Income-Taxation Mamalateo OCR

CHAPTER I OVERVIEW OF

INCOME TAXATION

Income Tax Income tax has been denned as a tax on all yearly profits arising from property, professions, trades or offices, or as a tax on a person's income, emoluments, profits and the like (Fisher vs. Trinidad, 43 Phil. 981). Income tax is a direct tax on actual or presumed income (gross or net) of taxpayers during the taxable year. A final income tax may also be imposed on certain one-time transactions like the sale of real property classified as capital asset. 1

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Income Tax Law The Philippine income tax law is embodied in Title II (Tax on Income) of the National Internal Revenue Code ("Tax Code"), consisting of sixteen (16) chapters and sixty-two (62) sections as well as in numerous: (a) revenue regulations promulgated by the Secretary of Finance upon the recommendation of the Commissioner of Internal 3

'The general rule is that income tax applies only when the income, profit or gain is realized or received (Sec. 39[B], NIRC), except when real property classified as a capital asset is sold by a taxpayer, in which case, the law presumes that there is a capital gain realized from the sale, and the basis for computing the 6% capital gains tax is the gross selling price or fair market value as determined by the Commissioner, whichever is higher (Sec. 24[D][1], NIRC). Also, when listed shares of stocks of a domestic corporation are traded in a local stock exchange, the law imposes the 1/2 of 1% stock transaction tax, which is based on the gross selling price without deducting cost. The real property classified as capital asset must not be a "principal residence" of an individual taxpayer, because it is exempt from income tax upon satisfaction of certain conditions. Revenue regulations are formal interpretations of Tax Code provisions promulgated by the Secretary of Finance, upon the recommendation of the Commissioner of Internal Revenue pursuant to Sec. 244 of the Tax Code. As the regulations are promulgated by the Secretary of Finance, there is permanence and stability in tax laws. Regulations cannot just be changed or amended by rulings or other administrative issuances signed by the Commissioner. To revoke, modify or amend existing regulations, another regulation is required. 2

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PHILIPPINE INCOME T A X

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Revenue, and (b) BIR rulings and other administrative issuances signed by the Commissioner of Internal Revenue to implement and interpret various provisions of the tax law. The latest major amendments to the income tax law were introduced by: (a) Republic Act No. 8424, which became effective on January 1,1998; (b) Republic Act No. 9337, November 1, 2005; and (c) Republic Act No. 9504, July 6, 2008. There are, however, other sources of tax laws such as the Constitution, tax treaties, and general and special laws as well as decisions of the Supreme Court and the Court of Tax Appeals. 5

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The Tax Code is a special law which prevails over the New Civil Code, which is a general law (Guagua Electric Company vs. Collector, 19 SCRA 796; Republic vs. Gancayco, 115 SCRA 380). The Tax Code is classified as civil in nature and not a political law; hence, it is enforced even during the enemy occupation (Hilado vs. Collector, 100 Phil. 288). Although penalties are provided for violations of the Tax Code, it is not a penal law (Lorenzo vs. Posadas, 64 Phil. 353). The present law authorizes the collection of national internal revenue laws through the summary remedies of distraint and levy as well as the filing of civil and criminal actions against taxpayers. Regulations promulgated in accordance with law have the force and effect of law. It cannot be contended that an administrative regulation should not be given the same weight as a rule of court but should rather be given a more liberal interpretation, for a regulation adopted pursuant to law has the force and effect of law. Administrative regulations should be given the same force as rules of court in order to maintain the regularity of administrative proceedings (Valerio vs. Secretary of Agriculture and Natural Resources, L-18587, Apr. 23, 1963). A rule or regulation must bear upon, and be consistent with, the provisions of the enabling statute to be valid. In case of conflict between a statute and an administrative order, the former must 8

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BIR rulings are less formal interpretations of the Tax Code provisions issued by the Commissioner of Internal Revenue pursuant to Sec. 4 of the Tax Code. They could be in the form of BIR rulings, V A T ruling, IT AD rulings, DA rulings, or Revenue Memorandum Circulars. R.A. No. 8424 was published in the December 26, 1997 issue of T h e Manila Bulletin" (BIR Ruling No. 050-2000, Oct. 30, 2000). Court decisions form part of the laws of the land (Art. 8, New Civil Code of the Philippines). Court decisions take precedence over those issued by administrative bodies such as the BIR (BIR Ruling No. 059-01, Dec. 20, 2001). R.A. No. 1125, as amended by R.A. No. 9282, created The Court of Tax Appeals, which is a special collegiate court that has appellate and original jurisdiction over final decisions of the Commissioner of Internal Revenue. "Mindanao Bus Co. vs. Collector, L-14078, Feb. 24. 1961, 1 SCRA 538. 5

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OVERVIEW OF INCOME T A X A T I O N

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prevail. A contrary conclusion would mean the Commissioner could very well moot the law or arrogate legislative authority unto himself (Fort Bonifacio Development Corporation vs. Commissioner, G.R. No. 158885, Apr. 2, 2009). Regulations implementing doubtful statutory provisions have strong persuasive force, but they are not conclusive upon the courts (Hilado vs. Collector, 100 Phil. 288). But regulations in conflict of law are null and void (Greenfield vs. Meer, 77 Phil. 394; Wise & Co. vs. Meer, 78 Phil. 655).

Income Tax Systems There are three (3) basic types of income tax systems adopted in the Philippines at varying periods. These are as follows: 1. Global Tax System. — Under the global tax system (prevailing until 1981), the total allowable deductions as well as personal and additional exemptions, in case of individuals, or the total allowable deductions, in case of corporations, are deducted from the gross income (i.e., sum of all items of taxable income, profit and gain) to arrive at the net taxable income subject to the graduated income tax rates ranging from 3% to 70%, in case of individuals, or to the twotiered income tax rates of 25% and 35%, in the case of corporations. It did not matter whether the income received by the taxpayer was classified as compensation income, business or professional income, passive investment income (e.g., interest, royalty, or dividend), capital gain, or other income. All items of gross income, deductions, and personal and additional exemptions, if any, were declared in one income tax return, and one set of tax rates were applied on the net taxable income. 9

The formula for computing income tax under the global tax system shall be as follows: Gross sales Less: Sales discounts Sales returns and allowances Net sales Less: Cost of goods sold or services 9

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Congress believes that the global tax system will ensure that the burden of taxation is distributed in accordance with the taxpayers ability to pay, and is in keeping with the Constitutional mandate that "Congress shall evolve a progressive system of taxation." The system is more equitable and makes the job of the BIR in monitoring the reported income of taxpayers and their tax payments easier. The global tax system was enforced until December 31, 1981, with maximum rate of 70% applied on net income of individuals.


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Gross income Less: Deductions Personal and additional exemptions (for individual) Net taxable income Income tax due Less: Creditable withholding tax Quarterly income tax paid Tax still due and demandable

xxx xxx xxx

xxx xxx xxx

xxx xxx

xxx xxx

2. Schedular Tax System. — Under the schedular tax system, adopted by the Philippines by virtue of Batas Pambansa Big. 135, there are different types of incomes that are subject to different sets of graduated or flat income tax rates. The applicable tax rate(s) will depend on the classification of the taxable income and the basis could be gross income (without deductions) or net income (i.e., gross income less allowable deductions). Separate income tax return or capital gains tax return, whichever is applicable, is filed by the recipient of income for the particular types of income received, but no income tax return is filed by the recipient of passive income subject to final withholding tax because the withholding agent is primarily responsible for the filing of the withholding tax return and the payment of final tax to the BIR on such income. 10

In Sison vs. Ancheta (G.R. No. 59431, July 25, 1984), Sison assailed the constitutionality of Batas Pambansa Big. 135, claiming that by the imposition of higher tax rates (5% to 60%) upon his income derived from the exercise of his profession, he would be unduly discriminated against compared to those imposed upon compensation income earners (0% to 35%). The Supreme Court ruled in favor of the constitutionality of said law. The court said that there is no legal objection to a broader tax base or taxable income by eliminating some deductible items from business or 10

On January 1, 1982, Batas Pambansa Big. 135 adopted the schedular tax system and introduced for the first time the gross income taxation on compensation income of individuals, wherein the adjusted gross compensation income, after deducting personal and additional exemptions, is subject to the graduated tax rates ranging from 0% to 35%. Business, professional, and other incomes, net of allowable deductions, are subject to the graduated tax rates ranging from 5% to 60%. Capital gains from sale of shares of stock of domestic corporations and real property as well as passive investment incomes are subject to final withholding taxes at preferential rates. The schedular tax system was enforced from January 1, 1982 to December 31, 1985.


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professional income and at the same time reducing the applicable tax rate on compensation income. Taxpayers may be classified into different categories. It is enough that the classification must rest upon substantial distinctions that make real differences. Taxpayers who receive compensation income are set apart as a class. As there is practically no overhead expense on earning salaries, these taxpayers are not entitled to make deductions because they are in the same situation, more or less. In the case of professionals and businessmen, however, there is no uniformity in the costs and expenses necessary to produce their income. It would not be just then to disregard the disparities (between individuals deriving compensation income and business/professional income) by giving all of them zero deduction and indiscriminately impose on all alike the same tax rates on the basis of gross income. Under the schedular tax system, there are several ways of imposing final income tax on certain incomes subject to final withholding tax. Thus: a.

Tax base is consideration or fair market value at the time of sale, whichever is higher.

Example: Sale of real property classified as capital asset P900,000 Fair market value of real property 800,000 Income tax due: P900,000 x 6% P540,000 b.

Tax base is net capital gain (i.e.. gross selling price or fair market value, whichever is higher, less cost or adjusted basis).

Example: Sale of unlisted shares of stocks of ABC Corp. Fair market value of shares of stocks Cost

P10,000 11,000 5,000

Income tax due: Fair market value Less: Cost

P11,000 5,000

Gain Multiplied by: Capital gains tax

P6,000 x5% P300


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c.

Tax base is gross income (without any deduction) Example: Gross interest income on bank peso deposit Multiplied by: Final withholding tax Gross dividend income from domestic corporation received by resident citizen Multiplied by: Final withholding tax

PI,000 x20% P200 P50,000 x 10% P5.000

3. Semi-Schedular or Semi-Global Tax System. — Under the semi-schedular or semi-global tax system, all compensation income, business or professional income, capital gain, passive income, and other income not subject to final tax are added together to arrive at the gross income, and after deducting the sum of allowable deductions from business or professional income, capital gain and passive income, and other income not subject to final tax, in the case of corporation, as well as personal and additional exemptions, in the case of individual taxpayer, the taxable income {i.e., gross income less allowable deductions and exemptions) is subjected to one set of graduated tax rates (if an individual) or normal corporate income tax rate (if a corporation). With respect to the above incomes not subject to final withholding tax, the computation of income tax is "global." However, passive investment incomes subject to final tax and capital gains from the sale or transfer of shares of stocks of a domestic corporation and real properties remain subject to different sets of tax rates and covered by different tax returns. On January 1,1986, the Philippines, through Executive Order No. 37, adopted the semi-schedular or semi-global tax system and reduced the range of graduated tax rates applied on the net taxable income of self-employed and professionals from 5% to 60% to 0% to 35%, but it increased the preferential tax rates on capital gains and passive investment incomes. On January 1, 1998, the Congress of the Philippines enacted Republic Act No. 8424, which introduced some structural and administrative reforms. Said law retains the semi-schedular or semiglobal features of the existing tax system with some refinements. The number of tax brackets was reduced from ten to six, tax rates were


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made in multiples of five, and the maximum rate of tax was reduced by 1% every year. Thus, the maximum rate of tax for 1998 was 34%; for 1999, 33%; for 2000 and subsequent years, 32%. R.A. No. 9337 increased the corporate income tax rate to 35% beginning November 1, 2005 but reduced the corporate income tax rate to 30% effective January 1, 2009.

Features of the Philippine Income Tax Law 1. Income tax is a direct tax because the tax burden is borne by the income recipient upon whom the tax is imposed. It is a tax demanded from the very person who, it is intended or desired, should pay it, while indirect tax is a tax demanded in the first instance from one person in the expectation and intention that he can shift the burden to someone else. 11

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2. Income tax is a progressive tax, since the tax base increases as the tax rate increases. It is founded on the ability to pay principle and is consistent with the Constitutional provision that "Congress shall evolve a progressive system of taxation." 13

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3. The Philippines has adopted the most comprehensive system of imposing income tax by adopting the citizenship principle, the residence principle, and the source principle. Any one of the three principles is enough to justify the imposition of income tax on the income of a resident citizen and domestic corporation that are taxed on worldwide income. Other types of taxpayers (whether individual or corporation) are taxed only on their income from sources within the Philippines beginning January 1, 1998. 4. The Philippines follows the semi-schedular or semiglobal system of income taxation, although certain passive investment incomes, capital gains on sale of shares of stock of domestic corporations and real property located in the Philippines, and other income are subject to final taxes at preferential tax rates.

" I t is not uncommon for the contracting parties, however, to stipulate in their contract that the final capital gains tax due on the transaction shall be borne by the buyer thereof. ^Commissioner vs. Tours Specialists, Inc. and CTA, G.R. No. 66416, Mar. 21, 1990. Those who receive more income and thus have more capacity to pay shall pay more in taxes. Former President Ramon Magsaysay, Jr. figuratively put it in this way: "Those who have less in life should have more in law." Sec. 28, Art. V I , 1987 Constitution of the Philippines. l3

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5. The Philippine income tax law is a law of American origin. Thus, the authoritative decisions of the U.S. courts and officials charged with enforcing the U.S. Internal Revenue Code have peculiar force and persuasive effect for the Philippines. Great weight should be given to the construction placed upon a revenue law, whose meaning is doubtful, by the department charged with its execution. In view thereof, this book still has cited applicable American jurisprudence. 15

Criteria in Imposing Philippine Income Tax The Philippines has adopted the most comprehensive income tax system for resident citizens and domestic corporations, such that any one of the following criteria is enough to levy income tax on their income, gain or profit. 1. Citizenship or nationality principle. - A citizen of the Philippines is subject to Philippine income tax (a) on his worldwide income, if he resides in the Philippines, or (b) only on his Philippinesource income, if he qualifies as a non-resident citizen; hence, his foreign-source income shall be exempt from Philippine income tax. 2. Residence or domicile principle. — An alien is subject to Philippine income tax because of his residence in the Philippines. This principle was copied from the U.S. tax law, but was discarded in R.A. No. 8424 in view of the complexity in tax administration. Thus, a resident alien is now liable to pay Philippine income tax only on his income from sources within the Philippines but is exempt from tax on his income from sources outside the Philippines. 3. Source of income principle. - An alien is subject to Philippine income tax because he derives income from sources within the Philippines. Thus, a non-resident alien or non-resident foreign corporation is liable to pay Philippine income tax on income from sources within the Philippines, such as dividend, interest, rent, or royalty, despite the fact that he has not set foot in the Philippines. The income tax law, in levying the tax, adopts the most comprehensive tax situs of nationality and residence of resident citizens and domestic corporations that subject them to income tax liability on their income from all sources within and without the Philippines, while the law adopts the source rule with respect to income received by taxpayers, other than resident citizens and domestic corporations (Tan vs. Del Rosario, 237 SCRA 324, 334). ,s

Madrigal vs. Rafferty, G.R. No. 12287, Aug. 8, 1918.


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Types of Philippine Income Tax There are several types of income tax under Title II of the Tax Code, namely: 1. Graduated income tax on individuals; 2. Normal corporate income tax on corporations; 3. Minimum corporate income tax on corporations; 4. Special income tax on certain corporations (e.g., private educational institutions; foreign currency deposit units; and international carriers); 5. Capital gains tax on sale or exchange of unlisted shares of stock of a domestic corporation classified as a capital asset; 6. Capital gains tax on sale or exchange of real property located in the Philippines classified as a capital asset; 7. Final withholding tax on certain passive investment incomes; 8. Final withholding tax on income payments made to nonresidents (individual or corporation); 9. Fringe benefit tax; 10. Branch profit remittance tax; and 11. Tax on improperly accumulated earnings. Accordingly, when a person sells real property classified as capital asset located in the Philippines and pays the 6% capital gains tax, he will no longer have to declare his gain from such sale and pay the ordinary income tax based on his net taxable income during the year. Only one type of income tax shall be paid on the transaction. 16

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The Bureau of Internal Revenue (BIR) considers the 3% tax paid to the national government, out of the 5% final tax imposed 16

BIR is the executive agency of the government that administers the 1997 Tax Code and other special laws with tax implications. Tax incentive laws are, however, administered by the PEZA and other GOCCs created pursuant to the incentive laws. In BIR Ruling No. 064-2000 (Nov. 27,2000), it was ruled that the BIR is not authorized to reverse or invalidate the action of a co-equal administrative body; hence, the action taken by the BOI in the grant of income tax holiday in favor of industrial estate enterprises is within its administrative powers. "There are those who believe that the 3% final tax paid under R.A. No. 7916 and R.A. No. 7227 is not creditable against the foreign income tax of the foreign parent company or head office, because the 5% final tax on gross income earned is "in lieu of all taxes, national and local."


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under R.A. No. 7916 on enterprises registered with the Philippine Export Zone Authority (PEZA), and under R.A. No. 7227 on enterprises registered with freeport zones like Subic Bay Metropolitan Authority (SBMA), Clark Development Authority (CDA), Camp John Hay Development Authority (CJHDA), and other freeport zones, as income tax that may be credited against the foreign income tax of their foreign parent companies or head offices. 19

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The Supreme Court also considered the 35% transaction tax on money market transactions under the former Section 210 (Title V-Other Percentage Taxes) of the 1977 Tax Code as an income tax on interest earnings of lenders or players (Western Minolco Corp. vs. Commissioner, et ah, 124 SCRA 212). The court held that the transaction tax, although nominally categorized as a business tax, is in reality a withholding (income) tax as positively stated in Letter of Instructions No. 340 (Marinduque Mining and Industrial Corp. vs. Commissioner, cited in Paper Industries Corporation of the Philippines vs. Commissioner, G.R. No. 106949, Dec. 1, 1995). To correct this aberration, Presidential Decree No. 1739 was issued to repeal Section 210 of the 1977 Tax Code, by imposing a 20% final tax on interests and yield from deposit substitutes such as commercial papers issued in the primary market as principal instruments. 21

Along the same vein, the BIR effectively considers the 1/2 of 1% stock transaction tax under Section 127(A), Title V (Other Percentage Taxes) of the Tax Code as another form of income tax that may be credited against the foreign income tax liability of a foreign corporation. 22

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Chapter VII on Export Processing Zone Authority (EPZA) under Executive Order (EO) No. 227 (BOI law) was removed and transferred under R.A. No. 7916, otherwise known as the Philippine Export Zone Authority Act. All areas used to be military bases of the United States were transferred for administration by the Bases Conversion Development Authority created under R.A. No. 7227. Sec. 5(b), Rev. Regs. 16-99, Sept. 27, 1999 applies to SBMA-registered companies; Rev. Regs. 1-2000, Nov. 12, 1999 applies to PEZA-registered companies. During the years that the Philippines were under martial law, then President of the Philippines exercised executive and legislative powers. He issued Presidential Decrees (P.D.), Executive Orders (E.O.), Letters of Instructions (L.O.I.), which were part of the laws of the land. R.A. No. 7717 is explicit that the capital gain shall be exempt from income tax, but the trading of listed shares of stock of a domestic corporation in a local stock exchange shall be subject to Vi of 1% stock transaction tax (BIR Ruling No. 010-97, Jan. 28, 1997). Therefore, the position taken by BIR appears to be inconsistent with the provision of law. 19

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When is Income Taxable? Income, gain, or profit is subject to income tax when the following conditions are present: 1.

There is income, gain or profit;

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The income, gain or profit is received or realized during the taxable year; and

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The income, gain or profit is not exempt from income tax.

Existence of Income, Gain or Profit Income tax applies only when there is income, gain, or profit. Income, in its broad sense, means all wealth that flows into the taxpayer other than as a mere return of capital. Income is "an amount of money coming to a person or corporation within a specified time, whether as payment for services, interest or profit from investment." Unless otherwise specified, it means cash or its equivalent. Income can also be thought of as a flow of the fruits of one's labor (Conwi vs. Court of Tax Appeals, 213 SCRA 83 [1992]). Payment of loan principal represents mere return of capital which is exempt from income tax. 23

Realization or Receipt of Income

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Income is realized from the sale, exchange or other disposition of real property. As a general rule, a mere increase in the value of property is not income but merely an unrealized increase in capital. For the same reason, a decrease in the value of the property is not normally allowable as a deductible loss. No income is derived nor a loss incurred by the owner until after the actual sale or other disposition of the property in excess of its cost. Income is received not only when it is actually handed to a person but also when it is merely constructively received by him. The withdrawal in 1958 of the deposits in court pertaining to the 1957 rental income is not sufficient justification for the non-declaration of said income in 1957, since the deposit was resorted to due to the refusal of the lessor to accept the same, and was not the fault of its tenants. The lessor is deemed to have constructively received such rentals in 1957 (Limpan Investment Corp. vs. Commissioner, G.R. No. L-21570, July 26, 1966). 23 24

Sec. 36, Rev. Regs. No. 2. Sec. 170, Rev. Regs. No. 2.


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If the taxpayer, however, follows the accrual method of accounting income and expenses, the income shall be recognized in the year when the service is rendered or earned, which is evidenced by the billing statement issued by the seller of service. To report such income only in the year of receipt of payment is already late. In Commissioner vs. Isabela Cultural Corp. (G.R. No. 172231, Feb. 12, 2007), the Court ruled that accrual of income and expense is permitted when the "All Events Test" has been met. This principle does not demand that the amount of income or liability be known absolutely; it only requires that a taxpayer has at its disposal the information necessary to compute the amount with reasonable accuracy, which implies something less than an exact or completely accurate amount.

Income, Gain or Profit is Not Exempt from Tax The income, gain or profit may be exempt from income tax under Section 30(B) of the Tax Code or under the Constitution, tax treaty, or a special law. The exemption must, however, be expressly provided in the statute, and in case of doubt as to whether the income, gain or profit is taxable or exempt, it is safer to tax it, because taxation is the rule and exemption is the exception. Besides, exemption from tax is generally construed strictly against the taxpayer claiming it.

Provisions of Tax Code Prevail Accounting Principles All returns required to be filed by the Tax Code shall be prepared always in conformity with the provisions of the Tax Code and the rules and regulations issued implementing said Tax Code. Taxability of income and deductibility of expenses shall be determined strictly in accordance with the provisions of the Tax Code and the rules and regulations issued implementing the said Tax Code. In case of difference between the provisions of the Tax Code and the rules and regulations implementing the Tax Code, on one hand, and the generally accepted accounting principles ( G A A P ) and the generally accepted auditing standards (GAAS), on the other, the provisions of the Tax Code and the rules and regulations issued implementing the said Tax Code shall prevail. 25

Effects of the Application of Tax Treaties As a general rule, the provisions of the Philippine Tax Code (domestic law) shall apply on the income, gain or profit of any person 25

Rev. Memo. Circular (RMC) No. 22-2004, Feb. 12, 2004.


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liable to income tax. However, there are bilateral tax treaties which the Philippines had concluded with other Contracting States that may have different tax treatments with respect to incomes and rates of taxes. Thus, in case of conflict between the provisions of a tax treaty and domestic law, the provisions of the tax treaty generally prevail over the provisions of the domestic law. However, where the rate of tax imposed under the domestic law is lower than the rate imposed under the tax treaty, the lower tax rate under the domestic law shall prevail. For example, the rental income of a non-resident foreign corporation from lease of aircraft, machinery and equipment to a Philippine company is subject only to 7.5% final withholding tax under the Tax Code, but rentals and royalties are generally subject to the 15% final withholding tax under the tax treaties. As in the Philippine Tax Code, tax treaties also impose income tax on the basis of semi-schedular tax system, whereby business profits arising from sale of goods, properties or services are subject to the global tax system, while capital gains from sale of shares and investment incomes, such as interest income, royalty and dividends, are subject to another types of taxation. This book mainly discusses the principles and rules provided for in the Tax Code, except in some instances where the treatment of a particular income or gain under a tax treaty is also taken up.

CHAPTER II DEFINITION OF T E R M S

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Definition of Terms. — As used in the Tax Code: (A) The term 'person' means an individual, a trust, estate, or corporation. (B) The term 'corporation', shall include partnerships, no matter how created or organized, joint-stock companies, joint accounts (cuentas en participacion), associations, or insurance companies, but does not include general professional partnerships and a joint venture or consortium formed for the purpose of undertaking construction projects or engaging in petroleum, coal, geothermal and other energy operations pursuant to an operating or consortium agreement under a service contract with the Government. 'General professional partnerships' are partnerships formed by persons for the sole purpose of exercising their common profession, no part of the income of which is derived from engaging in any trade or business. (C) The term 'domestic', when applied to a corporation, means created or organized in the Philippines or under its laws. (D) The term 'foreign', when applied to a corporation, means a corporation which is not domestic. (E) The term 'non-resident citizen' means: (1) A citizen of the Philippines who establishes to the satisfaction of the Commissioner the fact of his physical presence abroad with a definite intention to reside therein. (2) A citizen of the Philippines who leaves the Philippines during the taxable year to reside abroad, either as an immigrant or for employment on a permanent basis. 'Sec. 22, NIRC.

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D E F I N I T I O N OF T E R M S

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(3) A citizen of the Philippines who works and derives income from abroad and whose employment thereat requires him to be physically present abroad most of the time during the taxable year. (4) A citizen who has been previously considered as nonresident citizen and who arrives in the Philippines at any time during the taxable year to reside permanently in the Philippines shall likewise be treated as a non-resident citizen for the taxable year in which he arrives in the Philippines with respect to his income derived from sources abroad until the date of his arrival in the Philippines. (5) The taxpayer shall submit proof to the Commissioner to show his intention of leaving the Philippines to reside permanently abroad or to return to and reside in the Philippines as the case may be for purposes of this Section. (F) The term 'resident alien' means an individual whose residence is within the Philippines and who is not a citizen thereof. (G) The term 'non-resident alien' means an individual whose residence is not within the Philippines and who is not a citizen thereof. (H) The term 'resident foreign corporation' applies to a foreign corporation engaged in trade or business within the Philippines. ( I ) The term 'non-resident foreign corporation' applies to a foreign corporation not engaged in trade or business within the Philippines. (J) The term 'fiduciary' means a guardian, trustee, executor, administrator, receiver, conservator or any person acting in any fiduciary capacity for any person. ( K ) The term 'withholding agent' means any person required to deduct and withhold any tax under the provisions of Section 57. ( L ) The term 'shares of stock' shall include shares of stock of a corporation, warrants and/or options to purchase shares of stock, as well as units of participation in a partnership (except general professional partnerships), joint stock companies, joint accounts, joint ventures taxable as corporations, associations, and recreation or amusement clubs (such as golf, polo or similar clubs), and mutual fund certificates.


