Income Taxation Dimaampao

BASICAPPf TO INCOME TJ JUSTICE JAPAR B. DI

tsA:Sll,; APPROACH

TO INCOME TAXATION By

JAPAR B. DIMAAMPAO Associate Justice, Court of Appeals Professor of Law, Bar Reviewer

FOURTH EDITION

2011

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Tel. Nos. 736·05-67 • 735·13-64 1977 c.M. Recto Avenue

Tel. Nos. 735·55·27 • 735.55.34 Manila, Philippines www.rexpublishing.com.ph

CONTENTS Chapter 1 Salient Features of the Present Tax System 1: Individual Income System................................. II. Corporate Income Taxation............................... Ill. Common Features ............................................

1 2 2

Chapter 2 Income and Requisites; Income Tax; Nature and Functions A.

B. C. D. E.

F.

Definitions.......................................................... (1.) Judicial Definitions..................................... (2.) Economist's Definition................................ Income, Capital, Revenue, Receipts; Distinctions................................................. Sources of Income............................................ Income Tax; Basis, Nature, Functions.............. Requisites for Income to be Taxable ......... ....... ( 1 . ) Doctrine of Constructive Receipt of Income............................................ Doctrines on Determination of Taxable Income ( 1.) Claim of Right Doctrine.............................. (2.) Severance test theory................................ (3.) Control test.................................................

4 4 4 5 5 7 8 9

11 11 11 11

Chapter 3 Gross Income A.

General Statutory Definition.............................. xix

12

B.

A. B.

Broad Definition ................................................. Formula: Gross Income; Net Income; Taxable Compensation Income; Income Tax Due; Income Tax Payable .................................. Gross Income Taxation and Net Income Taxation; Distinctions; Advantages and Disadvantages ........................................... Exclusions from Gross Income ......................... Reasons for Exclusion ...................................... Exclusions from Gross Income ......................... (1.) Proceeds of life insurance ......................... (2.) Amount received as return of premium ..... (3.) Gifts, bequests and devises ...................... (4.) Compensation for injuries or sickness ....... (5.) Income exempt under treaty ...................... (6.) Retirement benefits, pensions, gratuities, etc ...................................... (7.) Miscellaneous items ...................................

13

(1.) Other tax implications of condonation

13 14 15 15 15 15 16 17 17 18

E.

F. G.

A.

18 21

Chapter 4 Individual Income Taxation A.

B. C.

Classification of Individual Taxpayers (1.) Resident citizen .......................................... (2.) Non-resident citizen ................................... (3.) Resident alien ............................................ (4.) Non-resident alien ...................................... (5.) Non-resident alien not engaged in trade or business ................................ General Principles; Sources of Income; Tax Base .................................................... Categories of Income ........................................ a. Definition .................................................... b. Basis/Test ................................................... c. Requisites for Taxability ............................. d. Forms of Compensation ............................ xx

25 25 25 27

of indebtedness ......................... Other tax implications of premiums (2.) paid by employer ....................... of the Employer Convenience a.) ............................... Rule De minim is benefits ..................... b.) Special Rules on Fringe Benefits ..................... Doctrine of Cash Equivalent ............................. Allowable Deductions from Gross Compensation Income ............................... (1.) Personal exemptions ................................. (2.) Premium Payments on Health and/or Hospitalization Insurance ........................... Business/Trade/Professional Income Income Covered (1.) Income derived by self-employed from trade or business (trading, manufacturing, merchandising, farming. and others) ........................... Income derived by professionals ............... (2.) (3.) Gross income of farmers include ............... i.) Interest Income ................................. ii.) Rental Income ................................... iii.) Dividend Income ............................... iv.) Passive Investment Income .............. (4.) Other Sources ............................................

30 30 31 32 33 38 38 38 43

44 45 46 46 46 48 50 51

Chapter 5

27

Corporate Income Taxation

27 28 28 29 29 29

A. B.

Definition under the NIRC ................................. Major Groups of Corporation for Income Tax Purposes ............................................. (1.) Domestic Corporations .............................. (2.) Resident Foreign Corporations .................. (3.) Non-resident Foreign Corporations ........... xxi

53 56 56 57 60

C. D. E.

Minimum Corporate Income Tax....................... Improperly Accumulated Earnings Tax............. Other Corporate Tax Rates............................... (1.) Common Tax Rates................................... (2.) Domestic Corporations ............................. , (3.) Resident Foreign Corporations.................. (4.) Non-resident Foreign Corporations........... F. Tax Exempt Corporations Under the NIRC ...... ( 1.) Labor, Agriculture or Horticultural Organization Not Organized Principally for Profit............................. (2.) Mutual Savings Banks and Cooperative Banks.................................................. (3.) Fraternal Beneficiary Society, Order or Association ..... ....... ... ....... .. ..... .... .... (4.) Cemetery Companies................................ (5.) Religious, Charitable, Scientific, Athletic or Cultural Corporations .... ... .... .... ... .. . (6.) Business, Chamber of Commerce, or Board of Trade.................................... (7.) Civic League.............................................. (8.) Non-Stock, Non-Profit Educational Institutions........................................... (9.) Government Educational Institution........... (10.) Mutual Fire Insurance Companies and Like Organizations....................... (11.) Farmers, Fruit Growers' or Like Association.......................................... Tax-Exempt Corporations under Special Laws.......................................

61 69 73 73 73 74 75 77

E.

77 F. 77 78 79 80 80 82 83 85

86

xx ii

H.

90 I.

Allowable Deductions from Gross Income

Basic Principles................................................. The Cohan Rule Principle.................................

G.

85

Chapter 6

A. B.

C. D.

91 91

(1.) Distinctions: Deductions, Exclusions and Personal Exemptions.......................... Kinds of Allowable Deductions ....... ...... ... .. (1.) Itemized Deductions.................................. (2.) Optional Standard Deduction..................... Kinds of Itemized Deductions ... ... ........... ..... ... .. Business Expenses........................................... Interest Expenses............................................. Definition ....... .... .... ... .... ..... ... ...... ...... .......... .. .... . Taxes................................................................. Nature and Scope............................................. Losses............................................................... (1.) Definition.................................................... (2.) Kinds of Losses ........................... .............. (3.) Special Kinds of Losses............................ a.) Wagering losses........................................ b.) Losses due to voluntary removal of building incident to renewal or replacement........................... c.) Loss of useful value of capital asset due to changes in business condition..................................... (4.) Casualty Losses......................................... (5.) Non-deductible Losses.............................. Bad Debts ..... ..... ... ..... ... .. ... .. ... ... ...... ... ..... ... ...... (1.) Definition.................................................... (2.) Requisites for deductibility......................... (3.) Measure of Bad Debts deductible............. Depreciation...................................................... (1.) Definition.................................................... (2.) Requisites for deductibility......................... Depletion........................................................... (1.) Definition.................................................... (2.) Theory and purpose of Depletion allowance............................................ (3.) Who are entitled......................................... Essential factors......................................... xxiii

92 92 92 93 93 93 106 106 110 110 113 113 114 115 115

117

118 122 123 126 126 126 129 131 131 131

134 134 134 134 135

J.

K.

L.

Charitable and Other Contributions ................. . (1.) Kinds ........................................................ .. (2.) Entitled ................................... ., ................. . (3.) Requisites for deductibility ........................ . (4.) Contributions deductible in full ................. .. (5.) Contribution subject to limitation ............... . (6.) Deductible under Special Laws ................ . Research and Development Expenditure ........ . (1.) In General ................................................. . (2.) Limitations on Deduction .......................... . Employer's Contribution to Pension Trust ...... .. (1.) Nature ...................................................... .. (2.) Requisites for Deductibility ....................... . (3.) There is no need of special permit from the BIR to put up a pension plan for the benefit of employees ................... . (4.) Treatment of Income from Pension Plan .. . (5.) Deductible payments to pension trusts .... . Optional Standard Deduction ................... .. Special deductions allowed to Insurance Companies ......................................... . Items not deductible .................................. .

136 136 136 136 137 138 139 139 139 140 140 140 140

141 141 141 141

B.

Settled Case on the Tax Situs of Interest Income ....................................................... Capital Transactions ..........................................

150 153

Chapter 9 Income Tax Rules on Dealings in Property A.

A. B. C. D. E. F.

142 143

Capital Gains from Sale or Other Disposition of Real Property ( 1.) Individual Taxpayers .................................. (2.) Corporate Taxpayers .................................. Gains and Losses from Dealings in Property .......................................... Concept ............................................................. Measure of Income or Loss .............................. Adjusted Basis or Cost of the Property Sold .... Settled Rules on Sale or Exchange .................. Tax-exempt Sales or Exchanges ...................... Gain recognized, loss not recognized Rule ......

164 166 166 166 167 167 169 170 172

Chapter 10 Taxpayers Required to File Income Tax Returns

Chapter 7 A. B.

Estates and Trusts A. B.

C.

Estate ............................................................... . Trust ............. .. ··················································· (1.) Taxable Trust.. ........................................... . (2.) Rules on Taxability ................................... .. Computation of Tax on Estate and Trust.. ...... ..

146 147 147 147 148

C.

Individuals ......................................................... Corporations no matter How created or organized including General Professional Partnerships ............................................... Estates and Trusts Engaged in Trade or Business ................................................

173

175 175

APPENDICES Chapter 8 Special Topics in Income Taxation A.

Determination of Source According to Kind of Income ................................................. .. xx iv

149

Appendix A - Revenue Regulations No. 9-98 .........

176

Appendix B - Revenue Regulations No. 5-99 .........

186

Appendix C - Revenue Regulations No. 13-2000 ..

191

xxv

Appendix D - Revenue Regulations No. 2-2001 ....

197

Appendix E - Revenue Regulations No. 25-2002...

204

Appendix F - Revenue Regulations No. 76-2003...

207

Appendix G - Revenue Regulations No. 12-2007.. Appendix H - 2011 Bar Coverage for Taxation....... Appendix I - Bar Examination Questions on Taxation.................................................

211 220

Chapter 1

259

SALIENT FEATURES OF THE PRESENT INCOME TAX SYSTEM I.

INDIVIDUAL INCOME TAXATION A.

B.

C.

Schedular Tax Treatment

1.

It classifies income.

2.

It provides different tax rules.

3.

It imposes different tax rates.

Net Income Taxation

1.

Resident citizen (RC)

2.

Non-resident citizen (NRC)

3.

Resident alien (RA)

4.

Non-resident alien engaged in trade or business (NRA-ETB)

Gross Income Taxation Non-resident alien not engaged in trade or business (NRA-NETB)

D.

E.

xxvi

Income Tax Situs 1.

Residence

RA,RC

2.

Place

NRA, NRC

3.

Citizenship

RC

Individual taxpayers (compensation earners) except NRA-NETB are entitled to personal exemptions

2

II.

BASIC APPROACH TO INCOME TAXATION

CORPORATE INCOME TAXATION A.

B.

C.

Global Tax Treatment

1.

It generally provides for uniform rules.

2.

It generally imposes uniform tax rate.

3.

It does not generally classify income.

Net Income Taxation

1.

Domestic Corporation (DC)

2.

Resident Foreign Corporation (RFC)

Gross Income Taxation Non-resident Foreign Corporation (NRFC)

D.

Income Tax Situs 1.

Residence

RFC

2.

Place

NRFC

3.

Nationality

DC

Ill. COMMON FEATURES A.

B.

Pay as you File System 1.

Individuals returns

upon filing of their income tax

2.

Corporations - upon filing of their quarterly corporate income tax returns and final adjustment corporate returns

Creditable Withholding Tax System 1.

Withholding agent (source) - withholds the tax and remits the same to the BIR

2.

Tax withheld due

creditable against income tax

CHAPTER 1 SALIENT FEATURES OF THE PRESENT INCOME TAX SYSTEM

C.

3

Final Withholding Tax System 1.

Withholding agent (source) - withholds the tax and remits the same to the BIR

2.

Tax withheld - final settlement of the tax liability on the income covered

CHAPTER2 5 INCOME AND REQUISITES; INCOME TAX; NATURE AND FUNCTIONS

•

it cannot be determined by reckoning cash receipts; other income determining factors: inventories, accounts receivable, property acquisition and accounts payable for expenses incurred.

B.

INCOME, CAPITAL, REVENUE, RECEIPTS; DISTINCTIONS (1995 Bar)

Chapter 2 INCOME AND REQUISITES; INCOME TAX; NATURE AND FUNCTIONS

Capital A.

DEFINITIONS (1969 Bar)

In a broad sense, income means all wealth that flows into the taxpayer other than as a mere return of capital. It includes the forms of income specifically described as gains and profits including gains derived from the sale or other disposition of capital assets.

•

gain derived from capital, or from labor, or from both capital and labor, including the gain derived from the sale or exchange of capital assets (Fisher v. Trinidad, 43 Phil. 973; Eisner v. Macomber, 252 U.S. 189, 40 S. Ct. 189, 64 L. Ed. 521 1920). amount of money coming to a person or corporation within a specified time, whether as payment for services, interest or profit from investment (CONWI v. CTA, 213 SCRA83).

Economist's definition •

money value of the net accretion to one's economic power between two points of time (R.M. Haig, The Federal Income Tax, Columbia University; Anderson, Taxation and the American Economy). 4

Income

Fund

Flow

Wealth

Service of wealth

Tree (property)

Fruit (metaphorical language)

Gross receipt includes receipts which may constitute capital as well as income; therefore, broader in scope. Income connotes a narrower concept limited only to gain derived from labor, capital or property, excluding non-income items such as the capital invested, cost of goods sold or those excluded by law from income taxation.

Judicial definitions •

v.

Revenue refers to all funds or income derived by the government whether from tax or other sources. Revenue is to the government as income is to private persons or corporations. C.

SOURCES OF INCOME •

Property (capital)

•

Labor (service)

•

Sale/Exchange of capital asset and activity

Source of income is any property, activity or service that produced the income (COM v. BOAC, 149 SCRA 395). It may also be in the form of proceeds from sales of transport documents.

6


CHAPTER 2 7 INCOME AND REQUISITES; INCOME TAX; NATURE AND FUNCTIONS

,,,_.-"..,-,,

~!J/Bad debt r~covery-. must be cl_aimed as deduction

Under the Tax Code, however, income derived from whatever source forms part of the taxpayer's income. This includes the following: (1.) Treasure found or punitive damages representing profits lost; (2.) Amount received by mistake (Javier v. CA, 199 SCRA 824; Javier v. Com, CTA Case No. 3393, July 27, 1983).

-

D.

from gross income 1n the preceding year. It assumes that the taxpayer has a net income, not a net loss (2005, 2003 Bar). A!O/ 'f AY.H?t~ 11 ~-" !lei11,;rvi' INCOME TAX; BASIS, NATURE, FUNCTIONS (1.) It is a tax on all yearly profits arising from property, profession, trades or offices or as a tax on a person's income, emoluments, profits and the like.

If a foreign bank erroneously remitted U.S.$1 million instead of U.S.$1,000.00 and it appears subsequently that the recipients spent the difference of U.S. $999,000 on various purchases of property both here and abroad of their own material benefit, the said sum constitutes taxable income.

(2.) It is based on income, either gross or net, realized in one taxable year.

It has been held that if a taxpayer receives earnings under a claim of right without restrictions as to its disposition, he has received income even though it may still be claimed that he is not entitled to retain the money and even though he may still be adjudged liable to restore its equivalent. This is an exception to the rule that income received through mistake is not taxable as its receipt is offset by liability to the party making the excessive payment (North American Consolidated v. Burnet, 286 U.S. 417).

(4.) Functions of income tax:

(3.) Cancellation of the taxpayer's indebtedness. (4.) Payment of usurious interest. (5.) Illegal gains - gambling, theft, embezzlement, extortion, fraud - income to embezzler if forgiven by the owner. (6.) Tax refund - must be claimed as deduction from gross income in the preceding year. It means that the tax must be a deductible one (2005, 2003 Bar).

(3.) Excise tax - it is not levied upon the person or property but upon the right of a person to receive income or profits. a.) to provide large amounts of revenues; b.) to offset regressive sales and consumption taxes; c.) to mitigate the evils arising from the inequalities in the distribution of income and wealth which are considered deterrents to social progress, by a progressive scheme of taxation (Report of the Tax Commission of the Phil., Vol. II; Madrigal v. Rafferty, 38 Phil. 414 ). (5.) The basis of the right of the government to tax income emanates from its partnership in the production of income by providing the protection, resources, incentive and proper climate for such production (Com. v. Lednicky, 11 SCRA 603). This is called the Partnership Theory which has spawned the following principles: a)

Protection theory. It dictates that when the flow of wealth proceeded from, and occurred

8


within, Philippine territory, enjoying the protection accorded by the Philippine government, the same, in consideration of such protection should share the burden of supporting the government [CIR v. BOAC, 149 SCRA 395, 407 (2009 Bar)]. b)

@,

E. Fr'111.iic:11

ri.u:

Theory offavorable business climate. Domestic corporations owe their corporate existence and privilege to do business to the government. They also benefit from the efforts of the government to improve the financial market and to ensure a favorable business climate. It is therefore fair for the government to require them to make a reasonable contribution to the public expenses (CREBA v. Romulo, 614 SCRA 605, 622).

REQUISITES FOR INCOME TO BE TAXABLE (1.) There must be gain or profit, whether in cash or its --· eq(Jivalent. J.~.)

The gain must be realized or received. This implies that not all economic gains constitute taxable income. ~J

Mere increase in the value of property is not income (unrealized increase in capital).

_tl.1

Increases in the taxpayer's net worth are not taxable increases in net worth if they are not the result of the receipt by it of unreported or unexplained taxable income, but are shown to be merely the result of the correction of errors in its entries in its books relating to its indebtedness to certain creditors, which had been erroneously overstated or listed as outstanding when they had in fact been duly paid (Fernan-


dez v. Commissioner of Internal Revenue, 29 SCRA 553). c.) But if the increase in the net worth of a taxpayer is the result of the receipt by it of unreported or unexplained taxable income, the correction is taxable income. d J Receipt includes constructive receipt.

-- ·- *1[ill Doctrine of Constructive Receipt of Income - Income which is credited to the account of and §€lt EIP§rt for a J.i:t)(payer and which may be drawn by him at any time is subject to tax for the year during which it was so credited or set apart although not yet then actually received or reduced to his possession. To constitute receipt in such case, the income must be credited to the taxpayer without any substantial limitation or condition upon which payment is to be made. Examples of Constructive Receipt: i.

Matured interest coupons due and demandable (convertible into cash);

ii.

Share in the profits of a partner in a partnership;

iii.

Interest credited on savings bank deposit (Section 53, Revenue Regulations No.2);

iv.

Dividends applied by the corporation against the indebtedness of a stockholder (Section 50, Revenue Regulations No. 2);

v.

Rental payments refused by the lessor when the lessee tendered payment and the latter made a judicial deposit of the

10



rental (Limpian Investment Corporation v. Com., 17 SCRA 703). vi.

Amount credited to shareholders of a building and loan association when such credit passes without restriction to the shareholder. The Doctrine of Constructive Receipt is designed to prevent the taxpayer using the cash basis from deferring or postponing the actual receipt of taxable income. Without the rule, the taxpayer can conveniently select the year in which he will report the income. In Filipinas Synthetic Fiber Corporation v. CA [316 SCRA 480, 486], the Supreme Court ruled that it is the right to receive income, and not the actual receipt, that determines when to include the amount in gross income. For taxpayer using the accrual method, the determinative question is, when do the facts present themselves in such a manner that the taxpayer must recognize income? The accrual of income is permitted when the all-events test has been met. This test requires: (1) fixing of a right to income to pay; and (2) the availability of the reasonable accurate determination of such income. [Commissioner of Internal Revenue v. lsabela Cultural Corporation, 515 SCRA 556, 564-565 (2010 Bar)].

@J The gain must not be excluded by law or treaty from taxation. This means that not all income is required to be included in computing the taxable income.

F.

DOCTRINES ON DETERMINATION OF TAXABLE INCOME (1.)it.£\tlaim~~f1"£i@l\ff~{!l©~frlllfta- illegally acquired income

constitutes realized gain (Rutkin v. U.S., 343 U.S. 130). (2001 Bar) (2. )illlil:e\Uil~al!l:!ils&testtl!life1i\l]iY- separation from capital of something which is of exchangeable value (Eisner v. Macomber, 252 U.S. 189). (3. )lk
Dl?l!r - ~d
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'"·'·"'''''"· , C~lJ.i he (1)

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Pit

CHAPTER 3 GROSS INCOME

B.

Chapter 3

13

BROAD DEFINITION In a broad sense, gross income means income less income which by statutory definition or otherwise, is exempt from the tax imposed by law. Stated otherwise, gross income means all items of income less exclusions.

GROSS INCOME A.

GENERAL STATUTORY DEFINITION

FORMULA: GROSS INCOME; NET INCOME; TAXABLE COMPENSATION INCOME; INCOME TAX DUE; INCOME TAX PAYABLE

In a narrow sense, gross income means all income derived from whatever source, including but not limited to the following:

Gross Income

(1.) Compensation for services in whatever form paid including but not limited to fees, salaries, wages, commissions and similar items;

= All income less exclusions (1980,1983 Bar)

Net or Taxable Income

= Gross income less allowable deductions (1977, 2000 Bar)

Taxable Compensation Income

= Gross compensalion less personal and additional exemptions (Individual Taxpayers)

Income Tax Due

= Taxable ornet income multiplied by income tax rate

Income Tax Payable

= Income Tax due less creditable withholding tax or tax credit

(2.) Gross income derived from the conduct of trade or business or the exercise of profession; (3.) Gains derived from dealings in property; (4.) Interests; (5.) Rents; (6.) Royalties; (7.) Dividends; (8.) Annuities; (9.) Prizes and winnings; (10.) Pensions; and (11.) Partner's distributive share from the net income of the general professional partnership.

12

14



GROSS INCOME TAXATION AND NET INCOME TAXATION; DISTINCTIONS; ADVANTAGES AND DISADVANTAGES

EXCLUSIONS FROM GROSS INCOME

Gross Income Taxation Allows no deductions Grants no exemptions Tax base: Gross income

Net Income Taxation Deductions are allowed Exemptions are granted Tax base: Net income

Advantages of Gross Income Taxation Simplifies the income tax system Does away with wastage of manpower and supplies Substantial reduction in corruption and tax evasion exercise of discretion to allow or disallow deductions dispensed with

Advantages of Net Income Taxation Fair and just due to grant of deductions Tax audit minimizes fraud

Disadvantages of Gross Income Taxation No deductions and exemptions allowed

Provides equitable reliefs in the form of deductions, exemptions and tax credits

Disadvantages of Net Income Taxation Vulnerable to corruption on account of margin of discretion in the grant of deduclions Susceptible of fraud in the Confusing and complex absence of general audit process of filing income tax return Taxpayers lose interest to Difficult/costly to administer earn more thereby lessening their purchasing capacity

A.

15

REASONS FOR EXCLUSION (1.) The item ofreceipt does not fall within the definition of income for income tax purposes. •

Damages recovered in libel and slander suits

•

Damages recovered for alienation of affection

•

Damages recovered for breach of promise to marry

•

Damages recovered for loss of life of spouse

•

Damages recovered in annulment of marriage

(2.) A provision of the Tax Code or special law exempts it from income tax.

B.

