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
case of individuals. (Note difference in gross
income in indiv. And gross income perse).
Requisites:
b.1 it must arise from personal services under
and employer employee relationship
b.2 It is in the nature of income to the recipient
employee
Example: Directors fee deemed by law as
compensation income ;
Non- compensation income any other income
that is not derived from personal services or not
related to an employer- employee relationship
and is subject to tax on net income basis.
It includes: Capital gain gains from dealings
in capital assets;
Business income gains from selling
merchandise
Professional income fees derived
from engaging in an endeavor requiring
special training as professional
Note: in corporations, both compensation and non
compensation are subjectto tax in the basis of net
income since gross tax scheme is limited to
compensation arising from personal and not
corporater services.
Non taxable income those excluded by law or
th
treaty from taxation. Ex: 13 month pay
Income tax tax on all yearly profits arising from
property, professions, trades or offices or as a
tax on a persons income, emoluments, profits
and the like. It is also a direct tax on actual or
presumed income of a taxpayer
received,accrued or realized during the taxable
year.
Types of income tax:
Personal income tax on individuals
Regular corporate income tax on corporations
Minimum corporate income tax on corporations
Capital gains tax on sale of shares of stocks of
domestic corporation by a person who is not a
dealer in securities
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
Capital gains tax on sale of real property
classified as a capital asset by a person who is
not a real estate dealer or developer; if it is
classified as ordinary asset subject to ordinary
income tax
Tax on passive investment income, such as
interest, dividend and royalty
Fringe benefits tax
Branch profit remittance tax on Philippine
branches of foreign corporations
Tax on improperly accumulated earnings tax of
corporations
Final withholding taxes on certain income from
sources within the Philippines payable to
resident or non resident persons
Capital denotes original investment or fund
used in order to generate earnings which is
called income
Example: Amount of money deposited is
100,000 for 5 years. Interest rate is 12% per
annum. How much is capital? How much is
income per year?
Car bought for 100,000 in year 2008 was sold for
100,000 in year 2010. Depreciation rate is 5%
per annum. How much is capital? How much is
income in year 2010?
Differences Between income and capital
Madrigal Vs Rafferty 38 Phil 414
Income Capital
All wealth other Fund or property existing at
than mere an instant of time, which can
return of capital be used in producing goods
or services
Flow of wealth Fund or property
Service of Wealth
wealth
Income is Return of capital is not
subject to tax subject to tax
Revenue Distinguished from income:
Revenue pertains to all funds accruing to the
treasury of the government derived from tax,
donation, grants and any other source.
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 INCOME TAXATION
Income refers to the earnings of individual
persons, partnership, corporation or estate and
trust whethero or not subject to tax.
TESTS APPLIED IN DETERMINING THE EXISTENCE OF INCOME
1. Severance test income is recognized when there is
separation of something which is of exchangeable
value
2. Realization test no taxable income until there is a
separation from capital of something of
exchangeable value (money), thereby supplying the
realization or transmutation which would result in
the receipt of income.
3. Tax Benefit Rule
4. Economic Benefit Test any economic benefit to the
employee that increases his net worth whatever
may have been the mode by which it is effected is
taxable
5. Claim of Right Doctrine a taxable gain is
conditioned upon the presence of a claim of right to
the alleged gain and the absence of a definite
unconditional obligation to return or repay.
Principle of Constructive receipt of Income
Income which is credited to the account of or
set apart for a taxpayer and which may be
drawn upon by him at anytime is subject to tax
for the year during which so credited or set
apart although not then actually reduced to
possesion.
6. Income from Whatever Source Income sources
whether legal or illegal
REQUISITES FOR THE TAXABILITY OF AN INCOME
1. Existence of a gain- the value received in the form of
cash or its equivalent as a result of rendition of
service or earnings in excess of capital invested.
Example: cancellation of a taxpayers indebtedness
as a remuneration for service rendered is an income.
Note: mere expectation of profit is not an income
and therefore not taxable.
2. Realization of a gain realization of gain may take
the form of actual receipt of cash or may occur as a
constructive receipt of income. Mere increase in the
value of property is not income but merely an
unrealized increase in invested capital.
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
a. Actual
Example:
1. Mr x purchased a land for 10,000. After 3 yrs
the value of the land was 15,000. On the fourth
year Mr X sold the land for 13,000. He paid
1,000 to B as brokers commission.
Formula: Income = Sales proceeds (Cost of land +
necessary expenses for the sale of land)
= 13,000 (10,000 + 1,000)
= 2,000
Income should be reported on the fourth year only
since it was in that year that it was realized.
2. B sold to C a car with FMV of 40 pesos, for 50
pesos on installment with 1/5 purchase price to
be paid annually. C in year 2 paid 20 pesos to B
as payment for years 2 and 3. How much is Bs
income in year 2? Ans: 4 pesos.
b. Constructive (sec 26) an income is considered
constructively received when it is credited to the
account of or segregated in favor of a person.
The person may withdraw the said account
credited in his favor anytime without any
substantial limitations or conditions upon which
payment or enjoyment is to be made or
exercised.
Example: Dividends applied by the corporation
against the indebtedness of a stockholder.
c. Presumptive (24 d)
As If theory of constructive income it
presumes the existence of income on
transactions supposedly not subject to tax.
Example: Real property sold at a loss is subject
to capital gains tax of 6% of the selling price or
fair market value whichever is higher.
3. Gain must not be excluded (Sec 32 B) law or treaty
does not exclude the gain from taxation.
THE PHILIPPINE INCOME TAX SYSTEM
1. Types of Income Tax Systems
a. Schedular System- Different types of incomes
are subject to different sets of graduated or flat
income tax rates. Applicable tax rates will
depend on the classification of the taxable
income and the basis could be gross
income(without deductions) or net income
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 INCOME TAXATION
(deductions were already subracted). (Applic to
phil from Jan 1, 1982 to Dec 31, 1985)
The Recipient of the income files separate
regular income tax return or capital gains tax
return except for passive income subject to final
witholding tax.
Reason for the exception: It is the
witholding agent who is responsible for filing
the witholding tax return and payment of
income tax to the BIR on such passive income of
the investor.
Example:
a) Sale of real property subjected to flat
income tax rates:
Lot classified as capital asset sold
at 500,000 with fair market value of 300,000.
Tax base is either consideration
from sale or FMV whichever is higher
Formula: Capital gains tax = Taxbase x 6%
Solution: CGT = 500,000 x 6%
Ans: 30,000
b) Sale of stocks subjected to graduated tax
rates (Sample only)
Taxbase: value of stocks sold
>100,000 (10%) >200,000 (20% excess)
b. Global System The taxpayer is required to
lump up all items of income earned during a
taxable period and pay a single set of income tax
rates on these different items of income.
Net taxable income is subject to the graduated
income tax rates in case of individuals and to
corporate income tax rates in case of
corporations. It does not matter whether the
income received by the taxpayer is classified as
compensation income, business professional
income, passive investment income, capital gain
or other income. All items of gross income as
well as deductions and personal and additional
exemptions are reported in ONE income tax
return to be filed at least annually and the
applicable tax rate is applied on the tax base.
(applic to phil up to dec 1981)
Example:
Gross income = 100,000
Subtract (-) allowable deductions = 10,000
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
Subtract (-) personal and additional
exemption (does not apply in case of
corporations) =10,000
Difference is Net taxable income = 80,000
80,000 is subjected to graduated
tax rates to arrive at tax due
c. Semi-schedular or semi Global tax system
Under this system, compensation income,
business or professional income, capital gain
and passive income not subject to FWIT (final
withholding income tax) and other income are
added together to arrive at the gross income.
Obtain net taxable income by subtracting from
the gross income the sum of allowable
deductions from business or professional incom,
capital gain, passive income not subject to FWIT
in the case of corporations and personal and
additional exemption in case of individuals and
subject such taxable income to one set of
graduated tax rates (individual) or normal
corporate income tax rate (corporation)
Note: Passive investment income subject to FWIT,
Captal gains from sale or transfer of stocks of a
domestic corp and real properties classified as
capital assets remain subject to different sets of
tax rates and covered by differect tax returns.
Case: Sison Vs Ancheta GR No. L-59431, Jult 25
1984
d. Schedular Rates of Taxes Vs Schedular System
Schedular rates of taxes rates of taxes that
applies to each category of income.
2. The Philippine Income Tax System as a Semi Global
or Mixed System - Effective jan 1, 1986, Executive
order No. 37 adopted the semi-global or semi-
schedular tax system by reducing the graduated
rates on business and professional income from 60%
to 35% and by increasing the preferential tax rates
on capital gains and passive investment incomes. RA
8424 (1998) retained the semiglobal or
semischedular tax system by introducing some
structural and administrative reforms and by
reducing the tax rates on corporations by 1% every
year from 35% to 32%. The same tax system was
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)
1. Services: Place of performance of the service
If the service is performed in the Philippines, the
income is treated as from sources within the
Philippines
It includes compensation for labor or personal
services performed within the Philippines, regardless
of the residence of the payor, of the place in which
the contract for service was made, or of the place of
payment
Compensation is either in cash or in kind
Example:
Juliane a non-resident alien appointed as a commission
agent by a domestic corporation with a sales commission of
10% all sales actually concluded and collected through her
efforts. The local company withheld the amount of P107,000
from her sales commission and remitted the same to the
BIR. She filed a claim for refund alleging that her sales
commission is not taxable because the same was a
compensation for her services rendered in Germany and
therefore considered as income from sources outside the
Philippines. Is her contention correct ?
SUGGESTED ANSWER: Yes. The important factor which
determines the source of income of personal services is not
the residence of the payor, or the place where the contract
for service is entered into, or the place of payment, but the
place where the serviceswere actually performed. Since the
activity of securing the sales were in Germany, thenthe
income did not originate from sources from within the
Philippines.(Commissioner of Internal Revenue v. Baier-Nickel,
G. R. No. 153793,
August 29, 2006)
NOTE AND COMMENTS: In the above case, the SupremeCourt
reiterated the rule that source of income relates to the
property, activity or service that produced the income. With
respect to rendition of labor or personal service, it is the
place where the labor or service was performed that
determines the source of the income.
2. Interest Income: Residence of the debtor
If the obligor or debtor (corporation or otherwise) is
a resident of the Philippines, the interest income is
treated as income from within the Philippines. It
does not matter whether the loan agreement is
signed in the Philippines or abroad or the loan
proceeds will be used in a project inside or outside
the country
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
3. Dividends: Residence of the corporation paying dividend
Dividends received from a domestic corporation or
from a foreign corporation are treated as income
from sources within the Philippines, unless less than
50% of the gross income of the foreign corporation
for the three-year period preceding the declaration
of such dividends was derived from sources within
the Philippines, in which case, only the amount
which bears the same ratio to such dividends as the
gross income of the corporation for such period
derived from sources within the Philippines bears to
its gross income from all sources shall be treated as
income from sources within the Philippines.
4. Rents and Royalties: Location of the property or interest
in such property
If the property or interest is located or used in the
Philippines, the gain or income is treated as income
from sources within the Philippines
5. Sale of property
a. Real Property: Location of real property
If the real property sold is located within the
Philippines, the gain is considered as income from
the Philippines
b. Personal Property
Personal property produced (in whole or in part) by
the taxpayer within the Philippines and sold without
the Philippines, or produced without and sold within
Any gain, profit or income shall be treated
as derived partly from sources within and
partly from sources without the Philippines
Purchase of personal property within and its sale
without the Philippines, or purchase of personal
property without and its sale within the Philippines
Any gain, profit or income shall be treated
as derived entirely from sources within the
country in which sold. Accordingly, if the
goods are shipped in a foreign port under
Free-on-Board (FOB) shipping point
arrangement, title to the good is
transferred at the foreign port and any gain
from the sale of such goods to a Philippine
importer shall be treated as income from
sources outside the Philippines.
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 INCOME TAXATION
DETERMINATION OF GROSS INCOME AND THE
RULES OF INCLUSION AND EXCLUSION FROM
GROSS INCOME
A. THE CONCEPT OF GROSS INCOME
a. Gross income definition
Sec 32. General definition: Except when
otherwise provided in this title (II), gross income
means all income derived from whatever source
including but not limited to the following items:
a. Compensation for services in whatever
form paid including but not limited to fees,
salaries, wages, commissions and other
similar items
b. Conduct of trade or business or the exercise
of a profession
c. Gains derived from the dealings in property
d. Interests
e. Rents
f. Royalties
g. Dividends
h. Annuities
i. Prizes and winnings
j. Pensions
k. Partners distributive share from the net
income of the general professional
partnership
b. Gross sales- total sales for a period before discounts,
returns and freight expenses have been deducted.
B. THE GENERAL RULES ON INCLUSION AND EXCLUSION OF
INCOME OF ITEMS (Section 31, 32A and 32B)
Sec 31. Taxable income defined
Gross Income
Less -Deductions allowed by law
-Personal exemptions
Taxable income
Exclusions Sec 32 B.
Exclusions from Gross Income. - The following items
shall not be included in gross income and shall be
exempt from taxation under this title: (code: MARC
GIL)
(1) Life Insurance.
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
The proceeds of life insurance policies paid
to the heirs or beneficiaries upon the death of
the insured, whether in a single sum or
otherwise, but if such amounts are held by the
insurer under an agreement to pay interest
thereon, the interest payments shall be included
in gross income.
(2) Amount Received by Insured as Return of
Premium.
The amount received by the insured, as a
return of premiums paid by him under life
insurance, endowment, or annuity contracts,
either during the term or at the maturity of the
term mentioned in the contract or upon
surrender of the contract.
(3) Gifts, Bequests, and Devises.
The value of property acquired by gift,
bequest, devise, or descent:
Provided, however, That income from such
property, as well as gift, bequest, devise or
descent of income from any property, in cases
of transfers of divided interest, shall be included
in gross income.
(4) Compensation for Injuries or Sickness.
- amounts received, through Accident or
Health Insurance or under Workmen's
Compensation Acts, as compensation for
personal injuries or sickness, plus the amounts
of any damages received, whether by suit or
agreement, on account of such injuries or
sickness.
(5) Income Exempt under Treaty.
Income of any kind, to the extent required
by any treaty obligation binding upon the
Government of the Philippines.