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Philippine Depository Receipts being issued by domestic corporations to certain clients to be listed and traded in the Philippine Stock Exchange are similar to the "listed equity-linked warrants" and shall be subject to the stock transaction tax of 1/2 of 1% of the gross selling price, which shall be paid by the seller or transferor. 2

(M) The term 'shareholder' shall include holders of a share/s of stock, warrant/s and/or option/s to purchase shares of stock of a corporation, as well as a holder of a unit of participation in a partnership (except general professional partnerships) in a joint stock company, a joint account, a taxable joint venture, a member of an association, recreation or amusement club (such as golf, polo, or similar clubs) and a holder of a mutual fund certificate, a member in an association, joint-stock company, or insurance company. ( N ) The term 'taxpayer' means any person subject to tax imposed by this Title. (O) The terms 'including' and 'includes', when used in a definition contained in this Title, shall not be deemed to exclude other things otherwise within the meaning of the term defined. (P) The term 'taxable year' means the calendar year, or the fiscal year ending during such calendar year, upon the basis of which the net income is computed under this Title. 'Taxable year includes, in the case of a return made for a fractional part of a year under the provisions of this Title or under rules and regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner, the period for which such return is made. (Q) The term 'fiscal year' means an accounting period of twelve (12) months ending on the last day of any month other than December. (R) The terms 'paid or incurred' and 'paid or accrued' shall be construed according to the method of accounting upon the basis of which the net income is computed under this Title. (S) The term 'trade or business' includes the performance of the functions of a public office. (T) The term 'securities' means shares of stock in a corporation and rights to subscribe for or to receive such shares. The term includes bonds, debentures, notes, or certificates, or other 2

BIR Ruling No. 136-99, Aug. 30, 1999.


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evidence of indebtedness, issued by any corporation, including those issued by a government or political subdivision thereof, with interest coupons or in registered form. (U) The term 'dealer in securities' means a merchant of stocks or securities, whether an individual, partnership or corporation, with an established place of business, regularly engaged in the purchase of securities and the resale thereof to customers; that is, one who, as a merchant, buys securities and re-sells them to customers with a view to the gains and profits that may be derived therefrom. (V) The term 'bank' means every banking institution, as defined in Section 2 of Republic Act No. 337, as amended, otherwise known as the General Banking Act. A bank may either be a commercial bank, a thrift bank, a development bank, a rural bank or a specialized government bank. ( W ) The term 'non-bank financial intermediary' means a financial intermediary, as defined in Section 2(D)(c) of Republic Act No. 337, as amended, otherwise known as the General Banking Act, authorized by the Bangko Sentral ng Pilipinas (BSP) to perform quasi-banking activities. (X) The term 'quasi-banking activities' means borrowing funds from twenty (20) or more personal or corporate lenders at any one time, through the issuance, endorsement, or acceptance of debt instruments of any kind other than deposits for the borrower's own account, or through the issuance of certificates of assignment or similar instruments, with recourse, or of repurchase agreements for purposes of re-lending or purchasing receivables and other similar obligations: Provided, however, That commercial, industrial and other non-financial companies, which borrow funds through any of these means for the limited purpose of financing their own needs or the needs of their agents or dealers, shall not be considered as performing quasi-banking functions. ( Y ) The term 'deposit substitutes' shall mean an alternative form of obtaining funds from the public (the term 'public' means borrowing from twenty [20] or more individual or corporate lenders at any one time), other than deposits, through the issuance, endorsement, or acceptance of debt instruments for the borrower's own account, for the purpose of relending or purchasing of receivables and other obligations, or financing their own needs or the needs of their agent or dealer. These instruments may include, but need not be limited to bankers' acceptances, promissory notes, repurchase agreements,


18

including reverse repurchase agreements entered into by and between the Bangko Sentral ng Pilipinas (BSP) and any authorized agent bank, certificates of assignment or participation and similar instruments with recourse: Provided, however, That debt instruments issued for inter-bank call loans with maturity of not more than five (5) days to cover deficiency in reserves against deposit liabilities, including those between or among banks and quasi-banks, shall not be considered as deposit substitute debt instruments. 3

The ten-year PEACe Bonds to be offered to the public by the national government "at any one time" does not constitute borrowing from the public, since said bonds would be sold or disposed of only to one bank, RCBC. Hence, it does not fall under the concept of deposit substitutes. Moreover, gains realized from the sale, exchange or retirement of bonds with maturity of five years or more are exempt from income tax. 4

The PHP30B-U.S.-linked peso note program to be launched by the Philippine Government by offering said Notes to the public to finance its budgetary requirements will be treated as deposit substitute, and the gains, if any, which the investors will realize therefrom will be subject to the 20% final withholding tax. 5

(Z) The term 'ordinary income' includes any gain from the sale or exchange of property which is not a capital asset or property described in Section 39(A)(1). Any gain from the sale or exchange of property which is treated or considered, under other provisions of this Title, as "ordinary income" shall be treated as gain from the sale or exchange of property which is not a capital asset as defined in Section 39(A)(1). The term "ordinary loss" includes any loss from the sale or exchange of property, which is not a capital asset. Any loss from the sale or exchange of property which is treated or considered, under other provisions of this Title, as 'ordinary loss' shall be treated as loss from the sale or exchange of property which is not a capital asset. (AA) The term 'rank and file employees' shall mean all employees who are holding neither managerial nor supervisory position as defined under existing provisions of the Labor Code of the Philippines, as amended.

'See Rev. Regs. No. 16-2009, Feb. 9, 2009. BIR Ruling No. 035-2001, Aug. 16, 2001. BIR Ruling No. 052-2001, Nov. 16, 2001.

4

5


19

(BB) The term 'mutual fund company' shall mean an open-end and close-end investment company as denned under the Investment Company Act. ( C O The term 'trade, business or profession' shall not include performance of services by the taxpayer as an employee. (DD) The term 'regional or area headquarters' shall mean a branch established in the Philippines by multinational companies and which headquarters do not earn or derive income from the Philippines and which act as supervisory, communications and coordinating center for their affiliates, subsidiaries, or branches in the Asia-Pacific Region and other foreign markets. (EE) The term 'regional operating headquarters' shall mean a branch established in the Philippines by multinational companies which are engaged in any of the following services: general administration and planning; business planning and coordination; sourcing and procurement of raw materials and components; corporate finance advisory services; marketing control and sales promotion; training and personnel management; logistic services; research and development services and product development; technical support and maintenance; data processing and communication; and business development. (FF) The term long-term deposit or investment certificate' shall refer to certificate of time deposit or investment in the form of savings, common or individual trust funds, deposit substitutes, investment management accounts and other investments with a maturity period of not less than five (5) years, the form of which shall be prescribed by the Bangko Sentral ng Pilipinas (BSP) and issued by banks only (not by non-bank financial intermediaries and finance companies) to individuals in denominations of Ten thousand pesos (P10,000) and other denominations as may be prescribed by the BSP. (GG) The term 'statutory minimum wage' shall refer to the rate fixed by the Regional Tripartite Wage and Productivity Board, as defined by the Bureau of Labor and Employment Statistics (BLES) of the Department of Labor and Employment (DOLE). 6

(HH)The term 'minimum wage earner' shall refer to a worker in the private sector paid the statutory minimum wage, or to an employee in the public sector with compensation income of not more 6

See R.A. No. 9504, effective July 6, 2008.

20


than the statutory minimum wage in the non-agricultural sector where he/she is assigned. In addition to the terms denned in Section 22 of the Tax Code, there are many other important terminologies that a student of taxation or tax practitioner must be familiar with. These terms are denned in the succeeding relevant Chapter(s).

CHAPTER I I I KINDS OF INCOME TAXPAYERS

Chapter I I I deals with the kinds of income taxpayers. This Chapter will cover the following sections of the Tax Code: 1.

Section 22(B) - Corporation; Section 22(C) and (D) - Domestic corporation and foreign corporation; Section 22(E) - Non-resident citizen; Section 22(F) - Resident citizen; Section 22(G) - Non-resident alien; Section 22(H) and ( I ) - Resident and non-resident foreign corporations;

2.

Section 23 - General principles of income taxation;

3.

Section 24 - Income tax rates on individual citizen and resident alien;

4.

Section 25 - Tax on non-resident alien individual;

5.

Section 26 - Tax liability of members of general professional partnerships;

6.

Section 27 - Tax on domestic corporations;

7.

Section 28 - Tax on foreign corporations;

8.

Section 60 - Estates and trusts; and

9.

Section 73(D) - Net income of a partnership deemed constructively received by partners.

In analyzing any problem or issue involving income taxation, it is well to remember that the first thing to look for in trying to find the solution to the problem or the answer to the question is: Who 21


22

is the taxpayer? There are only two exceptions to the general rule where the kind of taxpayer in the transaction is not important to be ascertained and these are (1) where the transaction involves the sale of shares of stocks of a domestic corporation, whether listed and traded in a local stock exchange, or unlisted or listed but not traded in a local stock exchange. In this case, it does not matter who the seller of the shares is because either the transaction is subject to the 1% of stock transaction tax or 5%/10% capital gains tax on net capital gain, whether the seller is an individual, citizen or alien, or a corporation, domestic or foreign; and (2) where the real property sold is a capital asset located in the Philippines, that is subject to the 6% capital gains tax.

In General The term "taxpayer" means any person subject to tax imposed by Title II (Income Tax) of the Tax Code. A "person" means an individual, a trust, estate, or corporation. The word "person" is a generic term used to refer to an income taxpayer who may be an individual, estate or trust, partnership, association, or a corporation. 1

2

A "person liable to tax" has been held to be a "person subject to tax." The two phrases both impose a legal obligation or duty to pay tax. It is very difficult and conceptually impossible to consider a person who is statutorily made "liable to tax" as not "subject to tax." By any reasonable standard, such a person {i.e., withholding agent) should be regarded as a party-in-interest, or as a person having sufficient legal interest to bring a suit for refund of taxes he believes were illegally or erroneously collected from him (Commissioner vs. Procter & Gamble PMC, Dec. 2, 1991, 204 SCRA 378).

Importance of Tax Status of Taxpayer It is important to know the tax status of a taxpayer for income tax purposes, since only resident citizens and domestic corporations are taxable on their worldwide income, while the other types of individual and corporate taxpayers are taxable only on income derived from sources within the Philippines. Thus, a citizen of the Philippines residing therein is taxable on all income derived from sources within and without the Philippines. A non-resident citizen is taxable only on income derived from sources within the Philippines. A citizen of 'Sec. 22(N), NIRC. 'Sec. 22(A), NIRC.

the Philippines who is working and deriving income from abroad as an overseas contract worker is taxable only on income from sources within the Philippines, Provided, That a seaman who is a citizen of the Philippines and who receives compensation for services rendered abroad as a member of the complement of a vessel engaged exclusively in international trade shall be treated as an overseas contract worker. An alien individual, whether or not a resident of the Philippines, is taxable only on income derived from sources within the Philippines. On the other hand, a domestic corporation is taxable on all its income from sources within and without the Philippines. However, a foreign corporation, whether resident or non-resident, is taxable only on income from sources within the Philippines. 3

The tax status of the taxpayer is generally considered in determining his/its income tax liability. Thus, for compensation income, business and professional income, capital gain, passive investment income, and other income not subject to final tax, the income tax due is a function of the taxpayer's tax status. For capital gains subject to final tax, the question as to whether the seller or transferor is a dealer in securities or dealer in real estate must first be answered, and only when the answer to su ch question is "no" that the transaction becomes subject to the final capitals tax at preferential rates. With respect to passive investment income subject to final tax, the question on who is the taxpayer must also be raised, for the tax rate applicable on the income depends on the tax status of the recipient of the income. For example, royalty is subject to 20% final withholding tax when paid to a domestic corporation, but the tax rate is reduced to 10% where such royalty payment for books, other literary works and musical compositions is paid to a resident citizen, or increased to 25% where the payee is a non-resident alien not engaged in trade or business in the Philippines. Also, dividend paid by a domestic corporation to another domestic corporation is not liable to income tax, but dividend paid to a resident citizen or a non-resident alien not engaged in trade or business in the Philippines is taxed at 10% or 25%, respectively.

Individual Taxpayers Individual taxpayers are classified into citizens of the Philippines and aliens. Citizens are classified into resident citizens and nonresident citizens. Aliens are also classified into resident aliens and 3

Sec. 23, NIRC.


24

non-resident aliens. Non-resident aliens are further classified as resident aliens engaged or not engaged in trade or business in the Philippines.

Citizens Under the Constitution, the following individuals are considered as citizens of the Philippines: 4

1.

Those who are citizens of the Philippines at the time of the adoption of the Constitution (on February 2, 1987);

2.

Those whose fathers or mothers are citizens of the Philippines;

3.

Those born before January 17, 1973 (date of adoption of the 1973 Constitution), of Filipino mothers, who elect Philippine citizenship upon reaching the age of majority; and

4.

Those who are naturalized in accordance with law.

Citizens of the Philippines who marry aliens shall retain their citizenship, unless by their omission they are deemed, under the law, to have renounced their citizenship. Philippine citizenship may be lost or reacquired in the manner provided by law. 5

Generally, a citizen has only one tax status during the calendar year, either as a resident citizen or a non-resident citizen. However, it is possible for a citizen to have dual status (resident and nonresident) during a calendar year for income tax purposes. He may be treated as a resident citizen and at the same time a non-resident citizen during the same taxable year, if at the beginning of the year, he derives compensation and/or business/professional income, and sometime later during the same year, he departs from the Philippines as an immigrant or a qualified non-resident citizen, or vice versa.

Residence of Citizens It is important to know whether a citizen is a resident or non-resident of the Philippines. A person will be taxable on his worldwide income if he is treated as a resident citizen, and he shall also be taxable on his income from sources within the Philippines. 4 6

Sec. 1, Art. Ill, Constitution of the Philippines. Sec. 3, Rev. Regs. No. 2.

K I N D S OF INCOME TAXPAYERS

25

However, he shall be exempted on his income from sources outside the Philippines, if he qualifies as a non-resident citizen. A resident Filipino citizen is taxed on his worldwide income because of the protection he gets from the Philippine Government even when he is outside the country. The Philippines retains personal jurisdiction over the person of the citizen no matter how long he lives in a foreign country, for as long as he remains a citizen. 6

Resident Citizens

7

A resident citizen can be (a) engaged in trade or business or in the exercise of his profession in the Philippines, or (b) not engaged in trade or business or in the exercise of his profession, or (c) engaged in trade or business or in the exercise of his profession and at the same time, he derives compensation and/or other income ("mixed income"). It is important to determine whether or not a resident citizen is engaged in trade or business or in the exercise of his profession, since he is entitled to deduct certain deductions from his business and/or professional income, capital gain not subject to final tax, passive income not subject to final tax, and other income. However, no deductions are allowed from his gross compensation income, although personal and additional exemptions, if any, may be deducted therefrom, and from capital gains and passive incomes subject to final tax at preferential rates. If a resident citizen derives non-business or professional income, he receives either compensation income (there is employer-employee relationship between him and his employer, or he derives passive investment incomes, or he realizes capital gain from the sale or transfer of shares of stock of a domestic corporation or real property).

Non-Resident Citizens The term "non-resident citizen" means: 1. A citizen of the Philippines who establishes to the satisfaction of the Commissioner the fact of his physical presence abroad with a definite intention to reside therein; »Cook vs. Tait, 265 U.S. 47, 68 L. Ed. 895, 44. '"Residence" refers to an individual's habitual place of abode to which whenever absent, he has the intention of returning. A citizen shall be deemed a resident of the Philippines and thus subject to income tax on his worldwide income, unless he qualifies as a non-resident citizen under Sec. 22(E), NIRC.


26

2. A citizen of the Philippines who leaves the Philippines during the taxable year to reside abroad, either as an immigrant or for employment on a permanent basis; 3. A citizen of the Philippines who works and derives income from abroad and whose employment thereat requires him to be physically present abroad most of the time during the taxable year; 8

4. A citizen who has been previously considered as nonresident citizen and who arrives in the Philippines at any time during the taxable year to reside permanently in the Philippines. Balikbayan trip to Manila. - The trip to Manila of a nonresident citizen under the Balikbayan Program did not interrupt his residence abroad. The phrase "uninterrupted period" should not be interpreted literally as to negate the continuity of residence abroad. If the reason for the physical presence abroad is established such as employment on a more or less regular tenure, such physical presence abroad for the taxable year is not deemed interrupted by reason of visits or travels to the Philippines, no matter how often made as to negate the citizen's status as a non-resident citizen. 9

10

Under Section 22(E)(2) of the 1997 Tax Code, the employment abroad of a citizen must be "on a permanent basis" and not just on a "more or less permanent basis" required under the 1977 Tax Code, as amended. Pilots, stewardesses and other crew members. - Pilots, stewardesses and other crew members plying international routes who are holders of immigrant visas or working visas and have left the Philippines qualify as non-resident citizens. The fact that their salaries are paid locally does not remove them from this category. Employees under secondment agreement. - The employees of a company who are assigned abroad through Secondment Agreement with its overseas client are classified as non-resident citizens or overseas contract workers, if they spend at least 183 days during any given taxable year, or if the workers' employment contract passes through the Philippine Overseas Employment Agency. 11

T h e phrase "most of the time" means at least 183 days. His presence abroad, however, need not be continuous. BIR Ruling, Apr. 2, 1974; see Sec. 45, NIRC. Sec. 2, Rev. Regs. No. 9-73; BIR Ruling No. 74-004, Mar. 15, 1974. "BIR Ruling No. 033-2000, Sept. 5, 2000. 9

10


27

Aliens Alien individuals are classified into resident alien and nonresident alien.

Residence of aliens The Tax Code does not define "residence," but the regulations provide relevant guidelines on this matter. Thus, an alien actually present in the Philippines who is not a mere transient or sojourner is a resident of the Philippines for income tax purposes. A mere floating intention indefinite as to time, to return to another country is not sufficient to constitute him a transient. If he lives in the Philippines and has no definite intention as to his stay, he is a resident. One who comes to the Philippines for a definite purpose, which in its nature may be promptly accomplished, is a transient. But if his purpose is of such a nature that an extended stay may be necessary for its accomplishment, and to that end the alien makes his home temporarily in the Philippines, he becomes a resident, though it may be his intention at all times to return to his domicile abroad when the purpose for which he came has been consunmated or abandoned. A resident alien loses his residence status if he actually leaves the Philippines and abandons his residency thereof without any intention of returning. 12

It has been ruled that the fact that a resident alien leaves the Philippines with a re-entry permit proves that he has not abandoned his residence in this country. 13

Resident Aliens (RA) A resident alien is an individual whose residence is within the Philippines and who is not a citizen thereof. He is taxed in the same manner as a resident citizen, except that only his income from Philippine sources is taxable in the Philippines beginning January 1, 1998. His income from foreign sources is not liable to Philippine income tax; hence, up to December 31, 1997, a resident alien was subject to income tax on his worldwide income. In view thereof, 14

15

16

"Sec. 5, Rev. Regs. No. 2. "BIR Ruling, Mar. 12, 1974. "Sec. 22(G), NIRC. "Before the enactment of R.A. No. 8424, resident aliens were subject to Philippine income tax on income from within and outside the Philippines. Sec. 7, Rev. Regs. No. 2. l6


28

the material distinction between a resident alien and a non-resident alien engaged in trade or business in the Philippines was effectively removed by R.A. No. 8424. Thus, the significance of the term "resident" with respect to aliens had been eliminated and the only material issue for non-resident aliens is whether or not they are considered as engaged in trade or business in the Philippines. Pre-arranged alien employee. - An alien who has acquired residence in the Philippines retains his status as a resident until he abandons the same and actually departs from the Philippines. An intention to change his residence does not change his status as a resident alien to that of a non-resident alien. Thus, an alien who has acquired a residence in the Philippines (when his temporary visitor visa was converted into non-immigrant visa for pre-arranged employee) is taxable as a resident for the remainder of his stay in the Philippines. The conversion of his visa gave a more definite shape to petitioner's extended stay. He had now that involvement for the specific time as may be required by the exigency of his position as Assistant Manager in the Manila Office. The locus of the undertaking established, petitioner did take his home and continued to reside and live with his family in the Philippines through 1975 to 1979 until transferred to another foreign station. 17

Non-Resident Aliens A non-resident alien is an individual whose residence is not within the Philippines and who is not a citizen thereof. A nonresident alien is further classified into: (a) engaged in trade or business in the Philippines, or (b) not engaged in trade or business in the Philippines, depending on the length of his stay in the Philippines. If the aggregate period of his stay in the Philippines is more than one hundred eighty (180) days during any calendar year, he shall be deemed a 'non-resident alien doing business in the Philippines,' Section 22(G) of the Tax Code notwithstanding. As such, he is taxed on his income from sources within the Philippines (after deducting personal and additional exemptions, if any) at the graduated income tax rates (5% to 32%), while his passive investment incomes shall generally be subject to 20% final tax. For the specific tax rate applicable on certain types of income, please see Chapter V I I (Taxable Bases and Tax Rates). 18

17

Sec. 6, Rev. Regs. No. 2. See Ota vs. Commissioner, CTA Case No. 3161, Mar. 21, 1982. Sec. 22(G), NIRC. 18


29

On the other hand, if the aggregate period of the non-resident alien's stay in the Philippines does not exceed 180 days during any calendar year, he shall be deemed a 'non-resident alien not doing business in the Philippines.' As such, he is taxed on his compensation income, business or professional income, capital gain, passive investment income, and other income from sources within the Philippines at the flat rate of 25%, but capital gains from sale or exchange of shares of stocks in a domestic corporation and real property shall be subject to capital gains tax or stock transaction tax, as the case may be. 19

The phrase "engaged in trade or business within the Philippines" includes the performance of personal services within the Philippines. Whether a non-resident alien has an "office or place of business," however, implies a place for the regular transaction of business and does not include a place where casual or incidental transactions might be, or are, effected. Neither the beneficiary nor the grantor of a trust, whether revocable or irrevocable, is deemed to be engaged in trade or business in the Philippines or to have an office or place of business therein, merely because the trustee is engaged in trade or business in the Philippines or has an office or place o' business therein. 20

180-Day Rule to ascertain whether an alien is engaged in trade or business in the Philippines. — Section 25(A) of the 1997 Tax Code adopts the "180-day rule" in determining whether a nonresident alien is engaged in trade or business in the Philippines in order to simplify the manner of its determination. If an alien stays in the Philippines for 180 days or less during the calendar year, he shall be deemed a non-resident alien not doing business in the Philippines, regardless of whether he actually engages in trade or business therein. On the other hand, if his stay exceeds 180 days during the calendar year, he shall be deemed engaged in trade or business in the Philippines, although he does not actually engage in trade or business in the Philippines. There are many instances, however, where the alien's contract of employment in the Philippines is for two years or more, and they generally start work during the second half of the year. For example, an alien will work in the Philippines for three years starting in September, 2002. One school of thought is that for the year 2002, he shall be deemed a non-resident alien not engaged in trade or business "•See. 25(B), NIRC. Sec. 8, Rev. Regs. No. 2.

M


30

in the Philippines because his stay in the country during the year is for less than 180 days. There is another school of thought that he shall be considered as a non-resident alien engaged in trade or business in the Philippines for the year 2002 despite the fact that the aggregate period of his stay in 2002 is less than 180 days. They argue that the aggregate period of his stay as shown in his contract of employment which definitely exceeds the 180-day rule shall be considered for purposes of determining his tax status during his entire stay in the country. The phrase "engaged in trade or business within the Philippines" includes the performance of personal services within the Philippines. Whether a non-resident alien has an "office or place of business," however, implies a place for the regular transaction of business and does not include a place where casual or incidental transactions might be, or are, effected. Neither the beneficiary nor the grantor of a trust, whether revocable or irrevocable, is deemed to be engaged in trade or business in the Philippines or to have an office or place of business therein, merely because the trustee is engaged in trade or business in the Philippines or has an office or place of business therein. 21

Individuals subject to preferential tax rates Certain alien individuals who are employed in the Philippines are entitled to the 15% preferential income tax rate on their gross compensation income from sources within the Philippines. These employees are alien individuals employed by: (a) regional or area headquarters and regional operating headquarters of multinational companies in the Philippines; (b) offshore banking units established in the Philippines; and (c) foreign service contractor or sub-contractor engaged in petroleum operations in the Philippines. 22

The same tax treatment shall apply to Filipinos employed and occupying the same position as those of aliens employed by the entities mentioned above, regardless of whether or not there is an alien executive occupying the same position. Filipino employees employed by Regional Headquarters or Regional Operating Headquarters governed by E.O. No. 226, as amended by R.A. No. 8756, may choose to be taxed either at the 15% preferential tax rate on their gross income or at the graduated tax rates. 23

21

Sec. 8, Rev. Regs. No. 2. "See Sec. 25(C), (D) and (E), NIRC. ^Sec. 2.57.K5XD), Rev. Regs. No. 2-98, Apr. 17,1998, as amended by Rev. Regs. No.


31

Estates and Trusts 24

25

Taxable estates and trusts are taxed in the same manner and on the same basis as an individual. However, it is entitled only to personal exemption equivalent to a single individual in the amount of P20,000 (raised to P50,000 effective July 6, 2008). 26

The taxable income of estates and trusts shall include: 1.

Income accumulated in trust for the benefit of unborn or unascertained person or persons with contingent interests, and income accumulated or held for future distribution under the terms of the will or trust;

2.

Income which is to be distributed currently by the fiduciary to the beneficiaries, and income collected by a guardian of an infant which is to be held or distributed as the court may direct;

3.

Income received by estates of deceased persons during the period of administration or settlement of the estate; and

4.

