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INCOME

TAXATION
REVIEWER
Mariano Marcos State
University- College of Law
2011

Prepared by:
Kristelle Joy Ann Quibuyen
Dandy Cruz
Moera Joy Galing-Luna
Rizza Joy Santos-Vallestero
Myrel Tajon
May Encarnina Gaoiran
INCOME TAXATION

BASIC CONCEPTS OF PHILIPPINE INCOME Item Increase net Decrease net


assets assets
TAXATION
Increase in cash 20,000
Decrease in 80,000
THE CONCEPT OF INCOME accounts
1. Income is a flow of service rendered by capital by receivable
the payment of money from such capital or any Increase in 150,000
benefit rendered by a fund of capital thourgh a inventory
period of time. Refers to all gains, profits or income Decrease in 60,000
accounts payable
derived from any source such as services whether
Increase in notes 30,000
constituting a demandable debt or not or from the payable
use of capital. Total 230,000 110,000

Conwi Vs CIR, 213 Scra 83 An income is the Net increase 120,000


amount of money coming to a perosn or (Increase-
corporation within a specified time, whether as decrease)
payment for services, interest or profit form Add dividend paid 80,000
investment. Unless otherwise specified, income during the year
means cash or its equivalent Since dividends are
obtained from
earnings
Rule of thumb test- to determine income is the total 200,000
increase in net worth Less proceeds from 100,000
Example: sale of capital
b.1 (individual) As capital from the stock (return of
beginning (Jan 2000) is 100,000 capital)
As capital ending (Dec 2000) is 90,000 Net income 100,000
As additional investment during the
year(Feb 2000) is 5,000
As personal withdrawal during the Taxable income pertinent items of gross
year(May 2000) is 40,000 income specified in NIRC less the deductions
How much is Mr. As income for calendar year and or personal and additional exemptions if
2000? 140,000 95,000 = 45,000 any.Synonymous with net income.
It does not include items received which do not add
Note: personal withdrawals are added to capital to the taxpayers net worth or redound to his benefit
bec they decrease the ending capital but might such as amounts merely deposited or entrusted to
have been taken from the earnings during the him
year
b.2 (corporation) B reported the following 3 categories of taxable income:
during the taxable year: Passive investment income subject to final tax
Sold 1000 shares at 100 pesos no longer included in the taxpayers taxable
Paid dividend amounting to 80,000 income
How much is the net income? Example: royalties, interest income from
Philippine currency bank deposits
Compensation income income from personal
services under employer- employee
relationship; allowable deductions are only
premiums paid for health and hospitalization

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INCOME TAXATION

insurance. Tax is computed on gross income in Capital gains tax on sale of real property
case of individuals. (Note difference in gross classified as a capital asset by a person who is
income in indiv. And gross income perse). not a real estate dealer or developer; if it is
Requisites: classified as ordinary asset subject to ordinary
b.1 it must arise from personal services under income tax
and employer employee relationship Tax on passive investment income, such as
b.2 It is in the nature of income to the recipient interest, dividend and royalty
employee Fringe benefits tax
Example: Directors fee deemed by law as Branch profit remittance tax on Philippine
compensation income ; branches of foreign corporations
Non- compensation income any other income Tax on improperly accumulated earnings tax of
that is not derived from personal services or not corporations
related to an employer- employee relationship Final withholding taxes on certain income from
and is subject to tax on net income basis. sources within the Philippines payable to
It includes: Capital gain gains from dealings resident or non resident persons
in capital assets;
Business income gains from selling Capital denotes original investment or fund
merchandise used in order to generate earnings which is
Professional income fees derived called income
from engaging in an endeavor requiring Example: Amount of money deposited is
special training as professional 100,000 for 5 years. Interest rate is 12% per
annum. How much is capital? How much is
Note: in corporations, both compensation and non income per year?
compensation are subjectto tax in the basis of net Car bought for 100,000 in year 2008 was sold for
income since gross tax scheme is limited to 100,000 in year 2010. Depreciation rate is 5%
compensation arising from personal and not per annum. How much is capital? How much is
corporater services. income in year 2010?
Differences Between income and capital
Non taxable income those excluded by law or Madrigal Vs Rafferty 38 Phil 414
th
treaty from taxation. Ex: 13 month pay
Income tax tax on all yearly profits arising from Income Capital
property, professions, trades or offices or as a All wealth other Fund or property existing at
tax on a persons income, emoluments, profits than mere an instant of time, which can
and the like. It is also a direct tax on actual or return of capital be used in producing goods
presumed income of a taxpayer or services
received,accrued or realized during the taxable Flow of wealth Fund or property
year. Service of Wealth
wealth
Income is Return of capital is not
Types of income tax:
subject to tax subject to tax
Personal income tax on individuals
Regular corporate income tax on corporations Revenue Distinguished from income:
Minimum corporate income tax on corporations Revenue pertains to all funds accruing to the
Capital gains tax on sale of shares of stocks of treasury of the government derived from tax,
domestic corporation by a person who is not a donation, grants and any other source.
dealer in securities

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INCOME TAXATION

Income refers to the earnings of individual a. Actual


persons, partnership, corporation or estate and Example:
trust whethero or not subject to tax. 1. Mr x purchased a land for 10,000. After 3 yrs
the value of the land was 15,000. On the fourth
TESTS APPLIED IN DETERMINING THE EXISTENCE OF INCOME year Mr X sold the land for 13,000. He paid
1. Severance test income is recognized when there is 1,000 to B as brokers commission.
separation of something which is of exchangeable Formula: Income = Sales proceeds (Cost of land +
value necessary expenses for the sale of land)
2. Realization test no taxable income until there is a = 13,000 (10,000 + 1,000)
separation from capital of something of = 2,000
exchangeable value (money), thereby supplying the Income should be reported on the fourth year only
realization or transmutation which would result in since it was in that year that it was realized.
the receipt of income. 2. B sold to C a car with FMV of 40 pesos, for 50
3. Tax Benefit Rule pesos on installment with 1/5 purchase price to
4. Economic Benefit Test any economic benefit to the be paid annually. C in year 2 paid 20 pesos to B
employee that increases his net worth whatever as payment for years 2 and 3. How much is Bs
may have been the mode by which it is effected is income in year 2? Ans: 4 pesos.
taxable b. Constructive (sec 26) an income is considered
5. Claim of Right Doctrine a taxable gain is constructively received when it is credited to the
conditioned upon the presence of a claim of right to account of or segregated in favor of a person.
the alleged gain and the absence of a definite The person may withdraw the said account
unconditional obligation to return or repay. credited in his favor anytime without any
substantial limitations or conditions upon which
Principle of Constructive receipt of Income payment or enjoyment is to be made or
Income which is credited to the account of or exercised.
set apart for a taxpayer and which may be Example: Dividends applied by the corporation
drawn upon by him at anytime is subject to tax against the indebtedness of a stockholder.
for the year during which so credited or set c. Presumptive (24 d)
apart although not then actually reduced to As If theory of constructive income it
possesion. presumes the existence of income on
6. Income from Whatever Source Income sources transactions supposedly not subject to tax.
whether legal or illegal Example: Real property sold at a loss is subject
to capital gains tax of 6% of the selling price or
REQUISITES FOR THE TAXABILITY OF AN INCOME fair market value whichever is higher.
1. Existence of a gain- the value received in the form of 3. Gain must not be excluded (Sec 32 B) law or treaty
cash or its equivalent as a result of rendition of does not exclude the gain from taxation.
service or earnings in excess of capital invested.
Example: cancellation of a taxpayers indebtedness THE PHILIPPINE INCOME TAX SYSTEM
as a remuneration for service rendered is an income. 1. Types of Income Tax Systems
Note: mere expectation of profit is not an income a. Schedular System- Different types of incomes
and therefore not taxable. are subject to different sets of graduated or flat
2. Realization of a gain realization of gain may take income tax rates. Applicable tax rates will
the form of actual receipt of cash or may occur as a depend on the classification of the taxable
constructive receipt of income. Mere increase in the income and the basis could be gross
value of property is not income but merely an income(without deductions) or net income
unrealized increase in invested capital.

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INCOME TAXATION

(deductions were already subracted). (Applic to Subtract (-) personal and additional
phil from Jan 1, 1982 to Dec 31, 1985) exemption (does not apply in case of
The Recipient of the income files separate corporations) =10,000
regular income tax return or capital gains tax Difference is Net taxable income = 80,000
return except for passive income subject to final 80,000 is subjected to graduated
witholding tax. tax rates to arrive at tax due
Reason for the exception: It is the c. Semi-schedular or semi Global tax system
witholding agent who is responsible for filing Under this system, compensation income,
the witholding tax return and payment of business or professional income, capital gain
income tax to the BIR on such passive income of and passive income not subject to FWIT (final
the investor. withholding income tax) and other income are
Example: added together to arrive at the gross income.
a) Sale of real property subjected to flat Obtain net taxable income by subtracting from
income tax rates: the gross income the sum of allowable
Lot classified as capital asset sold deductions from business or professional incom,
at 500,000 with fair market value of 300,000. capital gain, passive income not subject to FWIT
Tax base is either consideration in the case of corporations and personal and
from sale or FMV whichever is higher additional exemption in case of individuals and
Formula: Capital gains tax = Taxbase x 6% subject such taxable income to one set of
Solution: CGT = 500,000 x 6% graduated tax rates (individual) or normal
Ans: 30,000 corporate income tax rate (corporation)
b) Sale of stocks subjected to graduated tax
rates (Sample only) Note: Passive investment income subject to FWIT,
Taxbase: value of stocks sold Captal gains from sale or transfer of stocks of a
>100,000 (10%) >200,000 (20% excess) domestic corp and real properties classified as
capital assets remain subject to different sets of
b. Global System The taxpayer is required to tax rates and covered by differect tax returns.
lump up all items of income earned during a Case: Sison Vs Ancheta GR No. L-59431, Jult 25
taxable period and pay a single set of income tax 1984
rates on these different items of income. d. Schedular Rates of Taxes Vs Schedular System
Net taxable income is subject to the graduated Schedular rates of taxes rates of taxes that
income tax rates in case of individuals and to applies to each category of income.
corporate income tax rates in case of
corporations. It does not matter whether the 2. The Philippine Income Tax System as a Semi Global
income received by the taxpayer is classified as or Mixed System - Effective jan 1, 1986, Executive
compensation income, business professional order No. 37 adopted the semi-global or semi-
income, passive investment income, capital gain schedular tax system by reducing the graduated
or other income. All items of gross income as rates on business and professional income from 60%
well as deductions and personal and additional to 35% and by increasing the preferential tax rates
exemptions are reported in ONE income tax on capital gains and passive investment incomes. RA
return to be filed at least annually and the 8424 (1998) retained the semiglobal or
applicable tax rate is applied on the tax base. semischedular tax system by introducing some
(applic to phil up to dec 1981) structural and administrative reforms and by
Example: reducing the tax rates on corporations by 1% every
Gross income = 100,000 year from 35% to 32%. The same tax system was
Subtract (-) allowable deductions = 10,000 maintained under RA 9337 in 2005 but corporate tax

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INCOME TAXATION

rate was increased to 35% and reduced to 30% in Jan At graduated income tax rate of 5% to 32%,
1, 2009. white his passive investment incomes shall
3. Features of Income tax law: generally be subject to 20% final tax
a. Direct tax burden is borne by income recipient Not Engaged in Trade or Business in the Philippines
upon whom the tax is imposed If the aggregate period of his stay in the
b. Progressive tax tax base increases as tax rate Philippines does not exceed 180 days during
increases any calendar year
c. Comprehensive tax situs- by adopting His compensation income, business or
nationality, residence and source principle professional income, capital gain, passive
d. Philippines has retained more schedular than investment income, and other income from
global features with respect to individual sources within the Philippines is taxed at
taxpayers but has maintained a more global the flat rate of 25%
treatment on corporations Capital gains from sale or exchange of
e. American origin great weight should be given shares of stocks in a domestic corporation
to the construction placed upon a revenue law and from real property located in the
whose meaning is doubtful by the department Philippines shall be subject to capital gains
charged with its execution tax or stock transaction tax, as the case may
be.
CRITERIA IN IMPOSING PHILIPPINE INCOME TAXES
3. Citizenship
1. Place where income was earned or the source
A citizen of the Philippines is subject to Philippine income tax:
An alien is subject to Philippine income tax because
Resident citizen on his worldwide income from
he derives income from sources within the
within and without the Philippines
Philippines. Thus, a non-resident alien is liable to pay
Nonresident citizen only on his sources within the
Philippine income tax on his income from sources
Philippines
within the Philippines, such as dividend, interest,
Types of nonresident citizen
rent, or royalty, despite the fact that he has not set
1. Immigrants
foot in the Philippines.
2. Employees of a foreign entity on a
2. Residency
permanent basis
Resident Alien
3. Overseas contract workers
An alien was subject to Philippine income tax on his
(1) and (2) are treated as nonresidents
worldwide income because of his residence in the
citizens from the time they depart from the
Philippines. This principle is however discarded in
Philippines
R.A. 8424 (1998) in view of the complexity in tax
(3) must be physically present abroad most
administration it brings. Thus, a resident alien is now
of the time (at least 183 days) to qualify
liable to pay Philippine income tax only on his
as nonresident citizens. His presence
income from sources within the Philippines and is
abroad is however need not be continuous.
exempt from tax on his income from sources outside
the Philippines.
THE INCOME TAXPAYERS AND THE GENERAL PRINCIPLES OF
Nonresident Alien
THEIR TAXABILITY (Tax Situs for Income Tax Purposes)
Engaged in Trade or Business in the Philippines
1. Section 23 of the NIRC
If the aggregate period of his stay in the
2. Individual Taxpayers (Section 24-26)
Philippines is more than 180 days during
3. Corporations (Section 27-30 R.A. 9337)
any calendar year
4. Estates and Trusts (Section 60-66)
Taxed on his income from sources within
5. Definition of Terms Under Section 22
the Philippines

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INCOME TAXATION

SOURCES OF INCOME (Section 42) 3. Dividends: Residence of the corporation paying dividend
1. Services: Place of performance of the service Dividends received from a domestic corporation or
If the service is performed in the Philippines, the from a foreign corporation are treated as income
income is treated as from sources within the from sources within the Philippines, unless less than
Philippines 50% of the gross income of the foreign corporation
It includes compensation for labor or personal for the three-year period preceding the declaration
services performed within the Philippines, regardless of such dividends was derived from sources within
of the residence of the payor, of the place in which the Philippines, in which case, only the amount
the contract for service was made, or of the place of which bears the same ratio to such dividends as the
payment gross income of the corporation for such period
Compensation is either in cash or in kind derived from sources within the Philippines bears to
its gross income from all sources shall be treated as
Example: income from sources within the Philippines.
Juliane a non-resident alien appointed as a commission
agent by a domestic corporation with a sales commission of 4. Rents and Royalties: Location of the property or interest
10% all sales actually concluded and collected through her in such property
efforts. The local company withheld the amount of P107,000
If the property or interest is located or used in the
from her sales commission and remitted the same to the
BIR. She filed a claim for refund alleging that her sales Philippines, the gain or income is treated as income
commission is not taxable because the same was a from sources within the Philippines
compensation for her services rendered in Germany and
therefore considered as income from sources outside the 5. Sale of property
Philippines. Is her contention correct ? a. Real Property: Location of real property
If the real property sold is located within the
SUGGESTED ANSWER: Yes. The important factor which
Philippines, the gain is considered as income from
determines the source of income of personal services is not
the residence of the payor, or the place where the contract the Philippines
for service is entered into, or the place of payment, but the b. Personal Property
place where the serviceswere actually performed. Since the Personal property produced (in whole or in part) by
activity of securing the sales were in Germany, thenthe the taxpayer within the Philippines and sold without
income did not originate from sources from within the the Philippines, or produced without and sold within
Philippines.(Commissioner of Internal Revenue v. Baier-Nickel,
Any gain, profit or income shall be treated
G. R. No. 153793,
August 29, 2006) as derived partly from sources within and
NOTE AND COMMENTS: In the above case, the SupremeCourt partly from sources without the Philippines
reiterated the rule that source of income relates to the Purchase of personal property within and its sale
property, activity or service that produced the income. With without the Philippines, or purchase of personal
respect to rendition of labor or personal service, it is the property without and its sale within the Philippines
place where the labor or service was performed that Any gain, profit or income shall be treated
determines the source of the income.
as derived entirely from sources within the
2. Interest Income: Residence of the debtor country in which sold. Accordingly, if the
If the obligor or debtor (corporation or otherwise) is goods are shipped in a foreign port under
a resident of the Philippines, the interest income is Free-on-Board (FOB) shipping point
treated as income from within the Philippines. It arrangement, title to the good is
does not matter whether the loan agreement is transferred at the foreign port and any gain
signed in the Philippines or abroad or the loan from the sale of such goods to a Philippine
proceeds will be used in a project inside or outside importer shall be treated as income from
the country sources outside the Philippines.