(6) Retirement Benefits, Pensions, Gratuities, etc.-
(a) Retirement benefits received under
Republic Act No. 7641
and those received by officials and
employees of private firms,
- whether individual or corporate,
in accordance with a reasonable
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 INCOME TAXATION
private benefit plan maintained by
the employer:
Provided,
That the retiring
official or employee has been
in the service of the same
employer for at least ten (10)
years
and is not less than fifty
(50) years of age at the time
of his retirement:
Provided, further,
That the benefits granted
under this subparagraph shall
be availed of by an official or
employee only once.
For purposes of this
Subsection, the term
'reasonable private benefit
plan'
-means a pension,
gratuity, stock bonus or profit-
sharing plan maintained by an
employer for the benefit of
some or all of his officials or
employees, wherein
contributions are made by
such employer for the officials
or employees, or both, for the
purpose of distributing to such
officials and employees the
earnings and principal of the
fund thus accumulated, and
wherein its is provided in said
plan that at no time shall any
part of the corpus or income
of the fund be used for, or be
diverted to, any purpose other
than for the exclusive benefit
of the said officials and
employees.
(b) Any amount received by an official or
employee or by his heirs from the
employer as a consequence of
separation of such official or employee
from the service of the employer
because of death sickness or other
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
physical disability or for any cause
beyond the control of the said official
or employee.
(c) The provisions of any existing law to
the contrary notwithstanding, social
security benefits, retirement gratuities,
pensions and other similar benefits
received by resident or nonresident
citizens of the Philippines or aliens who
come to reside permanently in the
Philippines from foreign government
agencies and other institutions, private
or public.
(d) Payments of benefits due or to become
due to any person residing in the
Philippines under the laws of the
United States administered by the
United States Veterans Administration.
(e) Benefits received from or enjoyed
under the Social Security System in
accordance with the provisions of
Republic Act No. 8282.
(f) Benefits received from the GSIS under
Republic Act No. 8291, including retirement
gratuity received by government officials
and employees.
(7) Miscellaneous Items. -
(a) Income Derived by Foreign
Government.
Income derived from investments
in the Philippines in loans, stocks, bonds or
other domestic securities, or from interest
on deposits in banks in the Philippines by
(i) foreign governments,
(ii) financing institutions
owned, controlled, or
enjoying refinancing from
foreign governments, and
(iii) international or regional
financial institutions
established by foreign
governments.
(b) Income Derived by the Government or
its Political Subdivisions.
- Income derived from any public
utility or from the exercise of any essential
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 INCOME TAXATION
governmental function accruing to the
Government of the Philippines or to any
political subdivision thereof.
(c) Prizes and Awards.
- Prizes and awards made primarily
in recognition of religious, charitable,
scientific, educational, artistic, literary, or
civic achievement but only if:
(i) The recipient was selected
without any action on his part to
enter the contest or proceeding;
and
(ii) The recipient is not required to
render substantial future services
as a condition to receiving the
prize or award.
(d) Prizes and Awards in sports
Competition.
- All prizes and awards granted to
athletes in local and international sports
competitions and tournaments whether
held in the Philippines or abroad and
sanctioned by their national sports
associations.
th
(e) 13 Month Pay and Other Benefits.
- Gross benefits received by
officials and employees of public and
private entities: Provided, however, That
the total exclusion under this subparagraph
shall not exceed Thirty thousand pesos
(P30,000) which shall cover:
(i) Benefits received by officials
and employees of the national and
local government pursuant to
Republic Act No. 6686;
(ii) Benefits received by employees
pursuant to Presidential Decree
No. 851, as amended by
Memorandum Order No. 28, dated
August 13, 1986;
(iv) Benefits received by officials
and employees not covered by
Presidential decree No. 851, as
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
amended by Memorandum
Order No. 28, dated August
13, 1986; and
(iv) Other benefits such as
productivity incentives and
Christmas bonus: Provided,
further, That the ceiling of Thirty
thousand pesos (P30,000) may be
increased through rules and
regulations issued by the Secretary
of Finance, upon recommendation
of the Commissioner, after
considering among others, the
effect on the same of the inflation
rate at the end of the taxable year.
(f) GSIS, SSS, Medicare and Other
Contributions.
- GSIS, SSS, Medicare and Pag-ibig
contributions, and union dues of
individuals.
(g) Gains from the Sale of Bonds,
Debentures or other Certificate of
Indebtedness.
Gains realized from the same or
exchange or retirement of bonds,
debentures or other certificate of
indebtedness with a maturity of more
than five (5) years.
(h) Gains from Redemption of Shares in
Mutual Fund.
- Gains realized by the investor
upon redemption of shares of stock in a
mutual fund company as defined in
Section 22 (BB) of this Code.
C. THE RULES AS APPLIED TO COMPENSATION INCOME AND
OTHER BENEFITS
a. Taxability of compensation income and the application
of the employers convenience rule
Compensation income as defined in sec 32 :
compensation for services in whatever form paid
including but not limited to fees, salaries, wages,
commissions and similar items.
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 INCOME TAXATION
However, this is not the correct definition.
Rev. Reg. 2-98 defines compensation income all
remuneration for services rendered by an employee
for his employer under an ER-EE relationship, unless
specifically excluded under the tax code.
Implications of the definition:
a. There are really tax exempt or excluded gross
compensation income from gross income as
provided in Sec32 B.
b. Not all compensation for services rendered may be
subjected to tax.
Example: in the case of services performed by an
independent contractor in the absence of ER-EE
relationship, the income received by the contractor shall
be recorded as trade or business income. Professional
income should not be included in the gross
compensation income in the absence of ee-er
relationship.
Test whether income is compensation income:
It is not the name of the remuneration upon which it
is paid and the manner of payment, what is
important is that it is derived from ER-EE
relationship.
Test to determine the existence of ER-EE relationship (code:
AC-DC)
A-appointment/selection
C- Compensation or payment of wages
D- Dismissal
C-Compensation
Tax implications when the payment is made for services
rendered
1. For the employer- it may be claimed as
deductible expense. Sec 34 A (1,a,i) provides
reasonable allowance for salaries, wages
2. For the employee- it is a taxable income.
Convenience of the employer rule (Henderson Doctrine)
Allowances in kind furnished to the employee for
and as a necessary incident to the performance of
his duties are not taxable. (Valencia p 174)
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
-this is the justification that may be used in granting
exemptions from income tax on certain benefits that
may be received under an ER-EE relationship.
-examples: food and lodging benefit by a household
maid, driver, etc.
Rules on the application of the doctrine:
A. Living quarters and meals (Valencia p 174)
1. When living quarters are furnished in
addition to cash salary, the rental value of
such quarters should be reported as
income.
2. However if living quarters or meals are
furnished to an employee for the
convenience of the employer, the value
thereof need not be included as part of
compensation income.
Henderson vs. CIR 1 SCRA 650
Unless provided for the exclusive benefit of
the employer, the rental value of living quarters is
compensation income to the employee to the extent
of his reasonable needs and the excess shall be
considered as expenses of the corporation.
The exclusion for meals is allowed only when:
a. They are furnished within the
employers business premises. The
exclusion for lodging is allowed only
when it is furnished within the business
premises of the employer; and
b. The employee accepts the lodging as a
condition of his employment in order
to perform his duties properly.
Unless the above conditions are met, the
value of any board and lodging furnished by
an employer is ordinarily taxable to the
employee.
Rev. Reg 10-2000 : meal allowance for overtime
work is tax exempt under the convenience rule
provided that the meal allowance does not exceed
25% of the basic minimum wage and it applies only
to managerial/supervisory employee.
b.Retirement Payments, Pensions and Gratuities.
c. Separation payments
d. leave benefits
th
e.13 month pay and other bonuses
Page 11

f. SSS/GSIS benefits
g. SSS/GSIS/Philhealth/ Pag ibig/Union dues
Items excluded
Retirement benefit from
a private retirement plan
Separation pay
Social security benefits;
retirement gratuities and
other similar benefits
Benefits from US
Veterans Administration
SSS RA 8282
GSIS- RA 8291
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
INCOME TAXATION
Conditions /particulars
Requisites (code: FORT)
a. Retiring official must be
at least Fifty (50) years
of age.
b. Approved or availed
only Once
c. Reasonable private
benefit plan approved
by the BIR
d. Ten (10) years in service
Note: if the employee is still on
active employment with the
company, any and all the funds
distributed from the fund to the
active member over and above
his personal contributions shall
be taxable.
The benefit shall be tax exempt,
whether his employee is a
private firm or the government
provided the pay is given on
account of:
a. Death
b. Sickness
c. Other physical disability
d. Or any cause beyond
the control of the
official or employee
Received by RC, NRC, and RA
from foreign government
agencies and other private or
public institutions
By veterans residing in the
Pilippines
Tax exempt
Tax exempt
COMMUTATION OR MONETIZED VALUE OF LEAVE PAY
Vacation Leave Sick Leave
If it forms part of the terminal
leave pay
-not taxable -not taxable
If given during the taxable
year with NO retirement to:
a. Government
employees Tax exempt Tax exempt
b. Rank and file Exempt up to 10 days Unused- taxable
h. Fringe benefits
Means any good, services or other benefit
Furnished or granted by employer
In cash or in kind, given in addition to the basic
salary of an individual employee, except rank and file
such as but not limited to the following ( HEV HIM
HEEL)
a. Housing
Exemption: i. Military housing
ii. temporary housing unit
( 3 months or less stay in
the premises)
iii. business premise of
the ER including housing
unit w/in 50 meters from
the perimeter of the
business premise
b. Expense Account
c. Vehicle of any kind
Exemption: i. helicopters or aircrafts
since they are considered
as business expense of
the employer
d. Household personnel-maid, driver, etc
e. Interest on loan at less than market rate (12%
benchmark rate) to the extent of the difference
between the market rate and the actual rate granted
If the actual interest imposed is less than
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
borne by the employer for the employee in social and
athletics clubs or other similar organizations
g. Holiday and vacation expenses
h. Expenses for foreign travel
Exempt if:
1. Required by the nature of the
employers trade, business, or
exercise of profession
2. Paid or incurred in connection with
the business conventions,
meetings or seminars abroad
3. All expenses are substantiated by
receipts or records
4. There must be an official
communication coming from the
business associates abroad
5. Allowance exempt only up to
300.00 dollars.
Tax treatment of the cost of airline ticket
Economy class-exempt
Business class- exempt
st
1 class tickets- exempt only up to 70%
i. Educational assistance to the EE or his
dependents
Exempt in 2 cases:
1. Scholarship grant to managerial or
supervisory employees
2. Scholarship grant to dependents of
an employee
j. Life or health insurance and other non life
premiums or similar amounts in excess of the law
allows.
3 tax exempt life insurance premium
1. GSIS
2. SSS
3. Group insurance policy
Rules on fringe benefits
1. It is subject to final tax
2. Need not be reported as part of the gross income,
since it is subject to final tax.
Sec 33-C Fringe benefits not taxable
1. Fringe benefits which are authorized and
exempt from tax under special laws
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
2. Contributions of the employer for the benefit of
the employee to retirement, insurance and
hospitalization benefit plans
3. Benefits given to the rand and file EE whether
granted under a collective baragaining
agreement or not.
4. De minimis benefits
Recent regulation is Rev Reg 10-
2000
These refer to facilities or
privileges furnished or offered by
an employer to his employee that
are relatively small value and are
offered or furnished by the
employer merely as a means of
promoting health, goodwill,
contentment or efficiency of his
employees.
D. THE RULES AS APPLIED TO TRADE/BUSINESS OF
PROFESSIONAL INCOME
Income covered:
1. Income derived by self employed from trade or
business (trading, manufacturing, merchandising,
farming and others)
Self employment income- consist of the
earnings derived by te individual from:
a. Practice of profession
b. Conduct of trade or business,
as sole proprietor or
c. A partnership of which he is a
member
2. Income derived by professionals from the practice of
profession
Professionals- persons who derive their
income from the practice of their
profession-lawyers and other persons
registered with the PRC. It may also refer to
one who pursues an art and make living
there from such as artists, athletes and
others similarly situated.
Business income- one which entails time, effort
and activity for purpose of livelihood and profit
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 INCOME TAXATION
Formula of gross income:
Example:
Gross sales: 1,000,000,000.00
Less: Cost of investment:
Cost of sale
Cost of goods
Sales allowance
Sales discount
530,000.00
Gross business income: 470,000.00
Example: Suppose Corporation A gave 100,000 to a customs
official to process their license. Is the 100,000 taxable as
income? May the corporation deduct the same as business
expense?
Ans:
On the part of the official: included in
taxable gross income(income from
whatever source)
On the corporation: not deductible.
Unlawful expenses not deductible from
gross income
General professional partnerships
General professional partnerships are partnerships
formed by persons for the sole purpose of exercising
their common profession, no part of the income of
which is derived from engaging in any trade or
business, [Sec. 22 (b), NIRC].
Persons engaging in business as partners in a general
professional partnership shall be liable for income
tax only in their separate and individual capacities,
[Sec. 26, NIRC].
For purposes of computing the distributive share of
the partners, the net income of the partnership shall
be computed in the same manner as a corporation,
[Sec. 26, NIRC].
Each partner shall report as gross income his
distributive share, actually or constructively
received, in the net income of the partnership,[Sec.
26, NIRC]
Income of a general professional partnership are
deemed constructively received by the partners,
[Sec. 73 (d), NIRC].
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
Ordinary business partnership
An ordinary business partnership is considered as a
corporation and is thus subject to tax as such.
Partners are considered stockholders and, therefore,
profits distributed to them by the partnership are
considered as dividends.
Unregistered partnership and co-ownership for tax purposes
If the activities of co-owners are limited to the
preservation of the property and the collection of
income therefrom, in which case, each co-owner is
taxed individually on his distributive share in the
income of the co-ownership.
If the co-owners invest the income in business for
profit, they would be constituting themselves into a
partnership taxable as a corporation.
Joint venture; how created
A joint venture is created when two corporations,
while registered and operating separately, were
placed under a sole management which operated
the business affairs of said companies as though
they constituted a single entity thereby obtaining
substantial economy and profits in the operation.
As stated, a joint venture is not taxed as a
corporation, just like a general professional
partnership.
