Income Tax (1)_final

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

TAXATION

Increase in cash

THE CONCEPT OF INCOME 1.

Income – is a flow of service rendered by capital by the payment of money from such capital or any benefit rendered by a fund of capital thourgh a period of time. Refers to all gains, profits or income derived from any source such as services whether constituting a demandable debt or not or from the use of capital. 

Conwi Vs CIR, 213 Scra 83 An income is the amount of money coming to a perosn or corporation within a specified time, whether as payment for services, interest or profit form investment. Unless otherwise specified, income means cash or its equivalent



Rule of thumb test- to determine income is the increase in net worth Example: b.1

(individual)

A’s

capital

from

the

beginning (Jan 2000) is 100,000 A’s capital ending (Dec 2000) is 90,000

Decrease in accounts receivable Increase in inventory Decrease in accounts payable Increase in notes payable Total

Increase net assets 20,000

Decrease net assets 80,000

150,000 60,000 30,000 230,000

110,000

Net increase (Increasedecrease) Add dividend paid during the year Since dividends are obtained from earnings total

120,000

Less proceeds from sale of capital stock (return of capital) Net income

100,000

80,000

200,000

100,000

A’s additional investment during the

year(Feb 2000) is 5,000 A’s personal withdrawal during the



Taxable income – pertinent items of gross income specified in NIRC less the deductions

year(May 2000) is 40,000 How much is Mr. A’s 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 taxpayer’s 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 during the taxable year:

3 categories of taxable income : 

Passive investment income subject to final tax

Sold 1000 shares at 100 pesos

– no longer included in the taxpayer’s 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

Page 2 Prepared by: Dandy, Kristelle, Myrel, Riza, Joy and Maen

INCOME TAXATION insurance. Tax is computed on gross income in



case of individuals. (Note difference in gross

classified as a capital asset by by a person who who is

income in indiv. And gross income perse).

not a real estate dealer or developer; if it is

Requisites:

classified as ordinary asset – subject to ordinary

b.1 it must arise from personal services under

income tax 

and employer employee relationship b.2 It is in the nature of income to the recipient

Tax on passive investment income, such as interest, dividend and royalty

employee



Fringe benefits tax

Example: Directors fee – deemed by law as



Branch profit remittance tax on Philippine

compensation income ; 

Capital gains tax on sale of real property

branches of foreign corporations

Non- compensation income – any other income



that is not derived from personal services or not related to an employer- employee relationship

Tax on improperly accumulated earnings tax of corporations



Final withholding taxes on certain income from

and is subject to tax on net income basis .

sources within the Philippines payable to

It includes:

resident or non resident persons

Capital gain – gains from dealings

in capital assets; Business income – gains from selling



Capital – denotes original investment or fund

merchandise

used in order to generate earnings which is

Professional income – fees derived

called income

from engaging in an endeavor requiring

Example: Amount of money deposited is

special training as professional

100,000 for 5 years. Interest rate is 12% per annum. How much is capital? How much is

Note: in corporations, both compensation and non

income per year?

compensation are subjectto tax in the basis of net

Car bought for 100,000 in year 2008 was sold for

income since gross tax scheme is limited to

100,000 in year 2010. Depreciation rate is 5%

compensation

per annum. How much is capital? How much is

arising

from

personal

and

not

corporater services. 

income in year 2010?

Non taxable income – those excluded by law or



Differences Between income and capital



Madrigal Vs Rafferty 38 Phil 414

th

treaty from taxation. Ex: 13 month pay 

Income tax – – tax on all yearly profits arising from

Income

Capital

property, professions, trades or offices or as a

All wealth other than mere return of capital

Fund or property existing at an instant of time, which can be used in producing goods or services Fund or property

tax on a person’s income , emoluments, profits

and the like. It is also a direct tax on actual or presumed

income

of

a

taxpayer Flow of wealth

received,accrued or realized during the taxable

Service of wealth Income is subject to tax

year. Types of income tax : 

Personal income tax on individuals



Regular corporate income tax on c orporations



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



Wealth Return of capital is not subject to tax

Revenue Distinguished from income: income : Revenue pertains to all funds accruing to the treasury of the government derived from tax, donation, grants and any other source.

dealer in securities


INCOME TAXATION Income refers to the earnings of individual

a. Actual

persons, partnership, corporation or estate and

Example:

trust whethero or not subject to tax.

1.

Mr x purchased a land for 10,000. After 3 yrs the value of the land was 15,000. On the fourth

TESTS APPLIED IN DETERMINING THE EXISTENCE OF INCOME 1.

2.

year Mr X sold the land for 13,000. He paid

Severance test – income is recognized when there is

1,000 to B as brokers commission.

separation of something which is of exchangeable

Formula: Income = Sales proceeds – (Cost of land +

value

necessary expenses for the sale of la nd)

Realization test – no taxable income until there is a

= 13,000 – (10,000 + 1,000)

separation

= 2,000

from

capital

of

something

of

exchangeable value (money), thereby supplying the

Income should be reported on the fourth year only

realization or transmutation which would result in

since it was in that y ear that it was realized.

the receipt of income.

2.

B sold to C a car with FMV of 40 pesos, pesos, for 50

3.

Tax Benefit Rule

pesos on installment with 1/5 purchase price to

4.

Economic Benefit Test – – any economic benefit to the

be paid annually. C in year 2 paid 20 pesos to B

employee that increases his net worth whatever

as payment for years 2 and 3. How much is B’s

may have been the mode by which it is effected is

income in year 2? Ans: 4 pesos.

taxable 5.

b.

Constructive (sec 26) – an income is considered

Claim of Right Doctrine – a taxable gain is

constructively received when it is credited to the

conditioned upon the presence of a claim of right to

account of or segregated in favor of a person.

the alleged gain and the absence of a definite

The person may withdraw the said account

unconditional obligation to return or repay.

credited in his favor anytime without any substantial limitations or conditions upon which

Principle of Constructive receipt of Income

payment or enjoyment is to be made or



Income which is credited to the account of or

exercised.

set apart for a taxpayer and which may be

Example: Dividends applied by the corporation

drawn upon by him at anytime is subject to tax

against the indebtedness of a stockholder.

for the year during which so credited or set

6.

c.

Presumptive (24 d)

apart although not then actually reduced to

As If theory of constructive income – it

possesion.

presumes

the

existence

of

income

on

Income from Whatever Source – Income sources

transactions supposedly not subject to tax.

whether legal or illegal

Example: Real property sold at a loss is subject to capital gains tax of 6% of the selling price or fair market value whichever is higher.

REQUISITES FOR THE TAXABILITY OF AN INCOME 1.

Existence of a gain- the value received in the form of

3.

cash or its equivalent as a result of rendition of

Gain must not be excluded (Sec 32 B) – law or treaty does not exclude the gain from taxation.

service or earnings in excess of capital invested. Example: cancellation of a taxpayer’s indebtedness

THE PHILIPPINE INCOME TAX SYSTEM

as a remuneration for service rendered is an income.

1.

Note: mere expectation of profit is not an income 2.

Types of Income Tax Systems a.

Schedular System - Different types of incomes

and therefore not taxable.

are subject to different sets of graduated or flat

Realization of a gain – realization of gain may take

income tax rates. Applicable tax rates will

the form of actual receipt of cash or may occur as a

depend on the classification of the taxable

constructive receipt of income. Mere increase in the

income

value of property is not income but merely an

income(without deductions) or net income

and

the

basis

could

be

gross

unrealized increase in invested capital.


INCOME TAXATION (deductions were already subracted). (Applic to

Subtract

phil from Jan 1, 1982 to Dec 31, 1985)

exemption (does not apply in case of

The Recipient of the income files separate

and

additional =10,000

Difference is Net taxable income = 80,000

return except for passive income subject to final

80,000 is subjected to graduated

witholding tax. for

personal

corporations)

regular income tax return or capital gains tax

Reason

(-)

tax rates to arrive at tax due the

exception:

It

is

the

c.