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INCOME TAXATION

DETERMINATION OF GROSS INCOME AND THE The proceeds of life insurance policies paid
RULES OF INCLUSION AND EXCLUSION FROM to the heirs or beneficiaries upon the death of
the insured, whether in a single sum or
GROSS INCOME
otherwise, but if such amounts are held by the
insurer under an agreement to pay interest
A. THE CONCEPT OF GROSS INCOME thereon, the interest payments shall be included
in gross income.
a. Gross income definition
Sec 32. General definition: Except when
otherwise provided in this title (II), gross income (2) Amount Received by Insured as Return of
means all income derived from whatever source Premium.
including but not limited to the following items: The amount received by the insured, as a
a. Compensation for services in whatever return of premiums paid by him under life
form paid including but not limited to fees, insurance, endowment, or annuity contracts,
salaries, wages, commissions and other either during the term or at the maturity of the
similar items term mentioned in the contract or upon
b. Conduct of trade or business or the exercise
surrender of the contract.
of a profession
c. Gains derived from the dealings in property
d. Interests (3) Gifts, Bequests, and Devises.
e. Rents The value of property acquired by gift,
f. Royalties bequest, devise, or descent:
g. Dividends Provided, however, That income from such
h. Annuities property, as well as gift, bequest, devise or
i. Prizes and winnings descent of income from any property, in cases
j. Pensions
of transfers of divided interest, shall be included
k. Partners distributive share from the net
income of the general professional in gross income.
partnership
b. Gross sales- total sales for a period before discounts, (4) Compensation for Injuries or Sickness.
returns and freight expenses have been deducted. - amounts received, through Accident or
Health Insurance or under Workmen's
B. THE GENERAL RULES ON INCLUSION AND EXCLUSION OF Compensation Acts, as compensation for
INCOME OF ITEMS (Section 31, 32A and 32B) personal injuries or sickness, plus the amounts
of any damages received, whether by suit or
Sec 31. Taxable income defined agreement, on account of such injuries or
Gross Income sickness.
Less -Deductions allowed by law
-Personal exemptions (5) Income Exempt under Treaty.
Income of any kind, to the extent required
Taxable income by any treaty obligation binding upon the
Government of the Philippines.
Exclusions Sec 32 B.
Exclusions from Gross Income. - The following items (6) Retirement Benefits, Pensions, Gratuities, etc.-
shall not be included in gross income and shall be (a) Retirement benefits received under
exempt from taxation under this title: (code: MARC Republic Act No. 7641
GIL) and those received by officials and
(1) Life Insurance. employees of private firms,
- whether individual or corporate,
in accordance with a reasonable

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INCOME TAXATION

private benefit plan maintained by physical disability or for any cause


the employer: beyond the control of the said official
Provided, or employee.
That the retiring
(c) The provisions of any existing law to
official or employee has been
the contrary notwithstanding, social
in the service of the same
security benefits, retirement gratuities,
employer for at least ten (10)
pensions and other similar benefits
years
received by resident or nonresident
and is not less than fifty
citizens of the Philippines or aliens who
(50) years of age at the time
come to reside permanently in the
of his retirement:
Philippines from foreign government
Provided, further,
agencies and other institutions, private
That the benefits granted or public.
under this subparagraph shall
be availed of by an official or (d) Payments of benefits due or to become
employee only once. due to any person residing in the
For purposes of this Philippines under the laws of the
Subsection, the term United States administered by the
United States Veterans Administration.
'reasonable private benefit
plan' (e) Benefits received from or enjoyed
-means a pension, under the Social Security System in
gratuity, stock bonus or profit- accordance with the provisions of
sharing plan maintained by an Republic Act No. 8282.
employer for the benefit of
some or all of his officials or (f) Benefits received from the GSIS under
employees, wherein Republic Act No. 8291, including retirement
contributions are made by gratuity received by government officials
such employer for the officials and employees.
or employees, or both, for the
purpose of distributing to such (7) Miscellaneous Items. -
officials and employees the (a) Income Derived by Foreign
earnings and principal of the Government.
fund thus accumulated, and Income derived from investments
wherein its is provided in said in the Philippines in loans, stocks, bonds or
plan that at no time shall any other domestic securities, or from interest
part of the corpus or income on deposits in banks in the Philippines by
of the fund be used for, or be (i) foreign governments,
(ii) financing institutions
diverted to, any purpose other
owned, controlled, or
than for the exclusive benefit enjoying refinancing from
of the said officials and foreign governments, and
employees. (iii) international or regional
financial institutions
(b) Any amount received by an official or established by foreign
employee or by his heirs from the governments.
employer as a consequence of (b) Income Derived by the Government or
separation of such official or employee its Political Subdivisions.
from the service of the employer - Income derived from any public
because of death sickness or other utility or from the exercise of any essential

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governmental function accruing to the amended by Memorandum


Government of the Philippines or to any Order No. 28, dated August
political subdivision thereof. 13, 1986; and
(iv) Other benefits such as
productivity incentives and
(c) Prizes and Awards.
Christmas bonus: Provided,
- Prizes and awards made primarily
further, That the ceiling of Thirty
in recognition of religious, charitable,
thousand pesos (P30,000) may be
scientific, educational, artistic, literary, or
increased through rules and
civic achievement but only if:
regulations issued by the Secretary
of Finance, upon recommendation
(i) The recipient was selected
of the Commissioner, after
without any action on his part to
considering among others, the
enter the contest or proceeding;
effect on the same of the inflation
and
rate at the end of the taxable year.
(ii) The recipient is not required to
render substantial future services
(f) GSIS, SSS, Medicare and Other
as a condition to receiving the
Contributions.
prize or award. - GSIS, SSS, Medicare and Pag-ibig
contributions, and union dues of
(d) Prizes and Awards in sports individuals.
Competition.
- All prizes and awards granted to (g) Gains from the Sale of Bonds,
athletes in local and international sports Debentures or other Certificate of
competitions and tournaments whether Indebtedness.
held in the Philippines or abroad and Gains realized from the same or
sanctioned by their national sports exchange or retirement of bonds,
associations. debentures or other certificate of
indebtedness with a maturity of more
th
(e) 13 Month Pay and Other Benefits. than five (5) years.
- Gross benefits received by
officials and employees of public and (h) Gains from Redemption of Shares in
private entities: Provided, however, That Mutual Fund.
the total exclusion under this subparagraph - Gains realized by the investor
shall not exceed Thirty thousand pesos upon redemption of shares of stock in a
(P30,000) which shall cover: mutual fund company as defined in
(i) Benefits received by officials Section 22 (BB) of this Code.
and employees of the national and
local government pursuant to C. THE RULES AS APPLIED TO COMPENSATION INCOME AND
OTHER BENEFITS
Republic Act No. 6686;
(ii) Benefits received by employees a. Taxability of compensation income and the application
pursuant to Presidential Decree of the employers convenience rule
No. 851, as amended by
Memorandum Order No. 28, dated Compensation income as defined in sec 32 :
August 13, 1986; compensation for services in whatever form paid
(iv) Benefits received by officials including but not limited to fees, salaries, wages,
and employees not covered by commissions and similar items.
Presidential decree No. 851, as
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However, this is not the correct definition. -this is the justification that may be used in granting
Rev. Reg. 2-98 defines compensation income all exemptions from income tax on certain benefits that
remuneration for services rendered by an employee may be received under an ER-EE relationship.
for his employer under an ER-EE relationship, unless -examples: food and lodging benefit by a household
specifically excluded under the tax code. maid, driver, etc.

Implications of the definition: Rules on the application of the doctrine:


a. There are really tax exempt or excluded gross A. Living quarters and meals (Valencia p 174)
compensation income from gross income as 1. When living quarters are furnished in
provided in Sec32 B. addition to cash salary, the rental value of
b. Not all compensation for services rendered may be such quarters should be reported as
subjected to tax. income.
2. However if living quarters or meals are
Example: in the case of services performed by an furnished to an employee for the
independent contractor in the absence of ER-EE convenience of the employer, the value
thereof need not be included as part of
relationship, the income received by the contractor shall
compensation income.
be recorded as trade or business income. Professional
income should not be included in the gross Henderson vs. CIR 1 SCRA 650
compensation income in the absence of ee-er Unless provided for the exclusive benefit of
relationship. the employer, the rental value of living quarters is
compensation income to the employee to the extent
Test whether income is compensation income: of his reasonable needs and the excess shall be
It is not the name of the remuneration upon which it considered as expenses of the corporation.
is paid and the manner of payment, what is
important is that it is derived from ER-EE The exclusion for meals is allowed only when:
relationship. a. They are furnished within the
employers business premises. The
Test to determine the existence of ER-EE relationship (code: exclusion for lodging is allowed only
AC-DC) when it is furnished within the business
A-appointment/selection premises of the employer; and
b. The employee accepts the lodging as a
C- Compensation or payment of wages
condition of his employment in order
D- Dismissal to perform his duties properly.
C-Compensation
Unless the above conditions are met, the
Tax implications when the payment is made for services value of any board and lodging furnished by
rendered an employer is ordinarily taxable to the
1. For the employer- it may be claimed as employee.
deductible expense. Sec 34 A (1,a,i) provides
reasonable allowance for salaries, wages
Rev. Reg 10-2000 : meal allowance for overtime
2. For the employee- it is a taxable income.
work is tax exempt under the convenience rule
Convenience of the employer rule (Henderson Doctrine) provided that the meal allowance does not exceed
Allowances in kind furnished to the employee for 25% of the basic minimum wage and it applies only
and as a necessary incident to the performance of to managerial/supervisory employee.
his duties are not taxable. (Valencia p 174) b.Retirement Payments, Pensions and Gratuities.
c. Separation payments
d. leave benefits
th
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INCOME TAXATION

f. SSS/GSIS benefits COMMUTATION OR MONETIZED VALUE OF LEAVE PAY


g. SSS/GSIS/Philhealth/ Pag ibig/Union dues
Vacation Leave Sick Leave

Items excluded Conditions /particulars If it forms part of the terminal


leave pay
Retirement benefit from -not taxable -not taxable
Requisites (code: FORT)
a private retirement plan If given during the taxable
a. Retiring official must be
year with NO retirement to:
at least Fifty (50) years
of age. a. Government
b. Approved or availed employees Tax exempt Tax exempt
only Once
b. Rank and file Exempt up to 10 days Unused- taxable
c. Reasonable private
benefit plan approved
by the BIR
d. Ten (10) years in service
h. Fringe benefits
Note: if the employee is still on Means any good, services or other benefit
active employment with the Furnished or granted by employer
company, any and all the funds In cash or in kind, given in addition to the basic
distributed from the fund to the salary of an individual employee, except rank and file
active member over and above such as but not limited to the following ( HEV HIM
his personal contributions shall HEEL)
be taxable. a. Housing
Exemption: i. Military housing
Separation pay The benefit shall be tax exempt,
ii. temporary housing unit
whether his employee is a
( 3 months or less stay in
private firm or the government
the premises)
provided the pay is given on
iii. business premise of
account of:
the ER including housing
a. Death
unit w/in 50 meters from
b. Sickness
c. Other physical disability the perimeter of the
d. Or any cause beyond business premise
the control of the b. Expense Account
official or employee c. Vehicle of any kind
Social security benefits; Received by RC, NRC, and RA Exemption: i. helicopters or aircrafts
retirement gratuities and from foreign government since they are considered
other similar benefits agencies and other private or as business expense of
public institutions the employer
d. Household personnel-maid, driver, etc
Benefits from US By veterans residing in the e. Interest on loan at less than market rate (12%
Veterans Administration Pilippines benchmark rate) to the extent of the difference
between the market rate and the actual rate granted
SSS RA 8282 Tax exempt
If the actual interest imposed is less than
GSIS- RA 8291 Tax exempt 12%, the same is taxable. If it is exactly 12%
or more, it is tax exempt.

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INCOME TAXATION

f. Membership fees, dues and other expenses 2. Contributions of the employer for the benefit of
borne by the employer for the employee in social and the employee to retirement, insurance and
athletics clubs or other similar organizations hospitalization benefit plans
g. Holiday and vacation expenses 3. Benefits given to the rand and file EE whether
h. Expenses for foreign travel granted under a collective baragaining
Exempt if: agreement or not.
1. Required by the nature of the 4. De minimis benefits
employers trade, business, or Recent regulation is Rev Reg 10-
exercise of profession 2000
2. Paid or incurred in connection with These refer to facilities or
the business conventions, privileges furnished or offered by
meetings or seminars abroad
an employer to his employee that
3. All expenses are substantiated by
receipts or records are relatively small value and are
4. There must be an official offered or furnished by the
communication coming from the employer merely as a means of
business associates abroad promoting health, goodwill,
5. Allowance exempt only up to contentment or efficiency of his
300.00 dollars. employees.

Tax treatment of the cost of airline ticket


D. THE RULES AS APPLIED TO TRADE/BUSINESS OF
Economy class-exempt
PROFESSIONAL INCOME
Business class- exempt
st Income covered:
1 class tickets- exempt only up to 70%
1. Income derived by self employed from trade or
i. Educational assistance to the EE or his business (trading, manufacturing, merchandising,
dependents farming and others)
Exempt in 2 cases: Self employment income- consist of the
1. Scholarship grant to managerial or earnings derived by te individual from:
supervisory employees
a. Practice of profession
2. Scholarship grant to dependents of
b. Conduct of trade or business,
an employee
as sole proprietor or
c. A partnership of which he is a
j. Life or health insurance and other non life member
premiums or similar amounts in excess of the law 2. Income derived by professionals from the practice of
allows. profession
3 tax exempt life insurance premium Professionals- persons who derive their
1. GSIS income from the practice of their
2. SSS
profession-lawyers and other persons
3. Group insurance policy
registered with the PRC. It may also refer to
Rules on fringe benefits one who pursues an art and make living
1. It is subject to final tax there from such as artists, athletes and
2. Need not be reported as part of the gross income, others similarly situated.
since it is subject to final tax.
Business income- one which entails time, effort
Sec 33-C Fringe benefits not taxable and activity for purpose of livelihood and profit

1. Fringe benefits which are authorized and


exempt from tax under special laws

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INCOME TAXATION

Formula of gross income: Ordinary business partnership


Example:
Gross sales: 1,000,000,000.00 An ordinary business partnership is considered as a
corporation and is thus subject to tax as such.
Partners are considered stockholders and, therefore,
Less: Cost of investment:
profits distributed to them by the partnership are
Cost of sale considered as dividends.
Cost of goods
Sales allowance Unregistered partnership and co-ownership for tax purposes
Sales discount
If the activities of co-owners are limited to the
preservation of the property and the collection of
530,000.00
income therefrom, in which case, each co-owner is
Gross business income: 470,000.00
taxed individually on his distributive share in the
income of the co-ownership.
Example: Suppose Corporation A gave 100,000 to a customs If the co-owners invest the income in business for
official to process their license. Is the 100,000 taxable as profit, they would be constituting themselves into a
income? May the corporation deduct the same as business partnership taxable as a corporation.
expense?
Joint venture; how created
Ans:
On the part of the official: included in
A joint venture is created when two corporations,
taxable gross income(income from while registered and operating separately, were
whatever source) placed under a sole management which operated
On the corporation: not deductible. the business affairs of said companies as though
Unlawful expenses not deductible from they constituted a single entity thereby obtaining
gross income substantial economy and profits in the operation.
As stated, a joint venture is not taxed as a
corporation, just like a general professional
partnership.
General professional partnerships

General professional partnerships are partnerships Non-Resident Alien Engaged in Trade or Business
formed by persons for the sole purpose of exercising
their common profession, no part of the income of A non-resident alien engaged in trade or business
which is derived from engaging in any trade or shall be subject to the same income tax rates as a
business, [Sec. 22 (b), NIRC]. citizen and a resident alien.
Persons engaging in business as partners in a general Exception: Cash and/or property dividends received
professional partnership shall be liable for income by a non-resident alien Individual shall be subject to
tax only in their separate and individual capacities, a final tax of 20% for citizens and resident aliens, the
[Sec. 26, NIRC]. rate is 10% since year 2000.
For purposes of computing the distributive share of
Non-Resident Alien Not Engaged in Trade or Business
the partners, the net income of the partnership shall
be computed in the same manner as a corporation,
A non-resident alien individual not engaged in trade
[Sec. 26, NIRC].
or business shall pay a tax equivalent to 25% on all
Each partner shall report as gross income his
items of income, except, for gain on sale of shares of
distributive share, actually or constructively
stock in any domestic corporation and real property
received, in the net income of the partnership,[Sec.
which shall be subject to the same rate applied to
26, NIRC]
other individual taxpayers.
Income of a general professional partnership are
Gain on sale of shares of stock:
deemed constructively received by the partners,
1. Not over P100,000 - 5%
[Sec. 73 (d), NIRC].
2. Over P100,000 -10%

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INCOME TAXATION

Capital gains on sale or disposition of property 6% 2000 onwards 32%


of GSP or FMV, whichever is higher.
Tax is imposed on taxable or net income.
General Professional Partnerships These rates are not applicable if the amount
corresponding to the rates are lower than 2% of the
General professional partnerships are partnerships gross income of such corporate income taxpayer.
formed by persons for the sole purpose of exercising This is called the Minimum Corporate Income Tax.
their common profession, no part of the income of
which is derived from engaging in any trade or Optional 15% tax on gross income
business.
Persons engaged in business as partners in a general The President, upon the recommendation of the
professional partnership shall be liable for income Secretary of Finance, may, effective Jan. 1, 2000,
tax only on their separate and individual capacities. allow corporations the option to be taxed at 15% of
Each partner shall report as gross income his distributive gross income, provided certain conditions are
share, actually or constructively received, in the net income satisfied.
of the partnership. This is available to firms whose ratio of cost of sales
to gross sales or receipts form all sources does not
The net income of the general professional exceed 55%.
partnership shall be computed in the sale manner as Once elected by the corporation, the option shall be
a corporation for purposes of computing the irrevocable for the succeeding three consecutive
distributive shares of the partners. years.