Non-Resident Alien Engaged in Trade or Business
A non-resident alien engaged in trade or business
shall be subject to the same income tax rates as a
citizen and a resident alien.
Exception: Cash and/or property dividends received
by a non-resident alien Individual shall be subject to
a final tax of 20% for citizens and resident aliens, the
rate is 10% since year 2000.
Non-Resident Alien Not Engaged in Trade or Business
A non-resident alien individual not engaged in trade
or business shall pay a tax equivalent to 25% on all
items of income, except, for gain on sale of shares of
stock in any domestic corporation and real property
which shall be subject to the same rate applied to
other individual taxpayers.
Gain on sale of shares of stock:
1. Not over P100,000 - 5%
2. Over P100,000 -10%
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 INCOME TAXATION
Capital gains on sale or disposition of property 6%
of GSP or FMV, whichever is higher.
General Professional Partnerships
General professional partnerships are partnerships
formed by persons for the sole purpose of exercising
their common profession, no part of the income of
which is derived from engaging in any trade or
business.
Persons engaged in business as partners in a general
professional partnership shall be liable for income
tax only on their separate and individual capacities.
Each partner shall report as gross income his distributive
share, actually or constructively received, in the net income
of the partnership.
The net income of the general professional
partnership shall be computed in the sale manner as
a corporation for purposes of computing the
distributive shares of the partners.
TAX ON CORPORATIONS
CORPORATE TAXPAYER
Corporation, includes, partnerships no matter how created or
organized, joint account companies, or insurance companies
and other associations.
It excludes:
1. General Professional Partnerships;
2. Joint venture for the purpose of
undertaking construction projects;
3. Joint consortium for the purpose of
engaging in petroleum, geothermal and
other energy operations pursuant to a
consortium agreement with the
government.
RATES OF INCOME TAX ON DOMESTIC CORPORATIONS
IN General
Rate of tax, in general:
1997 35%
1998 34%
1999 33%
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
2000 onwards 32%
Tax is imposed on taxable or net income.
These rates are not applicable if the amount
corresponding to the rates are lower than 2% of the
gross income of such corporate income taxpayer.
This is called the Minimum Corporate Income Tax.
Optional 15% tax on gross income
The President, upon the recommendation of the
Secretary of Finance, may, effective Jan. 1, 2000,
allow corporations the option to be taxed at 15% of
gross income, provided certain conditions are
satisfied.
This is available to firms whose ratio of cost of sales
to gross sales or receipts form all sources does not
exceed 55%.
Once elected by the corporation, the option shall be
irrevocable for the succeeding three consecutive
years.
Conditions to be satisfied for the availability of the 15%
optional corporate tax:
1. A tax effort ratio of twenty percent (20%) of the
Gross National Product;
2. A ratio of 40% between total income tax collection
and to total tax revenues;
3. A VAT tax effort ratio of 4% of the Gross National
Product;
4. A 0.9% ration between the Consolidated Public
Sector Financial Position to the GNP.
Some definitions for this purpose:
Gross Income derived from business shall be
equivalent to gross sales, less sales returns,
discounts and allowances, and cost of goods sold.
For taxpayers engaged in the sale of services, gross
income means gross receipts less sales returns,
allowances and discounts.
Cost of goods sold shall include all business
expenses directly incurred to produce the
merchandise to bring them to their present location
and use.
Tax rate for proprietary educational institutions and
hospitals
10% on taxable income, except of certain passive
incomes.
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 INCOME TAXATION
Predominance test The ordinary rate on
corporations shall apply to proprietary educational
institutions and hospitals when their gross income
form unrelated trade, business or other activity
exceeds 50% of their total gross income derived
from all sources.
Unrelated trade, business or other activity
This means any trade, business or other activity, the
conduct of which is not substantially related to the
exercise or performance by such educational
institution or hospital of its primary purpose or
function.
Proprietary educational institution
A proprietary educational institution is any private
school maintained and administered by private
individuals or groups with an issued permit to
operate from the DepEd, CHED, or TESDA, as the
case may be.
GOCCs, AGENCIES OR INSTRUMENTALITIES
All corporations, agencies or instrumentalities
owned or controlled by the government shall pay
such rate of tax upon their taxable income as are
imposed upon corporations or associations engaged
in a similar business, industry, or activity.
Exceptions: GOCCs and instrumentalities not subject
to tax are the ff:
1. GSIS
2. SSS
3. Phil Health Insurance Corporation
4. PCSO
5. PAGCOR
Rule for Corporation exempt from taxation
General rule: those enumerated under Section 30 are exempt
Exception: exempted corporations are subject to income tax
on their income from any of their properties, real or personal,
or from any activities conducted for profit regardless of the
disposition made of such income.
TAX ON RESIDENT FOREIGN CORPORATIONS
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
Resident Foreign Corporation
A resident foreign corporation is one organized,
authorized, or existing under the laws of any foreign
country, engaged in the trade or business within the
Philippines.
In order that a foreign corporation may be regarded
as doing business within a state, there must be
continuity of conduct and intention to establish a
continuous business, such as the appointment of a
local agent, and not one of temporary character.
Tax rates in General
Rate of tax, in general:
1997 35%
1998 34%
1999 33%
2000 onwards 32%
Tax is imposed on taxable or net income.
These rates are not applicable if the amount
corresponding to the rates are lower than 2% of the
gross income of such corporate income taxpayer.
This is called the Minimum Corporate Income Tax
(same as with domestic corporation)
Optional 15% tax on gross income The option to
be taxed at 15% on its gross income is also available
to Resident Foreign Corporations, subject to the
same conditions.
Available to firms whose ratio of cost of
sales to gross sales or receipts from all sources does
not exceed 55%
Tax on specific resident foreign corporations
1. International Carrier 2 of Gross Philippine Billings
2. Offshore Banking Units - !0% of income derived from
foreign currency transactions with local commercial
banks, including branches of foreign banks that may
be authorized by the BSP to transact business with
offshore banking units, including any interest income
derived from foreign currency loans granted to
residents
Any income of non-residents, whether
individuals or corporations, from transactions with
said offshore banking units shall be exempt from
income tax
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 INCOME TAXATION
3. Tax on branch profits remittances 15% of total
profits applied or earmarked for remittance without
deduction for the tax component thereof.
4. Regional or area headquarters shall not be subject to
income tax
5. Regional operating headquarters shall be subject to
a tax of 10% of their taxable income.
Gross Philippine Billings for International carriers
Gross Philippine Billings refer to the amount of
gross revenue derived from carriage of persons,
excess baggage, cargo and mail originating from the
Philippines in a continuous and uninterrupted flight,
irrespective of the place of sale or issue and the
place of payment of the ticket or passage document.
Tickets revalidated, exchanged and/or endorsed to
another international airline form part of the Gross
Philippine Billings of the passenger boards a plane in
a port or point in the Philippines.
For a flight which originates from the Philippines, but
transhipment of passenger takes place at any port
outside the Philippines on another airline, only the
aliquot portion of the cost of the ticket
corresponding to the leg flown from the Philippines
to the point of transhipment shall form part of the
Gross Philippine Billing.
Gross Philippine Billings for International Shipping
Gross Philippine Billings means gross revenue
whether for passenger, cargo or mail, originating
from the Philippines up to final destination,
regardless of the place of sale or payments of the
passage or freight documents.
Tax on branch profit remittances
Any profit remitted by a branch to its head office
shall be subject to a tax of 15% which shall be based
on the total profits applied or earmarked for
remittance without any deduction for the tax
component thereof except those activities which are
registered with the Philippine Economic Zone
Authority.
The following shall not be treated as branch profits
unless the same are effectively connected with the
conduct of its trade or business in the Philippines:
1. Interests
2. dividends
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
3. rents
4. royalties
5. remuneration for technical services
6. salaries
7. wages
8. premiums
9. annuities
10. emoluments
11. other fixed or determinable annual, periodic, or
casual gains, profits, income and capital gains.
Regional or area headquarters of multinational companies
Regional or area headquarters shall not be subject to
income tax.
Regional operating headquarters of multinational
companies
Regional operating headquarters shall pay a tax of
ten percent (10%) on their taxable income.
Tax on certain incomes received by a resident foreign
corporation
1. Interest from deposits and yield or any other
monetary benefit from deposit substitutes, trust
funds and similar arrangements and royalties.
Interest income from any currency bank deposit and
yield or any other monetary benefit from deposit
substitutes and from trust funds and similar
arrangements and royalties derived from sources
within the Philippines shall be subject to a final
income tax at the rate of twenty percent (20%) of
such interest.
However, interest income derived by a resident
foreign corporation from a depository bank under
the expanded foreign currency deposit system shall
be subject to a final income tax at the rate of seven
and one-half percent (7 %) of such interest income.
2. Income derived under the expanded foreign
currency deposit system
This refers to income derived by a depositary bank
under the expanded foreign currency deposit system
from foreign currency transactions with local
commercial banks including branches of foreign
bank that many be authorized by the Bangko Sentral
ng Pilipinas to transact business with foreign
Page 17
 INCOME TAXATION
currency deposit system units and other depositary
banks under the expanded foreign currency deposit
system, including interest income from foreign
currency loans granted by such depositary banks
under said expanded foreign currency deposit
system to residents.
A final income tax at the rate of ten percent (10%) is
imposed on such income.
3. Intercorporate dividends
Dividends received by a resident foreign corporation
from a domestic corporation liable to tax under the NIRC shall
not be subject to income tax.
TAX ON NON-RESIDENT FOREIGN CORPORATION
Taxation of a non-resident foreign corporation, in general
Rates of tax, in general
1997 35%
1998 34%
1999 33%
2000 32%
However, the tax is imposed on gross income, not on
taxable or net income.
Such gross income may include interests, dividends,
rents, royalties, salaries, premiums (except
reinsurance premiums), annuities, emoluments or
other fixed or determinable annual, periodic or
casual gains, profits and income, and capital gains,
except capital gains from the sale of shares of stock
not traded in the stock exchange.
Taxation of certain non-resident foreign corporations
1. Non-resident cinematographic film owner, lessor or
distributor 25% of gross income
2. Non-resident owner or lessor of vessels chartered by
Philippine nationals 4 % of gross rentals, lease or
charter fees
3. Non-resident owner or lessor of aircraft, machineries
and other equipment 7 % of gross rentals or fees
Non-resident cinematographic film owner, lessor
distributor
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
A cinematographic film owner, lessor, or distributor
shall pay a tax of twenty five percent (25%) of its
gross income from all sources within the Philippines.
Non-resident owner or lessor of vessel chartered by
Philippine nationals
A non-resident owner or lessor of vessels shall be
subject to a tax of four and one-half percent (4 %)
of gross rentals, lease or charter fees from leases or
charters to Filipino citizens or corporations, as
approved by the Maritime Industry Authority.
Non-resident owner or lessor of aircraft, machineries and
other equipment
Rentals, charters and other fees derived by a non-
resident lessor of aircraft, machineries and other
equipment shall be subject to a tax of seven and
one-half percent (7 %) of gross rentals or fees.
Tax on certain incomes received by a non-resident foreign
corporation
1. Interest on foreign loans
A final withholding tax at the rate of twenty percent
(20%) is hereby imposed on the amount of interest on
foreign loans contracted on or after 01 August 1986.
2. Intercorporate dividends
A Final withholding tax at the rate of fifteen percent
(15%) is hereby imposed on the amount of cash and/or
property dividends received by a non-resident foreign
corporation from a domestic corporation, subject to the
condition that the country in which the non-resident
foreign corporation is domiciled shall allow a credit
against the tax due from the non-resident foreign
corporation taxes deemed to have been paid in the
Philippines equivalent to thirty two percent (32%) in the
year 2000.
This is the so-called tax sparing rule.
3. Capital gains from sale of shares of stock not traded
in the stock exchange
a. Not over P100,000 5%
b. Over P100,000 10%
or
E. THE RULES AS APPLIED TO PASSIVE INCOME
Passive income
Page 18
 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:

Page 19
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
 INCOME TAXATION
1. If there is a change in the stockholders
interest in the net assets of the corporation;
2. If it is one issued by another corporation.
This is called dividend stock.
Stock dividend vs. Dividend stock: Stock dividend is
not taxable, while dividend stock is taxable
3. Redemption of stock dividend;
4. If the corporation had issued to a
stockholder 2 different classes of shares of
stock, any stock dividend that may be
issued to such stockholder shall be taxable.
A stock dividend representing the transfer of surplus
to capital account shall not be subject to tax.
It shall be taxable only if subsequently cancelled and
redeemed by the corporation.
It is also taxable if it leads to a substantial alteration
in the proportion of tax ownership in a corporation.
Dividends paid in property
Dividends paid in securities or other property, in
which the earnings of a corporation have been
invested, are income to the recipients to the amount
of the full market value of such property when
receivable by individual stockholders.
A dividend paid in a stock of another corporation is
not a stock dividend, even though the stock
distributed was acquired through the transfer by the
corporation declaring the dividends of property to
the corporation the stock of which is distributed as a
dividend. [Section 251, Revenue Regulations 2].
Liquidating dividend
Where a corporation distributes all its assets in
complete liquidation or dissolution, the gain realized
or loss sustained by the stockholder, whether
individual or corporation, is a taxable income or
deductible loss, as the case may be.
Disguised dividends
These are payments which are equivalent to
dividend distribution.
In the case of excessive payments by corporations, if
such payments correspond or bear a close
relationship to stockholdings, and are found to be a
distribution of earnings or profits, the excessive
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
payments will be treated as dividends. [Section 71,
Revenue Regulation 2]
1.Cash and/or property dividends
10% final tax, by January 1, 2000, on the following:
a) Cash and or property dividend actually
or constructively received from a
domestic corporation or from a joint
stock company, insurance or mutual
fund companies and regional operating
headquarters of multinational
companies.
b) Share of an individual in the distributive
net income after tax of a partnership
except a general professional
partnership of which he is a partner
c) Share of an individual in the net income
after tax of an association, joint
account, or a joint venture or
consortium taxable as a corporation of
which he is a member or a co-venturer
2.CIR vs CA and ANSCOR, GR no. 108576, January 20,
1999
Facts: Don Andres Soriano, a citizen and resident of the
United States, formed the corporation "A. Soriano Y Cia",
predecessor of ANSCOR. Don Andres transferred some of his
shares his two sons, Jose and Andres, Jr., as their initial
investments in ANSCOR. Both sons are foreigners.