Income which, in the discretion f f the fiduciary, may be either distributed to the beneficiaries or accumulated. 27

The above income shall either be taxable to the fiduciary, if the trust instrument is irrevocable, or taxable to the grantor, if the trust instrument is revocable. The trust instrument is "revocable" where at any time the power to revest in the grantor title to any part of the corpus of the trust is vested: (a) in the grantor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, or (b) in any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom, the income of such part of the trust. 28

6-2001. Alien employees of representative offices of MNC in the Philippines were subject to the 15% preferential tax rate on their gross income, pursuant to RR 2-98 were deleted from the list of alien employees entitled to the reduced tax rate beginning Jan. 1, 2002. A n estate i6 created by operation of law, when an individual dies, leaving properties to his compulsory or other heirs. A trust is a legal arrangement whereby the owner of property (the trustor) transfers ownership to a person (the trustee) who is to hold and control the property according to the owner's instructions, for the benefit of a designated person(s) (the beneficiary). Legal title to the trust property is vested in the trustee, while equitable title belongs to the beneficiary. Sec. 62, NIRC. "Sec. 60(A), NIRC. ^Sec. 63, NIRC. M

25

26


32

29

If the trust were an employee's trust which forms part of an employer's pension, stock or profit-sharing plan that complies with the requirements of tax exemption under Section 60(B) of the Tax Code, as implemented by Revenue Regulations No. 1-68, as amended, its income would be exempt from income tax. Since said provision grants tax exemption, the requirements of Section 60(B) of the 1997 Tax Code are mandatory and should be strictly construed. These requirements are: (a) contributions are made to the trust by the employer, or employees, or both for the purpose of distributing to the employees the earnings and principal of the fund accumulated by the trust in accordance with such plan; and (b) under the trust instrument, it is impossible, at any time prior to the satisfaction of all liabilities with respect to employees under the trust, for any part of the corpus or income to be (within the taxable year or thereafter) used for, or diverted to, purposes other than for the exclusive benefit of his employees. However, any amount actually distributed to any employee or distribute shall be taxable to him in the year in which so distributed to the extent that it exceeds the amount contributed by such employee or distribute (Commissioner vs. Visayan Electric Co., 23 SCRA 715). The taxable income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, except that: a.

In computing the taxable income of the estate or trust, the amount of the income of the estate or trust for the taxable year which is to be distributed currently by the fiduciary to the beneficiaries, and the amount of the income collected by the guardian of an infant which is to be held or distributed as the court may direct, shall be allowed a deduction from gross income, but the amount so deducted shall be included in computing the taxable income of the beneficiaries, whether distributed to them or not.

b.

In the case of income received by estates of deceased persons during the period of administration or settlement of the estate, and in the case of income which, in the discretion of the fiduciary, may be either distributed to the beneficiary

"Employee trust is a trust created for the benefit of employees and usually for the purpose of acquiring share capital in the employer company so that the employees can share in the ownership of the business. Such a trust can also be created to provide pensions for employees, the trust money being invested in approved investments (Lyons, Susan M., International Tax Glossary, 2nd ed., p. 261).


33

or accumulated, there shall be allowed as an additional deduction in computing the taxable income of the estate or trust the amount of the income of the estate or trust for its taxable year, which is properly paid or credited during such year to any legatee, heir or beneficiary, but the amount so allowed as a deduction shall be included in computing the taxable income of the legatee, heir or beneficiary. c. In the case of a trust administered in a foreign country, the deductions mentioned above shall not be allowed, Provided, That the amount of any income included in the return of said trust shall not be included in computing the income of the beneficiaries. 30

Co-ownership For income tax purposes, the co-owners in a co-ownership report their share of the income from the property owned in common by them in their individual tax returns for the year, and the co-ownership is not considered as a separate taxable entity or a corporation as defined in Section 22(B) of the 1997 Tax Code. In a co-ownership arising from the death of a decedent, the court clearly established that such co-ownership is automatically terminated upon the partition and distribution of the properties of the estate and an unregistered partnership is created when the heirs invested the common properties and income and placed them under a single management. However, the co-ownership is not converted into a partnership where the transactions of the co-owners intended to liquidate the co-ownership are few or isolated, and the element of habituality is not present. The intention of the co-owners to establish a partnership should also be considered. Illustrative Cases: Co-ownership due to death of a decedent. - In general, co-ownerships are not treated as separate taxable entities. The income of co-ownerships is not subject to income tax, if the activities of the co-owners are limited to the preservation of the property and the collection of the income therefrom. In which case, each co-owner is taxed individually on his distributive share. Before the partition and distribution of the estate of the deceased, all the income thereof does belong commonly to all ""Sec. 61, NIRC.

34


the heirs. Should the co-owners invest the income of the coownership in any income-producing properties after the extrajudicial partition of the estate, they would constitute themselves into a partnership which is consequently subject to income tax as a corporation. The co-ownership of inherited properties is automatically converted into an unregistered partnership the moment the said common properties and/or the incomes derived therefrom are used as a common fund with intent to produce profits for the heirs in proportion to their respective shares in the inheritance as determined in a project partition either duly executed in an extra-judicial settlement or approved by the court in the corresponding testate or intestate proceeding. From the moment of such partition, the heirs are already entitled to their respective definite shares of the estate and the income thereof, for each heir to manage and dispose of as exclusively his own without the intervention of the other heirs. Accordingly, the heir becomes liable individually for all taxes in connection with his co-heirs. If after such partition, he allows his shares to be held in common with his co-heirs under a single management to be used with the intent of making profit thereby in proportion to his share, there can be no doubt that, even if no document or instrument were executed for the purpose, at least an unregistered partnership is formed for tax purposes (De Leon vs. Commissioner, CTA Case No. 728, Sept. 11, 1961; Ona vs. Commissioner, L-19342, May 25,1972). Isolated transactions of unimproved properties. — The petitioners bought two parcels of land in 1965. They did not sell the same nor make any improvements thereon. In 1966, they bought three more parcels of land from one seller. In 1968, they sold the two parcels at a profit after which they did not make any additional or new purchase. In 1970, they sold the remaining parcels also at a profit. It was held that there was no adequate basis to support the proposition that they thereby formed an unregistered partnership. The character of habituality peculiar to business transactions for the purpose of gain must be present to consider them so. Where the transactions are isolated, in the absence of other circumstances showing a contrary intention, the case can only give rise to co-ownership. The sharing of the profits in a common property does not of itself establish a partnership that is but a consequence of a joint or common right or interest in the property. There must be a clear intent to form a partnership, the existence of a juridical personality different


35

from the individual partners, and the freedom of each party to transfer or assign the whole property (Pascual vs. Commissioner 166 SCRA 560, Oct. 18, 1988). Transfer of property from father to children. - After completing payment on two lots, the father transferred his rights to his four children to enable them to build their residences. After having held the two lots for more than a year, they sold them at a profit. They treated the profit as a capital gain and paid income tax on one-half thereof. The court ruled that there was no partnership. To regard them as having a taxable partnership would result in oppressive taxation and obliterate the distinction between a co-ownership and a partnership. The children had no intention of forming a partnership. The transaction was isolated. Their original purpose was to divide the lots for residential purposes. If later on they found it not feasible to build their residences on the lots because of the high cost of construction, then they had no choice but to resell the same to dissolve the co-ownership. The division of the profit was merely incidental to the dissolution of the co-ownership which was in the nature of things a temporary state. The sharing of gross returns does not of itself establish a joint partnership whether or not the persons sharing them have a joint or common right or interest in the property from which the returns are derived. There must instead be an unmistakable intention to form that partnership or joint venture (Obillos vs. Commissioner, L-68118, Oct. 29, 1985,139 SCRA 436). No community of interests where parties severally retain title. - Persons who contribute property or funds to a common enterprise and agree to share the gross returns of that enterprise in proportion to their contribution, but who severally retain the title to their respective contribution, are not thereby rendered partners. They have no common stock capital, and no community of interest as principal proprietors in the business itself from which the proceeds are derived (Pascual vs. Commissioner, 166 SCRA 560, cited in Solid Bank Corporation vs. Commissioner, CTA Case No. 4868, June 19, 1997).

General Professional Partnership (GPP) A general professional partnership is a partnership formed by persons for the sole purpose of exercising their common profession,


36

no part of the income of which is derived from engaging in any trade or business. 31

A general professional partnership is not considered as a taxable entity for income tax purposes. The partners themselves, not the partnership (although it is still obligated to file an income tax return), are liable for the payment of income tax in their individual capacity computed on their respective distributive shares of the partnership profit. In the determination of the tax liability, a partner does so as an individual, and there is no choice on the matter. In fine, the general professional partnership is deemed to be no more than a mere mechanism or a flow-through entity in the generation of income by, and the ultimate mechanism distribution of such income to, respectively, each of the individual partners (Rufi.no Tan, et al. vs. Commissioner, G.R. No. 109289, Oct. 3, 1994). Since a general professional partnership is exempt from income tax, the professional fees paid to it are thus exempt from the expanded withholding tax.

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The net profit of a general professional partnership is, however, deemed distributed to the partners composing the partnership in accordance with their agreement. The share of an individual partner in the net profit of a general professional partnership is deemed to have been actually or constructively received by the partner in the same taxable year in which such partnership net income was earned, and shall be taxed to them in their individual capacity, whether actually distributed or not, at the graduated rates of income tax ranging from 5% to 32%. Thus, the principle of constructive receipt of income or profit is being applied to undistributed profits of taxable partnerships, but the subsequent payment of such tax-paid profit in another year should no longer be liable to income tax. 33

34

Illustration: Jaime Miguel and Joaquin Antonio, both lawyers, formed a general professional partnership in January, 2002. In accordance with their agreement, they would equally divide the profits and losses. During the year, the partnership had a net profit of Plmillion and P800.000 was distributed to the partners. Under Section 73(D) of thel997 Tax Code, each partner must report an income of P500,000 (not just P400,000), because the income 31

Sec. 22(B), NIRC. Rev. Regs. No. 13-78, as amended by Rev. Regs. No. 14-2002. Sec. 73(D), NIRC. "Sec. 73(D), NIRC. 32 33


37

is taxable in the year earned and is deemed distributed in the same year.

Corporations The term "domestic," when applied to a corporation means created or organized in the Philippines or under its laws, while the term "foreign," when applied to a corporation, means a corporation which is not a domestic. A "resident foreign corporation" is a foreign corporation engaged in trade or business within the Philippines, and a "non-resident foreign corporation" is a foreign corporation not engaged in trade or business within the Philippines. 35

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Test in Determining Residence of Corporations For purposes of determining the tax status or residence of a corporation, the Philippines adopted the "law of incorporation test" under which a corporation is considered as a domestic corporation, if it is organized or created in accordance with or under the laws of the Philippines, or as a foreign corporation, if it is organized or created in accordance with or under the laws of a foreign country. Thus, for income tax purposes, a corporation registered with the Securities and Exchange Commission which is managed or controlled by foreigners is a domestic corporation, provided that it is organized under the laws of the Philippines. On the other hand, a corporation established by Filipino citizens under the laws of a foreign country will be treated as a foreign corporation, and the branch that such foreign corporation sets up in the Philippines is a resident foreign corporation.

Domestic Corporation A domestic corporation is taxable on all income derived from sources within and without the Philippines, while a foreign corporation, whether engaged or not in trade or business in the Philippines, is taxable only on income derived from sources within the Philippines. 39

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Sec. 22(C), NIRC. Sec. 22(D), NIRC. Sec. 22(H), NIRC. Sec. 22(1), NIRC. It is thus redundant to describe a non-resident foreign corporation aa not doing business in the Philippines. Sec. 23, NIRC. 36

37

38

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Definition of "Corporation" The Tax Code definition of a "corporation" is so broad that it includes all types of corporations, partnerships (no matter how created or organized), joint stock companies, joint accounts, associations, or insurance companies, whether or not registered with the Securities and Exchange Commission. However, it does not include the following: (a) general professional partnerships, (b) joint venture or consortium formed for the purpose of undertaking construction projects, or (c) joint venture or consortium engaging in petroleum, coal, geothermal and other energy operations pursuant to an operating or consortium agreement under a service contract with the government. 40

41

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For income tax purposes, the term "corporation" includes not only private corporations organized under the corporation law and government-owned or controlled corporations but also registered or unregistered general partnerships, limited partnerships, joint stock companies, insurance companies, joint ventures (except those expressly exempt by law) and similar entities (Rizal Theatrical Co., Inc. andAyala Corp. vs. Commissioner, CTA Case No. 3463, Apr. 24, 1989). 43

Bank with RBU and FCDU It is required that only one income tax return shall be filed by the taxpayer in reporting his income for a taxable year. However, this 40

By the contract of partnership, two or more persons bind themselves to contribute money, property, or industry to a common fund, with the intention of dividing the profits among themselves (Art. 1767, R.A. No. 386, as amended, otherwise known as the Civil Code of the Philippines). •"The qualifying words "no matter how created or organized" indicate that a joint venture need not be undertaken in any of the standard forms or in conformity with the usual requirements of the law on partnerships in order that one could be deemed so constituted for purposes of the tax on corporations (Evangelista, et al. vs. Collector, 102 Phil. 140). The reasons for excluding construction activity in the definition of the term "corporation" by P.D. No. 929 are as follows: 1. Local contractors contribute substantially to the development program of the country; 2. Local contractors are at a disadvantage in competitive bidding with foreign contractors in view of limited capital and financial resources; 3. In order to be able to compete with big foreign contractors, it may be necessary for them to enter into joint ventures to pool their limited resources in undertaking big construction projects; and 4. To assist them in achieving competitiveness with foreign contractors, the joint ventures formed by them should not be considered as a taxable entity. "General professional partnerships as well as joint ventures or consortia engaged in construction and energy-related activities are not considered as separate taxable entities. 42


39

rule is not suited in the conduct of activities by banks which perform regular banking activities through the Regular Banking Unit (RBU) and at the same time have Foreign Currency Deposit Units (FCDU) dealing in foreign currency transactions. 44

While the FCDU is considered not as a branch but just a unit or division of the Bank, the taxability of the transactions undertaken by the FCDU materially differs from activities conducted by the bank's RBU. Hence, a bank which is authorized to operate an FCDU is considered for income tax purposes to have dual tax status. As a matter of fact, the FCDU is considered as a separate taxable unit under Revenue Regulations No. 10-98 that must have its own T I N . The income of the bank from its RBU is subject to the regular income tax rate or MCIT, as the case maybe, under Section 27 (Rates of Income Tax on Domestic Corporations) or 28 (Rates of Income Tax on Foreign Corporations) of the Tax Code. However, income derived under the Expanded Foreign Currency Deposit System from foreign currency transactions with local commercial bank, including branches of foreign banks authorized by Bangko Sentral ng Pilipinas (BSP) to transact business with FCDUs and other depository banks under the expanded foreign currency deposit system, including interest income from foreign currency loans granted by FCDUs to residents, are subject to a final tax at the rate of ten percent (10%) of such income pursuant to Sections 27(D)(3) and 28(A)(7)(b) of the Code, while other FDCU income which could not be classified as either onshore or offshore is subject to the regular income tax rate under Section 27(A) or (E), or 28(A)(1) or (2), as the case may be. In order to distinguish the FCDU transactions from the RBU transactions of the Bank, the current regulations require banks to file an income tax return (BIR Form 1702) exclusively for its RBU transactions and another income tax return (BIR Form 1702) covering its FCDU transactions income subject to the 10% rate and other income of the FCDU subject to the regular corporate income tax rate, as described in the preceding paragraph, for the same taxable year. A bank with an FCDU must file two income tax returns for the same taxable year but covering the two different types of income, namely: the FCDU income and the RBU income. In case of interest income from foreign currency loans granted to residents where the 10% tax has already been withheld in accordance with Section 58 "RMC 14-2002, Apr. 10, 2002.

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(Returns and Payment of Taxes Withheld at Source) of the Tax Code, where the payor-borrower is constituted as the withholding agent charged with the obligation of deducting, withholding and remitting to the BIR the tax due thereon, such interest income shall be reported in the income tax return of the FCDU for information purposes. However, a copy of the withholding tax return filed, together with the copy of the official receipts denoting payments thereon, and the Certificate of Final Tax Withheld at Source (BIR Form 2306) shall be furnished directly to the FCDU concerned, which shall in turn submit to the BIR said documents, together with a statement/schedule showing a list of all its domestic borrowers, amount borrowed interest income thereon and the tax withheld and remitted by the withholding agent. The statement shall be filed together with the income tax return (BIR Form 1702Q/1702) required above. A Foreign Currency Deposit Unit final consolidated/annual return (BIR Form 1702), covering the total taxable income referred to in Sections 27(D)(3) and 28(A)(7)(b), independent of the income of the RBU for the preceding calendar or fiscal year, shall be filed on or before the 15th day of the fourth month following the close of the bank's taxable period. The tax shown on the final or annual tax return, after deducting therefrom the quarterly income taxes paid and withheld during the preceding three quarters of the same taxable year, shall be paid upon filing of the return. The statement showing the details of Onshore and Offshore income and other income required under Section 69 of Revenue Regulations No. 10-1976 shall be attached to the annual return (BIR Form 1702), irrespective of whether the income was subjected to final withholding tax or not. In reporting the taxable income earned by the FCDU from foreign currency transactions subject to the tax rate of ten percent (10%), such income shall be presented under Special Rate Column provided in BIR Form Nos. 1702Q and 1702. Other income earned not classified as either onshore or offshore shall be subject to the normal income tax rate and accordingly be presented under the Regular Rate Column of the said BIR Forms. Local Water Districts Local Water Districts are subject to the corporate income tax despite the fact that they are government-owned or controlled corporations incorporated as public utilities, since they are not composite of the essential government functions as contemplated


41

by laws. Besides, the income tax exemption privilege granted to local water districts was limited to a period of five (5) years from the effectivity of R.A. No. 7109 on August 13, 1996. 45

Partnership Taxable as a Corporation Except for a general professional partnership and an unincorporated joint venture or consortium engaged in construction or energy projects under Section 22(B) of the Tax Code, which in reality is also a partnership, the Tax Code mandates that every other type of business partnership is subject to income tax in the same manner and at the same rate as a corporation. In other words, the provisions in civil law regarding the organization, legal relationships between or among partners, and extent of the partners' liabilities to its creditors, among others, are effectively disregarded for income tax purposes. Indeed, the Tax Code attempts to place on similar footing a business partnership and an ordinary corporation, by imposing the 10% dividend tax on the actual distribution of undistributed partnership profits to the partners. Thus, profits actually distributed by a business partnership to the partners during the year they are earned are taxable as dividend income subject to the 10% tax, but the undistributed partnership profits are not subject to the 10% tax on dividends until they are actually distributed to the individual partners. In view of the foregoing, there seems to be an unintended benefit granted to the partners of a business partnership who would be taxed at 10% only on the partnership profits actually distributed during the year compared to the partners of a general professional partnership who would be taxed on their entire share of the general professional partnership profits, whether distributed or not during the same taxable year. However, it is worthwhile to note that the business partnership net income is subject to the 30% regular corporate income tax, while the net income of a general professional partnership is exempt from income tax.

Joint Venture and Consortium To constitute a "joint venture," certain factors are essential. Thus, each party to the venture must make a contribution, not necessarily of capital, but by way of services, skill, knowledge, material or money; profits must be shared among the parties; there must be a joint proprietary interest and right of mutual control over "BIR Ruling No. 074-98, May 27, 1998; RMC 62-2003, Oct. 10, 2003.


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the subject matter of the enterprise; and usually, there ia single business transaction. 46

Exempt Joint Venture or Consortium Exempt joint venture is an unincorporated joint venture engaged in construction or energy-related project. — The term "joint venture or consortium," referred to in Section 22(B) of the Tax Code that is not considered as a separate taxable entity, means an unincorporated entity formed by two or more persons (individuals, partnerships or corporations) for the purpose of undertaking construction project or engaging in petroleum and other energy operations with operating contract with the government. Since it is not considered as a separate taxable entity, the net income or loss of the joint venture or consortium is taken up and reported by the co-venturers or consortium members in accordance with their participation in the project as set forth in their agreement. The two elements — unincorporated entity (or entity not registered with the Securities and Exchange Commission) and for the purpose of undertaking construction or energy-related project — must be present in order that the joint venture or consortium may not be considered as a separate taxable entity. Foreign joint venture not selling services in the Philippines. - A joint venture or consortium formed among nonresident foreign corporations in connection with a local project in the Philippines is not subject to Philippine income tax, where said foreign joint venture or consortium does not sell goods nor perform any service in the Philippines. This rule is anchored on the fact that a foreign corporation is taxable only on income from sources within the Philippines. Accordingly, no withholding tax is required to be deducted and withheld by the Philippine payor from income payments to the foreign joint venture or consortium in such a case. 47

Exempt joint venture may become taxable partnership. An exempt joint venture or consortium undertaking a construction of office tower project may subsequently become subject to income tax as a separate joint venture or consortium, where after the construction period, the joint venture partners engaged in the business of leasing the building floors or portions thereof separately owned by them. The 48

'BIR Ruling No. 317-92. 'BIR Ruling No. 23-95. 'BIR Ruling No. 317-92, Oct. 28, 1992.


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tax exemption of the joint venture granted under the law is valid only up to the completion of the construction project and does not extend to the sale or lease of the developed condominium floors or units to customers after the completion of the project. Books of accounts and records of exempt joint venture. - Since there is no implementing regulation for this particular provision, a joint venture or consortium may: (a) maintain and keep a separate set of books for the project and the share of the joint venture or consortium member in the net income or loss of the venture or consortium at the end of the year may be reported by it in its income tax return, or (b) choose not to maintain a separate set of books for the joint venture or consortium and record all its transactions relating to the project in its own books of accounts. In any case, it appears that the joint venture or consortium is not required under existing rules to file an information return for the project.

Examples of Unincorporated Joint Venture

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Project to construct condominium building on land belonging to another ZEB and PBR executed a Memorandum of Agreement, whereby ZEB contributes to the construction project three parcels of land located at Mandaluyong City, while PBR shall develop, erect and construct two 5-storey buildings on the land in accordance with R.A. No. 4726, otherwise known as The Condominium Act. Upon completion of the condominium buildings and as a return of the contributions made by the parties to the construction project, specific floors or portions of the floors in the condominium buildings will be allocated in separate ownership between ZEB and PBR. The parties will form a condominium corporation that will hold title to, manage, and maintain the land and the common areas. For this purpose, the parties will transfer the land and the common areas to the condominium corporation, without any monetary consideration, by executing a Deed of Conveyance in favor of said corporation. 50

GTPI, which owns eight parcels of land, will enter into a joint venture agreement with SLRDC to develop the parcels of land into 49

In view of the liberal interpretation given to the term "construction project" as shown in the following examples, reclamation of land projects undertaken by private contractors for the Phillipine Reclamation Authority (formerly Public Estate Authority), NHA, or LGU fall within the meaning of the term. B I R Ruling DA-207-04-05-99; BIR Ruling 018-99, Feb. 11, 1999. M


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a subdivision. Under the agreement, the developer will shoulder the cost to develop the land; title to the properties will remain in the name of the landowner with the joint venture agreement annotated on the titles; both parties agree to share in the proceeds of sale; both parties shall at all times maintain separate ownership of their individual resources and properties contributed in undertaking said project; and both parties shall keep and main separate books of accounts for each party to monitor their cost and expenses in the project. 51

Project to develop land belonging to another into residential subdivision RLC, as Owner, and THDC, as Developer, entered into an Exclusive Development and Marketing Agreement, whereby several parcels of land owned by RLC will be developed into a residential subdivision and/or other land uses by T H D C . The Owner and Developer shall share in the project by dividing the saleable lots between themselves so that the Developer shall be entitled to 60% of the saleable lots and the Owner, 40%. The Developer and Owner shall agree on the specific lots that will pertain to each. The Developer shall have the right to build housing units on the saleable lots of the Owner. Proceeds of the housing units shall belong to the Developer while the proceeds from lots sales remains for the benefit of the Owner. ULI, JLI, and GDC entered into an agreement for the development of the properties owned by U L I and JLI into a single, unified and integrated residential subdivision project. 52

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Project to Construct Light Rail Transit The Philippine government was considering the construction of a Light Rail Transit System (LRT System) in Manila. As owner, the government issued on March 24, 1979 a call for bids relative to the rolling stock, tracks, certain electrical and mechanical equipment to spare parts and to technical assistance of the owner. As a result of said call for bids, Belgian Consortium (BC) consisting of the following Belgian companies: Ateliers de Constructions Electriques de Charleroi S.A., Chuissee de Charleroi, Constructions Ferroviaires et Metalliques, BN S.A., Transurb Consult, Tractionel Engineering International S.A., was formed to submit a bid and was designated 61

52

53

BIR Ruling DA-187-03-25-99. BIR Ruling DA-263-05-05-99. BIR Ruling DA-165-03-18-99.


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as having the first priority to negotiated with the government for award of the contract. Construction Development Corporation of the Philippines (CDCP renamed as PNCC) was designated as contractor for civil works portion of the LRT System. Consequently, BC and CDCP decided to join their skills and efforts to negotiate a contract in pursuance of the wish of the government, and in case of award, to implement the construction of the LRT System. BC and CDCP agreed to set up an Association governed by an Agreement executed by them on February 11,1980, the purpose of which is to prepare the contract for the LRT System in agreement with the Owner, the negotiation, execution and implementation of the contract between the Owner and the Association. Said Agreement apportions the scope of work to be executed by BC and PNCC. BC shall undertake the conceptual design of the system, detailed design of the equipment to be supplied by it, design of the track as well as the supply of electromechanical components therefor. PNCC shall undertake the detailed engineering and architectural design of all civil works of the LRT System. As leader of the Association, PNCC agreed to pay BC a leadership fee and service fees for the supply of specialis+s and experts during the period of construction. The joint venture between BC and PNCC for the purpose of undertaking a construction project is exempt from income. BC, having been formed by Belgian companies to undertake portions of said construction project, is also exempt from income tax. Such being the case, the leadership fee paid by PNCC to BC is not subject to Philippine income tax. For the same reasons, gross payments either to the joint venture of BC and CDCP or to BC are not subject to the expanded withholding tax law prescribed by Section 51 of the Tax Code, as amended by PD 1351 and its implementing regulations. 54

Project to rehabilitate road RMCC, a domestic corporation engaged in general construction business, and FEMCO, an American corporation incorporated in the State of Delaware and authorized by the SEC to do business in the Philippines, have entered into a joint venture agreement for the purpose of participating in the bidding for the rehabilitation of the Calamba-San Pablo City road. It was awarded the contract. 55

M M

B I R Ruling No. 115-86, July 17, 1986. B I R Ruling No. 115-86; BIR Ruling No. 274-92.

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Sumulong drainage outfall project CBC and an individual formed a joint venture for the construction of the drainage project.