Conditions to be satisfied for the availability of the 15%


TAX ON CORPORATIONS optional corporate tax:

CORPORATE TAXPAYER 1. A tax effort ratio of twenty percent (20%) of the


Gross National Product;
Corporation, includes, partnerships no matter how created or 2. A ratio of 40% between total income tax collection
organized, joint account companies, or insurance companies and to total tax revenues;
and other associations. 3. A VAT tax effort ratio of 4% of the Gross National
Product;
It excludes: 4. A 0.9% ration between the Consolidated Public
Sector Financial Position to the GNP.
1. General Professional Partnerships;
2. Joint venture for the purpose of Some definitions for this purpose:
undertaking construction projects;
3. Joint consortium for the purpose of Gross Income derived from business shall be
engaging in petroleum, geothermal and equivalent to gross sales, less sales returns,
other energy operations pursuant to a discounts and allowances, and cost of goods sold.
consortium agreement with the For taxpayers engaged in the sale of services, gross
government. income means gross receipts less sales returns,
allowances and discounts.
Cost of goods sold shall include all business
RATES OF INCOME TAX ON DOMESTIC CORPORATIONS expenses directly incurred to produce the
IN General merchandise to bring them to their present location
and use.
Rate of tax, in general:
1997 35% Tax rate for proprietary educational institutions and
hospitals
1998 34%
10% on taxable income, except of certain passive
1999 33% incomes.

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INCOME TAXATION

Predominance test The ordinary rate on Resident Foreign Corporation


corporations shall apply to proprietary educational A resident foreign corporation is one organized,
institutions and hospitals when their gross income authorized, or existing under the laws of any foreign
form unrelated trade, business or other activity country, engaged in the trade or business within the
exceeds 50% of their total gross income derived Philippines.
from all sources. In order that a foreign corporation may be regarded
as doing business within a state, there must be
Unrelated trade, business or other activity continuity of conduct and intention to establish a
continuous business, such as the appointment of a
This means any trade, business or other activity, the local agent, and not one of temporary character.
conduct of which is not substantially related to the
exercise or performance by such educational Tax rates in General
institution or hospital of its primary purpose or Rate of tax, in general:
function. 1997 35%

Proprietary educational institution 1998 34%

A proprietary educational institution is any private 1999 33%


school maintained and administered by private
individuals or groups with an issued permit to 2000 onwards 32%
operate from the DepEd, CHED, or TESDA, as the
case may be. Tax is imposed on taxable or net income.
These rates are not applicable if the amount
GOCCs, AGENCIES OR INSTRUMENTALITIES corresponding to the rates are lower than 2% of the
gross income of such corporate income taxpayer.
All corporations, agencies or instrumentalities This is called the Minimum Corporate Income Tax
owned or controlled by the government shall pay (same as with domestic corporation)
such rate of tax upon their taxable income as are Optional 15% tax on gross income The option to
imposed upon corporations or associations engaged be taxed at 15% on its gross income is also available
in a similar business, industry, or activity. to Resident Foreign Corporations, subject to the
Exceptions: GOCCs and instrumentalities not subject same conditions.
to tax are the ff: Available to firms whose ratio of cost of
1. GSIS sales to gross sales or receipts from all sources does
2. SSS
not exceed 55%
3. Phil Health Insurance Corporation
4. PCSO
Tax on specific resident foreign corporations
5. PAGCOR
1. International Carrier 2 of Gross Philippine Billings
2. Offshore Banking Units - !0% of income derived from
Rule for Corporation exempt from taxation
foreign currency transactions with local commercial
banks, including branches of foreign banks that may
General rule: those enumerated under Section 30 are exempt
be authorized by the BSP to transact business with
offshore banking units, including any interest income
Exception: exempted corporations are subject to income tax derived from foreign currency loans granted to
on their income from any of their properties, real or personal, residents
or from any activities conducted for profit regardless of the Any income of non-residents, whether
disposition made of such income. individuals or corporations, from transactions with
said offshore banking units shall be exempt from
TAX ON RESIDENT FOREIGN CORPORATIONS
income tax

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INCOME TAXATION

3. Tax on branch profits remittances 15% of total 3. rents


profits applied or earmarked for remittance without 4. royalties
deduction for the tax component thereof. 5. remuneration for technical services
4. Regional or area headquarters shall not be subject to 6. salaries
income tax 7. wages
5. Regional operating headquarters shall be subject to 8. premiums
a tax of 10% of their taxable income. 9. annuities
Gross Philippine Billings for International carriers 10. emoluments
11. other fixed or determinable annual, periodic, or
Gross Philippine Billings refer to the amount of casual gains, profits, income and capital gains.
gross revenue derived from carriage of persons,
excess baggage, cargo and mail originating from the Regional or area headquarters of multinational companies
Philippines in a continuous and uninterrupted flight,
irrespective of the place of sale or issue and the Regional or area headquarters shall not be subject to
place of payment of the ticket or passage document. income tax.
Tickets revalidated, exchanged and/or endorsed to
another international airline form part of the Gross Regional operating headquarters of multinational
Philippine Billings of the passenger boards a plane in companies
a port or point in the Philippines.
Regional operating headquarters shall pay a tax of
ten percent (10%) on their taxable income.
For a flight which originates from the Philippines, but
transhipment of passenger takes place at any port Tax on certain incomes received by a resident foreign
outside the Philippines on another airline, only the corporation
aliquot portion of the cost of the ticket
corresponding to the leg flown from the Philippines 1. Interest from deposits and yield or any other
to the point of transhipment shall form part of the monetary benefit from deposit substitutes, trust
Gross Philippine Billing. funds and similar arrangements and royalties.
Interest income from any currency bank deposit and
yield or any other monetary benefit from deposit
Gross Philippine Billings for International Shipping
substitutes and from trust funds and similar
Gross Philippine Billings means gross revenue arrangements and royalties derived from sources
whether for passenger, cargo or mail, originating within the Philippines shall be subject to a final
from the Philippines up to final destination, income tax at the rate of twenty percent (20%) of
regardless of the place of sale or payments of the such interest.
passage or freight documents.
However, interest income derived by a resident
foreign corporation from a depository bank under
Tax on branch profit remittances
the expanded foreign currency deposit system shall
be subject to a final income tax at the rate of seven
Any profit remitted by a branch to its head office
shall be subject to a tax of 15% which shall be based and one-half percent (7 %) of such interest income.
on the total profits applied or earmarked for
remittance without any deduction for the tax 2. Income derived under the expanded foreign
component thereof except those activities which are currency deposit system
registered with the Philippine Economic Zone This refers to income derived by a depositary bank
Authority. under the expanded foreign currency deposit system
The following shall not be treated as branch profits from foreign currency transactions with local
unless the same are effectively connected with the commercial banks including branches of foreign
conduct of its trade or business in the Philippines: bank that many be authorized by the Bangko Sentral
1. Interests ng Pilipinas to transact business with foreign
2. dividends

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INCOME TAXATION

currency deposit system units and other depositary A cinematographic film owner, lessor, or distributor
banks under the expanded foreign currency deposit shall pay a tax of twenty five percent (25%) of its
system, including interest income from foreign gross income from all sources within the Philippines.
currency loans granted by such depositary banks
Non-resident owner or lessor of vessel chartered by
under said expanded foreign currency deposit
Philippine nationals
system to residents.
A non-resident owner or lessor of vessels shall be
A final income tax at the rate of ten percent (10%) is
subject to a tax of four and one-half percent (4 %)
imposed on such income. of gross rentals, lease or charter fees from leases or
charters to Filipino citizens or corporations, as
3. Intercorporate dividends approved by the Maritime Industry Authority.
Dividends received by a resident foreign corporation
from a domestic corporation liable to tax under the NIRC shall Non-resident owner or lessor of aircraft, machineries and
not be subject to income tax. other equipment

TAX ON NON-RESIDENT FOREIGN CORPORATION Rentals, charters and other fees derived by a non-
resident lessor of aircraft, machineries and other
Taxation of a non-resident foreign corporation, in general equipment shall be subject to a tax of seven and
one-half percent (7 %) of gross rentals or fees.
Rates of tax, in general
1997 35% Tax on certain incomes received by a non-resident foreign
corporation
1998 34%
1. Interest on foreign loans
1999 33%
A final withholding tax at the rate of twenty percent
2000 32% (20%) is hereby imposed on the amount of interest on
foreign loans contracted on or after 01 August 1986.
However, the tax is imposed on gross income, not on
taxable or net income. 2. Intercorporate dividends
Such gross income may include interests, dividends, A Final withholding tax at the rate of fifteen percent
rents, royalties, salaries, premiums (except (15%) is hereby imposed on the amount of cash and/or
reinsurance premiums), annuities, emoluments or property dividends received by a non-resident foreign
other fixed or determinable annual, periodic or corporation from a domestic corporation, subject to the
casual gains, profits and income, and capital gains, condition that the country in which the non-resident
except capital gains from the sale of shares of stock
foreign corporation is domiciled shall allow a credit
not traded in the stock exchange.
against the tax due from the non-resident foreign
Taxation of certain non-resident foreign corporations corporation taxes deemed to have been paid in the
Philippines equivalent to thirty two percent (32%) in the
1. Non-resident cinematographic film owner, lessor or year 2000.
distributor 25% of gross income
2. Non-resident owner or lessor of vessels chartered by This is the so-called tax sparing rule.
Philippine nationals 4 % of gross rentals, lease or
charter fees 3. Capital gains from sale of shares of stock not traded
3. Non-resident owner or lessor of aircraft, machineries in the stock exchange
and other equipment 7 % of gross rentals or fees a. Not over P100,000 5%
b. Over P100,000 10%
Non-resident cinematographic film owner, lessor or
distributor E. THE RULES AS APPLIED TO PASSIVE INCOME

Passive income

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INCOME TAXATION

1. Passive income from Philippine sources subject to iv. Other winnings, except PCSO and
final tax. Lotto, derived from sources within
2. Passive income from Philippine sources not subject the Philippines 20%
to final tax.
3. Passive income from sources outside the Philippines. b. Interest Income from bank deposits and deposit
substitutes

Passive income 1. interest from any currency bank deposit and yield
or any other monetary benefit from deposit substitutes and
1. Interest income from trust funds and similar arrangement 20% final tax
2. Rentals/ leases except non- resident alien not engaged in trade or business
3. Royalties which is 25%
4. Dividends
5. Annuities and proceeds of life insurance/ other types
2. interest income received by an individual (except
of insurance
a nonresident individual)from a depositary bank under the
6. Prizes and winnings, awards, and rewards
expanded foreign currency deposit system 7.5% except non
7. Gifts, bequests, and devises
resident alien, non resident engaged in trade/business and
8. Other types of passive income
non resident alien not engaged in trade and business

a. Royalties, Prizes and Winnings


3. interest income from long term deposit or
investment in the form of savings, common or individual trust
1. Exclusion from gross income fund, deposit substitutes, investment management accounts
a. Prizes, awards in sports competition and other investments evidenced by certification in such form
sanctioned by national sports associations prescribed by the BSP all exempt except non- resident alien
whether held in Philippines or abroad not engaged in trade/business which is subject to 25%
contemplates a particular competition, not
a cumulative achievement (Ex. Sportsman
4. Interest income from long term deposit or
of the year award does not qualify for
investment evidenced by certificates prescribed by BSP:
exemption)
a) Exempt, if investment is held for more
b. Prizes and awards
than 5 years
i. In recognition of religious,
b) If investment is pre-terminated,
charitable scientific, educational,
interest income on such investment
artistic literary or civic
shall be subject to the following rates:
achievement but if only if:
20% - If pre-terminated in less than 3 years
ii. Recipient was selected without any
action oh his part
12% - If pre-terminated after 3 years to less than 4
iii. Recipient not required to render
substantial future services as a years
condition of receiving the
5%- If pre-terminated after 4 years to less than 5
prize/award Example: Nobel prize
award years
c. Rates of tax in certain passive income
i. Royalties, except on books, as well c. Dividends
as other literary works and musical
compositions 20% Stock dividend
ii. Royalties on books, literary works As a rule stock dividends are not taxable. This is so,
and musical compositions 10%
because there is no income here. It merely represents the
iii. Prizes over P10,000 20% (Note:
prizes less than P10,000 are transfer of surplus accounts to the capital account.
included in the income tax of the
individual subject to the scheduler Exception to the rule: Stock dividend may be subject to
rate) tax under the following exceptional cases:

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INCOME TAXATION

1. If there is a change in the stockholders payments will be treated as dividends. [Section 71,
interest in the net assets of the corporation; Revenue Regulation 2]
2. If it is one issued by another corporation.
This is called dividend stock. 1.Cash and/or property dividends

Stock dividend vs. Dividend stock: Stock dividend is 10% final tax, by January 1, 2000, on the following:
not taxable, while dividend stock is taxable
a) Cash and or property dividend actually
3. Redemption of stock dividend; or constructively received from a
4. If the corporation had issued to a domestic corporation or from a joint
stockholder 2 different classes of shares of stock company, insurance or mutual
stock, any stock dividend that may be fund companies and regional operating
issued to such stockholder shall be taxable. headquarters of multinational
companies.
A stock dividend representing the transfer of surplus b) Share of an individual in the distributive
to capital account shall not be subject to tax. net income after tax of a partnership
It shall be taxable only if subsequently cancelled and except a general professional
redeemed by the corporation. partnership of which he is a partner
It is also taxable if it leads to a substantial alteration c) Share of an individual in the net income
in the proportion of tax ownership in a corporation. after tax of an association, joint
account, or a joint venture or
Dividends paid in property consortium taxable as a corporation of
Dividends paid in securities or other property, in which he is a member or a co-venturer
which the earnings of a corporation have been
invested, are income to the recipients to the amount 2.CIR vs CA and ANSCOR, GR no. 108576, January 20,
of the full market value of such property when 1999
receivable by individual stockholders.
A dividend paid in a stock of another corporation is Facts: Don Andres Soriano, a citizen and resident of the
not a stock dividend, even though the stock United States, formed the corporation "A. Soriano Y Cia",
distributed was acquired through the transfer by the predecessor of ANSCOR. Don Andres transferred some of his
corporation declaring the dividends of property to shares his two sons, Jose and Andres, Jr., as their initial
the corporation the stock of which is distributed as a investments in ANSCOR. Both sons are foreigners.
dividend. [Section 251, Revenue Regulations 2].
By 1947, ANSCOR declared stock dividends. Other stock
Liquidating dividend dividend declarations were made between 1949 and
December 20, 1963. On December 30, 1964 Don Andres
Where a corporation distributes all its assets in died. As of that date, the records revealed that he has a total
complete liquidation or dissolution, the gain realized shareholdings of 185,154 shares 50,495 of which are
or loss sustained by the stockholder, whether original issues and the balance of 134.659 shares as stock
individual or corporation, is a taxable income or dividend declarations. Correspondingly, one-half of that
deductible loss, as the case may be. shareholdings or 92,577 shares were transferred to his wife,
Doa Carmen Soriano, as her conjugal share. The other half
Disguised dividends formed part of his estate.