By 1947, ANSCOR declared stock dividends. Other stock
dividend declarations were made between 1949 and
December 20, 1963. On December 30, 1964 Don Andres
died. As of that date, the records revealed that he has a total
shareholdings of 185,154 shares 50,495 of which are
original issues and the balance of 134.659 shares as stock
dividend declarations. Correspondingly, one-half of that
shareholdings or 92,577 shares were transferred to his wife,
Doa Carmen Soriano, as her conjugal share. The other half
formed part of his estate.
Doa Carmen requested a ruling from the United States
Internal Revenue Service (IRS), inquiring if an exchange of
common with preferred shares may be considered as a tax
avoidance scheme under Section 367 of the 1954 U.S.
Revenue Act. he IRS opined that the exchange is only a
recapitalization scheme and not tax avoidance. Doa Carmen
exchanged her whole 138,864 common shares for 138,860 of
the newly reclassified preferred shares. The estate of Don
Page 20
 INCOME TAXATION
Andres in turn, exchanged 11,140 of its common shares, for
the remaining 11,140 preferred shares, thus reducing its (the
estate) common shares to 127,727.
In 1973, after examining ANSCOR's books of account and
records, Revenue examiners issued a report proposing that
ANSCOR be assessed for deficiency withholding tax-at-source,
pursuant to Sections 53 and 54 of the 1939 Revenue
Code, for the year 1968 and the second quarter of 1969
based on the transactions of exchange 31 and redemption of
stocks. The Bureau of Internal Revenue (BIR) made the
corresponding assessments despite the claim of ANSCOR that
it availed of the tax amnesty under Presidential Decree (P.D.)
23 which were amended by P.D.'s 67 and 157.
Issue: whether the stock dividends of the Late Don are
taxable and not covered by the tax amnesty.
Held: Sec. 83(b) of the 1939 NIRC was taken from the Section
115(g)(1) of the U.S. Revenue Code of 1928. It laid down the
general rule known as the proportionate test wherein stock
dividends once issued form part of the capital and, thus,
subject to income tax.
Specifically, the general rule states that:
A stock dividend representing the transfer
of surplus to capital account shall not be
subject to tax.
the Exception
However, if a corporation cancels or redeems
stock issued as a dividend at such time and in such
manner as to make the distribution and cancellation
or redemption, in whole or in part, essentially
equivalent to the distribution of a taxable dividend,
the amount so distributed in redemption or
cancellation of the stock shall be considered
as taxable income to the extent it represents a
distribution of earnings or profits accumulated
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
device for the actual distribution of cash dividends, which is
taxable.
Although redemption and cancellation are generally
considered capital transactions, as such. they are not subject
to tax. However, it does not necessarily mean that a
shareholder may not realize a taxable gain from such
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
transactions. Simply put, depending on the circumstances,
the proceeds of redemption of stock dividends are essentially
distribution of cash dividends, which when paid becomes the
absolute property of the stockholder. Thereafter, the latter
becomes the exclusive owner thereof and can exercise the
freedom of choice. Having realized gain from that
redemption, the income earner cannot escape income tax
3.Section 73. Distribution of dividends or Assets by
Corporations. -
(A) Definition of Dividends. - The term 'dividends'
when used in this Title means any distribution made
by a corporation to its shareholders out of its
earnings or profits and payable to its shareholders,
whether in money or in other property.
Where a corporation distributes all of its assets in
complete liquidation or dissolution, the gain realized
or loss sustained by the stockholder, whether
individual or corporate, is a taxable income or a
deductible loss, as the case may be.
(B) Stock Dividend. - A stock dividend representing
the transfer of surplus to capital account shall not be
subject to tax. However, if a corporation cancels or
redeems stock issued as a dividend at such time and
in such manner as to make the distribution and
cancellation or redemption, in whole or in part,
essentially equivalent to the distribution of a taxable
dividend, the amount so distributed in redemption
or cancellation of the stock shall be considered as
taxable income to the extent that it represents a
distribution of earnings or profits.
(C) Dividends Distributed are Deemed Made from
Most Recently Accumulated Profits. - Any
distribution made to the shareholders or members
of a corporation shall be deemed to have been made
form the most recently accumulated profits or
surplus, and shall constitute a part of the annual
income of the distributee for the year in which
received.
(D) Net Income of a Partnership Deemed
Constructively Received by Partners. - The 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
imposed therein, shall be deemed to have been
actually or constructively received by the partners in
the same taxable year and shall be taxed to them in
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 INCOME TAXATION
their individual capacity, whether actually
distributed or not.
d.Capital Gains from Sale of Real Property
1. 6% final tax on gross selling price or current fair
market value, whichever is higher
2. imposed upon capital gains presumed to have
been realized from the sale, exchange, or other
dispositions of real property located in the
Philippines, including pacto de retro sales and other
forms of conditional sales
3. law presumes a gain, hence even if the sale was at
a loss (bought for 2M, sold for 1.5M), CGT will still be
imposed on entire process of the disposition.
Reason: the law does not talk about the net gain, it
only considers gross selling price/FMV whichever is
higher
4. refers to real property held as capital asset as
opposed to ordinary asset(used in ordinary course of
business)
5. Rules for disposition to government:
a. taxpayer has option of treating the
proceeds as taxable income (5-32% on net gain) or
as capital gains (6% final tax on FMV/gross selling
price)
b. if second option is chosen it shall be
based on actual consideration and not FMV since the
former is usually lower than FMV (BIR ruling)
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
disposition by judicial order and other forms of
forced disposition
6. Rule for Exchange
- FMV of the property exchanged/given up
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.)
7. exception on principal residence
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
a. gains presumed to have been realized
from sale or disposition of principal residence, the
proceeds of which is fully utilized in acquiring new
principal residence within 18 months from
disposition shall be exempt from CGT
b. can be availed only once every 10 years
c. if the new principal residence is cheaper
than old (meaning there is no full utilization of the
proceeds), the difference will be subject to CGT
d. exemption does not include exchange of
principal residence for a new principal residence ->
subject to rules on exchange above.
e. Sales of shares of stock not listed or trated in the stock
exchange
CAPITAL GAIN DERIVED FROM SALE OF SHARES OF STOCK
Listed and traded through local stock exchange- this
is not subject to income tax but subject to
percentage tax of of 1% of the gross selling price.
Not listed and traded through local stock exchange-
this is the one subject to income tax.
Not over P100,000.00 5%
Amount over P100,000.00 10%
If the share of stock is not listed and traded through
local stock exchange, the basis of the tax is net
capital gain. So, you should first deduct the capital
loss.
If listed and traded through local exchange, there is
no deduction allowed because the basis of the tax
rate of of 1% of the gross selling price.
The above-mentioned tax rates apply to all individual
taxpayers.
Distribution of TREASURY STOCKS should be
considered taxable since the stocks are not sourced
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
- Cancellation of indebtedness Cancellation of
indebtedness has the following tax consequences:
a. It may account to taxable compensation
income if the indebtedness has been
cancelled in consideration of the services
rendered.
b. It may account to taxable gift or donation of
the indebtedness has been cancelled
without any consideration at all.
c. If may amount to capital transaction if the
creditor is a corporation and the debtor is
stockholder. If creditor corporation
condoned the indebtedness of the debtor
stockholder, that may amount to taxable
capital transaction. This is the form of
direct dividend.
- Income from lease and leasehold improvements
Operating lease
An operating lease is a contract under which the
asset is not wholly amortized during the primary
period of the lease, and where the lessor does not
rely solely on the rentals during the primary period
for his profits, but looks for the recovery of the
balance of his costs and for the rests of his profits
from the sale or re-lease of the returned assets at
the end of the primary lease period.
Financial lease
Also called full payout lease is a contract involving
payment over an obligatory period (also called
primary or basic period) of specified rental amounts
for the use of a lessors property, sufficient in total
to amortize the capital outlay of the lessor and to
provide for the lessors borrowing costs and profists.
Obligatory period is primary non-cancellable period
of the lease which in no case shall be less than 730
days.
Lesee exercise choice over the asset.
The following constitutes taxable rent income:
1. The regular rent may be monthly, semi-annually or
annually.
2. Additional rent income which includes:
a. Obligation of the lessor assumed by the
lesee. The following are obligations which
may be assumed by the lessee: [R.I.D.I.O.]
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
a.1. Real property taxed on leased premises
a.2. Obligation to pay insurance premium
on the insured leased premises.
a.3. If the lessor is a corp., the obligation to
distribute Dividends to its stockholders
a.4. Obligation to pay interest on the bonds
issued by the lessor.
a.5. Other obligations of the lessor which
may be assumed by the lesee.
b. Value of permanent improvements on
leased premises. This may be reported
through:
b.1. Outright method at the time of permanent
is completed, he may report that as additional
rent income FMV of the building or permanent
improvement
b.2. Spread out method by allocating the
depreciation among throughout the
remaining term of the leased.
c. Advanced rentals
c.1. If in the nature of the prepaid rentals
without restriction on the use of the
amount, it is taxable.
c.2. If it is in the nature of security deposit,
it is taxable rent income if there is a
violation of the term of the lease.
c.3. If it is in the nature of a loan to the
lessor, it is not taxable.
C. Income from Installment Transactions
Baoas vs. CA
Facts:
On February 20, 1976, petitioner, Bibiano V. Baas Jr. sold to
Ayala Investment Corporation. AYALA issued one promissory
note covering four equal annual installments. Each periodic
payment of P461,754.00 pesos shall be payable starting on
Page 23
 INCOME TAXATION
February 20, 1977, and every year thereafter, or until
February 20, 1980. The same day, petitioner discounted the
promissory note with AYALA, for its face value of
P1,847,016.00. AYALA issued nine (9) checks to petitioner, all
dated February 20, 1976, drawn against Bank of the
Philippine Islands with the uniform amount of two hundred
five thousand, two hundred twenty-four (P205,224.00) pesos.
In his 1976 Income Tax Return, petitioner reported the
P461,754 initial payment as income from disposition of
2
capital asset.
Selling Price of Land P2,308,770.00
3
Less Initial Payment 461,754.00
Unrealized Gain P1,847,016.00
1976 Declaration of Income on Disposition of Capital
Asset subject to Tax:
Initial Payment P461,754.00
Less: Cost of land and other
( 76,547.90)
incidental Expenses
Income P385,206.10
Income subject to tax (P385,206.
P192,603.65
10 x 50%)
In the succeeding years, until 1979, petitioner reported a
uniform income of two hundred thirty thousand, eight
4
hundred seventy-seven (P230,877.00) pesos as gain from
sale of capital asset. In his 1980 income tax amnesty return,
petitioner also reported the same amount of P230,877.00 as
the realized gain on disposition of capital asset for the year.
Revenue Director Mauro Calaguio authorized tax examiners
to examine the books and records of petitioner for the year
1976. They discovered that petitioner had no outstanding
receivable from the 1976 land sale to AYALA and concluded
that the sale was cash and the entire profit should have been
taxable in 1976 since the income was wholly derived in 1976.
The examiners recommended deficiency tax assessment for
two million, four hundred seventy-three thousand, six
hundred seventy-three (P2,473,673.00) pesos. However, after
reviewing the examiners' report, Larin directed the revision of
the audit report, with instruction to consider the land as
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
capital asset. The tax due was only fifty (50%) percent of the
total gain from sale of the property held by the taxpayer
5
beyond twelve months pursuant to Section 34 of the 1977
National Internal Revenue Code (NIRC). The deficiency tax
assessment was reduced to nine hundred thirty six thousand,
five hundred ninety-eight pesos and fifty centavos
(P936,598.50), inclusive of surcharges and penalties for the
year 1976.
respondent Larin sent a letter to petitioner informing of the
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
filed against petitioner for tax evasion.
Issue: Whether respondent court erred in finding that
petitioner's income from the sale of land in 1976 should be
declared as a cash transaction in his tax return for the same
year (because the buyer discounted the promissory note
issued to the seller on future installment payments of the
sale, on the same day of the sale);
Decision: Sec. 43 of the 1977 NIRC states,
Installment basis. (a) Dealers in personal property.
...
(b) Sales of realty and casual sales of personalty In
the case (1) of a casual sale or other casual
disposition of personal property (other than
property of a kind which would properly be included
in the inventory of the taxpayer if on hand at the
close of the taxable year), for a price exceeding one
thousand pesos, or (2) of a sale or other disposition
of real property if in either case the initial payments
do not exceed twenty-five percentum of the selling
price, the income may, under regulations prescribed
by the Minister of Finance, be returned on the basis
and in the manner above prescribed in this section.
As used in this section the term "initial payment"
means the payments received in cash or property
other than evidences of indebtedness of the
purchaser during the taxable period in which the
sale or other disposition is made. . . . (emphasis ours)
Revenue Regulation No. 2, Section 175 provides,
Sale of real property involving deferred payments.
Under section 43 deferred-payment sales of real
property include (1) agreements of purchase and
sale which contemplate that a conveyance is not to
be made at the outset, but only after all or a
Page 24
 INCOME TAXATION
substantial portion of the selling price has been paid,
and (b) sales in which there is an immediate transfer
of title, the vendor being protected by a mortgage or
other lien as to deferred payments. Such sales either
under (a) or (b), fall into two classes when
considered with respect to the terms of sale, as
follows:
(1) Sales of property on the installment
plan, that is, sales in which the payments
received in cash or property other than
evidences of indebtedness of the purchaser
during the taxable year in which the sale is
made do not exceed 25 per cent of the
selling price;
(2) Deferred-payment sales not on the
installment plan, that is sales in which the
payments received in cash or property
other than evidences of indebtedness of the
purchaser during the taxable year in which
the sale is made exceed 25 per cent of the
selling price;
In the sale of mortgaged property the amount of the
mortgage, whether the property is merely taken
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
mortgage, to the extent it does not exceed the basis
to the vendor of the property sold, shall not be
considered as a part of the "initial payments" or of
the "total contract price," as those terms are used in
section 43 of the Code, in sections 174 and 176 of
these regulations, and in this section. The term
"initial payments" does not include amounts
received by the vendor in the year of sale from the
disposition to a third person of notes given by the
vendee as part of the purchase price which are due
and payable in subsequent years. Commissions and
other selling expenses paid or incurred by the
vendor are not to be deducted or taken into account
in determining the amount of the "initial payments,"
the "total contract price," or the "selling price." The
term "initial payments" contemplates at least one
other payment in addition to the initial payment. If
the entire purchase price is to be paid in a lump sum
in a later year, there being no payment during the
year, the income may not be returned on the
installment basis. Income may not be returned on
the installment basis where no payment in cash or
property, other than evidences of indebtedness of
the purchaser, is received during the first year, the
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
purchaser having promised to make two or more
payments, in later years.