Common Rulings Involving Joint Ventures and Consortia Allocation of floors, units, or lots to joint venture partners is mere return of capital. - The joint ventures described above are not subject to the corporate income tax under Section 27 of the Tax Code, since the term "corporation" does not include a joint venture or consortium formed for the purpose of undertaking construction projects pursuant to Section 22(B) of the Tax Code. Accordingly, the memorandum of agreement, joint venture agreement, or exclusive development and marketing agreement between or among the contracting parties, as the case may be, will not give rise to a taxable joint venture, and the allocation of specific floors or units or subdivision lots in the project is not a taxable event and is not subject to income tax and expanded withholding tax, because the allocation is a mere return of the capital that each party has contributed to the project. Distribution of developed units/lots is merely an act of partitioning commonly owned property. - Joint venture agreements for the construction and development of real property may or may not be treated as a separate taxable unit, depending on whether or not a separate taxable entity is established by the joint venture partners. If the parties did not form a separate entity and merely agreed to pool their resources to a common fund, no separate taxable unit is created. In this case, each joint venture partner has to account for his respective share in the net revenue earned from the joint venture project separate from other joint venture partners. Hence, the partners may file separate income tax returns for its net revenue for the project less its respective proportionate share in the joint venture expenses. The contribution of land to the joint venture is not a taxable event that will give rise to capital gains tax on sale or transfer of land. Such transfer is similar to a capital contribution that does not give rise to income tax. The distribution of developed lots/ units is merely an act of partitioning the commonly owned property. It is nothing more than an act of terminating the co-ownership by making each partner specific owner of the identifiable lot or unit. At this stage, no taxable sum has yet been realized by the joint venture partners. That act of allocation or assigning portions of the developed lots to each member of the joint venture cannot be treated as a taxable


47

event. The same is true despite the fact that the shares allocated to or received by the partners may not necessarily correspond to the lot area originally contributed by them to the joint venture. Hence, the titling of the land back to the joint venture partners is not subject to income tax, expanded withholding tax, and value added tax. 56

Sale of developed floor, unit or lot is subject to income tax. - Should the landowner or developer sell any of the floors or portions of the floors allocated to them to third parties at any stage of construction or after its completion, the gain that may be realized by them from such sale will be subject to the regular corporate income tax and to the expanded withholding tax under Revenue Regulations No. 2-98, as amended. 57

The marketing agreement provides that the Developer shall have exclusive marketing rights over all saleable lots of the property, including the 40% share of the Owner. Inasmuch as the term "marketing" includes but is not limited to the determination of marketing policies, pricing, terms and conditions of sale, restrictions to be annotated on the titles of lots, documentation and collection of proceeds of sales, the Developer may exec ite the Deed of Absolute Sale in its name in order to transfer title to the property in the name of the buyers with regard to its share in the saleable lots as well as the 40% share of the Owner, Provided, That it should be stated in the Deed of Absolute Sale that the Developer is acting as Attorneyin-Fact for the 40% share of the Owner, notwithstanding the fact that in the latter case, titles to the properties may still be in the name of the Owner. Such being the case, the expanded withholding tax, documentary stamp tax, and value added tax paid thereon may be credited in the name of the Owner. The Revenue District Officer of the revenue district where the properties are located is authorized to issue the corresponding Tax Clearance Letter (TCL) or Certificate Authorizing Registration (CAR) with regard to the sale of real properties pertaining to their respective shares upon presentation of the evidence of payment of the expanded withholding tax, documentary stamp tax, and value added tax.

Taxable Joint Venture or Consortium A domestic corporation jointly owned by individuals and by two or more existing domestic corporations and/or foreign corporations M

B I R Ruling DA-165-03-18-99. "BIR Ruling NOB. 274-92, Sept. 30, 1992 and UN-025-95, Jan. 11, 1995.


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that is incorporated or duly registered with the Securities and Exchange Commission is a taxable corporation, even if it is engaged in the business of construction or energy-related activity. If the unincorporated joint venture or consortium (or unregistered partnership) is engaged in any other line of business than construction or energy-related activity with operating contract with the government, the same will also be treated as a taxable corporation. Its income and expenses must thus be reported by it during the taxable year. Illustrative Cases: Joint emergency operations between two bus companies. - The joint emergency venture between Batangas Transportation Company and Laguna Bus Company, two separate corporations engaged in the business of land transportation, was considered a partnership taxable as a corporation, when the two companies were placed under one sole management as though constituted a single entity thereby obtaining substantial economy and profits in the operation (Collector vs. Batangas Transportation Co., L-9692, Jan. 6,1958, 102 Phil. 822)™ Purchase of sweepstakes ticket. — Fifteen persons contributed small amounts to purchase a two-peso sweepstakes ticket with the agreement that they would divide the prize. The ticket won the third prize of P150,000. Having organized and constituted a partnership of a civil nature, said entity is the one bound to pay the income, and the court considered without merit the contention that the tax should be pro-rated among them and paid individually, which would have resulted in their exemption from the tax (Gatchalian vs. Collector, 67 Phil. 666). [NOTE: Sweepstakes prizes were not yet exempt from income tax at that time. They are currently exempt from income tax.] 59

Lease of properties under common management. Three sisters borrowed money from their father and bought twenty-four (24) pieces of real property that they leased to various tenants for over fifteen years and derived rentals therefrom. 58

See BIR Ruling Nos. 187-82, June 3, 1982; 115-86, July 17, 1986; 069-90, May 9, 1990; and 254-91, Nov. 26, 1991. Sec. 24(B)(1), NIRC. 59


49

They appointed their brother to manage their properties and to collect and receive rents. The court ruled that a taxable partnership was formed. There were series of transactions where petitioners purchased twenty-four lots, showing that the purpose was not limited to the conservation of the common fund or even the properties acquired by them. The character of habituality peculiar to business transactions engaged in for the purpose of gain was present. The properties were leased out to tenants for several years. Moreover, the term "corporation" includes organizations that are not necessarily "partnerships" in the technical sense of the term as well as partnerships, no matter how created or organized. This qualifying expression clearly indicates that a joint venture need not be undertaken in any of the standard forms, or in conformity with the usual requirements of the law on partnerships, in order that one could be deemed constituted for purposes of the tax on corporations (Evangelista vs. Collector, 102 Phil. 140). When a father and son purchased a lot and building, entrusted the administration of the building to an administrator and divided equally the net income, there is a taxable partnership (Reyes vs. Commissioner, 24 SCRA 198). Insurance pool or clearing house. - An insurance pool or clearing house, composed of 41 non-life insurance corporations, whose role was limited to its principal function of allocating and distributing the risks arising from the original insurance among the signatories to the treaty or the members of the pool on their ability to absorb the risks ceded as well as the performance of incidental functions, such as records, maintenance, collection and custody of funds, and which did not insure or assure any risk in its own name, was treated as a partnership or association subject to tax as a corporation. Article 1767 of the Civil Code recognizes the creation of a contract of partnership when "two or more persons bind themselves to contribute, money, property, or industry to a common fund, with the intention of dividing the profits among themselves. Its requisites are mutual contribution to a common stock, and a joint interest in the profits (AFISCO Insurance Corp., etal. vs. Commissioner, G.R. No. 112675, Jan. 25, 1999). Article 1768 of the Philippine Civil Code expressly provides that a partnership has a juridical personality separate and distinct from that of each of the partners, even in case of failure


50

to register with the Securities and Exchange Commission. The separate personality given by law to a joint venture, whether incorporated or not, allows it to contract and own properties in its own name. 60

Agreement to manage and operate mine denominated as 'Power of Attorney.' - Philex Mining Corporation entered into an agreement denominated as "Power of Attorney" with Baguio Gold Mining Corporation to manage and operate the latter's mining claim. In managing the project, Philex made advances of cash and property. The mine suffered continuing losses resuling in Philex's withdrawal as manager and cessation of mine operations. A "Compromise with Dation in Payment" was executed by the parties, where Baguio Gold admitted its liabilities to Philex and agreed to pay the same. Philex wrote off in the books the remaining outstanding indebtedness of Baguio Gold by charging a portion of the amount to allowances and reserves that were set up in 1981 and a portion to the 1982 operations. The amount allocated to 1982 was deducted from the 1982 gross income as "loss on settlement of receivables." But the BIR disallowed the deduction for bad debt and assessed Philex deficiency taxes because the advances are Philex's investment in a partnership with Baguio Gold for the exploitation and development of the mine. The totality of the circumstances and the stipulations in the parties' agreement indubitably lead to the conclusion that a partnership was formed between the parties. First, it does not appear that Baguio Gold was unconditionally obligated to return the advances made by Philex under the agreement. Second, the Tax Court correctly observed that it was unlikely for a business corporation to lend hundreds of millions to another corporation with neither security nor collateral or a specific deed evidencing the terms and conditions of such loans. The parties also did not provide for a specific maturity date for the advances to become due and demandable, and the manner of payment was unclear. Third, the strongest indication that Philex was a partner is the fact that it would receive 50% of the net profits as "compensation" under the agreement (Philex Mining Corp. vs. Commissioner, G.R. No. 148187, Apr. 16, 2008).

'Philippine Corporate Law by C. Villanueva, p. 730.


51

Foreign Corporations There are two (2) types of foreign corporations under the Tax Code, namely: (1) resident foreign corporation; and (2) non-resident foreign corporation. Foreign corporations are corporations organized or formed under the laws of a foreign country, even if owned wholly by Filipino citizens or Philippine nationals.

Resident Foreign Corporation A "resident foreign corporation" is a foreign corporation engaged in trade or business within the Philippines. Thus, the term "resident" is used to describe a corporation organized under the laws of a foreign country which does business in the Philippines, and it is not being used in its ordinary meaning that the foreign corporation acquires residence or domicile in the Philippines. It cannot acquire "residence" in its common meaning precisely because it is formed under the laws of a foreign country. A good example of a resident foreign corporation is the Philippine branch of a foreign corporation. The Philippine branch is owned wholly by the foreign head office (i.e., non-resident foreign corporation) and does not have n( r issue Philippine shares of stocks. The Philippine branch of a foreign corporation is merely an extension of the foreign corporation in the Philippines. There is only one single entity to speak of. However, for income tax purposes, only the income of the Philippine branch from sources within the Philippines is subject to Philippine income tax, and the income of the Philippine branch as well as that of the foreign head office from sources outside the Philippines are exempt from the Philippine income tax. Corollarily, the gross income from sources within the Philippines of the foreign head office is subject to the final income tax that must be withheld and remitted to the BIR by the Philippine payor, unless such income of the foreign head office is attributed and thus taxed to the Philippine branch, while its income from sources outside the Philippines shall be exempt from Philippine income tax. 61

Types of Resident Foreign Corporations There are two (2) general types of resident foreign corporations: (1) those exempt from income tax because they are not engaged in trade or business in the Philippines; and (2) those that are subject to income tax at (a) 10% preferential tax rate, or (b) 30% regular corporate income tax rate or 2% minimum corporate income tax "Sec. 22(H), NIRC.

52


rate, whichever is higher. Falling under the first category are the regional or area headquarters pursuant to E.O. No. 226, as amended by R.A. No. 8756, representative offices, and regional warehouses of multinational corporations in the Philippines. They are exempt from income tax because they are supposed not to engage in trade or business in the Philippines and thus do not derive income from sources within the Philippines. Falling under the second category are Philippine branches of foreign corporations engaged in trade or business in the Philippines. The regional operating headquarters of multinational corporations in the Philippines are authorized to sell various services to their affiliates, subsidiaries or branches within the Asia-Pacific Region and their net taxable income from sources within the Philippines are subject to the 10% preferential income tax. Also, OBUs are taxed on their onshore interest income at 10% final withholding tax. All other types of Philippine branches of foreign corporations are subject to the 30% corporate income tax based on their net taxable income from sources within the Philippines starting in January 2009, unless the 2% minimum corporate income tax that is computed at 2% of their gross income from sources within the Philippines is higher than the normal corporate income tax.

Offline International Air Carrier

62

The issue of whether or not an offline international air carrier that did not pick up passengers departing from the Philippines to several foreign destinations can be considered as doing business in the Philippines was finally resolved by the Supreme Court. Thus, in the leading case of British Overseas Airways Corporation (BOAC) vs. Commissioner (G.R. L-65773, Apr. 30,1987,149 SCRA 395), the court ruled that BOAC is considered as a resident foreign corporation. The term "doing business" implies a continuity of commercial dealings and arrangements, and contemplates, to that extent, the performance of acts or works or the exercise of some of the functions normally incident to, and in progressive prosecution of commercial gain or for the purpose of business organization. In order that a foreign corporation may be regarded as doing business within a State, there must be continuity of conduct and intention to establish a continuous business, such as the appointment of a local agent, and not one of a temporary character. The activity that produces the income is the sale of tickets " A n off-line international carrier is a foreign air carrier that has no landing rights in the Philippines and is not issued a license to do business in the Philippines by the Civil Aviation Board.


53

in the Philippines by its general sales agent. The tickets exchanged hands here and the payments for fares were also made in the Philippines in Philippine currency. As the flow of wealth proceed from and occurred within the Philippine territory, it should share the burden of supporting the government because of the protection accorded to it by the government. The same rule was reiterated by the Supreme Court in the other succeeding cases where the offline international carrier had liaison office, agency or branch in the Philippines. 63

Philippine branch is merely an Extension of the Foreign Head Office The general rule is that the head office of a foreign corporation is the same juridical entity as its branch in the Philippines following the "single entity concept." The income from sources within the Philippines of the foreign head office shall thus be taxable to the Philippine branch. But when the head office of a foreign corporation independently and directly invested in a domestic corporation without the funds passing through its Philippine branch, the taxpayer with respect to the tax on dividend income would be the foreign corporation itself and the income shall be subject to the tax similarly imposed on non-resident foreign corporations (Marubeni Corporation vs. Commissioner, G.R. L-76573, Sept. 14,1989, 177 SCRA 500).

Branch Profit Remittance Tax To equalize the tax burden on foreign corporations maintaining, on one hand, local branch offices, and organizing, on the other hand, a subsidiary domestic corporation where at least a majority of all the latter's shares of stock are owned by such foreign corporations, the 15% branch profit remittance tax is imposed on the profit actually remitted by the Philippine branch to its head office (Bank of America N.T. and S.A. vs. Court of Appeals, et ah, G.R. No. L-103092, July 21, 1994, 234 SCRA 302). Effective January 1,1998, the tax base of the 15% branch profit remittance tax imposed on profit remitted by the Philippine branch to its foreign head office is the total profit, applied or earmarked for remittance without any deduction for the tax component thereof ^ 6

63

See Commissioner vs. Air India, 157 SCRA 648; Commissioner vs. American Airlines, 180 SCRA 264; Japan Air Lines vs. Commissioner, G.R. No. L-30041, Feb. 3,1969. "Prior to R.A. No. 8424 (Jan. 1,1998), only the amount of profit actually remitted abroad was ruled by the courts subject to the 15% branch profit remittance tax. The


54

(except those activities which are registered with the Philippine Economic Zone Authority). Revenue Regulations No. 2-98 also exempts from the branch profit remittance tax enterprises registered with the Subic Bay Metropolitan Authority (SBMA), the Clark Development Authority (CDA), and other freeport zone authorities which are covered under R.A. No. 7227, as amended. The interest, dividends, royalties, and other income, gain or profit received by a foreign corporation from sources within the Philippines shall not be treated as branch profits, unless the same are effectively connected with the conduct of its trade or business in the Philippines. Because of the express grant of tax exemption from the branch profit remittance tax to the Philippine branch of a foreign corporation located in a special economic zone or freeport zone, which by fiction of law is treated as a foreign territory, foreign investors that have manufacturing or other business operations inside said special economic zone or freeport zone should have special bias for doing business inside the zones through a branch (rather than through a subsidiary). 65

The branch profit remittance tax applies whether the remittance of profit is done actually or constructively, as when the Philippine branch of a foreign banking corporation did not actually remit the profit to its foreign head office because such profit was made part of the assigned capital of the foreign head office in the Philippine branch (ING Bank [Manila Branch] us. Commissioner, CTA Case No. 6017, Mar. 11, 2002). Any form of remittance of profit, direct or indirect, made to the head office abroad shall be presumed to come from accumulated profits of the Philippine branch. 66

Capital gains derived by Oxbow Mindanao Power I and Oxbow Mindanao Power II from the sale of their respective interests in Mindanao Geothermal Partnerships (MGP I and MGP I I ) in which the capital gains tax had been paid, are not subject to the branch profit remittance tax. 67

tax is imposed on the amount sent abroad and the law calls for nothing further (Bank of America NT & SA vs. Commissioner, G.R. Nos. 103092 and 103106, July 21,1994). Sec. 28(A)(5), NIRC. P.D. No. 778 and Sec. 2, Rev. Regs. No. 8-75, Oct. 29, 1975. "BIR Ruling No. 055-2001, Dec. 4, 2001. The author has some reservations to this ruling, considering that the branch profit remittance tax is imposed on the profit remitted by the Philippine branch to its foreign head office. It does not matter whether such profits come from sale of ordinary assets subject to the normal corporate income tax or from sale of capital assets subject to the capital gains tax. 65

66


55

Subsidiary and Branch of a Foreign Corporation Compared 1. Tax base and rate on dividend or profit remittance. - Dividend paid by a domestic corporation to a resident foreign corporation is not subject to income tax. If paid to a non-resident foreign corporation, the final withholding tax rate on gross dividend income is 30%, although this rate may be reduced to 15%, if the country of residence of the foreign corporation will allow the tax "deemed paid" to the Philippine government as a credit against the foreign income tax of the foreign corporation or the foreign government does not impose income tax on offshore dividend. The branch profit is remitted by the Philippine branch to its foreign head office. Generally, the 15% branch profit remittance tax is imposed upon remittance of the branch profit. Remittance of profit may be actual or constructive, direct or indirect. The basis of the tax beginning January 1, 1998 is the total profits applied or earmarked for remittance without deduction for the branch profit remittance tax. 2. Existence of retained earnings and formality required. — The dividend must be declared by the Board of Directors of the paying corporation out of its retained earnings; hence, there must be unappropriated retained earnings from which the dividends could be paid out before a corporation could declare dividends. There is no board resolution necessary for the remittance of the branch profits to the foreign head office. If compensation for services that are done by the Philippine branch in the Philippines for a foreign client is paid directly by said foreign client to the foreign head office of the Philippine branch, there is already a constructive remittance of the profit. There must be a branch profit that can be remitted to the foreign head office; without such branch profit, any remittance made represents return of capital. 3. Source of dividend or profit. - The source of dividend must be specified in the board resolution declaring the dividend; otherwise, the law presumes that it comes from the latest accumulated earnings. There is no similar provision with respect to branch profit remittance. However, interests, dividends, rents, royalties, and other income of the branch shall not be treated as branch profits, unless


56

68

the same are effectively connected with the conduct of its trade or business in the Philippines. Thus, profits that are not effectively connected with the conducts of its trade or business in the Philippines are not subject to the branch profit remittance tax. 4. Retained earnings before 1998. - Accumulated retained earnings as of December 31,1997 of a subsidiary are not subject to 10% final withholding tax when a citizen, resident alien, or to 20%, when a non-resident alien engaged in trade or business in the Philippines, receives the dividend even in 1998 or subsequent years. Accumulated branch profits as of December 31,1997 are subject to the branch profits remittance tax if remitted in 1998. There is no provision similar to dividends that only branch profits earned on or after 1998 shall be subject to the tax. 5. Legal personality and attribution of income. — A subsidiary is an entity separate and distinct from its stockholders. It can deal with its foreign parent company, provided that the transactions are at arm's length. There would be no attribution of the income of the subsidiary to the foreign parent company because of the separate entity concept. Interest paid by the subsidiary on a loan granted by the foreign parent company is deductible from the subsidiary's gross income, while the interest income paid to the foreign parent company shall be subject to the final withholding tax. The Philippine branch is merely an extension of the foreign head office. Because of the single entity concept, the transactions and income of the Philippine branch may be attributed to the foreign head office based on a formula stated in Revenue Audit Memorandum Order No. 1-95. Interest paid by the Philippine branch on a loan extended by the foreign head office is not deductible from the branch's gross income. Corollarily, the interest income of the foreign head office is not subject to Philippine withholding tax in accordance with the tax treaty provisions. 69

6. Allocation of overhead expenses. — The overhead expenses of a regional office of a foreign corporation may be allocated 6

"Income is "effectively connected" if it is derived from assets which are used in or held for use in the Philippines, and the business in the Philippines is a material factor in the realization of the income. The "force of attraction rule" adopted by the BIR under RAMO 1-86 was discarded in favor of a more reasonable interpretation of income of a branch or liaison office under RAMO 1-95. 6s


57

to the different subsidiaries and affiliates in the Asia-Pacific Region. 70

The overhead expenses of a foreign head office may be allocated to its branches located worldwide, including the Philippine branch, provided that the international external auditor of the foreign head office certifies to the correctness of the figures used in the allocation, the deductions pro-rated to the Philippine branch do not include net losses of any operating unit or branch, income tax, capital expenditures, and expenses directly attributable to any branch, and that the method used (gross income or net sales in the Philippines over total gross income or total net sales worldwide) in allocating overhead expenses among its branches worldwide is consistent from year to year. 71

7. Creation of permanent establishment. - A subsidiary is generally not treated as a permanent establishment of the foreign parent company, provided that the transactions between them are at arm's length. 72

A Philippine branch is a permanent establishment; hence, treated as a resident foreign corporation subject to Philippine income tax on net income from sources within the Philippines. 8. Basis of income taxation. - A subsidiary is taxable on worldwide income at 30% of its net taxable income. A branch is taxable on its income from sources within the Philippines at 30% of its net taxable income. There are exempt branches (e.g., regional area headquarters and representative offices) and special branches subject to preferential tax rates of 10%. 9. Entitlement to income tax holiday. - A subsidiary is entitled to income tax holiday under the Board of Investments (BOI) law and the Build-Operate-Transfer (BOT) law. A branch is not so entitled to income tax holiday under the BOI and BOT laws. It is entitled to income tax holiday under the PEZA law and BCDA law. 10. Stockholder's extent of liability. - The stockholder of a subsidiary is liable only to the extent of his/its subscription in 70

BIR Ruling No. 079-99, June 20, 1999. Rev. Regs. No. 16-86, Sept. 26, 1986. An 'arm's length price' is the price independent or unrelated parties would have agreed upon under the same or similar circumstances. 71

72


58

such corporation. Shares of stock of the corporation are issued to ita stockholders. The foreign head office is liable for the liabilities of the Philippine branch; hence, the assets of the head office may still be reached by creditors of the Philippine branch. No shares of stock are issued by the Philippine branch to its head office. 11. Cash or security deposit with SEC. - There is no deposit required to be made by a subsidiary of a foreign corporation. The Philippine branch of a foreign corporation is required to put up a deposit of Phpl00,000 or 2% of its gross sales or receipts under the Corporation Code of the Philippines. 12. Administrative requirements and filing of audited financial statements. - Being engaged in business in the Philippines, both domestic corporation and branch of a foreign corporation in the Philippines are subject to the administrative requirements, such as: (a) registration as a V A T or non-VAT taxpayer and withholding agent with the BIR office exercising jurisdiction over it; (b) secure T I N for itself, which is different from the T I N of its agent in the Philippines; (c) Register its books of accounts and other accounting records, including sales invoices and receipts, with the BIR; (d) File tax returns and pay taxes; and withhold and remit taxes to the BIR on compensation and income payments subject to income tax. Its books of accounts and accounting records are mandated to be audited by an independent Certified Public Accountant.

Non-Resident Foreign Corporation A "non-resident foreign corporation" is a foreign corporation not engaged in trade or business within the Philippines but deriving income from sources within the Philippines. Thus, the term "nonresident" means "not engaged in trade or business in the Philippines." Except as otherwise provided for in the Tax Code, gross income from sources within the Philippines paid to a non-resident foreign corporation, shall be subject to the 30% final corporate income tax that must be withheld by the Philippine payor of the income and remitted to the BIR. 73

Foreigners owning condominium units and leasing these out to others and deriving income therefrom fall under the status of "non'Sec. 22(1), NIRC.


59

resident foreign corporations doing business in the Philippines." These "investors" can hire the services of a fiduciary who will file their income tax returns which shall indicate only rental income representing income realized from the lease of their condominium units. The Taxpayer Identification Number ( T I N ) of the fiduciary shall suffice to effect the withholding of the income tax from the remittance of rental income to the foreign investors. 74

"BIR Ruling No. 101-96, Oct. 4,1996. The ruling erroneously describes the lessor aa a "non-resident foreign corporation doing business in the Philippines." In reality, it is a "resident foreign corporation" and must file tax return through a fiduciary. Being a resident foreign corporation, it shall be taxed on its net taxable income from sources within the Philippines.

CHAPTER I V GROSS INCOME

Chapter IV (Gross Income) covers the various items of gross income as well as the sources and types of income, gain or profit. The following sections of the Tax Code are relevant in the study of items of income:

A.

1.

Section 31 - Taxable income;

2.

Section 32(A) - Gross income definition;

3.

Section 33 - Special treatment of fringe benefits;

4.

Section 39 - Capital gains and losses;

5.

Section 40 - Determination of amount and recognition of gain or loss;

6.

Section 42 - Income from sources within and without the Philippines; and

7.

Section 73 - Distribution of dividends or assets by corporations.

Gross Income "Gross income" means income, gain, or profit subject to income tax. It includes compensation for personal services, business income, profits, and income derived from any source whatever (whether legal or illegal), unless it is exempt from income tax by law or it is subject to final withholding income tax in accordance with the semi-global or semi-schedular tax system adopted by the Philippines. It is the difference between Gross Sales (for sellers of goods) or Gross Revenue (for sellers of services) and the Cost of Goods Sold and Cost of Services. The 1

'Proceeds of an embezzlement and income from an illegal business, swindling operations, extortions, drug operations, gambling, or bribery are taxable.