EXCLUSIONS FROM GROSS INCOME

(1.) Proceeds of life insurance .(2007, 2005, 2003 Bar) - received in a single sum or installments - not taxable-Reason: indemnity ratherthan as gain or profit. Insurance contract is a contract of indemnity. Exception - interest payments s.hall be included in 7 gross income if such amount is QE)lg,by the insurer \ under the agreement to pay interest thereon.

j

r

However, prgceeds of life insurance where the beneficiary is~evocabl~ is subject to estate tax. The exclusion from'mcome taxation applies regardless of who the beneficiary is, whether a family member, or other individual, corporation or partnership. Exclusion applies to group insurance, death benefits under the Workmen's Compensation Insurance or under health or accident insurance contract having the characteristics of life insurance proceeds

16


CHAPTER3 GROSS INCOME

by reason of death (El Orients v. Posadas, 56 Phil. 147).

Amount other than amount paid by reason of death. Excess of the amounts received over the aggregate premiums or consideration paid is taxable. Hence, if a taxpayer took out a P100,000.00 endowment policy in which he paid P80,000.00 as aggregate premiums and upon maturity he received P100,000.00, only P20,000.00 is taxable.

Transfer of insurance contract -- amount excludible should only be the amount or value of actual consideration paid and the premiums paid later by the transferee. Where the consideration and premiums paid exceed the proceeds, no amount is includible in the gross income of the transferee.

•

(3.) Gifts, bequests and devises Reason: Not a product of capital nor industry.

other tax implications of life insurance proceeds (2003 Bar) a.) Included in the gross estate:

•

Third person is revocably designated as beneficiary;

•

Estate, executor or administrator is designated as beneficiary, revocable or irrevocable.

C•MMnt.<;, P"'«r'-tl..i (,

•

Gifts are subject to donor's tax, whereas bequests and devises are subject to estate tax (1994 Bar).

•

But the income from such property is taxable. If the taxpayer inherits securities, the value of such securities does not constitute income but the dividends and interest paid on such securities are taxable.

ht1~kt:i- in

•

b.) Excluded from the gross estate: (2007 Bar)

•

Third person is irrevocably designated as beneficiary;

•

Proceeds of group insurance.

(2.) Amount received as retqm of premium- under life insurance, endowment or annuity contracts, either during the term or at the maturity of the contract. Cash surrender value of the policy is also nontaxable. Return of premium means a repayment of a part or the whole of the premiums paid (Com. v. Winslow, 113F [Ed.] 418). Reason for the exclusion: Return of capital

17

, 111

Principal paid under a marriage settlement and alimony or allowance based on separation agreement are considered as gifts.

(4.) Compensation for injuries or sickness (2003, 1995, 1986, 1967, 1964 Bar) Reason: Compensatory; not gain/profit; adds nothing to the individual (Lawkins v. Com., 6 B.T.A. 1032).

•

Through accident or health insurance;

•

Workmen's Compensation;

•

Damages received whether by suit or agreement on account of such injuries or sickness;

•

Damages recovered are taxable if the amount represents loss of anticipated profits; not tax-

18


•

•


able if it represents a return of capital or investment (BIR Ruling, September 8, 1954).

iii.

At least 50 years of age at the time of the retirement;

If the recovery represents damages for lost profits, it is taxable as ordinary income (36 T.C. 1173 [1961], Federal Income Taxation Third Edition, Rose and Chommie, p. 24)'. (2005 Bar)

iv.

The benefit of exclusion shall be availed of only once. (Santos v. Servier Philippines, Inc .. 572 SCRA 487, 499) •

Even if the member has attained 50 years of age with at least ten years of service, if the employee-member is still on active employment with the company, any and all amounts distributed from the fund to the private member over and above his personal contributions shall be taxable to the said employee recipient as wages were received before his retirement from the service of his employer (BIR Ruling 97-86, April 4, 1986).

•

An agreement to pay the taxes on the retirement benefits as an incentive to prospective retirees and for them to avail of the optional retirement scheme is not contrary to law or public morals (International Broadcasting Corporation v. Amarilla, 505 SCRA 687, 702).

Disability benefits paid under life insurance are also excluded although the law refers to accidents and health insurance (Wong v. Wing Non, 18TC 205, December 18, 1949).

(5.) Income exempt under treaty. This is premised on ou~ adher~nce to the generally accepted principles of international law. In this category, the following items of income are tax exempt: •

•

Income derived by the US Consular officials in the Philippines in connection with such consular service (USPI Consular Convention). Income exempt under tax treaty with foreign countries.

(6.) Retirement benefits, pensions, gratuities, etc. ... (2000, 1999, Bar)

~)®

Retirement benefits received by officials and employees of private firms, individuals or corporations. Requisites for exclusions: i.

ii.

19

Reasonable private plan maintained by the employer duly approved by the BIR for exclusive benefit of the members- employees; Retiring official or employee who has rendered at least 1O years of service;

b.) Separation benefits due to death, sickness or other physical disability or for any cause beyond the control of the said official or employee. •

Any amount received from an employer as aresultof separation from service due to ~icknes~ is exempt from all taxes (BIR Ruling1~87, January 9, 1987; Ruling 3987, February 10, 1987).

20


•

•

•

The law does not require that the exclusion be enjoyed once:

•

•

c.) Social Security benefits; retirement gratuities received by resident or non-resident citizens or resident aliens from foreign government agencies and other private or public institutions. (2007 Bar)

Benefits received as a result of voluntary resignation are taxable ( 1984 Bar). Reason: It is a cause within the control of the said official or employee. The exemption holds regardless of the employee's age and length of service (1999 Bar).

Pensions received by retirees from foreign sources (BIR Ruling 72-87, March 12, 1987). d.) Benefits received from US Veterans Administration (R.A. No. 360) by veterans residing in the Philippines. e.) Payment of benefits under the Social Security System in accordance with the provisions of R.A. No. 8282.

Separation of employee due to dissolution of a law firm is a cause beyond the control of said employee (BIR Ruling No. 73-85, May 20, 1985).

Compulsory retirement- cause beyond the control of the employee (Request for reconsideration of Atty. Zialcita, 190 SCRA 851). Terminal leave pay is excluded from gross income. Compulsory retirement may be considered as a cause beyond the control of the said official or employee. Consequently, the amount received by way of commutation of his accumulated leave credits as a result thereof falls within the enumerated exclusion from gross income. It is not considered compensation for services rendered. Reason: It is paid when the employer has already severed

21

his connection with his employees and who is no longer working (Ibid.) (1996, 1991 Bar).

Separation benefits paid to retrenched employees as a consequence of either the sale of the entire business to another corporation or the cessation of the employer's. business are exempt from income tax (BIR Ruling 130-87, May 14, 1987).

•

•


f.)

Benefits received from the GSIS under R.A. No. 8291 including retirement gratuity.

/)l!;l)Uliit,t

@~ Miscellaneous items ~-·''

a.) Income received by foreign governments from their investments in the Philippines. Reason: To lessen the burden of foreign loans inasmuch as the interest of these loans are, by contractual arrangement, borne by the domestic borrowers. Foreign governments include financing institutions owned, controlled and financed by them and international or regional financing institutions established by governments.

•

To be exempt, the creditor must be the foreign government or financing institutions owned, controlled and established by it.

22


•

Mitsubishi Metal Corporation, a Japanese Corporation, borrowed $20 million from the Import-Export Bank of Japan (Eximbank), owned, controlled and financed by the Japanese government through a consortium of Japanese banks. Mitsubishi used the same amount in extending loan to Atlas which agreed to sell copper concentrates to the former. RULING: Mitsubishi, not Eximbank, is the sole creditor of Atlas in the contract of loan, hence, the interest income of Mitsubushi is subject to income tax. Eximbank (not party in interest) had nothing to do with the sale of the copper concentrates. When Mitsubishi obtained the loan of $20 million from Eximbank of Japan, said amount ceased to be the property of the bank and became the property of Mitsubishi. Tax exemptions are construed STRICTISSIMI JURIS (Com. v. Mitsubishi Metal Corp., 181 SCRA214).

•

Income of foreign government from operation in the Philippines of vessels owned or chartered by it is taxable (Opinion of the Secretary of Justice, 40 O.G. 785).

b.) Income derived by the Government of the Philippines or any political subdivision from any public utility or from the exercise of any essential governmental function (e.g., income derived by a municipality from the operation of a market or an electric power plant) - This is in recognition of the principle of exemption from taxation of government agencies or entities.


23

c.) Prizes and awards under the following conditions (2000 Bar): i.

Received in recognition of religious, charitable, scientific, educational, artistic, literary or civic achievement.

ii.

Recipient was selected without any action on his part to enter the contest or proceeding.

iii.

Recipient is not required to render substantial future services as a condition to receiving the prize or award.

d.) Prizes and awards in sports competition granted to athletes whether held in the Philippines or abroad and sanctioned by their national sports associations (1996 Bar). e.) 13th-month pay and other benefits:

f.)

i.

Other benefits cover productivity incentives and Christmas bonus;

ii.

Total exclusion shall not exceed P30,000.00.

GSIS, SSS, Medicare and other contributions.

g.) Gains from the sale or exchange of retirement of bonds, debentures, or other certificate of indebtedness with a maturity of more than five (5) years. h.} Gains from redemption of shares in Mutual Fund Company. •

Tax-exempt income under special laws i.

Prizes received in charity, horse racing, sweepstakes from the Philippine

24


Charity Sweepstakes Office (R.A. No. 1169).

ii.

Salaries and stipend in dollars received by non-Filipino citizens serv" ing as staff of: •

International Rice Research Institute (R.A. No. 2707);

•

Ford Foundation Grants (R.A. No. 3538);

•

• iii.

iv.

Agricultural Department of the Southeast Asian Fisheries Development Center (SEAFDEC) (P.D. No. 246); Population Council of New York (P.D. No. 246).

Income from bonds and securities: •

For sale in the international market (P.D. No. 81);

•

Issued by EPZA (P.D. No. 66).

Income derived from the installment sales of houses to their employees and workers or to low-income groups in housing projects or income derived from rentals thereof (P.D. Nos. 745 and 1217- Housing Program of the government).

Chapter 4

INDIVIDUAL INCOME TAXATION A.

CLASSIFICATION OF INDIVIDUAL TAXPAYERS (1.) Resident citizen (RC) - citizens of the Philippines who are residing therein (Article IV, Constitution). (2.) Non,resident citizen (NRG) - citizens of the Philippines who are physically present abroad for an uninterrupted period covering an entire taxable year. NRC means one who establishes to the satisfaction of the BIR Commissioner the fact of his physical presence abroad with definite intention to reside therein, either as: a.) Immigrant; b.) Employee on a more or less permanent basis; c.) Contract workers whose contracts of employment are renewed from time to time within or during the taxable year. NRC may be considered RC or NRC depending upon his departure and arrival. In this regard, NRC shall submit proof to the BIR to show his intention of leaving the Philippines to reside permanently abroad or to return to and reside in the Philippines for this purpose. (3.) Resident Alien (RA)- non-citizens who reside in the Philippines 25

26


CHAPTER4 INDIVIDUAL INCOME TAXATION

a.) He must be a resident not mere transient or sojourner (whether he is a transient or not is determined by his intention with regard to the length and nature of his stay).

period exceeding three months as of and including December 31. (4.) Non-Resident Alien (NRA) resident of the Philippines

b.) Alien living in the Philippines and has no definite intention (floating intention) as to the time of return to his country or his stay in the Philippines.

b.) ETB - includes the performance of personal services within the Philippines c.)

BIR regulation provides no fixed or definite criterion of determining residency beyond stating that NRA must have no residence in the Philippines. The difficulty however, arises where an alien lives in the Philippines, though he does not maintain residence therein. Maintemmce of residence is the test but actual stay is a basic factor in determining residency. Therefore, the following must be considered: i.

Maintenance of residence in the Philippines;

ii.

Actual physical residence in the Philippines;

iii.

His temporary stay (with intention to return) is on an extended stay;

iv. v.

Considered resident alien if he resides for more than one year; Loses his residence if he stays outside the Philippines for a continuous

neither citizen nor

a.) NRA-ETB - comes and stays in the Philippines for an aggregate period of more than 180 days during the calendar year (Section 25 A[1], NIRC, as amended) (2000 Bar).

c.) Those who come to the Philippines and whose extended stay may be necessary to accomplish the purpose and to that end they may have the intention at any time to return home, when their purpose of stay is accomplished/completed. •

27

Foreign technician on a job contract for one year

(5.) Non-ResidentA/ien Not Engagedin Trade or Busi'ness- NRA-NETB. In general, his income is taxed at 25% final tax based on gross or entire income. However, NRA-NETB is taxed at special rate of 15% if employed by the following: a.) Regional or area headquarters of multi-national corporations; b.) Offshore banking units established in the Philippines; c.)

B.

Petroleum service contractors or sub-contractors.

GENERAL PRINCIPLES: SOURCES OF INCOME; TAX BASE Sources of Income

Tax Base

RC

within and without taxable income

NRC

within

. taxable income

RA

within

taxable income

28

NRA-ETB

within

NRA-NETB within C.



taxable income gross income

CATEGORIES OF INCOME (1967, 1969, 1970 Bar)

B.

BASIS/TEST: Designation/name of the remuneration upon which it is paid and the manner of payment is IMMATERIAL What is important is that it is derived from employer-employee relationship. •

However, not every compensation income is includible under the term gross compensation income. Compensation for services rendered by an independent contractor does not fall under the legal category of "gross compensation income."

•

Amounts paid either as advances or reimbursement for transportation, representation and other bona fide ordinary and necessary expenses incurred in the performance of his duties - not taxable compensation income. Only the excess, if any, over actual expenses is taxable.

•

Three years back wages shall be taxable to an illegally separated employee but not attorney's fees which are not subject to tax (BIR Ruling, 13 July 1992).

•

Income derived by partner from professional partnership does not form part of the gross compensation income.

CATEGORIES OF INCOME Compensation income Business income derived by self-employed Professional income derived by professionals Passive investment income Gains derived from dealings in property

COMPENSATION INCOME

A.

DEFINITION All remuneration for services rendered by an employee for his employer unless specifically excluded under the Tax Code (Revenue Regulations 2-98). It includes salaries, wages, emoluments, honoraria, bonuses, allowances (transportation, representation, entertainment and the like), fringe benefits (monetary and non-monetary fees) including director's fee, taxable pensions and retirement pay and other income of similar nature including compensation paid in kind. Income of similar nature - proceeds from property sharing; COLA, PERA, housing allowance, overtime pay, emergency pay, hazard pay, rice and clothing allowance, medical allowance, grocery allowance.

29

C. REQUISITES FOR TAXABILITY ---. (1.) Personal services actually rendered; (2.) Payment is for such services rendered; (3.) Payment is reasonable. D. FORMS OF COMPENSATION -.... Form/Kind -

Measure of income:

(1.) Cash or in money -Amount of money received.



30

eficiary designated is the family, executor, administrator or the estate of the employee (2007, 2004 Bar);

(2.) Property or in kind (Doctrine of Cash Equivalent) -FMV. (3.) Price is stipulated - FMV of the compensation in the absence of contrary evidence. (4.) Promissory notes or other evidence of indebtedness (not mere security)- Not Discounted: Face Value; Discounted: 1.) Year of receipt - Discounted value; 2.) Maturity Date - Difference between Face Value and Fair Market Value (5.) Cancellation or forgiveness of indebtedness made in consideration of debtor's services rendered amount of debt cancelled •

Other tax implications of condonation of indebtedness: i.

If no consideration is given, it amounts to taxable donation and therefore subject to donor's tax as far as the creditor (donor) is concerned ( 1997 Bar);

ii.

It amounts to taxable indirect dividend if the creditor is a corporation and the debtor is the stockholder.

(6.) Premiums paid by employer on the life insurance policy of employee whose family, executor, administrator or his estate is the beneficiary - amount of the premium paid. •

Conversely, premiums are not taxable if the beneficiary is the employer whether directly or indirectly designated. Other tax implications of premiums paid by employer: i.

Employer may claim the premiums as deductible from gross income if the ben-

31

ii.

Employer is not allowed to claim premiums paid as deductible if he is directly or indirectly designated as beneficiary (Section 36[A][4]) (1978 Bar).

(7.) Income tax paid by employer in consideration of the employee's services rendered - amount of such tax paid (8.)

P~rsonal

without -

services performed partly within and partly apportion on the time basis

(9.) Tax exempt compensation income (benefits, privileges, facilities and the like)

&

Convenience of the Employer Rule (1995 Bar). It grants exemption to benefits which are given for the exclusive benefit or convenience of the employer.

•

If such quarters and other facilities exceed the employee's needs, only a ratable part of the value thereof as employee would have spent therefor constitutes taxable income. The remainder is considered expense of the employer (Collector v. Henderson, 1 SCRA 649). Lodging quarters furnished to an employee by or on behalf of the employer shall be excluded from employee's gross income if the living quarter is situated within the business premises of the employer and the employee is required to accept such lodging facility as a condition of his employment (Revenue Audit Memo. Order No. 1-87, April 23, 1987).

32



•

•

JU.

not more than P1 ,500.00; (2007 Bar; RR 5-2008)

The value of meal furnished to an employee by or on behalf of his employer shall be excluded from the employee's gross income if the meals are furnished . in the business premises of the employer and the meals are for the convenience of the employer (Ibid.}. Under Revenue Regulations 3-98, the monetary value of housing unit or the rental value thereof is tax exempt if the housing unit is situated within the business premises of the employer. In this case, the recipient must be a managerial or supervisory employee.

Monetized unused vacation leave credits of private employees not exceeding ten (10) days during the year;

ii.

Monetized value of leave creqjts. paid to: . government officials and employees;,. ·:

iii.

Medical cash allowance to dependents of employees not exceeding P750.00 per employee per semester or P125.00 per month;

iv.

Rice subsidy of P1 ,500.00 or one ( 1) sack of 50-kg. rice per month amounting to

v.

Uniform and clothing allowance not exceeding P4,000.00 per annum; (RR 5-2008)

vi.

Actual yearly medical benefits not exceeding P10,000.00 per annum;

vii. Laundry allowance not exceeding P300.00 per month; viii. Employee achievement awards, e.g., for length of service or safety achievement, which must be in the form of tangible personal property other than cash or gift certificate, with an annual monetary value not exceeding P10,000.00 received by the employee under an established written plan which does not discriminate in favor of highly paid employees;

De minimis benefits. These refer to facilities or privileges furnished or offered by an employer to his employees that are of 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. These include only, pursuant to RR 5-2011, the following:

i.

33

E.

ix.

Gifts given during Christmas and major anniversary celebrations not exceeding P5,000.00 per employee per annum;

ix.

Flowers, fruits, books, or similar items given to employees under special circumstances, e.g., on account of illness, marriage, birth of a baby, etc.; and

x.

Daily meal allowance for overtime work not exceeding twenty-five percent (25%) of the basic minimum wage.

SPECIAL RULES ON FRINGE BENEFITS (1.) What is a fringe benefit? Fringe benefits refer to goods, services, or other benefits furnished or granted by an employer,

~·

,....,,._,,.,,

''"-'"'-'' j

IV 11\IVUIVIC 1~1 IUN

in cash or in kind, in addition to basic salaries, to managerial or supervisory employees such as, but not limited to the following:

CHAPTER 4 INDIVIDUAL INCOME TAXATION

35

are involuntarily separated from work are not subject to FBT;

•

Housing;

•

Expense account;

b.) Contributions of the employer for the benefit of the employee to retirement, insurance and hospitalization benefit plans;

•

Vehicle of any kind;

c.)

•

Household personnel, such as maid, driver and others;

•

Interest on loan at less than market rate (benchmark rate of 12%) to the extent of the difference between the market rate and actual rate granted;

•

Membership fees, dues and other expenses borne by the employer for the employee in social and athletic clubs or other similar organizations;

Benefits given to the rank and file, whether granted under a collective bargaining agreement or not;

d.) De minimis benefits (refer to Tax Exempt Compensation Income, item no. 9[b]); e.) Benefits granted to employee as required by the nature of, or necessary to the trade, business or profession of the employer; f.)

Benefits granted for the convenience of the employer.

(3.) Benefits which are considered necessary to the - business of the employer, or are granted for the convenience of the employer.

•

Expenses for foreign travel;

•

Holiday and vacation expenses;

•

Educational assistance to the employee or his dependents; and

The following fringe benefits are not subject to FBT because they are given primarily for the convenience of the employer:

•

Life or health insurance and other non-life insurance premiums or similar amounts in excess of what the law allows.

a.) Housing privilege of military officials of the AFP located inside or near the military camps;

(2.) Not all benefits given by an employer to his employees are subject to FBT. The following benefits are not subject to FBT: a.) Fringe benefits which are authorized and exempted from income tax under the Code or under special law. For instance, separation benefits which are given to employees who

b.) A housing unit which is situated inside or at most 50 meters from the perimeter of the business premises; c.) Temporary housing for an employee for 3 months or less; d.) Expenses of the employee which are reimbursed by the employer if they are supported by receipts in the name of the employer and do

36



not partake the nature of a personal expense of the employee; e.) Motor vehicles used for sales, freight, delivery service and other non-personal uses; f.)

The use of aircraft (including helicopters) owned and maintained by the employer;

g.) Business expenses which are paid by the employer for the foreign travel of his employees in connection with business meetings or conventions. The expenses should be supported by documents proving the actual occurrences of the meetings/conventions, or official communications from business associates.

The FBT is collected from the employer even if the employer is a tax-exempt corporation, or an instrumentality of the Philippine government. (7.) Why is the FBT collected from the employer? (2003 Bar) Valuation of benefits is easier at the level of the firm. The problem of allocating the benefits among individual employees is avoided. Collection of the FBT is also ensured because the FBT is withheld at source and does not depend on the self-declaration of the individual. (8.) FBT is not an additional tax on the employer. The FBT is not an additional tax on the employer. He can claim the fringe benefit and the FBT as a deductible expense from his gross income.

(il Nature of Fringe Benefits Tax. The Fringe Benefits Tax is a tax imposed on fringe benefits which are granted or are paid by an employer to an employee occupying a managerial or supervisory position.

(]) Benefits subject to the FBT. The FBT is imposed on fringe benefits given or furnished to managerial or supervisory employees on or after January 1, 1998. Fringe benefits granted to rank and file employees are not subject to FBT.

(5.) Purpose of the FBT. The FBT is a measure to ensure that an income tax is paid on fringe benefits (FBs ). If they were given in cash, an income is automatically withheld and collected by government. An additional compensation which is given in non-cash form is virtually untaxed. This situation has caused inequity in the distribution of the tax burden. The FBT can enhance the progressiveness and fairness of the tax system. (6.) Who should pay the FBT? (2003 Bar) The FBTis a tax on the income of an employee which is paid by the employer on behalf of the employee.

37

(10.)

Who are considered as managers? supervisors? rank-and-file? "Managerial employees" refer to those who are given powers or prerogatives to lay down and execute management policies and/or to hire, transfer, suspend, lay-off, recall, discharge, assign or discipline employees. "Supervisory employees" are those who effectively recommend such managerial actions if the exercise of such authority is not merely routinary or clerical in nature but requires the use of independent judgment.

,i."Rank-and-file employees" mean all employees who are holding neither managerial nor supervisory position.

F.

39

•

They are intended to substitute for the disallowance of personal family or living expenses.