Petitioner asserts that Sec. 43 allows him to return as income
in the taxable years involved, the respective installments as
provided by the deed of sale between him and AYALA.
Consequently, he religiously reported his yearly income from
sale of capital asset, subject to tax, as follows:
Year 1977 (50% of P461,754) P230,877.00
1978 230,877.00
1979 230,877.00
1980 230,877.00
Petitioner says that his tax declarations are acceptable modes
of payment under Section 175 of the Revenue Regulations
(RR) No. 2. The term "initial payment", he argues, does not
include amounts received by the vendor which are part of the
complete purchase price, still due and payable in subsequent
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
agreement in the Deed of Sale should not be affected by the
subsequent discounting of the bill.
On the other hand, respondents assert that taxation is a
matter of substance and not of form. Returns are scrutinized
to determine if transactions are what they are and not
declared to evade taxes. Considering the progressive nature
of our income taxation, when income is spread over several
installment payments through the years, the taxable income
goes down and the tax due correspondingly decreases. When
payment is in lump sum the tax for the year proportionately
increases. Ultimately, a declaration that a sale is on
installment diminishes government taxes for the year of
initial installment as against a declaration of cash sale where
taxes to the government is larger.
As a general rule, the whole profit accruing from a sale of
property is taxable as income in the year the sale is made.
But, if not all of the sale price is received during such year,
and a statute provides that income shall be taxable in the
year in which it is "received," the profit from an installment
sale is to be apportioned between or among the years in
13
which such installments are paid and received.
Sec. 43 and Sec. 175 says that among the entities who may
use the above-mentioned installment method is a seller of
real property who disposes his property on installment,
provided that the initial payment does not exceed 25% of the
Page 25
 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

Page 26
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
 INCOME TAXATION

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
Page 27
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
 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
senior citizens is a tax credit, not merely a tax deduction from
the gross income or gross sale of the establishment
concerned. A tax credit is used by a private establishment
only after the tax has been computed; a tax deduction,
before the tax is computed. RA 7432 unconditionally grants a
tax credit to all covered entities. Thus, the provisions of the
revenue regulation that withdraw or modify such grant are
void. Basic is the rule that administrative regulations cannot
amend or revoke the law.
Facts: Respondent is a domestic corporation primarily
engaged in retailing of medicines and other pharmaceutical
products. In 1996, it operated six (6) drugstores under the
business name and style Mercury Drug.
From January to December 1996, respondent
granted twenty (20%) percent sales discount to qualified
senior citizens on their purchases of medicines pursuant to
Republic Act No. [R.A.] 7432 and its Implementing Rules and
Regulations. For the said period, the amount totalled
P904,769.00.
On April 15, 1997, respondent filed its Annual
Income Tax Return 1996 declaring that it incurred net losses
from its operations.
On January 16, 1998, respondent filed with
petitioner a claim for tax refund/credit in the amount of
Prescinding from the above, it could logically be
deduced that tax credit is premised on the existence of tax
liability on the part of taxpayer. In other words, if there is no
tax liability, tax credit is not available.
The MR filed by the respondent was granted by the
CTA. It then ordered petitioner to issue a Tax Credit
Certificate in favor of Central Luzon Drug.
The CA affirmed in toto the Resolution of the Court
of Tax Appeals (CTA) in the reduced amount of P903,038.39.
It reasoned that Republic Act No. (RA) 7432 required neither
a tax liability nor a payment of taxes by private
establishments prior to the availment of a tax credit.
Moreover, such credit is not tantamount to an unintended
benefit from the law, but rather a just compensation for the
taking of private property for public use.
Issue : Is the 20% sales discount a tax credit or a deduction
from gross income or gross sales?
Ruling: The 20% sales discount is a tax credit as expressly
provided for by RA 7432.
Tax Credit versus Tax Deduction
Tax credit generally refers to an amount that is
subtracted directly from ones total tax liability. It
is an allowance against the tax itself or a

Page 28
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
 INCOME TAXATION
deduction from what is owed by a taxpayer to the
government. Examples of tax credits are withheld
taxes, payments of estimated tax, and investment
tax credits.
Tax deduction -- defined as a subtraction from
income for tax purposes, or an amount that is
allowed by law to reduce income prior to *the+
application of the tax rate to compute the amount of
tax which is due. An example of a tax deduction is
any of the allowable deductions enumerated in
Section 34[20] of the Tax Code.
A tax credit differs from a tax deduction. On the
one hand, a tax credit reduces the tax due, including
-- whenever applicable -- the income tax that is
determined after applying the corresponding tax
rates to taxable income.
A tax deduction, on the other, reduces the income
that is subject to tax in order to arrive at taxable
income. To think of the former as the latter is to
avoid, if not entirely confuse, the issue. A tax credit
is used only after the tax has been computed; a tax
deduction, before.
By ordinary acceptation, a discount is an abatement or
reduction made from the gross amount or value of anything.
To be more precise, it is in business parlance a deduction or
lowering of an amount of money; or a reduction from the
full amount or value of something, especially a price. In
business there are many kinds of discount, the most common
of which is that affecting the income statement or financial
report upon which the income tax is based.
To stress, the effect of a sales discount on the income
statement and income tax return of an establishment
covered by RA 7432 is different from that resulting from the
availment or use of its tax credit benefit. While the former is
a deduction before, the latter is a deduction after, the income
tax is computed. As mentioned earlier, a discount is not
necessarily a sales discount, and a tax credit for a simple
discount privilege should not be automatically treated like a
sales discount. Where the law does not distinguish, we ought
not to distinguish.
When the law says that the cost of the discount may be
claimed as a tax credit, it means that the amount -- when
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
claimed -- shall be treated as a reduction from any tax
liability, plain and simple
Granting that there is a tax liability and respondent
claims such cost as a tax credit, then the tax credit can easily
be applied. If there is none, the credit cannot be used and
will just have to be carried over and revalidated accordingly.
If, however, the business continues to operate at a loss and
no other taxes are due, thus compelling it to close shop, the
credit can never be applied and will be lost altogether.
Tax Credit Benefit Deemed Just Compensation
Sections 2.i and 4 of RR 2-94 deny the exercise by the
State of its power of eminent domain. Be it stressed that the
privilege enjoyed by senior citizens does not come directly
from the State, but rather from the private establishments
concerned. Accordingly, the tax credit benefit granted to
these establishments can be deemed as their just
compensation for private property taken by the State for
public use.
SC affirmed Decision and Resolution of the Court of
Appeals.
ii) CIR vs. Central Luzon Drug Corp,
GR No. 148512, 26 June 2006
AZCUNA, J.:
FACTS: Central Luzon Drug Corporation has been a retailer of
medicines and other Pharmaceutical products since
December 19, 1994. In 1995, it opened three (3) drugstores
as a franchisee under the business name and style of
Mercury Drug.
For the period January 1995 to December 1995, in
conformity to the mandate of Sec. 4(a) of R.A. No. 7432
(Senior Citizens Act), petitioner granted a 20% discount on
the sale of medicines to qualified senior citizens amounting to
P219,778.
Pursuant to Revenue Regulations No. 2-94[1]
implementing R.A. No. 7432, which states that the discount
given to senior citizens shall be deducted by the
establishment from its gross sales for value-added tax and
other percentage tax purposes, respondent deducted the
total amount of P219,778 from its gross income for the
taxable year 1995. For said taxable period, respondent
Page 29
 INCOME TAXATION
reported a net loss of P20,963 in its corporate income tax
return. As a consequence, respondent did not pay income
tax for 1995.
Subsequently, on December 27, 1996, claiming that
according to Sec. 4(a) of R.A. No. 7432, the amount of
P219,778 should be applied as a tax credit, respondent filed a
claim for refund in the amount of P150,193, thus:
Since the Commissioner of Internal Revenue was
not able to decide the claim for refund on time,*2+
respondent filed a Petition for Review with the Court of Tax
Appeals (CTA) on March 18, 1998.
The CTA dismissed the petition, declaring that even
if the law treats the 20% sales discounts granted to senior
citizens as a tax credit, the same cannot apply when there is
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
the extent of the tax liability. Also, no refund can be granted
as no tax was erroneously, illegally and actually collected
based on the provisions of Section 230, now Section 229, of
the Tax Code. Furthermore, the law does not state that a
refund can be claimed by the private establishment
concerned as an alternative to the tax credit.
Thus, respondent filed with the CA a Petition for Review.
CA concluded that the 20% discount given to senior
citizens which is treated as a tax credit pursuant to Sec. 4(a)
of R.A. No. 7432 is considered just compensation and, as
such, may be carried over to the next taxable period if there
is no current tax liability.
ISSUE: whether the 20% sales discount granted by
respondent to qualified senior citizens may be claimed as a
tax credit or as a deduction from gross sales.
RULING: The CA and the CTA correctly ruled that based on
the plain wording of the law discounts given under R.A. No.
7432 should be treated as tax credits, not deductions from
income.
The provision of RA 7432 explicitly employed the
word tax credit. Nothing in the provision suggests for it to
mean a deduction from gross sales. To construe it
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
otherwise would be a departure from the clear mandate of
the law.
Accordingly, when the law says that the cost of the
discount may be claimed as a tax credit, it means that the
amount -- when claimed shall be treated as a reduction
from any tax liability.
The tax credit that is contemplated under the Act is a
form of just compensation, not a remedy for taxes that were
erroneously or illegally assessed and collected. In the same
vein, prior payment of any tax liability is not a precondition
before a taxable entity can benefit from the tax credit. The
credit may be availed of upon payment of the tax due, if any.
Where there is no tax liability or where a private
establishment reports a net loss for the period, the tax credit
can be availed of and carried over to the next taxable year.
It must also be stressed that unlike in Sec. 229 of the
Tax Code wherein the remedy of refund is available to the
taxpayer, Sec. 4 of the law speaks only of a tax credit, not a
refund.
The tax credit benefit granted to the establishments
can be deemed as their just compensation for private
property taken by the State for public use. The privilege
enjoyed by the senior citizens does not come directly from
the State, but rather from the private establishments
concerned.
SC affirmed Decision of the Court of Appeals.
iii) Bicolandia Drug Corp vs. CIR GR
No. 142299, 22 June 2006
AZCUNA, J.:
FACTS: Petitioner Bicolandia Drug Corporation is a domestic
corporation principally engaged in the retail of
pharmaceutical products. Petitioner has a drugstore located
in Naga City under the name and business style of Mercury
Drug.
Pursuant to the provisions of R.A. No. 7432 (Senior
Citizens Act), and Revenue Regulations No. 2-94, petitioner
granted to qualified senior citizens a 20% sales discount on
their purchase of medicines covering the period from July 19,
1993 to December 31, 1994.
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 INCOME TAXATION
When petitioner filed its ITR 1993 and 1994, it
claimed as a deduction from its gross income the respective
amounts of P80,330 and P515,000 representing the 20% sales
discount it granted to senior citizens.
However, alleging error in the computation and
claiming that the aforementioned 20% sales discount should
have been treated as a tax credit pursuant to R.A. No. 7432
instead of a deduction from gross income, petitioner filed a
claim for refund or credit of overpaid income tax for 1993 and
1994.
Petitioner contended that Section 4 of R.A. No. 7432
provides in clear and unequivocal language that discounts
granted to senior citizens may be claimed as a tax credit.
Revenue Regulations No. 2-94, therefore, which is merely an
implementing regulation cannot modify, alter or depart from
the clear mandate of Section 4 of R.A. No. 7432, and, thus, is
null and void for being inconsistent with the very statute it
seeks to implement.
The CIR, on the other hand, maintained that the
aforesaid section providing for a 20% sales discount to senior
citizens is a misnomer as it runs counter to the solemn duty
of the government to collect taxes. The Commissioner
likewise pointed out that the provision in question employs
the word may, thereby implying that the availability of the
remedy of tax credit is not absolute and mandatory and it
does not confer an absolute right on the taxpayer to avail of
the tax credit scheme if he so chooses. The Commissioner
further stated that in statutory construction, the
contemporaneous construction of a statute by executive
officers of the government whose duty is to execute it is
entitled to great respect and should ordinarily control in its
interpretation.
The CTA ruled that:
Revenue Regulations No. 2-94
gave a new meaning to the phrase tax
credit, interpreting it to mean that the 20%
discount granted to qualified senior citizens
is an amount deductible from the
establishments gross sales, which is
completely contradictory to the literal or
widely accepted meaning of the said
phrase, as an amount subtracted from an
individuals or entitys tax liability to arrive
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
at the total tax liability (Blacks Law
Dictionary).
In view of such apparent
discrepancy in the interpretation of the
term tax credit, the provisions of the law
under R.A. 7432 should prevail over the
subordinate regulation issued by the
respondent under Revenue Regulation No.
2-94. x x x
On the issue of whether or not petitioner is entitled
to the claim for refund of its overpaid income taxes for the
years 1993 and 1994 based on the evidence at hand, the CTA
ordered CIR to ISSUE tax credit certificates in favor of
petitioner [in] the amounts representing overpaid income tax
for the years 1993 and 1994. On the other hand, the CIRs
Motion for Reconsideration is DENIED for lack of merit.
Consequently, the Commissioner filed a petition for
review with the CA asking for the reversal of the CTA Decision
and Resolution. However, CA denied such petition.
Issue: The matter to be determined is the amount of tax
credit that may be claimed by a taxable entity which grants a
20% sales discount to qualified senior citizens on their
purchase of medicines. Is it the acquisition cost or the actual
amount of discount?
Ruling:
Section 4(a) of R.A. No. 7432 states that:
Sec. 4. Privileges for the Senior citizens.