These are payments which are equivalent to Doa Carmen requested a ruling from the United States
dividend distribution. Internal Revenue Service (IRS), inquiring if an exchange of
common with preferred shares may be considered as a tax
avoidance scheme under Section 367 of the 1954 U.S.
In the case of excessive payments by corporations, if Revenue Act. he IRS opined that the exchange is only a
such payments correspond or bear a close recapitalization scheme and not tax avoidance. Doa Carmen
relationship to stockholdings, and are found to be a exchanged her whole 138,864 common shares for 138,860 of
distribution of earnings or profits, the excessive the newly reclassified preferred shares. The estate of Don

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INCOME TAXATION

Andres in turn, exchanged 11,140 of its common shares, for transactions. Simply put, depending on the circumstances,
the remaining 11,140 preferred shares, thus reducing its (the the proceeds of redemption of stock dividends are essentially
estate) common shares to 127,727. distribution of cash dividends, which when paid becomes the
absolute property of the stockholder. Thereafter, the latter
In 1973, after examining ANSCOR's books of account and becomes the exclusive owner thereof and can exercise the
records, Revenue examiners issued a report proposing that freedom of choice. Having realized gain from that
ANSCOR be assessed for deficiency withholding tax-at-source, redemption, the income earner cannot escape income tax
pursuant to Sections 53 and 54 of the 1939 Revenue
Code, for the year 1968 and the second quarter of 1969 3.Section 73. Distribution of dividends or Assets by
based on the transactions of exchange 31 and redemption of Corporations. -
stocks. The Bureau of Internal Revenue (BIR) made the
corresponding assessments despite the claim of ANSCOR that (A) Definition of Dividends. - The term 'dividends'
it availed of the tax amnesty under Presidential Decree (P.D.) when used in this Title means any distribution made
23 which were amended by P.D.'s 67 and 157. by a corporation to its shareholders out of its
earnings or profits and payable to its shareholders,
Issue: whether the stock dividends of the Late Don are whether in money or in other property.
taxable and not covered by the tax amnesty.
Where a corporation distributes all of its assets in
Held: Sec. 83(b) of the 1939 NIRC was taken from the Section complete liquidation or dissolution, the gain realized
115(g)(1) of the U.S. Revenue Code of 1928. It laid down the or loss sustained by the stockholder, whether
general rule known as the proportionate test wherein stock individual or corporate, is a taxable income or a
dividends once issued form part of the capital and, thus, deductible loss, as the case may be.
subject to income tax.
(B) Stock Dividend. - A stock dividend representing
Specifically, the general rule states that: the transfer of surplus to capital account shall not be
subject to tax. However, if a corporation cancels or
A stock dividend representing the transfer redeems stock issued as a dividend at such time and
of surplus to capital account shall not be in such manner as to make the distribution and
subject to tax. cancellation or redemption, in whole or in part,
essentially equivalent to the distribution of a taxable
the Exception 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
However, if a corporation cancels or redeems
distribution of earnings or profits.
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 (C) Dividends Distributed are Deemed Made from
equivalent to the distribution of a taxable dividend, Most Recently Accumulated Profits. - Any
the amount so distributed in redemption or distribution made to the shareholders or members
cancellation of the stock shall be considered of a corporation shall be deemed to have been made
as taxable income to the extent it represents a form the most recently accumulated profits or
distribution of earnings or profits accumulated surplus, and shall constitute a part of the annual
income of the distributee for the year in which
received.
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 as a (D) Net Income of a Partnership Deemed
device for the actual distribution of cash dividends, which is Constructively Received by Partners. - The taxable
taxable. income declared by a partnership for a taxable year
which is subject to tax under Section 27 (A) of this
Code, after deducting the corporate income tax
Although redemption and cancellation are generally
imposed therein, shall be deemed to have been
considered capital transactions, as such. they are not subject
actually or constructively received by the partners in
to tax. However, it does not necessarily mean that a
the same taxable year and shall be taxed to them in
shareholder may not realize a taxable gain from such

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INCOME TAXATION

their individual capacity, whether actually a. gains presumed to have been realized
distributed or not. from sale or disposition of principal residence, the
proceeds of which is fully utilized in acquiring new
d.Capital Gains from Sale of Real Property principal residence within 18 months from
disposition shall be exempt from CGT
1. 6% final tax on gross selling price or current fair
market value, whichever is higher b. can be availed only once every 10 years

2. imposed upon capital gains presumed to have c. if the new principal residence is cheaper
been realized from the sale, exchange, or other than old (meaning there is no full utilization of the
dispositions of real property located in the proceeds), the difference will be subject to CGT
Philippines, including pacto de retro sales and other
forms of conditional sales d. exemption does not include exchange of
principal residence for a new principal residence ->
3. law presumes a gain, hence even if the sale was at subject to rules on exchange above.
a loss (bought for 2M, sold for 1.5M), CGT will still be
imposed on entire process of the disposition. e. Sales of shares of stock not listed or trated in the stock
Reason: the law does not talk about the net gain, it exchange
only considers gross selling price/FMV whichever is
higher CAPITAL GAIN DERIVED FROM SALE OF SHARES OF STOCK

4. refers to real property held as capital asset as Listed and traded through local stock exchange- this
opposed to ordinary asset(used in ordinary course of is not subject to income tax but subject to
business) percentage tax of of 1% of the gross selling price.

5. Rules for disposition to government:


Not listed and traded through local stock exchange-
a. taxpayer has option of treating the this is the one subject to income tax.
proceeds as taxable income (5-32% on net gain) or
as capital gains (6% final tax on FMV/gross selling Not over P100,000.00 5%
price)
Amount over P100,000.00 10%
b. if second option is chosen it shall be
If the share of stock is not listed and traded through
based on actual consideration and not FMV since the
local stock exchange, the basis of the tax is net
former is usually lower than FMV (BIR ruling)
capital gain. So, you should first deduct the capital
loss.
c. if the disposition took nature of
expropriation, transaction is not subject to CGT. Net
gain (if any) will be treated as part of GI. Includes
If listed and traded through local exchange, there is
disposition by judicial order and other forms of
no deduction allowed because the basis of the tax
forced disposition
rate of of 1% of the gross selling price.

6. Rule for Exchange


The above-mentioned tax rates apply to all individual
- FMV of the property exchanged/given up taxpayers.
shall be basis of CGT. (ex. A exchanges property
worth 2M for Bs property worth 4M; therefore CGT
on A will be based on 2M and 4M for B.) Distribution of TREASURY STOCKS should be
considered taxable since the stocks are not sourced
7. exception on principal residence from the unissued shares of the corporation and
there being no transfer from surplus to capital.

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INCOME TAXATION

F. OTHER SOURCES OF NCOME a.1. Real property taxed on leased premises

- Cancellation of indebtedness Cancellation of a.2. Obligation to pay insurance premium


indebtedness has the following tax consequences: on the insured leased premises.
a. It may account to taxable compensation
income if the indebtedness has been a.3. If the lessor is a corp., the obligation to
cancelled in consideration of the services distribute Dividends to its stockholders
rendered.
b. It may account to taxable gift or donation of a.4. Obligation to pay interest on the bonds
the indebtedness has been cancelled issued by the lessor.
without any consideration at all.
c. If may amount to capital transaction if the a.5. Other obligations of the lessor which
creditor is a corporation and the debtor is may be assumed by the lesee.
stockholder. If creditor corporation
condoned the indebtedness of the debtor b. Value of permanent improvements on
stockholder, that may amount to taxable leased premises. This may be reported
capital transaction. This is the form of through:
direct dividend. b.1. Outright method at the time of permanent
is completed, he may report that as additional
- Income from lease and leasehold improvements
rent income FMV of the building or permanent
improvement
Operating lease
An operating lease is a contract under which the b.2. Spread out method by allocating the
asset is not wholly amortized during the primary depreciation among throughout the
period of the lease, and where the lessor does not
rely solely on the rentals during the primary period remaining term of the leased.
for his profits, but looks for the recovery of the
balance of his costs and for the rests of his profits c. Advanced rentals
from the sale or re-lease of the returned assets at c.1. If in the nature of the prepaid rentals
the end of the primary lease period.
without restriction on the use of the
Financial lease
amount, it is taxable.
Also called full payout lease is a contract involving
payment over an obligatory period (also called c.2. If it is in the nature of security deposit,
primary or basic period) of specified rental amounts
it is taxable rent income if there is a
for the use of a lessors property, sufficient in total
to amortize the capital outlay of the lessor and to
violation of the term of the lease.
provide for the lessors borrowing costs and profists.
Obligatory period is primary non-cancellable period
c.3. If it is in the nature of a loan to the
of the lease which in no case shall be less than 730
days. lessor, it is not taxable.
Lesee exercise choice over the asset.
C. Income from Installment Transactions

The following constitutes taxable rent income: Baoas vs. CA

1. The regular rent may be monthly, semi-annually or Facts:


annually.
2. Additional rent income which includes: On February 20, 1976, petitioner, Bibiano V. Baas Jr. sold to
a. Obligation of the lessor assumed by the Ayala Investment Corporation. AYALA issued one promissory
lesee. The following are obligations which note covering four equal annual installments. Each periodic
may be assumed by the lessee: [R.I.D.I.O.] payment of P461,754.00 pesos shall be payable starting on

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INCOME TAXATION

February 20, 1977, and every year thereafter, or until capital asset. The tax due was only fifty (50%) percent of the
February 20, 1980. The same day, petitioner discounted the total gain from sale of the property held by the taxpayer
5
promissory note with AYALA, for its face value of beyond twelve months pursuant to Section 34 of the 1977
P1,847,016.00. AYALA issued nine (9) checks to petitioner, all National Internal Revenue Code (NIRC). The deficiency tax
dated February 20, 1976, drawn against Bank of the assessment was reduced to nine hundred thirty six thousand,
Philippine Islands with the uniform amount of two hundred five hundred ninety-eight pesos and fifty centavos
five thousand, two hundred twenty-four (P205,224.00) pesos. (P936,598.50), inclusive of surcharges and penalties for the
year 1976.
In his 1976 Income Tax Return, petitioner reported the
P461,754 initial payment as income from disposition of respondent Larin sent a letter to petitioner informing of the
2
capital asset. income tax deficiency that must be settled him immediately
but petitioner insisted that the sale of his land to AYALA was
on installment. As a consequence, a criminal complaint was
Selling Price of Land P2,308,770.00
filed against petitioner for tax evasion.
3
Less Initial Payment 461,754.00
Issue: Whether respondent court erred in finding that
petitioner's income from the sale of land in 1976 should be
Unrealized Gain P1,847,016.00
declared as a cash transaction in his tax return for the same
year (because the buyer discounted the promissory note
1976 Declaration of Income on Disposition of Capital issued to the seller on future installment payments of the
Asset subject to Tax: sale, on the same day of the sale);

Initial Payment P461,754.00 Decision: Sec. 43 of the 1977 NIRC states,


Less: Cost of land and other
( 76,547.90)
incidental Expenses Installment basis. (a) Dealers in personal property.
...

Income P385,206.10
(b) Sales of realty and casual sales of personalty In
the case (1) of a casual sale or other casual
Income subject to tax (P385,206. disposition of personal property (other than
P192,603.65
10 x 50%) 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
In the succeeding years, until 1979, petitioner reported a thousand pesos, or (2) of a sale or other disposition
uniform income of two hundred thirty thousand, eight of real property if in either case the initial payments
4
hundred seventy-seven (P230,877.00) pesos as gain from do not exceed twenty-five percentum of the selling
sale of capital asset. In his 1980 income tax amnesty return, price, the income may, under regulations prescribed
petitioner also reported the same amount of P230,877.00 as by the Minister of Finance, be returned on the basis
the realized gain on disposition of capital asset for the year. and in the manner above prescribed in this section.
As used in this section the term "initial payment"
Revenue Director Mauro Calaguio authorized tax examiners means the payments received in cash or property
to examine the books and records of petitioner for the year other than evidences of indebtedness of the
1976. They discovered that petitioner had no outstanding purchaser during the taxable period in which the
receivable from the 1976 land sale to AYALA and concluded sale or other disposition is made. . . . (emphasis ours)
that the sale was cash and the entire profit should have been
taxable in 1976 since the income was wholly derived in 1976. Revenue Regulation No. 2, Section 175 provides,

The examiners recommended deficiency tax assessment for Sale of real property involving deferred payments.
two million, four hundred seventy-three thousand, six Under section 43 deferred-payment sales of real
hundred seventy-three (P2,473,673.00) pesos. However, after property include (1) agreements of purchase and
reviewing the examiners' report, Larin directed the revision of sale which contemplate that a conveyance is not to
the audit report, with instruction to consider the land as be made at the outset, but only after all or a

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INCOME TAXATION

substantial portion of the selling price has been paid, purchaser having promised to make two or more
and (b) sales in which there is an immediate transfer payments, in later years.
of title, the vendor being protected by a mortgage or
other lien as to deferred payments. Such sales either Petitioner asserts that Sec. 43 allows him to return as income
under (a) or (b), fall into two classes when in the taxable years involved, the respective installments as
considered with respect to the terms of sale, as provided by the deed of sale between him and AYALA.
follows: Consequently, he religiously reported his yearly income from
sale of capital asset, subject to tax, as follows:
(1) Sales of property on the installment
plan, that is, sales in which the payments
Year 1977 (50% of P461,754) P230,877.00
received in cash or property other than
evidences of indebtedness of the purchaser 1978 230,877.00
during the taxable year in which the sale is
made do not exceed 25 per cent of the 1979 230,877.00
selling price; 1980 230,877.00

(2) Deferred-payment sales not on the


installment plan, that is sales in which the Petitioner says that his tax declarations are acceptable modes
payments received in cash or property of payment under Section 175 of the Revenue Regulations
other than evidences of indebtedness of the (RR) No. 2. The term "initial payment", he argues, does not
purchaser during the taxable year in which include amounts received by the vendor which are part of the
the sale is made exceed 25 per cent of the complete purchase price, still due and payable in subsequent
selling price; years. Thus, the proceeds of the promissory notes, not yet
due which he discounted to AYALA should not be included as
income realized in 1976. Petitioner states that the original
In the sale of mortgaged property the amount of the
agreement in the Deed of Sale should not be affected by the
mortgage, whether the property is merely taken
subsequent discounting of the bill.
subject to the mortgage or whether the mortgage is
assumed by the purchaser, shall be included as a
part of the "selling price" but the amount of the On the other hand, respondents assert that taxation is a
mortgage, to the extent it does not exceed the basis matter of substance and not of form. Returns are scrutinized
to the vendor of the property sold, shall not be to determine if transactions are what they are and not
considered as a part of the "initial payments" or of declared to evade taxes. Considering the progressive nature
the "total contract price," as those terms are used in of our income taxation, when income is spread over several
section 43 of the Code, in sections 174 and 176 of installment payments through the years, the taxable income
these regulations, and in this section. The term goes down and the tax due correspondingly decreases. When
"initial payments" does not include amounts payment is in lump sum the tax for the year proportionately
received by the vendor in the year of sale from the increases. Ultimately, a declaration that a sale is on
disposition to a third person of notes given by the installment diminishes government taxes for the year of
vendee as part of the purchase price which are due initial installment as against a declaration of cash sale where
and payable in subsequent years. Commissions and taxes to the government is larger.
other selling expenses paid or incurred by the
vendor are not to be deducted or taken into account As a general rule, the whole profit accruing from a sale of
in determining the amount of the "initial payments," property is taxable as income in the year the sale is made.
the "total contract price," or the "selling price." The But, if not all of the sale price is received during such year,
term "initial payments" contemplates at least one and a statute provides that income shall be taxable in the
other payment in addition to the initial payment. If year in which it is "received," the profit from an installment
the entire purchase price is to be paid in a lump sum sale is to be apportioned between or among the years in
13
in a later year, there being no payment during the which such installments are paid and received.
year, the income may not be returned on the
installment basis. Income may not be returned on Sec. 43 and Sec. 175 says that among the entities who may
the installment basis where no payment in cash or use the above-mentioned installment method is a seller of
property, other than evidences of indebtedness of real property who disposes his property on installment,
the purchaser, is received during the first year, the provided that the initial payment does not exceed 25% of the

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INCOME TAXATION

selling price. They also state what may be regarded as installment since, a taxable disposition resulted and
installment payment and what constitutes initial payment. petitioner was required by law to report in his returns the
Initial payment means the payment received in cash or income derived from the discounting. What petitioner did is
property excluding evidences of indebtedness due and tantamount to an attempt to circumvent the rule on payment
payable in subsequent years, like promissory notes or of income taxes gained from the sale of the land to AYALA for
mortgages, given of the purchaser during the taxable year of the year 1976
sale. Initial payment does not include amounts received by
the vendor in the year of sale from the disposition to a third Long-term contracts
person of notes given by the vendee as part of the purchase
14
price which are due and payable in subsequent years. Such The term long term contract means building,
disposition or discounting of receivable is material only as to installation or construction contracts covering a
the computation of the initial payment. If the initial payment period in excess of one year. [Section 48, NIRC]
is within 25% of total contract price, exclusive of the proceeds
of discounted notes, the sale qualifies as an installment sale, Treatment of income from long-term contracts
15
otherwise it is a deferred sale.
1. Percentage of completion basis
Although the proceed of a discounted promissory note is not 2. Completed contract basis
considered part of the initial payment, it is still taxable
income for the year it was converted into cash. The
subsequent payments or liquidation of certificates of Note: Section 48 of the NIRC provides that Persons whose
indebtedness is reported using the installment method in gross income is derive in whole or in part from such (long
16
computing the proportionate income to be returned, during
term) contracts shall report such income upon the basis of
the respective year it was realized. Non-dealer sales of real or
percentage of completion.
personal property may be reported as income under the
installment method provided that the obligation is still
The return should be accompanied by a return
outstanding at the close of that year. If the seller disposes the
entire installment obligation by discounting the bill or the certificate of architects or engineers showing the percentage
promissory note, he necessarily must report the balance of of completion during the taxable year of the entire work
the income from the discounting not only income from the performed under the contract.
initial installment payment.
G. EXCLUSION BY REASON OF SPECIAL LAWS
Where an installment obligation is discounted at a bank or
finance company, a taxable disposition results, even if the RA 9504 -Income and withholding tax exemption for
seller guarantees its payment, continues to collect on the minimum wage earners
installment obligation, or handles repossession of
17
merchandise in case of default. This rule prevails in the
18 Personal Exemptions:
United States. Since our income tax laws are of American
19
origin, interpretations by American courts an our parallel
For single individual or married individual judicially decreed
tax laws have persuasive effect on the interpretation of these
20 as legally separated with no qualified
laws. Thus, by analogy, all the more would a taxable
dependentsP 50,000.00
disposition result when the discounting of the promissory
For head of familyP 50,000.00
note is done by the seller himself. Clearly, the indebtedness
For each married individual *P 50,000.00
of the buyer is discharged, while the seller acquires money
Note: In case of married individuals where only one of the
for the settlement of his receivables. Logically then, the
spouses is deriving gross income, only such spouse will be
income should be reported at the time of the actual gain. For
allowed to claim the personal exemption.
income tax purposes, income is an actual gain or an actual
21
increase of wealth. Although the proceeds of a discounted
Additional Exemptions:
promissory note is not considered initial payment, still it must
be included as taxable income on the year it was converted to
cash. When petitioner had the promissory notes covering the For each qualified dependent, an P25,000 additional
succeeding installment payments of the land issued by exemption can be claimed but only up to 4 qualified
AYALA, discounted by AYALA itself, on the same day of the dependents
sale, he lost entitlement to report the sale as a sale on