•

Nature: Personal exemptions are the theoretical, personal, living and family expenses of an individual allowed to be deducted from the gross or net income of an individual taxpayer (Pansacola v. CIR, 507 SCRA81, 87).

•

Basis: Principle that the burden of income taxation should be adjusted according to one's capacity to pay.

•

Taxpayers entitled -

DOCTRINE OF CASH EQUIVALENT It provides that any economic benefit to the employee whatever may have been the mode by which it is effected is compensation income. In stock option, for instance, the difference between the FMV of the shares at the time the option is exercised and the option price constitutes additional compensation income to the employee (Com. v. Smith, 324 U.S. 177; Com. v. Le Bue, 1 U. 243).

G.



38

a.) Resident citizen

ALLOWABLE DEDUCTIONS FROM GROSS COMPENSATION INCOME

b.) Non-resident citizen

(1.) Personal exemptions:

d.) Non-resident alien engaged in trade or business on the basis of reciprocity. The reciprocity rule applies only to basic personal exemption. The basic personal exemption that may be allowed must not be more than the aforestated amounts.

a.) Basic Personal Exemption (R.A. No. 9504) Each married individual Head of family -

P50,000.00

50,000.00

Single or legally separated individual with no dependents -

50,000.00 .

b.) Additional exemption for qualified dependent child - P25,000.00 but not in excess of four (4) or P100,000 (R.A. No. 9504). •

Personal exemptions are arbitrary amounts (they may not be fully adequate to cover all personal expenses) allowed in the nature of a deduction from gross or net income, for personal, living or family expenses. According to the Supreme Court, the amount has been calculated to be roughly equivalent to the minimum of subsistence (Madrigal v. Rafferty, 38 Phil. 414 ).

c.) Resident alien

Conditions for the grant of basic personal exemption to NRA-ETB:

•

His foreign (mother) country has income tax law;

•

His foreign country allows personal exemptions to citizens of the Philippines not residing therein;

•

File an accurate return of his income from all sources within the Philippines on time;

•

Amount allowable - not to exceed our maximum allowable personal exemption.



40

•

•

Series of 1961. However, Section 35 of the Tax Code excludes them from qualified dependents;

In the case of legally separated spouse, additional exemption may be claimed only by the spouse who has custody of the child or children. The total additional exemption claimed by both must not exceed four (4) or P100,000.00.

ii.

Head of family means an unmarried or legally segarated man or womal)lwittfone or bot,h parents otWith one or more brothers or sisters of't.tith one or

him/her for chief support, where such ·t)rothers or sisters or children are not more than twenty-one (21) 'years of ageffhnmarried and not gainfully employed or where such children, brothers or sisters, reg9gjless of age are incapable of self-support because of mental or physical defect. Qualified dependents:

•

a.) Parents (step parents, parents-in-law are excluded) - Living with the taxpayer and dependent on the taxpayer for chief support. b.) Brothers and sisters (full or half blood): Living with and dependent upon the taxpayer for chief support;

ii.

Unmarried and not gainfully employed;

iii.

Not more than twenty-one (21) years of age except if incapable of self support because of physical or mental defect.

c.) Children (legitimate, recognized illegitimate and legally adopted) - Same qualifications as brothers and sisters:

i.

Stepchildren are qualified dependents under BIR Revenue Regulations 235,

Legally adopted child. There must be a judicial order by competent court, not mere affidavit (BIR Ruling 572, 29 October 1959).

d.) ·Senior eiti:Zen: Uhder Republic Act No. 7432 as implemented by Revenue Regulations No. 2-94, senior citizen means any resident citizen of the Philippinesvat least sixty (60) years old, including those who have retired from both governmeJ;;IJ offices and. private enterprises, and has ali'income of not more than sixty thousand pesos (P60,000.00) per annum subject to review by the National Economic and Development Authority (NEDA) every three (3) years.

~d0~~t:cTi~~1~~~~Jtei~ii~X~~:g:~~~~~~;;~~~!e~;~~

i.

41

•

The term head of family includes an unmarried or legally separated man or woman who is the benefactor of a qualified senior citizen. Benefactor means any person whether or not related to the senior citizen who takes care of the latter as a dependent.

''Living1with'' does not connote actual or physical togetherness. It means that taxpayer exercised control based on some moral or legal obligation and makes the taxpayer's home as his principal place of abode. Dependent must be a member of the taxpayer's family by blood relationship, relationship by marriage, or by adoption (Section 11, Rev. Reg. No. 2, Stanley & Kilcullen). a.) Temporary absence from their common residence brought about by force of circumstances,

42



e.g., taxpayer may be away on business or to earn livelihood, or dependent may be boarding elsewhere in the pursuit of education. b.) Children of resident alien residing abroad are not considered living with the taxpayer (Section 11, Revenue Regulations No. 2). •

•

·Chief.support means principal or main support not just partial support. It must be more than 50% of the dependent's need pertaining to food, clothing and shelter. Rules on change of status (1997 Bar) a.) Death of the taxpayer - Estate may claim the appropriate personal exemptions. b.) Death of the dependent - Taxpayer is still entitled to additional exemption. c.) Additional dependent -Taxpayer is still entitled to additional exemption. d.) Dependent becoming more than twenty-one (21) years of age - Taxpayer can still claim him or her as dependent. e.) Marriage of the taxpayer -Taxpayer is entitled to full exemption for the particular taxable year. f.)

•

Death of spouse - Surviving spouse may still claim the full amount of thirty-two thousand (P32,000.00) (2004 Bar).

New rules under Section 35(C):

•

43

BIR Rulings: (a.) Non-resident Chinese stockholders of a local bank are not entitled to personal exemptions granted in accordance with the reciprocity provisions of the Tax Code. Reason: The laws of China do not grant similar exemptions to nonresident Filipinos (BIR Ruling No. 164, series of1961). (b.) Where both husband and wife are employees, the latter can claim additional exemptions for her two.minor children by her first marriage in their(foinV income tax return (BIR Ruling No. 216, series of 1960). (c.) A resident alien supporting his wife and children living abroad is entitled to a personal exemption corresponding to a married person provided that proof of marriage is established to the satisfaction of the BIR and he is not legally separated from his wife. However, he is not allowed to claim an additional exemption because without necessity, the children continuously make their home abroad (BIR Ruling No. 371, series of 1958). (d.) Only one exemption is allowed even if taxpayer received accumulated pension corresponding to six years (BIR Ruling No. 203, series of 1960).

g.) Marriage of dependent - Taxpayer can still claim him or her as dependent for the particular taxable year.

(2.) Premium Payments on Health and/or Hospitalization Insurance (2001 Bar).

h.) Gainful employment of dependent-Taxpayer can still claim him or her as dependent for the particular taxable year.

a.) Claimant: spouse claiming the additional exemption for dependents.

Conditions:

44



b.) Amount allowed: P2,400.00 per annum or P200.00 a month.

Answer:

c.) Limitation: family gross income must not be more than P250,000.00 for the taxable year. BUSINESS/TRADE/PROFESSIONAL INCOME A.

•

INCOME COVERED (1.) Income derived by self-employed from trade or business (trading, manufacturing, merchandis· ing, farming, and others). •

•

•Business is any activity that entails the time, attention and effort of an individual or group of individuals for livelihood or profit.

•

In the case of manufacturing, merchandising, or mining business, how is the gross income computed?

Gross income means the total sales, less the cost of goods sold plus any income from investments and incidental operations (Section 48, Rev. Reg. No. 2).

How is income from long-term contracts (building installations or construction contracts covering a period of more than one [1] year) treated for income tax purposes? Answer:

Self-employment income consists of the earnings derived by the individual from the practice of profession or conduct of trade or business carried on by him as a sole proprietor or by a partnership of which he is a member. Self-employed - means a person engaged in trade or business or performs services for others for a fee and who derived personal income from such trade or business or from the performance of such services. The term includes but is not limited to single proprietorships engaged in trade or business as manufacturers, traders, market vendors, owners of eateries and farmers as well as owner of service shops, brokers, agents and others similarly situated.

45

@]

•

Percentage of completion basis - gross income already earned though not yet received, based on estimates of architects or engineers duly certified by them is reported in a taxable year and all deductions relating to such for the taxable year, even if not yet paid, are taken into account.

•

Completed contract basis - taxpayer reports his income and deductions in the year the contract is finally completed (Section 44, Revenue Regulations No. 2).

Income derived by professionals from the practice of professions. Professionals - refer to persons who derive their income from the practice of their profession. The term includes lawyers and other persons who are registered with the PRC such as doctors, dentists, CPA's and others similarly situated. It may also refer to one who pursues an art and makes living therefrom such as artists, athletes, and others similarly situated.

46


GU


Gross income of farmers include: a.) Sale of livelihood and farm products received from the farm; b.) Value of merchandise and other property received from such sales;

marks, patents and natural resources under lease. c.) Items considered likewise as rental income •

Obligations of lessor to 3rd parties assumed by the lessee:

c.) Profit from the sale of livestock and other items purchased; d.) Gross income from all other sources, rent received on crop shares, proceeds of income of growing crops.

i.

Real estate taxes on leased premises;

ii.

Insurance premiums paid by lessee on property;

iii.

Dividends paid by lessee to stockholders of lessor-corporation;

iv.

Interest paid by lessee to holder of bonds issued by lessor-corporation.

!NTEREST INCOME

a.) Definition - amount of compensation paid for the use of money or forbearance from such use. b.) Includes such interest arising from indebtedness - business or non-business, legal or illegal, usurious or not: i.

Interest on government securities able effective January 1, 1998;

ii.

Interest on savings deposit, time deposits and deposit substitutes subject to 20% final tax.

_8.ENTAL INCOME

Value of permanent improvements made by lessee on leased property that will become the property of the lessor upon the expiration of the lease. The lessor shall report such an income under any of the following methods ( 1995 Bar):

•

tax-

,

a.) Definition - fixed sum either in cash or property equivalent, to be paid at a definite period for the use or enjoyment of a thing or right. b.) Scope - all rentals (including royalties) derived from lease of property, whether used in business or not, from real estate or personal property; earnings from copyrights, trade-

47

i.

Outright method - Fair Market Value of the completed building or improvement shall be reported as additional rent income;

ii.

Spread out method -Allocate the depreciated value over the remaining term of the lease contract.

d.) Are advance rentals taxable? i.

Prepaid rentals - taxable if so received under a claim of right and without restriction as to its use.

4~


ii.

Security deposit- nottaxable. However, it is taxable if the lessee violates any provision of the contract.

iii.

Loan -

are nothing but an enrichment through increase in value of capital investment (Commissioner v. Court of Appeals, 301 SCRA 152).

not taxable.

-

DIVIDEND INCOME

Exceptions, however, are as follows:

a.) Definition - corporate profit set aside, declared and distributed by the director of a corporation to be paid to stockholders on demand or at a fixed time. Under the Tax Code, any distribution made by a corporation to its stockholders, whether in money or property out of its earnings and profit accrued since 1 March 1913.

E:l

Kinds of Dividend i.

Cash dividend money.

Property dividend - one paid by corporation in securities (not its own stock) or other property.

iii.

Stock dividend - one paid by a corporation with its own stock. It represents transfer of surplus to capital account. It may be of the same kind or different from that on which it is issued. As a general rule, stock dividends are not taxable (2003 Bar). Reason:

•

Change in the stockholder's equity, right/interest in the net assets of the corporation;

•

Recipient is other than shareholder. Stock dividend is taxable to usufructuary (Bachrach v. Siefert, 87 Phil. 483);

•

Cancellation or redemption of shares of stock (Ibid.);

•

Distribution of treasury stocks;

•

Dividends declared in the guise of treasury stock dividend to avoid the effects of income taxation (Commissioner v. Manning, 66 SCRA 14) (1994 Bar);

•

Different classes of stock were issued.

paid in given sum of

ii.

They are considered unrealized gain, and ~annot be subjected to income tax until that gain has been realized. Mere issuance thereof is not yet subject to income tax as they

49


Illustration of taxability/non-taxability of stock dividend Case

Authorized C/S

Issued & Outstanding

Stock Dividend Common

Taxable/Not Taxable

I

Common

Common

Not Taxable

II

Com & Pref.

Common

Preferred

Not Taxable

Ill

Com & Pref.

Com & Pref.

Common

Taxable

IV

Com & Pref.

Com & Pref.

Preferred

Taxable

50

iv.

Scrip Dividend - one that is paid in the form of promissory notes.

v.

Indirect Dividend - one made through the exercise of right or other means of pay-· ment, e.g., cancellation or condonation of indebtedness.

vi.

@> iK



d.) Taxpayer is not required to file ITR if his or her income consists solely of income subject to final tax. e.) The tax withheld constitutes final settlement of the tax liability on the income. f.)

Liquidating dividend - one resulting from the distribution by a corporation of all its property or assets in complete liquidation or dissolution. Taxable income refers to the excess of amount received over cost of the share surrendered.

Giver

Recipient

Taxable (tax rate)/Exempt

Domestic

Domestic/RFC

tax exempt (2005 Bar)

Domestic

RC,NRC,RA

10% - effective taxable year 2000

Domestic

NRA-ETB

20%

Domestic

NRA-NETS

25%

Domestic

NRFC

15% subject to allowance for tax credit

51

Examples of income subject to final tax (2001 Bar): •

Interest income from bank deposit;

•

Royalties;

•

Dividend received from domestic corporation by individual or non-resident foreign corporation (NRFC);

•

Prizes amounting to more than P10,000.00;

•

Winnings (except sweepstakes and lotto).

•

Partner's share from the net income after tax of business partnership, joint account, joint venture or consortium.

(4.) Other Sources

----

a)

Capital Gain from Sale of Shares of Stock i.

/ASSIVE INVESTMENT INCOME

If not listed and traded through stock exchange:

a.) It is an income subject to final withholding tax (2001 Bar).

•

Net capital gain not over P100,000 -5%;

b.) The withholding agent withholds the tax and remits the same to the BIR.

•

Any amount in excess of P100,000 -10%.

c.) The recipient is not required to inclu9e the income in his gross income. Neither is the taxpayer required to include it in the taxable income (CIR v. PAL, 504 SCRA 90).

ii.

If listed and traded through local stock exchange - 1/2% of 1% of Gross Selling Price. The tax is in the nature of percentage tax not an income tax.

52


.~)

Acquisition and disposition of capital stock which include sales and retirement of bonds.

_c;)

Illegal gains - gambling, betting, lotteries, extortion or fraud.

-~)

Recovery of damages sents lost profit/income.

_e)

Bad Debts recovery - taxable if it results in reduction of the taxpayer's tax liability in the previous year. "TaxQellefitrl11e" or the "Doctrine of equitablebenefit" applies in this

taxable -

case.

_f)

Chapter 5

it repre-

CORPORATE INCOME TAXATION

A.

DEFINITION UNDER THE NIRC

r

It must be claimed as a deduction from the gross income in the preceding year.

Corporation includes partnerships, no matter how created or organized, joint stock companies, joint accounts, associations or insurance companies except:

.r

The reduction results in a tax benefit.

•

Joint construction venture; (2007 Bar)

Tax refund - taxable if it results in reduction of the taxpayer's liability in the preceding year. This means that the tax' refunded must be prnviollsly claimed as deduction from gross i!J<,:Qme. J""ax benefit rule likewise applies.· - ··

•

General professional partnership;

•

Joint venture for engaging in petroleum, coal, geothermal and other energy operations pursuant to a consortium agreement with the government

(1.) Unregistered or registered partnership - taxable provided that the following requisites concur: a.) Agreement, oral or writing, to contribute money, property or industry to a common fund; b.) Intention to divide the profits. i.

Two sisters purposely created a common fund without being registered for the purpose of engaging in a series of transactions for profit - taxable unregistered partnership is created (Evangelista v. Commissioner, 102 Phil. 140) .

• 53

54


ii.

Taxable partnership is formed where fifteen (15) persons contributed money to purchase sweepstakes tickets for the sole purpose of dividing among themselves the prize.

iii.

Two persons entered into agreement to operate cockpit under which one was to contribute his services and the other to provide the capital - taxable partnership is formed (Rallos v. Rallos, 2 Phil. 509).

iv.

As a rule, co-ownership is tax-exempt. It becomes taxable if it is converted into an unregistered partnership. Converted into partnership if the properties and income are used as common fund with intention to produce profits. If after partition, the shares of the heirs are held under a single management for profit making, unregistered partnership is formed (1997 Bar) (Ona, et al. v. Commissioner, 45 SCRA 74).

v.

Pascual and Dragon bought two (2) parcels of land from Bernardino and three (3) from Roque. Thereafter, the first two (2) were sold to Meirenir Development Corporation at a profit of P165,224. 70 and the three (3) to Reyes and Samson for a profit of P60,000. They divided the profits between the two (2) of them. RULING: There was no partnership formed. The sharing of returns does not in itself establish a partnership whether or not the persons sharing therein have a joint or common right or interest in the property

CHAPTER 5 CORPORATE INCOME TAXATION

55

(Article 1769, NCC) (Pascual and Dragon v. Commissioner, 166 SCRA 560). vi.

On 2 March 1973, Joe Obillos, Sr. transferred his rights under contract with Ortigas Co. to this four (4) children to enable them to build residences on the lots. TCTs were issued. Instead of building houses, the Obillos children sold them after one (1) year to Walled City Securities Corporation and Olga Cruz Canda. The Supreme Court held that the Obillos children are co-owners. It is an isolated act which shows no intention to form a partnership. It appears that they decided to sell it after they found it expensive to build houses (Obillos, Sr. v. Commissioner, 139 SCRA 436).

(2.) Joint accounts or joint ventures formed for profits. Joint Emergency Operation - (no legal personality) operates the business affairs of the two companies as though they constitute a single entity thereby obtaining substantial economy and profit in operation - taxable (Collector v. Batangas Co., 54 OG 6724). (3.) Joint Stock Companies-generally classified as a partnership possessing some of the characteristics of a corporation. They appear to be like corporations to the extent that they have capital stock but when capital is divided or made transferable even without the consent of the co-partner, they partake of the nature of partnership (Brocki v. American Express Company, CA Michigan, 279F 2d 785, 787).

56

B.


MAJOR GROUPS OF CORPORATION FOR INCOME TAX PURPOSES (Sources, tax base, tax rate)

canteen, cafeteria, dormitory and bookstore within the school premises (BIR Ruling 237-87, 16 December 1987).

(1.) DOMESTIC CORPORATIONS Source:

Within and without

b.) Non-profit hospital

Tax base: Taxable income Tax rate:

35% effective July 01, 2005; 30% effective January 1, 2009 (R.A. No. 9337)

•

Same rules as private educational institution.

•

Unrelated trade, business, or other activity - the conduct of which is not substantially related to the exercise or performance by such hospital of its primary purpose or function.

Special domestic corporations: a.) Private Educational Institution •

•

Subject to ten percent (10%) on their taxable income provided that its gross income from unrelated trade, business or other activity does not exceed fifty percent (50%) of the total income. Conversely, it is subject to thirty-five percent (35%) if its income from unrelated trade or business exceeds fifty percent (50%) of the total (gross) income. Private educational Institution - is any "private school" maintained and administered by private individuals or groups issued a permit to operate by Secretary of DECS in accordance with existing laws and regulations.

•

Unrelated trade, business, orotheractivity -the conduct of which is not substantially related to the exercise or performance by such educational institution of its educational purpose or function.

•

Related activities include income derived from auxiliary activities - ~chool owned

57


(2.) RESIDENT FOREIGN CORPORATIONS Source:

Within

Tax base:

Taxable income

Tax rate:


Special Resident Foreign Corporations: a.) International Carriers Billings - 2.5%; b.) Offshore banking unit shore income - 10%; c.)

within within -

Gross Phil. Gross on-

Foreign currency deposit unit-within - Gross onshore income - 10%.

Transacting business - means continuity of commercial dealings and arrangements (Far East Import-Export Corp. v. Nankai Kogyo Co., Ltd., Int'!., No. L-13525, 30 November 1962, 6 SCRA 725). Gross Philippine Billings -- refers to the amount of gross revenue realized from carriage of persons, excess baggage, cargo and mail original-

58


ing 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. (2005 Bar) FOREIGN AIRLINE COMPANIES WITH· OUT FLIGHTS STARTING FROM OR PASSING THROUGH ANY POINT IN THE PHILIPPINES An off-line airline having a branch office or a sales agent in the Philippines which sells passage documents for compensation or commission to cover offline flights of its principal or head office, or for other airlines covering flights originating from Philippine ports or off-line flights, is not considered engaged in business as an international air carrier in the Philippines and is, therefore, not subject to Gross Philippine Billings Tax provided for in Section 28(A)[3][a] of the Code nor to the three percent (3%) common carrier's tax under Section 118(A) of the same Code. (2005 Bar) This provision is without prejudice to classifying such taxpayer under a different category pursuant to a separate provision of the same Code (Rev. Reg. No. 15-2002). / International Air Carrier and International Shipping - shall be taxed on the basis of their Gross Philippine Billings. /Off-line international airline is subject to corporate income tax Sec. 28(A)(3)(a) of the 1997 NIRC does not, in any categorical term, exempt all international air carriers from the coverage of Sec. 28(A)(1) of the 1997 NIRC. Certainly, had legislature's intentions been to completely exclude all international air carriers from the application of the general rule under Sec. 28(A)(1 ), it would have used the appropriate


59

language to do so; but the legislature did not. Thus, the logical interpretation of such provisions is that, if Sec. 28(A)(3)(a) is applicable to a taxpayer, then the general rule under Sec. 28(A)( 1) would not apply. If, however, Sec. 28(A)(3)(a) does not apply, a resident foreign corporation, whether an international air carrier or not, would be liable for the tax under Sec. 28(A)(1 ). Clearly, no difference exists between British Overseas Airways and South African Airways. The findings therein that an off-line carrier is doing business in the Philippines and that income from the sale of passage documents here is Philippinesource income must be upheld. The general rule is that resident foreign corporations shall be liable for a 32% (now 30%) income tax on their income from within the Philippines, except for resident foreign corporations that are international carriers that derive income "from carriage of persons, excess baggage, cargo and mail originating from the Philippines" which shall be taxed at 2 1/2% of their Gross Philippine Billings. South African Airways, being an international carrier with no flights originating from the Philippines, does not fall under the exception. As such, petitioner must fall under the general rule. This principle is embodied in the Latin maxim, exception firmat regu/am in casibus non exceptis, which means, a thing not being excepted must be regarded as coming within the purview of the general rule. To reiterate, the correct interpretation of the above provisions is that, if an international air carrier maintains flights to and from the Philippines, it shall be taxed at the rate of 2 1/2% of its Gross Philippines Billings, while international air carriers

60

CHAPTERS CORPORATE INCOME TAXATION


that do not have flights to and from the Philippines but nonetheless earn income from other activities in the country will be taxed at the rate of 32% (now 30%) of such income. [see South African Airways v. Commissioner of Internal Revenue, 612 SCRA 665, 675-676, 678 (201 O)] (3.) NON-RESIDENT FOREIGN CORPORATIONS Source:

Within

Tax base:

Gross income

Tax rate:


Special Non-Resident Foreign Corporations: a.) NR-lessorof cinematographicfilm-within - Gross income - 25% final tax; b.) NR - owner or lessor of vessels chartered by Phil. Nationals - within - Gross rental - 4.5% final tax; c.)