The senior citizens shall be entitled to the following:
a) the grant of twenty percent (20%)
discount from all establishments relative to
utilization of transportation services, hotels and
similar lodging establishments, restaurants and
recreation centers and purchase of medicines
anywhere in the country: Provided, That private
establishments may claim the cost as tax credit.
The term "cost" in the above provision refers to the
amount of the 20% discount extended by a private
establishment to senior citizens in their purchase of
medicines. This amount shall be applied as a tax credit, and
may be deducted from the tax liability of the entity
concerned. If there is no current tax due or the establishment
Page 31
 INCOME TAXATION
reports a net loss for the period, the credit may be carried
over to the succeeding taxable year. This is in line with the
interpretation of this Court in Commissioner of Internal
9
Revenue v. Central Luzon Drug Corporation wherein it
affirmed that R.A. No. 7432 allows private establishments to
claim as tax credit the amount of discounts they grant to
senior citizens.
Accordingly, petitioners claim for refund must be
denied. The law expressly provides that the discount given to
senior citizens may be claimed as a tax credit, and not a
refund.
iv) CIR vs. Central Luzon Drug Corp,
GR No. 159610, 12 June 2008 (in
relation to RA 9257) CARPIO, J.:
Facts: Respondent is a domestic corporation engaged in the
retail of medicines and other pharmaceutical products. In
1997, it operated eight drugstores under the business name
6
and style "Mercury Drug."
Pursuant to the provisions of RA 7432 and Revenue
Regulations No. (RR) 2-94 issued by the BIR, respondent
granted 20% sales discount to qualified senior citizens on
their purchases of medicines covering 1997 which totalled
P2,798,508.00.
Respondent filed its 1997 Corporate Annual ITR
reflecting a nil income tax liability due to net loss incurred
from business operations of P2,405,140.00. Respondent filed
its 1997 ITR under protest.
In March 1999, respondent filed with the petitioner
a claim for refund or credit of overpaid income tax for the
taxable year 1997 in the amount of P2,660,829.00.
Respondent alleged that the overpaid tax was the result of
the wrongful implementation of RA 7432. Respondent
treated the 20% sales discount as a deduction from gross
sales in compliance with RR 2-94 instead of treating it as a tax
credit as provided under Section 4(a) of RA 7432.
Petitioner contended that the construction given to
a statute by a specialized administrative agency like the BIR is
entitled to great respect and should be accorded great
weight. When RA 7432 allowed senior citizens' discounts to
be claimed as tax credit, it was silent as to the mechanics of
availing the same. For clarification, the BIR issued RR 2-94 and
defined the term "tax credit" as a deduction from the
establishment's gross income and not from its tax liability in
12
order to avoid an absurdity that is not intended by the law.
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
The Ruling of the Court of Tax Appeals
The CTA rendered ordered petitioner to issue a tax credit
certificate in the amount of P2,376,805.63 in favor of
respondent. In a number of analogous cases, CTA has
consistently ruled that the 20% senior citizens' discount
should be treated as tax credit instead of a mere deduction
from gross income. In quoting its previous decisions, the CTA
ruled that RR 2-94 engraved a new meaning to the phrase
"tax credit" as deductible from gross income which is a
deviation from the plain intendment of the law. An
administrative regulation must not contravene but should
conform to the standards that the law prescribes.
The CTA also ruled that respondent has properly
substantiated its claim for tax credit by documentary
evidence. However, based on the examination, the CTA
deemed it proper to consider the lesser of two amounts.
Aggrieved by the CTA's decision, petitioner elevated the case
before the Court of Appeals.
The Ruling of the Appellate Court
The CA affirmed the CTA's decision in toto.
The CA distinguished "tax credit" as an amount subtracted
from a taxpayer's total tax liability to arrive at the tax due
while a "tax deduction" reduces the taxpayer's taxable
income upon which the tax liability is computed. "A credit
differs from deduction in that the former is subtracted from
tax while the latter is subtracted from income before the tax
19
is computed."
Hence, this petition.
Issue: Whether the respondent may claim the 20% senior
citizens' sales discount as a tax credit deductible from future
income tax liabilities instead of a mere deduction from gross
income or gross sales
The Ruling of the Court
The petition lacks merit.
In two similar cases involving the same parties on the same
issues, the Court has squarely ruled that the 20% senior
citizens' discount required by RA 7432 may be claimed as a
tax credit and not merely a tax deduction from gross sales or
gross income. Under RA 7432, Congress granted the tax credit
benefit to all covered establishments without conditions. The
net loss incurred in a taxable year does not preclude the
Page 32
 INCOME TAXATION
grant of tax credit because by its nature, the tax credit may
still be deducted from a future, not a present, tax liability.
However, the senior citizens' discount granted as a tax credit
cannot be refunded.
RA 7432 expressly allows private establishments
to claim the amount of discounts they grant to
senior citizens
as tax credit.
Section 4(a) of RA 7432 states:
SECTION 4. Privileges for the Senior Citizens.
- The senior citizens shall be entitled to the
following:
a) the grant of twenty percent
(20%) discount from all
establishments relative to the
utilization of transportation
services, hotels and similar lodging
establishments, restaurants and
recreation centers and purchase of
medicines anywhere in the
country: Provided, That private
establishments may claim the cost
as tax credit; (Emphasis supplied)
However, RR 2-94 interpreted the tax credit
provision of RA 7432 in this wise:
Sec. 2. DEFINITIONS. - For purposes
of these regulations:
xxx
i. Tax Credit - refers to the amount
representing 20% discount
granted to a qualified senior
citizen by all establishments
relative to their utilization of
transportation services, hotels and
similar lodging establishments,
restaurants, drugstores, recreation
centers, theaters, cinema houses,
concert halls, circuses, carnivals
and other similar places of culture,
leisure and amusement, which
discount shall be deducted by the
said establishments from their
gross income for income tax
purposes and from their gross
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
sales for value-added tax or other
percentage tax purposes.
(Emphasis supplied).
xxx
Sec. 4. Recording/Bookkeeping
Requirement for Private
Establishments
xxx
The amount of 20% discount shall
be deducted from the gross
income for income tax purposes
and from gross sales of the
business enterprise concerned for
purposes of the VAT and other
percentage taxes. (Emphasis
supplied)
Tax credit is defined as a peso-for-
peso reduction from a taxpayer's tax
liability. It is a direct subtraction from the
tax payable to the government. On the
other hand, RR 2-94 treated the amount of
senior citizens' discount as a tax deduction
which is only a subtraction from gross
income resulting to a lower taxable income.
RR 2-94 treats the senior citizens' discount
in the same manner as the allowable
deductions provided in Section 34, Chapter
VII of the National Internal Revenue Code.
RR 2-94 affords merely a fractional
reduction in the taxes payable to the
government depending on the applicable
tax rate.
In Commissioner of Internal Revenue v. Central Luzon
Drug Corporation, the Court ruled that petitioner's definition
in RR 2-94 of a tax credit is clearly erroneous. To deny the tax
credit, despite the plain mandate of the law, is indefensible.
In Commissioner of Internal Revenue v. Central Luzon Drug
Corporation, the Court declared, "When the law says that the
cost of the discount may be claimed as a tax credit, it means
that the amount- when claimed shall be treated as a
reduction from any tax liability, plain and simple."
The tax credit may still be deducted
from a future, not a present, tax liability.
Page 33
 INCOME TAXATION
Petitioner-CIR alleged that respondent incurred a net
loss from its business operations in 1997; hence, it did not
pay any income tax. Since no tax payment was made, it
follows that no tax credit can also be claimed because tax
credits are usually applied against a tax liability.
In Commissioner of Internal Revenue v. Central Luzon
Drug Corporation, the Court stressed that prior payment of
tax liability is not a pre-condition before a taxable entity can
avail of the tax credit. The Court declared, "Where there is no
tax liability or where a private establishment reports a net
loss for the period, the tax credit can be availed of and
carried over to the next taxable year." It is irrefutable that
under RA 7432, Congress has granted the tax credit benefit to
all covered establishments without conditions. Therefore,
neither a tax liability nor a prior tax payment is required for
the existence or grant of a tax credit.
Hence, respondent is entitled to claim the amount of
P2,376,805.63 as tax credit despite incurring net loss from
business operations for the taxable year 1997.
The senior citizens' discount may be claimed
as a tax credit and not a refund.
Section 4(a) of RA 7432 expressly provides that
private establishments may claim the cost as a tax
credit. A tax credit can only be utilized as payment
for future internal revenue tax liabilities of the
taxpayer while a tax refund, issued as a check or a
warrant, can be encashed. A tax refund can be
availed of immediately while a tax credit can only be
utilized if the taxpayer has existing or future tax
liabilities.
Hence, the senior citizens' discount may be claimed as a tax
credit and not as a refund.
RA 9257 now specifically provides that all covered
establishments
may claim the senior citizens' discount as tax
deduction.
On 26 February 2004, RA 9257, otherwise known as
the "Expanded Senior Citizens Act of 2003," was
signed into law and became effective on 21 March
2004.
31
RA 9257 has amended RA 7432.
Section 4(a) of RA 9257 reads:
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
"Sec. 4. Privileges for the Senior
Citizens. - The senior citizens shall
be entitled to the following:
(a) the grant of twenty percent
(20%) discount from all
establishments relative to the
utilization of services in hotels and
similar lodging establishments,
restaurants and recreation centers,
and purchase of medicines in all
establishments for the exclusive
use or enjoyment of senior citizens,
including funeral and burial
services for the death of senior
citizens;
xxx
The establishment may claim the
discounts granted under (a), (f),
(g) and (h) as tax deduction based
on the net cost of the goods sold or
services rendered: Provided, That
the cost of the discount shall be
allowed as deduction from gross
income for the same taxable year
that the discount is granted.
Provided, further, That the total
amount of the claimed tax
deduction net of value added tax if
applicable, shall be included in
their gross sales receipts for tax
purposes and shall be subject to
proper documentation and to the
provisions of the National Internal
Revenue Code, as amended."
(Emphasis supplied)
Contrary to the provision in RA 7432 where the senior
citizens' discount granted by all covered establishments can
be claimed as tax credit, RA 9257 now specifically provides
that this discount should be treated as tax deduction.
With the effectivity of RA 9257 on 21 March 2004, there is
now a new tax treatment for senior citizens' discount granted
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
taxable year 1997 and is thus governed by the old law, RA
7432.
Page 34
 INCOME TAXATION
The Decision of the CA was AFFIRMED.
B. KINDS OF ALLOWABLE DEDUCTIONS
a) Optional Standard Deductions (OSD)
b) Special Deductions
c) Itemized Deductions (ID)
SPECIAL DEDUCTIONS those which are allowed by law to
specific taxpayers only.
1. Private Proprietary Educational Institutions (PPEI)
[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
depreciable assets for expansion of school facilities
such as:
a) Outright expense (the entire amount is
deducted from gross income); or
b) Capital asset and deduct only from the gross
income an amount equivalent to its
depreciation every year.
2. Insurance Companies (Section 37, NIRC) can deduct
the following:
a) Net additions required by law to be made within
the year to reserve funds; AND
b) Sums other than dividends paid within the year
on policy and annuity contracts
3. Estates and Trusts (Section 61, NIRC) can deduct the
following:
a) Amount of income paid, credited or
distributed to the heirs/ beneficiaries;
AND
b) Amount applied for the benefit of the
grantor
C. THE OPTIONAL STANDARD DEDUCTION (RA 9054, June
17, 2008)
Earlier, only individual subject to tax under Section
24 of the NIRC (other than a non resident alien) may elect a
standard deduction. However, the new RA 9504 (Act
Amending among others Section 34 of the NIRC) allows OSD
not only to individual taxpayer (other than a non-resident
alien) but also to corporation subject to tax under Section
27(A) and 28 (A)(1) of the Tax Code.
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
In lieu of the itemized allowable deductions, the OSD
may be deducted from the gross income as follows:
a) An individual other than a
non resident alien OSD
must not exceed 40% of
his gross sales or gross
receipts
b) A corporation OSD is not
exceeding 40% of its gross
income
From its name itself, standard deduction is optional
(Mamalateo, page 213). The taxpayer must signify in his
return that he elects the OSD, otherwise he shall be
considered as having availed of the itemized deductions.
The Tax Code provides that once a taxpayer elected
a deduction (either OSD or itemized) in his ITR, such election
is irrevocable for the taxable year which the return is made
[Section 34(L), NIRC]. Hence, the taxpayer can change to
itemized deductions in succeeding years. (Mamalateo, page
213).
Requites for the exercise of OSD:
1) Available to both corporations and individuals
other than non-resident aliens
2) OSD is optional - taxpayer signifies in his return
his intention to elect OSD otherwise he is
considered as having availed of ID
3) Election is irrevocable for the year in which it is
made
4) Amount is limited to 40% of taxpayers gross
income or gross receipts
5) Proof of actual expenses is not required.
Illustration 1 (Individual Taxpayer):
Mr. X, a practicing lawyer, received
a total professional fee amounting to
P600K during the taxable year. His related
itemized deduction allowed amounted to
P100K. Mr. X opted to deduct OSD in lieu
of itemized deductions (ID).
Page 35
 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

Page 36
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
 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.

Page 37
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
 INCOME TAXATION
payments made in cash or cash
equivalents over a period of more
than one year.
are used to acquire assets or improve
the useful life of existing assets.
Ordinary Expenditure
expenses commonly incurred in the
trade or business of the taxpayer with
a useful life of not more than one
year.
iii. Rule re: Proprietary Educational
Institutions
deduct expenditures otherwise
considered as capital outlays
o capital outlays- same as capital
expenditures
deduct allowance for depreciation
iv. Reasonableness Test
CIR v. General Foods, Inc. (G.R. No. 143672
April 24, 2003)
Issue: WON the subject media advertising
expense for "Tang" incurred by respondent
corporation was an ordinary and necessary
expense fully deductible under the NIRC.
Held: NO!
o If the advertising is designed to stimulate
the future sale of merchandise or use of
services, it is not deductible as an ordinary
and necessary expense. Rationale- "it has
not been established that the item being
claimed as deduction is excessive."
o There is yet to be a clear-cut criteria or
fixed test for determining the
reasonableness of an advertising expense.
o There being no hard and fast rule on the
matter, the right to a deduction depends
on a number of factors such as but not
limited to:
1) the type and size of business in
which the taxpayer is engaged;
2) the volume and amount of its
net earnings;
3) the nature of the expenditure
itself;
4) the intention of the taxpayer
and the general economic
conditions.