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The additional exemption can be claimed by the following: gross income in because exempted
order to arrive at a by tax treaty, statute
net taxable income or the Constitution
The husband who is deemed the head of the family (NIRC) (in the nature of tax
unless he explicitly waives his right in favor of his exemptions) and
wife those which do not
come within the
The spouse who has custody of the child or children definition of income
in case of legally separated spouses. Provided, that
the total amount of additional exemptions that may
be claimed by both shall not exceed the maximum 2. Allowed only to 2. Can be availed by all
businesses, kinds of taxpayer
additional exemptions allowed by the Tax Code.
corporations,
The individuals considered as Head of the Family institutions.
supporting a qualified dependent

3. Amounts spent or 3. Amounts earned or


The maximum amount of P 2,400 premium payments on
paid in the process received by the
health and/or hospitalization insurance can be claimed if: of earning gross taxpayer but do not
income form part of the
gross income
Family gross income yearly should not be more than
P 250,000
For married individuals, the spouse claiming the 4. Used in computing 4. Used in computing
additional exemptions for the qualified dependents TAXABLE INCOME GROSS INCOME
shall be entitled to this deduction

DEDUCTIONS FROM GROSS INCOME c) Deductions vs. Cost

DEDUCTIONS COST
A. CONCEPT OF ALLOWABLE DEDUCTIONS

a) Deductions, Defined

DEDUCTIONS items or amounts which the law


allows to be deducted from gross income in order to
arrive at the taxable income (2010 Beda Notes, page
66)
d) Deductions, When Allowed
Nature of Deductions (Valencia, Roxas, page 365)
INSTANCES WHEN DEDUCTIONS ARE
In general, deductions or allowable deductions
ALLOWED:
are business expenses and losses incurred which the
law allows to reduce gross business income to arrive 1. Existence of a law authorizing the
at net income subject to tax. They are kind of deductions taxpayer seeking the
legislative grace. They are not presumed but deduction must point some specific
allowable only by specific provisions of law. They provision of the statute authorizing the
are construed strictly against the taxpayer. deductions
2. Tax payer must be able to prove that he is
entitled to such deductions
b) Deductions vs. Exclusions 3. Any amount paid or payable which is
otherwise deductible from, or taken into
DEDUCTIONS EXCLUSIONS account in computing gross income or for
depreciation or amortization may be
1. Amount which the 1. Flow of wealth not
law allows to be treated as part of allowed as deduction only if it is shown that
subtracted from the gross income the tax required to be deducted and
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INCOME TAXATION

withheld therefrom has been paid to BIR P904,769.00 allegedly arising from the 20% sales discount
(Section 34(K), NIRC) granted by respondent to qualified senior citizens in
compliance with [R.A.] 7432. Unable to obtain affirmative
response from petitioner, respondent elevated its claim to
the Court of Tax Appeals [(CTA or Tax Court)] via a Petition for
e) Deductions vs. Tax Credit
Review.
DEDUCTIONS TAX CREDIT
The Tax Court dismissed respondents Petition for lack of
1. Subtracted from the gross 1. Deducted from taxable merit. CTA said:
income to arrive at net income to arrive at income
taxable income tax payable
x x x, if no tax has been paid to the government,
erroneously or illegally, or if no amount is due and
2. Diminishes income tax 2. Diminishes tax liability collectible from the taxpayer, tax refund or tax credit
payable
is unavailing. Moreover, whether the recovery of
the tax is made by means of a claim for refund or tax
i) CIR vs. Central Luzon Drug Corp, GR No. credit, before recovery is allowed[,] it must be first
159647, 15 April 2005 established that there was an actual collection and
receipt by the government of the tax sought to be
PANGANIBAN, J.: recovered. x x x.

The 20 percent discount required by the law to be given to Prescinding from the above, it could logically be
senior citizens is a tax credit, not merely a tax deduction from deduced that tax credit is premised on the existence of tax
the gross income or gross sale of the establishment liability on the part of taxpayer. In other words, if there is no
concerned. A tax credit is used by a private establishment tax liability, tax credit is not available.
only after the tax has been computed; a tax deduction,
before the tax is computed. RA 7432 unconditionally grants a The MR filed by the respondent was granted by the
tax credit to all covered entities. Thus, the provisions of the CTA. It then ordered petitioner to issue a Tax Credit
revenue regulation that withdraw or modify such grant are Certificate in favor of Central Luzon Drug.
void. Basic is the rule that administrative regulations cannot
amend or revoke the law. The CA affirmed in toto the Resolution of the Court
of Tax Appeals (CTA) in the reduced amount of P903,038.39.
Facts: Respondent is a domestic corporation primarily It reasoned that Republic Act No. (RA) 7432 required neither
engaged in retailing of medicines and other pharmaceutical a tax liability nor a payment of taxes by private
products. In 1996, it operated six (6) drugstores under the establishments prior to the availment of a tax credit.
business name and style Mercury Drug. Moreover, such credit is not tantamount to an unintended
benefit from the law, but rather a just compensation for the
From January to December 1996, respondent taking of private property for public use.
granted twenty (20%) percent sales discount to qualified
senior citizens on their purchases of medicines pursuant to Issue : Is the 20% sales discount a tax credit or a deduction
Republic Act No. [R.A.] 7432 and its Implementing Rules and from gross income or gross sales?
Regulations. For the said period, the amount totalled
P904,769.00. Ruling: The 20% sales discount is a tax credit as expressly
provided for by RA 7432.
On April 15, 1997, respondent filed its Annual
Income Tax Return 1996 declaring that it incurred net losses Tax Credit versus Tax Deduction
from its operations.
Tax credit generally refers to an amount that is
On January 16, 1998, respondent filed with subtracted directly from ones total tax liability. It
petitioner a claim for tax refund/credit in the amount of is an allowance against the tax itself or a

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deduction from what is owed by a taxpayer to the claimed -- shall be treated as a reduction from any tax
government. Examples of tax credits are withheld liability, plain and simple
taxes, payments of estimated tax, and investment
tax credits. Granting that there is a tax liability and respondent
claims such cost as a tax credit, then the tax credit can easily
Tax deduction -- defined as a subtraction from be applied. If there is none, the credit cannot be used and
income for tax purposes, or an amount that is will just have to be carried over and revalidated accordingly.
allowed by law to reduce income prior to *the+ If, however, the business continues to operate at a loss and
application of the tax rate to compute the amount of no other taxes are due, thus compelling it to close shop, the
tax which is due. An example of a tax deduction is credit can never be applied and will be lost altogether.
any of the allowable deductions enumerated in
Section 34[20] of the Tax Code. Tax Credit Benefit Deemed Just Compensation

A tax credit differs from a tax deduction. On the Sections 2.i and 4 of RR 2-94 deny the exercise by the
one hand, a tax credit reduces the tax due, including State of its power of eminent domain. Be it stressed that the
-- whenever applicable -- the income tax that is privilege enjoyed by senior citizens does not come directly
determined after applying the corresponding tax from the State, but rather from the private establishments
rates to taxable income. concerned. Accordingly, the tax credit benefit granted to
these establishments can be deemed as their just
A tax deduction, on the other, reduces the income compensation for private property taken by the State for
that is subject to tax in order to arrive at taxable public use.
income. To think of the former as the latter is to
avoid, if not entirely confuse, the issue. A tax credit SC affirmed Decision and Resolution of the Court of
is used only after the tax has been computed; a tax Appeals.
deduction, before.
ii) CIR vs. Central Luzon Drug Corp,
By ordinary acceptation, a discount is an abatement or GR No. 148512, 26 June 2006
reduction made from the gross amount or value of anything.
AZCUNA, J.:
To be more precise, it is in business parlance a deduction or
lowering of an amount of money; or a reduction from the FACTS: Central Luzon Drug Corporation has been a retailer of
full amount or value of something, especially a price. In medicines and other Pharmaceutical products since
business there are many kinds of discount, the most common December 19, 1994. In 1995, it opened three (3) drugstores
of which is that affecting the income statement or financial as a franchisee under the business name and style of
report upon which the income tax is based. Mercury Drug.

To stress, the effect of a sales discount on the income For the period January 1995 to December 1995, in
statement and income tax return of an establishment conformity to the mandate of Sec. 4(a) of R.A. No. 7432
covered by RA 7432 is different from that resulting from the (Senior Citizens Act), petitioner granted a 20% discount on
availment or use of its tax credit benefit. While the former is the sale of medicines to qualified senior citizens amounting to
a deduction before, the latter is a deduction after, the income P219,778.
tax is computed. As mentioned earlier, a discount is not
necessarily a sales discount, and a tax credit for a simple Pursuant to Revenue Regulations No. 2-94[1]
discount privilege should not be automatically treated like a implementing R.A. No. 7432, which states that the discount
sales discount. Where the law does not distinguish, we ought given to senior citizens shall be deducted by the
not to distinguish. establishment from its gross sales for value-added tax and
other percentage tax purposes, respondent deducted the
When the law says that the cost of the discount may be total amount of P219,778 from its gross income for the
claimed as a tax credit, it means that the amount -- when taxable year 1995. For said taxable period, respondent

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INCOME TAXATION

reported a net loss of P20,963 in its corporate income tax otherwise would be a departure from the clear mandate of
return. As a consequence, respondent did not pay income the law.
tax for 1995.
Accordingly, when the law says that the cost of the
Subsequently, on December 27, 1996, claiming that discount may be claimed as a tax credit, it means that the
according to Sec. 4(a) of R.A. No. 7432, the amount of amount -- when claimed shall be treated as a reduction
P219,778 should be applied as a tax credit, respondent filed a from any tax liability.
claim for refund in the amount of P150,193, thus:
The tax credit that is contemplated under the Act is a
Since the Commissioner of Internal Revenue was form of just compensation, not a remedy for taxes that were
not able to decide the claim for refund on time,*2+ erroneously or illegally assessed and collected. In the same
respondent filed a Petition for Review with the Court of Tax vein, prior payment of any tax liability is not a precondition
Appeals (CTA) on March 18, 1998. before a taxable entity can benefit from the tax credit. The
credit may be availed of upon payment of the tax due, if any.
The CTA dismissed the petition, declaring that even Where there is no tax liability or where a private
if the law treats the 20% sales discounts granted to senior establishment reports a net loss for the period, the tax credit
citizens as a tax credit, the same cannot apply when there is can be availed of and carried over to the next taxable year.
no tax liability or the amount of the tax credit is greater than
the tax due. In the latter case, the tax credit will only be to It must also be stressed that unlike in Sec. 229 of the
the extent of the tax liability. Also, no refund can be granted Tax Code wherein the remedy of refund is available to the
as no tax was erroneously, illegally and actually collected taxpayer, Sec. 4 of the law speaks only of a tax credit, not a
based on the provisions of Section 230, now Section 229, of refund.
the Tax Code. Furthermore, the law does not state that a
refund can be claimed by the private establishment The tax credit benefit granted to the establishments
concerned as an alternative to the tax credit. can be deemed as their just compensation for private
property taken by the State for public use. The privilege
Thus, respondent filed with the CA a Petition for Review. enjoyed by the senior citizens does not come directly from
the State, but rather from the private establishments
concerned.
CA concluded that the 20% discount given to senior SC affirmed Decision of the Court of Appeals.
citizens which is treated as a tax credit pursuant to Sec. 4(a)
of R.A. No. 7432 is considered just compensation and, as iii) Bicolandia Drug Corp vs. CIR GR
such, may be carried over to the next taxable period if there No. 142299, 22 June 2006
is no current tax liability.
AZCUNA, J.:
ISSUE: whether the 20% sales discount granted by
respondent to qualified senior citizens may be claimed as a FACTS: Petitioner Bicolandia Drug Corporation is a domestic
tax credit or as a deduction from gross sales. corporation principally engaged in the retail of
pharmaceutical products. Petitioner has a drugstore located
RULING: The CA and the CTA correctly ruled that based on in Naga City under the name and business style of Mercury
the plain wording of the law discounts given under R.A. No. Drug.
7432 should be treated as tax credits, not deductions from
income. Pursuant to the provisions of R.A. No. 7432 (Senior
Citizens Act), and Revenue Regulations No. 2-94, petitioner
The provision of RA 7432 explicitly employed the granted to qualified senior citizens a 20% sales discount on
word tax credit. Nothing in the provision suggests for it to their purchase of medicines covering the period from July 19,
mean a deduction from gross sales. To construe it 1993 to December 31, 1994.

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INCOME TAXATION

When petitioner filed its ITR 1993 and 1994, it at the total tax liability (Blacks Law
claimed as a deduction from its gross income the respective Dictionary).
amounts of P80,330 and P515,000 representing the 20% sales
discount it granted to senior citizens. In view of such apparent
discrepancy in the interpretation of the
However, alleging error in the computation and term tax credit, the provisions of the law
claiming that the aforementioned 20% sales discount should under R.A. 7432 should prevail over the
have been treated as a tax credit pursuant to R.A. No. 7432 subordinate regulation issued by the
instead of a deduction from gross income, petitioner filed a respondent under Revenue Regulation No.
claim for refund or credit of overpaid income tax for 1993 and 2-94. x x x
1994.
On the issue of whether or not petitioner is entitled
Petitioner contended that Section 4 of R.A. No. 7432 to the claim for refund of its overpaid income taxes for the
provides in clear and unequivocal language that discounts years 1993 and 1994 based on the evidence at hand, the CTA
granted to senior citizens may be claimed as a tax credit. ordered CIR to ISSUE tax credit certificates in favor of
Revenue Regulations No. 2-94, therefore, which is merely an petitioner [in] the amounts representing overpaid income tax
implementing regulation cannot modify, alter or depart from for the years 1993 and 1994. On the other hand, the CIRs
the clear mandate of Section 4 of R.A. No. 7432, and, thus, is Motion for Reconsideration is DENIED for lack of merit.
null and void for being inconsistent with the very statute it
seeks to implement. Consequently, the Commissioner filed a petition for
review with the CA asking for the reversal of the CTA Decision
The CIR, on the other hand, maintained that the and Resolution. However, CA denied such petition.
aforesaid section providing for a 20% sales discount to senior
citizens is a misnomer as it runs counter to the solemn duty Issue: The matter to be determined is the amount of tax
of the government to collect taxes. The Commissioner credit that may be claimed by a taxable entity which grants a
20% sales discount to qualified senior citizens on their
likewise pointed out that the provision in question employs
purchase of medicines. Is it the acquisition cost or the actual
the word may, thereby implying that the availability of the
amount of discount?
remedy of tax credit is not absolute and mandatory and it
does not confer an absolute right on the taxpayer to avail of Ruling:
the tax credit scheme if he so chooses. The Commissioner
further stated that in statutory construction, the Section 4(a) of R.A. No. 7432 states that:
contemporaneous construction of a statute by executive
officers of the government whose duty is to execute it is Sec. 4. Privileges for the Senior citizens.
entitled to great respect and should ordinarily control in its The senior citizens shall be entitled to the following:
interpretation.
a) the grant of twenty percent (20%)
The CTA ruled that: discount from all establishments relative to
utilization of transportation services, hotels and
Revenue Regulations No. 2-94 similar lodging establishments, restaurants and
gave a new meaning to the phrase tax recreation centers and purchase of medicines
anywhere in the country: Provided, That private
credit, interpreting it to mean that the 20%
establishments may claim the cost as tax credit.
discount granted to qualified senior citizens
is an amount deductible from the
The term "cost" in the above provision refers to the
establishments gross sales, which is amount of the 20% discount extended by a private
completely contradictory to the literal or establishment to senior citizens in their purchase of
widely accepted meaning of the said medicines. This amount shall be applied as a tax credit, and
phrase, as an amount subtracted from an may be deducted from the tax liability of the entity
individuals or entitys tax liability to arrive concerned. If there is no current tax due or the establishment

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INCOME TAXATION

reports a net loss for the period, the credit may be carried The Ruling of the Court of Tax Appeals
over to the succeeding taxable year. This is in line with the
interpretation of this Court in Commissioner of Internal The CTA rendered ordered petitioner to issue a tax credit
9
Revenue v. Central Luzon Drug Corporation wherein it certificate in the amount of P2,376,805.63 in favor of
affirmed that R.A. No. 7432 allows private establishments to respondent. In a number of analogous cases, CTA has
claim as tax credit the amount of discounts they grant to consistently ruled that the 20% senior citizens' discount
senior citizens. should be treated as tax credit instead of a mere deduction
from gross income. In quoting its previous decisions, the CTA
Accordingly, petitioners claim for refund must be ruled that RR 2-94 engraved a new meaning to the phrase
denied. The law expressly provides that the discount given to "tax credit" as deductible from gross income which is a
senior citizens may be claimed as a tax credit, and not a deviation from the plain intendment of the law. An
refund. administrative regulation must not contravene but should
conform to the standards that the law prescribes.
iv) CIR vs. Central Luzon Drug Corp,
GR No. 159610, 12 June 2008 (in The CTA also ruled that respondent has properly
relation to RA 9257) CARPIO, J.: substantiated its claim for tax credit by documentary
evidence. However, based on the examination, the CTA
Facts: Respondent is a domestic corporation engaged in the deemed it proper to consider the lesser of two amounts.
retail of medicines and other pharmaceutical products. In
1997, it operated eight drugstores under the business name Aggrieved by the CTA's decision, petitioner elevated the case
6
and style "Mercury Drug." before the Court of Appeals.