60

GROSS INCOME

61

definition of gross income is broad and comprehensive to include proceeds from sales of transport documents. 2

The above definition is the definition used for purposes of computing the regular corporate income tax (RCIT). The term "gross income" for purposes of computing the minimum corporate income tax (MCIT) shall mean gross sales less sales returns, discounts and allowances and cost of goods sold. The term "gross income" or "gross income earned" (GIE) of an enterprise registered with PEZA, SBMA, CDA Poro Point Development Authority, and other special economic and freeport authorities means gross income less certain limited deductions authorized under the law creating such special economic or freeport zones. 3

"Net income" means gross income less statutory deductions and exemptions. Net income must be computed with respect to a fixed period or taxable year. That period is normally a calendar year covering twelve months ending December 31st of every year, except in the case of a corporation filing returns on a fiscal year basis, in which case net income will be c imputed on the basis of such fiscal year. Items of income and of expenditures, which, as gross income and deductions, are elements in the computation of net income, need not to be in the form of cash. It is sufficient that such items may be appraised in terms of money. 4

5

6

To Whom Income, Gain or Profit is Taxable Income from sale or lease of goods or properties is taxable to the owner-seller or lessor of the goods or properties, while income from sale of services is taxable to the person who renders the services, although payment of the consideration for said goods, properties, or services is made by the buyer to another person (not the seller or lessor) upon the instruction of the owner thereof or in accordance with their agreement. Passive investment incomes (i.e., interest, royalty, and dividend) arising from the use or lease of certain properties or property rights shall be reported by the creditor, owner of the patent and other Commissioner vs. BOAC, GR L-65773-74, Apr. 30, 1987. Sec. 27(E)(4), NIRC. Rev. Regs. No. 9-98, however, expanded the definition of "gross income" by including "other income" of the corporation. Sec. 36, Rev. Regs. No. 2. Any twelve-month period ending in any month other than December 31 of the year. "See. 37, Rev. Regs. No. 2. 3

4

6


intellectual property, or owner of the shares of stocks, as the case may be. Dividends are prima facie the income of the owner of the stock as of the date of declaration of the dividend and are taxable to such owner. But where the record owner has sold the stock under an escrow agreement under which title is to be retained by him, the dividends received by such owner and applied in reduction of the purchase price are not taxable to him (Moore vs. Commissioner, 124 F[2d] 991). Securities Borrowing and Lending (SBL) Agreement. - While there is transfer of the shares of stock/securities to the Borrower pursuant to the Securities Borrowing and Lending (SBL) Agreement, the Lender retains certain rights accruing to the shares of stock/securities lent, such as the right to receive cash, stock dividends or interest which the Borrower is obliged to manufacture or reimburse to the Lender during the borrowing period. These cash, stock dividends or interest which the Borrower is required to manufacture or reimburse to the Lender are otherwise referred to as "Manufactured Dividends or Benefits." The Lender may likewise retain voting rights over the loaned shares of stock/securities while in the possession of the Borrower, if mutually agreed upon by the parties. 7

Receipt of the "Manufactured Dividends or Benefits" shall not be a taxable income of the Lender since it just represents dividends/other benefits that the lender would have received had the share not been loaned pursuant to SBL agreement. However, the payment of such amount by the Borrower shall not be a tax deductible expense. On the other hand, the receipt of cash dividend from the issuing company by the Borrower or Buyer shall be subject to the provisions of existing laws (e.g., final withholding tax of 10% on gross dividend paid to a citizen).

Sources of Income The source rules to determine whether income shall be treated as income from within or outside the Philippines can be found in Section 42 of the Tax Code. There are different source rules for different types of income. The following incomes are considered as income from sources within the Philippines: 'See Sec. 6, Rev. Regs. No. 1-2008, Feb. 1, 2008.

GROSS INCOME

63

1. Interests - Residence of the debtor If the obligor or debtor (corporate or otherwise) is a resident of the Philippines, the interest income is treated as income from within the Philippines. 2. Dividends - Residence of the corporation paying dividend. Dividends received from a domestic corporation or from a foreign corporation are treated as income from sources within the Philippines, unless less than 50% of the gross income of the foreign corporation for the three-year period preceding the declaration of such dividends was derived from sources within the Philippines, in which case, only the amount which bears the same ratio to such dividends as the gross income of the corporation for such period derived from sources within the Philippines bears to its gross income from all sources shall be treated as income from sources within the Philippines. 3. Services - Performance of the service. If the service is performed in the Philippines, the income shall be treated as from sources within the Philippines. There is no other criterion used to determine source of income from sale of services. Gross income from sources within the Philippines includes compensation for labor or personal services performed within the Philippines, regardless of the residence of the payor, of the place in which the contract for service was made, or of the place of billing or payment. If a specific amount is paid for labor or personal services performed in the Philippines, such amount shall be included in the gross income. If no accurate allocation or segregation of compensation for labor or personal services performed in and outside the Philippines, the amount to be included in the gross income from sources within the Philippines shall be determined by an apportionment of the total income on time basis; i.e., there shall be included in the gross income an amount which bears the same relation to the total compensation as the number of days of performance of the labor or services within the Philippines bears to the total number of days of performance of labor or services for which the payment is made. Wages received for services rendered inside the territorial limits of the Philippines and wages of an alien seaman earned on a coastwise vessel are to be regarded as from sources within the Philippines. 8

"Sec. 155, Rev. Regs. No. 2.


64

Cost-sharing reimbursements to be made by the Philippine branch to its U.S. affiliate, being compensation for services rendered in the U.S., shall be considered as income from sources outside the Philippines; hence, not subject to Philippine income tax. 9

Non-resident alien acting as President of Philippine company and as commission agent abroad A non-resident alien is taxed only on her income for services rendered in the Philippines. - Baier-Nickel, a non-resident German citizen, is the President of Jubanitex, Inc., a domestic corporation engaged in manufacturing, marketing, acquiring, importing and exporting and selling embroidered textile products. Through its General Manager, the corporation engaged the services of Baier-Nickel as commission agent, who will receive 10% sales commission on all sales abroad actually concluded and collected through her efforts. In 1995, Baier-Nickel received commission income, from which Jubanitex withheld 10% and remitted to the BIR. Baier-Nickel filed her income tax return on October 17, 1997. On April 14, 1998, she filed a claim for refund, contending that her commission income is not taxable in the Philippines because it was compensation for her marketing services rendered in Germany and not compensation income as President of Jubanitex. After all, she came to and stayed in the Philippines only for short periods. Non-resident aliens, whether or not engaged in trade or business, are subject to Philippine income tax on their income received from all sources within the Philippines. The underlying theory is that the consideration for taxation is protection of life and property and that the income rightly to be levied upon to defray the burdens of the Government is that income which is created by activities and property protected by the Government or obtained by persons enjoying that protection. The important factor, therefore, which determines the source of income of personal services is not the residence of the payor, or the place where the contract for service is entered into, or the place of payment, but the place where the services were actually rendered (Baier-Nickel vs. Commissioner, G.R. No. 156305, Feb. 17,2003). 'BIR Ruling No. 165-99, Oct. 21, 1999.

GROSS INCOME

65

In another case, however, the appointment letter of BaierNickel, as agent of Jubanitex, stipulated that the activity or the service which would entitle her to 10% commission income are sales actually concluded and collected through her efforts. What she presented as evidence to prove that she performed income-producing activities abroad were copies of documents she allegedly faxed to Jubanitex and bearing instructions as to the sizes of, or designs and fabrics to be used in the finished products as well as samples of sales orders purportedly relayed to her by clients. However, these documents do not show whether the instructions or orders faxed ripened into concluded or collected sales in Germany. At the very least, these pieces of evidence show that while Baier-Nickel was in Germany, she sent instructions/ orders to Jubanitex in the Philippines. Thus, claim for refund was denied (Commissioner vs. Baier-Nickel, G.R. No. 153793, Aug. 29, 2006). Philippine Turnkey Contract with Onshore and Offshore Portions While the construction and installation work were completed within the Philippines; hence, subject to tax in the Philippines, the evidence is clear that some pieces of equipment and supplies were completely designed and engineered in Japan. In effect, the turnkey contract for the sales of services is divisible (and not indivisible as claimed by the BIR). The two sets of ship unloader and loader, the boats and the mobile equipment for the NDC project and the ammonia storage tanks and refrigeration units were made and completed in Japan. They were already finished products when shipped to the Philippines. The other construction supplies listed under the Offshore Portion, such as steel sheets, pipes and structures, electrical and instrument apparatus, were not finished products when shipped to the Philippines. They, however, were likewise fabricated and manufactured by the sub-contractors in Japan. All services for the design, fabrication, engineering and manufacture of the materials and equipment under Japanese Portion Yen I were made and completed in Japan. These services were rendered outside the taxing jurisdiction of the Philippines and are therefore not subject to tax (Commissioner vs. Marubeni Corporation, G.R. No. 137377, Dec. 18, 2001).


66

International Carriers International carriers by air or water are special types of income taxpayers because their sources of income do not strictly follow the territorial jurisdiction of the Philippines, which is provided for in the Philippine 1987 Constitution and the Law of the Sea. In order to avoid the numerous problems of allocating the transport income between the Philippines and the foreign country where the foreign aircraft or vessel go to or come from on the basis of distance traveled, the tax authorities agreed to simplify the tax rule to determine the source of income. Thus, revenues associated with outbound trips (originating from the Philippines to a foreign port) of the aircraft or shipping line referred to in the law as "Gross Philippine Billings" shall be considered as income from sources within the Philippines, while revenues associated with inbound trips (originating from a foreign port to the Philippines) of the aircraft or vessel shall be treated as income from sources without the Philippines. However, other incomes such as demurrage fees, detention fees and other charges of foreign carriers related to their outbound trips shall be subject to Philippine income tax under the regular corporate income tax rate. 10

International Air Carriers British Overseas Airways Corporation ( B O A C ) is an offline international air carrier. Since it was not granted a Certificate of Public Convenience and Necessity to operate in the Philippines, it did not carry passengers and/or cargo to and from the Philippines, although during the period covered by the assessment, it maintained a general sales agent in the Philippines not of a temporary character, which was responsible for selling BOAC tickets covering passengers and cargoes. The court ruled that the source of an income is the property, activity or service that produced the income. For the source of income to be considered as coming from the Philippines, it is sufficient that the income is derived from activity within the Philippines. In BOAC's case, the sale of tickets in the Philippines is the activity that produces the income. The tickets exchanged hands here and payments for fares were also made here in Philippine currency. The Court ruled that the situs of the source of payments is the 10

See RMC 31-2008, Jan. 30, 2008 (for international shipping lines) and RMC 46-2008, Feb. 1, 2008 (for international air carriers).

Philippines. The flow of wealth proceeded from, and occurred within, Philippine territory, enjoying the protection accorded by the Philippine government. In consideration for such protection, the flow of wealth should share the burden of supporting the government. A transportation ticket is not a mere piece of paper. When issued by a common carrier, it constitutes the contract between the ticket-holder and the carrier. The test of taxability is the source, and the source of income is that activity which produced the income. The word "source" conveys one essential idea, that of origin, and the origin of the income is the Philippines (Commissioner vs. British Overseas Airways Corp., et ah, G.R. L-65773-74, Apr 30,1987,149 SCRA 395[1987]; Commissioner vs. Air India, et al., 157 SCRA 648; Commissioner vs. American Airlines, et al., 180 SCRA 264 [1989]). The above cases must be distinguished from the case of Japan Air Lines vs. Commissioner (G.R. No. L-30041, Feb. 3, 1969), where the CTA ruled that the mere sale of tickets, unaccompanied by the physical act of carriage of transportation, does not render the taxpayer herein subject to the common carrier's tax. As elucidated by the Tax C!ourt, the common carrier's tax is an indirect tax and excise tax, being a tax on the activity of transporting, conveying or removing passengers and cargo from one place to another. It purports to tax the business of transportation. Being an excise tax, the same can be levied by the State only when the acts, privileges or businesses are done or performed within the jurisdiction of the Philippines. The subject matter of this BOAC case is income tax, a direct tax on the income of persons and other entities "of whatever kind and in whatever form derived from any source." Since the two cases treat of a different subject matter, the decision in one cannot be res judicata to the other. 11

The reaction of Congress and tax administration to the court decisions cited above was to amend the tax law (Sec. 28[A][3][a], NIRC), by providing that the tax on GPB shall apply only to the revenue portion of the Philippine leg of the "Justice Feliciano issued a dissenting opinion against the majority view on the above cases. He stated that the basic problem here is one of characterization of the transactions entered into by BOAC in the Philippines. Those transactions may be characterized either as sales of personal property (sales of airline tickets) or as entering into a lease of services or a contract of service or carriage. Justice Feliciano believes that the appropriate characterization is that of entering into contracts of service; i.e., carriage of passengers or cargo between points located outside the Philippines.


68

flight, where transshipment of passenger takes place at anyport outside the Philippines on another plane. Thus, the term "Gross Philippine Billings" (GPB) refers to the amount of gross revenue derived from carriage of persons, excess baggage, cargo and mail originating from the Philippines in a continuous and uninterrupted flight, irrespective of the place of sale or issue and the place of payment of the ticket or passage document. Tickets revalidated, exchanged and/or indorsed to another international airline form part of the GPBs, if the passenger boards a place in a port or point in the Philippines. However, for a flight which originates from the Philippines, but transshipment of passenger takes place at any port outside the Philippines on another airline, only the aliquot portion of the cost of the ticket corresponding to the leg flown from the Philippines to the point of transshipment shall form part of GPB. 12

International Shipping Lines In the case of an international shipping line, "Gross Philippine Billings" (GPB) means gross revenue whether for passenger, cargo, or mail originating from the Philippines up to final destination, regardless of the place of sale or payments of the passage or freight documents. Thus, even if there is transshipment of cargoes from one vessel to another vessel in a foreign country, the entire GPB on outbound cargoes shall be subject to Philippine income tax. 13

Telecommunications Companies Telecommunication companies are special types of corporate taxpayers because the transmission of communications to and from the Philippines are done through the facilities of several domestic corporations and also through satellites of foreign corporations that are located outside the Philippines. Obviously, the tax authorities cannot cope with the fast pace of advances in science and technology, for until now, no new regulation on taxation of telecommunications companies have been promulgated in order to establish and clarify the 12

Sec. 28(A)(3)(a), NIRC, as amended by R.A. No. 8424 (Jan. 1, 1998) and as implemented by Rev. Regs. No. 15-2002. Thus, in case of transshipment of passenger, only the revenue corresponding to the Philippine leg shall form part of GPB of the international air carrier. Sec. 28(A)(3)(b), NIRC. 13

GROSS INCOME

69

complicated system of taxation applicable to them. In this regard, we reproduce here the old provisions. Thus: To determine the gross income of corporations carrying on the business of transmission of telegraph or cable messages between points in the Philippines and points outside of the Philippines, the following items should be added: 1.

Gross receipts derived from messages originating in the Philippines; and

2.

Amounts collected abroad and collect messages originating in the Philippines. Amounts paid or accrued for transmission beyond the company's own circuit should be deducted from this sum.

From this gross income, all amounts received by the company in the Philippines with respect to collect messages originating from abroad must be excluded. The net income of these companies is computed by deducting from the gross income the following items: 1.

All expenses incurred in the Philippines incident to the carrying on of the business;

2.

All direct expenses incurred abroad in the transmission of messages originating in the Philippines;

3.

Depreciation of property located in the Philippines and used in the trade or business; and

4.

A proportionate part of the general overhead expenses and of maintenance, repairs and depreciation of the cables of the entire cable system of the enterprise. The amount allowable as depreciation of the cables is based on the ratio which the number of words originating in the Philippines bears to the total words transmitted by the enterprise. 14

Subscription and advertising fees paid to foreign magazines Subscription payments and advertising fees paid by Philippine subscribers or advertisers to a non-resident company (e.g., Time-Life International Philippines) that publishes the 14

Jose Aranas, "Annotations and Jurisprudence on the National Internal Revenue Code of 1977, as Amended," 1983 ed., pp. 395-396.


70

magazine abroad are deemed as coming from sources within the Philippines; hence, subject to income tax and withholding tax. 15

4.

Rentals and royalties -

Location of the property or interest in such property. - If the property or interest is located or used in the Philippines, the gain or income is treated as income from sources within the Philippines. 5.

Sale of real property -

Location of real property. - If the real property sold is located within the Philippines, the gain is considered as income from the Philippines. 6.

Sale of personal property -

a. Personal property produced (in whole or in part) by the taxpayer within the Philippines and sold without the Philippines, or produced (in whole or in part) by the taxpayer without and sold within the Philippines - Any gain, profit or income shall be treated as derived partly from sources within and partly from sourcos without the Philippines. b. Purchase of personal property within and its sale without the Philippines, or purchase of personal property without and its sale within the Philippines - Any gain, profit or income shall be treated as derived entirely from sources within the country in which sold. Accordingly, if the goods are shipped in a foreign port under "FOB shipping point," title to the goods is transferred at the foreign port and any gain from the sale of such goods to a Philippine importer shall be treated as income from sources outside the Philippines. Where title to the articles sold to the foreign buyers were transferred to the latter from the moment they were placed on board the carrying vessels, the gain on the transaction is from the Philippines. - A domestic corporation sold and shipped articles under the terms "FOB Manila" to foreign buyers, whereby the shipment were insured by the buyers and the freight charges were paid by the buyers at destination, while payments for the shipment in foreign currency were made through drafts or letters of credit drawn against local banks. The l5

BIR Ruling No. 136-98, Sept. 24, 1998.

GROSS INCOME

71

fact that the transactions were paid in foreign currency did not make them foreign transactions, because the title to the articles sold to the foreign buyers were transferred to the latter from the moment they were placed on board the carrying vessels. Under these circumstances, all its rights ended there and the sole authority for the disposition of the shipped merchandise rest upon the foreign buyers. While it was true that payments were made after the vessel had left the Philippine waters, the delay which was merely caused by the preparation of papers for submission to the banks against whom the letter of credit had been drawn did not change the fact that the transactions were consummated in the Philippines. The delivery of the goods on board the carrying vessels partook of the nature of actual delivery, and from that time, the foreign buyers assumed the risk of loss of the goods and paid the insurance premiums covering the loss (Rattan Art and Decorations, Inc. vs. Collector, et al., 13 SCRA 626). Sales are domestic where freight were paid by the Japanese buyers and the payments of the logs were effected by means of irrevocable letters of credit in favor of petitioner. - Petitioner sold logs to Japanese firms at prices "FOB Agusan." The Free-On-Board (FOB) prices included costs of loading, wharfage, stevedoring, and other costs in the Philippines. The freight were paid by the Japanese buyers and the payments of the logs were effected by means of irrevocable letters of credit in favor of petitioner and payable through Philippine National Bank or any other bank named by it. The FOB feature of the sales indicated that the parties intended the title to pass to the buyer upon delivery of the logs in Agusan on board the vessels that took the goods to Japan. The sales are domestic or local. The specification in the bill of lading that the goods are deliverable to the order of the seller or his agent does not necessarily negate the passing of title to the goods upon delivery to the carrier (Butuan Sawmill, Inc. vs. CTA, et al., G.R. No. L-20601, Feb. 28,1966). The transactions were consummated upon delivery of the cargo to the consignee. - During the period involved, the free market conversion rate ranged from P3.47 to P3.65 to a U.S. dollar, at which rates the freight fees were computed in the contested assessment. Inasmuch as said fees were revenues derived from "foreign exchange" transactions, it follows necessarily that the petitioner was fully justified in computing the taxpayer's receipts at said free market rates. The transactions


72

from which said revenues were derived involved the loading of cargo in the Philippines, the transportation of said cargo to its ports of destination, the delivery of the cargo to the respective consignees, and the payment of the corresponding fees to the taxpayer's head office at Amsterdam. As regards the taxpayer, the transactions were consummated upon delivery of the cargo to the consignee. Upon the other hand, the obligations of the latter or the shipper were discharged upon payment of the freight at Amsterdam. The question whether or not such fees were to be remitted by the taxpayer's head office in Amsterdam to its branch office in the Philippines, which had earned it, was one that concerned exclusively the former and the latter, it being independent of the rights and obligations of the parties to the transactions, which were extinguished upon delivery of the cargo at destination and payment of the freight to said main office of the taxpayer. The remittance or non-remittance of said fees could not affect the nature of said transactions, as involving foreign exchange, not being a part thereof in any manner whatsoever (Commissioner vs. Royal Inter-ocean Lines and CTA, G.R. No. L-26806, July 30, 1970). c. Shares of stock of a domestic corporation. - Gain, profit or income from sale of shares of stocks of a domestic corporation is treated as derived entirely from sources within the Philippines, regardless of where the said shares are sold and who is the seller thereof. However, gain from the sale of shares of stocks of a foreign corporation shall be taxed in the place of residence or domicile of the owner-seller, following the principle of mobilia sequuntur personam. 16

Enumeration of Income in Section 42 is not Exclusive It must be noted that the enumeration of income in Section 42 of the Tax Code is not exclusive. Thus, there are other types of income not clearly falling under any of the above enumeration that are subject to income tax, whose sources are not determined using the source rules described above. 17

Illustrative Cases: Location of insured and risks determine situs of taxation of premium. - In 1935, MERALCO, a domestic 1B

Sec. 44(E), NIRC. "See Alexander Howden & Co. vs. Collector. G.R. L-19392. Apr. 14. 1965.

GROSS INCOME

73

corporation, insured with the City of New York Insurance Company and the U.S. Guaranty Corporation, certain real and personal properties situated in the Philippines. The insurance companies are foreign corporations not licensed to do business in the Philippines and having no agents therein. Premiums were paid in New York through the broker. The court ruled that where the insured is within the Philippines, the risk insured against is also within the Philippines, and certain incidents of the contract are to be attended to in the Philippines, such as payment of dividends, sending of an adjuster into the Philippines in case of dispute, or making of proof of loss, the Philippines has the power to impose the tax upon the insured, regardless of whether the contract is executed in a foreign country and with a foreign corporation (Manila Electric Company us. Yatco, 69 Phil. 89 [1939]). Place of activity, not place of business, is situs of income. - On various dates, PGCI, a domestic insurance company, entered into reinsurance contracts with foreign insurance companies not doing business in the Philippines. PGCI thereby agreed to cede to the foreign reinsurers a portion of the premiums on insurance it has originally underwritten in the Philippines, in consideration for the assumption by the latter of liability on an equivalent portion of the risks insured. Said reinsurance contracts were signed by PGCI in Manila and by foreign reinsurers outside of the Philippines, except the contract with Swiss Reinsurance Company, which was signed by both parties in Switzerland. PGCI was required to keep a register in Manila where the risks ceded to the foreign reinsurers were entered, and entry therein was binding upon the reinsurers. Conflicts and/or differences between the parties under the reinsurance contracts were to be arbitrated in Manila. PGCI and Swiss Reinsurance Company stipulated that their contract shall be construed by the laws of the Philippines. The court held that the reinsurance premiums are taxable in the Philippines. Foreign corporations are taxable on their income from sources within the Philippines. "Sources" has been interpreted as the activity, property or service giving rise to the income. The foreign insurers' place of business should not be confused with their place of activity. Business implies continuity and progression of transactions, while activity may consist of only a single transaction. An activity may occur outside the place of business. Section 24 of the Tax Code does not require a foreign


corporation to engage in business in the Philippines in subjecting its income to tax. It suffices that the activity creating the income is performed or done in the Philippines. What is controlling, therefore, is not the place of business but the place of activity (Philippine Guaranty Co., Inc. vs. Commissioner and CTA, G.R. No. L-22074, Apr. 30, 1965). Reinsurance premiums are income from sources within the Philippines. - Reinsurance premiums remitted by domestic insurance company to foreign reinsurance companies are considered income of the latter derived from sources within the Philippines. Since Section 53 (now Section 57) of the Tax Code subjects to withholding tax various specified income, among them, premiums, the generic connotation of each and every word or phrase composing the enumeration in subsection (b) is income. Perforce, the word "premiums" which is neither qualified nor denned by the law itself, should mean income and should include all premiums constituting income, whether they be insurance or reinsurance premiums. Section 24 (now Section 28) of the Tax Code does not require a foreign corporation to be engaged in business in the Philippines, in order for its income from sources within the Philippines to be taxable. It subjects foreign corporations not doing business in the Philippines to tax for income from sources within the Philippines. If by source of income is meant the business of the taxpayer, foreign corporations not engaged in business in the Philippines would be exempt from taxation on their income from sources within the Philippines. Section 37 (now Section 42) of the Tax Code is not an all-inclusive enumeration; it provides that "the following items of gross income shall be treated as gross income from sources within the Philippines." It does not state or imply that an income not listed therein is necessarily from sources outside the Philippines (Alexander Howden & Co., Ltd., et al. vs. Collector, G.R. No. L-19392, Apr. 14, 1965).

Types of Income, Gain or Profit Income "Income" means an amount of money coming to a person or corporation within a specified time, whether as payment for services, interest or profit from investment. Unless otherwise specified, income means cash or its equivalent (Conwi vs. Court of Tax Appeals and Commissioner, G.R. No. 48532, Aug. 31,

GROSS INCOME

75

1992, 213 SCRA 83; Alexander Howden & Co. vs. Collector, CTA Case 22848, Nov. 24, 1961). Income is a flow of service rendered by capital by the payment of money from it or any other benefit rendered by a fund of capital in relation to such fund through a period of time (Madrigal vs. Rafferty, 38 Phil. 414). Income covers gain derived from capital, from labor, or from both combined, provided it be understood to include profit gained through a sale or conversion of capital assets (Fisher vs. Trinidad, 43 Phil. 981). Income includes earnings, lawfully or unlawfully acquired, without consensual recognition, express or implied, of an obligation to repay and without restriction as to their disposition (James vs. U.S., 366 U.S. 213). Thus, income from illegal drug and gambling activities is taxable as well. Increase in inventory is considered income. - The increase in its inventory is considered income. It is a realization of gain derived from capital for the use, benefit and disposal of the property. However, a mere increase in the value of property is not income but merely an increase of capital. The revenue law employs the term "income" in its natural and obvious sense, as importing something distinct from principal or capital . 18

Transfer of appreciated property to employee for services rendered is income. — An employer transferred its appreciated property to an employee for services rendered. The employer should report the appreciation as a taxable gain. The employer realized the appreciated value in the form of future or past services because it could deduct the appreciated value as an expense (International Freighting Corporation vs. Commissioner, 135 F. 2d 310 [2d Circ. 1943]). 19

Sale of goodwill is income. - Goodwill created by an incorporator in the course of the business of a corporation and appraised to pay the unpaid price of shares subscribed by said incorporator, is a profit subject to income tax (Anderson vs. Posadas, 66 Phil. 205). 20

18

Par. 5.05, Vol. I, Law of Federal Income Taxation; BIR Ruling No. 67-018, Apr 26, 1967; Frederick Fisher vs W. Trinidad, Collector, G.R. No. 17518, Oct 30, 1922. There are two taxable transactions here. The first transaction involves the assignment or sale of appreciated property by the employer to its employee, and the taxable gain of the employer is computed by deducting the cost from the consideration or fair market value of the property, whichever is higher. The second transaction involves the sale of service by the employee, for which he is paid compensation in kind or property. ^ h e court deemed that the goodwill (as an asset) was sold or transferred by the owner to the corporation in payment of his unpaid subscription. 19

76


Just compensation for expropriated property is income. - The acquisition by the government of private properties through the exercise of the power of eminent domain is just compensation and is embraced within the meaning of the term "sale" or "disposition of property" and is thus taxable. Only the fair market value as of the date of acquisition should be considered in determining gain or loss when the property was disposed, without taking into account the purchasing power of the currency used in the transaction (Gutierrez us. CTA and Collector, G.R. No. L-9738, May 31, 1957). Not considered as income Deposit of property that does not increase networth of taxpayer. - Taxable income does not include items received that do not add to the taxpayer's net worth or redound to his benefit such as amounts merely deposited or entrusted to him. It is not necessary that there must be a law or regulation that would exempt such monies or receipts entrusted to the taxpayer that do not belong to them (Commissioner vs. Tours Specialist, 183 SCRA 402). Increase in networth due to correction of errors in book entries. — Where it is shown that the increase in the taxpayer's net worth were not the result of the receipt by it of unreported or unexplained taxable income but were 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, the increase in the taxpayer's net worth was not taxable (Fernandez Hermanos, Inc. us. Commissioner, G.R. No. L-21551, Sept. 30, 1969). Voluntary assessments by a corporation paid by its shareholders. - Where a corporation requires additional funds for conducting its business and obtains such needed money through voluntary process payments by its shareholders, the amounts so received being credited to its surplus account or to a special capital account, will not be considered income, although there is no increase in the outstanding shares of stock of the corporation. The payments in such circumstances are in the nature of voluntary assessments upon, and represent an additional price paid for, in shares of stock by the shareholders,

GROSS INCOME

77

and will be treated as an addition to and as part of the operating capital of the company. 21

Stock dividend is not income. - A stock dividend is not income but capital. A stock dividend really takes nothing from the property of the corporation, and adds nothing to the interests of the shareholder. The property of the corporation is not diminished and the interests of stockholders are not increased. The proportional interest of each shareholder remains the same even after the declaration of stock dividend. In short, the corporation is no poorer and the stockholder is no richer than they were before the declaration of stock dividend (Gibbons vs. Mahon, 136 U.S. 549). When a corporation issues "stock dividends," it shows that the corporation's accumulated profits have been capitalized, instead of distributed to the stockholder or retained as surplus available for distribution, in money or in kind, should opportunity offer. Far from being a realization of profits of the stockholder, it tends rather to postpone said realizations, in that the fund represented by the new stock has been transferred from surplus to assets, and no longer is available for actual distribution (Eisner vs. Macomber, 252 U.S. 189). Dollar earnings that are not converted into another foreign currency are not receipts derived from foreign exchange transactions. - A foreign exchange transaction is simply that - a transaction in foreign exchange, foreign exchange being "the conversion of an amount of money or currency of one country into an equivalent amount of money or currency of another." When petitioners were assigned to the foreign subsidiaries of Procter & Gamble, they were earning in their nation's currency and were also spending said currency. There was no conversion, therefore, from one currency to another (Conwi, et al. vs. CTA and Commissioner, G.R. No. 48532, Aug. 31, 1992). Security deposits paid to a lessor. - Security advances and security deposits paid by a lessee to a lessor should not be considered as income for tax purposes. By their very nature, the amount received by the lessor as security advances or deposits is eventually returned to the lessees; hence, the lessor did not earn any gain or profit therefrom (Tourist Trade and "Sec. 56, Rev. Regs. No. 2.