NR- owner or lessor of aircraft, machinery & equipment-within - Gross rental - 7.5% final tax. Two vessels of V. Reederji Amsterdam called on Philippine ports twice to unload cargoes for foreign destination. It has no office in the Philippines. The fees were collected by its husbanding agent, Royal International Ocean Lines. The Supreme Court held that the corporation is considered non-resident foreign corporation. Casual activity as in this case, does not amount to engaging in trade or business in the Philippines (N.V. Reederji Amsterdam v. Com., L-460229, 23 June 1988, 162 SCRA 487).

C.

61

MINIMUM CORPORATE INCOME TAX (Sections 27[E], 28A[2] /mp/emented by Revenue Regulations No. 9-98 as amended by Revenue Regulations 122007) (1) Concept and Rationale of the MCIT The MCIT on domestic corporations is a new concept introduced by RA 8424 to the Philippine taxation system. It came about as a result of the perceived inadequacy of the self-assessment system in capturing the true income of corporations. ft was devised as a relatively simple and effective revenue-raising instrument compared to the normal income tax which is more difficult to control and enforce. It is a means to ensure that everyone will make some minimum contribution to the support of the public sector. x x x Domestic corporations owe their corporate existence and their privilege to do business to the government. They also benefit from the efforts of the government to improve the financial market and to ensure a favorable business climate. It is therefore fair for the government to require them to make a reasonable contribution to the public expenses. Congress intended to put a stop to the practice of corporations which, while having large turn-overs, report minimal or negative net income resulting in minimal or zero income taxes year in and year out, through under-declaration of income or over-deduction of expenses otherwise called tax shelters. x x x The primary purpose of any legitimate business is to earn a profit. Continued and repeated losses after operations of a corporation or con-

62


sistent reports of minimal net income render its financial statements and its tax payments suspect. For sure, certain tax avoidance schemes resorted to by corporations are allowed in our jurisdiction» The MCIT serves to put a cap on such tax shelters. As a tax on gross income, it prevents tax evasion and minimizes tax avoidance schemes achieved through sophisticated and artful manipulations of deductions and other stratagems. Since the tax base was broader, the tax rate was lowered. To further emphasize the corrective nature of the MCIT, the following safeguards were incorporated into the law. First, recognizing the birth pangs of businesses and the reality of the need to recoup initial major capital expenditures, the imposition of the MCIT commences only on the fourth taxable year immediately following the year in which the corporation commenced its operations. This grace period allows a new business to stabilize first and make its ventures viable before it is subjected to the MCIT. Second, the law allows the carrying forward of any excess of the MCIT paid over the normal income tax which shall be credited against the normal income tax for the three immediately succeeding years. Third, since certain businesses may be incurring genuine repeated losses, the law authorizes the Secretary of Finance.Jo suspend the imposition of MCIT if a corporation suffers losses due to prolonged labor dispute, force majeure and legitimate business reverses. [CREBA v. Romulo, 614 SCRA 605, 622-624 (2010)]


~)Purpose of MCIT (2001

63

Bar)

The imposition of the MCIT is designed to forestall the prevailing practice of corporations of over claiming deductions in order to reduce their income tax payments.

(3.) Nature of minimum corporate income tax (MCIT) The MCIT is an estimate of the income tax that is due from a firm. It is equal to two percent (2%) of the gross income of a corporation at the close of each taxable quarter. Being a minimum income tax, a corporation should pay the MCITwhenever its regular (normal) income tax is lower than the MCIT, or when the firm reports a net loss in its tax return. Conversely, the regular income tax is paid when it is higher than the MCIT.

(4.) MCIT is not an additional tax to the regular or normal income tax At the end of the taxable quarter, the MCIT is compared with the regular income tax which is due from a corporation. If the regular income is higher than the MCIT, then the corporation does not pay the MCIT. Newly established firms, or those which are on their first three years of operations are not covered by the MCIT.

jfr.J"coverage of the MCIT (2001 Bar) The MCIT covers domestic and resident foreign corporations which are subject to the regular income tax. The term "regular income tax" refers to the regular income tax rates under the Tax Code.

64



The period of reckoning the start of its business operations is the year when the corporation was registered with the BIR. This rule will apply regardless of whether the corporation is using the calendar year or fiscal year as its taxable year (Manila Banking Corporation v. CIR, 499 SCRA 782, 788).

The tax rate is 33% for 1999, 32% for 2000, 35% effective July 01, 2005 and 30% effective January 01, 2009. Thus, corporations which are subject to a special corporate tax system do not fall within the . coverage of the MCIT. These are as follows: /:

•

Schools, hospitals, and income of Offshore Banking Units (OBUs), and Foreign Currency Deposit Unit (FCDU) from foreign currency transactions;

•

Regional operating headquarters; The incomes of these corporations are subject to a ten percent (10%) preferential tax rate;

•

Firms under a special income tax regime such as those under the PEZA law and the Bases Conversion Development Act;

•

International carriers subject to tax at 2 1/2% of their Gross Philippine Billings.

For corporations whose operations or activities are partly covered by the regular income tax system and partly covered under a special income tax system, the MCIT shall apply on operations covered by the regular income tax system. For example, the MCIT does not cover an activity of a firm which is registered with the Board of Investments (BOI) and is granted an income tax holiday. The MCIT shall cover its other activities which are not covered by the SOI tax incentives.

(9,) When does a corporation start to be covered by the MCIT? ~ A corporation starts to be covered by the MCIT on the fourth (4th) year of its business operations.

65

Firms that were registered in 1994 and earlier years are covered by the MCIT beginning January 1, 1998.

Firms which were registered with the BIR in any month in 1998 will be covered by the MCIT after the lapse of three calendar years, i.e., 2002. (~

Suspension of the payment of MCIT The Secretary of Finance, upon the recommendation of the BIR Commissioner, may suspend the imposition of the MCIT on a corporation in any of the following cases: •

Sustained losses from prolonged labor dispute;

•

Force majeure;

•

Legitimate business reverses.

"Sustained losses from a prolonged labor dispute" means losses arising from a strike staged by employees which lasted for more than six (6) months within a taxable period and which has caused the temporary shutdown of business operations. "Force majeure" means a cause due to an irresistible force as by "Act of God" like lightning, earthquake, storm, flood and other natural calamities. This term would also include armed conflicts like war or insurgency.

66


"Legitimate business reverses" shall include substantial losses due to fire, robbery, theft or embezzlement, or for other economic reason as determined by the Secretary of Finance.

67


services required by the customers and clients including: •

Salaries and employee benefits of personnel, consultants and specialists directly rendering the service;

The MCIT is equal to two percent (2%) of the gross income of the corporation at the end of the taxable year.

•

Cost of facilities directly utilized in providing the service such as depreciation or rental of equipment used;

~< "Gross income" means gross sales less . sales returns, discounts and allowances and cost of goods sold. It will also include all items of gross income enumerated under Section 32(A) of the Tax Code, as amended, except income exempt from income tax and income subject to final withholding tax.

•

Cost of supplies.

(8.) How is the MCIT computed? --~~

Cost of goods sold include all business expenses directly incurred to produce the merchandise to bring them to their present location and use. For a trading or merchandising concern, cost of goods sold means the invoice cost of goods sold, plus import duties, freight in transporting the goods to the place where the goods are actually sold, including insurance while the goods are in transit. For a manufacturing concern, cost of goods manufactured and sold means all costs of production of finished goods such as raw materials used, direct labor and manufacturing overhead, freight cost, insurance premiums and other costs incurred to bring the raw materials to the factory or warehouse. For sale of services, gross income'means gross receipts less sales returns, allowances, discounts and cost of services which cover all direct costs and expenses necessarily incurred to provide the

Interest expense is not included as part of cost of service, except in the case of banks and other financial institutions. The term "gross receipts" means amounts actually or constructively received during the taxable year. However, for taxpayers employing the accrual basis of accounting, it means amounts earned as gross income. - - -- '.,.,- '-•-•

••--., °'"'""""> -•••-

,,M

(9.) When is the MCIT reported and paid? The MCIT shall be paid in the same manner prescribed for the payment of the normal corporate income tax which is on a quarterly and on a yearly basis. The taxpayer shall pay the MCIT whenever it is greater than the regular or normal corporate income tax which is imposed under Section 27(A) and Section 28(A)(1) of the Code. Thus, in the computation of the tax due for the taxable quarter, if the computed quarterly MCIT is higher than the quarterly normal income tax, the tax due to be paid for such taxable quarter and the time of filing the quarterly corporate income tax return shall be the MCITwhich is two percent (2%) of the gross income as of the end of the taxable quarter.

68



The final comparison between the normal income tax payable by the corporation and the MCIT shall be made at the end of the taxable year and the payable or excess payment in the Annual Income Tax Return shall be computed taking into consideration corporate income tax payment made at the time of filing of quarterly corporate income tax return whether this be MCIT or normal income tax. (10.) Can the company claim the MCIT it paid as a deduction from gross income? Since the MCIT is an estimate of the normal income tax, it cannot be claimed as deduction. (11.) What is the carry-forward provision under the MCIT? Any excess of the MCIT over the normal income tax may be carried forward on an annual basis and be credited against the normal income tax for the three immediately succeeding taxable years.

The taxpayer is required to pay the MCIT whenever it is_QJE:l§l§f than the reg[Jlar income tax. Thus, in 2000, the taxpayer will pay MCIT of P75,000 since this is greater than the normal income tax of P50,000. In 2001, the taxpayer will pay MCIT of P100,000 because its MCIT in 2001 is still higherthan the regular income tax. The excess MCIT of P25,000 in 2000 (or the difference between the MCIT and the regular income tax ,,.---""' in 2000)E'3_~!19tlbe used in this instance. In 2002, )!l{hf?~ the rmJ1,1l9rii:ic;Qrne t9x of P100,000 is(b_ig_h~wthan the MCIT of P60,000, the taxpayer is allowed to claim as credit the excess MCIT of P25,000 and P40,000 for 2000 and 2001 respectively, or a total crE!di! of P65,000. Hence, the taxpayer will pa~(only P35,000 (P100,000- P65,000). ~--···· . ·

0.--· IMPROPERLY ACCUMULATED EARNINGS TAX (Sec-

Illustration:

tion 29 as Implemented by Rev. Reg. No. 2-2001) 2000

2001

2002

Normal income tax

50,000

60,000

100,000

MCIT

75,000

100,000

60,000

Amount of tax to be paid

75,000

100,000

100,000

Less: Excess MCIT 2000- 25,000 65,000

2001 - 40,000 Net amount of tax payable

69

75,000

100,000

•

35,000

(1.) Rationale of improperly accumulated earnings tax of 10% If the earnings and profits were distributed, the shareholders would then be liable to income tax thereon, whereas if the distribution were not made to them, they would incur no tax in respect to the undistributed earnings and profits of the corporalion. Thus, a tax is being imposed in the nature of a penalty to the corporation for the improper accumulation of its earnings, and as a form of deterrent to the avoidance of tax on shareholders who are

70



able capital expenditure as approved by the Board of Directors or equivalent body;

supposed to pay dividends tax on the earnings distributed to them by the corporation.

(2.) What is the touchstone of the liability? It is the purpose behind the accumulation ofthe income and not the consequences of the accumulation. Thus, if the failure to pay dividends is due to some other causes, such as the use of undistributed earnings and profits for the reasonable needs of the business, such purpose would not generally make the accumulated or.undistributed earnings subject to the tax. However, if there is a determination that a corporation has accumulated income beyond the reasonable needs of the business, 10% improperly accumulated earnings tax shall be imposed. (3.) Determination of reasonable needs of the business An accumulation of earnings or profits (including undistributed earning or profits of prior years) is reasonable if it is necessary for the purpose of the business, considering all the circumstances of the case. The term "reasonable needs of the business" are hereby construed to mean the immediate needs of the business, including reasonably anticipated needs. (~J

-

What constitute accumulation of earnings for the reasonable needs of the business? a.) Allowance for the increase in the accumulation of earnings up to 100% of the paid-up capital of the corporation as of Balance Sheet date, inclusive of accumulations taken from other years; b.) Earnings reserved for definite corporate expansion projects or programs requiring consider-

71

c.) Earnings reserved for building, plants or equipment acquisition as approved by the Board of Directors or equivalent body; d.) Earnings reserved for compliance with any loan covenant or pre-existing obligation established under a legitimate business agreement; e.) Earnings required by law or applicable regulations to be retained by the corporation or in respect of which there is legal prohibition against its distribution; f.)

In the case of subsidiaries of foreign corporations in the Philippines, all undistributed earnings intended or reserved for investments within the Philippines as can be proven by corporate records and/or relevant documentary evidence. •

To determine the 'reasonable needs' of the business in order to justify an accumulation of earnings, the Courts of the United States have invented the so-called "Immediacy Test" which construed the words 'reasonable needs of the business' to mean the immediate needs of the business, and it was generally held that if the corporation did not prove an immediate need for the accumulation of earnings and profits, the accumulation was not for the reasonable needs of the business, and the penalty tax would apply [Mertens, Law of Federal Income Taxation, Vol. 7, Chapter 39, p. 103]. (2010 Bar)

[ 72


(5.) Coverage of IAET The 10% Improperly Accumulated Earnings Tax (IAET) is imposed on improperly accumulated taxable income earned starting January 1, 1998 by domestic corporation as defined under the Tax Code and which are classified as closely held corporations.

I


I

I

(6-) What are closely-held corporations? Closely-held corporations are those corporations at least fifty percent (50%) in value of the outstanding capital stock or at least fifty percent (50%) of the total combined voting power of all classes of stock entitled to vote is owned directly or indirectly by not more than twenty (20) individuals.

(7) Corporations not subject to IAET: •

Banks and other non-bank financial intermediaries;

,,

Insurance companies;

•

Publicly-held corporations;

•

Taxable partnerships;

•

General professional partnerships;

•

Non-taxable joint ventures;

•

Enterprises duly registered with the Philippine Economic Zone Authority (PEZA) under R.A. No. 7916, and enterprises registered pursuant to the Bases Conversion and Development Act of 1992 under R.A. No. 7227.

(8.) Prima facie instances of accumulation of profits beyond the reasonable needs of a business are indicative of purpose to avoid income tax upon shareholders:

•

Investment of substantial earnings and profits of the corporation in unrelated business or in stock or securities of unrelated business;

•

Investment in bonds and other long-term securities;

•

Accumulation of earnings in excess of 100% of paid-up capital, not otherwise intended for the reasonable needs of the business.

'

1'

E.

i

I I

73

OTHER CORPORATE TAX RATES (1.) Common Tax Rates a.) Capital gain from sale of share of stock.

i.

ii.

If not listed and traded through stock exchange: •

Net capital gain not over P100,000 -5%;

•

Any amount in excess of P100,000 -10%.

If listed and traded through local stock exchange - 1/2% of 1% of Gross Selling Price (not income tax).

(2.) Domestic Corporations a.) Corporations have the option to be taxed at fifteen percent (15%) of gross income. In this regard, the President may, upon the recommendation of the Secretary of Finance, effective 1 January 2000, allow corporations the option to be taxed at fifteen percent (15%) of gross income, after the following conditions have been satisfied: i.

A tax effort ratio of twenty percent (20%) of Gross National Product (GNP);

74


iI


75

!

ii. iii. iv.

f;

•

'I'

Tax base: Profits applied or earmarked for remittance. This took effect on 1 January 1998.

•

Tax rate: 15% final tax.

•

•

Condition: Branch profits are effectively connected with the conduct of its trade or business in the Philippines (1999 Bar).

•

The dividend income remitted to Marubeni Corporation of Japan arising from its equity investments in Atlantic, Gulf and Pacific Company of Manila is considered separate and distinct income from the branch office in the Philippines. There can be no other logical conclusion that the investment was made for purposes peculiarly germane to the conduct of the corporate affairs of Marubeni, Japan, but certainly not of the branch in the Philippines (Commissioner v. Marubeni, 177 SCRA 500).

A ratio of forty percent (40%) of income tax collection to total tax revenues;

!

A VAT tax effort of four percent (4%) of GNP; and A 0.9 percent (0.9%) ratio of the Consolidated Public Sector Financial Position (CPSFP) to GNP. •

The option to be taxed based on gross income shall be available only to firms whose ratio of cost of sales to gross sales or receipts from all sources does not exceed fifty-five percent (55%).

•

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

•

The term "gross income" derived from business shall be equivalent to gross sales less sales returns, discounts and allowances and cost of goods sold. "Cost of goods sold" shall include all business expenses directly incurred to produce the merchandise to bring them to their present location and use.

b.) Interest on currency deposit and royalties derived from sources within the Philippines 20% Final Tax. (3.) Resident Foreign Corporations a.) Branch Profit Remittance Tax

t

I

I I

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I•

II

' !

II. '

II

•

'

Exempt profits remitted: Derived from activities registered with the Philippine Economic Zone Authority (PEZA).

(4.) Non-Resident Foreign Corporations a.) Interest on foreign loan -

20% Final Tax.

b.) Dividend received from domestic corporation. This is known as the tax sparing credit rule (Section 28 B 5[b), NIRC). •

Tax rate: 15% final tax.

76



Condition: foreign government shall allow a credit against the tax due from the foreign corporation taxes deemed to have been paid. •

provision or revenue regulation requiring "Actual Grant." Therefore, the phrase "deemed paid" "tax credit" does not imply tax credit actually granted by the foreign government.

Tax credit allowed: 20% effective July 1, 2005; 15% effective January 1, 2005 (R.A. No. 9337).

•

Issues: •

May a subsidiary corporation (withholding agent) file an action for refund?

Answer: Procter and Gamble Philippines, subsidiary corporation of P & G-USA is properly re, garded as a "taxpayer" within the meaning of Section 309, NIRC [now Section 22(N)] and therefore, authorized to file refund. Withholding agent is technically considered as taxpayer. Reason: It is also an agent of the taxpayer in reporting such an income (Com. v. Procter, 204 SCRA377). •

Does the phrase "deemed paid" tax credit mean tax credit actually granted by the foreign country?

Answer: The Tax Code merely requires that the foreign country (USA) shall allow a credit against the tax due from Procter and Gamble-USA for taxes deemed to have been paid in the Philippines. There is no statutory

77

F.

Purpose of Tax Sparing Credit: To encourage foreign investments and to attract foreign investors.

TAX EXEMPT CORPORATIONS UNDER THE NIRC (1.) Labor, Agriculture, or Horticultural Organization Not Organized Principally for Profit a.) Provincial fairs and like associations of a quasipublic character designed to encourage development of better agricultural and horticultural products through a system of awards, prizes or premiums and whose income derived from gate receipts, entry fees, donations, etc. is used exclusively to meet necessary expenses of upkeep and operation are thus exempt. b.) On the other hand, the holding of periodical race meets by associations, the profits from which inure to the benefit of their stockholder are not tax-exempt. Similarly, corporations engaged in growing agricultural or horticultural products or raising livestock or similar products for profit are subject to tax (Section 25, Rev. Reg. No. 2). (2.) Mutual Savings Banks and Cooperative Banks a.) Requisites for exemption:

i.

No capital stock represented by shares;

78


ii.

Earnings, less only the expenses of operating are distributable wholly among the depositors (Section 26, Rev. Reg. No. 2);

iii.

Operated for mutual purposes and without profit.


c.)

b.) Exemption applies to foreign as well as domestic banks c.)

a.) Requisites for exemption: i.

ii.

iii.

Operated under lodge system or for the exclusive benefit of the members of a society - they have parent and local organizations which are active (Western Funeral Benefit Association v. Hellmich, 2F, [2d] 367); Established system of payment to its members or their dependents of life, sick, accident, or other benefits (Section 27, Rev. Reg. No. 2);

Mutual protective societies not operating under the lodge system and traveler's association providing for fixed death benefits to the beneficiaries or members are not tax exempt (Commercial Travelers Life and Accident Association v. Radway, 235 Fed. 370).

(4.) Cemetery Companies a.) Requisites for exemption:

Not qualified as mutual savings bank if deposits are made compulsory under contracts between the bank and depositors and is operated for speculation rather than for savings (C.C. 262; C.B. 111-2, 248; Mateus, ibid., Vol. 6, p. 7).

(3.) Fraternal Beneficiary Society, Order or Associa~ ti on

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i.

Owned and operated exclusively for the benefit of its owners;

ii.

Not operated for profit.

b.) Any cemetery corporation chartered solely for burial purposes and not permitted by its charter to engage in any business not necessarily incident to that purpose, is exempt from income, provided that no part of its net earnings inures to the benefit of any private shareholder or individual. c.)

Cemetery company which fulfills the other requirements of the Statute may be exempt, even though it issues preferred stock entitling the holders to dividend at a fixed rate, provided that its articles of incorporation require: i.

that the preferred stock shall be retired at par as soon as the sufficient funds are realized from sales; and

ii.

that all funds not required for the payment of dividends upon or for the retirement of preferred stock shall be used by the company for the care and improvement of the cemetery/property.

No part of the net income inures to the benefit of the stockholders or members.

b.) A grand lodge established for the care of the members, their dependents, and members of an affiliated lodge unable to earn a livelihood by reason of the infirmities of age was held tax exempt.

79

80



d.) Cemetery having a capital stock represented by shares, or which is operated for profit or for the benefit of persons other than its members, does not come within the exempted class (Section 29, Rev. Reg. No. 2).

(5.) Religious, Charitable, Scientific, Athletic or Cultural Corporations a.) Requisites for exemption: i.

Organized and operated for one or more of the specified purposes;

i r

81

a.) Requisites for exemption:

i.

Association of persons having some common business interest;

~-

ii.

Limited its activities to work for such common interests;

!

iii.

Not engaged in a regular business for profit;

iv.

No part of the net income inures to the benefit of any private stockholder or individual.

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ii.

No part of its net income must inure to the benefit of private stockholders or individuals.

b.) In the case of religious activities, income from the conduct of strictly religious activities, such as fees received for administering baptismal, solemnizing marriages, attending burials, holding masses, and other like income is exempt (Section 30, Rev. Reg. No. 2). c.)

Charitable corporation includes association for the relief of the families of clergymen, even though the latter make contributions to the fund established for this purpose, or for furnishing the series of trained nurses to persons unable to pay for them or for aiding the general body of litigants by improving the efficient administration of justice (Ibid.).

d.) Scientific corporation includes an association for the scientific study of law with a view to improving its administration (Ibid.).

(6.) Business, Chamber of Commerce, or Board of Trade

t

I i

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I

I

b.) Ceases to be tax exempt if it engages in a regular business for profit even if it conducts business on a cooperative basis or produces only sufficient income to be self-assessing. c.) An association engaged in furnishing information to prospective investors, to enable them to make sound investment, is not exempt, since its members have no common business interests even though all its income is devoted to the purpose stated. d.) A clearing house association, not organized for profit, no part of the net income of which inures to the benefit of any private shareholder or individual, is exempt provided its activities are limited to the exchange of checks and similar work for the common benefit of its member. e.) An association of persons who are engaged in the transportation business whether by land or water, which is designed to promote the legitimate objects of such business, and all of the income of which is derived from membership fee dues and is expended for office expenses is exempt (Section 31, Rev. Reg. No. 2).

82


f.)

Makati Stock Exchange is not a business league, chamber of commerce, or board of trade within the purview of Section 30(f) of the Tax Code, as amended, and must pay income tax on its taxable income. Earnings inure to the benefit of its members (BIR Ruling No. 64-027).

(7.) Civic League a.) Requisites for exemption: i.

ii.

iii.

Not organized for profit but operated exclusively for purposes beneficial to the community as a whole. In general, organizations engaged in promoting the welfare of mankind (Section 32, Rev. Reg. No. 2); Sworn affidavit with the BIR showing the following:

•

Character of the league or organization;

•

Purpose for which it was organized;

•

Actual activities;

•

Sources of income and disposition there;

•

All facts relating to the operation of the organization which affects its right to exemption.

The copy of articles of incorporation, bylaws and financial statements should be attached to the sworn affidavit (BIR Ruling No. 21, January 23, 1961).

b.) Activities which consist in the doing of acts and things designed to promote the best interests and well-being, as well as to safeguard


83

the community welfare, of the residents of the place which is a contiguous community of property owners and residents within an area, its source of income coming from dues assessed against the members on the basis of their relative holding in said place, and no part of such income inures to the benefit of any private stockholder or individual is exempt from the payment of income (BIR Ruling, 31 March 1959). c.) An association organized for maintaining sanitation, to afford community police protection, fire prevention as well as the beautification and uniformity of the surrounding premises of the occupants of a subdivision is exempt from income tax (BIR Ruling No. 520, series of 1959). (8.) Non-Stock, Non-Profit Educational Institutions (Revenue Memorandum Circular No. 76-2003) a.) The exemption of non-stock, non-profit educational institutions refers to internal revenue taxes imposed by the National Government on all revenues and assets used actually, directly and exclusively for educational purposes (Paragraph 3, Section 4, Article XIV of the Constitution). b.) Furthermore, revenues derived from assets used in the operation of cafeterias/canteens and bookstores are exempt from taxation provided they are owned and operated by the educational institution as ancillary activities and the same are located within the school premises. c.) However, they shall be subject to internal revenue taxes on income from trade, busi-

84



struction and/or improvement of school buildings and facilities, acquisition of equipment, books and the like) to be funded out of the money deposited in banks or placed in money markets, on or before the 14th day of the fourth month following the end of its taxable year (Sec. 3, Finance Department Order No. 137-87).

ness or other activity, the conduct of which is not related to the exercise or performance by such educational institutions of their educational purposes or functions (Sec. 2, Finance Department Order No. 137-. 87 as amended by Finance Department Order No. 92-88) i.e., rental payment from their building/premises.

d.} Unlike non-stock, non-profit corporations, their interest income from currency bank deposits and yield from deposit substitute instruments used actually, directly and exclusively in pursuance of their purposes as an educational institution, are exempt from the 20% final tax and 7 1/2% tax on interest income under the expanded foreign currency deposit system imposed under Section 27(D)[1] of the Tax Code of 1997, subject to compliance with the conditions that as a tax-exempt educational institution, they shall on annual basis submit to the Revenue District Office concerned an annual information return and duly audited financial statement together with the following: i.

ii. iii.

Certification from their depository banks as to the amount of interest income earned from passive investment not subject to the 20% final withholding tax and 7 1/2% tax on interest income under the expanded foreign currency deposit system imposed by Section 27(D)[1] of the Tax Code of 1997; Certification of actual utilization of the said income; and Board Resolution by the school administration on proposed projects (i.e., con-

85

e.) Finally, the exemption does not cover withholding taxes. As an educational institution, they are constituted as withholding agents for the government required to withhold the tax on compensation income of their employees, or the withholding tax on income payments to persons subject to tax pursuant to Section 57 of the Tax Code of 1997. (9.) Government Educational Institution

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a.) UP (Act No. 1870, as amended) is subject to 20% final tax. Other government educational institutions are likewise subject thereto. Reason: Income from properties, real or personal or from any of their activities conducted for profit, regardless of the disposition made of such income shall be subject to tax (BIR Ruling 21-90, 28 February 1990). (10.) Mutual Fire Insurance Companies and Like Organizations a.) Requisites for exemption:

I

i.

Income is derived solely from assessments, dues and fees collected from members;

!

ii.

Fees collected from members are for the sole purpose of meeting its expenses.

{

86


b.) Receipt which is a mere incident of the business of the company does not prevent exemption. Thus, receipt or the proceeds of the sale of badges, office supplies, or equipment will not defeat the exemption. The same holds true with the receipt of interest upon government bonds. c.)

However, where such bonds are bought as permanent investment, the receipt of interest destroys the exemption.


b.) Cooperative dairy companies which are engaged in collecting milk and disposing of it, or the products thereof and distributing the proceeds less necessary operating expenses among the members upon the basis of the quantity of the milk or of butter fat in the milk are exemptfrom the tax (Section 35, Rev. Reg. No. 2). c.)

d.) Receipt of entrance fee (premium) does not render the company taxable.

EXCEPTION: Issuing policies for stipulated cash premiums or requiring advance deposits to cover the cost of insurance and maintaining investment from which income is derived - no longer exempt (Section 34, Rev. Reg. No. 2). e.) Advance assessment for the sole purpose of meeting losses and expenses - tax exempt (Ibid.). ( 11.) Farmers, Fruit Growers' or Like Association

a.) Requisites for exemption: i.

Formed and organized as sales agent for the purpose of marketing the product of its members;

ii.

No net income to the members;

iii.

Proceeds of the sale shall be turned over to them less necessary selling expenses on the basis of the quantity of produce finished by them.

87

If the proceeds of the business are distributed in any other way other than on such proportionate basis, the company will be subject to tax (Ibid.).

d.) Farmers association is not tax exempt, if it deducts more than the necessary selling expenses incurred in accounting the proceeds to the farmers (Ibid.). e.) Cooperative associations acting as purchasing agents are not expressly exempt from tax, but rebates made to purchases, whether or not member of the association, in proportion to their purchases may be excluded from gross income, any profits made from non-members and distributed to members in the guise of rebates are, of course, subject to tax (Ibid.). f.)

"Like associations" is construed as referring only to association whose activities are similar to farming and fruit growing (Garden House Co. v. Com., 64 F [2d] 953). Credit Union which is a non-stock corporation organized and operated for mutual purposes without profit, its activities being confined to the members thereof, is exempt from income business and residence taxes (BIR Ruling No. 605, 13October1958).

88


COMMON REQUISITES:


ii.

Young Men's Christian Association of the Philippines, Inc. (YMCA) established as "a welfare educational and charitable non-profit corporation" is subject to income tax on the rental income derived from the lease of its properties, real or personal, and is therefore not exempt from income taxation, even if such income is exclusively used for the accomplishment of its objectives. The exemption claimed by the YMCA is expressly disallowed by the very wording of the last paragraph of then Section 26 (now last paragraph of Section 30) of the NIRC which mandates that income of exempt organizations (such as the YMCA) from any of their properties, real or personal, be subject to the tax imposed by the same Code. Because the last paragraph of said section unequivocally subjects to tax the rent income of the YMCA from its real property, the Court is duty-bound to abide strictly by its literal meaning and to refrain from resorting to any convoluted attempt at construction (Commissioner of Internal Revenue v. Court of Appeals, 298 SCRA 83).

•

Tax exempt government-owned and controlled corporations (GOCC) (Sec. 27[c] as amended by R.A. No. 9337

a.) Not organized and operated principally for profit; b.) No part of the net income inures to the benefif of any member or individual; c.) No capital represented by shares of stock; d.) Educational or instructive in character. Objectives: betterment of the conditions engaged in such pursuits, the improvement of the grade of their product and the development of a higher degree of efficiency in their respective occupations. COMMON LIMITATIONS: The income of whatever kind and character of the foregoing organizations from any of their properties, real or personal or from any of their activities conducted for profit, regardless of the disposition made of such income shall be subject to tax (2002 Bar).

i.

The income of such organizations which is considered as income from their properties, real or personal, generally consists of income from corporate dividend, rentals received from their properties, interests from Philippine currency bank deposits or capital loaned to other persons, income from agricultural lands, owned by such corporations, profits from the sale of property, real or personal and other similar income are taxable. EXCEPTION: When earned by a non-stock, non-profit educational institution (Article XIV, Section 4[3], 1987 Constitution).

89

i.

Government Service Insurance System;

ii.

Social Security System;

iii.

Philippine Health Insurance Corporation;

iv.

Philippine Charity Sweepstakes Office.

90


Tax-exempt corporations under special laws ( 1.) Cooperatives are exempted from taxes subject to certain conditions under Republic Act No. 6938 (Rev. Memo. Circular 48-91 ).

Chapter 6 ALLOWABLE DEDUCTIONS FROM GROSS INCOME

(2.) Foundation created for scientific advancement is exempt from tax under Section 24 of Republic Act No. 2067. A.

BASIC PRINCIPLES: ( 1.) The taxpayer must point to some specific provisions of the statute authorizing the deduction; and (2.) He must be able to prove that he is entitled to the deduction authorized or allowed (1955 Ph. Fed. Tax Course, par. 1801; Atlas Consolidated Mining v. Com., 102 SCRA 246).

B.

•

If a taxpayer fails to deduct certain expenses for the taxable year, he cannot deduct them from the income of the next or any succeeding year (Section 76, Rev. Reg. No. 2).

•

Not allowed to claim deductions (Tax base: Gross Income):

i.

NRA- NETB

ii.

NRFC

THE COHAN RULE PRINCIPLE: If there is showing that expenses have been incurred but the exact amount thereof cannot be ascertained due to the absence of documentary evidence, it is the duty of the BIR to make an estimate of deduction that may be allowed in computing the taxpayer's taxable income bearing heavily against the taxpayer whose inexactitude is of his own 91

92


r

CHAPTER 6 ALLOWABLE DEDUCTIONS FROM GROSS INCOME

making. A disallowance of 50% of the taxpayer's claimed deduction is valid (Rev. Memo. Circular No. 23-2000). Deductions

2.

amounts/items exempt from tax by virtue of the Tax Code or special law v.

Personal Exemptions (2001 Bar)

business expenses represent cost of doing business

personal expenses cover personal, living or family expenses

both individual and corporate taxpayers may claim

only individual is entitled

Optional Standard Deduction (OSD) KINDS OF ITEMIZED DEDUCTIONS

C.

BUSINESS EXPENSES Requisites for deductibility (1968 Bar) ( 1.) The expense must be ordinary and necessary. There is no hard and fast rule on the matter.

•

It depends upon particular facts such as, the type of business (custom), intention of the taxpayer, time, place and prevailing circumstances. The Supreme Court has never attempted to define with precision the terms ordinary and necessary.

•

However, Section 34(A)[1a] of the NIRC, as amended by R.A. 8424, provides that expenses are considered "ordinary and necessary" if they are directly attributable to development, management, operation, and or conduct of the trade or business of the taxpayer, or in the exercise of the taxpayer's profession.

KINDS OF ALLOWABLE DEDUCTIONS

1.

Itemized deductions a.) Business expenses b.) Interest c.) Taxes d.) Losses e.) Bad debts f.)

Depreciation

g.) Depletion h.) Charitable and other contributions i.)

Pension trust contribution

v. Exclusions (2001 Bar)

amounts deducted from gross income to arrive at net income Deductions

j.)

93

Research and development expenditure

Guiding principles: Ordinary, when it is normal (common or usual) in relation to the business of the taxpayer and the surrounding circumstances. Need not be recurring, e.g., lawyer's fee to prosecute infringement suit. It is called ordinary in most cases to distinguish it from a capital expenditure (1955 CCH Fed. Tax Course, par. 403). •

Recapitalization and reorganization expenses are capital expenditure as well as cost of

94


obtaining stock subscription and promotion expenses (Atlas Consolidated Mining and Development Corp. v. Com., 120 SCRA246). Necessary, where it is appropriate and helpful in the development of the taxpayer's business. It is intended to realize a profit or to minimize a loss (Visayan Cebu Terminal Co. v. Collector, CTA Case No. 28, 29 June 1957). •

Ransom money paid to secure the return of an individual is not deductible as it has nothing to do with profit-making (Teodoro and De Leon, op. cit., pp. 64-65).

•

Payment of the debts of bankrupt company to which the taxpayer was an officer to establish his credit is, according to U.S. Supreme Court not ordinary (Welch v. Helvering, 290 U.S. 11 [1933]).

(2.) The expenses must be incurred in trade or business carried on by the taxpayer - This means that the same is not incurred in the trade or business of another. a.) Stockholder's expense in connection with the acquisition of additional stock in order to sell it to certain company executives in furtherance of a management incentive plan of the company - not incurred in connection with the trade or business of the company (Stanly and Kilcullen, pp. 63-64). b.) Fees paid by the taxpayer to recover its lost assets occasioned by the war and to rehabilitate its business - business connected expenses (Collector v. Phil. Education Co., G.R. No. L-8505, 30 May 1953).

r

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95

c.) Mere holding of investments cannot be considered engaging in business so that the expenses in managing the investments are not considered ordinary and necessary in the pursuit of a trade or business (Hospital De San Juan De Dias v. Com., G.R. No. 311305, 10 May 1990). d.) Margin fees of P340,822.04 paid to the Central Bank by ESSO, a foreign corporation doing business in the Philippines, on its profit remittances to its New York head office are not ordinary and necessary expenses. REASON: The fees were paid not in the production of income, but in the disposition of said income after it had already been earned. Hence, it is an expense properly attributable to the head office and not in the carrying on of its trade or business in the Philippines (ESSO Standard Eastern, Inc. v. Com., 175 SCRA 158-159). (3.) The expenses must be substantiated by proof a.) It is incumbent upon the taxpayer to establish proximate relation (logical link or nexus) between the expense and the taxpayer's business (Atlas Consolidated v. Com., 102 SCRA 246, 256). b.) Receipts are the best proof. Burden of proof lies upon the taxpayer. In certain cases, this rule is relaxed. Even if no records/receipts are available, the oral testimony of a CPA, if not contradicted by the government is sufficient (Basilan Estates v. Com., G.R. No. L-22494, 5September1967).

96


(4.) The expenses must be reasonable a.) Promotional expenses incurred or paid by Phil. Sugar Estate Development Co. to Algue Inc. amounting to P125,000.00 was reasonable in the light of the efforts exerted in inducing investors and prominent businessman to venture in a experimental enterprise (Vegetable Oil Investment Corp.), and to invest in a new business involving millions of pesos (Com. v. Algue, 158SCRA11). (5.) Paid or incurred during the taxable year a.) Cash basis method - deducts expenses in the year in which they are paid. b.) Accrual basis method-recognizes expenses in the year they accrue. •

•

•

The propriety of an accrual must be judged by the facts that a taxpayer knew, or could reasonably be expected to have known, at the closing of its books for the taxable year. Accrual method of accounting presents largely a question of fact; such that the taxpayer bears the burden of proof of establishing the accrual of an item of deduction. The all-events test requires that the liability be fixed, and the amount of such liability be determined with reasonable accuracy. The amount of liability does not have to be determined exactly; it must be determined with reasonable accuracy (something less than an exact or complete accurate amount). Applying the all-events test, the Supreme Court ruled in the recent case of CIR v. Isa-

CHAPTER6 ALLOWABLE DEDUCTIONS FROM GROSS INCOME

97

be/a Cultural Corporation [515 SCRA 566-

567], that the professional fees of SGV & Co., for auditing the financial statements of ICC for the year 1985 cannot be validly claimed as expense deductions in 1986. Reason: ICC failed to present evidence showing that even with only "reasonable accuracy, it cannot determine the professional fees which said company could charge for its services." (6.) Expenses must not be against public policy, public moral or law a.) Fines and penalties -

against public policy.

b.) Attorney's fee incurred in defending civil action based on illegal act - deductible provided it is business connected. c.) Even though the defense is unsuccessful - as long as it is business connected - deductible. d.) Entertainment expenses incurred by officer of a corporation to entertain certain government officials to discuss transactions/dealings at Manila Hotel - against public policy (Nava v. Collector, CTANo. 568, 25September1961). e.) The purchase price of political influence to obtain or hold public contracts; dollar allocations from the Central Bank; import control licenses; payments in excess of the maximum amount authorized by law - against public policy. Reason: To permit a violator to gain a tax advantage through deductions would in effect lessen the degree of punishment intended, or would frustrate the purpose and effectiveness

98


c~~ffiB

w

ALLOWABLE DEDUCTIONS FROM GROSS INCOME

f.)

of the public policy that has been violated ( 1955 PH Fed. Taxes, pars. 11, 1235, 11, 237).

including contribution under SSS Act;

Bribe to obtain protection from arrest or prosecution - against public policy.

• other forms of compensation for services actually rendered.

(7.) If subject to withholding tax, proof of payment · to BIR must be shown •

Professional expenses -

10%

•

Rent expense -10% (Rev. Reg. No. 6-85, 2 May 1985)

KINDS OF BUSINESS EXPENSES (1.) Compensation for personal services Requisites: a)

Personal services actually rendered;

b)

Compensation is for such services rendered;

c)

Reasonable.

What are included in compensation for services which are allowed as deductions from gross income? (1968 Bar) Answer:

• wages, salaries, etc.; •

bonuses in good faith;

•

commissions, professional fees, vacation-leave pay, retirement pay;

•

management expenses;

•

premiums and compensation for injuries if not compensated for by insurance or otherwise;

•

contribution to pension trust created for the benefit of the employees,

Factors/tests which determine whether compensation paid for services rendered is deductible or not •

Any amount paid in the form of compensation which does not partake of the purchase price of services is not deductible. Example: 1) Ostensible salary paid by a corporation may be treated as distribution of dividend upon stock. This is likely to occur in the case of a corporation having few stockholders, practically all of whom drew salaries. Reasonable amount - deductible from gross income; Excess over reasonable amount - not deductible. Example: 2) An ostensible salary may be in part payment for property - Partnership sells out to a corporation; the former partners agreeing to continue in the service of the corporation. The salaries are not merely for services but payment for the transfer of their business (Section 70, Rev. Reg. No. 2; Alhambra v. Collector 105, 106 Phil. 355). The form or method of fixing compensation is not decisive as to deductibility. Contingent compensation may be deductible as long as it is not influenced by any consideration other than securing fair and advantageous terms (Reyes v. CTA No. 4, 30 September 1957).

100


•

Bonuses are deductible under the following conditions:

Other forms of compensation: a.) Housing and meals; b.) Courtesy discounts;

b.) Reasonable amount. To hold otherwise would open the gate to rampant tax evasion (Kuenzle & Strife, Inc. v. Collector, 106 Phil. 355);

c.) Entertainment and gifts to company officers during Christmas and major anniversary, sports tournament and company picnics (Rev. Audit Memo Order 1-87, 23 April 1987);

Suggested tests: (Consider the date when the contract for services was made, not at the date when the contract is questioned) a.) good faith; b.) character of business; c.) salary policy of the corporation; d.) type and extent of services; e.) employee's qualification and contribution; f.)

•

•

101

a.) Paid in good faith as additional compensation for services rendered;

c.) Not to exceed reasonable compensation when added to stipulated salaries.

•


general economic conditions (C.M. Hoskins & Co. v. Com., L-24059, 28 November 1969).

Bonuses granted to corporate officers for the successful sale of a piece of land effected through broker - no services rendered not deductible as reasonable and necessary expenses (Aguinaldo Industries Corp. v. Com., L-29790, 25 February 1982). It is immaterial whether bonuses are paid in cash or in kind or partly in cash and partly in kind.

d.) Legitimate expenses (salaries and miscellaneous expenses) of an illegitimate business are deductible based on the theory that the income tax is not a tax on gross income even if such income is earned from an illegal business (1.T. 2581, 1942-2 Com Bell 88). (2.) Travelling expenses - include transportation expenses and meals and lodging (Sections 65 and 66, Rev. Reg. No. 2). Requisites for deductibility: a.) Paid or incurred while "away from home."

i.

Transportation expenses from main office to branch, from branch office to main office - deductible.

ii.

Transportation expenses from office to home; home to office - not deductible.

iii.

If a company car is utilized both for business and personal use - proportion to the use.

b.) Paid or incurred in the conduct of trade or business.

102


c.) Reasonable and necessary expenses. (3.) Representation and Entertainment expenses Requisites for deductibility: a.) Subject to the rule of substantiation - receipt or adequate records, amount of expense, date and place of expense, purpose of expense and professional or business relationship of expense; b.) Paid or incurred in the pursuit of trade or business; c.) Paid or incurred in the taxable year; d.) Not contrary to law, morals and public policy; e.) Reasonable. Dues paid to social, athletic, or sporting club or organization per officer; to professional or business organization (Lions, Kiwanis) deductible. Purchase of propriety shares and playing rights - not deductible. (4.) Advertising and Promotional Expenses a.) Must be substantiated. b.) All payments for the purchase of promotional give-aways, contest prizes or similar material must be properly receipted. All payments for services such as radio and TV time, print ads, advertising expense must be subjected to withholding tax. •

There is yet to be a clear-cut criteria or fixed test for determining the reasonableness of an advertising expense. There


103

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: the type and size of business in which the taxpayer is engaged; the volume and amount of its net earnings; the nature of the expenditure itself; the intention of the taxpayer and the general economic conditions. It is the interplay of these, among other factors and properly weighed, that will yield a proper evaluation. Advertising is generally of two kinds: (1) advertising to stimulate the current sale of merchandise or use of services and (2) advertising designed to stimulate the future sale of merchandise or use of services. The second type involves expenditures incurred, in whole or in part, to create or maintain some form of goodwill for the taxpayer's trade or business or for the industry or profession of which the taxpayer is a member. If the expenditures are for the advertising of the first kind, then, except as to the question of the reasonableness of amount, there is no doubt such expenditures are deductible as business expenses. If, however, the expenditures are for advertising of the second kind, then normally they should be spread out over a reasonable period of time. The protection of brand franchise is analogous to the maintenance of goodwill or title to one's property. This is a capital expenditure which should be spread out over a reasonable period of time. Cor-

104



porate taxpayer's venture to protect its brand franchise was tantamount to efforts to establish a reputation. [Commissioner of Internal Revenue v. General Foods (Phils.), Inc., 401 SCRA 545 (2003) 2009 Bar] •

Expenses incurred or paid to promote sale of capital stock for acquisition of additional capital is not deductible from taxable income. Efforts to establish reputation are akin to acquisition of capital assets and, therefore, expenses related thereto are not business expense but capital expenditures. [Welch v. Helvering, 290 U.S. 111, 78 L Ed. 212, 545 Ct. 8 (1933))

(5.) Rent Expense (Rev. Reg. No. 8-90 dated 15 October 1990) a.) Business property- at least P500 -

5%.

105

(7.) Repairs Rules on deductibility a.) Incidental or ordinary repairs - keeps the asset in its ordinary working condition (does not add material value to the property or prolong its life as distinguished from extra-ordinary repairs). i.

Expense for the maintenance and repair of fishponds - deductible - It keeps the fishponds in an ordinary efficient operating condition (Villegas v. Com., CTA case dated 7 October 1963).

ii.

Repairs on the second floor of plant to strengthen it and avoid danger of collapse - deductible (Kerotest Mfg. Co., BTA Mamo Op., 25 November 1941 ).

b.) Extraordinary repairs are not deductible they are capital expenditures.

at least

i.

(6.) Cost of material and supplies - deductible only to the amount actually consumed or used in operation.