Pursuant to the provisions of RA 7432 and Revenue The Ruling of the Appellate Court
Regulations No. (RR) 2-94 issued by the BIR, respondent
granted 20% sales discount to qualified senior citizens on The CA affirmed the CTA's decision in toto.
their purchases of medicines covering 1997 which totalled
P2,798,508.00. The CA distinguished "tax credit" as an amount subtracted
from a taxpayer's total tax liability to arrive at the tax due
Respondent filed its 1997 Corporate Annual ITR while a "tax deduction" reduces the taxpayer's taxable
reflecting a nil income tax liability due to net loss incurred income upon which the tax liability is computed. "A credit
from business operations of P2,405,140.00. Respondent filed differs from deduction in that the former is subtracted from
its 1997 ITR under protest. tax while the latter is subtracted from income before the tax
19
is computed."
In March 1999, respondent filed with the petitioner
a claim for refund or credit of overpaid income tax for the Hence, this petition.
taxable year 1997 in the amount of P2,660,829.00.
Respondent alleged that the overpaid tax was the result of Issue: Whether the respondent may claim the 20% senior
the wrongful implementation of RA 7432. Respondent citizens' sales discount as a tax credit deductible from future
treated the 20% sales discount as a deduction from gross income tax liabilities instead of a mere deduction from gross
sales in compliance with RR 2-94 instead of treating it as a tax income or gross sales
credit as provided under Section 4(a) of RA 7432.
The Ruling of the Court
Petitioner contended that the construction given to
a statute by a specialized administrative agency like the BIR is
The petition lacks merit.
entitled to great respect and should be accorded great
weight. When RA 7432 allowed senior citizens' discounts to
In two similar cases involving the same parties on the same
be claimed as tax credit, it was silent as to the mechanics of
issues, the Court has squarely ruled that the 20% senior
availing the same. For clarification, the BIR issued RR 2-94 and
citizens' discount required by RA 7432 may be claimed as a
defined the term "tax credit" as a deduction from the
tax credit and not merely a tax deduction from gross sales or
establishment's gross income and not from its tax liability in
12 gross income. Under RA 7432, Congress granted the tax credit
order to avoid an absurdity that is not intended by the law.
benefit to all covered establishments without conditions. The
net loss incurred in a taxable year does not preclude the
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INCOME TAXATION

grant of tax credit because by its nature, the tax credit may sales for value-added tax or other
still be deducted from a future, not a present, tax liability. percentage tax purposes.
However, the senior citizens' discount granted as a tax credit (Emphasis supplied).
cannot be refunded.
xxx
RA 7432 expressly allows private establishments
to claim the amount of discounts they grant to Sec. 4. Recording/Bookkeeping
senior citizens Requirement for Private
as tax credit. Establishments

Section 4(a) of RA 7432 states: xxx

SECTION 4. Privileges for the Senior Citizens. The amount of 20% discount shall
- The senior citizens shall be entitled to the be deducted from the gross
following: income for income tax purposes
and from gross sales of the
a) the grant of twenty percent business enterprise concerned for
(20%) discount from all purposes of the VAT and other
establishments relative to the percentage taxes. (Emphasis
utilization of transportation supplied)
services, hotels and similar lodging
establishments, restaurants and Tax credit is defined as a peso-for-
recreation centers and purchase of peso reduction from a taxpayer's tax
medicines anywhere in the liability. It is a direct subtraction from the
country: Provided, That private tax payable to the government. On the
establishments may claim the cost other hand, RR 2-94 treated the amount of
as tax credit; (Emphasis supplied) senior citizens' discount as a tax deduction
which is only a subtraction from gross
However, RR 2-94 interpreted the tax credit income resulting to a lower taxable income.
provision of RA 7432 in this wise: RR 2-94 treats the senior citizens' discount
in the same manner as the allowable
Sec. 2. DEFINITIONS. - For purposes deductions provided in Section 34, Chapter
of these regulations: VII of the National Internal Revenue Code.
RR 2-94 affords merely a fractional
xxx reduction in the taxes payable to the
government depending on the applicable
tax rate.
i. Tax Credit - refers to the amount
representing 20% discount
granted to a qualified senior In Commissioner of Internal Revenue v. Central Luzon
citizen by all establishments Drug Corporation, the Court ruled that petitioner's definition
relative to their utilization of in RR 2-94 of a tax credit is clearly erroneous. To deny the tax
transportation services, hotels and credit, despite the plain mandate of the law, is indefensible.
similar lodging establishments, In Commissioner of Internal Revenue v. Central Luzon Drug
restaurants, drugstores, recreation Corporation, the Court declared, "When the law says that the
centers, theaters, cinema houses, cost of the discount may be claimed as a tax credit, it means
concert halls, circuses, carnivals that the amount- when claimed shall be treated as a
and other similar places of culture, reduction from any tax liability, plain and simple."
leisure and amusement, which
discount shall be deducted by the The tax credit may still be deducted
said establishments from their from a future, not a present, tax liability.
gross income for income tax
purposes and from their gross

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INCOME TAXATION

Petitioner-CIR alleged that respondent incurred a net "Sec. 4. Privileges for the Senior
loss from its business operations in 1997; hence, it did not Citizens. - The senior citizens shall
pay any income tax. Since no tax payment was made, it be entitled to the following:
follows that no tax credit can also be claimed because tax
credits are usually applied against a tax liability. (a) the grant of twenty percent
(20%) discount from all
In Commissioner of Internal Revenue v. Central Luzon establishments relative to the
Drug Corporation, the Court stressed that prior payment of utilization of services in hotels and
tax liability is not a pre-condition before a taxable entity can similar lodging establishments,
avail of the tax credit. The Court declared, "Where there is no restaurants and recreation centers,
tax liability or where a private establishment reports a net and purchase of medicines in all
loss for the period, the tax credit can be availed of and establishments for the exclusive
carried over to the next taxable year." It is irrefutable that use or enjoyment of senior citizens,
under RA 7432, Congress has granted the tax credit benefit to including funeral and burial
all covered establishments without conditions. Therefore, services for the death of senior
neither a tax liability nor a prior tax payment is required for citizens;
the existence or grant of a tax credit.
xxx
Hence, respondent is entitled to claim the amount of
P2,376,805.63 as tax credit despite incurring net loss from The establishment may claim the
business operations for the taxable year 1997. discounts granted under (a), (f),
(g) and (h) as tax deduction based
The senior citizens' discount may be claimed on the net cost of the goods sold or
as a tax credit and not a refund. services rendered: Provided, That
the cost of the discount shall be
Section 4(a) of RA 7432 expressly provides that allowed as deduction from gross
private establishments may claim the cost as a tax income for the same taxable year
credit. A tax credit can only be utilized as payment that the discount is granted.
for future internal revenue tax liabilities of the Provided, further, That the total
taxpayer while a tax refund, issued as a check or a amount of the claimed tax
warrant, can be encashed. A tax refund can be deduction net of value added tax if
availed of immediately while a tax credit can only be applicable, shall be included in
utilized if the taxpayer has existing or future tax their gross sales receipts for tax
liabilities. purposes and shall be subject to
proper documentation and to the
Hence, the senior citizens' discount may be claimed as a tax provisions of the National Internal
credit and not as a refund. Revenue Code, as amended."
(Emphasis supplied)
RA 9257 now specifically provides that all covered
establishments Contrary to the provision in RA 7432 where the senior
may claim the senior citizens' discount as tax citizens' discount granted by all covered establishments can
deduction. be claimed as tax credit, RA 9257 now specifically provides
that this discount should be treated as tax deduction.
On 26 February 2004, RA 9257, otherwise known as
the "Expanded Senior Citizens Act of 2003," was With the effectivity of RA 9257 on 21 March 2004, there is
signed into law and became effective on 21 March now a new tax treatment for senior citizens' discount granted
2004.
31 by all covered establishments. This discount should be
considered as a deductible expense from gross income and
no longer as tax credit. The present case, however, covers the
RA 9257 has amended RA 7432.
taxable year 1997 and is thus governed by the old law, RA
Section 4(a) of RA 9257 reads:
7432.

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INCOME TAXATION

The Decision of the CA was AFFIRMED. In lieu of the itemized allowable deductions, the OSD
may be deducted from the gross income as follows:
B. KINDS OF ALLOWABLE DEDUCTIONS
a) An individual other than a
a) Optional Standard Deductions (OSD) non resident alien OSD
b) Special Deductions must not exceed 40% of
c) Itemized Deductions (ID) his gross sales or gross
receipts
SPECIAL DEDUCTIONS those which are allowed by law to
b) A corporation OSD is not
specific taxpayers only.
exceeding 40% of its gross
1. Private Proprietary Educational Institutions (PPEI) income
[Section 34(A)(2)] - in addition to the expenses
allowed as deduction, PPEI has the option to treat
the amount utilized for the acquisition of From its name itself, standard deduction is optional
depreciable assets for expansion of school facilities (Mamalateo, page 213). The taxpayer must signify in his
such as: return that he elects the OSD, otherwise he shall be
a) Outright expense (the entire amount is considered as having availed of the itemized deductions.
deducted from gross income); or
b) Capital asset and deduct only from the gross The Tax Code provides that once a taxpayer elected
income an amount equivalent to its a deduction (either OSD or itemized) in his ITR, such election
depreciation every year. is irrevocable for the taxable year which the return is made
2. Insurance Companies (Section 37, NIRC) can deduct [Section 34(L), NIRC]. Hence, the taxpayer can change to
the following: itemized deductions in succeeding years. (Mamalateo, page
a) Net additions required by law to be made within 213).
the year to reserve funds; AND
Requites for the exercise of OSD:
b) Sums other than dividends paid within the year
on policy and annuity contracts 1) Available to both corporations and individuals
3. Estates and Trusts (Section 61, NIRC) can deduct the other than non-resident aliens
following: 2) OSD is optional - taxpayer signifies in his return
a) Amount of income paid, credited or his intention to elect OSD otherwise he is
distributed to the heirs/ beneficiaries; considered as having availed of ID
AND 3) Election is irrevocable for the year in which it is
b) Amount applied for the benefit of the made
grantor 4) Amount is limited to 40% of taxpayers gross
income or gross receipts
C. THE OPTIONAL STANDARD DEDUCTION (RA 9054, June
5) Proof of actual expenses is not required.
17, 2008)
Illustration 1 (Individual Taxpayer):
Earlier, only individual subject to tax under Section
24 of the NIRC (other than a non resident alien) may elect a Mr. X, a practicing lawyer, received
standard deduction. However, the new RA 9504 (Act a total professional fee amounting to
Amending among others Section 34 of the NIRC) allows OSD P600K during the taxable year. His related
not only to individual taxpayer (other than a non-resident itemized deduction allowed amounted to
alien) but also to corporation subject to tax under Section P100K. Mr. X opted to deduct OSD in lieu
27(A) and 28 (A)(1) of the Tax Code. of itemized deductions (ID).

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INCOME TAXATION

The net income of Atty. X before Net Income


personal exemption would be: P1,200,000.00

Gross Receipts professional fee - P600,000.00 NOTES:


Less: OSD (P600K x 40%) - 240,000.00 a) The following corporations may claim
Net Income before Personal Exemption P360,000.00 OSD in lieu of ID:
1. Domestic Corporations
NOTES: 2. Resident Foreign Corporations
a) The following individuals may claim OSD in lieu
of ID: b) Components of GROSS INCOME FOR
1. Resident Citizen OSD
2. Non-resident Citizen
3. Resident Alien Gross Income includes other
4. Taxable Estates and Trusts income not subjected to final tax.
Other income includes interest
b) Submission of supporting financial statements income earned from outside
to tax return shall not be required if a qualified source as well as gain from sale of
individual claims OSD (Valencia, Roxas, page capital assets. The other should
371, 2010). Simply stated, proof of actual have been reported in the ITR and
expenses is not required to support claim of not subjected to final tax or CGT.
OSD (Mamalateo, page 213).
Hence, the basis of the 40% OSD
c) OSD is based on gross sales during the taxable should include other taxable
year if an individual employs the accrual basis of income not subjected to final tax.
accounting of his income and deductions
c) If taxpayer elects to offset his losses
d) Sales discounts, sales returns and sales against his profit from capital asset
allowances should reduce the gross sales in transaction, he may no longer claim
computing OSD (based on the tax principle that OSD because OSD shall be in lieu of the
lower amount of deduction will be allowed for itemized allowed deductions which
income tax purposes) (Valencia, Roxas, page evidently includes losses from sales or
371, 2010) exchanges of capital assets (Valencia,
Roxas, Income Taxation, page 372,
Illustration 2 (Corporate Taxpayer): 2010)

X Corportion reported a gross sales of


P5M, cost of sales of P3M and itemized
deductions of P500K. The Company opted
to deduct OSD in lieu of itemized
OSD or ID of HUSBAND and WIFE
deductions.
For married individuals, the husband may choose
The net income of X Corporation
OSD and the wife ID (or vice versa) to minimize their
would be:
individual income tax.
Sales -
P5,000,000.00 ILLUSTRATION:
Less: Cost of Sale -
The husband and wife may compute separately
3,000,000.00
Gross Income their individual income tax based on their
2,000,000.00 respective taxable income as follows:
Less: OSD (P2M x 40%)-
800,000.00

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INCOME TAXATION

Mr. X Mrs. X i. The All-Events Test


Gross receipts from P P CIR v. Isabela Cultural Corporation (G.R.
business service 400,000.00 600,000.00 No. 172231 February 12, 2007)
Less: OSD (P400K x 40%) 160,000.00 The CA sustained the deduction of the
expenses for professional and security
ID 400,000.00
services from ICCs gross income.
Income from business P 240,000.00 P 200,00.00 Requisites for the deductibility of
Add: Compensation 300,000.00 ordinary and necessary trade,
Income business, or professional expenses,
Income before personal P 540,000.00 P 200,00.00 like expenses paid for legal and
exemption auditing services, are:
1) the expense must be ordinary
and necessary;
NOTES: 2) it must have been paid or
a) Compensation Income is not allowed to be reduced incurred during the taxable year;
by OSD 3) it must have been paid or
b) If any income of the husband and wife cannot be incurred in carrying on the trade
definitely identified as income exclusively earned or or business of the taxpayer; and
4) it must be supported by receipts,
realized by either of the spouses the same shall be
records or other pertinent
divided equally between them in order to determine
papers.
their respective taxable income. Requisites for All-events test
c) In the case of individual entitled to claim OSD, 1) the right to income or liability be
allowable deductions shall mean aforesaid OSD fixed; and
plus deductions of premium payments (if applicable) 2) the amount of such income or
on: liability be determined with
reasonable accuracy.
1) Health insurance, and/or
The amount of liability does not have to
2) Hospitalization Insurance, be determined exactly; it must be
determined with "reasonable accuracy."
D. ITEMIZED DEDUCTIONS: CONCEPTS, KINDS, RULES AND 1) "Reasonable accuracy"- implies
REQUISITES something less than an exact or
completely accurate amount.
Itemized Deductions
Held: The disallowance of the expense
specific business operating expenses allowed by the deduction of ICC for professional and
Tax Code to be deducted from the gross income security services is declared valid only
it includes special deductions allowed to insurance insofar as the expenses for the
companies professional fees of SGV & Co. and of the
generally, these require supporting documents to law firm.
justify the reduction from gross income 1) ICC can be expected to have
N/A reasonably known the retainer fees
o NOLCO charged by the firm as well as the
o any item of incentive deduction allowable compensation for its legal services.
under any special law 2) ICC, in the exercise of due diligence
a. General Business Expenses could have inquired into the amount
expenses refer to all the ordinary and of the obligation to the firm.
necessary expenses paid or incurred 3) ICC owes familiarity with the rates
during the taxable year charged by their long time legal
in carrying on or which are directly consultant.
attributable to the development, ii. Capital Expenditure v. Ordinary
management, operation and/or conduct of Expenditure
the trade, business or the exercise of a Capital Expenditure
profession.