78

Travel Corp. vs. Commissioner, CTA Case No. 4806, Jan. 19, 1996). 22

Award of certain damages. — Award of damages, such as moral and exemplary damages, to the petitioner are not subject to income tax and consequently to withholding tax, the same being merely reimbursement of expenses/advances in the course of hearing a complaint (Ishwar Jethmal Ramnani, et al. vs. Commissioner, CTA Case No. 5108, Sept. 13, 1996). Contributions by lot owners for the memorial park care fund— Amounts paid by its customers to Manila Memorial Park Cemetery, Inc. as their contributions to the Memorial Park Care Fund are not subject to the 35% (now 30%) corporate income tax, since said contributions do not form part of the purchase price of the cemetery lot but intended exclusively as a trust fund for the care of the cemetery. 23

Distinctions between Capital and Income The income tax law of the United States then in force in the Philippines had selected income as the test of faculty in taxation. This concept :s still enforced in the country today. The essential differences between capital and income are as follows: 24

22

1.

Capital (e.g., savings bank deposit) is a fund, while income (e.g., interest on savings bank deposit) is a flow;

2.

A fund of property (e.g., building for lease) existing at an instant of time is called capital, while a flow of services rendered by that capital by the payment of money from it or any other benefit rendered by a fund of capital (e.g., rental income) in relation to such fund through a period of time is called income;

3.

Capital (e.g., shares of stock) is wealth, while income (e.g., dividend income) is the service of wealth;

Security deposits are liabilities of the lessor. They do not constitute income until the security deposits are applied against unpaid rental due from the lessee. BIR Ruling No. 098-96, Sept. 10, 1996. •"The aim has been to mitigate the evils arising from the inequalities of wealth by a progressive scheme of taxation, which places the burden on those best able to pay. However, some authors proposed "consumption" as the basis for computing income tax. Under this system, income tax is imposed when there is consumption (not when income is received). 23

GROSS INCOME

79

4.

Capital is the tree, while income is the fruit; labor is a tree, income the fruit; property is a tree, income the fruit (Madrigal vs. Rafferty, 38 Phil. 414; Waring vs. City of Savannah [1878] 60 Ga., 93).

5.

Return of capital (e.g., payment of loan principal by the debtor) is not subject to income tax on the part of the creditor, while receipt of income (e.g., interest income on loan by the lender) is subject to tax.

Tests in Determining Income One or more of the following tests may apply to income of a taxpayer: 1. Severance or realization test.- There is no taxable income until there is a separation from capital of something of exchangeable value, thereby supplying the realization or transmutation which would result in the receipt of income (Eisner vs. Macomber, 252 U.S. 189, 207-208). Thus, in Fisher vs. Trinidad, 43 Phil. 973, it was held that stock dividends are not income subject to income tax. 2. Doctrine of command or control of income. — The power to dispose of income is the equivalent of ownership of it. The exercise of that power to procure the payment of income to another is the enjoyment; hence, the realization of the income by him who exercises it. The dominant purpose of the revenue laws is the taxation of income to those who earn or otherwise create the right to receive it and enjoy the benefit of it when paid (Helvering vs. Horst, 311 U.S. 112-122). 3. Claim of right doctrine. —A taxable gain is conditioned upon the presence of a claim of right to the alleged gain and the absence of a definite unconditional obligation to return or repay that which would otherwise constitute a gain. To collect a tax would give the government an unjustified preference as to the part of the money that rightfully and completely belongs to the victim. The embezzler's title is void (Commissioner vs. Wilcox, 286 U.S. 417, 424). On May 27, 1977, Dolores Ventosa requested the transfer of $1,000 from the First National Bank of Moundsville, West Virginia, to Victoria Javier in Manila through the Prudential Bank. Accordingly, the First National Bank requested the

80


Mellon Bank to effect the transfer. Unfortunately, the wire sent by Mellon Bank to Manufacturers Hanover Bank, a correspondent bank of Prudential Bank, indicated the amount transferred as "US $1,000,000.00" instead of US $1,000.00. Hence, Manufacturers Hanover Bank transferred one million dollars less bank charges to the Prudential Bank for the account of Victoria Javier. On June 3, 1977, Javier opened a new dollar account (No. 343) in the Prudential Bank and deposited $999,943.70. Immediately thereafter, Victoria Javier and her husband, Melchor Javier, Jr., made withdrawals from the account, deposited them in several banks only to withdraw them later in an apparent plan to conceal, launder and dissipate the erroneously sent amount. Spouses Melchor and Victoria Javier filed their consolidated income tax return for the year with the notation "The taxpayer was the recipient of some money from abroad which he presumed to be a gift but turned out to be an 'error' and is now subject of litigation" but did not declare it as income. The court ruled that the amount received is income subject to tax, but the tax return filed cannot be considered as fraudulent because petitioner literally "laid his cards on the table" for respondent to examine. Error or mistake of fact or law is not fraud (Commissioner us. Javier, G.R. No. 71479, July 31, 1991, 199 SCRA 824). Award of damages by lower court is taxable despite possibility of repayment in case judgment is reversed by appellate court. - If a taxpayer obtains earnings under a claim of right and without restriction as to its disposition, he has received income which he is required to include in his tax return, even though it may be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent. Thus, where a taxpayer sued and was awarded damages by the trial court, and the award was received pending appeal, the money received is includible in his gross income, notwithstanding the possibility of repayment in case the judgment would be reversed by the appellate court (North American Oil Consolidated vs. Burnett, 286 U.S. 417). 4. Income from whatever source. — A l l income not expressly excluded or exempted from the class of taxable income, irrespective of the voluntary or involuntary action of the taxpayer in producing the income, and regardless of the source of income, is taxable (Gutierrez vs. Collector, CTA Case No. 65,

GROSS INCOME

81

Aug. 31, 1965). The words "income from any source whatever" discloses a legislative policy to include all income not expressly exempted from the class of taxable income under our laws (Madrigal vs. Rafferty, supra; Commissioner vs. BOAC, supra). 5. Equivalent of cash doctrine. — Any economic benefit that increases the networth of a taxpayer, whatever may have been the mode by which it is effected, is taxable. Thus, in stock options, the difference between the fair market value of the shares at the time the option is exercised and the option price constitutes additional compensation income to the employee at the time of exercise (not upon the grant or vesting of the right) (Commissioner vs. Smith, 324 US 177). Significance of knowing the type or character of income In general, it is important to know the types of income realized by the taxpayer, since the Philippines has adopted the semi-global or semi-schedular tax system. Under this tax system, compensation income, business/professional income, capital gains, passive investment income, and other income not subject to final income tax are added together to arrive at the amount of gross income of an individual, and after deducting the allowable deductions from business/professional income, capital gains, passive investment income, and other income not subject to final income tax as well as personal and additional exemptions, the graduated income tax rates ranging from 5% to 32% are applied on the resulting net taxable income to arrive at the income tax due and payable. The passive investment incomes are generally subject to the final withholding tax; hence, the income recipient does not file a tax return covering such passive investment incomes, although the withholding agent/payor of income is held responsible under the law to deduct, withhold and remit the final income tax thereon to the BIR. Capital assets subject to the final capital gains tax such as shares of stock of a domestic corporation and real property, except when sold or transferred by a dealer in securities or real estate dealer, are covered by the capital gains tax return; hence, not included in the taxable income of the taxpayer which is subject to the graduated income tax rates (if an individual) or fixed rate of 30% (if a corporation). The same rules discussed in the preceding paragraph apply to a corporation, except that the corporation does not receive compensation income and are not entitled to deduct personal

82


and additional exemptions from their gross income during the year. In particular, the type or character of income is necessary for the following reasons: 1. To determine whether the income is considered as active business or professional income, or capital gain or passive income not subject to final tax at preferential rates, or other income subject to the graduated income tax rates (if an individual) or normal corporate income tax (if a corporation) for which deductions from gross income are allowed, or as passive income or capital gain subject to final tax or compensation income, for which no deductions from gross income are authorized; 2. To know the particular schedular income tax system that will apply to the income - whether the income is subject to gross or net income tax, or whether it is liable to final or creditable withholding tax. For example, interest income from peso bank deposits is subject to the 20% final withholding tax, but interest income from a loan of a parent company to its subsidiary is not subject to the final tax but added to the parent company's gross income subject to the 30% normal corporate income tax based on its net taxable income during the year. 3. To evaluate the legal ways by which the investments of the investor may be recovered in a tax-efficient manner without violating any Tax Code provisions. For example, if the investor is a domestic corporation, equity investments in another domestic corporation will yield for it tax-exempt dividend income. If it invests by extending a loan to its subsidiary, such interest income is taxed at 30% of the creditor-corporation's net taxable income. If the creditor is a non-resident foreign corporation, the final withholding tax on the gross interest income is reduced to 20%. 4. To determine the period such income must be reported for income tax purposes. Generally, a taxpayer may choose the cash method or the accrual method in reporting income during the year. However, advance rentals are required to be reported for tax purposes in the year of receipt, although the lessor regularly computes his income based on the accrual method. 5. To use the proper income tax return and file it within the time specified by law or the regulations and to pay the

GROSS INCOME

83

correct type of income tax due thereon. Complying strictly with these requirements will prevent the imposition of penalties (i.e., surcharge and deficiency interest) upon the taxpayer. By paying the correct amount of tax, the expensive and time-consuming process of filing written claims for tax credits or refunds for erroneously or illegally paid taxes can also be avoided. Filing the correct income tax return starts the running of the statute of limitations on the right of the government to make an assessment. Kinds of Income The Tax Code categorizes income, gain or profit as follows: Compensation income In general, the term "compensation" means all remuneration for services performed by an employee for his employer under an employer-employee relationship, unless specifically excluded by the Tax Code or special law. Under R.A. No. 9504, statutory minimum wage received on or after July 6, 2008 is exempt from income tax. Example: A lawyer who is employed by a domestic corporation as its Chief, Legal Division is considered as an employee. Accordingly, compensation income paid to him shall be subject to the creditable withholding tax on compensation prescribed under Revenue Regulations No. 2-98, as amended. Compensation paid in promissory notes. - Promissory notes or other evidence of indebtedness received in payment for services, and not as security for such payment, constitute income to the amount of their fair market value. A taxpayer receiving as compensation a note regarded as good for its face value at maturity, but not bearing interest, shall treat as income as of the time of receipt the fair market value of the note at that time. 25

T h e term " c o m p e n s a t i o n income" means all remuneration (other than fees paid to a public official) for services performed by an employee for his employer, including the cash value of all remuneration paid in any medium other than cash, except that such term shall not include remuneration paid (a) for agricultural labor paid entirely in products of the 25

Sec. 42, Rev. Regs. No. 2.


84

farm where the labor is performed; or (b) for domestic service in a private home; or (c) for casual labor not in the course of the employer's trade or business; or (d) for services by a citizen or resident of the Philippines for a foreign government or an international organization. There are various types of taxable compensation income, such as salaries, wages, bonus, remuneration, honorarium, benefits and allowances (including representation and transportation allowance (RATA), personal emergency relief allowance (PERA), longevity pay, subsistence allowance, and hazard pay. 26

27

Statutory Minimum Wage. - However, compensation income falling within the meaning of "statutory minimum wage" (SMW) under R.A. No. 9504, effective July 6, 2008, as implemented by Revenue Regulations No. 10-2008 dated July 8, 2008, shall be exempt from income tax and withholding tax. Holiday pay, overtime pay, night shift differential pay, and hazard pay earned by Minimum Wage Earner ( M W E ) shall likewise be covered by the above exemption, provided that an employee who receives/earns additional compensation such as commissions, honoraria, fringe benefits, benefits in excess of the allowable statutory amount of P30,000, taxable allowances and other taxable income other than the SMW, holiday pay, overtime pay, hazard pay and night shift differential pay shall not enjoy the privilege of being a MWE and, therefore, his/her entire earnings are not exempt from income tax and withholding tax. 28

Hazard pay shall mean the amount paid by the employer to MWEs who were actually assigned to danger or strife-torn areas, disease-infested places, or in distressed or isolated stations and camps, which expose them to great danger of contagion or peril 26

Sec. 78(A), NIRC. BIR Ruling Nos. 120-96, Nov. 8, 1996 and 062-2000, Nov. 20, 2000 exempt benefits and allowances such as longevity pay, subsistence allowance, and hazard pay granted to uniformed policemen and jail guards under R.A. No. 6975 (DILG Act of 1990). However, if the recipient is an A F P personnel, all remunerations (monetary and non-monetary) are taxable, except allowances for quarters, clothing and subsistence which are exempt from income tax pursuant to RMC 15-87 (BIR Ruling No. 143-96, Dec. 24, 1996). 27

'""Statutory Minimum Wage" (SMW) shall refer to the rate fixed by Regional Tripartite Wage and Productivity Board, as defined by the Bureau of Labor and Employment Statistics of DOLE. The RTWPB of each region shall determine the wage rates in the different regions based on established criteria and shall be the basis of exemption from income tax for this purpose.

GROSS INCOME

85

to life. Any hazard pay paid to MWEs which does not satisfy the above criteria is deemed subject to income tax and withholding tax. 29

Illustrative Cases: Filipino citizens working in the Embassy of Peru in Manila are subject to income tax, but the embassy is not subject to the requirements of the withholding tax provisions with respect to compensation paid to the Filipino citizens. 30

Officials of the United Nations and its specialized agencies are exempt from taxation on the salaries and emoluments paid to them by the United Nations. However, interest income from personal deposits of the personnel of the U.N. residing in the Philippines (whether Filipino or alien) is subject to tax. 31

One-time relocation assistance in excess of P12,000.00 extended by a domestic corporation to its employees who will be relocated to its new site in Laguna when the company transfers to its plant and operations there may be considered as other benefits and shall form part of their compensation income which are subject to withholding tax. 32

Financial assistance granted by the employer to an employee dismissed from employment for cause is subject to income tax and withholding tax. Said separation does not fall under the concept of "involuntariness." 33

34

When an award of back wages is made, there is an acceptance that the employee was illegally or unjustly dismissed, and the back wages are the salaries he was supposed to have earned had he not been dismissed. It is as though he was not separated from employment, and as though he actually rendered service (Escareal vs. Court of Tax Appeals, et al., CA-GR SPNo. 41989, Sept. 30, 1998). 29

See Sec. 1, Rev. Regs. No. 10-2008, July 8, 2008. BIR Ruling No. 080-97, July 11, 1997. Art. V(18)(b), Convention on the Privileges and Immunities of the United Nations. BIR Ruling No. 059-97, May 15, 1997. BIR Ruling No. 022-2001, June 13, 2001. Since the law requires that an income shall be taxed only when received or realized, and considering that the back wages are received upon award by the court, the entire compensation income must be declared for tax purposes in the year of receipt and may not be reported over the number of years the case is being negotiated or litigated. 30

31

32

33

34


86

A corporation grants options to its employees to buy its shares of stock at P150 per share. The employees exercised the options at the time the shares of stock were selling at the stock exchange at P200 per share. There is additional compensation income of P50 per share at the exercise date (Commissioner vs. Smith, 324 U.S. 177). 35

The 85% share of employees from the 10% service charge collected by a restaurant company from its customers is considered as tip or gratuity; hence, considered as compensation income for services rendered by said employees. 36

Justices and judges are subject to income tax on their compensation income (Polo vs. Commissioner, G.R. No. 78780, July 23, 1987). The previous ruling on the cases of Perfecto vs. Meer and Endencia vs. David, which held that the imposition of income tax upon them is an unconstitutional diminution of their salary, was discarded. If the payment is intended to represent payment, whether designated as compensation or otherwise, for services rendered either in the past, present or future, the amount received will be taxable income to the recipient (Thomas vs. Commissioner, 135 F2d 378, CCA 5th). However, if the payments are made to show goodwill or a mere kindness towards the recipients and are not intended as a recompense for services rendered, then the payments represent gifts and should be exempt from income tax (Scholl vs. Commissioner, 174 F2d 893, CCA 5th). 37

Business Income A.

National Internal Revenue Code (NIRC) Business income of a taxpayer may relate to sale of goods, properties, or services. It may come from the conduct of trade or business or the exercise of a profession, or gain derived from dealings in property. A stock corporation is presumed to carry on a trade or business. An individual who carries on a trade or business as a proprietor or who renders services as an independent contractor or exercises his profession is 38

;

BIR Ruling No. 135-97, Dec. 11, 1997. 'BIR Ruling No. 062-97, May 20, 1997. 'The donation may be subject to donor's tax under Title III of the Tax Code. 'Sec. 32(A), NIRC.

GROSS INCOME

87

39

treated as self-employed and derives self-employment income. Examples are manufacturer of furniture, dealer of real property, and contractor, respectively. Under the Philippine Tax Code, business or trade income of a foreign corporation is taxable in the Philippines only if the source of income, gain or profit is from within the Philippines. Professional Income Professional income refers to the fees received by a professional from the practice of his profession, provided that there is no employer-employee relationship between him and his clients. The existence or absence of the employer-employee relationship determines whether the income shall be treated as compensation income or professional fee. This fact is material for purposes of taxation because there is no deduction allowed against compensation income, whereas allowable deductions may be made from professional income. Thus, a lawyer may practice his profession as a legal officer of a private corporation, but for income tax purposes, such compensation is subject to the graduated income tax rates without deductions (except for his personal and additional exemptions) because of the existence of employer-employee relationship. Engaged in Trade or Business There is no specific criterion as to what constitutes "doing" or "engaging in" or "transacting" business. Each case must be judged in the light of its peculiar environmental circumstances. The term implies a continuity of commercial dealings and arrangements, and contemplates, to that extent, the performance of acts or works or the exercise of some of the functions normally incident to, and in progressive prosecution of, commercial gain or for the purpose and object of the business organization (Commissioner vs. British Overseas Airways Corp., G.R. L-65773, Apr. 30, 1987, 149 SCRA 395). "To engage" is to embark in a business or to employ oneself therein. The word "engage" connotes more than a single act or a single transaction; it involves some continuity of action (Imperial vs. Collector, 97 Phil. 992,1002). "To engage in business" is uniformly construed as signifying to follow the employment or occupation which 39

Prentice-Hall Federal Tax Handbook, 1983, p. 118.


88

occupies the time, attention, and labor for the purpose of a livelihood or profit (Semple vs. Guenther, 96 N.W. 895, 896). The expressions "carrying on business" or "doing business" do not have different meanings but separately convey the idea of progression, continuity, sustained activity, and "engaged in business" means occupied or employed in business. "Carrying on business" does not mean the performance of a single disconnected act but means conducting, prosecuting, and continuing business by performing progressively all the acts normally incident thereto while "doing business" conveys the idea of business being done, not from time to time, but all the time (Llewellyn vs. Pittsburgh B. & L.E.R. Co., CCA. Pa. 22 F. 177,185). When used in tax statutes, "business" or "doing business" connotes something more than the ownership of property and the receipt of income derived from property. There has evolved the principles which distinguishes between a passive and an active owner or investor. One who allocates the active administration of the properties to others and himself performs only such acts are appropriate to safeguard his ownership is to be distinguished from one who himself actively participates in administering the management of the properties (Arguelles vs. Meer, 92 Phil. 14). Gross income from business. — In the case of manufacturing, merchandising, or mining business, "gross income" means the total sales, less the cost of goods sold, plus any income from investments and from incidental or outside operations or sources. In determining the gross income, subtractions should not be made for depreciation, depletion, selling expenses or losses, or for items not ordinarily used in computing the cost of goods sold. 40

Gross income of insurance companies. — In general, the gross income of insurance companies consists of their total revenue from the operation of the business and of their incomes from all other sources within the taxable year, except as otherwise provided by the statute. Gross income includes net premiums (that is, gross premium less returned premiums on policies cancelled and premiums on policies not taken). Investment income, profits from the sale of assets, and all gains, profits, and income reported to the Insurance Commissioner, except income specifically exempt from tax. A net decrease in 'Sec. 43, Rev. Regs. No. 2.

GROSS INCOME

89

reserve funds required by law within the taxable year must be included in the gross income to the extent that such funds are released to the general uses of the company and increase its free assets. Any net increases in reserves shall be added to the gross income, unless the company shall show that such decrease resulted from the application of reserves to the purposes for which they were established. 41

Long-term contracts. — Income from long-term contracts is taxable for the period in which the income is determined, such determination depending upon the nature and terms of the particular contract. "Long-term contracts" means building, installation, or construction contracts covering a period in excess of one year. Persons whose income is derived in whole or in part from such contracts shall report their income on the basis of percentage of completion. There should be deducted from such gross income all expenditures made during the taxable year on account of the contract, account being taken of the material and supplies for use in connection with the work under the contract but not yet so applied. 42

Gross income of farmers. — A farmer reporting on the basis of receipts and disbursements (in which no inventory to determine profits is used) shall include in his gross income for the taxable year: (1) the amount of cash or the value of merchandise or other property received from the sale of livestock and produce which were raised during the taxable year or prior years; (2) the profits from the sale of any livestock or other items which were purchased; and (3) gross income from all other sources. The profit from the sale of livestock or other items which were purchased is to be ascertained by deducting the cost from the sale price in the year in which the sale occurs, except that in the case of sale of animals purchased as draft or work animals, or solely for breeding or dairy purposes and not for resale, the profit shall be the amount of any excess of the sale price over the amount representing the difference between the cost and the depreciation therefore sustained and allowed as a deduction in computing net income. In the case of a farmer reporting on the accrual basis (in which an inventory is used to determine profits), his gross "Sec. 123, Rev. Regs. No. 2. Sec. 44, Rev. Regs. No. 2. 4J

90


profits are ascertained by adding to the inventory value of livestock and products on hand at the end of the year the amount received from the sale of livestock products, and miscellaneous receipts for hire of teams, machinery, and the like, during the year, and deducting from the sum of inventory value of livestock and products on hand at the beginning of the year and the cost of the livestock and products purchased during the year. In such cases, all livestock raised or purchased for sale shall be included in the inventory at their proper valuation determined in accordance with the method authorized and adopted for the purpose. Also, livestock acquired for drafts, breeding, or dairy purposes and not for sale may be included in the inventory, instead of being treated as capital assets subject to depreciation, provided such practice is followed consistently by the taxpayer. In case of the sale of any livestock included in an inventory, their cost must not be taken as an additional deduction in the return of income, as such deduction will be reflected in the inventory. 43

Sale of patents and copyrights. — A taxpayer disposing of patents or copyrights by sale should determine the profit or loss arising therefrom by computing the difference between the selling price and the cost. The taxable income in the case of patents or copyrights acquired prior to March 1, 1913, should be ascertained in accordance with the provisions of section 136 of these regulations. The profit or loss thus ascertained should be increased or decreased, as the case may be, by the amounts deducted on account of depreciation of such patents or copyrights since the date of acquisition. 44

Sale and retirement of corporate bonds. — If bonds are issued by a corporation at their face value, the corporation realizes no gain or loss. If thereafter, the corporation purchases and retires any of such bonds at a price in excess of the issuing price or face value, the excess of the purchase price over the issuing price or face value is a deductible expense for the taxable year. If, however, the corporation purchases and retires any of such bonds at a price less than the issuing price or face value, the excess of the issuing price or face value over the purchase price is gain or income for the taxable year. "Sec. 45, Rev. Regs. No. 2. "Sec. 46, Rev. Regs. No. 2.