CM Hoskins v. CIR (G.R. No. L-24059 November 28,
1969)
Issue: WON payment by the taxpayer to its
controlling stockholder of 50% of its
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
supervision fees or the amount of P99,977.91 is
a deductible ordinary and necessary expense
and should be treated as a distribution of
earnings and profits of the taxpayer.
Held: NO!
o For income tax purposes the employer
cannot legally claim such bonuses as
deductible expenses unless they are shown
to be reasonable.
o CM Hoskins is bound to pay the income tax
imposed by law on corporations and may
not legally be permitted, by way of
corporate resolutions authorizing payment
of inordinately large commissions and fees
to its controlling stockholder, to dilute and
diminish its corresponding corporate tax
liability.
v. Representation Expenses
these are entertainment, amusement and
recreation expenses
incurred or paid during the year that are
directly connected to the development,
management and operation of the trade,
business or profession of the taxpayer
Requisites:
1) It must be substantiated with sufficient
evidence such as receipts and or
adequate records;
2) It must be limited to the ceiling
requirement as provided in Rev. Reg.
10-2002
of net sales for taxpayers
engaged in sale of
goods/properties; or
1% of the net revenue for
taxpayers engaged in sale of
services, including exercise of
profession and use or lease of
properties.
vi. Substantiation Rule and Cohan Rule
Substantiation Rule-
All deductions from gross
income must be
substantiated with sufficient
evidence, and as official
receipts and other adequate
records.
Cohan Rule-
Where it is certain from the
evidence adduced that the
taxpayer did incur expenses
but the actual amount
Page 38
 INCOME TAXATION
thereof has not established,
the Commissioner should
make a close approximate
thereof.
Gancayco v. CIR (G.R. No. L-13325 April 20,
1961)
Issue: WON the sum of P16,860.31 is due from
Gancayco as deficiency income tax for 1949
hinges on the validity of his claim for deduction
of two (2) items, namely: (a) for farming
expenses, P27,459.00; and (b) for representation
expenses, P8,933.45.
Held: Partly YES, Partly NO!
o Gancayco's claim for representation
expenses aggregated P31,753.97, of which
P22,820.52 was allowed, and P8,933.45
disallowed.
o Such disallowance is justified by the record,
for, apart from the absence of receipts,
invoices or vouchers of the expenditures in
question, petitioner could not specify the
items constituting the same, or when or on
whom or on what they were incurred.
b. Bad Debts
debts due to the taxpayer which are
actually ascertained to be worthless and
charged off within the taxable year.
Requisites:
1) There must be a valid and subsisting
debt;
2) The debt must be actually ascertained
to be worthless and uncollectible
during the taxable year;
3) The debt must be charged off during
the taxable year; and
4) The debt must be connected with the
trade, business or profession of the
taxpayer, and not sustained in a
transaction entered into between
related taxpayers.
i. Tax Benefit Rule
GR: the recovery of
amounts deducted in
previous years from gross
income become taxable
income
XPN: to the extent thereof
the deduction did not
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
result in any benefit to the
taxpayer
Otherwise stated, if the
recovery of bad debts
resulted in a tax benefit to
the taxpayer, that is
taxable. If it did not result
in any tax benefit to the
taxpayer, that is not
taxable.
c. Interests
i. Requisites:
1) This must be paid or incurred
DURING the taxable year.
2) This must be paid or incurred in
connection with the trade,
business or profession of the
taxpayer
3) There must be an obligation which
is valid and subsisting.
4) There must be an agreement in
writing to pay interest.
ii. Tax Arbitrage Scheme
If a taxpayer incurred indebtedness
and interest expense connected
with his trade or business during the
taxable year and also earned
interest income which had been
subjected to final withholding tax,
the amount of interest expense
shall be subject to the limitation as
provided for by law.
It was stressed that the law did not
require that there be a tax arbitrage
in order that the limitation on the
deduction of the interest expense
can be applied. RR No. 13-00 itself
specifically provides that the
limitation shall apply regardless of
whether or not a tax arbitrage
scheme was entered into by the
taxpayer.
REVENUE REGULATIONS NO. 13-
2000 issued December 29,
2000 implements the provisions of
Section 34(B) of the Tax Code of
1997 relative to the requirements
for the deductibility of interest
expense from the gross income of a
corporation or an individual
engaged in trade, business or in the
practice of profession.
Page 39
 INCOME TAXATION
oIn general, subject to certain
limitations, the following are
the requisites for the
deductibility of interest
expense from gross income:
1) there must be an
indebtedness;
2) there should be an interest
expense paid or incurred
upon such indebtedness;
3) the indebtedness must be
that of the taxpayer;
4) the indebtedness must be
connected with the
taxpayer's trade, business
or exercise of profession;
5) the interest expense must
have been paid or incurred
during the taxable year;
6) the interest must have
been stipulated in writing;
7) the interest must be legally
due;
8) the interest payment
arrangement must not be
between related taxpayers
9) the interest must not be
incurred to finance
petroleum operations; and
10) in case of interest incurred
to acquire property used in
trade, business or exercise
of profession, the same was
not treated as a capital
expenditure.
iii. On Capital Expenditure
At the option of the taxpayer, interest
incurred to acquire property used in
trade, business or exercise of a
profession may be allowed as a
deduction or treated as a capital
expenditure.
iv. Rules re: deductibility
Taxpayer is not entitled to both:
o deduction from gross income;
and
o increased basis for
determining gain or loss and
the allowable depreciation
charge.
interest on unclaimed salaries of the
employees- not deductible
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
interest charged to the capital of the
taxpayer- not deductible
interest on preferred stock- not
deductible; XPN- if it is not dependent
upon corporate profits or earnings
INTEREST ON GOVT SECURITIES is now
taxable.
v. Interest on Tax Delinquencies
For interest to be allowed as deduction
from gross income, it must be shown
that there be an indebtedness, that
there should be interest upon it, and
that what is claimed as an interest
deduction should have been paid or
accrued within the year.
The term indebtedness has been
defined as an unconditional and legally
enforceable obligation for the payment
of money. Within the meaning of that
definition, a tax may be considered as
an indebtedness.
Hence, interest paid for late payment
of the donors tax in deductible from
gross income.
The interest on deficiency
donors tax is deductible.
The SC explained that
taxes here are considered
obligations or
indebtedness. And it ruled
that we have to relax the
distinction between tax
and ordinary obligation in
this respect.
Interest on deficiency
income tax can also be
claimed as deductible
interest expense because
taxes here are considered
ordinary obligations.
d. Taxes
i. Requisites:
1. It must be paid or incurred within the
taxable year;
2. It must be paid or incurred in
connection with the taxpayers
profession, trade or business; and
3. The tax must be imposed directly upon
the taxpayer
ii. Deductible Taxes
1. Import duties
Page 40
 INCOME TAXATION
2. Local Business taxes
3. Occupation taxes
4. Privilege and license taxes
5. Excise taxes
6. Documentary stamp taxes
7. Automobile registration fees
8. Community Tax
9. Municipal Tax
iii. Non-deductible Taxes
1. Philippine income tax
2. Foreign income tax, if claimed as tax
credit
3. Estate and donors taxes
4. Value-added tax
5. Taxes not related to business, trade, or
profession
6. Other items related to tax such as:
(1) special assessment tax
(2) surcharges
(3) compromise penalty
Interest
delinquent taxes can
be deducted
interest expense at its
full amount.
e. Depreciation
gradual diminution in the useful value of
tangible property used in trade, business or
profession resulting from exhaustion, wear
and tear, and obsolescence
also applied to amortization of the value of
intangible assets, the use of which in trade or
business is definitely limited in duration
Requisites:
1. The allowance for depreciation must
be reasonable.
2. It must be for property used in the
trade, business, or profession.
3. It must be charged off during the
taxable year.
4. The asset must have a limited useful
life.
5. The depreciable asset must be
located in the Philippines if a
taxpayer is a nonresident alien or a
foreign corporation.
i. Properties subject to depreciation
1) Depreciation of Properties Used in
Petroleum Operations
- An allowance for depreciation in respect of all
properties DIRECTLY related to production of
petroleum shall be allowed under the
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
straightline or declining-balance method of
depreciation at the option of the service
contractor.
- However, if the service contractor initially
elects the declining-balance method, it may
shift to the straightline method.
- The useful life of properties used in or related
to production of petroleum shall be ten (10)
years or such shorter
life as may be permitted by the
Commissioner.
- Properties NOT USED DIRECTLY in the
production of petroleum shall be depreciated
under the straight- line method on the basis
of an estimated useful life of 5 years.
2) Depreciation of Properties Used in
Mining Operations
- An allowance for depreciation in respect of all
properties used in mining
operations other than petroleum operations,
shall be computed as follows:
on a. At the normal rate of depreciation if the
expected life is ten (10) years or
as less; or
b. Depreciated over any number of years
between five (5) years and the expected
life IF more than ten (10) years,
- Provided, That the contractor notifies the
Commissioner at the beginning of the
depreciation period which depreciation rate
allowed will be used.
- Depreciation Deductible by Nonresident Aliens
Engaged in Trade or Business (NRAETB) or
Resident Foreign Corporations (RFC)
A reasonable allowance for the
deterioration of property arising out
of its use or employment or its non-
use in the business, trade or
profession shall be permitted only
when such property is located in the
Philippines.
Deduction for obsolescence
If the whole or any portion of the physical property
is clearly shown by the taxpayer as being affected by
economic conditions that will result in its being
abandoned at a future date prior to the end of its
natural life, so that depreciation deductions alone
would be insufficient to return the cost at the end of
its economiv terms of usefulness, reasonable
deduction for obsolescence, in addition to
depreciation, may be allowed.
Page 41
 INCOME TAXATION
Property held for life
In case of property held by one person for life with
remainder to another person, the deduction, shall be
computed as if the life tenant were the absolute
owner of the property and, shall be computed as
such to the life tenant.
In case of property held in trust
Allowable deductions shall be apportioned between
the income beneficiaries and the trustees in
accordance with the pertinent provisions of the
instrument creating the trust, or in the absence of
such provisions, on the basis of the trust income
allowable to each.
ii. Allowable Modes of Depreciation
1. The straight line method Equal
depreciation per unit of time,
regardless of use or production output
of the property.
2. Declining balance method Amount of
depreciation is subtracted annually
from the cost of the property and the
rate then only applied to the resulting
balance.
3. Sum of the year digit method
application of a changing fraction to
the taxpayers cost basis for the
property, reduced by the estimated
residual salvage value.
4. Unit of work or unit of production
method A provision is made for equal
depreciation per unit of use regardless
of the lapse of time.
5. Job basis method The allowance is
computed as being equal to the
difference between the cost of
depreciation of the asset purchased for
a particular job, and the salvage value
at the end of the job.
6. Retirement method The cost of the
property retired each year is credited
to the capital asset account and less
net salvage value actual or estimated.
Charged to expense in lieu of an annual
provision for depreciation deductions.
7. Such other methods as may be allowed
by the Sec. of Finance upon
recommendation by the Commissioner.
f. Depletion
exhaustion of natural resources such as oil
and gas wells and mines as a result of
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
production or severance from such mines or
wells
Determination of amount of depletion
In determining the amount of allowable
depletion cost, the following three factors
are essential, namely:
1. The basis for the cost of the
property;
2. The estimated total recoverable
units in the property; and
3. The number of units recovered
during the taxable year in
question. [Consolidated Mines V.
CTA 58 SCRA 618]
Basis, means the amount of the taxpayers
capital or investment in the property which
he is entitled to recover tax-free during the
period he is removing mineral in the
deposit.
Intangible cost in petroleum operations
This refers to any cost incurred in
petroleum operations which in itself has no
salvage value and which is incidental to and
necessary for the drilling of wells and
preparation of wells for the production of
petroleum.
Depletion and Depreciation
Both are predicated upon the same basic
premise of avoiding tax on capital.
However, depletion is based upon the
concept of the exhaustion of a natural
resource, whereas, depreciation is based
upon the concept of exhaustion of the
property, not otherwise a natural resource,
used in trade or business or held for the
production of income. Thus, depletion and
depreciation are made applicable to
different types of assets.
g. Losses
implies an unintentional parting with
something of value
Requisites:
1. The loss must be incurred in the
trade, business or profession of the
taxpayer.
2. It must be actually sustained and
charged off within the taxable year.
3. It must be evidenced by a closed
and completed transaction.
Completed Transaction this means that the loss must be
fixed by identifiable event.
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 INCOME TAXATION
Example: If it is a loss sustained from sale, the event that
may identify or complete the transaction is the
consummation of the contract of sale.
Suppose it is in the nature of casualty losses like fire?
The fire destroyed your property in 1995, no payment has
been made because the insurer and the insured were still
under negotiation. It was only in 1997 that they agreed on
the amount. The amount agrees upon is P100,000. The
taxpayer may claim that casualty losses only in 1997 when
payment was actually made. This is the event that will
complete the transaction.
4. It must not be compensated for by
insurance or other forms of
indemnity.
5. If it is a casualty loss, the taxpayer
has filed a sworn declaration of loss
within 45 days after the date of the
discovery of the casualty or robbery,
theft, or embezzlement.
Some recognized losses
1. Ordinary losses/business losses sustained in the
course of trade, business or profession
2. Casualty losses
3. Capital losses involved are capital assets.
4. Securities becoming worthless
5. Losses from wash sales of stock or securities
6. Wagering losses
Note: Capital losses and securities becoming worthless are
governed by rules on loss from the sale or exchange of capital
assets.
Casualty loss
This must be reported to the BIR earlier than 30 days
but not later than 45 days following the date of loss.
Loss arises from fires, storms, shipwreck, or other
casualties, or from robbery, theft or embezzlement.
Loss limitation rule for capital losses
Losses from sales or exchanges of capital assets shall
be allowed only to the extent of the gains from such
sales or exchanges.
Securities becoming worthless
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
1. Securities become worthless during the taxable year
2. Securities are capital assets
3. Losses are considered as losses from the sale or
exchange, on the last day of such taxable year, of
capital assets.