Expenses necessitated by radical changes in design made during construction are not deductible - part of the cost of the project (Dirscoll v. Com., 1477 [2d) 493).

ii.

Expenses of repairs to walls and roof of a building to prevent leakage - deductible (Buckland v. U.S. D.C. Com., 9 May 1946).

iii.

Cost of demolishing building and erecting a new one is a capital expenditure (Law of Federal Income Taxation, Merters, Vol. 4, p. 372).

b.) Non-business/residential property P10,000.00- 5%.

Methods utilized to determine materials used: a.) Actual consumption method (inventory method); b.) Direct purchase method. Taxpayer purchases materials but has no record of consumption - deductible provided the net income is clearly reflected by this method (Section 67, Rev. Reg. No. 2).

•

Organization costs are amortized over the life of the corporation.

106


•

Private or proprietary educational institution may, at its option, elect either: a)

b) D.


To deduct expenditure otherwise considered as capital outlets of depreciable assets incurred during the taxable year for the expansion of school facilities, or

•

Interest paid for late payment of donor's tax is deductible (Com. v. Prieto, L-13912, 30 September 1960).

•

What are included in the term "indebtedness" interest of which is deductible? (1968 Bar)

•

Gifts when proven to be bonafide loans

•

Taxes

•

Obligations of joint obligor

•

Discount on notes issued to bank for loan

Deduct allowance for depreciation therefrom.

INTEREST EXPENSES

(1.) Definition - amount which one has contracted to pay for the use of borrowed money (Old Colony Bay Co., 284 U.S. 552) or amount of compensation paid for the use of money or forbearance from such use. Requisites for deductibility: a.) There must be an indebtedness:

i.

no indebtedness -- no deduction;

ii.

Indebtedness- unconditional and legally enforceable obligation for payment of a sum certain in money;

iii.

Embraces not only contractual debts but also interest accruing as a result of delinquency for payment of the tax. However, penalties (civil or criminal) are excluded;

iv.

Distinction between taxes and debts are, on account of their nature and in certain cases, inconsequential (Sambrano v. CTA, L-8652, 30 March 1957). Correspondingly: •

Interest on delinquent tax liabilities is deductible (Com. v. Palanca, 18 SCRA496);

107

b.) Incurred in connection with taxpayer's trade or business c.) Indebtedness must be that of the taxpayer: i.

Corporation was allowed interest deduction for payments made on loans obtained in its corporate capacity, using corporate assets as security, through borrowed funds were subsequently loaned to a stockholder.

ii.

Interest on income tax deficiency on property after transfer to transferee (Arcale Realty Co., Inc., 35 TC 256).

iii.

Interest on mortgage by legal or equitable owner not directly liable upon indebtedness (Section 8, Rev. Reg. No. 2).

d.) The interest must have been stipulated in writing in consonance with Article 1956, New Civil Code which provides that no interest shall be

108


due unless it has been expressly stipulated in writing. e.) Paid or accrued within the taxable year. Cash basis actually paid.

deductible in the year it is .

Accrual basis - deductible in the year it is accrued even if not actually paid. Deductible interest expenses a.) Interest on taxes. Reason: Taxes for this purpose are indebtedness. Fines, penalties and surcharges on taxes are not deductible.

(6.) Interest on indebtedness paid in advance through discount or otherwise (cash basis). Deductible in the year the indebtedness was paid, not when interest was paid in advance. (7.) Interest between related taxpayers. a.) Members of a family - brothers and sisters (full or half), spouse, ancestors and lineal descendants. b.) Individual and corporate - individual owns directly or indirectly more than 50% of the outstanding stock. c.)

b.) Interest paid by corporation on scrip dividends. c.)

Interest on deposits paid by authorized bank of the Central Bank.

d.) Interest paid by legal or equitable owner on mortgage of real property.

Between corporations - more than 50% of the outstanding stock both owned directly or indirectly by the same individual.

d.) Grantor and fiduciary (trustee) of any trust. e.) Fiduciary and another fiduciary granter. f.)

Some non-deductible interest expenses

(3.) Interest on capital for cost keeping. Reason: No indebtedness. (4.) Interest paid where parties provide no stipulation to pay interest in writing. (5.) Interest on indebtedness if incurred to finance petroleum exploration.

the same

Fiduciary and beneficiary or such trust. •

Theoretical interest is not deductible as it is merely computed or calculated. It does not arise from interest bearing obligation (PICOP v. CA, 250 SCRA 434 ).

•

Optional treatment of interest expense on capital expenditure. At the option of the taxpayer, interest expense on a capital expenditure incurred to acquire property used in trade, business or exercise of a profession may be allowed as a: ( 1) deduction in full in the year when incurred, the provisions of Section 36 (A)[2] and [3] of the Tax Code of 1997 to the contrary notwithstanding; or may be treated as a (2)

(1.) Interest on preferred stock which is considered interest on capital by virtue of RMC 17-71 dated 12 July 1971 (1999 Bar). (2.) Interest on undrawn salaries and bonuses (Keunzle & Streiff, Inc. v. Collector, 106 Phil. 355).

109


110


capital expenditure for which the taxpayer may claim only as a deduction the periodic amortization of such expenditure (Section 34(8)[3] as implemented by Rev. Reg. No. 13-2000). •

E.

Arbitrage rule on deductible interest. The percentage by which the taxpayer's otherwise allowable deduction for interest expense shall be reduced, has been increased from 38% to 42% of the interest income subjected to final tax effective July 1, 2005. It shall be reduced to 33% effective January 1, 2009 (Section 34[8], as amended by R.A. No. 9337).

1·

•

No deductions are allowed for amounts representing: (1) interest; (2) surcharges; and (3) fines or penalties incident to delinquency (Par. 2, Section 80, Rev. Reg. No. 2).

•

Postage is not a tax. Automobile registration fees are not considered taxes (Section 80, Rev. Reg. 2).

•

Under Section 4(a), R.A. No. 9257 (Expanded Senior Citizens Act), the twenty percent (20%) discount granted to senior citizens shall be allowed as tax deduction from gross income for the same taxable year that the discount is granted.

Requisites for deductibility:

TAXES (1.) NATURE AND SCOPE -All taxes, whether national or local, paid or accrued, within the taxable year in connection with the taxpayer's trade or business, except: a.) Philippine income tax; b.) Income, war profit, and excess profit taxes imposed by the authority of any foreign country provided the taxpayer chooses to take a tax credit (If a taxpayer is qualified to take a tax credit for income, war profits and excess profits taxes paid or accrued to a foreign country such taxes, when not taken as tax credit, may be claimed as deductions from gross income); c.)


Estate and donor's tax;

d.) Special assessment tax; e.) Taxes paid for commodity not connected with the taxpayer's business:

(1.) Paid or incurred within the taxable year; (2.) Paid or incurred in connection with taxpayer's business; (3.) Deductible only by the person upon whom the tax is imposed by law (VAT is deductible only by seller). EXCEPTIONS: a.) Taxes of shareholder upon his interest as such and paid by the corporation without reimbursement from him can be claimed by the corporation as deduction. b.) A corporation paying the tax for the holder of its bond or other obligations containing a tax-free covenant clause cannot claim deduction for such taxes paid by it pursuant to such covenant (Sec. 80, Rev. Reg. No. 2).

112

BASIC APPROACH TO INCOME TAXATION CHAPTER 6 ALLOWABLE DEDUCTIONS FROM GROSS INCOME

113

When may deduction for taxes be claimed? the taxpayer's taxable income from sources without the Philippines bears to his entire taxable income for the same taxable year.

Answer: Year paid or incurred in general. However, in the case of contingent tax liability, the obligation to deduct arises only when the liability is finally determined.

Tax Deduction

Tax Credit- amount allowed by law to reduce the Philippine income tax due on account of income war-profit tax, excess profit tax, paid or accrued to' a foreign country. Only domestic corporations are entitled to avail of the tax credit.

Reason/Purpose: To lessen the harshness of taxation in cases where an income is subject to both foreign tax and Philippine income tax.

•

•

v.

Tax Credit

Deductible from gross income

Deductible from Phil. income tax

Sources: Deductible taxes such as business tax, excise tax, percentage tax and other business-connected taxes

Sources: Foreign income war-profits and excess profit tax

•

The taxpayer has the option either to claim foreign income taxes paid as deduction from gross income or tax credit against the Philippine income tax. If claimed as tax credit, it is no longer deductible from gross income.

Tax deduction reduces taxable income while tax credit reduces the taxpayer's liability (CIR v. Bicolandia Drug Corporation, 496 SCRA 176, 182).

Administrative conditions for allowance of credit for foreign taxes:

If claimed as tax credit, the allowable tax credit is subject to the following limitations:

(1.) The taxpayer must signify in his income tax return his desire to claim tax credit;

a.) The amount of the credit with respect to the tax paid or incurred to any country shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer's taxable income from sources within such country bears to his entire taxable income for the same taxable year; and

(2.) The return must be accompanied by the propriate form prescribed by the BIR Commissioner, signed and sworn, carefully filled up and containing the information required.

b.) The total amount of the credit shall not exceed the same proportion of the tax against which such credit is taken, which

ap-

If credit is sought for taxes already paid, receipt for payment must be attached.

F.

LOSSES (1.) DEFINITION The term implies an unintentional parting with something of value. It is used in the income tax law

114


in a very broad sense to comprehend all losses which are not general or natural to the ordinary course of business and are not covered under some other heading such as bad debts, inventory tosses; depreciation, etc. (1955 CCH Test Tax Course, Par.

598). Treatment of losses depends upon: a.) Class of taxpayers; b.) Nature of losses.


115

is due to a fluctuation in the market price or to other similar cause, the amount of loss is not deductible until it is disposed of (Sec. 99, Rev. Reg. No. 2). b.) Must be claimed in the year the worthlessness occurs. The law requires that it must be considered as a loss from the sale or exchange of capital assets on the last day of the taxable year in which it occurred. e.) Losses from short sale of property.

(2.) KINDS OF LOSSES: a.) Ordinary losses those incurred in trade or business. b.) Those incurred in any transaction entered for profit though not connected with the trade or business. ' c.)

Casualty Losses those incurred by property connected with the trade or business, if the loss arises from fire, storm, shipwreck, or other casualties or from robbery, theft or embezzlement.

d.) Capital losses deductible only to the extent of capital gains: •

Losses from sale or exchange of capital assets;

•

Losses resulting from securities becoming worthless which are capital assets.

Two important requisites: a.) It becomes worthless upon the happening of an identifiable event which evidences destruction of value. However, when the decline in value

f.)

Losses due to failure to exercise privilege or option to buy or sell property.

g.) Abandonment losses (oil exploration).

i.)

All accumulated exploration and development expenditures pertaining to partially or fully abandoned petroleum operations shall be allowed as deduction. In all cases, notices of abandonment shall be filed with the BIR.

ii.)

Subsequently abandoned producing well - the unarmortized costs and undepreciated costs of equipment directly used shall be allowed as deduction. If the well is reentered and production resumed, or if such equipment or facility is restored into service - the costs shall be included as part of the gross income and shall be amortized or depreciated, as the case may be.

(3.) SPECIAL KINDS OF LOSSES: a.) Wagering losses - deductible only to the extent of gain or winning:

116

l


Illustrations: Gambling winning

1,000.00

Gambling loss

500.00

Deductible loss

500.00

Gambling winning

500.00

Gambling loss Deductible loss Gambling winning Gambling loss Deductible loss i.

ii.

1,000.00 500.00 0 1,000.00 0

Thus, a taxpayer whose gambling transactions resulted in losses of P500 and gains of P400 in another gambling game, would be obliged to report the gain of P400 in order to obtain a deduction of the loss for P500. The excess of the loss over the gain is not deductible. On the other hand, the excess of the gain over loss is taxable (Humpreyv. Com., 35AFTR, 1572; Francis M. Cronon, 33 BTA 668). The cost of the unsold tickets of a sweepstakes agent constitutes his investment in a wagering transaction. Losses he may incur therefrom can be allowed as deduction only up to the extent of the gains realized. But, R.A. No. 1169 exempts sweepstakes winnings from taxation, it follows that no losses incurred therefrom can be allowed as deductions from gross income (BIR Ruling No. 62-006, 26 January 1962). Losses from an illegal transaction are not deductible and they cannot be off-

!


117

set against gains from a legal transaction (Section 96, Rev. Reg. No. 2). b.) losses due to voluntary removal of building incident to renewal or replacement (1968 Bar). Tax Code does not provide for the deductibility of losses arising from voluntary removal of old building, or scrapping of machinery or equipment. Rev. Reg. No. 2, Section 87 granted the deductibility of losses sustained if building, machinery or equipment is old, and the demolition or scrapping thereof is made , incident to removals or replacements. This presupposes that the building is already existing on the lot owned by the taxpayer before the demolition. With respect to the building existing at the time of purchase of the lot upon which the said building is erected, the rules are the following: i.)

When a taxpayer buys a real estate upon which a building is built, the cost to build another building and the cost of removal of the old building is not deductible. The value of the real estate, exclusive of old improvements, being presumably equal to the purchase price of the land and building plus the cost of removing the useless building.

ii.)

However, if the removal of the building was required by the authorities because the building was a fire hazard, the value of the building and the cost of its removal will be deductible as losses (Com. v. Prescilla Estate, Inc., et al., 11 SCRA 130 ).

118


c.) Loss of useful value of capital asset due to changes in business condition. i.)

ii.)

When taxpayer discontinues the business or discards such assets permanently from use in such business, he may claim as deduction the actual loss sustained. In determining the amount of loss, adjustment must be made, however, for improvements, depreciation and salvage value of the property. This is an exception to the rule requiring a sale or other disposition of property in order to establish a loss (Section 98, Rev. Reg. No. 2). Proof required to establish loss of useful value (Unforeseen causes): •

Increase in the cost or change in the manufacture of any product;

•

New legislation directly makes the continued profitable use of the property impossible.

I I I

I


Foreign Corporations tained:

Useful life of property terminates solely as a result of those gradual processes for which depreciation is authorized;

•

Inventories (Section 98, Rev. Reg. No. 2).

Domestic Corporations - All losses actually sustained and charged off within the taxable year and not compensated for by insurance.

Losses actually sus-

a.) In business or trade conducted in the Philippines; b.) In transaction entered into for profit in the Philippines; c.) Not compensated for by insurance or otherwise.

Requisites for deductibility (In general): a.) The loss claimed as deduction must be that of a taxpayer. i.

The taxpayer must prove that the loss was suffered by said taxpayer. •

Where a taxpayer operates two phases of industry, one exempt from income tax pursuant to RA. No. 901 and the other taxable, losses sustained in the tax-exempt operation cannot be deducted from income of the taxable industry (Marcelo Steel Corp. v. Collector, G.R. No. L-12401, 31 October 1960).

•

If the taxpayer is engaged in several businesses such that its gross income arises from operations of two or more businesses, loss sustained in one line of business cannot be claimed as a deduction or be offset from the income of its other line of businesses (BIR Ruling No. 123-87, 4 May 1987).

•

If a taxpayer derived income from manufacturing and at the same time

iii.) Non-deductible loss due to loss of useful value: •

119

120


was engaged in the business of farming, but its farming expenses exceeded its farming income, the taxpayer cannot offset its net loss from farming against its manufacturing income (BIR Ruling No. 31-84, 9 · February 1994). b.) The loss must have been sustained during the taxable year. A taxpayer is not allowed to defer the deduction to some other time other than the year in which the loss was actually sustained (Com. v. Asturias Sugar Central, Inc., G.R. No. L-15013, 31August1961)

•

I


If

r

I

I

The phrase "closed and completed transaction" means that the loss is fixed by an identifiable event occurring in the taxable year in which, under the surrounding facts and circumstances, the basis of an immediate recoupment is not present (Louisville Trust Co. v. Glenn, 25 AFTR 464 ). Consequently, where the fact would indicate substantial basis for recoupment and reasonably recognized as such, the matter is not a closed transaction until

121

the receipt of the recoup men! fixed the amount of the net loss (Section 96, Rev. Reg. No. 2). There should be an identifiable cause which fixed the loss. ii.

Loss from sale. Consumption of the sale is the identifiable event which fixes the loss.

iii.

Building, worth P500,000.00, insured for P500,000.00; burned in the year 2000. The insurer refused to acknowledge its'liability; action was brought in court by the insured. In the year 2001, the parties agreed to compromise the case - P400,000.00. Loss deductible (P500,000.00 - 400,000.00) = P100,000.00 in the year 2001 when the insurance recovery is definitely established and not 2000. Closed and completed transaction - final settlement and determination of the insurance recovery, event which took place in 2001 (1955 PH Fed. Tax Course, par. 2207).

War losses due to enemy attacks and sustained subsequent to 6 December 1941, but not later than 1 July 1942 - deductible in the year when the taxpayer was advised by the War Damage Commission (Philippine Sugar Estate Development Company v. Posadas, 68 Phil. 216).

c.) Loss evidenced by a closed and completed transaction. i.

I

d.) Loss not compensated by insurance or otherwise. i.

Not indemnified by insurance or other forms of indemnification.

ii.

Insurance or otherwise. Otherwise means in other ways - refers to compensation due under a title analogous or similar to insurance (ejusdem generis; noscitur a sociis) inasmuch as the latter is a contract establishing a legal obligation, namely: law, contract, quasi-contract, torts or crime.

122


Included - insurance created by operation of law such as the War Damage Corporation Act of the United States (Com. v.Asturias Sugar Central, Inc., G.R. No. L-15013, 31August1961). Excluded (Income Tax Law) hope, or even moral certainty, proposed legislation - authorizing payment of an indemnity, not due either the general principles of law, or under any particular statute - would eventually be approved (Cu Unjieng Sons, Inc. v. BTA, G.R. No. L-6296, 29 September 1956).


123

c.) Proof of the elements of the loss claimed, such as the actual nature and occurrence of the event and the amount of the loss. i.)

Casualty loss - documentary proof of costs, photograph showing extent of damage, condition or value of the property after it was repaired, restored or replaced.

ii.)

Robbery, theft or embezzlement losses amount of loss. Police report is necessary although not conclusive proof of the loss arising therefrom.

(5.) NON-DEDUCTIBLE LOSSES

(4.) CASUALTY LOSSES (fire, storms, robbery, theft or embezzlement)

(1.) Losses in dealings between related taxpayers (except in case of distribution in liquidation)

Requisites for deductibility (Rev. Reg. No.12-77)

a.) Members of a family. Family means taxpayer's brothers and sisters (whether by whole or by half blood), spouse, ancestors and lineal descendants.

a.) Sworn declaration of loss must be filed with the BIR. i.)

Nature of the event giving rise to loss and time of its occurrence;

ii.)

Description of the damaged property and its location;

iii.) Items needed to compute the loss such as cost or other basis of the property, depreciation allowed if any, value of the property before and after the event, cost of repair; iv.) Amount of insurance or other compensation received or receivable. b.) Filed through the nearest RDO within 45 days after the date of the occurrence.

i.

Loss on a bonafide sale to a son-inlaw of the taxpayer's brother - deductible.

ii.

Prohibition applies to indirect sale or exchange. Consequently, if the taxpayer seeks to deduct a net operating loss, the prohibition does not apply (AnyderSons Co. v. Comm., G.AFTR 2d. 875).

b.) Between an individual and corporation. More than 50% of the outstanding stock of the corporation is owned directly or indirectly by the individual.

124



applies to acquisition through a taxable exchange and the making of an option contract;

c.) Between two corporations: i.

ii.

iii.

One or both of the corporations is a personal holding company preceding the date of the sale or exchange;

Reasons for non-deductibility of loss from wash sale:

However, the limitation does not apply where the individual owning more than 50% of the stock of the purchasing corporation owned less than 50% of the stock of the selling corporation (Shelder Land Co., 42 BTA 498).

i.

Grantor and fiduciary (trustee);

ii.

Fiduciary of a trust and fiduciary of another trust - the same grantor;

iii.

e.) The seller is not dealer in securities.

More than 50% in value of the stock of each corporation is owned directly or indirectly by the same indvidual;

d.) Between parties to a trust:

Fiduciary and beneficiary.

i.

Prevent deduction of losses on sales of stock or securities that were replaced by substantially identical stocks or securities.

ii.

Loss is added to the cost of the subsequently acquired securities/stock. Hence, a mere artificial loss.

(3.) Loss due to removal of building if purchased (not existing and not incident to renewal) •

Net operating loss carry over (NOLCO) i.

Applies to individual and corporate.

ii.

Can be carried over in the next three consecutive taxable years.

iii.

Taxpayer is not exempt from income tax.

iv.

No substantial change in the ownership of the business or enterprise in that not less than 75% in nominal value of the outstanding issued shares or paid up capital of the corporation is held by or on behalf of the same person.

v.

Mines other than oil and gas wells may carry over net operating losses as deduction in the next five years.

(2.) Losses on wash sale (61-day sale) Points to be considered: a.) Taxpayer must have bought or sold stocks or securities; b.) Substantially identical stock or securities are acquired within a period beginning 30 days before the date of sale and ending 30 days after such date; c.) There must have been sale or disposition of stocks or securities; d.) Not limited to situations where the replacement is acquired by purchase. It also

125

126


I CHAPTER 6 ALLOWABLE DEDUCTIONS FROM GROSS INCOME

G.

127

BAD DEBTS (1.) DEFINITION

L)

Debts due to the taxpayer which are actually ascertained to be worthless and charged off within the taxable year. (2.) REQUISITES FOR DEDUCTIBILITY: a.) Existence of a valid debt and subsisting debt (legal and factual). L)

A debt is valid if there exists the relationship of a debtor and creditor. It is not necessary that the debt shall be due in the sense that it is then collectible. It must be an outstanding obligation, which if not due at the time, will certainly become due at some future date (Budsboro Steel Foundry & Machine Co. v. U.S., 12AFTR 1948).

Illustration: If the creditor could show that during the years he attempted to collect the debt, the debtor had property the title of which was in dispute but which would enable him to pay his debts when the title was cleared, the creditor would be entitled to defer the deduction on the ground that there was no genuine ascertainment of worthlessness.

iL) Where the debt, however, is subject to a contingency and such contingency did not occur, there is no valid subsisting debt (Evans Clark, 18TC 780). iii.) Repayment of the debt is essential for the existence of the debt Understanding that the payment of the alleged debt would never be demanded - there is no debt within the contemplation of the law. Exception: Even ifthe debt be uncollectible from its inception, it is the right of the endorser or guarantor to deduct payment which he is required to make upon default of the primary debtor. b.) Debts must be actually ascertained to be worthless.

Worthlessness is not determined by an inflexible formula but upon the exercise of sound business judgment Mere uncertainty of collection or investigation that the debtor is in an unsatisfactory financial condition and that the collection of the debt is doubtful will not suffice. All pertinent facts and evidence must be considered. The burden of proof to show worthlessness is on the taxpayer.

iL)

Factors affecting the worthlessness of a debt (2004 Bar): ii.a.

Bankruptcy or insolvency of the debtor;

iLb.

Insufficiency of the collateral;

iLc

Statute of limitation;

ii.d.

Death of the debtor leaving no assets;

ii.e.

Injury of the debtor making it impossible for him to earn a living (Section

128



102, Rev. Reg. No. 2; 1955 CCH Fed. Tax Course, par. 502);

Non-resident Foreign Corporation not entitled.

ii.f.