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payments made in cash or cash supervision fees or the amount of P99,977.91 is


equivalents over a period of more a deductible ordinary and necessary expense
than one year. and should be treated as a distribution of
are used to acquire assets or improve earnings and profits of the taxpayer.
the useful life of existing assets. Held: NO!
Ordinary Expenditure o For income tax purposes the employer
expenses commonly incurred in the cannot legally claim such bonuses as
trade or business of the taxpayer with deductible expenses unless they are shown
a useful life of not more than one to be reasonable.
year. o CM Hoskins is bound to pay the income tax
iii. Rule re: Proprietary Educational imposed by law on corporations and may
Institutions not legally be permitted, by way of
deduct expenditures otherwise corporate resolutions authorizing payment
considered as capital outlays of inordinately large commissions and fees
o capital outlays- same as capital to its controlling stockholder, to dilute and
expenditures diminish its corresponding corporate tax
deduct allowance for depreciation liability.
iv. Reasonableness Test
v. Representation Expenses
CIR v. General Foods, Inc. (G.R. No. 143672 these are entertainment, amusement and
April 24, 2003) recreation expenses
Issue: WON the subject media advertising incurred or paid during the year that are
expense for "Tang" incurred by respondent directly connected to the development,
corporation was an ordinary and necessary management and operation of the trade,
expense fully deductible under the NIRC. business or profession of the taxpayer
Held: NO! Requisites:
o If the advertising is designed to stimulate 1) It must be substantiated with sufficient
the future sale of merchandise or use of evidence such as receipts and or
services, it is not deductible as an ordinary adequate records;
and necessary expense. Rationale- "it has 2) It must be limited to the ceiling
not been established that the item being requirement as provided in Rev. Reg.
claimed as deduction is excessive." 10-2002
o There is yet to be a clear-cut criteria or of net sales for taxpayers
fixed test for determining the engaged in sale of
reasonableness of an advertising expense. goods/properties; or
o There being no hard and fast rule on the 1% of the net revenue for
matter, the right to a deduction depends taxpayers engaged in sale of
on a number of factors such as but not services, including exercise of
limited to: profession and use or lease of
1) the type and size of business in properties.
which the taxpayer is engaged; vi. Substantiation Rule and Cohan Rule
2) the volume and amount of its Substantiation Rule-
net earnings; All deductions from gross
3) the nature of the expenditure income must be
itself; substantiated with sufficient
4) the intention of the taxpayer evidence, and as official
and the general economic receipts and other adequate
conditions. records.
Cohan Rule-
CM Hoskins v. CIR (G.R. No. L-24059 November 28, Where it is certain from the
1969) evidence adduced that the
Issue: WON payment by the taxpayer to its taxpayer did incur expenses
controlling stockholder of 50% of its but the actual amount

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INCOME TAXATION

thereof has not established, result in any benefit to the


the Commissioner should taxpayer
make a close approximate Otherwise stated, if the
thereof. recovery of bad debts
resulted in a tax benefit to
Gancayco v. CIR (G.R. No. L-13325 April 20, the taxpayer, that is
1961) taxable. If it did not result
Issue: WON the sum of P16,860.31 is due from in any tax benefit to the
Gancayco as deficiency income tax for 1949 taxpayer, that is not
hinges on the validity of his claim for deduction taxable.
of two (2) items, namely: (a) for farming c. Interests
expenses, P27,459.00; and (b) for representation i. Requisites:
expenses, P8,933.45. 1) This must be paid or incurred
Held: Partly YES, Partly NO! DURING the taxable year.
o Gancayco's claim for representation 2) This must be paid or incurred in
expenses aggregated P31,753.97, of which connection with the trade,
P22,820.52 was allowed, and P8,933.45 business or profession of the
disallowed. taxpayer
o Such disallowance is justified by the record, 3) There must be an obligation which
for, apart from the absence of receipts, is valid and subsisting.
invoices or vouchers of the expenditures in 4) There must be an agreement in
question, petitioner could not specify the writing to pay interest.
items constituting the same, or when or on ii. Tax Arbitrage Scheme
whom or on what they were incurred. If a taxpayer incurred indebtedness
and interest expense connected
b. Bad Debts with his trade or business during the
debts due to the taxpayer which are taxable year and also earned
actually ascertained to be worthless and interest income which had been
charged off within the taxable year. subjected to final withholding tax,
Requisites: the amount of interest expense
1) There must be a valid and subsisting shall be subject to the limitation as
debt; provided for by law.
2) The debt must be actually ascertained It was stressed that the law did not
to be worthless and uncollectible require that there be a tax arbitrage
during the taxable year; in order that the limitation on the
deduction of the interest expense
can be applied. RR No. 13-00 itself
3) The debt must be charged off during specifically provides that the
the taxable year; and limitation shall apply regardless of
4) The debt must be connected with the whether or not a tax arbitrage
trade, business or profession of the scheme was entered into by the
taxpayer, and not sustained in a taxpayer.
transaction entered into between REVENUE REGULATIONS NO. 13-
related taxpayers. 2000 issued December 29,
i. Tax Benefit Rule 2000 implements the provisions of
GR: the recovery of Section 34(B) of the Tax Code of
amounts deducted in 1997 relative to the requirements
previous years from gross for the deductibility of interest
income become taxable expense from the gross income of a
income corporation or an individual
XPN: to the extent thereof engaged in trade, business or in the
the deduction did not practice of profession.

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INCOME TAXATION

oIn general, subject to certain interest charged to the capital of the


limitations, the following are taxpayer- not deductible
the requisites for the interest on preferred stock- not
deductibility of interest deductible; XPN- if it is not dependent
expense from gross income: upon corporate profits or earnings
1) there must be an INTEREST ON GOVT SECURITIES is now
indebtedness; taxable.
2) there should be an interest v. Interest on Tax Delinquencies
expense paid or incurred
For interest to be allowed as deduction
upon such indebtedness;
3) the indebtedness must be from gross income, it must be shown
that of the taxpayer; that there be an indebtedness, that
4) the indebtedness must be there should be interest upon it, and
connected with the that what is claimed as an interest
taxpayer's trade, business deduction should have been paid or
or exercise of profession; accrued within the year.
5) the interest expense must
The term indebtedness has been
have been paid or incurred
during the taxable year; defined as an unconditional and legally
6) the interest must have enforceable obligation for the payment
been stipulated in writing; of money. Within the meaning of that
7) the interest must be legally definition, a tax may be considered as
due; an indebtedness.
8) the interest payment Hence, interest paid for late payment
arrangement must not be of the donors tax in deductible from
between related taxpayers gross income.
9) the interest must not be The interest on deficiency
incurred to finance donors tax is deductible.
petroleum operations; and The SC explained that
10) in case of interest incurred taxes here are considered
to acquire property used in obligations or
trade, business or exercise indebtedness. And it ruled
of profession, the same was that we have to relax the
not treated as a capital distinction between tax
expenditure. and ordinary obligation in
iii. On Capital Expenditure this respect.
At the option of the taxpayer, interest Interest on deficiency
incurred to acquire property used in income tax can also be
trade, business or exercise of a claimed as deductible
profession may be allowed as a interest expense because
deduction or treated as a capital taxes here are considered
expenditure. ordinary obligations.
iv. Rules re: deductibility d. Taxes
Taxpayer is not entitled to both: i. Requisites:
o deduction from gross income; 1. It must be paid or incurred within the
and taxable year;
o increased basis for 2. It must be paid or incurred in
determining gain or loss and connection with the taxpayers
the allowable depreciation profession, trade or business; and
charge. 3. The tax must be imposed directly upon
interest on unclaimed salaries of the the taxpayer
employees- not deductible ii. Deductible Taxes
1. Import duties

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INCOME TAXATION

2. Local Business taxes straightline or declining-balance method of


3. Occupation taxes depreciation at the option of the service
4. Privilege and license taxes contractor.
- However, if the service contractor initially
5. Excise taxes
elects the declining-balance method, it may
6. Documentary stamp taxes shift to the straightline method.
7. Automobile registration fees - The useful life of properties used in or related
8. Community Tax to production of petroleum shall be ten (10)
9. Municipal Tax years or such shorter
iii. Non-deductible Taxes life as may be permitted by the
1. Philippine income tax Commissioner.
2. Foreign income tax, if claimed as tax - Properties NOT USED DIRECTLY in the
credit production of petroleum shall be depreciated
3. Estate and donors taxes under the straight- line method on the basis
4. Value-added tax of an estimated useful life of 5 years.
5. Taxes not related to business, trade, or 2) Depreciation of Properties Used in
profession Mining Operations
6. Other items related to tax such as: - An allowance for depreciation in respect of all
(1) special assessment tax properties used in mining
(2) surcharges operations other than petroleum operations,
(3) compromise penalty shall be computed as follows:
Interest on a. At the normal rate of depreciation if the
delinquent taxes can expected life is ten (10) years or
be deducted as less; or
interest expense at its b. Depreciated over any number of years
full amount. between five (5) years and the expected
e. Depreciation life IF more than ten (10) years,
gradual diminution in the useful value of - Provided, That the contractor notifies the
tangible property used in trade, business or Commissioner at the beginning of the
profession resulting from exhaustion, wear depreciation period which depreciation rate
and tear, and obsolescence allowed will be used.
also applied to amortization of the value of - Depreciation Deductible by Nonresident Aliens
intangible assets, the use of which in trade or Engaged in Trade or Business (NRAETB) or
business is definitely limited in duration Resident Foreign Corporations (RFC)
Requisites: A reasonable allowance for the
1. The allowance for depreciation must deterioration of property arising out
be reasonable. of its use or employment or its non-
2. It must be for property used in the use in the business, trade or
trade, business, or profession. profession shall be permitted only
3. It must be charged off during the when such property is located in the
taxable year. Philippines.
4. The asset must have a limited useful
life. Deduction for obsolescence
5. The depreciable asset must be If the whole or any portion of the physical property
located in the Philippines if a is clearly shown by the taxpayer as being affected by
taxpayer is a nonresident alien or a economic conditions that will result in its being
foreign corporation. abandoned at a future date prior to the end of its
i. Properties subject to depreciation natural life, so that depreciation deductions alone
1) Depreciation of Properties Used in would be insufficient to return the cost at the end of
Petroleum Operations its economiv terms of usefulness, reasonable
- An allowance for depreciation in respect of all deduction for obsolescence, in addition to
properties DIRECTLY related to production of depreciation, may be allowed.
petroleum shall be allowed under the

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INCOME TAXATION

Property held for life production or severance from such mines or


In case of property held by one person for life with wells
remainder to another person, the deduction, shall be Determination of amount of depletion
computed as if the life tenant were the absolute In determining the amount of allowable
owner of the property and, shall be computed as depletion cost, the following three factors
such to the life tenant. are essential, namely:
1. The basis for the cost of the
In case of property held in trust property;
Allowable deductions shall be apportioned between 2. The estimated total recoverable
the income beneficiaries and the trustees in units in the property; and
accordance with the pertinent provisions of the 3. The number of units recovered
instrument creating the trust, or in the absence of during the taxable year in
such provisions, on the basis of the trust income question. [Consolidated Mines V.
allowable to each. CTA 58 SCRA 618]

ii. Allowable Modes of Depreciation Basis, means the amount of the taxpayers
1. The straight line method Equal capital or investment in the property which
depreciation per unit of time, he is entitled to recover tax-free during the
regardless of use or production output period he is removing mineral in the
of the property. deposit.
2. Declining balance method Amount of Intangible cost in petroleum operations
depreciation is subtracted annually This refers to any cost incurred in
from the cost of the property and the petroleum operations which in itself has no
rate then only applied to the resulting salvage value and which is incidental to and
balance. necessary for the drilling of wells and
3. Sum of the year digit method preparation of wells for the production of
application of a changing fraction to petroleum.
the taxpayers cost basis for the Depletion and Depreciation
property, reduced by the estimated Both are predicated upon the same basic
residual salvage value. premise of avoiding tax on capital.
4. Unit of work or unit of production However, depletion is based upon the
method A provision is made for equal concept of the exhaustion of a natural
depreciation per unit of use regardless resource, whereas, depreciation is based
of the lapse of time. upon the concept of exhaustion of the
5. Job basis method The allowance is property, not otherwise a natural resource,
computed as being equal to the used in trade or business or held for the
difference between the cost of production of income. Thus, depletion and
depreciation of the asset purchased for depreciation are made applicable to
a particular job, and the salvage value different types of assets.
at the end of the job. g. Losses
6. Retirement method The cost of the implies an unintentional parting with
property retired each year is credited something of value
to the capital asset account and less Requisites:
net salvage value actual or estimated. 1. The loss must be incurred in the
Charged to expense in lieu of an annual trade, business or profession of the
provision for depreciation deductions. taxpayer.
7. Such other methods as may be allowed 2. It must be actually sustained and
by the Sec. of Finance upon charged off within the taxable year.
recommendation by the Commissioner. 3. It must be evidenced by a closed
f. Depletion and completed transaction.
exhaustion of natural resources such as oil Completed Transaction this means that the loss must be
and gas wells and mines as a result of fixed by identifiable event.

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INCOME TAXATION

Example: If it is a loss sustained from sale, the event that 1. Securities become worthless during the taxable year
may identify or complete the transaction is the
consummation of the contract of sale. 2. Securities are capital assets

Suppose it is in the nature of casualty losses like fire? 3. Losses are considered as losses from the sale or
exchange, on the last day of such taxable year, of
The fire destroyed your property in 1995, no payment has capital assets.
been made because the insurer and the insured were still
under negotiation. It was only in 1997 that they agreed on Net operating loss
the amount. The amount agrees upon is P100,000. The
taxpayer may claim that casualty losses only in 1997 when It means the excess of allowable deduction over
payment was actually made. This is the event that will gross income of the business in a taxable year.
complete the transaction.
4. It must not be compensated for by NET OPERATING LOSS CARRY-OVER (NOLCO)
insurance or other forms of
indemnity. NOLCO shall be carried over as a deduction from the
gross income for the next three (3) consecutive
5. If it is a casualty loss, the taxpayer taxable years immediately following the year of loss.
has filed a sworn declaration of loss
within 45 days after the date of the Such loss shall be allowed as a deduction if it had not
discovery of the casualty or robbery, been previously offset as deduction from gross
theft, or embezzlement. income.

Some recognized losses However, any net loss incurred in a taxable year
1. Ordinary losses/business losses sustained in the during which the taxpayer was exempt from income
course of trade, business or profession tax shall not be allowed as a deduction
2. Casualty losses
3. Capital losses involved are capital assets. NOLCO shall be allowed only if there has been no
4. Securities becoming worthless substantial change in the ownership of the business
5. Losses from wash sales of stock or securities or enterprise.
6. Wagering losses
There is no substantial change when:
Note: Capital losses and securities becoming worthless are
governed by rules on loss from the sale or exchange of capital 1. Not less than 75% in nominal value of
assets. outstanding issued shares, if the business is
in the name of a corporation, is held by or
Casualty loss on behalf of the same persons; or
2. Not less than 75% of the paid up capital of
This must be reported to the BIR earlier than 30 days the corporation, if the business is in the
but not later than 45 days following the date of loss. name of a corporation, is held by or on
behalf of the same persons.
Loss arises from fires, storms, shipwreck, or other
casualties, or from robbery, theft or embezzlement. Losses form wash sales of stock or securities

No deduction for loss shall be allowed for wash sales


Loss limitation rule for capital losses unless the claim is made by a dealer in stock or
securities and with respect to a transaction made in
Losses from sales or exchanges of capital assets shall the ordinary course of the business of such dealer.
be allowed only to the extent of the gains from such
sales or exchanges. WASH SALE

Securities becoming worthless A wash sale occurs where it appears that within a
period beginning thirty (30) days before the date of

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INCOME TAXATION

the sale or disposition of shares of stock or securities Exception:A may claim that as deductible loss if this was
and ending thirty (30) days after such date, the demolished by value of a court order because the govt
taxpayer has acquired (by purchase or exchange) or considered this as a fire hazard, loss of useful value of
has entered into a contract or option to so acquire, property or capital asset.
substantially identical stock or securities.