GROSS INCOME

91

If bonds are issued by a corporation at a premium, the net amount of such premium is gain or income which should be prorated or amortized over the life of the bond. If thereafter, the corporation purchases and retires any of such bonds at a price in excess of the issuing price minus any amount of premium already returned as income, the excess of the purchase price over the issuing price minus any amount of premium already return as income (or over the face value plus any amount of premiums not yet returned as income) is a deductible expense for the taxable year. If, however, the corporation purchases and retires any of such bonds at a price less than the issuing price minus any amount of premium already returned as income, the excess of the issuing price minus any amount of premium already returned as income (or of the face value plus any amount of premium not yet returned as income) over the purchase price is gain or income for the taxable year. If bonds are issued by a corporation at a discount, the net amount of such discount is deductible and should be pro-rated or amortized over the life of the bonds. If thereafter the corporation purchases and retires any of such bonds at a price in excess of the issuing price plus any amount of discount already deducted, the excess of the purchase price over the issuing price plus any amount of discount already deducted (or over the face value minus any amount of discount not yet deducted) is a deductible expense for the taxable year. If, however, the corporation purchases and retires any of such bonds at a price less than the issuing price plus any amount of discount already deducted, the excess of the issuing price plus any amount of discount already deducted (or of the face value minus any amount of discount not yet deducted) over the purchase price is gain or income for the taxable year. 45

46

Sale of goodwill. — Gain or loss from a sale of goodwill results only when the business, or a part of it, to which the goodwill attaches is sold, in which case the gain or loss will be determined by comparing the sale price with the cost or other basis of the assets, including goodwill. If specific payment was not made for goodwill, there can be no deductible loss with respect thereto, but gain may be realized from the sale of goodwill built up through expenditures which have been currently deducted. <5 46



92

It is immaterial that goodwill may never have been carried on the books as an asset, but the burden of proof is on the taxpayer to establish the cost or fair market value of the goodwill sold. 41

Annuities and insurance policies. —Annuities paid by religious, charitable, and educational corporations under annuity contracts are subject to tax to the extent that the aggregate amount of the payments to the annuitant exceeds the amount paid by him as consideration for the contract. An annuity charged upon devised land is taxable to a doneeannuitant, whether paid by the devisee out of the rents of the land or from other sources. The devisee is not required to return as gross income the amount of rent paid to the annuitant, and he is not entitled to deduct from his gross income any return of premiums paid by him under life insurance, endowment, or annuity contracts, such as the so-called "dividends" of a mutual insurance company, which may be credited against the current premium, are not subject to tax. Distributions on paid-up policies that are made out of the earnings of the insurance company subject to tax are in the nature of corporate dividends and should be included in the taxable income of the individual, without any credit for the amount of tax paid by the corporate at source. Gain from forced sale of property. — The acquisition by the Government of private properties through the exercise of the power of eminent domain, said properties being justly compensated, is embraced within the meaning of the term "sale" or "disposition of property," and the proceeds derived therefrom is subject to income tax as capital gain (since the property is not used in the owner's trade or business). Only the fair market value of the property as of the date of acquisition should be considered in determining the gain or loss, without taking into account the purchasing power of the currency used in the transaction (Bias Gutierrez and Maria Morales vs. CTA and Collector, G.R. Nos. L-9738 & 9771, May 31, 1957). Conditional sale of property. - Sellers who are desirous of making conditional sales of their goods, but who do not wish openly to make a bargain in that form, have frequently resorted to the device of making contracts in the form of leases, either with option to the buyer to purchase for a small consideration at the end of term, provided the so-called rent has been duly paid, 47


GROSS INCOME

93

or with stipulations that if the rent throughout the term is paid, title shall thereupon vest in the lessee. It is obvious that such transactions are leases only in name. The so-called rent must necessarily be regarded as payment of the price in installments since the due payment of the agreed amount results, by the terms of the bargain, in the transfer of title to the lessee (Teodorica R. Viuda de Jose vs. Julio Barrueco, G.R. No. 45955, Apr. 5,1939). In a contract of finance lease, where the lessee is granted the right to purchase the equipment covered by the lease contract at a nominal amount or that the lessee may consider the periodic rental payments as part payments of the purchase of the leased property, said finance lease will be treated as a conditional sale for tax purposes. 48

Lease of Real Property "Gross income" means all income derived from whatever source, including rents. Rental income is treated as business income to which the lessor may claim allowable deductions under Section 34 of the 1997 Tax Code. 49

If the lessor is a citizen, resident alien, or non-resident alien engaged in trade or business in the Philippines, his net taxable income shall be subject to the graduated income tax rates provided for in Section 24 of the Tax Code, and if the lessors are the husband and wife, they shall compute separately their individual income tax based on their respective taxable income. However, if any income cannot be definitely attributed to or identified as income exclusively earned or realized by either of the spouses, the same shall be divided equally between the spouses for the purpose of determining their respective taxable income. 50

If the lessor is a non-resident alien not engaged in trade or business in the Philippines, the rental income from real property located in the Philippines shall be subject to 25% final withholding tax, such tax to be withheld and remitted by the lessee in the Philippines to the BIR within the prescribed dates. 51

52

48

Rev. Regs. No. 19-86. Sec. 32(AX5), NIRC. "Sec. 24(A), NIRC. Sec. 25(B), NIRC. Secs. 57 and 58, NIRC.

49

61

62


94

If the lessor is a domestic corporation or a resident foreign corporation, its net taxable income shall be subject to the 30% normal corporate income tax, or its gross income will be subject to the 2% minimum corporate income tax, whichever is higher. However, if the lessor is a non-resident foreign corporation, the gross rental income from real property located in the Philippines shall be subject to the 30% corporate income tax, such tax to be withheld and remitted by the lessee in the Philippines to the BIR within the prescribed dates. 53

54

55

Income from leased property. —Where a corporation has leased its property in consideration that the lessee shall pay in lieu of other rental, an amount equivalent to a certain rate of dividend on the lessor's capital stock or the interest on the lessor's outstanding indebtedness, together with taxes, insurance or other fixed charges, such payments shall be considered rental payments and shall be returned by the lessor corporation as income, notwithstanding the fact that the dividends and interest are paid by the lessee directly to the shareholders and bondholders of the lessor. The fact that a corporation has conveyed or let its property and has parted with its management and control, or has ceased to engage in business for which it was originally organized, will not relieve it from liability to the tax. While the payments made by the lessee directly to the bondholders or shareholders of the lessor are rentals as to both the lessee and lessor (rentals paid in one case and rentals received in the other), to the bondholders and shareholders, such amounts are interest and dividend payments received as from the lessor and as such shall be accounted for in their returns. 56

Improvements by lessees. — When buildings are erected or improvements made by a lessee in pursuance of an agreement with the lessor, and such buildings or improvements are not subject to removal by the lessee, the lessor may at his option report the income therefrom upon either of the following bases: 1. 53

The lessor may report as income at the time when such buildings or improvements are completed the

Sec. 27(A) and Sec. 28(A), NIRC. ' Sec. 28(B), NIRC. Sec. 58, Rev. Regs. No. 2. ™Sec. 49, Rev. Regs. No. 2. f 4 55

GROSS INCOME

95

fair market value of such buildings or improvements subject to the lease; or 2.

The lessor may spread over the life of the lease the estimated depreciated value of such buildings or improvements at the termination of the lease and report as income for each year of the lease an aliquot part thereof.

If for any reason than a bona fide purchase from the lessee by the lessor, the lease is terminated, so that the lessor comes into possession or control of the property prior to the time originally fixed for the termination of the lease, the lessor receives additional income for the year in which the lease is to be terminated to the extent that the value of such buildings or improvements when he became entitled to such possession exceeds the amount already reported as income on account of the erection of such buildings or improvements. No appreciation in value due to causes other than the premature termination of the lease shall be included. Conversely, if the buildings or improvements are destroyed pr'or to the expiration of the lease, the lessor is entitled to deduct as a loss for the year when such destruction takes place the amount previously reported as income because of the erection of such buildings or improvements, less any salvage value subject to the lease to the extent that such loss was not compensated for by insurance. A mere refusal to accept rental income does not give right to the lessor to postpone the reporting of such income for tax purposes. A lessor who refused to accept rental payments from the lessee is deemed to have constructively received the same when the lessee tendered payment and later made a judicial deposit of the rental due (Limpan Investment Corp. vs. Commissioner, 17 SCRA 703). Exchanges of real property classified as capital assets by individuals are subject to the capital gains tax based on the fair market value of the real property. So is a deed of reconveyance with assumption of mortgage. In mortgage foreclosure sales, the amount of loan secured by the mortgage is not considered as basis in computing the capital gains tax. 57

58

59

" B I R Ruling No. 037, Feb. 10, 1988. BIR Ruling No. 298, July 6, 1988. BIR Ruling No. 455, Sept. 16, 1988. 58

59


Section 24(D)(1) is comprehensive enough to cover not only voluntary sales but also involuntary sales, like execution sale and expropriation sale. In case of expropriation by the government, the actual consideration may be used as basis in determining the capital gains tax. The just compensation paid by the government to the seller/owner of property is the equivalent for the value of the property at the time of its taking. It is the fair and full equivalent for the loss sustained by the transferor that is the measure of indemnity. Such being the case, the amount approved by the court as fair compensation must be used as the tax base for computing the gains derived out of such transaction. The forced character of the disposition of the real property provides the justification for the above-stated treatment of gain arising from the expropriation sale. 60

61

62

Tax Treaties Under the tax treaties the Philippines has concluded with other countries, such business or trade income, gain or profit (which is described in the tax treaty as business profits), although it is derived from sources within the Philippines, is still exempt from the Philippine income tax and withholding tax, Provided, That the foreign corporation has no permanent establishment in the Philippines. The tax treaty adequately provides for definite guidelines as to when a permanent establishment of a foreign corporation is created or deemed created in the Philippines. And for purposes of determining prices at arm's length, the BIR subscribes to the guidelines adopted by the OECD countries relating to transfer pricing guidelines. 63

Consultancy/service fees which the Department of Trade or Industry will pay to a New York-based fashion designer, for the preparation of a curriculum/report on fashion/design courses which DTI plans to put up for its Asian Institute of Design and Technology is exempt from Philippine income, since the U.S.-based corporation has no permanent establishment in the Philippines and the preparation of the feasibility study and ""BIR Ruling No. 091, May 2, 1989. BIR Ruling No. 175, Sept. 30, 1990. BIR Ruling No. 061, Apr. 11, 1991. "RMC 26-2008, Mar. 24, 2008 61

62

GROSS INCOME

97

submission of final report will take only 150 days, or less than six months. 64

Income of US$1,000 a month in the form of retainer fee derived by a U.S. consultancy firm from a domestic corporation, is not subject to Philippine income tax, inasmuch as the U.S.-based company has no permanent establishment in the Philippines. 65

Income derived by a Japanese-based firm not engaged in trade or business in the Philippines and which has no permanent establishment in the country, for the construction of a factory project is not subject to Philippine income tax. Such income is taxable only in Japan. 66

Compensation income derived by a resident of New Zealand assigned by a foreign corporation licensed to do business in the Philippines to oversee a one-year contract which it entered into with Philippine Geothermal, Inc. is not subject to Philippine income tax. 67

Capital Gains For tax purposes, there are three (3) general types of capital assets. These are: (a) shares of stock of a domestic corporation; (b) real property (of individuals) or land/or building (of corporations); and (c) other types of assets, including shares of stock of a foreign corporation. The rules provided for in the 1997 Tax Code are summarized below. Shares of Stock of a Domestic Corporation In transactions involving sale or exchange of shares of stock of a domestic corporation, the tax status of the seller M

B I R Ruling No. 113-96, Oct 25,1996. Under Art. 5 oftheRP-US Tax Treaty, a U.S. corporation may create a permanent establishment in the Philippines if it sends employees or consultants whose aggregate period of stay in the Philippines exceeds ninety (90) days during the year. In this ruling, the consultant will stay for 150 days in the Philippines. BIR Ruling No. 059-98, May 21, 1998. " B I R Ruling Nos. 116-96 and 117-96, Nov. 4, 1996. BIR Ruling No. 044-97, Apr. 14,1997. Under the RP-New Zealand Tax Treaty, no permanent establishment is created where the non-resident foreign corporation sends its employee or consultant in the Philippines for an aggregate period of not more than 183 days during the year. Since the term of employment of the New Zealand employee in the Philippines is one year, and considering that the foreign corporation is licensed to do business in the Philippines, there is clearly a permanent establishment in the Philippines. 65

67


98

or transferor (whether an individual, citizen or alien, or a corporation, domestic or foreign) is not material. Under the Tax Code, whoever is the seller or transferor of the shares of stock of a domestic corporation, the transaction is either subject to (a) the 1/2 of 1% stock transaction tax, if the sale of the listed shares takes place through a stockbroker of a local stock exchange, or (b) 5%/10% capital gains tax, if the shares are unlisted or they are listed shares but traded outside of the local stock exchange. The rules on sale or exchange of shares of stock of a domestic corporation are: 68

1. If the seller or transferor is a dealer in securities, the shares of stock (whether listed and traded in the local stock exchange, listed but not traded in the local stock exchange, or not listed) shall be treated as ordinary assets and the ordinary gain, if any, from the sale or transfer thereof shall be subject to the graduated income tax rates, in the case of individual seller or transferor, or to the normal corporate income tax, in the case of corporate seller or transferor. 2. If the seller or transferor is not a d e a l e r in securities, the shares of stock are regarded as capital assets. There is a need to determine if the shares of stock are listed and traded in the Philippine Stock Exchange. a. If the shares of stock are listed and traded in the local stock exchange, the transaction is exempt from income tax, regardless of the nature of business of the seller or transferor (individual or corporation). However, it is subject to the one-half of one percent (1/2 of 1%) stock transaction tax imposed in Section 127(A) of the 1997 Tax Code, based on the gross selling price or gross value in money of the shares of stock sold or transferred. 69

Tax treatment of Securities Lending and Borrowing (SLB). - For purposes of these M

A dealer in securities is a merchant of stock or securities, whether an individual, partnership or corporation, with an established place of business, regularly engaged in the purchase of securities and their resale to customers; that is, one who as a merchant buys securities and sells them to customers with a view to the gains and profits that may be derived therefrom (Rev. Regs. No. 7-95; Sec. 22[UJ, NIRC). Stock transaction tax of V* of 1% of gross selling price was increased to 1/2 of 1% by R.A. No. 7717 and made part of Section 127-A of the Tax Code. 69

GROSS INCOME

99

70

Regulations, the Securities Lending and Borrowing transactions of shares of stocks/securities listed in the PSE, as well as the delivery to, and return by, the Lender/Lending Agent of collateral appurtenant thereto or the Equivalent Shares of Stock/Securities, shall not be subject to the stock transaction tax under Section 127 or capital gains tax under Sections 24(C), 25(A)(3), 28(A)(7)(c), and 28(B)(5)(c) of the Tax Code! provided that a valid MSLA is executed by the parties and registered with and approved by the BIR, the SBL Program is in accordance with the rules and regulations of the SEC, and such SBL Program is under the administration and supervision of the PSE. b.

If the shares of stock are not listed, or they are listed but not traded in the local stock exchange, the net capital gains realized during the year, if any, shall be subject to the final capital gains tax equivalent to 5% of the net capital gains not exceeding P100,000, and 10%, on any amount in excess of P100,000. An annual capital gains tax return must be filed by the taxpayer, covering all his stock transactions during the calendar year, not later than April 15 of the following year. The effect of this provision is to allow the taxpayer to claim the lower rate of 5% only on the first P100,000 gross sales. Take note that it does not matter who is the seller or transferor (whether he is an individual (citizen or alien) or a corporation (domestic or foreign), provided he/it is not a dealer in securities, except in the case of a non-resident alien individual not engaged in trade or business in the Philippines whose capital gain shall be taxed at 25% of his gross income under Section 25(B) of the Tax Code. 71

72

Gross Selling Price In determining the selling price, the following rules shall apply: 73

70

Rev. Regs. No. 20-2006, as amended by Rev. Regs. No. 1-2008 dated Feb. 1,2008. "Sec. 24(C) and Sec. 25(A)(3); Sec. 27(D)(2) and Sec. 28(A)(7)(c) and Sec. 28(B) (5Xc), NIRC "Rev. Regs. No. 2-82. See Rev. Regs. No. 6-2008 dated Apr. 22, 2008. 73


100

i.

In the case of cash sale, the selling price shall be the total consideration per deed of sale;

ii.

If the total consideration of the sale or disposition consists partly in money and partly in kind, the selling price shall be the sum of money and the fair market value of the property received;

iii.

In the case of exchange, the selling price shall be the fair market value of the property received;

iv.

In case the fair market value of the shares of stock sold, bartered, or exchanged is greater than the amount of money and/or fair market value of the property received, the excess of the fair market value of the shares of stock sold, bartered or exchanged over the amount of money and the fair market value of the property, if any, received as consideration shall be deemed a gift subject to donor's tax under Section 100 of the Tax Code.

The fair market value of the unlisted shares of stock sold shall be the book value of the shares of stock as shown in the financial statements duly certified by an independent certified public accountant nearest to the date of sale. The capital gain from the sale of listed shares over the counter or outside of the local stock exchange shall be subject to the 5%/10% capital gains tax, since the law requires that the listed shares must be traded in the local stock exchange. However, the capital loss from the sale of listed shares outside of the local stock exchange can be deducted from the capital gain from another sale of unlisted shares, or listed shares but traded outside of the local stock exchange. c. If the shares of stocks are covered by SBL agreements under Revenue Regulations No. 10-2006, as amended by Revenue Regulations No. 1-2008, dated February 1, 2008, the following rules shall apply: "SEC. 5. Tax Treatment of Securities Borrowing and Lending (SBL). - For purposes of these Regulations, the Securities Borrowing and Lending transactions of shares of stock/securities listed in the PSE, as well as the delivery to, and return by, the Lender/Lending Agent

GROSS INCOME

101

of collateral appurtenant thereto or the Equivalent Shares of Stock/Securities, shall not be subject to the stock transaction tax under Section 127 or capital gains tax imposed under Sections 24(C), 25(A)(3), 28(A)(7) (c), and 28(B)(5)(c) of the Tax Code, and documentary stamp taxes under Section 176 and Section 199(c) of the National Internal Revenue Code, as amended by RA 9243; Provided, That, a valid MSLA is executed by the parties and registered with and approved by the BIR, the SBL Program is in accordance with the rules and regulations of the SEC, and such SBL Program is under the administration and supervision of the PSE. However, all other applicable taxes prescribed by the Tax Code and special laws shall continue to apply. Unless the terms and conditions of these Regulations are complied with, the borrowing (lending) of shares of stock/securities shall be treated as a disposal (an acquisition) by the lender (Borrower), and the return of borrowed shares/securities shall be treated as an acquisition (disposal) by the Lender (Borrower), in which case, the applicable taxes on the transaction shall be imposed." d.

Under the tax treaties, capital gains from sale or exchange of shares of stock of a domestic corporation are generally not liable to Philippine income tax, provided that there is no real property interest thereon. 74

It must be noted that gains from the sales of shares of stocks of a foreign corporation, although treated as capital assets of the owner-seller, are subject to the global tax system [i.e., net taxable income times 5%-32% (if individual) or 30% (if corporation)] and not to the 5%/10% capital gains tax explained above. In the hands of a resident individual, only 50% of the gain shall be deemed realized during the year of sale if he held such shares of stocks of the foreign corporation for more than twelve months.

7<

BIR Ruling No. 007-96, Jan. 18, 1996 (Japan); No. 009-96, Jan. 23, 1996 (Netherlands); No. 037-96, Mar. 7,1996, No. 099-97, Aug. 29,1997-PSE seat (Malaysia); No. 089-97, Aug. 5, 1997 (Australia);


102

Real Property

75

The rules on the sale or exchange of real property located in the Philippines are summarized below: 1.

If the seller or transferor is a real estate dealer, the real property sold is an ordinary asset, and the gain, if any, is subject to the graduated income tax (if an individual who is a citizen, or a resident or nonresident alien engaged in trade or business in the Philippines, or 25% final tax if a non-resident alien not engaged in trade or business in the Philippines), or to the normal corporate income tax (if a domestic corporation or a resident foreign corporation). Nonresident foreign corporations are taxed on their gross income from sources within the Philippines, including gain from sale of real property. 76

A "real estate dealer" includes any person engaged in the business of buying, developing, selling, exchanging real properties as principal and holding himself out as a full or part-time dealer in real estate. 77

2.

If the seller or transferor is not a real estate dealer, determine whether the real property sold or transferred is (a) used in the taxpayer's trade, business or profession, or (b) treated as fixed asset used in his trade, business or profession, subject to depreciation. If the answer in either of the two cases above is in the affirmative, the real property shall be treated as ordinary asset, and the gain, if any, from the sale or transfer thereof shall be subject to the graduated income tax rates or to the normal corporate income tax rate, as discussed in the preceding paragraph. On the other hand, if the answer is in the negative, the real property shall be treated as capital asset, and the gain, if any, by a citizen, alien (resident or non-resident), and domestic corporation shall be subject to the final capital gains tax of 6%

"Since the Tax Code does not define term 'real property,' the definition of 'immovable property' in Art. 415, New Civil Code of the Philippines, shall be applied. ' Sec. 24(A), Sec. 25(A)(1) and (B), and Sec. 27(A), Sec. 28(A)(1) and(BXl), NIRC. "Sec. 4.106-1, Rev. Regs. No. 7-95, as amended. 6

GROSS INCOME

103

based on the gross selling price or fair market value of the property at the time of sale, whichever is higher. It is to be noted that foreign corporations (whether resident or non-resident) are not entitled to the preferential tax rates on their gain from sale of real property classified as capital asset because there is no similar express provision as that granted to domestic corporations. Therefore, regardless of classification, real property sold by a resident foreign corporation shall be subject to the normal corporate income tax and expanded withholding tax. However, if the seller is a non-resident foreign corporation, the gain from sale shall be taxed at 30%. 78

79

Foreclosure Sales by the Department of Agrarian Reform (DAR) 80

Facts: DAR, pursuant to Executive Order (EO) No. 406, series of 1990, which directed the acceleration of the Agrarian Reform Beneficiaries (ARBs) development through the provision of economic and social infrastructure support, had made available funds for lending to qualified ARBs/cooperatives through the Development Bank of the Philippines (DBP), its accredited loan administrator. DBP assigned all the rights and interests as mortgagee to DAR in the Deeds of Assignment executed between them for each and every Mortgage Contract made under the said financing program. DAR, through the Office of the Solicitor General, filed petitions for the extrajudicial foreclosures of mortgages of certain cooperatives which failed to settle their loans. In most cases, DAR was awarded the Sheriffs Certificates of Sale for the subject personal and real properties being the highest bidder during the foreclosure sales. In the registration of the Sheriffs Certificates of Sale for the foreclosed real properties, the DAR Provincial Offices where such assets are located were requested to secure a Certificate Authorizing Registration (CAR) from the concerned Revenue 1!

>Sec. 24(D) and Sec. 25(A)(3) and (B); Sec. 27(DX5), NIRC. Sec. 4(e) and (f), Rev. Regs. No. 7-2003. ""See RMC 62-2006 and Rev. Regs. No. 4-99.

79


104

District Offices (RDO). DAR has already a number of foreclosed properties that were not redeemed and should be consolidated in the name of the Republic of the Philippines. Since DAR is required to pay taxes and it has no funds for such purpose, the transfer of titles of the foreclosed real properties remains pending. In the case wherein the highest bidder is other than DAR, the highest bidder assumes payment of taxes imposed as a consequence of the foreclosure sale. Ruling: 1) Revenue Regulations No. 4-99 applies only to extrajudicial foreclosure sale initiated by banks, finance and insurance companies. Accordingly, said issuance is not applicable to the foreclosure sales initiated by DAR. 2) Like any other extrajudicial foreclosures which do not fall within the purview of RR No. 4-99, the capital gains tax (CGT) is due within thirty days from the time the foreclosure sale was made. The withholding and documentary stamp taxes are due on the fifth day after the close of the month when the foreclosure sale was made. DAR representing the owner-mortgagor is considered as the "statutory seller," supposedly the one liable to pay the capital gains/income/withholding tax due on such foreclosure sale based on the bid price in the auction sale or the zonal value of the foreclosed property, whichever is higher. However, in the case where DAR is the highest bidder in the foreclosure sale, of which it will eventually be the party to consolidate the title of the foreclosed property in the name of the Government if such property is not redeemed, DAR, as the statutory seller and at the same time the buyer, in effect, is exempt from all taxes, including the penalties, surcharge and interest, imposed in connection therewith inasmuch as the funds that will be used to defray the same will be coming from the government's treasury. As aptly said by the Supreme Court in the case of the Board of Assessment Appeals, Province of Laguna vs. CA and National Waterworks and Sewerage Authority, 8 Phil. 227: "Moreover, taxes are financial burden imposed for the purpose of raising revenues with which to

GROSS INCOME

105

defray the cost of the operation of the Government, and a tax on the property of the government, whether national or local, would merely have the effect of taking money from one pocket to put in another pocket (Cooley on Taxation, Sec. 621, 4th Edition). Hence, it would not serve, in the final analysis, the main purpose of taxation." However, before the foreclosed properties can be transferred in the name of the Republic of the Philippines, DAR must first obtain a CAR in the respective RDO where the subject properties are located. Section 58(E) of the Tax Code of 1997, as amended, provides, viz.: "No registration of any document transferring real property shall be effected by the Register of Deeds unless the Commissioner of Internal Revenue or his duly authorized representatives has certified that such transfer has been reported, and the capital gains or creditable withholding tax, if any, has been paid." On the other hand, and as represented, in the case wherein the highest bidder is other than DAR, the highest bidder assumes payment of taxes imposed as a consequence of the foreclosure sale. Thus, if there is delay in the payment of the taxes due thereon, the highest bidder shall be liable to pay the additions (penalties, surcharge and interest imposed for the delay in payment of taxes) thereto. Exchange of Properties Deed of exchange executed by the parties voluntarily and without any financial consideration, involving real properties, would subject both parties separately and distinctly to the capital gains tax, based on the fair market value or consideration, whichever is higher. In this case, there are two taxable transactions. 81

Income on sale of real property not located in the Philippines, regardless of classification, by resident citizens and domestic corporations shall be subject to the graduated income tax (if a resident citizen) or normal corporate income tax (if a "BIR Ruling No. 029-96, Feb. 27, 1996.


106

domestic corporation). Such income is exempt from income tax in the case of non-resident citizens, alien individuals, and foreign corporations because they are taxed only on Philippine-source income. Other Capital Assets All other properties, except shares of stocks of a domestic corporation and real property located in the Philippines, shall be subject to income tax at the graduated income tax rates (if seller is an individual) or at 30% corporate income tax (if seller is a corporation). However, only 50% of long-term capital gains are recognized as subject to income tax, if derived by an individual taxpayer, while 100% of the capital gains are subject to tax if derived by an individual taxpayer from short-term capital asset transactions. A capital gain is treated as (a) long-term if the asset sold or exchanged is held for more than twelve months, or (b) short-term if the asset sold or exchanged is held for twelve months or less. The holding period is not material in the case of corporate taxpayers and the capital gain or capital loss is recognized in full. 82

Passive Investment Income A.

Interest income

83

In general, interests are included in the gross income of the creditor/depositor, unless they are exempt from tax or subject to final tax at preferential rate under the 1997 Tax Code or under the applicable tax treaty. All interest received or credited to one's account is taxable, unless it is specifically exempt from tax. Interest income has to be examined closely to determine whether it is taxable in the Philippines, and if so, what kind of income tax and what rate of tax shall apply to it. The rules on interest income under the Philippine 1997 Tax Code are summarized as follows: 1. Gross interest income from Philippine currency bank deposits and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements are 8z

Sec. 39(B), NIRC. ^Interest is the income paid to the creditor for the use or forbearance of his money.