Meager amount involved;

d.) Debt arises from business or trade.

ii.g.

Improbability of success of judicial collection;

e.) Does not arise from transactions between related taxpayers.

ii.h.

Destruction by fire of original invoices evidencing the indebtedness (Goodwill International Rubber Co. v. Collector, CTA Case No. 468, 8 June 1963).

f.)

c.) Debt must be charged off within the year of worthlessness. A taxpayer may not defer deduction to a later year of a bad debt. If the charge off is made in a later year, the deduction will be disallowed (Collector v. Goodrich International Rubber Co., 21 SCRA 1336, 1314). Loss from theft or embezzlement i.

Deductible in the year in which it was sustained.

ii.

No means of determining the actual date of embezzlement - year of discovery (Boston Consolidated Gas Co. v. Comm., 126F [2d] 437).

iii.

-

129

Modified by the application of the bad debt theory which holds that since the embezzlement of funds creates a debtorcreditor relationship the loss is deductible as BAD DEBT in the year when the right of recovery become worthless. Deductible bad debts of Domestic and Resident Foreign Corporations - only business debts.

Additionally, before a debt can be ascertained to be worthless, the taxpayer must also show that it is indeed uncollectible in the future. Furthermore, there are steps outlined to be undertaken by the taxpayer to prove that he exerted efforts to collect the debts viz: (1) sending of statements of accounts·' (2) sending of collection letters; (3) giving' the account to a lawyer for collection; and (4) filing a collection case in court (PRC v. Commissioner, 256 SCRA 667).

•

In the case of banks, they shall submit a Bangko Sentraf ng Pifipinas/Monetary Board written approval of the writing off of the indebtedness from the bank's books of accounts at the end of the taxable year (Rev. Reg. No. 25-2002).

•

As regards insurance or surety company, writing off of a receivable from the books and claimed as bad debts deduction requires declaration of closure due to insolvency or for any such similar reason by the Insurance Commissioner. (Ibid).

(3.) MEASURE OF BAD DEBTS DEDUCTIBLE a.) Generally the entire amount of the bad debt. b.) Not necessarily so in the following instances:

130


i.

ii.

Unpaid wages paid in promissory note amount deductible is the value of the note and not the amount of the unpaid salary or wages; Distribution of the decedent's assets only the difference between creditor's claim and property received from the estate;

iii.

Account receivable becoming worthless in the hands of the purchaser - only the amount which represents the purchase price and not the face value of the note.

iv.

Foreclosure of mortgages: iv.a. Only the difference between the debt and the proceeds of the sale is generally deductible as bad debts; iv.b. If no foreclosure occurs and the debtor surrenders the property to the creditor - difference between the basis of the debt and FMV of the property is deductible (Section 103, Rev. Reg. No. 2).

v.


If creditor buys the mortgaged property and credits the debt with the purchase price even if such price is Jess than the indebtedness - no deductible bad debt, the security taking the place of the debt.

vii. Debt partially secured by a mortgage is deductible only to the extent not covered by mortgage. vii. A debt, say for P100,000, compromised for PS0,000.00 is deductible to the extent

131

of PS0,000.00 or the amount absolved if the debtor is insolvent. viii. Unpaid wages, salaries, rents and other similar income, deductible in full provided the same is returned as income.

H.

DEPRECIATION (1.) DEFINITION (1996 Bar) Gradual diminution in the useful (service) value of tangible property used in trade, profession or business resulting from exhaustion, wear and tear, and obsolescence. It applies also to the amortization of the value of intangible assets, the use of which in trade or business is definitely limited in duration (Basilan Estates, Inc. v. Com., 21 SCRA 17, 5September1967). Necessity of depreciation allowance -certain property used in the business gradually approaches a point where its usefulness is exhausted. By using the property, a gradual sale is made of it, and the depreciation change is the measure of the cost which has been sold (Ibid.).

(2.) REQUISITES FOR DEDUCTIBILITY: a.) The allowance for depreciation must be reasonable (Bacolod-Murcia Milling Co., Inc. v. Com., CTACase No. 1402, 31October1969). Depreciation is a question of fact and is not measured by theoretical yardstick. Reasonableness of a claim depends upon the conditions known to exist at the end of the period for which the return is made (Section 109, Rev. Reg. No. 2). It must be in accordance with a reasonable consistent plan.

132

BASIC APPROACH TO INCOME TAXATION CHAPTER 6 ALLOWABLE DEDUCTIONS FROM GROSS INCOME

The Tax Code, provides for the use of the following methods of depreciation, viz:

e.) Building and furnitures for personal use;

i.

Straight line method;

f.)

ii.

Declining balance method;

g.) Personal effects and clothing.

iii.

Sum of the years digit method;

iv.

Any other method which may be prescribed by the Secretary of Finance upon recommendation of the BIR Commissioner. The BIR and the taxpayer may agree in writing on the useful life of the property to be depreciated. The agreed rate may be modified if justified by facts or circumstances. The change shall not be effective before the taxable year on which notice in writing by registered mail or certified mail is sent by the party initiating.

b.) It must be for property used in trade or business or profession (depreciable assets). Depreciable assets: a.) Tangible property used in trade or business allowance; b.) Intangible property like patent, copyrights and franchises (Section 107, Rev. Reg. No. 2)amortization. Non-depreciable assets: a.) Inventories or stock; b.) Land and improvements; c.) Bodies of minerals subject to depletion; d.) Automobiles or transportation equipment for personal use (residence);

Intangibles -

133

use is unlimited·

Property kept in repair preciation

'

subject to de-

Properties and costumes used exclusively in business such as theatrical business, may be subject to deprec1at1on (Section 106, Rev. Reg. No. 2). Rules on the depreciation of properties used in petroleum operation: ( 1.) Depreciation is allowed - straight line or declining balance method at the option of the service contractor; (2.) Shift from declining to straight line is allowed; (3.) Useful life of properties used - ten (10) years or such shorter life as may be permitted by the BIR; (4.) Properties not used indirectly in petroleum operation 5 years. Depreciation deduction is not allowed: ( 1.) Property amortized to its scrap value and no longer in use (Section 108, Rev. Reg. No. 2); (2.) Beyond the capital investment in the assets being depreciated (Gutierrez v. Com., L-19587, 20 May 1965), otherwise some profit will be made. These deductions are privileges not matter of right. In the case of NRA and RFC located in the Philippines.

only properties

In the case of property held by one person for life with remainder to another person (usufruct or feidicommissarv substitution) - life tenant mav c.IFiim

134



the deduction as if he were the absolute owner of the property. Property held in trust - apportion between or among the beneficiaries and trustees in accordance with the trust instrument.

135

(2.) Charged off within the taxable year. (3.) Allowance for depletion is computed in accordance with the cost depletion method.

Essential Factors: a.) Basis of the property;

I.

DEPLETION

b.) Estimated total recoverable units in the property;

(1.) DEFINITION It is the exhaustion of natural resources like mines and oil and gas wells as a result of a production or severance from such mines or wells (1965 CCH Fed. Tax Course, par. 1201 ). (2.) THEORY AND PURPOSE OF DEPLETION ALLOWANCE - as the product of the mine is sold, a gradual sale is being made of the taxpayer's capital interest in the property. The purpose is, then, to enable him to recover that capital interest free of income tax at its cost or on some other basis. (3.) WHO ARE ENTITLED - only persons having an economic interest in a mineral land or oil or gas wells. To acquire an economic interest, the taxpayer must have a capital investment in the property and not mere economic disadvantage. The taxpayer must have acquired at least, by investment, any interest in oil or gas, or mineral in place, and services, by any form of legal relationship, income derived from the extraction of the oil, gas or mineral to which he must look for a return of his capital (Gen. Cir. No. V-332, 6 January 1961 ).

Requisites for deductibility (1.) Depletible asset- natural resources and oil wells.

c.) Number of units recovered during the taxable year. (4.) Depletion deductible: a.) Domestic Corp. - oil, gas wells or mines located within and without; b.) Resident Corp. - gas wells and mines located in the Philippines. (5.) May the taxpayer deduct exploration and development expenditures paid or incurred during the taxable year? YES. At taxpayer's option, he may deduct exploration and development expenditures (mines) provided that it shall not exceed 25% of the taxable income from mining operations computed without the benefit of any tax incentives under existing laws. NO. With respect to improvements of property subject to allowance for depreciation (expenditure) and those paid or incurred for the exploration and development of oil and gas

Depreciation mines, gas

Depreciable assets

v.

Depletion Natural resources

136

J.


CHARITABLE AND OTHER CONTRIBUTIONS (1.) KINDS: (a.) Ordinary- subject to limitation; (b.) Special -

deductible in full.

(2.) ENTITLED: a.) Corporate taxpayer except NRFC - 5% of the Net Income before Charitable Contribution; b.) Individual taxpayer except NRA-NETB - 10% of the Net Income before Charitable Contribution. (3.) REQUISITES FOR DEDUCTIBILITY

CHAPTERS ALLOWABLE DEDUCTIONS FROM GROSS INCOME

his right to prove his contribution in accordance with the rules of evidence (Ramirez v. Com., CTA Case No. 544, 14 September 1959). b.) Must be given to the organization specified by Tax Code or special law. c.) The net income of the institution must not inure to the benefit of any member or individual. (4.) CONTRIBUTIONS DEDUCTIBLE IN FULL a.) Donations to the government or political subdivision including fully-owned government corporation to be used exclusively in undertaking priority activities in: i.

education;

ii.

health;

Requirements/conditions (to be stated in the return):

iii.

youth and sports development;

iv.

human settlement;

i.

Name and address of organization;

v.

science and culture;

ii.

Approximate date and amount of the gift;

vi.

economic development.

iii.

If not in money, FMV of the gift;

iv.

Signed by the responsible officer of the corporation.

a.) Contribution or gift must be actually paid during the taxable year.

Question - May the deduction of contribution be allowed even in the absence of supporting receipts? Answer - YES. Attachment of receipts for contribution to the return is merely an administrative device for the convenience and facility of the BIR in verifying the income tax return and the requirement cannot deprive the taxpayer of

137

b.) Donations to international organizations or foreign institutions in compliance with agreements or treaties. c.) Donations to accredited non-government organizations (NGO). i.

Exclusively for: a.

scientific;

b.

research;.

c.

character building;

d.

youth and sports development;

1 Jti



ii.

139

e.

health;

vi.

f.

social welfare;

vii. social welfare.

g.

cultural;

h.

charitable;

a.) IBP (P.O. 1810)

i.

any combination thereof.

b.) Development Academy of the Philippines (P.O. 205)

(6.) DEDUCTIBLE UNDER SPECIAL LAWS (IN FULL)

Utilized not later than 15th day of the 3rd month following the close of its taxable year.

iii.

Administrative expense must not exceed 30% of total expenses.

iv.

Upon dissolution, assets must be distributed to another non-profit domestic corporation or to the state.

c.) Agricultural Department of Southeast Asian Fisheries Development Center (P.O. 292) d.) National Social Action Council (P.O. 294) e.) Task Force on Human Settlement f.)

h.) Social Welfare, Cultural & Charitable Institution (P.O. 507)

a.) Not in accordance with priority plan. b.) Conditions are not complied with. c.) Donation to the government of the Philippines or political subdivision exclusive for public purposes.

i.

religious;

ii.

charitable;

iii.

scientific;

iv.

cultural;

v.

educational;

National Museum, Library & Archives (P.O. 373)

g.) Ministry of Youth & Sports Development (P.O. 604)

(5.) CONTRIBUTION SUBJECT TO LIMITATION (5% or 10% of Net Income before Charitable Contribution)

d.) Donations to domestic corporations organized exclusively for:

rehabilitation of veteran;

i.)

Museum of Philippine Costumes (P.O. 1388)

j.)

lntramuros Administration (P.O. 1616)

k.)

Lungsod ng Kabataan (P.O. 1631)

•

K.

Contributions to International Lions Club not Deductible (BIR Ruling, 16 July 1955).

RESEARCH AND DEVELOPMENT EXPENDITURE (1.) IN GENERAL - A taxpayer may treat research or development expenditures which are paid or incurred by him during the taxable year in connection with his trade, business or profession as ordinary and necessary expenses which are not chargeable to capital account. The expenditures so treated shall

140


be allowed as deduction during the taxable year when paid or incurred. (2.) LIMITATIONS ON DEDUCTION-The following expenditures are not deductible: · a.) Any expenditure for the acquisition or improvement of land, or for the improvement of property to be used in connection with research and development of a character which is subject to depreciation; and b.) Any expenditure paid or incurred for the purpose of ascertaining the existence, location, extent, or quality of any deposit of ore or other mineral, including oil or gas.

L.

EMPLOYER'S CONTRIBUTION TO PENSION TRUST (1.) NATURE - applicable only to the employer on account of its contribution to a private pension plan for the benefit of its employee. Purely business in character. (2.) REQUISITES FOR DEDUCTIBILITY:


141

(3.) There is no need of special permit from the BIR to put up a pension plan for the benefit of employees. However, the provision of Section 118 of Rev. Reg. No. 2 must be complied with (BIR Ruling, 26 July 1956). (4.) TREATMENT OF INCOME FROM PENSION PLAN a.) Not taxable to the employee (BIR Ruling, 20 November 1956). b.) In case any portion of the funds is reverted back to the employer, said fund forms part of the income of the employer during the taxable year of reversion (BIR Ruling, 3 April 1959). (5.) DEDUCTIBLE PAYMENTS TO PENSION TRUSTS a.) Employer's current liability- amount contributed during the taxable year - ordinary and necessary expenses. b.) Employer's liability for past services - onetenth (1/10) of the reasonable amount paid b~ the employer to cover pension liability applicable to the preceding 1Oyears - payment to pension trust.

a.) Employer must have established a pension or retirement plan for the payment of reasonable pension to its employees;

OPTIONAL STANDARD DEDUCTION (OSD) as amended by R.A. No. 9504

b.) Pension plan is reasonable and actuarially sound (Section 118, Rev. Reg. No. 2);

a.) Individual Taxpayers Entitled: Resident Citizen (RC), Non-resident Citizen (NRC), Resident Alien (RA).

c.) Funded by the employer (employer contributes cash); d.) Amount contributed must no longer be subject to control of the employer;

b.) Individual Taxpayers Not Entitled: NonResident alien whether engaged in trade or business (NRA-ETB & NRA-NETB).

e.) Payment has not yet been allowed as deduction.

c.) Corporate Taxpayers Entitled: Domestic Corporation (DC) and Resident Foreign Corporation (RFC).

142


d.) Limitation: 40% of: d. 1) Gross income -

DC and RFC

d.2) Gross sales or receipts-RC, NRC, RA . e.) Option/Election. Taxpayer entitled must signify his intention in his income tax return which shall be irrevocable for the taxable year for which the return is made. (2009 Bar) SPECIAL DEDUCTIONS ALLOWED TO INSURANCE COMPANIES

(1.) Non-life insurance (domestic or foreign doing busi-


a.) Portion of the premium deposits returned to the policy holders; b.)

Portion of the premium deposits retained for payment of losses, expenses and reinsurance reserve.

(4.) Assessment insurance (domestic or foreign). a.) Amount actually deposited with officers of the government of the Philippines pursuant to law as addition to guarantee or reserve funds. ITEMS NOT DEDUCTIBLE

(1.) Items not deductible:

ness in the Philippine).

a.) Personal, living or family expenses.

a.) Net additions, if any, required by law to be made within the year to reserve funds;

Reason: Non-business expenses.

b.) Sums other than dividends paid within the year on policy and annuity contracts provided that the released reserve be treated as income for the year released. (2.) Mutual marine insurance companies (Gross income from gross premiums less reinsurance): a.) Amounts repaid to policy holders on account of premiums previously paid by them; b.) Interest paid upon those amounts between the date of ascertainment and the date of its payment (3.) Mutual insurance (other than mutual marine and mutual life) - mutual fire and mutual employer's liability and mutual workmen's compensation and mutual casualty insurance companies:

143

b.) Amounts paid out for new buildings or for permanent improvements, or betterment made to increase the value of any property or estate. Exception: Intangible drilling and development cost incurred in petroleum operations. Reason: Capital expenditure - that results in obtaining benefits of a permanent nature such as land, buildings, and machinery (Encyclopedia Dictionary of Business, p. 127). Examples of Capital Expenditures (Rev. Reg. No. 2):

i.

Cost of defending or perfecting title to property;

ii.

Architects fee ing;

part of the cost of build-

144


iii.

Commissions paid in selling securities part of the cost;

iv.

Expenses of the administrator of the estate -Attorney's fee and Executor's commission - charge to the corpus of the estate;

v.

Corporate expenses for reorganization such as incorporation fees, attorney's fee and accountant charge - amortize.

c.) Amount expended in restoring property or in making good the exhaustion thereof for which an allowance has been made.

Reason: Capital Expenditure d.) Premiums paid on a life insurance policy covering the life of any officer or employee, or of any person financially interested in any trade or business carried on by the taxpayer, individual or corporate, when the taxpayer is directly or indirectly a beneficiary under such policy. i.

Premiums paid by a family corporation on the life insurance policy covering the life of its president where the wife is the beneficiary - Not deductible, corporation being indirectly beneficiary under the policy (BIR Ruling, 10 November 1960).

ii.

Premiums paid by a corporation on life insurance policies covering the lives of two executives naming each other beneficiary - deductible because the corporation is not directly and indirectly the beneficiary of the policies (BIR Ruling, 27May1953).

e.) Losses from sales or exchanges of property between related taxpayers.


145

Reason/Purpose:

i.

Members of the same Family - to prevent avoidance of income tax by means of purported or simulated sale or exchange.

ii.

Others -the law presumes that the transactions are devoid of free bargain between the seller and the buyer. It is immaterial whether the sale or exchange is bona fide or not (Lake Irrigation Co., Inc. v. Com., 128F [2], 418).

CHAPTER 7 ESTATES AND TRUSTS

147

after tax, is no longer taxable on the part of its recipient (BIR Ruling No. 233-86, 7 November 1986).

Chapter 7

B. TRUST- right to the property, whether real or personal,

ESTATES AND TRUSTS

held by one person for the benefit of another (1.) Taxable trusts:

A.

ESTATE - refers to the mass of properties left by a deceased person.

a.) Trust, the income of which is to be accumulated;

(1.) Taxable estate entity- estate under administration or judicial settlement.

b.) Trust, in which the fiduciary may, at his discretion, either distribute or accumulate the income.

(2.) Hence, if not under judicial testamentary or intestate proceedings, it is not taxable entity. The income thereof is taxable directly to the heir or beneficiary. (3.) Subject to income tax in the same manner as individuals. Its own status is dependent on the status of the decedent immediately prior to his death. a.) Personal exemption i.

ii.

P20,000.00

If the taxpayer should die during the taxable year, his estate may still claim the personal and additional exemptions for himself. Distribution to the heirs during the taxable year is deductible from estate income which distributed share would then form part of the recipient heirs' respective income. Where no such distribution to the heirs is made during the taxable year that the income is earned, which is then subject to income tax payment by the estate, the subsequent distribution thereof 146

(2.) Rules on taxability: a.) Taxable to the beneficiary- income of the trust for the taxable year which is to be distributed to the beneficiaries; b.) Taxable to trustee or fiduciary- income of the trust which is to be accumulated or held for future distribution, whether consisting of ordinary income or gain from sale of assets included in the "corpus" of the estate (revocable trust). Exceptions: i.

Revocable trust trustee;

taxable to granter or

ii.

Income is held for the benefit of the granter - taxable to the granter.

"The income of the trust shall be included in computing the taxable income of the granter where the power to revest title to any part of the corpus of the trust is vested: (1.) In the granter, either alone or in conjunction with any person not having a substantial adverse inter-

148


est in the disposition of the corpus or the income therefrom; or

Chapter 8

(2.) In any person not having a substantial adverse interest in the disposition of the corpus or the income therefrom." C.

SPECIAL TOPICS IN INCOME TAXATION

COMPUTATION OF TAX ON ESTATE AND TRUST A.

( 1.) Allowable deductions same as individual. (2.) Special deductions. a.) Personal exemption -

DETERMINATION OF SOURCE ACCORDING TO KIND OF INCOME Kinds of Income

P20,000.00.

b.) Amount of income which is to be distributed currently to the beneficiaries. c.) Amount of income collected by a guardian of an infant which is to be held or distributed as the court may direct. However, the amount so allowed as deduction shall be included in computing the net income of the heir, legatee or beneficiary. Trust administered in foreign country-deductions in (a) (b) and (c) are not allowed.

Less: Consolidated deduction Consolidated net income Less: Personal exemption P20,000

1.) Service or compensa- Place of performance of tion income service 2.) Rent

Location of property (real or personal)

3.) Royalties (copyright, Place of use of intangibles patent, design trademark, etc.) 4.) Merchandising

Place of sale

5.) Gain on sale of per- Place of sale sonal property

6.) Gain on sale of real Location of property property

Formula: Consolidated gross income

Source (Tax Situs)

Pxxxx xxxx Pxxxx xx xx

Taxable income of several trusts Apply 5-32% (year 2000)

Pxxxx

Tax due

Pxxxx

7.) Mining income

Location of the mines

8.) Farming income

Place of farming activities

9.) Gain on sale of domes- Income within the Philiptic stock pines 10.) Interest

Residence of the debtor

149


150

Tax

situs of three possible sources of income

CHAPTERS SPECIAL TOPICS IN INCOME TAXATION

151

Income from labor (services)-the place where the labor is done;

interest paid even in Tokyo by NOC to the ship builders is considered as income from the Philippines (NOC v. Com., 151 SCRA 472).

Income from capital - the place where the capital is employed;

(11.) Gain on sale of transport document activity that produces income

Income from the sale of capital assets - the place where the sale is made. [8 Mertens, Law of Federal Income Taxation, Section 45.27 (1957)] Settled Case on the Tax (1989 Bar)

Situs of Interest Income

FACTS: National Development Corporation (NOC) entered into contracts in Tokyo with Japanese building companies for the construction of 12 ocean-going vessels. Initial payments were in cash and irrevocable letters of credit. The balance was secured by promissory notes guaranteed by the Republic of the Philippines. The vessels were completed and delivered to the NOC in Tokyo. The promissory notes and interest therein were paid by NOC. ISSUE: Is interest on the promissory notes to be treated income from the Philippines considering that all the elements of the main transaction, i.e., construction and delivery of vessels, were all performed in Japan? HELD: The interest is considered income from the Philippines. According to Section 36 [now Section 42A(1 )] of the NIRC as amended, xxx interest on bonds or other interest bearing obligations of residents, corporate or otherwise, is considered income from the Philippines. The law does not speak of the activity which gave rise to the obligation, but solely of the residence of the obligor. NOC is undoubtedly resident of the Philippines. Hence,

Place of

The source of an income is the property, activity or service that produced the income. For the income to be considered as coming from the Philippines, it is sufficient that the income is derived from activity within the Philippines. In Commissioner v. BOAC, 149 SCRA395, the sale of tickets in the Philippines is the activity that produced the income. The tickets exchanged hands here and payments for fares were also made here in the Philippine currency. The flow of wealth proceeded from and, occurred within Philippine territory, enjoying the protection accorded by the Philippine government. In consideration of such protection, the flow of wealth should share the burden of supporting the government. The absence of flight operations to and from the Philippines is not determinative of the source of income or the situs of income taxation. Admittedly, BOAC was an off-line international airline at the time pertinent to this case. The test of taxability is the "source" and the source of an income is that activity (sale of airline tickets) which produced the income. Unfortunately, the passage documents were sold in the Philippines and the revenue therefrom was derived from a business activity regularly pursued within the Philippines xxx. The word "source" conveys one essential idea, that of origin, and the origin of the income herein is the Philippines (Ibid.). However, Rev. Reg. No. 15-2002, implementing Section 28A(3), provides that in computing for


152

CHAPTER 8 SPECIAL TOPICS IN INCOME TAXATION

"Gross Philippine Billings," there shall be included the total amount of gross revenue derived from passage of persons, excess baggage, cargo and/or 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 passage documents. (2005 Bar)

c.) Foreign corporation If for the 3-year period preceding the declaration of such dividend, the ratio of such corporation's Philippine income to the world (total) income was:

(12.) Manufacturing a.) Produced in whole within and sold within Income purely within b.) Produced in whole without and sold without - Income purely without c.) Produced within and sold without - Income partly within and Income partly without d.) Produced without and sold within - Income partly within and Income partly without From the income partly within and partly without, income purely within is derived as follows: Net Income 2

x Value of property within

2

b)

50% to 85% -

c)

More than 85% -

Entirely without

Proportionate Entirely within (Phil.)