Wagering losses PICOP VS CA December 1, 1995

Losses from wagering shall be allowed only to the Issue: Whether Picop is entitled to deductions against income
extent of gains form such transactions. of net operating losses incurred by the Rustan Pulp and Paper
The amount that is deductible must not exceed the Mills, Inc.; and
gains Decision:
(1) On 18 January 1977, Picop entered into a merger
Abandonment losses agreement with the Rustan Pulp and Paper Mills, Inc.
("RPPM") and Rustan Manufacturing Corporation
In the event a contract area where petroleum ("RMC"). Under this agreement, the rights,
operations are undertaken is partially or wholly properties, privileges, powers and franchises of
abandoned, all accumulated exploration and RPPM and RMC were to be transferred, assigned and
development expenditures pertaining thereto shall conveyed to Picop as the surviving corporation. The
be allowed as a deduction. entire subscribed and outstanding capital stock of
RPPM and RMC would be exchanged for 2,891,476
In case a producing well is subsequently abandoned, fully paid up Class "A" common stock of Picop (with a
the unamortized costs thereof, as well as the par value of P10.00) and 149,848 shares of preferred
undepreciated costs of equipment directly used stock of Picop (with a par value of P10.00), to be
therein, shall be allowed as a deduction in the year issued by Picop, the result being that Picop would
such well, equipment or facility is abandonment by wholly own both RPPM and RMC while the
the contracto. stockholders of RPPM and RMC would join the ranks
of Picop's shareholders. In addition, Picop paid off
SPECIAL LOSSES include the following: the obligations of RPPM to the Development Bank of
a. loss arising from voluntary removal of buildings as an the Philippines ("DBP") in the amount of
incident to renewal or replacement P68,240,340.00, by issuing 6,824,034 shares of
preferred stock (with a par value of P10.00) to the
Problem: DBP. The merger agreement was approved in 1977
Supposed the taxpayer had a building constructed on a parcel by the creditors and stockholders of Picop, RPPM
of land. He owned this as well as the building erected and RMC and by the Securities and Exchange
thereon. He had business and his business was conducted Commission. Thereupon, on 30 November 1977,
within the premises. Then, he decided to remove such apparently the effective date of merger, RPPM and
building as to construct a new building for new business. RMC were dissolved. The Board of Investments
approved the merger agreement on 12 January
Is the cost of demolition to give way to a new building 1978.
deductible loss? YES.
(2) In the instant case, to allow the deduction claimed
Suppose A purchased that parcel of land of B and included in by Picop would be to permit one corporation or
that sale was that of the building. A demolish this building in enterprise, Picop, to benefit from the operating
order to construct a new building. Is the cost of demolition losses accumulated by another corporation or
deductible insofar as A is concerned? enterprise, RPPM. RPPM far from benefiting from
the tax incentive granted by the BOI statute, in fact
NO. That can only be claimed as deductions if the one gave up the struggle and went out of existence and
demolishing the same is the taxpayer. The moment that is its former stockholders joined the much larger group
sold to another claim that as deductible loss. The treatment of Picop's stockholders. To grant Picop's claimed
here is, the cost of demolition should be capitalized in the deduction would be to permit Picop to shelter its
selling price. otherwise taxable income (an objective which Picop
had from the very beginning) which had not been

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INCOME TAXATION

earned by the registered enterprise which had


suffered the accumulated losses. In effect, to grant 2. No part of the net income of the beneficiary must
Picop's claimed deduction would be to permit Picop inure to the benefit of any private stockholder or
to purchase a tax deduction and RPPM to peddle its individual.
accumulated operating losses. Under the CTA and
Court of Appeals decisions, Picop would benefit by 3. It must be made within the taxable year.
immunizing P44,196,106.00 of its income from
taxation thereof although Picop had not run the risks 4. It must not exceed 10% in case of an individual, and
and incurred the losses which had been encountered 5% in case of a corporation, of the taxpayers taxable
and suffered by RPPM. Conversely, the income that income (except when the donation is deductible in
would be shielded from taxation is not income that full) to be determined without the benefit of the
was, after much effort, eventually generated by the contribution.
same registered operations which earlier had
sustained losses. We consider and so hold that there 5. It must be evidenced by adequate records or
is nothing in Section 7 (c) of R.A. No. 5186 which receipts.
either requires or permits such a result. Indeed, that
result makes non-sense of the legislative purpose Contributions deductible in full
which may be seen clearly to be projected by Section
7 (c), R.A. No. 5186. 1. Donations to the Philippine Government or to any of
its political subdivisions according to a national
It appears that RPPM and RMC were, like Picop, BOI- priority plan determined by the NEDA.
registered companies. Immediately before merger effective
date, RPPM had over preceding years accumulated losses in 2. Donations to foreign institutions or international
the total amount of P81,159,904.00. In its 1977 Income Tax organizations which are fully deductible in
Return, Picop claimed P44,196,106.00 of RPPM's pursuance of or in compliance with agreements,
accumulated losses as a deduction against Picop's 1977 gross treaties or commitments entered into by the
income. Philippines or in pursuance of special laws.

Upon the other hand, even before the effective date of 3. Donations to accredited non-governmental
merger, on 30 August 1977, Picop sold all the outstanding organizations.
shares of RMC stock to San Miguel Corporation for the sum of
P38,900,000.00, and reported a gain of P9,294,849.00 from * These are fully deductible if the contributions are given to
this transaction. the following: [F. A. G.]
1. Government or its political subdivisions, agencies or
In claiming such deduction, Picop relies on section 7 (c) of instrumentalities, for the purpose of undertaking priority
R.A. No. 5186. projects of the government;
These priority projects include: [S.H.E.]
h. Charitable Contributions a. Sports development, science and invention
b. Health and human settlement
Kinds of charitable contributions c. Educational and economic development

1. Ordinary or those which are subject to limitations as 2. Foreign government or institution and international civic
to the amount deductible from gross income. organizations;

2. Special or those which are deductible in full from 3. Accredited NGO


gross income.
N.G.O. means non-profit domestic corporation which are
Requisite for deductibility of charitable contributions formed and organized for any of the following purposes:
[C.H.E.R.S.]
1. The contribution must actually be paid, or made a. Research
payable to the Philippine government or any political b. Health
subdivision thereof, or any domestic corporation or c. Education
association specified by the NIRC. d. Charitable, cultural, character building

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INCOME TAXATION

e. Sports development and social welfare thereof, where no part of the net income of which
inures to the benefit of any private individual.
The amount of charitable contribution that may be claimed
as deduction may be: 2. Utilizes the contribution directly for the active
conduct of the activities constituting the purpose or
1. In the case of individual taxpayer: function for which it is organized and operated not
th
- Not more than 10% of the net income before charitable later than the 15 day of the month after the close
contribution of accredited NGOs taxable year in which the
contribution were received.
2. In the case of corporate taxpayer:
- Not more than 5% of the net income before the charitable 3. Administrative expenses shall, in no case, exceed
contribution thirty percent (30%) of the total expense.

IF the recipient of such contribution is any of the following 4. The assets, in the event of dissolution, would be
DC formed or organized for: [R.E.C.S.] distributed to another non-profit domestic
1. Religious purpose and rehabilitation of veterans corporation organized for a similar purpose, or to
2. Educational purpose like educational corporations the state for public purpose, or would be distributed
which are not qualified as NGO by a court to another organization.
3. Charitable, cultural purpose
4. Scientific, sports development an social welfare Utilization
purpose
1. Any amount of cash or kind (including administrative
10% or 5% of the net income before charitable expenses) paid or utilized to accomplish one or more
contribution purposes for which the accredited non-
governmental organization was created or
Example: organized.
If an individual taxpayer has a gross income of
P100,000 and the allowable deduction, except charitable 2. Any amount paid to acquire an asset used (or held
contribution, is P50,000. The Charitable contribution is for use) directly in carrying out one or more
P5,000. purposes for which the accredited non-
governmental organization was created or
Deduction first P50,000 from P100,000 and the organized.
result is P50,000.
This P50,000 is the basis of that 10% or 5% of net Proof of deductions
income before charitable contribution. So, 10% of the
P50,000 is P5,000. Hence, the actual contribution of P5,000 Contributions or gifts shall be allowable deductions
may be fully claimed as deduction. only if verified under the rules and regulations prescribed by
the Sec. of Finance.
But let us say, the amount of charitable contribution
is P10,000. So, he can only deduct P5,000 as charitable i. Pension Trusts
contribution, and not the actual amount of P10,000 because
the law imposes a limitation that the amount that may be Requisites for the deductibility of payments to pension trusts
claimed as deduction must not be more than 10% of net
income before charitable contribution. 1. The employer must have established a pension or
retirement plan to provide for the payment of
Non-governmental organization reasonable pensions to his employees.

It means a non-profit domestic corporation: 2. The pension plan is reasonable and sound.

1. Organized and operated exclusively for scientific, 3. it must be funded by the employer.
research, educational, character-building, and youth
and sports development, health, social welfare, 4. the amount contributed must no longer be subject
cultural or charitable purposes, or any combination to the control or disposition of the employer.

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INCOME TAXATION

other words, P200.00 a month. The P2,400.00 is


5. the payment has not been allowed as deduction. the maximum amount that may be claimed as
deductions.
6. the deduction is apportioned in equal parts over a
period of ten (10) consecutive years beginning with b. The family must have an income of not more
the year in which the transfer or payment was made. than P250,000.00 a year.

Contribution to pension trust may refer to the c. The claimant must be the spouse claiming the
current year or past years. additional exemption.
CURRENT YEAR- this is considered as ordinary & necessary
expenses Premiums on life insurance policy is also included here
because it is included under the health insurance policy.
Employer may also make a contribution to the pension plan
in regard to the services rendered for the past 10 years. * If taxpayer has no compensation income, these deductions
may be claimed against the gross income of his business,
j. Research and Development Costs trade, or profession.

A taxpayer may treat research and development PERSONAL EXEMPTIONS


expenditures which are paid or incurred by him during the
taxable year in connection with his trade, business or Personal exemptions are arbitrary amounts allowed,
profession, as ordinary expenses and necessary expenses in the nature of a deduction from taxable income,
which are not chargeable to capital account. The for personal, living or family expenses of an
expenditures so treated shall be allowed as deduction during individual taxpayer. They are considered to be the
the taxable year when paid or incurred. equivalent of the minimum of subsistence of the
taxpayer.
This may not be claimed as deduction if the amount is:
1. Spent for the acquisition or improvements of land or Who are allowed personal exemptions?
for the improvement or development of natural
resources, or a character which is subject to depreciation 1. Citizens
and depletion.
2. Paid or incurred for the purpose of ascertaining the 2. Resident aliens
existence, location, extent or quality of any natural
resources like deposits of ore or other minerals including 3. Non-resident aliens engaged in trade or
oil or gas. business in the Philippines under certain
conditions
D. Other Forms of Deductions
4. Estates and trusts, which are treated for
DECUCTIONS ALLOWED ONLY TO INDIVIDUAL TAXPAYERS purposes of personal exemptions, as a
single individual
Deductions allowed only to individual taxpayers
Amount of personal exemptions allowed to citizens and
1. Personal exemption resident aliens

2. Additional exception P20,000 single person or a married person


judicially decreed as legally separated from his or her
3. Premium payments on health and/or hospitalisation spouse with no qualified dependents. Applies also
insurance if the taxpayer has no compensation to estates under judicial settlement and
income, this can be claimed as deduction from gross irrecoverable trusts.
income from business, trade or profession.
P25,000 head of the family
Premiums on health and hospital insurance
Limitations: P32,000 married person
a. It must not be more than P2,400.00 a year. In

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INCOME TAXATION

Note: Only the spouse deriving taxable income can claim the
P32,000 personal exemption; if both have taxable income, 3. one ore more legitimate, recognized natural, or
each can claim P32,000 exemption. legally adopted children living with and dependent
Head of the family upon him or her for their chief support.

It means an unmarried or legally separated man or Additional exemption


woman with one or both parents, or with one or
more brothers or sisters, or with one or more A married person or a head of a family may claim an
legitimate, recognized natural or legally adopted additional exemption of P8,000 for each dependent,
children living with and dependent upon him or her not exceeding four (4).
for their chief support.
The additional exemption shall be claimed by only
Such brothers or sisters or children should be not one of the spouses in the case of married individuals.
more than 21 years old, unmarried and not gainfully
employed, or where such children, brothers or In the case of legally separated spouses, it may be
sisters, regardless or are, are capable of self-support claimed only by the spouse who has custody of the
because of mental or physical defect. child or children.

A head of family is an individual who actually Dependent


supports and maintains in one household one ore
more individuals, who are closely connected with Refers only to the legitimate, illegitimate or legally
him by blood relationship, relationship by marriage, adopted child of the taxpayer
or by adoption, and whose right to exercise family
control and provide for these dependent individuals The child is:
is based upon some moral or legal obligation.
1. living with the taxpayer;
Note: Consider discrepancy between definition of head of
family and dependent i.e. children. 2. chiefly dependent upon the taxpayer for support;

To be a head of a family, one or more legitimate, 3. not more than 21 years of age;
recognized natural or legally adopted children must live with
and depend on an unmarried or legally separated man or 4. not married; and
woman.
5. not gainfully employed or, even though over 21
A dependent, on the other hand, may be a years old, incapable of self support because of
legitimate, illegitimate or legally adopted child. mental or physical defect.

Both, however, define or qualify different terms.


Change of status
Living with
Taxpayer marries or have additional dependents
The term living with the person giving support
does necessarily mean actual and physical dwelling Taxpayer dies during the taxable year
together at all times and under all circumstances.
If the spouse or any of the dependents dies or if any
Family of such dependent marries, becomes 21 years old, or
becomes gainfully employed
The term family includes an unmarried or legally
separated person with: Note: As a general rule, interpret in favour of taxpayer.
Presumed that the change of status transpired at the end of
1. one or both parents; the taxable year.

2. one or more brothers or sisters; or

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PERSONAL EXEMPTIONS TO NON-RESIDENT ALIEN Exemption the


INDIVIDUAL maximum
allowable
Only personal exemption personal
exemption.
Non-resident alien individual engaged in trade or X
business Additional / / Rule on
Exemption / within within reciprocity X
Entitled only to personal exemption does not
apply.
Amount allowed is limited to exemptions granted to
Filipino citizens who are not residents in the aliens Legend: / - available; X not available
domicile country but not to exceed the amount
allowed to citizens or residents of the Philippines in Head of the family unmarried man or woman legally
the NIRC. separated man or woman who has the following qualified
dependents:
KINDS OF PERSONAL EXEMPTION:

1. Basic personal exemption: 1. Parents - One or both parents. Must be living with
the taxpayer and dependent upon the
a. single or legally separated without Php20,000.00 taxpayer for chief support.
dependent; - Parents must be natural parents.

b. head of the family; Php25,000.00 2. Brothers or sister - To be qualified they must be:
a. Living with the taxpayer;
c. each married individual if both of b. Dependent upon the taxpayer for chief
them are earning Compensation Php32,000.00 support;
income c. Unmarried;
(in case only one of the spouses is d. Not gainfully employed.
deriving gross income, only such e. No more than 21 years old except if
spouse shall be allowed the personal physically or mentally incapacitated;
exemptions) must be brothers or sisters by blood
one is enough
2. Additional exemption

- This only applies to qualified Php8,000.00 for 3. Children- Must be legitimate , illegitimate, legally
dependent child and children such every qualified adopted or stepchildren
as legitimate and illegitimate dependent child but Conditions:
children. not to exceed 4 a. Living with the taxpayer;
b. Dependent upon the taxpayer for chief
support;
Personal Exemption only individual taxpayers, including
c. Unmarried;
estate and trust, are entitled.
d. Not gainfully employed;
e. Not more than 21 years old except if
In case of estate and trust Php20,000.00
physically or mentally incapacitated.
R.C. N.R.C. R.A. NRA-NTB NRA-
NETB
/subject to
the rule on
reciprocity.
/ / / But it must
Personal within within not exceed X

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INCOME TAXATION

Dependent is considered living with the taxpayer even if there is no need of any recognition on the part of the
the former or the latter are not physically together if that is taxpayer.
brought about by force of circumstances. Example if one of
the parents will have to undergo by-pass operation in the U.S. Is this really the intention of law?

Chief Support means more than 50% of the needs of the No. The intention of the law has always been to recognize
dependents are provided by the taxpayer. this illegitimate child and this is one way of compelling the
taxpayers to recognize this child.

Problem: If the child or the brother/sister got married and The President of the Republic of the Phils. cannot issue an
then he has found to be physically or mentally incapacitated, executive order to increase the basic personal exemption
so bumalik si tatay at dependent sa tatay for chief support, because the provision under the Old Tax Code authorizing the
can he qualify as dependent? President to increase the personal and additional exemption
upon the recommendation of the Sec. of Finance has been
Answer: No, physical or mental defect applies only to age removed or deleted by RA 8424.
requirement. Once the child or brother/sister got married, he
is automatically disqualified as dependent. Now, you can only increase the amount of personal and
additional exemption by legislative enactment.
CHANGE OF STATUS:
1. Death of spouse during the taxable year;
2. Death of dependent during the taxable year;
3. Death of the taxpayer during the taxable year; estate of
the taxpayer may claim the basic personal exemption;
4. Additional dependent during the taxable year;
5. Taxpayer got married during the taxable year;
6. Gainful employment of the dependent during the
taxable year
7. Dependent became more than 21 years old during the
taxable year.

Even if the above-mentioned change of status happened


during the taxable year, the taxpayer may still claim the basic
personal exemption because it is as if the change of status
happened at the end of the taxable year.

There is a provision in the Tax Code, which is not so clear.


For purposes of head of the family, in the case of natural
children or child, there is that word acknowledged or
recognized.

For purposes of the definition of head of the family, it is


clear that to qualify as dependent, the natural child or
legitimate child must be acknowledged or recognized by the
taxpayer.
But in the definition of the dependent, dependent means
legitimate, illegitimate or legally adopted child or children.
There is no word acknowledged or recognized.

Was this deliberately omitted by our Congressmen? Does


this imply that since they have so may illegitimate children,
they may not be required to acknowledge or recognize them
and they can claim this illegitimate child as their dependent?
This is not clear. If we will try to interpret the law literally,

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Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen