar.!
- While it is true that economic gain is not always taxable as income, it is settled that the
realization of gain need not be in cash derived from the sale of an asset.!
- Gain may occur as a result of exchange of property, payment of the taxpayers indebtedness,
relief from a liability, or other profit realized from the completion of a transaction. !
- The fact that the gain is a portion of the value of property received by the taxpayer in the
transaction does not negative its realization.!
- As result of a business transaction, Bruun received back his land with a new building, which
added an ascertainable amount to its value.!
- It is not necessary to recognition of taxable gain that he should be able to sever the
improvement begetting the gain from his original capital.!
!
SEC. 73. Distribution of dividends or Assets by Corporations. -!
(A) Definition of Dividends. - The term "dividends" when used in this Title means any distribution
made by a corporation to its shareholders out of its earnings or profits and payable to its
shareholders, whether in money or in other property.!
Where a corporation distributes all of its assets in complete liquidation or dissolution, the gain
realized or loss sustained by the stockholder, whether individual or corporate, is a taxable income
or a deductible loss, as the case may be.!
(B) Stock Dividend. - 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.!
(C) Dividends Distributed are Deemed Made from Most Recently Accumulated Profits. - Any
distribution made to the shareholders or members of a corporation shall be deemed to have been
made form 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.!
!
CIR v. CA!
- 1930s: Don Andres Soriano, a citizen and resident of the US formed a corporation A Soriano Y
Cia, predecessor of ANSCOR with a 1M capitalization divided into 10,000 common shares at a
par value of P100 per share.!
- ANSCOR is wholly owned and controlled by the family of Don Andres who are all non-resident
aliens.!
- 1937: Don Andres subscribed to 4,963 shares of the 5,000 shares originally issued.!
- 1945: ANSCORs authorized capital stock was increased to P2.5M divided into 25,000 common
shares with the same par value. Of the additional 15,000 shares, only 10,000 was issued which
were all subscribed by Don Andres. His common shares then increased to 14,963. !
- Don Andres transferred 1,250 shares each to his two sons, Jose and Andres, Jr. as their initial
investments in ANSCOR.!
- 1947: ANSCOR declared stock dividends and more declarations were made between 1949 and
1963.!
Income Tax Notes
- In 1964, Don Andres died. Records revealed that he has a total shareholdings of 185,154
shares. 50,495 of which are original issues and the balance of 134,659 shares as stock dividend
declarations.!
- One half then went to Doa Carmen Soriano as her conjugal share. The other half formed part
of his estate.!
- ANSCOR increased its capital stock to 20M and in 1966 further increased it to 30M.!
- Stock dividends were respectively received by the Don Andres estate and Doa Carmen from
ANSCOR.!
- Doa Carmen requested a ruling from the United States Internal Revenue Service (IRS)
inquiring if an exchange of common with preferred shares may be considered as a tax
avoidance scheme.!
- ANSCOR reclassified its existing 300,000 common shares into 150,000 common and 150,000
preferred shares.!
- The IRS opined that the exchange is only a recapitalization scheme and not tax avoidance.!
- Doa Carmen exchanged her whole common shares for newly reclassified preferred shares.!
- Pursuant to a Board Resolution, ANSCOR redeemed 28,000 common shares from the Don
Andres estate. By 1968, the Board further increased ANSCORs capital stock to 75M divided
into 150,000 preferred shares and 600,000 common shares.!
- ANSCOR again redeemed 80,000 common shares from the Don Andres estate further reducing
the latters common shareholdings.!
- As stated in the resolutions, ANSCORs business purpose for both redemptions of stocks is to
partially retire said stocks as treasury shares in order to reduce the companys foreign exchange
remittances in case cash dividends are declared.!
- In 1973, after examining ANSCORs books of account and records, revenue examiners issued a
report proposing that ANSCOR be assessed for deficiency withholding tax-at-source based on
the transactions of exchange and redemption of stocks.!
- BIR made such assessment despite the claim of ANSCOR that it availed of the tax amnesty
under PD 23 which were amended by PD 67 and 157.!
- CIR ruled that the invoked decrees do not cover the assessment made on ANSCOR.!
- ANSCOR filed a petition for review with the CTA.!
- CTA reversed petitioners ruling after finding sufficient evidence to overcome the prima facie
correctness of the questioned assessments.!
- CA affirmed CTA.!
- ISSUE: WHETHER OR NOT ANSCORS REDEMPTION OF STOCKS FROM ITS
STOCKHOLDER AS WELL AS THE EXCHANGE OF COMMON WITH PREFERRED SHARES
CAN BE CONSIDERED AS ESSENTIALLY EQUIVALENT TO THE DISTRIBUTION OF
TAXABLE DIVIDEND, MAKING THE PROCEEDS THEREOF TAXABLE UNDER THE
PROVISIONS OF THE ABOVE-QUOTED LAW.!
- CIR: exchange transaction is tantamount to cancellation under Section 83(b) making the
proceeds thereof taxable. Said section applies to stock dividends which is the bulk of stocks that
ANSCOR redeemed. Under the net effect test, the estate of Don Andres gained from the
redemption. Thus it was the duty of ANSCOR to withhold the tax-at-source arising from the two
transactions.!
- ANSCOR: No duty to withhold any tax based on the transactions as the same were done for
legitimate business purposes which are to reduce its foreign exchange remittances in the event
the company would declare cash dividends and to subsequently Filipinize ownership of
ANSCOR as allegedly envisioned by Don Andres.!
- ON THE TAX AMNESTY!
- Taxpayer is covered, withholding agent is not. ANSCOR was assessed by CIR for deficiency
withholding tax. As such it is held liable in its capacity as a withholding agent and not in its
personality as a taxpayer.!
- ON TAXING DIVIDENDS.!
- General rule: A stock dividend representing the transfer of surplus to capital account shall not be
subject to tax.!
Income Tax Notes
- Stock dividends, strictly speaking, represent capital and do not constitute income to its recipient.
The mere issuance thereof is not yet subject to income tax as they are nothing but an
enrichment through increase in value of capital investment.!
- Income in tax law is an amount of money coming to a person within a specified time, whether as
payment for services, interest, or profit from investment. It means cash or its equivalent.!
- As capital, a stock dividend is not yet subject to income tax until the gain has been realized.!
- Capital is wealth or fund, income is profit or gain or the flow of wealth.!
- Exception: Redemption or cancellation of stock dividends, depending on the time and manner it
was made is essentially equivalent to a distribution of taxable dividends, making the proceeds
thereof taxable income to the extent it represents profits.!
- The exception was designed to prevent the issuance and cancellation or redemption of stock
dividends, which is fundamentally not taxable, from being made use of a device for the actual
distribution of cash dividends, which is taxable.!
- Although redemption and cancellation are generally considered capital transactions, as such,
they are not subject to tax. However, it does not necessarily mean that a shareholder may not
realize a taxable gain from such transactions. Simply put, depending on the circumstances, the
proceeds of redemption of stock dividends are essentially distribution of cash dividends, which
when paid becomes the absolute property of the stockholder.!
- American courts developed a criteria which includes the following:!
- presence/absence of real business purpose!
- amount of earnings and profits available for the declaration of a regular dividend and the
corporations past record with respect to the declaration of dividends!
- lapse of time between issuance and redemption!
- presence of a substantial surplus and a generous supply of cash which invites suspicion as
does a meager policy in relation both to current earnings and accumulated surplus.!
- For the exempting clause to apply (in other words, for the stock dividend to be taxable) it is
indispensable that!
- there is redemption or cancellation!
- the transaction involves stock dividends!
- the time and manner of the transaction makes it essentially equivalent to a distribution of
taxable dividends (most important)!
- Redemption is repurchase, a reacquisition of stock by a corporation which issued the stock in
exchange for property, whether or not the acquired stock is cancelled, retired or held in the
treasury!
- The corporations gets back some of its stock, distributes cash or property to the shareholder in
payment for the stock, and continues in business as before.!
- The redemption of stock dividends previously issued is used as a veil for the constructive
distribution of cash dividends.!
- In the case at bar, there is no dispute that ANSCOR redeemed shares of stocks from Don
Andres twice. Where did the shares redeemed come from?!
- If source is original capital subscriptions: not taxable as it is not income but a mere return of
capital!
- If redeemed shares are from stock dividend declarations other than as initial capital
investment, the proceeds of the redemption is additional wealth, for it is not merely a return of
capital but a gain thereon.!
- It is not the stock dividends but the proceeds of its redemption that may be deemed as taxable
dividends.!
- With respect to the third requisite, ANSCOR redeemed stock dividends issued just 2 to 3 years
earlier. The time alone that lapsed from the issuance to the redemption is not a sufficient
indicator to determine taxability. It is a must to consider the factual circumstances as to the
manner of both the issuance and the redemption. The time element is a factor to show a device
to evade tax and the scheme of cancelling or redeeming the same shares is a method usually
adopted to accomplish the end sought.!
- The existence of legitimate business purposes in support of the redemption of stock dividends is
immaterial in income taxation. It has no relevance in determining dividend equivalence.!
Income Tax Notes
- Such purposes may be material only upon the issuance of the stock dividends. The test of
taxability under the exempting clause, when it provides such time and manner as would make
the redemption essentially equivalent to the distribution of a taxable dividend, is whether the
redemption resulted into a flow of wealth. If no wealth is realized from the redemption, there may
not be a dividend equivalence treatment.!
- The three elements in the imposition of income tax are: (1) there must be gain or profit, (2) that
the gain or profit is realized or received, actually or constructively,[108] and (3) it is not exempted
by law or treaty from income tax. Any business purpose as to why or how the income was
earned by the taxpayer is not a requirement.!
- Profits derived from the capital invested cannot escape income tax. As realized income, the
proceeds of the redeemed stock dividends can be reached by income taxation regardless of the
existence of any business purpose for the redemption. Otherwise, to rule that the said proceeds
are exempt from income tax when the redemption is supported by legitimate business reasons
would defeat the very purpose of imposing tax on income.