Semi-schedular or semi Global tax system –

witholding agent who is responsible for filing

Under this system, compensation income,

the witholding tax return and payment of

business or professional income, capital gain

income tax to the BIR on such passive income of

and passive income not subject to FWIT (final

the investor.

withholding income tax) and other income are

Example:

added together to arrive at the gross income.

a)

Sale of real property subjected to flat

Obtain net taxable income by subtracting from

income tax rates:

the gross income the sum of allowable

Lot classified as capital asset sold

deductions from business or professional incom,

at 500,000 with fair market value of 300,000.

capital gain, passive income not subject to FWIT

Tax base is either consideration

in the case of corporations and personal and

from sale or FMV whichever is higher

additional exemption in case of individuals and

Formula: Capital gains tax = Taxbase x 6%

subject such taxable income to one set of

Solution: CGT = 500,000 x 6%

graduated tax rates (individual) or normal

Ans: 30,000

corporate income tax rate (corporation)

b) Sale of stocks subjected to graduated tax rates (Sample only)

Note: Passive investment income subject to FWIT,

Taxbase: value of stocks sold

Captal gains from sale or transfer of stocks of a

>100,000 (10%) >200,000 (20% excess)

domestic corp and real properties classified as capital assets – remain subject to different sets of

b.

Global System – The taxpayer is required to

tax rates and covered by d ifferect tax returns.

lump up all items of income earned during a

Case: Sison Vs Ancheta GR No. L-59431, Jult 25

taxable period and pay a single set of income tax

1984

rates on these different items of income.

d.

Schedular Rates of Taxes Vs Schedular Sy stem

Net taxable income is subject to the graduated

Schedular rates of taxes – rates of taxes that

income tax rates in case of individuals and to

applies to each category of income.

corporate

income

tax

rates

in

case

of

corporations. It does not matter whether the

2.

The Philippine Income Tax System as a Semi Global

income received by the taxpayer is classified as

or Mixed System - Effective jan 1, 1986, Executive

compensation income, business professional

order No. 37 adopted the semi-global or semi-

income, passive investment income, capital gain

schedular tax system by reducing the graduated

or other income. All items of gross income as

rates on business and professional income from 60%

well as deductions and personal and additional

to 35% and by increasing the preferential tax rates

exemptions are reported in ONE income tax

on capital gains and passive investment incomes. RA

return to be filed at least annually and the

8424

applicable tax rate is applied on the tax base.

semischedular tax system by introducing some

(applic to phil up to dec 1981)

structural and administrative reforms and by

Example:

reducing the tax rates on corporations by 1% every

Gross income

= 100,000

Subtract (-) allowable deductions = 10,000

(1998)

retained

the

semiglobal

or

year from 35% to 32%. The same tax system was maintained under RA 9337 in 2005 but corporate tax


INCOME TAXATION rate was increased to 35% and reduced to 30% in Jan 3.



1, 2009.

white his passive investment incomes shall

Features of Income tax law :

generally be subject to 20% final tax

a.

Direct tax – burden is borne by income recipient



upon whom the tax is imposed b. c. d.

e.

Philippines does not exceed 180 days during

increases

any calendar year

Comprehensive

tax

situs-

by

adopting



professional income, capital gain, passive

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% 

Capital gains from sale or exchange of

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.

3. Citizenship

An alien is subject to Philippine income tax because derives

income

from

sources

within

the

Philippines. Thus, a non-resident alien is liable to pay Philippine income tax on his income from sources within the Philippines, such as dividend, interest, rent, or royalty, despite the fact that he has not set foot in the Philippines.

2. Residency

A citizen of the Philippines is subject to Philippine income tax: 

Resident citizen – on his worldwide income from within and without the Philippines



Nonresident citizen – only on his sources within the Philippines Types of nonresident citizen 1.

Immigrants

2.

Employees of a foreign entity on a permanent basis

Resident Alien An alien was subject to Philippine income tax on his worldwide income because of his residence in the

3.

Overseas contract workers



(1) and (2) are treated as nonresidents 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 administration it brings. Thus, a resident alien is now liable to pay Philippine income tax only on his income from sources within the Philippines and is exempt from tax on his income from sources outside the Philippines. Nonresident Alien 

His compensation income, business or

nationality, residence and source principle

1. Place where income was earned or the source



If the aggregate period of his stay in the

Progressive tax – tax base increases as tax rate

CRITERIA IN IMPOSING PHILIPPINE INCOME TAXES

he

Not Engaged in Trade or Business in the Philippines 

treatment on corporations



At graduated income tax rate of 5% to 32%,

Engaged in Trade or Business in the Philippines 

If the aggregate period of his stay in the Philippines is more than 180 days during any calendar year



Taxed on his income from sources within the Philippines



(3) must be physically present abroad “most of the time” (at least 183 days) to qualify

as

nonresident

citizens.

His

presence

abroad is however need not be continuous.

THE INCOME TAXPAYERS AND THE GENERAL PRINCIPLES OF THEIR TAXABILITY (Tax Situs for Income Tax Purposes) 1. Section 23 of the NIRC 2. Individual Taxpayers (Section 24-26) 3. Corporations (Section 27-30 R.A. 9337) 4. Estates and Trusts (Section 60-66) 5. Definition of Terms Under Section 22


INCOME TAXATION SOURCES OF INCOME (Section 42) 1. Services: Place of performance of the service 





3. Dividends: Residence of the corporation paying dividend 

Dividends received from a domestic corporation or

If the service is performed in the Philippines, the

from a foreign corporation are treated as income

income is treated as from sources within the

from sources within the Philippines, unless less than

Philippines

50% of the gross income of the foreign corporation

It includes compensation for labor or personal

for the three-year period preceding the declaration

services performed within the Philippines, regardless

of such dividends was derived from sources within

of the residence of the payor, of the place in which

the Philippines, in which case, only the amount

the contract for service was made, or of the place of

which bears the same ratio to such dividends as the

payment

gross income of the corporation for such period

Compensation is either in cash or in kind

derived from sources within the Philippines bears to its gross income from all sources shall be treated as

Example:

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 “ surce f incme” 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 

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

If the obligor or debtor (corporation or otherwise) is

goods are shipped in a foreign port under

a resident of the Philippines, the interest income is

“Free-on-Board

treated as income from within the Philippines. It

arrangement,

does not matter whether the loan agreement is

transferred at the foreign port and any gain

signed in the Philippines or abroad or the loan

from the sale of such goods to a Philippine

proceeds will be used in a project inside or outside

importer shall be treated as income from

the country

sources outside the Philippines.

(FOB)

title

to

shipping

the

point”

good

is


INCOME TAXATION DETERMINATION OF GROSS INCOME AND THE RULES OF INCLUSION AND EXCLUSION FROM GROSS INCOME

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

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. Partner’s 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.

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

B. THE GENERAL RULES ON INCLUSION AND EXCLUSION OF

Compensation

INCOME OF ITEMS (Section 31, 32A and 32B)

personal injuries or sickness, plus the amounts

Acts,

as

compensation

for

of any damages received, whether by suit or Sec 31. Taxable income defined

Gross Income Less

agreement, on account of such injuries or sickness.

-Deductions allowed by law -Personal exemptions Taxable income

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

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. –

(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


INCOME TAXATION private benefit plan maintained by

physical disability or for any cause beyond the control of the said official or employee.

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

(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.

under this subparagraph shall be availed of by an official or employee only once. For purposes of this Subsection, 'reasonable

the private

term benefit

plan' -means

a

pension,

gratuity, stock bonus or profitsharing 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

(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 P hilippines by (i) (ii)

foreign governments, 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


INCOME TAXATION governmental function accruing to the

amended by Memorandum Order No. 28, dated August 13, 1986; and (iv) Other benefits such as

Government of the Philippines or to any political subdivision thereof.

productivity

(c) Prizes and Awards.

Christmas

- Prizes and awards made primarily in

recognition

of

religious,

achievement (i)

but

only

increased

if:

of

the

Commissioner,

after

effect on the same of the inflation rate at the end of the taxable year.

(ii) The recipient is not required to render substantial future services

(f) GSIS, SSS, Medicare and Other Contributions. - GSIS, SSS, Medicare and Pag-ibig

as a condition to receiving the prize or award.

contributions, in

and

considering among others, the

and

Awards

rules

of Finance, upon recommendation

enter the contest or proceeding;

and

through

regulations issued by the Secretary

The recipient was selected

Prizes

Provided,

thousand pesos (P30,000) may be

without any action on his part to

(d)

bonus:

and

further, That the ceiling of Thirty

charitable,

scientific, educational, artistic, literary, or civic

incentives

sports

and

union

dues

of

individuals.