Net operating loss
It means the excess of allowable deduction over
gross income of the business in a taxable year.
NET OPERATING LOSS CARRY-OVER (NOLCO)
NOLCO shall be carried over as a deduction from the
gross income for the next three (3) consecutive
taxable years immediately following the year of loss.
Such loss shall be allowed as a deduction if it had not
been previously offset as deduction from gross
income.
However, any net loss incurred in a taxable year
during which the taxpayer was exempt from income
tax shall not be allowed as a deduction
NOLCO shall be allowed only if there has been no
substantial change in the ownership of the business
or enterprise.
There is no substantial change when:
1. Not less than 75% in nominal value of
outstanding issued shares, if the business is
in the name of a corporation, is held by or
on behalf of the same persons; or
2. Not less than 75% of the paid up capital of
the corporation, if the business is in the
name of a corporation, is held by or on
behalf of the same persons.
Losses form wash sales of stock or securities
No deduction for loss shall be allowed for wash sales
unless the claim is made by a dealer in stock or
securities and with respect to a transaction made in
the ordinary course of the business of such dealer.
WASH SALE
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
and ending thirty (30) days after such date, the
taxpayer has acquired (by purchase or exchange) or
has entered into a contract or option to so acquire,
substantially identical stock or securities.
Wagering losses
Losses from wagering shall be allowed only to the
extent of gains form such transactions.
The amount that is deductible must not exceed the
gains
Abandonment losses
In the event a contract area where petroleum
operations are undertaken is partially or wholly
abandoned, all accumulated exploration and
development expenditures pertaining thereto shall
be allowed as a deduction.
In case a producing well is subsequently abandoned,
the unamortized costs thereof, as well as the
undepreciated costs of equipment directly used
therein, shall be allowed as a deduction in the year
such well, equipment or facility is abandonment by
the contracto.
SPECIAL LOSSES include the following:
a. loss arising from voluntary removal of buildings as an
incident to renewal or replacement
Problem:
Supposed the taxpayer had a building constructed on a parcel
of land. He owned this as well as the building erected
thereon. He had business and his business was conducted
within the premises. Then, he decided to remove such
building as to construct a new building for new business.
Is the cost of demolition to give way to a new building
deductible loss? YES.
Suppose A purchased that parcel of land of B and included in
that sale was that of the building. A demolish this building in
order to construct a new building. Is the cost of demolition
deductible insofar as A is concerned?
NO. That can only be claimed as deductions if the one
demolishing the same is the taxpayer. The moment that is
sold to another claim that as deductible loss. The treatment
here is, the cost of demolition should be capitalized in the
selling price.
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
Exception:A may claim that as deductible loss if this was
demolished by value of a court order because the govt
considered this as a fire hazard, loss of useful value of
property or capital asset.
PICOP VS CA December 1, 1995
Issue: Whether Picop is entitled to deductions against income
of net operating losses incurred by the Rustan Pulp and Paper
Mills, Inc.; and
Decision:
(1) On 18 January 1977, Picop entered into a merger
agreement with the Rustan Pulp and Paper Mills, Inc.
("RPPM") and Rustan Manufacturing Corporation
("RMC"). Under this agreement, the rights,
properties, privileges, powers and franchises of
RPPM and RMC were to be transferred, assigned and
conveyed to Picop as the surviving corporation. The
entire subscribed and outstanding capital stock of
RPPM and RMC would be exchanged for 2,891,476
fully paid up Class "A" common stock of Picop (with a
par value of P10.00) and 149,848 shares of preferred
stock of Picop (with a par value of P10.00), to be
issued by Picop, the result being that Picop would
wholly own both RPPM and RMC while the
stockholders of RPPM and RMC would join the ranks
of Picop's shareholders. In addition, Picop paid off
the obligations of RPPM to the Development Bank of
the Philippines ("DBP") in the amount of
P68,240,340.00, by issuing 6,824,034 shares of
preferred stock (with a par value of P10.00) to the
DBP. The merger agreement was approved in 1977
by the creditors and stockholders of Picop, RPPM
and RMC and by the Securities and Exchange
Commission. Thereupon, on 30 November 1977,
apparently the effective date of merger, RPPM and
RMC were dissolved. The Board of Investments
approved the merger agreement on 12 January
1978.
(2) In the instant case, to allow the deduction claimed
by Picop would be to permit one corporation or
enterprise, Picop, to benefit from the operating
losses accumulated by another corporation or
enterprise, RPPM. RPPM far from benefiting from
the tax incentive granted by the BOI statute, in fact
gave up the struggle and went out of existence and
its former stockholders joined the much larger group
of Picop's stockholders. To grant Picop's claimed
deduction would be to permit Picop to shelter its
otherwise taxable income (an objective which Picop
had from the very beginning) which had not been
Page 44
 INCOME TAXATION

earned by the registered enterprise which had

suffered the accumulated losses. In effect, to grant
Picop's claimed deduction would be to permit Picop
to purchase a tax deduction and RPPM to peddle its
accumulated operating losses. Under the CTA and
Court of Appeals decisions, Picop would benefit by
immunizing P44,196,106.00 of its income from
taxation thereof although Picop had not run the risks
and incurred the losses which had been encountered
and suffered by RPPM. Conversely, the income that
would be shielded from taxation is not income that
was, after much effort, eventually generated by the
same registered operations which earlier had
sustained losses. We consider and so hold that there
is nothing in Section 7 (c) of R.A. No. 5186 which
either requires or permits such a result. Indeed, that
result makes non-sense of the legislative purpose
which may be seen clearly to be projected by Section
7 (c), R.A. No. 5186.
It appears that RPPM and RMC were, like Picop, BOI-
registered companies. Immediately before merger effective
date, RPPM had over preceding years accumulated losses in
the total amount of P81,159,904.00. In its 1977 Income Tax
Return, Picop claimed P44,196,106.00 of RPPM's
accumulated losses as a deduction against Picop's 1977 gross
income.
2. No part of the net income of the beneficiary must
inure to the benefit of any private stockholder or
individual.
3. It must be made within the taxable year.
4. It must not exceed 10% in case of an individual, and
5% in case of a corporation, of the taxpayers taxable
income (except when the donation is deductible in
full) to be determined without the benefit of the
contribution.
5. It must be evidenced by adequate records or
receipts.
Contributions deductible in full
1. Donations to the Philippine Government or to any of
its political subdivisions according to a national
priority plan determined by the NEDA.
2. Donations to foreign institutions or international
organizations which are fully deductible in
pursuance of or in compliance with agreements,
treaties or commitments entered into by the
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
The amount of charitable contribution that may be claimed
as deduction may be:
1. In the case of individual taxpayer:
- Not more than 10% of the net income before charitable
contribution
2. In the case of corporate taxpayer:
- Not more than 5% of the net income before the charitable
contribution
IF the recipient of such contribution is any of the following
DC formed or organized for: [R.E.C.S.]
1. Religious purpose and rehabilitation of veterans
2. Educational purpose like educational corporations
which are not qualified as NGO
3. Charitable, cultural purpose
4. Scientific, sports development an social welfare
purpose
10% or 5% of the net income before charitable
contribution
Example:
If an individual taxpayer has a gross income of
P100,000 and the allowable deduction, except charitable
contribution, is P50,000. The Charitable contribution is
P5,000.
Deduction first P50,000 from P100,000 and the
result is P50,000.
This P50,000 is the basis of that 10% or 5% of net
income before charitable contribution. So, 10% of the
P50,000 is P5,000. Hence, the actual contribution of P5,000
may be fully claimed as deduction.
But let us say, the amount of charitable contribution
is P10,000. So, he can only deduct P5,000 as charitable
contribution, and not the actual amount of P10,000 because
the law imposes a limitation that the amount that may be
claimed as deduction must not be more than 10% of net
income before charitable contribution.
Non-governmental organization
It means a non-profit domestic corporation:
1. Organized and operated exclusively for scientific,
research, educational, character-building, and youth
and sports development, health, social welfare,
cultural or charitable purposes, or any combination
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
thereof, where no part of the net income of which
inures to the benefit of any private individual.
2. Utilizes the contribution directly for the active
conduct of the activities constituting the purpose or
function for which it is organized and operated not
th
later than the 15 day of the month after the close
of accredited NGOs taxable year in which the
contribution were received.
3. Administrative expenses shall, in no case, exceed
thirty percent (30%) of the total expense.
4. The assets, in the event of dissolution, would be
distributed to another non-profit domestic
corporation organized for a similar purpose, or to
the state for public purpose, or would be distributed
by a court to another organization.
Utilization
1. Any amount of cash or kind (including administrative
expenses) paid or utilized to accomplish one or more
purposes for which the accredited non-
governmental organization was created or
organized.
2. Any amount paid to acquire an asset used (or held
for use) directly in carrying out one or more
purposes for which the accredited non-
governmental organization was created or
organized.
Proof of deductions
Contributions or gifts shall be allowable deductions
only if verified under the rules and regulations prescribed by
the Sec. of Finance.
i. Pension Trusts
Requisites for the deductibility of payments to pension trusts
1. The employer must have established a pension or
retirement plan to provide for the payment of
reasonable pensions to his employees.
2. The pension plan is reasonable and sound.
3. it must be funded by the employer.
4. the amount contributed must no longer be subject
to the control or disposition of the employer.
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 INCOME TAXATION
5. the payment has not been allowed as deduction.
6. the deduction is apportioned in equal parts over a
period of ten (10) consecutive years beginning with
the year in which the transfer or payment was made.
Contribution to pension trust may refer to the
current year or past years.
CURRENT YEAR- this is considered as ordinary & necessary
expenses
Employer may also make a contribution to the pension plan
in regard to the services rendered for the past 10 years.
j. Research and Development Costs
A taxpayer may treat research and development
expenditures which are paid or incurred by him during the
taxable year in connection with his trade, business or
profession, as ordinary expenses and necessary expenses
which are not chargeable to capital account. The
expenditures so treated shall be allowed as deduction during
the taxable year when paid or incurred.
This may not be claimed as deduction if the amount is:
1. Spent for the acquisition or improvements of land or
for the improvement or development of natural
resources, or a character which is subject to depreciation
and depletion.
2. Paid or incurred for the purpose of ascertaining the
existence, location, extent or quality of any natural
resources like deposits of ore or other minerals including
oil or gas.
D. Other Forms of Deductions
DECUCTIONS ALLOWED ONLY TO INDIVIDUAL TAXPAYERS
Deductions allowed only to individual taxpayers
1. Personal exemption
2. Additional exception
3. Premium payments on health and/or hospitalisation
insurance if the taxpayer has no compensation
income, this can be claimed as deduction from gross
income from business, trade or profession.
Premiums on health and hospital insurance
Limitations:
a. It must not be more than P2,400.00 a year. In
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
other words, P200.00 a month. The P2,400.00 is
the maximum amount that may be claimed as
deductions.
b. The family must have an income of not more
than P250,000.00 a year.
c. The claimant must be the spouse claiming the
additional exemption.
Premiums on life insurance policy is also included here
because it is included under the health insurance policy.
* If taxpayer has no compensation income, these deductions
may be claimed against the gross income of his business,
trade, or profession.
PERSONAL EXEMPTIONS
Personal exemptions are arbitrary amounts allowed,
in the nature of a deduction from taxable income,
for personal, living or family expenses of an
individual taxpayer. They are considered to be the
equivalent of the minimum of subsistence of the
taxpayer.
Who are allowed personal exemptions?
1. Citizens
2. Resident aliens
3. Non-resident aliens engaged in trade or
business in the Philippines under certain
conditions
4. Estates and trusts, which are treated for
purposes of personal exemptions, as a
single individual
Amount of personal exemptions allowed to citizens and
resident aliens
P20,000 single person or a married person
judicially decreed as legally separated from his or her
spouse with no qualified dependents. Applies also
to estates under judicial settlement and
irrecoverable trusts.
P25,000 head of the family
P32,000 married person
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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,
each can claim P32,000 exemption.
Head of the family
It means an unmarried or legally separated man or
woman with one or both parents, or with one or
more brothers or sisters, or with one or more
legitimate, recognized natural or legally adopted
children living with and dependent upon him or her
for their chief support.
Such brothers or sisters or children should be not
more than 21 years old, unmarried and not gainfully
employed, or where such children, brothers or
sisters, regardless or are, are capable of self-support
because of mental or physical defect.
A head of family is an individual who actually
supports and maintains in one household one ore
more individuals, who are closely connected with
him by blood relationship, relationship by marriage,
or by adoption, and whose right to exercise family
control and provide for these dependent individuals
is based upon some moral or legal obligation.
Note: Consider discrepancy between definition of head of
family and dependent i.e. children.
To be a head of a family, one or more legitimate,
recognized natural or legally adopted children must live with
and depend on an unmarried or legally separated man or
woman.
A dependent, on the other hand, may be a
legitimate, illegitimate or legally adopted child.
Both, however, define or qualify different terms.
Living with
The term living with the person giving support
does necessarily mean actual and physical dwelling
together at all times and under all circumstances.
Family
The term family includes an unmarried or legally
separated person with:
1. one or both parents;
2. one or more brothers or sisters; or
Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen
3. one ore more legitimate, recognized natural, or
legally adopted children living with and dependent
upon him or her for their chief support.
Additional exemption
A married person or a head of a family may claim an
additional exemption of P8,000 for each dependent,
not exceeding four (4).
The additional exemption shall be claimed by only
one of the spouses in the case of married individuals.
In the case of legally separated spouses, it may be
claimed only by the spouse who has custody of the
child or children.
Dependent
Refers only to the legitimate, illegitimate or legally
adopted child of the taxpayer
The child is:
1. living with the taxpayer;
2. chiefly dependent upon the taxpayer for support;
3. not more than 21 years of age;
4. not married; and
5. not gainfully employed or, even though over 21
years old, incapable of self support because of
mental or physical defect.
Change of status
Taxpayer marries or have additional dependents
Taxpayer dies during the taxable year
If the spouse or any of the dependents dies or if any
of such dependent marries, becomes 21 years old, or
becomes gainfully employed
Note: As a general rule, interpret in favour of taxpayer.
Presumed that the change of status transpired at the end of
the taxable year.
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 INCOME TAXATION

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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