FORMULA (PROPORTIONATE - 50% TO 85%) Phil. Gross Income x Dividend received Income Entire Gross Income within (Phil.)

=

B.

CAPITAL TRANSACTIONS (2003, 1998 Bar) (1.) Definition of capital asset. The NIRC (Section 39) defines capital assets by exclusion. There is no concrete definition. The term "capital asset" means property held by the taxpayer (whether or not connected with his trade or business), but does not include the following (these are ordinary assets). a.) Stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory if on hand at the close of the taxable year (raw materials, work in process, finished goods, supplies);

=

Pxxxx

b.) Property held by the taxpayer primarily for sale to customers in the ordinary course of trade or business.

Gross sales within and without

Requisites:

Income purely within = (13.) Dividend income from: a.) Domestic corporation -

Less than 50% -

Pxxxx

Value of property within and without

x Gross sales within

a)

=

Add: Net Income

153

Income within (Phil.)

i.

Property must be held primarily for sale.

ii.

Property must be held for sale to customers.

154


•

iii.

A sale by dealer in securities is an ordinary transaction (BIR Ruling, 27 February 1954).

Property must be sold in the ordinary course of taxpayer's trade or business. •

•

c.)

Trade of business - that which occupies the time, attention, and labor of men for the purpose of livelihood or profit (Flint v. Storne Tracy Company, 220 U.S. 107, 31 S. Ct. 342, 55 L. Ed. 389; Kackler v. Commissioner, 133F [2d] 509). "Ordinary course" indicates significance of the transaction and, therefore, excluded are those sales which are effected by the taxpayer merely incidentally or accidentally to his business. Hence, isolated transactions would not be in the ordinary course of trade of business (Alfonso Zobel vs. Com., CTACase No. 622, 29April 1961)

Property used in trade or business of a character which is subject to the allowance for depreciation. i.

Depreciable personal properties such as furnitures, equipment, and machineries used in trade or business.

d.) Real properly used in trade or business of the taxpayer. i.


Properties used or connected with trade or business which are considered capital assets:

•

Account receivable;

•

Securities held as investments;

•

Goodwill.

155

Reason: Not included in the four categories of ordinary assets. ii.

Sale of a business to a corporation - Ordinary and capital assets. Consider the assets involved in the sale.

iii.

Sale of partner's interest in a partnership - capital asset. Reason:Not included in the category of ordinary assets

iv.

Car used in trade or business and for personal purpose •

One half of the value - ordinary asset - used in business.

•

One half of the value - capital asset - not used in business.

(2) The statutory definition of capital assets is negative in nature. If the asset is not among the exceptions, it is a capital asset; conversely, assets falling within the exceptions are ordinary assets. And necessarily, any gain resulting from the sale or exchange of an asset is a capital gain or an ordinary gain depending on the kind of asset involved in the transaction. However, there is no rigid rule or fixed formula by which it can be determined with finality whether property sold by a taxpayer was held primarily for sale to customers in the ordinary course of his trade or business or whether it was sold as a capital as-

156


set. Although several factors or indices have been recognized as helpful guides in making a determination none of these is decisive; neither is the pres' . ence nor the absence of these factors conclusive. Each case must in the last analysis rest upon its own peculiar facts and circumstances. [Calasanz v. CIR, 144 SCRA 664, 669-670 (1986)] Also a property initially classified as a capital asset may thereafter be treated as an ordinary asset if a combination of the factors indubitably tend to show that the activity was in furtherance of or in the course of the taxpayer's trade or business. Thus, a sale of inherited real property usually gives capital gain or loss even though the property has to be subdivided or improved or both to make it salable. However, if the inherited property is substantially improved or very actively sold or both it may be treated as held primarily for sale to customers in the ordinary course of the heir's business. [34 Am Jur 2d., p. 92]

CHAPTERS SPECIAL TOPICS IN INCOME TAXATION

d.) If conducted through a supervision over the agent; e.) Extent and nature of the taxpayer's efforts to sell (Smith v. Dunn, 224 F. [2d] 353, 47 A.F.T.R 1419; Tuazon v. Lingad, 58 SCRA 170; Blake v. Ravanagh, 107 R. 179). (5.) Guidelines in determining whether a particular real property is a capital asset or ordinary asset (Rev. Reg. No. 7-2003). a.) Taxpayers engaged in the real estate business. - Real property shall be classified with respect to taxpayers engaged in the real estate business as follows:

i.

Real Estate Dealer. -All real properties acquired by the real estate dealer shall be considered as ordinary assets.

ii.

Real Estate Developer. -All real properties acquired by the real estate developer, whether developed or undeveloped as of the time of acquisition, and all real properties which are held by the real estate developer primarily for sale or for lease to customers in the ordinary course of his trade or business or which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year and all real properties used in the trade or business, whether in the form of land, building, or other improvements, shall be considered as ordinary assets.

iii.

Real Estate Lessor. -All real properties of the real estate lessor, whether land and/ or improvements, which are for lease/rent

(3.) Construction and interpretation of capital assets - The general rule has been laid down that the coda! definition of a capital asset must be narrowly construed while the exclusions from such definitions must be interpreted broadly (Tuazon v. Lingad, 58 SCRA 176). (4.) Factors/tests determinative of capital or ordinary asset: a.) Nature and character of the taxpayer's title to the property; b.) Reason, purpose and interest of requisition, as well as its period of duration; c.) Taxpayer's vocation, extent of activities;

157


158

iv.

159

or being offered for lease/rent, or otherwise for use or being used in the trade or business shall likewise be considered as ordinary assets.

nally registered to be engaged in the real estate business, all real properties originally acquired by it shall continue to be treated as ordinary assets.

Taxpayers habitually engaged in the real estate business. -All real properties acquired in the course of trade or bu~i ness by a taxpayer habitually engaged 1n the sale of real estate shall be considered as ordinary assets.

e.) Treatment of abandoned and idle real properties. - Real properties formerly forming part of the stock in trade of a taxpayer engaged in the real estate business, or formerly being used in the trade or business of a taxpayer engaged or not engaged in the real estate business, which were later on abandoned and became idle, shall continue to be treated as ordinary assets.

b.) Taxpayer not engaged in the real estatet business. - In the case of a taxpayer no engaged in the real estate .business, real properties, whether land, bu1ld1ng, .or other improvements, which are used.or being used or have been previously used 1n the trade or business of the taxpayer shall be considered as ordinary assets. c.)


Taxpayer changing business from re_af estate business to non-real estate business. - In the case of a taxpayer who changed its real estate business to a non-real estate business, or who amended its Articles of Incorporation from a real estate business to a non-real estate business, such as a holding company, manufacturing company, trading company, etc., the change of business or amendment of the primary purpose of the business shall not result in the re-classification of real property held by it from ordinary asset to capital asset.

d.) Taxpayers originally regist~red to bf.e _e ndgaged in the real estate business but at1e to subsequently operate. - In the case. ~f subsequent non-operation by taxpayers ong1-

f.)

Treatment of real property subject of involuntary transfer. - In the case of involuntary transfers of properties, including expropriation or foreclosure sale, the involuntariness of such sale shall have no effect on the classification of such real property in the hands of the involuntary seller, either as capital asset or ordinary asset, as the case may be. Rules on capital gains and losses. Two conditions must concur: a) There must be a sale or exchange, and b) what is sold or exchange is a capital asset.

(6.) Special Rules on Capital Transactions INDIVIDUAL

CORPORATE

a.) HOLDING PERIOD RULE

I

x

b.) LOSS LIMITATION RULE

I

except trust company and bank



160

c.) NET CAPITAL LOSS CARRYOVER

I

x

Percentage of gain or loss recognized 100% if the asset was held for not more than 12 months 50% if the asset was held for more than 12 months Holding period - the length of time the asset was held by the taxpayer. It covers the period from the date of acquisition of the assets to the date of sale. In computing the period, the day on which the property was acquired is excluded, the day on which it was disposed of is included (1955 PH Fed. Tax Course, Par. 1604). **

Loss limitation rule - capital losses are allowed only to the extent of capital gains. Therefore, capital losses are not deductible from ordinary gains. Reason: To ensure the matching of costs against revenues consistent with the rule that only business expenses are deductible from gross income. Capital loss is not a business expense (2003 Bar).

*** Net capital loss (carry over)-shall be treated in the succeeding taxable year as loss from the sale or exchange of capital asset held for not more than 12 months. Limitation - not in excess of the taxable (net) income in the preceding year or the lower amount between the net income and the capital loss. •

The foregoing rules are not applicable to sale of shares of stock & real property.

(7.) Special capital transactions a.) Short sale. A transaction in which a speculator sells securities which he does not own in anticipation of a decline in its price. It represents a debt contracted in goods rather than cash. Should the price of the securities decline, the seller makes profit. If the price goes up, he incurs the loss b.) Securities becoming worthless. Requisites: i.

Ascertained to be worthless and charged off within the taxable year;

ii.

Worthlessness occurred during the taxable year;

iii.

Deductible on the last day of the taxable year.

Settled rules: a.) Ordinary loss is deductible from ordinary gain; b.) Capital loss is deductible from capital gain; c.) Capital loss is not deductible from ordinary gain; d.) Ordinary loss is deductible from capital gain. Net capital gain capital loss. Net capital loss gain.

excess of capital gain over

excess of capital loss over capital

161

•

If the loss is due to fluctuation of price in market, the loss is not deductible until finally disposed of.

c.) Failure to exercise privileges or option to buy or sell property. A sale of the option itself under allowable covenants would constitute


162


sale or exchange of a capital assets. In fine, the law considers an option or privilege as the capital asset itself and the failure to exercise the same as transaction. If the option is not exercised, it is deemed to have been sold or exchanged as of the day the option expires. d.) Retirement of bonds. Amounts received by the holder upon retirement of bonds, debentures, notes or certificates or other evidence of indebtedness issued by any corporation (including those issued by a government or political subdivision thereof) with interest coupons or in registered form, shall be considered as amounts received in exchange therefrom. e.) Readjustment of interest in a tax-exempt partnership (Section 142, Rev. Reg. No. 2). Where a partner retires from a tax-exempt partnership, or the partnership is dissolved, the partner realizes gain or suffers a loss determined as follows: Price received for his interest in the partnership

p xxx

Less: Cost of interest partnership

p xxx

Add: Share in any undistributed partnership net income since becoming partner xxx Capital gain or loss f.)

xxx p xxx

Receipt of liquidating dividend. If the stock was held as a capital asset, gain or loss is determined as follows:

Amount received from corp. Less: Cost of shares surrendered Capital gain or loss

163

p xxx xxx p xxx

g.) An equity investment is a capital, not ordinary, asset of the investor the sale or exchange of which results in either a capital gain or a capital loss (China Banking Corporation v. CA, 236 SCRA 178, 181). (8.) Expenses of acquisition and disposition of capital assets a.) Expenses of acquisition (purchase) should be capitalized together with the cost of acquisition; b.) Expenses of disposition (sale) such as commission and other selling expenses should be considered as reduction from the selling price. (9.) Exemption of capital gain from income tax -tax avoidance (both for individual and corporation) a.) Under the Investment Incentives Act, the capital gain realized from the sale of capital asset shall be exempt from income tax under the following conditions: i.

Investment in new issues of capital stock of BO! registered enterprise within six months from the date the gains were realized;

ii.

Sale and investment of the proceeds should be registered with the BOI and BIR.

iii.

Investment must not be disposed of: • 3 years - pioneer industry;

•

5 years -

non-pioneer industry.

CHAPTER 9 INCOME TAX RULES ON DEALINGS IN PROPERTY

•

Chapter 9 INCOME TAX RULES ON DEALINGS IN PROPERTY

A.

CAPITAL GAINS FROM SALE OR OTHER DISPOSITION OF REAL PROPERTY TRANSACTION COVERED Sale, exchange or other disposition of real property located in the Philippines classified as capital assets, including pacto de retro sales and other forms of conditional sales.

6%

b.) Basis: Gross Selling Price or zonal value (current fair market value), whichever is higher.

ii.

BIR should be notified of the intention to avail of the exemption within thirty (30) days from the date of sale or disposition;

iii.

Acquisition or construction of new principal residence must be made within eighteen (18) months from the date of sale or disposition;

iv.

The tax exemption can only be availed of once every ten (10) years;

v.

The buyer/transferee must withhold from the seller and deduct from the selling price the 6% capital gains tax which must be deposited in cash or manager's check with an Authorized Agent Bank (AAB) under an ESCROW Agreement between the Revenue District Officer, the seller, transferee and theAAB.

c.) Taxpayer covered: Citizen or resident alien. d.) Option: Apply the tax rates under Section 24(A) - 5% to 32% if the buyer is the government or any of its political subdivisions or agencies or government-owned or -controlled corporations. e.) Payment: Thirty (30) days after the sale. f.)

Tax avoidance scheme:

i.

The proceeds of the sale must be fully utilized in acquiring or constructing a new principal residence; 164

Principal residence shall refer to the dwelling house, including the land on which it is situated, where the husband and wife or an unmarried individual whether or not qualified as head of family: and members of his family reside. Actual occupancy of such principal residence shall not be considered interrupted or abandoned by reason of the individual's temporary absence therefrom due to travel or studies or work abroad or such other similar circumstances. Such principal residence must be characterized by permanency in that it must be the dwelling house to which, whenever absent, the said individual intends to return (Rev. Reg. No.

13-99).

(1.) INDIVIDUAL TAXPAYERS (Section 24[0]) a.) Final tax rate:

165



166

Answer:

Definition of ESCROW Agreement - refers to a scroll, writing or deed, delivered by the grantor, promisor or obligor into the hands of a third person, to be held by the latter until the happening of a contingency or performance of a condition, and then by him delivered to the grantee, promisee or obligee (Rev. Reg. No. 17-2003). vi.

After depositing the 6% capital gains tax, the buyer/ transferee and the seller shall jointly file, within 30 days from the date of the sale or disposition of the principal residence, the Final Capital Gains Tax Return (Ibid).

•

B.

•

Under the legal definition of gross income, what is included in gross income derived from dealings in property?

xxx

Gain (loss)

p xxx

(2.) The property received has a market value (Section 140, Rev. Reg. No. 2). C.

Include all gains or losses derived from the disposition of property (real, personal or mixed) for MONEY in case of SALE, or for PROPERTY in case of EXCHANGE, or from a combination of both sale and exchange.

Less: Cost

(1.) The property received in exchange is essentially different from the property disposed of;

Payment: thirty (30) days following the sale or disposition.

CONCEPT

p xxx

Two conditions:

b.) Real property: lands and/or buildings which are not actually used in the business.

A.

MEASURE OF INCOME OR LOSS Selling Price

a.) Only domestic corporation is subject to 6% of the gross selling price or zonal value (fair market value) whichever is higher (Section 27[D] [5]),

GAINS AND LOSSES FROM DEALINGS IN PROPERTY

It includes all income derived from the disposition of property whether real or personal, or mixed, for money (sale) or for other property (exchange) or for a combination of both, which results in gain (loss) because of the difference between the taxpayer's investment in what the disposed of and the value in what he received (1955 PH Fed. Handbook, par.

1401 ),

(2.) CORPORATE TAXPAYERS

c.)

167

ADJUSTED BASIS OR COST OF THE PROPERTY SOLD. It depends primarily on the manner in which the taxpayer acquired the property. (1.) By purchase: a.) acquired beifore 1 March 1913- FMV on such date; ·· b.) acquired on or after 1 March 1913 - Cost plus exp~nses of acquisition (Section 136, Rev. Reg: No. 2). (2.) Included in the inventory - its latest inventory value (Section 36, Rev. Reg. No. 2).

168


(3.) By devise, bequest or inheritance - FMV or value of such property at the time of the acquisition death of the decedent (Section 139, Rev. Reg. No. 2). (4.) By gift - the same basis as if it would be in the hands of the donor or the last preceding owner by whom it was acquired by gift, except that if such basis is greater than the fair market value of the property at the time of the gift, then for the purpose of determining the loss, the basis shall be such fair market value. (5.) Acquired (other than capital assets) for less than an adequate consideration in money or money's worth - amount paid by the transferee. (6.) Stock or security property received ifthe exchange is one where gain or loss may be recognized The same as the basis of the stock, or security or property given in exchange. (7.) Stock or security received if the exchange is one where the gain, if any, but not the loss is to be recognized Basis of the property, stock or security given in exchangeLess: Add:

Cash and FMV of property given in exchange Dividend and/or gain recognized

Basis of stock or security received (8.) Property transferred in the hands of the transferee if exchange is one where the gain, if any, but not the loss is to be recognized.


169

The same basis as it would be in the hands of transferor increased by the amount of the gain recognized to the transferor on the transfer. D.

SETTLED RULES ON SALE OR EXCHANGE (1.) Distribution in complete liquidation has been held to be an "exchange" for the purpose of determining whether or not gain or loss has been realized or sustained within the provisions pertinent (Helvering v. Chester N. Weaver Co., 305 U.S. 293). (2.) Conveyance of property in consideration of the transferee's assumption of accrued taxes for which the transferor was personally liable, as a compromise of the tax liability on other realty, has been construed to be a sale or exchange within the meaning of the law (Philipps v. Com., 112 F (2d] 721; C.L. Gransder & Co. v. Com., 117 [2d] 80). (3.) The words "sales or exchanges" have been interpreted quite liberally. Thus, forced sales such as foreclosure sales and tax sale, have been held to be embraced within the meaning of the law (Helve ring v. Hommel, 311 U.S. 504). (4.) A sale or exchange will ordinarily be held to occur on the date the transfer of title over the asset is effected or when ownership is terminated in the hands of the transferor. In other words, it is the consummation thereof not the perfection of the contract that is generally taken into account (American Fork & Hoe Co., T.C. Memo Op. Dkt. 108334, 22 September 1943; U.S. Industrial Alcohol Co. v. Helvering, 137 F.[2d]511). (5.) In condemnation proceedings, the sale occurs at the time of taking of the property rather than when the

170


t.;HAt-'I t:K 8

111

INCOME TAX RULES ON DEALINGS IN PROPERTY

proceeds of the judgment are received (Kiesel back v. Com., 317 U.S. 399, 87 L. Ed. 358, 63 S. Ct. 303). It is essential that the right of condemnation be legally recognized.

E.

TAX-EXEMPT SALES OR EXCHANGES "NO GAIN, NO LOSS RECOGNIZED" (Section 40{C)[2]) - Exceptions to the rule that the entire amount of gain or loss shall be recognized: (1.) Between corporation which are parties to the merger or consolidation (PROPERTY FOR STOCK). A corporation which is a party to a merger or consolidation exchanges property solely for stock in a corporation which is a party to the merger or consolidation. (2.) Between a stockholder of a corporation party to a merger or consolidation and the other party corporation (STOCK FOR STOCK). A shareholder exchanges stock in a corporation which is a party to the merger or consolidation, solely for the stock of another corporation also a party to the merger or consolidation. (3.) Between a security holder of a corporation party to the merger or consolidation and the other corporation (SECURITIES FOR SECURITIES OR STOCK). A security holder of a corporation which is a party to the merger or consolidation exchanges his securities in such corporation solely for stock or securities in another corporation, a party to the merger or consolidation. •

The term merger or consolidation shall be understood to mean: i.) The ordinary merger or consolidation, or ii.) the

acquisition by one corporation of all or substantially all the properties of another corporation solely for stock. (4.) Transfer or exchange of property for stock resulting in acquisition of corporate control (PROPERTY FOR STOCK). No gain or loss shall be recognized if property is transferred to a corporation by a person in exchange for stock in such corporation of which as a result of such exchange said person, alone or together with other, not exceeding four persons, gains control of said corporation. Stocks issued for services shall not be considered as issued in return of property. However, the BIR ruled that the law would apply even when the exchanger or exchangers already had control of the corporation at the time of the exchange (BIR Rulings Nos. 04987, 27 February 1987; 06087, 9 March 19987; 09887, 6 April 1987).

•

The term control shall mean ownership of stocks in a corporation possessing at least fifty-one percent (51 %) of the total voting power of all classes of stocks entitled to vote. In the foregoing cases, if the taxpayer receives stocks (or securities) and, as a part of the consideration, another party to the exchange assumes a liability of the taxpayer, or acquires from the taxpayer property subject to a liability, then such assumption or acquisition shall not be treated as money/or property, and it shall not prevent the exchange from being exempt.

172

F.


"GAIN RECOGNIZED, LOSS NOT RECOGNIZED RULE" APPLIES TO THE FOLLOWING TRANSACTIONS:

Chapter 10

( 1.) Transactions not solely in kind (Exchanges of property, stocks or securities plus cash or money);

TAXPAYERS REQUIRED TO FILE INCOME TAX RETURNS

(2.) Illegal transactions (2001 Bar); (3.) Transaction between related taxpayers: a.) Members of a family;

A.

INDIVIDUALS

b.) Corporation and individual - Individual owned more than fifty percent (50%) of the outstanding capital stock of the corporation;

(1.) Resident citizens receiving income from sources within or outside the Philippines:

c.) Two (2) corporations - more than fifty percent (50%) of the outstanding capital stock is owned by the same individual;

a.) Individuals deriving compensation income from 2 or more employers, concurrently or successively at anytime during the taxable year;

d.) Parties to a trust-truster, trustee, beneficiary and fiduciary.

b.) Employees deriving compensation income regardless of the amount, whether from a single or several employers during the calendar year, the income tax of which has not been withheld correctly (i.e., tax due is not equal to the tax withheld) resulting to collectible or refundable return;

(4.) Wash sale transaction (61-day sale). •

Purchase of substantially identical stock or securities beginning thirty (30) days before the date of sale and ending thirty (30) days thereafter.

•

Seller must not be a dealer in securities or stock.

•

It covers acquisition through a taxable exchange and the making of an option contract.

c.) Employees whose monthly gross compensation income does not exceed P5,000 or the statutory minimum wage, whichever is higher, and opted for non-withholding of tax on said income; d.) Individuals deriving other non-business nonprofessional related income in additi,on to compensation income not otherwise subject to a final tax; 173

Income Taxation Dimaampao

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