Competition. - All prizes and awards granted to

(g) Gains from the Sale of Bonds, Debentures or other Certificate of Indebtedness. – Gains realized from the same or

athletes in local and international sports competitions and tournaments whether held in the Philippines or abroad and sanctioned

by

their

national

exchange or retirement of bonds,

sports

debentures or other certificate of

associations.

indebtedness with a maturity of more th

than five (5) years.

(e) 13 Month Pay and Other Benefits. -

Gross

benefits

received

by

the total exclusion under this subparagraph

(h) Gains from Redemption of Shares in Mutual Fund. – - Gains realized by the investor

shall not exceed Thirty thousand pesos

upon redemption of shares of stock in a

(P30,000) which shall cover:

mutual fund company as defined in

officials and employees of public and private entities: Provided, however, That

Section 22 (BB) of this Code.

(i) Benefits received by officials and employees of the national and to

C. THE RULES AS APPLIED TO COMPENSATION INCOME AND OTHER BENEFITS

(ii) Benefits received by employees

a. Taxability of compensation income and the application f the emplyer’s cnvenience rule

local

government

pursuant

Republic Act No. 6686; pursuant to Presidential Decree No.

851,

as

amended

by

Memorandum Order No. 28, dated



Compensation income as defined in sec 32 :

August 13, 1986;

compensation for services in whatever form paid

(iv) Benefits received by officials and employees not covered by Presidential decree No. 851, as

including but not limited to fees, salaries, wages, commissions and similar items.


INCOME TAXATION However, this is not the correct definition.

-this is the justification that may be used in granting

Rev. Reg. 2- 98 defines compensation income “ all

exemptions from income tax on certain benefits that

remuneration for services rendered by an employee

may be received under an ER -EE relationship.

for his employer under an ER-EE relationship, unless

-examples: food and lodging benefit by a household

specifically excluded under the tax code.”

maid, driver, etc.

Implications of the definition: a.

b.

Rules on the application of the doctrine:

There are really tax exempt or excluded gross compensation income from gross income as provided in Sec32 B. Not all compensation for services rendered may be subjected to tax.

A.

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

compensation

not income

be in

included the

in

the

gross

of

ee-er

absence

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

relationship.

the employer, the rental value of living quarters is compensation income to the employee to the extent

Test whether income is compensation income : 

of his reasonable needs and the excess shall be

It is not the name of the remuneration upon which it

considered as expenses of the corporation.

is paid and the manner of payment, what is important

is

that

it

is

derived

from

ER-EE

The exclusion for meals is allowed only when:

relationship.

a.

Test to determine the existence of ER-EE relationship (code: AC-DC) A-appointment/selection

b.

C- Compensation or payment of wages D- Dismissal

They are furnished within the employer’s business premises. The exclusion for lodging is allowed only when it is furnished within the business premises of the employer; and The employee accepts the lodging as a condition of his employment in order to perform his duties properly.

C-Compensation Unless the above conditions are met, the Tax implications when the payment is made for services

value of any board and lodging furnished by

rendered

an employer is ordinarily taxable to the

1.

2.

For the employer- it may be claimed as deductible expense. Sec 34 A (1,a,i) provides “reasonable allowance for salaries, wages…” For the employee- it is a taxable income.

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

Convenience of the employer rule (Henderson Doctrine) 

Allowances in kind furnished to the employee for

25% of the basic minimum wage and it applies only

and as a necessary incident to the performance of

to managerial/supervisory employee.

his duties are not taxable. (Valencia p 174)

b.Retirement Payments, Pensions and Gratuities. c. Separation payments d. leave benefits th

e.13 month pay and other bonuses


INCOME TAXATION COMMUTATION OR MONETIZED VALUE OF LEAVE PAY

f. SSS/GSIS benefits g. SSS/GSIS/Philhealth/ Pag ibig/Union dues Items excluded

Conditions /particulars

Vacation Leave

Sick Leave

-not taxable

-not taxable

Government employees

Tax exempt

Tax exempt

Rank and file

Exempt up to 10 days

Unused- taxable

If it forms part of the terminal leave pay

Retirement benefit from

Requisites (code: FORT)

a private retirement plan a.

b. c.

d.

Retiring official must be at least Fifty (50) years of age. Approved or availed only Once Reasonable private benefit plan approved by the BIR Ten (10) years in service

If given during the taxable year with NO retirement to: a.

b.

h. Fringe benefits 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. Separation pay

The benefit shall be tax exempt,



Means any good, services or o ther 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

whether his employee is a

( 3 months or less stay in

private firm or the government

the premises)

provided the pay is given on

iii. business premise of

account of:

the ER including housing

a. b. c. d.

Social security benefits;

Death Sickness Other physical disability Or any cause beyond the control of the official or employee Received by RC, NRC, and RA

retirement gratuities and

from foreign government

since they are considered

other similar benefits

agencies and other private or

as business expense of

public institutions

the employer

Benefits from US

By veterans residing in the

Veterans Administration

Pilippines

SSS –RA 8282

Tax exempt

unit w/in 50 meters from the

Tax exempt

of

the

business premise b. Expense Account c. Vehicle of any kind Exemption:

i. helicopters or aircrafts

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 

GSIS- RA 8291

perimeter

If the actual interest imposed is less than 12%, the same is taxable. If it is exactly 12% or more, it is tax exempt.


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.

2.

3. 4.

5.

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:

2.

GSIS SSS Group insurance policy

Rules on fringe benefits 1. 2.

4.

It is subject to final tax Need not be reported as part of the gross income, since it is subject to final tax.

Contributions of the employer for the benefit of the employee to retirement, insurance and hospitalization benefit plans Benefits given to the rand and file EE whether granted under a collective baragaining agreement or not. De minimis benefits Recent regulation is Rev Reg 102000 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.

Scholarship grant to managerial or supervisory employees 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. 2. 3.

3.

Required by the nature of the employer’s tr ade, business, or exercise of profession Paid or incurred in connection with the business conventions, meetings or seminars abroad All expenses are substantiated by receipts or records There must be an official communication coming from the business associates abroad Allowance exempt only up to 300.00 dollars.

Tax treatment of the cost of airline ticket

1.

2.

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. b.

2.

Practice of profession Conduct of trade or business, as sole proprietor or c. A partnership of which he is a member Income derived by professionals from the practice of profession  Professionals- persons who derive their income

from

the

profession-lawyers

practice and

other

of

their

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

Sec 33-C Fringe benefits not taxable 1.

and activity for purpose of livelihood and profit

Fringe benefits which are authorized and exempt from tax under special laws


INCOME TAXATION Formula of gross income:

Ordinary business partnership

Example: Gross sales: Less:



1,000,000,000.00



Cost of investment: Cost of sale

An ordinary business partnership is considered as a corporation and is thus subject to tax a s such. Partners are considered stockholders and, therefore, profits distributed to them by the partnership are considered as dividends.

Cost of goods Sales allowance

Unregistered partnership and co-ownership for tax purposes

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?

Joint venture; how created

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 









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.

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] .

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%


INCOME TAXATION 

2000 onwards – 32%

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





Optional 15% tax on gross income 

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 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”.





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%

TAX ON CORPORATIONS

optional corporate tax:

CORPORATE TAXPAYER

1.

Corporation, includes, partnerships no matter how created or

2.

organized, joint account companies, or insurance companies and other associations.

3. 4.

It excludes:

1. 2. 3.

General Professional Partnerships; Joint venture for the purpose of undertaking construction projects; Joint consortium for the purpose of engaging in petroleum, geothermal and other energy operations pursuant to a consortium agreement with the government.

Some definitions for this purpose: 





RATES OF INCOME TAX ON DOMESTIC CORPORATIONS IN General 

Rate of tax, in general: 1997 – 35%

A tax effort ratio of twenty percent (20%) of the Gross National Product; A ratio of 40% between total income tax collection and to total tax revenues; A VAT tax effort ratio of 4% of the Gross National Product; A 0.9% ration between the Consolidated Public Sector Financial Position to the GNP.

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

1998 – 34% 

1999 – 33%

10% on taxable income, except of certain passive incomes.


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.

Resident Foreign Corporation 



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.

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%



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.

1998 – 34% 1999 – 33% 2000 onwards – 32%  

GOCCs, AGENCIES OR INSTRUMENTALITIES 



1. 2. 3. 4. 5.

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: GSIS SSS Phil Health Insurance Corporation PCSO 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



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. 2.

International Carrier – 2 ½ of Gross Philippine Billings 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


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.

3. 4. 5. 6. 7. 8. 9. 10. 11.

Regional or area headquarters of multinational companies 

For a flight which originates f rom 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.

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

Gross Philippine Billings for International Shipping 

Regional or area headquarters shall not be subject to income tax.

Regional





rents royalties remuneration for technical services salaries wages premiums annuities emoluments other fixed or determinable annual, periodic, or casual gains, profits, income and capital gains.

substitutes and from trust funds and similar arrangements and royalties derived from sources

“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.

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

Tax on branch profit remittances 



1. 2.

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: Interests dividends

the expanded foreign currency deposit system shall be subject to a final income tax at the rate of seven and one-half percent (7 ½%) 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


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

Non-resident owner or lessor of vessel chartered by Philippine nationals 

imposed on such income. 3.

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.

Intercorporate dividends Dividends received by a resident foreign corporation

A non-resident owner or lessor of vessels shall be subject to a tax of four and one-half percent (4 ½%) of gross rentals, lease or charter fees from leases or charters to Filipino citizens or corporations, as approved by the Maritime Industry Authority.

from a domestic corporation liable to tax under the NIRC shall

Non-resident owner or lessor of aircraft, machineries and

not be subject to income tax.

other equipment

TAX ON NON-RESIDENT FOREIGN CORPORATION



Taxation of a non-resident foreign corporation, in genera l 

Rates of tax, in general 1997 – 35%

Rentals, charters and other fees derived by a nonresident lessor of aircraft, machineries and other equipment shall be subject to a tax of seven and one-half percent (7 ½%) of gross rentals or fees.

Tax on certain incomes received by a non-resident foreign corporation

1998 – 34%

1.

1999 – 33%

Interest on foreign loans A final withholding tax at the rate of twenty percent

(20%) is hereby imposed on the amount of interest on

2000 – 32%

foreign loans contracted on or after 01 August 1986. 



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.

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

Taxation of certain non-resident foreign corporations

Philippines equivalent to thirty two percent (32%) in the 1. 2.

3.

Non-resident cinematographic film owner, lessor or distributor – 25% of gross income Non-resident owner or lessor of vessels chartered by Philippine nationals – 4 ½% of gross rentals, lease or charter fees Non-resident owner or lessor of aircraft, machin eries and other equipment – 7 ½% of gross rentals or fees

Non-resident

cinematographic

film

owner,

distributor

lessor

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


INCOME TAXATION 1. 2. 3.

Passive income from Philippine sources subject to final tax. Passive income from Philippine sources not subject to final tax. Passive income from sources outside the Philippines.

Passive income

1. 2. 3. 4. 5. 6. 7. 8.

Interest income Rentals/ leases Royalties Dividends Annuities and proceeds of life insurance/ other types of insurance Prizes and winnings, awards, and rewards Gifts, bequests, and devises Other types of passive income

a. Royalties, Prizes and Winnings 1.

Exclusion from gross income a. Prizes, awards in sports competition sanctioned by national sports associations whether held in Philippines or abroad – contemplates a particular competition, not a cumulative achievement (Ex. Sportsman of the year award does not qualify for exemption) b. Prizes and awards i. In recognition of religious, charitable scientific, educational, artistic literary or civic achievement but if only if: ii. Recipient was selected without any action oh his part iii. Recipient not required to render substantial future services as a condition of receiving the prize/award Example: Nobel prize award c. Rates of tax in certain passive income i. Royalties, except on books, as well as other literary works and musical compositions – 20% ii. Royalties on books, literary works and musical compositions – 10% iii. Prizes over P10,000 – 20% (Note: prizes less than P10,000 are included in the income tax of the individual subject to the scheduler rate)

iv.

Other winnings, except PCSO and Lotto, derived from sources within the Philippines – 20%

b. Interest Income from bank deposits and deposit substitutes 1. interest from any currency bank deposit and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangement – 20% final tax except non- resident alien not engaged in trade or business which is 25% 2. interest income received by an individual (except a nonresident individual)from a depositary bank under the expanded foreign currency deposit system – 7.5% except non resident alien, non resident engaged in trade/business and non resident alien not engaged in trade and business 3. interest income from long term deposit or investment in the form of savings, common or individual trust fund, deposit substitutes, investment management accounts and other investments evidenced by certification in such for m prescribed by the BSP – all exempt except non- resident alien not engaged in trade/business which is subject to 25% 4. Interest income from long term deposit or investment evidenced by certificates prescribed by BSP: a) Exempt, if investment is held for more than 5 years b) If investment is pre-terminated, interest income on such investment shall be subject to the following rates: 20% - If pre-terminated in less than 3 years 12% -

If pre-terminated after 3 years to less than 4 years

5%-

If pre-terminated after 4 years to less than 5 years

c. Dividends Stock dividend As a rule stock dividends are not taxable. This is so, because there is no income here. It merely represents the transfer of surplus accounts to the capital account. Exception to the rule: Stock dividend may be subject to

tax under the following exceptional cases:


INCOME TAXATION 1. 2.

payments will be treated as dividends. [Section 71, Revenue Regulation 2]

If there is a change in the stockholder’s interest in the net assets of the corporation; If it is one issued by another corporation. This is called “ dividend stock .”

1.Cash and/or property dividends

Stock dividend vs. Dividend stock: Stock dividend is

10% final tax, by January 1, 2000, on the following:

not taxable, while dividend stock is taxable a) 3. 4.







Redemption of stock dividend; 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. b)

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.

c)

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 a mount 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

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. Share of an individual in the distributive net income after tax of a partnership except a general professional partnership of which he is a pa rtner 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, Doña Carmen Soriano, as her conjugal share. The other half formed part of his estate. Doña 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. Doña Carmen exchanged her whole 138,864 common shares for 138,860 of the newly reclassified preferred shares. The estate of Don


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

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


INCOME TAXATION their individual distributed or not.

capacity,

whether

actually

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

d.Capital Gains from Sale of Real Property 1. 6% final tax on gross selling price or current fair market value, whichever is higher

b. can be availed only once every 10 years 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

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)

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 exchangethis is not subject to income tax but subject to percentage tax of ½ of 1 % of the gross selling price.

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





Not listed and traded through local stock exchangethis 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 ½ of 1% of the gross selling price.

6. Rule for Exchange 

- FMV of the property exchanged/given up shall be basis of CGT. (ex. A exchanges property worth 2M for B’s property worth 4M; therefore CG T on A will be based on 2M and 4M for B.) 7. exception on principal residence



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.


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.

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 rent income –





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 lessor’s property, sufficient in total to amortize the capital outlay of the lessor and to provide for the lessor’s 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.

additional

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

Financial lease 

as

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

The following constitutes taxable rent income: 1. 2.

The regular rent may be monthly, semi-annually or annually. 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.]

Baoas vs. CA

Facts: On February 20, 1976, petitioner, Bibiano V. Bañas 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


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

Less Initial Payment

461,754.00

Unrealized Gain

P1,847,016.00

P461,754.00

Less: Cost of land and other ( 76,547.90) incidental Expenses

Income

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.

3

1976 Declaration of Income on Disposition of Capital Asset subject to Tax: Initial Payment

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.

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

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


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

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


INCOME TAXATION selling price. They also state what may be regarded as installment payment and what constitutes initial payment. Initial payment means the payment received in cash or property excluding evidences of indebtedness due and payable in subsequent years, like promissory notes or mortgages, given of the purchaser during the taxable year of sale. Initial payment 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 14 price which are due and payable in subsequent years. Such disposition or discounting of receivable is material only as to the computation of the initial payment. If the initial payment is within 25% of total contract price, exclusive of the proceeds of discounted notes, the sale qualifies as an installment sale, 15 otherwise it is a deferred sale. Although the proceed of a discounted promissory note is not 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 indebtedness is reported using the installment method in 16 computing the proportionate income to be returned, during the respective year it was realized. Non-dealer sales of real or personal property may be reported as income under the installment method provided that the obligation is still outstanding at the close of that year. If the seller disposes the entire installment obligation by discounting the bill or the promissory note, he necessarily must report the balance of the income from the discounting not only income from the initial installment payment.

installment since, a taxable disposition resulted and petitioner was required by law to report in his returns the income derived from the discounting. What petitioner did is tantamount to an attempt to circumvent the rule on payment of income taxes gained from the sale of the land to AYALA for the year 1976 Long-term contracts 

The term “long term contract” means building, installation or construction contracts covering a period in excess of one year. [Section 48, NIRC]

Treatment of income from lo ng-term contracts

1. 2.

Percentage of completion basis Completed contract basis

Note: Section 48 of the NIRC provides that “Persons whose gross income is derive in whole or in part from such (long term) contracts shall report such income upon the basis of percentage of completion.”

The return should be accompanied by a return certificate of architects or engineers showing the percentage of completion during the taxable year of the entire work performed under the contract.

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 seller guarantees its payment, continues to collect on the installment obligation, or handles repossession of 17 merchandise in case of default. This rule prevails in the 18 United States. Since our income tax laws are of American 19 origin, interpretations by American courts an our parallel tax laws have persuasive effect on the interpretation of these 20 laws. Thus, by analogy, all the more would a taxable disposition result when the discounting of the promissory note is done by the seller himself. Clearly, the indebtedness of the buyer is discharged, while the seller acquires money for the settlement of his receivables. Logically then, the income should be reported at the time of the actual gain. For income tax purposes, income is an actual gain or an actual 21 increase of wealth. Although the proceeds of a discounted 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 succeeding installment payments of the land issued by AYALA, discounted by AYALA itself, on the same day of the sale, he lost entitlement to report the sale as a sale on

RA 9504 -Income and withholding tax exemption for minimum wage earners Personal Exemptions:

For single individual or married individual judicially decreed as legally separated with no qualified dependents………………………………………P 50,000.00 For head of family……………………………P 50,000.00 For each married individual …………P 50,000.00 Note: In case of married individuals where only one of the spouses is deriving gross income, only such spouse will be allowed to claim the personal exemption. Additional Exemptions: 

For each qualified dependent, an P25,000 additional exemption can be claimed but only up to 4 qualified dependents


INCOME TAXATION gross income in order to arrive at a net taxable income (NIRC)

The additional exemption can be claimed by the following: The husband who is deemed the head of the family unless he explicitly waives his right in favor of his wife The spouse who has custody of the child or children 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 additional exemptions allowed by the Tax Code. The individuals considered as Head of the Family supporting a qualified dependent







The maximum amount of P 2,400 premium payments on health and/or hospitalization insurance can be claimed if: Family gross income yearly should not be more than P 250,000 For married individuals, the spouse claiming the additional exemptions for the qualified dependents shall be entitled to this deduction





DEDUCTIONS FROM GROSS INCOME

2.

Allowed only businesses, corporations, institutions.

to

2.

Can be availed by all kinds of taxpayer

3.

Amounts spent or paid in the process of earning gross income

3.

Amounts earned or received by the taxpayer but do not form part of the gross income

4.

Used in computing TAXABLE INCOME

4.

Used in computing GROSS INCOME

c)

Deductions vs. Cost DEDUCTIONS

A. CONCEPT OF ALLOWABLE DEDUCTIONS a)

because exempted by tax treaty, statute or the Constitution (in the nature of tax exemptions) and those which do not come within the definition of income

COST

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) Nature of Deductions (Valencia, Roxas, page 365)

d)

Deductions, When Allowed INSTANCES

In general, deductions or allowable deductions

at net income subject to tax.

DEDUCTIONS

ARE

ALLOWED:

are business expenses and losses incurred which the law allows to reduce gross business income to arrive

WHEN

1.

They are kind of

Existence

of

deductions

a

–

law

authorizing

taxpayer

seeking

the the

legislative grace. They are not presumed but

deduction

allowable only by specific provisions of law. They

provision of the statute authorizing the

are construed strictly against the taxpayer.

deductions 2.

must

point

some

specific

Tax payer must be able to prove that he is entitled to such deductions

b)

3.

Deductions vs. Exclusions

Any amount paid or payable which is otherwise deductible from, or taken into

DEDUCTIONS 1.

Amount which the law allows to be subtracted from the

EXCLUSIONS 1.

Flow of wealth not treated as part of gross income

account in computing gross income or for depreciation

or

amortization

may

be

allowed as deduction only if it is shown that the tax required to be deducted and


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

e)

the Court of Tax Appeals [(CTA or Tax Court)] via a Petition for

Deductions vs. Tax Credit DEDUCTIONS

Review. TAX CREDIT

The Tax Court dismissed respondent’s Petition for lack of 1.

Subtracted from the gross income to arrive at net taxable income

1.

Deducted from taxable income to arrive at income tax payable

merit. CTA said: ‘x x x, if no tax has been paid to the government,

erroneously or illegally, or if no amount is due and 2.

Diminishes payable

income

tax

2.

Diminishes tax liability

collectible from the taxpayer, tax refund or tax credit is unavailing. Moreover, whether the recovery of the tax is made by means of a claim for refund or tax

i)

CIR vs. Central Luzon Drug Corp, GR No.

credit, before recovery is allowed[,] it must be first

159647, 15 April 2005

established that there was an actual collection and receipt by the government of the tax sought to be

PANGANIBAN, J.:

recovered. x x x.

The 20 percent discount required by the law to be given to

‘Prescinding from the above, it c ould logically be

senior citizens is a tax credit, not merely a tax deduction from

deduced that tax credit is premised on the existence of tax

the gross income or gross sale of the establishment

liability on the part of taxpayer. In other words, if there is no

concerned. A tax credit is used by a private establishment

tax liability, tax credit is not available.’

only after the tax has been computed; a tax deduction, The MR filed by the respondent was granted by the

before the tax is computed. RA 7432 unconditionally grants a tax credit to all covered entities. Thus, the provisions of the

CTA.

It then ordered petitioner to issue a Tax Credit

revenue regulation that withdraw or modify such grant are

Certificate in favor of Central Luzon Drug.

void. Basic is the rule that administrative regulations cannot The CA affirmed in toto the Resolution of the Court

amend or revoke the law.

of Tax Appeals (CTA) in the reduced amount of P903,038.39.

Facts:

Respondent is a domestic corporation primarily

It reasoned that Republic Act No. (RA) 7432 required neither

engaged in retailing of medicines and other pharmaceutical

a

tax

liability

nor

a

payment

of

taxes

by

private

products. In 1996, it operated six (6) drugstores under the

establishments prior to the availment of a tax credit.

business name and style ‘Mercury Drug.’

Moreover, such credit is not tantamount to an unintended benefit from the law, but rather a just compensation for the

From January to December 1996, respondent

taking of private property for public use.

granted twenty (20%) percent sales discount to qualified senior citizens on their purchases of medicines pursuant to

Issue : Is the 20% sales discount a tax credit or a deduction

Republic Act No. [R.A.] 7432 and its Implementing Rules and

from gross income or gross sales?

Regulations.

For the said period, the amount totalled

P904,769.00.

Ruling:

The 20% sales discount is a tax credit as expressly

provided for by RA 7432. On April 15, 1997, respondent filed its Annual Income Tax Return 1996 declaring that it incurred net losses from its operations.

Tax Credit versus Tax Deduction 

Tax credit generally refers to an amount that is

On January 16, 1998, respondent filed with

“subtracted directly from one’s total tax liability.” It

petitioner a claim for tax refund/credit in the amount of

is an “allowance against the tax itself” or “a


INCOME TAXATION deduction from what is owed” by a taxpayer to the

claimed -- shall be treated as a reduction from any tax

government. Examples of tax credits are withheld

liability, plain and simple

taxes, payments of estimated tax, and investment Granting that there is a tax liability and respondent

tax credits.

claims such cost as a tax credit, then the tax credit can easily 

Tax deduction -- defined as a subtraction “from

be applied. If there is none, the credit cannot be used and

income for tax purposes,” or an amount that is

will just have to be carried over and revalidated accordingly.

“allowed by law to reduce income prior to *the+

If, however, the business continues to operate at a loss and

application of the tax rate to compute the amount of

no other taxes are due, thus compelling it to close shop, the

tax which is due.” An example of a tax deduction is

credit can never be applied and will be lost altogether.

any of the allowable deductions enumerated in Section 34[20] of the Tax Code. 

Tax Credit Benefit Deemed Just Compensation

A tax credit differs from a tax deduction . On the

Sections 2.i and 4 of RR 2-94 deny the exercise by the

one hand, a tax credit reduces the tax due, including

State of its power of eminent domain. Be it stressed that the

-- whenever applicable -- the income tax that is

privilege enjoyed by senior citizens does not come directly

determined after applying the corresponding tax

from the State, but rather from the private establishments

rates to taxable income.

concerned. Accordingly, the tax credit benefit granted to these



establishments

can

be

deemed

as

their

just

A tax deduction, on the other, reduces the income

compensation for private property taken by the State for

that is subject to tax in order to arrive at taxable

public use.

income. To think of the former as the latter is to

SC affirmed Decision and Resolution of the Court of

avoid, if not entirely confuse, the issue. A tax credit is used only after the tax has been computed; a tax

Appeals.

deduction, before.

ii)

CIR vs. Central Luzon Drug Corp, GR No. 148512, 26 June 2006

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

AZCUNA, J.:

lowering of an amoun t of money;” or “a reduction from the

FACTS: Central Luzon Drug Corporation has been a retailer of

full amount or value of something, especially a price.” In

medicines

business there are many kinds of discount, the most common

December 19, 1994. In 1995, it opened three (3) drugstores

of which is that affecting the income statement or financial

as a franchisee under the business name and style of

report upon which the income tax is ba sed.

“Mercury Drug.”

and

other

Pharmaceutical

products

since

To stress, the effect of a sales discount on the income

For the period January 1995 to December 1995, in

statement and income tax return of an establishment

conformity to the mandate of Sec. 4(a) of R.A. No. 7432

covered by RA 7432 is different from that resulting from the

(Senior Citizen’s Act), petitioner granted a 20% discount on

availment or use of its tax credit benefit. While the former is

the sale of medicines to qualified senior citizens amounting to

a deduction before, the latter is a deduction after, the income

P219,778.

tax is computed.

As mentioned earlier, a discount is not

necessarily a sales discount, and a tax credit for a simple

Pursuant

to

Revenue

Regulations

No.

2-94[1]

discount privilege should not be automatically treated like a

implementing R.A. No. 7432, which states that the discount

sales discount. Where the law does not distinguish, we ought

given

not to distinguish.

establishment from its gross sales for value-added tax and

to

senior

citizens

shall

be

deducted

by

the

other percentage tax purposes, respondent deducted the When the law says that the cost of the discount may be

total amount of P219,778 from its gross income for the

claimed as a tax credit, it means that the amount -- when

taxable year 1995. For said taxable period, respondent


INCOME TAXATION reported a net loss of P20,963 in its corporate income tax

otherwise would be a departure from the clear mandate of

return. As a consequence, respondent did not pay income

the law.

tax for 1995. Accordingly, when the law says that the cost of the Subsequently, on December 27, 1996, claiming that

discount may be claimed as a tax credit, it means that the

according to Sec. 4(a) of R.A. No. 7432, the amount of

amount -- when claimed – shall be treated as a reduction

P219,778 should be applied as a tax credit, respondent filed a

from any tax liability.

claim for refund in the amount of P150,193, thus: The tax credit that is contemplated under the Act is a Since the Commissioner of Internal Re venue “was

form of just compensation, not a remedy for taxes that were

not able to decide the claim for refund on time,”*2+

erroneously or illegally assessed and collected. In the same

respondent filed a Petition for Review with the Court of Tax

vein, prior payment of any tax liability is not a precondition

Appeals (CTA) on March 18, 1998.

before a taxable entity can benefit from the tax credit. The credit may be availed of upon payment of the tax due, if any.

The CTA dismissed the petition, declaring that even

Where there is no tax liability or where a private

if the law treats the 20% sales discounts granted to senior

establishment reports a net loss for the period, the tax credit

citizens as a tax credit, the same cannot apply when there is

can be availed of and carried over to the next taxable year.

no tax liability or the amount of the tax credit is greater than the tax due. In the latter case, the tax credit will only be to

It must also be stressed that unlike in Sec. 229 of the

the extent of the tax liability. Also, no refund can be granted

Tax Code wherein the remedy of refund is available to the

as no tax was erroneously, illegally and actually collected

taxpayer, Sec. 4 of the law speaks only of a tax credit, not a

based on the provisions of Section 230, now Section 229, of

refund.

the Tax Code. Furthermore, the law does not state that a The tax credit benefit granted to the establishments

refund can be claimed by the private establishment concerned as an alternative to the tax credit.

can be deemed as their just compensation for private property taken by the State for public use. The privilege

Thus, respondent filed with the CA a Petition for Review.

enjoyed by the senior citizens does not come directly from the State, but rather from the private establishments concerned.

CA concluded that the 20% discount given to senior

SC affirmed Decision of the Court of Appeals.

citizens which is treated as a tax credit pursuant to Sec. 4(a) of R.A. No. 7432 is considered just compensation and, as

iii)

such, may be carried over to the next taxable period if there

Bicolandia Drug Corp vs. CIR GR No. 142299, 22 June 2006

is no current tax liability.

AZCUNA, J.: ISSUE:

whether the 20% sales discount granted by

respondent to qualified senior citizens may be claimed as a

FACTS: Petitioner Bicolandia Drug Corporation is a domestic

tax credit or as a deduction from gross sales.

corporation

principally

engaged

in

the

retail

of

pharmaceutical products. Petitioner has a drugstore located

RULING: The CA and the CTA correctly ruled that based on

in Naga City under the name and business style of “Mercury

the plain wording of the law discounts given under R.A. No.

Drug.”

7432 should be treated as tax credits, not deductions from Pursuant to the provisions of R.A. No. 7432 (Senior

income.

Citizens Act), and Revenue Regulations No. 2-94, petitioner The provision of RA 7432 explicitly employed the

granted to qualified senior citizens a 20% sales discount on

word “tax credit.” Nothing in the provision suggests for it to

their purchase of medicines covering the period from July 19,

mean a “deduction” from gross sales. To construe it

1993 to December 31, 1994.


INCOME TAXATION When petitioner filed its ITR 1993 and 1994, it

at the total tax liability (Black’s Law

claimed as a deduction from its gross income the respective

Dictionary).

amounts of P80,330 and P515,000 representing the 20% sales In

discount it granted to senior citizens.

view

of

such

apparent

discrepancy in the interpretation of the However, alleging error in the computation and

term “tax credit”, the provisions of the law

claiming that the aforementioned 20% sales discount should

under R.A. 7432 should prevail over the

have been treated as a tax credit pursuant to R.A. No. 7432

subordinate

instead of a deduction from gross income, petitioner filed a

respondent under Revenue Regulation No.

claim for refund or credit of overpaid income tax for 1993 and

2-94. x x x

regulation

issued

by

the

1994. On the issue of whether or not petitioner is entitled Petitioner contended that Section 4 of R.A. No. 7432

to the claim for refund of its overpaid income taxes for the

provides in clear and unequivocal language that discounts

years 1993 and 1994 based on the evidence at hand, the CTA

granted to senior citizens may be claimed as a tax credit.

ordered CIR to ISSUE tax credit certificates in favor of

Revenue Regulations No. 2-94, therefore, which is merely an

petitioner [in] the amounts representing overpaid income tax

implementing regulation cannot modify, alter or depart from

for the years 1993 and 1994. On the other hand, the CIR’s

the clear mandate of Section 4 of R.A. No. 7432, and, thus, is

Motion for Reconsideration is DENIED for lack of merit.

null and void for being inconsistent with the very statute it seeks to implement. The CIR, on the other hand, maintained that the

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.

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

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:

the tax credit scheme if he so chooses. The Commissioner further

stated

that

in

statutory

construction,

the

Section 4(a) of R.A. No. 7432 states that:

contemporaneous construction of a statute by executive officers of the government whose duty is to execute it is entitled to great respect and should ordinarily control in its

Sec. 4. Privileges for the Senior citizens. – The senior citizens shall be entitled to the following:

interpretation. The CTA ruled that: “Revenue Regulations No. 2 -94 gave a new meaning to the phrase “tax credit,” inter preting it to mean that the 20%

discount granted to qualified senior citizens is

an

amount

establishment’s

deductible gross

sales,

from which

the is

completely contradictory to the literal or widely accepted meaning of the said phrase, as an amount subtracted from an individual’s or entity’s tax liability to arrive

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


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, petitioner’s 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.

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


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.

sales for value-added tax or other percentage tax purposes. (Emphasis supplied). x x x

RA 7432 expressly allows private establishments to claim the amount of discounts they grant to senior citizens as tax credit .

Sec. 4. Recording/Bookkeeping Requirement for Private Establishments

Section 4(a) of RA 7432 states:

x x x

SECTION 4. Privileges for the Senior Citizens. - The senior citizens shall be entitled to the following:

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)

a) the grant of twenty percent all (20%) discount from establishments relative to the utilization of transportation services, hotels and similar lodging establishments, restaurants and recreation centers and purchase of anywhere in the medicines country: Provided, That private establishments may claim the cost ; (Emphasis supplied) as tax credit However, RR 2-94 interpreted the tax credit provision of RA 7432 in this wise: Sec. 2. DEFINITIONS. - For purposes of these regulations: x x x 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

Tax credit is defined as a peso-forpeso 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.


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.

"Sec. 4. Privileges for the Senior Citizens. - The senior citizens shall be entitled to the following: (a) the grant of twenty percent from all (20%) discount 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;

x x x 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 31 2004. RA 9257 has amended RA 7432. Section 4(a) of RA 9257 reads:

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.


INCOME TAXATION The Decision of the CA was AFFIRMED.

In lieu of the itemized allowable deductions, the OSD may be deducted from the gross income as follows:

B. KINDS OF ALLOWABLE DEDUCTIONS a) a)

Optional Standard Deductions (OSD)

non resident alien – OSD

b)

Special Deductions

must not exceed 40% of

c)

Itemized Deductions (ID)

his gross sales or gross receipts

SPECIAL DEDUCTIONS – those which are allowed by law to

b)

specific taxpayers only. 1.

An individual other than a

A corporation – OSD is not exceeding 40% of its gross income

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

From its name itself, standard deduction is optional

depreciable assets for expansion of school facilities

(Mamalateo, page 213).

such as:

return that he elects the OSD, otherwise he shall be

a)

Outright

expense

(the

entire

amount

is

The taxpayer must signify in his

considered as having availed of the itemized deductions.

deducted from gross income); or b)

income

an

amount

equivalent

to

its

depreciation every year. 2.

is irrevocable for the taxable year which the return is made [Section 34(L), NIRC].

the following:

itemized deductions in succeeding years. (Mamalateo, page

a)

213).

b)

Net additions required by law to be made within Sums other than dividends paid within the year on policy and annuity contracts

a)

1) Available to both corporations and individuals 2)

OSD is optional - taxpayer signifies in his return his intention to elect OSD otherwise he is

distributed to the heirs/ beneficiaries;

considered as having availed of ID 3)

Amount applied for the benefit of the grantor

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.

other than non-resident aliens

Amount of income paid, credited or AND

b)

Hence, the taxpayer can change to

Requites for the exercise of OSD:

Estates and Trusts (Section 61, NIRC) can deduct the following:

C.

a deduction (either OSD or itemized) in his ITR, such election

Insurance Companies (Section 37, NIRC) can deduct

the year to reserve funds; AND

3.

The Tax Code provides that once a taxpayer elected

Capital asset and deduct only from the gross

However, the new RA 9504 (Act

Election is irrevocable for the year in which it is made

4) Amount is limited to 40% of taxpayer’s 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

Amending among others Section 34 of the NIRC) allows OSD

P600K during the taxable year. His related

not only to individual taxpayer (other than a non-resident

itemized deduction allowed amounted to

alien) but also to corporation subject to tax under Section

P100K. Mr. X opted to deduct OSD in lieu

27(A) and 28 (A)(1) of the Tax Code.

of itemized deductions (ID).


INCOME TAXATION The net income of Atty. X before

Net Income P1,200,000.00

personal exemption would be: Gross Receipts – professional fee Less: OSD (P600K x 40%) Net Income before Personal Exemption

P600,000.00 240,000.00 P360,000.00

NOTES: a)

The following individuals may claim OSD in lieu of ID: 1. Resident Citizen 2. Non-resident Citizen 3. Resident Alien 4. Taxable Estates and Trusts

b)

Submission of supporting financial statements to tax return shall not be required if a qualified individual claims OSD (Valencia, Roxas, page 371, 2010). Simply stated, proof of actual expenses is not required to support claim of OSD (Mamalateo, page 213).

c)

OSD is based on gross sales during the taxable year if an individual employs the accrual basis of accounting of his income and deductions

NOTES: a) The following corporations may claim OSD in lieu of ID: 1. Domestic Corporations 2. Resident Foreign Corporations b)

Gross Income includes other income not subjected to final tax. Other income includes interest income earned from outside source as well as gain from sale of capital assets. The other should have been reported in the ITR and not subjected to final tax or CGT. Hence, the basis of the 40% OSD should include other taxable income not subjected to final tax. c)

d)

Components of GROSS INCOME FOR OSD

Sales discounts, sales returns and sales allowances should reduce the gross sales in computing OSD (based on the tax principle that lower amount of deduction will be allowed for income tax purposes) (Valencia, Roxas, page 371, 2010) Illustration 2 (Corporate Taxpayer):

If taxpayer elects to offset his losses against his profit from capital asset transaction, he may no longer claim OSD because OSD shall be in lieu of the itemized allowed deductions which evidently includes losses from sales or exchanges of capital assets (Valencia, Roxas, Income Taxation, page 372, 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

deductions. The net income of X Corporation would be:

OSD or ID of HUSBAND and WIFE For married individuals, the husband may choose OSD and the wife ID (or vice versa) to minimize their individual income tax.

Sales

P5,000,000.00 Less: Cost of Sale 3,000,000.00 Gross Income 2,000,000.00 Less: OSD (P2M x 40%)800,000.00

ILLUSTRATION: The husband and wife may compute separately their individual income tax based on their respective taxable income as follows:


INCOME TAXATION Mr. X Gross

receipts

from

i.

Mrs. X P

P

business service

400,000.00

600,000.00

Less: OSD (P400K x 40%)

160,000.00

ID

400,000.00

Income from business Add:

P 240,000.00

Compensation

300,000.00

Income before personal

P 540,000.00

P 200,00.00

Income P 200,00.00

exemption

NOTES: a)

Compensation Income is not allowed to be reduced by OSD

b)

If any income of the husband and wife cannot be definitely identified as income exclusively earned or realized by either of the spouses – the same shall be divided equally between them in order to determine their respective taxable income.

c)

In the case of individual entitled to claim OSD, “allowable deductions” shall mean aforesaid OSD

plus deductions of premium payments (if applicable) on: 1)

Health insurance, and/or

2)

Hospitalization Insurance,

D. ITEMIZED DEDUCTIONS: CONCEPTS, KINDS, RULES AND REQUISITES Itemized Deductions    

a.

specific business operating expenses allowed by the Tax Code to be deducted from the gross income it includes special deductions allowed to insurance companies generally, these require supporting documents to justify the reduction from gross income N/A NOLCO o o any item of incentive deduction allowable under any special law General Business Expenses  expenses refer to all the ordinary and necessary expenses paid or incurred during the taxable year  in carrying on or which are directly attributable to the development, management, operation and/or conduct of the trade, business or the exercise of a profession.

The All-Events Test  CIR v. Isabela Cultural Corporation (G.R. No. 172231 February 12, 2007)  The CA sustained the deduction of the expenses for professional and security services from ICC’s gross income.  Requisites for the deductibility of ordinary and necessary trade, business, or professional expenses, like expenses paid for legal and auditing services, are: 1) the expense must be ordinary and necessary; 2) it must have been paid or incurred during the taxable year; 3) it must have been paid or incurred in carrying on the trade or business of the taxpayer; and 4) it must be supported by receipts, records or other pertinent papers.  Requisites for All-events test 1) the right to income or liability be fixed; and 2) the amount of such income or liability be determined with reasonable accuracy.  The amount of liability does not have to be determined exactly; it must be determined with "reasonable accuracy." 1) "Reasonable accuracy" - implies something less than an exact or completely accurate amount.  Held: The disallowance of the expense deduction of ICC for professional and security services is declared valid only insofar as the expenses for the professional fees of SGV & Co. and of the law firm. 1) ICC can be expected to have reasonably known the retainer fees charged by the firm as well as the compensation for its legal services. 2) ICC, in the exercise of due diligence could have inquired into the amount of the obligation to the firm. 3) ICC owes familiarity with the rates charged by their long time legal consultant. ii. Capital Expenditure v. Ordinary Expenditure Capital Expenditure 


INCOME TAXATION 



iii. 



iv.

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. Rule re: Proprietary Educational Institutions deduct expenditures otherwise considered as capital outlays o capital outlays- same as capital expenditures deduct allowance for depreciation Reasonableness Test

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.

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! If the advertising is designed to stimulate o the future sale of merchandise or use of services, it is not deductible as a n ordinary and necessary expense. Rationale- "it has not been established that the item being claimed as deduction is excessive." There is yet to be a clear-cut criteria or o 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

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 ½ 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


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)

i.

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. Tax Benefit Rule the recovery of  GR: amounts deducted in previous years from gross income become taxable income  XPN: to the extent thereof the deduction did not



c.

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.

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. 1329, 2000 issued December 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.


INCOME TAXATION In 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. 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. Rules re: deductibility  Taxpayer is not entitled to both: deduction from gross income; o and increased basis for o determining gain or loss and the allowable depreciation charge.  interest on unclaimed salaries of the employees- not deductible



o

iii.

iv.





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 GOV’T 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. 

d.

Hence, interest paid for late payment of the donor’s tax in deductible from gross income. The interest on deficiency  donor’s 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.

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 taxpayer’s profession, trade or business; and 3. The tax must be imposed directly upon the taxpayer ii. Deductible Taxes 1. Import duties


INCOME TAXATION

e.

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 donor’s 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 on  Interest delinquent taxes can be deducted as interest expense at its full amount. 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

-

-

-

-

-

-

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 straightline 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: a. At the normal rate of depreciation if the expected life is ten (10) years or 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 nonuse 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.


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.

f.

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 taxpayer’s 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. Depletion  exhaustion of natural resources such as oil and gas wells and mines as a result of

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 taxpayer’s 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.


INCOME TAXATION Example:

1.

Securities become worthless during the taxable year

consummation of the contract of sale.

2.

Securities are capital assets

Suppose it is in the nature of casualty losses like fire?

3.

Losses are considered as losses from the sale or exchange, on the last day of such taxable year, of capital assets.

may

If it is a loss sustained from sale, the event that

identify

or

complete

the

transaction

is

the

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

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 n ot 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:

Note: Capital losses and securities becoming worthless are governed by rules on loss from the sale or exchange of capital assets.

1.

Casualty loss

2. 



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.

Losses form wash sales of stock or securities 

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

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 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.

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


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 f or 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.

Exception:A may claim that as deductible loss if this was demolished by value of a court order because the gov’t 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 a nd 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 a nd 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


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.

In claiming such deduction, Picop relies on section 7 (c) of R.A. No. 5186.

h.

Charitable Contributions

Kinds of charitable contributions

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 taxpayer’s 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

It appears that RPPM and RMC were, like Picop, BOIregistered 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. Upon the other hand, even before the effective date of merger, on 30 August 1977, Picop sold all the outstanding 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 this transaction.

2.

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.

3.

Donations to organizations.

accredited

non-governmental

* These are fully deductible if the contributions are given to the following: [F. A. G.] 1. Government or its political subdivisions, agencies or instrumentalities, for the purpose of undertaking priority projects of the government; These priority projects include: [S.H.E.] a. Sports development, science and invention b. Health and human settlement c. Educational and economic development

1.

Ordinary or those which are subject to limitations as to the amount deductible from gross income.

2.

Foreign government or institution and international civic organizations;

2.

Special or those which are deductible in full from gross income.

3.

Accredited NGO

Requisite for deductibility of charitable contributions

1.

The contribution must actually be paid, or made payable to the Philippine government or any political subdivision thereof, or any domestic corporation or association specified by the NIRC.

N.G.O. means non-profit domestic corporation which are formed and organized for any of the following purposes : [C.H.E.R.S.] a. Research b. Health c. Education d. Charitable, cultural, character building


INCOME TAXATION e.

Sports development and social welfare

thereof, where no part of the net income of which inures to the benefit of any private individual.

The amount of charitable contribution that may be claimed as deduction may be:

2.

Utilizes the contribution directly for the active conduct of the activities constituting the purpose or function for which it is organized and operated not th later than the 15 day of the month after the close of accredited NGO’s taxable year in which the contribution were received.

2. In the case of corporate taxpayer: - Not more than 5% of the net income before the charitable contribution

3.

Administrative expenses shall, in no case, exceed thirty percent (30%) of the total expense.

►IF

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.

1. In the case of individual taxpayer: - Not more than 10% of the net income before charitable contribution

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% r 5% cntributin”

f

the

net

incme

befre

Utilization

1.

Any amount of cash or kind (including administrative expenses) paid or utilized to accomplish one or more purposes for which the accredited nongovernmental 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 nongovernmental organization was created or organized.

charitable

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.

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.

Requisites for the deductibility of payments to pens ion trusts

1.

The employer must have established a pension or retirement plan to provide for the payment of reasonable pensions to his employees.

It means a non-profit domestic corporation:

2.

The pension plan is reasonable and sound.

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

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.

Non-governmental organization

1.

Pension Trusts


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.

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

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

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


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.

3.

Additional exemption 

 



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 l egal 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.

one ore more legitimate, recognized natural, or legally adopted children living with and dependent upon him or her for their chief support.



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.

A dependent, on the other hand, may be a legitimate, illegitimate or legally adopted child. Both, however, define or qualify differ ent terms.

Change of status 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.



Taxpayer marries or have additional dependents



Taxpayer dies during the taxable year



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

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.


INCOME TAXATION PERSONAL EXEMPTIONS INDIVIDUAL 







TO

NON-RESIDENT

ALIEN

Exemption

Only personal exemption Non-resident alien individual engaged in trade or business

Additional Exemption

/

/ within

/ within

Entitled only to personal exemption Amount allowed is limited to exemptions granted to Filipino citizens who are not residents in the alien’s domicile country – but not to exceed the amount allowed to citizens or residents of the Philippines in the NIRC.

the maximum allowable personal exemption. X Rule on reciprocity does not apply.

X

Legend: / - available; X – not available Head of the family – unmarried man or woman legally separated man or woman who has the following qualified dependents:

KINDS OF PERSONAL EXEMPTION: 1.

1. Basic personal exemption: a.

single or legally separated without dependent;

Php20,000.00

b.

head of the family;

Php25,000.00

c.

each married individual if both of them are earning Compensation income (in case only one of the spouses is deriving gross income, only such spouse shall be allowed the personal exemptions)

Parents -

-

One or both parents. Must be living with the taxpayer and dependent upon the taxpayer for chief support. Parents must be natural parents.

2.

Brothers or sister To be qualified they must be: a. Living with the taxpayer; b. Dependent upon the taxpayer for chief support; c. Unmarried; d. Not gainfully employed. e. No more than 21 years old except if physically or mentally incapacitated; ► must be brothers or sisters by blood ► one is enough

3.

Children-

Php32,000.00

2. Additional exemption - This only applies to qualified dependent child and children such as legitimate and illegitimate children.

Php8,000.00 for every qualified dependent child but not to exceed 4

Personal Exemption – only individual taxpayers, including estate and trust, are entitled. ►

►In case of estate and trust –

R.C.

/ Personal

N.R.C.

/ within

Php20,000.00 R.A.

NRA-NTB

/ within

/subject to the rule on reciprocity. But it must not exceed

Conditions: a. b. c. d. e.

Must be legitimate , illegitimate, legally adopted or stepchildren Living with the taxpayer; Dependent upon the taxpayer for chief support; Unmarried; Not gainfully employed; Not more than 21 years old except if physically or mentally incapacitated.

NRANETB

X


Income Tax (1)_final

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