GROSS INCOME

107

subject to the 20% final withholding tax, of all depositors, including enterprises registered with PEZA, SBMA, CDA, and other special economic zones and freeport zones, and senior citizens, except when the depositor is a non-resident alien not engaged in trade or business in the Philippines, where such interest income shall be subject to the higher 25% tax rate pursuant to Section 25(B) of the Tax Code. However, if the depositor is an employee trust fund or retirement plan, such interest income, yield or other monetary benefit is exempt from the final withholding tax. 84

85

86

2. Gross interest income from foreign currency deposits with an Offshore Banking Unit (OBU) or Foreign Currency Deposit Unit (FCDU) in the Philippines is subject to the final withholding tax of 7.5%. If the foreign currency deposit is made with a bank located outside the Philippines, the interest income is subject to the graduated income tax rates (if the depositor is a resident citizen) or the regular corporate income tax rate of 30% (if the depositor is a domestic corporation). Take note that interest income on foreign currency deposits with a bank located outside the Philippines by a ion-resident citizen, alien individual, and foreign corporation is exempt from income tax, pursuant to the express provisions of Section 28(A)(4) for OBU and Section 27(D)(3) for FCDU, both of the 1997 Tax Code. 87

The tax base upon which the appropriate withholding tax rate shall be applied by the bank on foreign currency denominated loans extended to resident borrowers is the total amount of the interest income to be paid, without grossing up thereto the corresponding withholding tax due thereon, whether the borrower assumes to pay the tax or not. 88

3. Interest income derived from loans and other transactions, other than those enumerated above, is subject to the graduated income tax rates (if the creditor is an individual) or the normal corporate tax rate (if the creditor is a corporation), except in the case of (a) non-resident alien not engaged in trade "Under Rev. Regs. No. 1-90, interest income from peso deposits with banks located within the SBMA and other Freeport zones shall be subject to the 5% final tax. This was amended by Rev. Regs. 20-2002 (Oct. 14, 2002), which imposes 20% final tax on such interest income from peso deposits with banks. ^BIR Ruling No. 066-2000, Nov. 27, 2000. GCL Retirement Plan vs Commissioner, supra. BIR Ruling No. 103-99, July 13, 1999. However, interest income from foreign currency transactions of a bank shall be subject to 10% final withholding tax. ""BIR Ruling No. 046-96, Apr. 2, 1996. m

87


108

or business in the Philippines where the rate applicable is 25% final tax, and (b) non-resident foreign corporation where the rate applicable is 20% final tax, unless a lower rate of tax under a tax treaty applies. If the loan was granted by a foreign government or by a financial institution owned, controlled or enjoying refinancing from the foreign government, or an international or regional financing institution established by governments, the interest income of the lender shall not be subject to the final withholding tax. 89

90

Interest on loan secured by Atlas in its own independent capacity from Mitsubishi who sourced the fund from Eximbank, without any provision or inference that the latter acted in behalf of Atlas, is taxable. - Atlas Consolidated Mining and Development Corporation borrowed from Mitsubishi Metal Corporation an amount to be used for the improvement of the former's copper production and the latter agreed to purchase all the copper concentrates produced from the improved facilities for a period of 15 years. Mitsubishi turned around and borrowed the equivalent amount in yen of the dollar loan from Export-Import Bank of Japan, a financial institution owned by the Japanese government, and a consortium of Japanese banks. The court ruled that when Mitsubishi secured funds for its reciprocal transaction with Atlas, it was in its own independent capacity as a private entity and not as a conduit of the consortium of Japanese banks or the Export-Import Bank of Japan (Eximbank). The court sided with the BIR that it was not Eximbank that was intended to be benefited as it was Mitsubishi that stood to profit from it. The court also noted that it was indubitable that Mitsubishi was the sole creditor of Atlas (not Eximbank) as there was nowhere in the contract could it be inferred that Mitsubishi acted for and in behalf of Eximbank nor of any entity, private or public, for that matter (Commissioner vs. Mitsubishi Metal Corp., et al., G.R. No. 54908 and G.R. No. 80041, Jan. 22, 1990). 4. Discount revenues in financing or factoring arrangements and in the issuance of long-term instruments and bonds are treated for income tax purposes in the same manner as interest income. ""Foreign loans are subject to 20% final withholding tax as implemented by Rev. Regs. No. 4-75. '"Sec. 32(B)(7)(a), NIRC.

GROSS INCOME

109

5. Interest income from long-term deposit or deposit substitutes, investment management accounts and other investments evidenced by certificates in such form prescribed by the Bangko Sentral ng Pilipinas received by a citizen, resident alien, and non-resident alien engaged in trade or business in the Philippines, shall be exempt from income tax. However, should the holder of the certificate pre-terminate the deposit or investment before the fifth year, a final tax shall be imposed on the entire income and shall be deducted and withheld by the depository bank from the proceeds of the long-term deposit or investment certificate based on the remaining maturity thereof: Four years to less than five years

-

5%;

Three years to less than four years

-

12%;

Less than three years

-

20%.

91

The preferential tax treatment accorded to individuals is not extended to corporations as no similar provision can be found in Sections 27 and 28 of the Tax Code. 6. Interest payments for loi-ns and other borrowings granted by financial institutions and individuals are not subject to the expanded withholding tax, unless the payor of interest is one of the Top 20,000 Corporations. 92

Interest income paid by a domestic corporation to a nonresident foreign corporation organized under the laws of foreign country which has an effective tax treaty with the Philippines is generally subject to 15% final withholding tax, although there are instances when such interest income is exempt from tax or the withholding tax rate is reduced to 10%. Distinctions Between Interest Income and Dividend Income The classic debt is an unqualified obligation to pay a sum certain at a reasonably close fixed maturity date along with a fixed percentage in interest payable, regardless of the debtor's income. While some variation from this formula is not fatal, a great variation will preclude such treatment. In short, the substance and not the form of the advances will determine 91

Sec. 24(BXD and Sec. 25(A)(2), NIRC. This tax exemption is not extended to nonresident alien not engaged in trade or business in the Philippines and to corporations. "'BIR Ruling No. 043-96, Mar. 25, 1996.


110

whether they are to be considered as loans or as capital contributions. The most important tax distinction between debt and equity is that periodic payments on debt, called interest, can be deducted by the corporation while the equivalent payment on equity, which is dividend, cannot be. 93

94

Decisions of the U.S. courts have provided the tests that will serve as guidelines in determining whether an interest payment is actually interest or dividend. Some of the tests are: a.

Whether the parties intend at the time of the issuance of the original documents to create a debtor-creditor relationship;

b.

The nomenclature/label used;

c.

Whether the obligation has a definite maturity date fixed or ascertainable;

d.

Whether the holders of the securities have voting powers;

e.

Whether the instrument bear a fixed rate of interest;

f.

Whether the obligation to pay interest is positive and unconditional.

Thus, interests paid under a Subordinated Loan Agreement pursuant to Rule 24(a)-2 of the Revised Securities Act shall be treated as interest (not as dividend). 95

Dividend vs. Loan Withdrawals by stockholders may either be loans or dividends. If the amounts withdrawn were at the time of withdrawals intended to be repaid, they are considered as loans and are thus not considered as income subject to tax (Brixton Investment Corp., et al. vs. Tabios, CTA Case No. 1681, Apr. 18, 1967). But if the withdrawals are substantially in proportion to stockholdings, especially in a close corporation, if no notes are executed, no interest is charged or paid, no repayment is made and no effort is exerted to enforce collection, they are held as dividends subject to tax if made by individuals and non-resident foreign corporations (Roy Kiener, 36 BTA 153). 93

Mertens, Tax Treatise, Vol. 41, Chapter 26, p. 48. "Abrams, Howard E. and Doemberg, Richard L., Federal Corporate Taxation, 4th ed., p. 70. I T A D Ruling Nos. 123-02, July 17, 2002 and 094-02, May 16, 2002. 96

GROSS INCOME

111

Dividend Income In general, dividends are included in the gross income of the stockholder, unless they are exempt from tax or subject to final tax at preferential rate under the 1997 Tax Code. Dividends comprise any distribution whether in cash or other property in the ordinary course of business, even though extraordinary in amount made by a domestic corporation, joint stock company, partnership, joint account, association, or insurance company to the shareholders or members out of its earnings or profits. A dividend is defined as a corporate profit set aside, declared, and ordered by the directors to be paid to the stockholders on demand or at a fixed time. Until the cash or property dividend is declared, the corporate profits belong to the corporation and not to the stockholders, and are liable for the payment of the debts of the corporation. 96

97

Cash dividend and property dividend are subject to income tax, whereas stock dividend is generally exempt from income tax. However, any type of dividend must come from the unappropriated retained earnings of the corporation. Property dividend is a dividend payable in property which may be investments in shares of stocks of a corporation, or real property, or some other property owned by the corporation. Property dividend is different from stock dividend in that the shares of stock declared as property dividend by a corporation are shares of stock of another corporation to which the corporation paying the dividend has investments and is shown as assets in its balance sheet. On the other hand, stock dividend is a dividend payable in the shares of stock of the corporation declaring such stock dividend. The issuance of the stock dividend will increase the number of shares issued and outstanding of the corporation that declared the stock dividend. A stock dividend, when declared, is merely a certificate of stock which evidences the interest of the stockholder in the increased capital of the corporation. A stock dividend, being one payable in capital stock, cannot be declared out of outstanding corporate stock, but only from retained earnings However, a. liquidating dividend, although so-called dividend, is not truly dividend as contemplated under the income tax law. "Sec. 250, Rev. Regs. No. 2. "Frederick Fisher vs. Collector, G.R. No. 17518, Oct. 30, 1922.


112

Rules on Taxation of Dividends The applicable rules with respect to dividend income under the Philippine Tax Code are as follows: 1.

Dividend is paid by a domestic corporation

Recipient is a citizen, resident alien, or non-resident alien engaged in trade or business in the Philippines Up to December 31, 1997, cash dividend or property dividend paid by a domestic corporation was exempt from income tax pursuant to the provisions of the 1977 Tax Code, as amended. Beginning January 1, 1998, cash dividend or property dividend paid by a domestic corporation or from a joint stock company, insurance or mutual fund company, or on the share of an individual in the distributable net income after tax of a partnership (except a general professional partnership) of which he is a partner, or on the share of an individual in the net income after tax of an association, joint account, or joint venture or consortium taxable as a corporation of which he is a member or co-venturer, out of its earnings or profits in 1998 or succeeding years is generally subject to the following final withholding tax rates: 6% - beginning January 1, 1998; 8% - beginning January 1, 1999; or 10% - beginning January 1, 2000. However, the tax on dividends shall apply only on income earned on or after January 1, 1998. Income forming part of retained earnings as of December 31, 1997 shall not, even if declared or distributed on or after January 1, 1998, be subject to this tax. 98

The appropriate tax rate to be deducted and withheld on the cash dividend by the paying corporation shall be the rate prescribed in the year of receipt of such dividend (not the rate in the year of declaration of such dividend). 99

'Sec. 24(B(2), NIRC. 'BIR Ruling No. 134-99, Aug 25, 1999.

GROSS INCOME

113

Recipient is a non-resident alien not engaged in trade or business in the Philippines Cash and/or property dividends shall be subject to the final withholding tax rate of 25%. 100

Recipient is a domestic corporation or a resident foreign corporation Dividends received by a domestic corporation or resident foreign corporation from a domestic corporation (inter-corporate dividend) shall not be subject to tax. 101

Dividend exclusion is a device to reduce double taxation on the same income. - Dividend exclusion has always been a dominant feature of corporate income tax. It is a device for reducing extra or double taxation of distributed earnings. Since a corporation cannot deduct from its gross income the amount of dividends distributed to its corporation shareholders during the taxable year, any distributed earnings are necessarily taxed twice; initially at the corporate level when they are included in the corporation's taxable income, and ; gain, at the corporationshareholder level when they are received as dividend. Thus, without exclusion, the successive taxation of the dividend as it passes from corporation to corporation would result in repeated taxation of the same income and would leave very little for the ultimate individual shareholder. At the same time, the decision to tax a part of such dividends reflects the policy of discouraging complicated corporate structures as well as corporate divisions in the form of parent-subsidiary arrangements adopted to achieve a lower effective corporate income tax rate (Filipinos Life Assurance Co. vs. CTA and Commissioner, G.R. No. L-21258, Oct. 31,1967). 102

Recipient is a non-resident foreign corporation Dividends received by a non-resident foreign corporation from a domestic corporation is subject to the 15% final withholding tax, subject to the condition that the country in which the non-resident foreign corporation is domiciled, shall allow a credit against the tax due from the non-resident foreign 100

Sec. 25(B), NIRC. Sec. 27(D)(4) and Sec. 28(A)(7)(d), NIRC. For the taxable year covered in this case, 10% final withholding tax was imposed on inter-corporate dividends. Beginning January 1, 1998, inter-corporate dividends are not subject to income tax under R.A. No. 8424. 101

102

114


corporation taxes deemed to have been paid in the Philippines equivalent to 20% for 1997,19% for 1998,18% for 1999, and 17% for 2000 and thereafter, which represents the difference between the regular income tax of 35% in 1997,34% in 1998, 33% in 1999, and 32% in 2000 and thereafter and the 15% tax on dividends as provided for in this paragraph. Effective November 1, 2005, the corporate income tax rate was increased to 35% under R.A. No. 9337; said law reduced the corporate income tax rate to 30% beginning January 1, 2009. 103

In the leading case of Commissioner vs. Procter & Gamble PMC (G.R. No. L-66838, Apr. 15, 1988, 160 SCRA 560), the court ruled that the preferential 15% tax on dividend paid to a non-resident foreign corporation is inapplicable because of the failure of the claimant to show the actual amount credited by the U.S. government, to present the U.S. income tax returns of PGMC-USA, and to submit a duly authenticated document evidencing the tax credit of the 20% differential. Upon motion for reconsideration, the Supreme Court in an en banc resolution reversed the earlier decision of the court. It pronounced that the 15% preferential tax rate was applicable to the case at bar, because it was established that the Philippine Tax Code only requires that the U.S. shall "allow" Procter & Gamble USA "deemed paid" the tax credit equivalent to twenty percent. Clearly, the "deemed paid" tax credit which must be allowed by U.S. law to P&G USA is the same "deemed paid" tax credit that Philippine law allows to a Philippine corporation with a whollyor majority-owned subsidiary in the U.S. The "deemed paid" tax credit allowed in Section 902, U.S. Tax Code, is no more a credit for "phantom taxes" than is the "deemed paid" tax credit granted in Section 30(C)(8), NIRC. The legal question should be distinguished from questions of administrative implementation arising after the legal question has been answered. The court rationalized its decision as follows: "An interpretation of a tax statute that produces a revenue flow for the government is not, for that reason alone, necessarily the correct reading of the statute. There are many tax statutes or provisions which are designed, not to trigger off an instant surge of revenues, but rather to achieve longer-term and broader-gauge fiscal and economic objectives. The task of our Court is to give effect to the legislative design and objectives as they are written into 'Sec. 28(B)(5)(b), NIRC; PD 69 and Sec, 2, Rev. Regs. No. 4-76.

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115

the statute even if, some revenues have to be foregone in that process. The economic objectives sought to be achieved by the Philippine Government by reducing the 35% dividend rate to 15% are set out in the preambular clauses of P.D. No. 369, which amended Section 24(B)(1), NIRC, into its present form. Section 24 seeks to promote the in-flow of foreign equity investment in the Philippines, by reducing the tax cost of earning profits here and thereby increasing the net dividends remittable to the investor. The foreign investor, however, would not benefit from the reduction of the Philippine dividend tax rate, unless its home country gives it some relief from double taxation (i.e., second-tier taxation), (the home country would simply have more "post R.P. tax" income to subject to its own taxing power) by allowing the investor additional tax credits which would be applicable against the tax payable to such home country. Accordingly, Section 24 requires the home or domiciliary country to give the investor corporation a "deemed paid" tax credit at least equal in amount to the twenty percentage points of dividend tax foregone by the Philippines, in the assumption that a positive incentive effect would thereby be felt by the investor" 'Commissioner vs. Procter & Gamble PMC, G.R. No. 66838, Dec. 2,1991, 204 SCRA 377). Illustration PHILCO is a domestic corporation which is 100% owned by JAPANCO. Under the laws of Japan and the Philippines-Japan Tax Treaty, the amount deemed paid in the Philippines by the subsidiary of a Japanese company can be credited against the corporate income tax payable by the Japanese company to the government of Japan. During the taxable year (2009), their corporate income tax returns show the following:

Gross income from operations Dividend income from PHILCO Deductions Net income Income tax paid at 30% Retained earnings Assumed Japanese corporate income tax rate

PHILCO

JAPANCO

100.00

500.00 14.00 400.00 114.00

80.00 20.00 6.00 14.00

40%

'"Although the current corporate income tax rate in Japan is 30%, in the illustration to emphasize or magnify the tax benefit.

104


116

A.

Tax spared by the Philippines is credited against Japanese income tax Philippines Dividend to JAPANCO 15% final withholding tax (P14 x 15%)

P14.00 2.10

Since the tax spared or waived by the Philippine government in the amount of P2.10 (equivalent to 15% of P14.00 deemed paid in the Philippines) will be credited by the government of Japan against the corporate income tax liability of JAPANCO, the applicable withholding tax rate on the dividend paid to JAPANCO that must be withheld and remitted to BIR by PHILCO is only P2.10 (equivalent to 15% of P14.00). The total tax paid to the Philippine government is P8.10, composed of P6.00-corporate income tax, and P2.10—15% withholding tax. Japan Japanese income tax ( P I 14 x 40%) Less: 15% final withholding tax 15% deemed paid tax TOTAL

P45.60 P2.10 2.10

- P4.20 P41.40

JAPANCO Because the tax spared or waived by the Philippine government is allowed to be credited by the Japanese government against the corporate income tax liability of JAPANCO, JAPANCO will pay a reduced corporate income tax of P49.50 for the year as follows: To Philippine government To Japanese government TOTAL

P 8.10 + P41.40 P49.50

In view thereof, we can conclude that the tax spared or waived by the Philippine government will benefit JAPANCO, and that it is expected to make additional investments in the Philippines on account of the tax benefit it derives.

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117

Tax spared by the Philippines is not credited against Japanese income tax Scenario No. 1 Assuming that the government of Japan does not allow the 15% "deemed paid" in the Philippines to be credited by JAPANCO in computing its corporate income tax payable to the government of Japan, but the Philippines still collects only the 15% final withholding tax on the dividend paid by PHILCO to JAPANCO. Philippines Dividend to JAPANCO 15% final withholding tax (P14 x 15%)

P14.00 P2.10

The total income tax collected by the Philippines is P8.10 broken down as follows: Corporate income tax Add: 15% final withholding tax TOTAL

P6.00 + P2.10 P8.10

Japan Japanese corporate income tax Less: 15% final withholding tax TOTAL

P45.60 - P2.10 P43.50

When Japan allows the 15% "deemed paid" tax in the Philippines to be credited against the corporate income tax liability of JAPANCO, it collects only P41.40. However, when the "deemed paid" tax is not allowed to be credited against the corporate income tax liability of JAPANCO, the Japanese government will collect P43.50. In other words, whatever is the tax waived by the Philippine government is correspondingly collected by the Japanese government. JAPANCO The total corporate income taxes to be paid by JAPANCO will be the same, since the tax spared or waived by the Philippine government is not allowed to be credited by the Japanese government; hence, the benefit will just go to the Japanese government. Taxes paid by JAPANCO will be as follows:


118

To Philippine government To Japanese government TOTAL

P8.10 + P43.50 P51 fiO

Scenario No. 2 Assuming that the government of Japan does not allow the 15% "deemed paid" in the Philippines to be credited by JAPANCO in computing its corporate income tax payable to the government of Japan, the Philippines would require that PHILCO withhold and remit to BIR the final withholding tax at the rate of 30% (not just 15%), since the tax benefit would go to the government of Japan, instead of going to JAPANCO. Philippines Dividend paid to JAPANCO 30% final withholding tax

P14.00 P4.20

The total income tax collected by the Philippine government is as follows: Corporate income tax 30% final withholding tax TOTAL

P6.00 + P4.20 P10.20

Japan Since the Japanese government allows to be credited against the Japanese corporate income tax of JAPANCO only the actual amount paid to the Philippine government, the 30% final withholding tax withheld by P H I L C O will be credited against the corporate income tax of JAPANCO. There will be lower income tax paid to the Japanese government. Japanese income tax ( P I 14 x 40%) Less: 30% final withholding tax TOTAL

P45.60 + P4.20 P41.40

JAPANCO The total amount of corporate income tax paid by JAPANCO will still be the same. Thus: To Philippine government To Japanese government TOTAL

P10.20 + P41.40 P51.60

GROSS INCOME

119

In sum, it can be safely concluded that where the Philippines imposes only the 15% final withholding tax on the dividend paid to JAPANCO and the Japanese government allows as a tax credit against JAPANCO's corporate income tax in Japan, not only the 15% withholding tax actually paid but also the 15% deemed paid by JAPANCO to the Philippines, then the tax benefit goes to JAPANCO, the foreign investor. But if the Japanese government would credit only against the corporate income tax of JAPANCO the actual amount paid by it to the Philippine government, there is no sense for the Philippine government to collect only the 15% final withholding tax on the dividend paid to JAPANCO by the domestic corporation, since in that case, the tax benefit will not go to the foreign investor but to the government of such foreign investor. The objective of the law is to encourage foreign investors to make investments in the Philippines. Cash dividends declared by China Banking Corporation to three American residents of Chinese descent are subject to the preferential tax rate of 25% under the RP-U.S. Tax Treaty. 105

Country of residence of foreign corporation does not impose income tax While it is true that claims for refunds are construed strictly against the claimant, the fact that Switzerland does not impose any tax on the dividends received from a domestic corporation should be considered as full satisfaction of the condition that the 20% (now 15% = 30% - 15%) differential is deemed credited by the Swiss government (as against the Commissioner's contention that the tax-sparing credit should apply only if the foreign country allows a foreign tax credit). The court observed that to deny private respondent the privilege to withhold only 15% provided for under Presidential Decree No. 69 would run counter to the very spirit and intent of said law and definitely will adversely affect foreign corporations' interest and discourage them from investing capital in our country (Commissioner vs. I06

B I R Ruling No. 056-98, May 21, 1998. Under the RP-U.S. Tax Treaty, the maximum rate of tax on dividend paid by a domestic corporation is 20%, yet the rate imposed in the ruling is 25%. This is due to the fact that the recipients of dividends are only American residents of Chinese descents who are not entitled to the preferential tax rates under the tax treaty. Since they are Chinese nationals and there was no effective RP-China Tax Treaty at that time, the pertinent provisions of the Philippine Tax Code should be applied.

120


Wander Philippines, Inc., 160 SCRA 573 [1988]). The same rule applies to dividends paid to corporations organized under the laws of Hong Kong, which country does not impose income tax on dividends paid by Philippine companies. Dividend paid to foreign head office of a Philippine branch Marubeni Japan established a branch in the Philippines. Marubeni Japan made direct equity investments in AG&P, a domestic corporation, from which it received cash dividends in 1981. The dividends were subjected to 10% inter-corporate dividend final tax (because of the existence of the Philippine branch) and to the 15% branch profit remittance tax, which taxes AG&P withheld and remitted to BIR. Marubeni Japan filed a claim for refund, which the BIR denied. 106

The Supreme Court ruled that a single corporate entity cannot be both a resident and a non-resident corporation depending on the nature of the particular transaction involved. Accordingly, where the dividends are paid directly to the head office or coursed through its local branch is of no moment for after all, the head office and the office branch constitute but one corporate entity, the Marubeni Corporation, under both Philippine tax and corporate laws, is a resident foreign corporation because it is transacting business in the Philippines (Marubeni Corporation vs. Commissioner & CTA, G.R. No. 76573, Sept. 14,1989). In a subsequent resolution, the Supreme Court stated that since the investment of Marubeni Japan was made for purposes peculiarly germane to the conduct of its corporate affairs, not of its branch in the Philippines, such investment was therefore attributable only to the head office which is a separate income taxpayer from its branch. Accordingly, Marubeni Japan could not avail of the preferential rate of 10% prescribed in the Tax Code on inter-corporate dividends which is applicable to a Philippine branch of a foreign corporation, nor is it liable to the 15% branch profit remittance tax as the income belongs to Marubeni Japan. The court also explained that the 25% tax rate under the tax treaty with Japan could not be imposed, as the treaty provides that the rate of tax "shall not exceed" 25%. In other words, the 25% rate would apply only if the tax "*Sec. 28(A)(7)(d), N I R C does not subject to income tax any dividend received resident foreign corporation from a domestic corporation.

GROSS INCOME

121

imposed under the Tax Code exceeds said 25% limitation. In this connection, Section 24(b)(l)(iii) of the old Tax Code provides that dividends received by a non-resident foreign corporation would be taxed at 15% if its state of domicile shall allow a credit against tax deemed paid in the Philippines equivalent to 20% thereof. Marubeni Japan was declared entitled to the refund "on the condition that its domicile state (Japan) extends" in its favor a "tax credit of not less than 20% of the dividends received" (Marubeni Corporation vs. Commissioner, G.R. No. 76573, Mar. 7,1990). 2.

Dividend is paid by a foreign corporation

Recipient is a resident citizen or a domestic corporation The dividend income is subject to Philippine income tax, since a resident citizen and a domestic corporation are liable to income tax on his/its worldwide income. However, the foreign income tax paid or withheld on such dividend may be credited against the Philippine income tax due, subject to limitation. Generally, the tax rate applied is the praduated income tax rates (if the recipient is a resident citizen) or 32% (if the recipient is a domestic corporation), unless a lower rate of tax is allowed under an effective tax treaty. 107

Dividends being remitted to the National Development Corporation (NDC) by Asean Bintula Sdn. Bhd, a joint venture based in Malaysia, in accordance with the basic Agreement on Asean Industrial Project agreed upon by the Foreign Ministers of the Asean governments, although tax-exempt in Malaysia, are taxable in the Philippines under the tax treaty. NDC, as a government-owned or controlled corporation, is subject to tax in the Philippines from worldwide income. 108

Dividends received by resident individual stockholders from the Philam First Asia Equity Fund, a close-ended mutual fund that will be listed at the Philippine Stock Exchange, shall be subject to the rates of 3% to 30% (now 5% to 32%), while dividends received by domestic corporate stockholders shall be subject to 35% (now 30%). 109

""Effective Jan. 1, 2009, the corporate income tax rate applicable is 30%. BIR Ruling No. 082-96, July 30, 1996. B I R Ruling No. 010-97, Jan. 28,1997 (as amended by RA 9337, Nov. 1, 2 108 l09

122


Recipient is a non-resident citizen or an alien, or a foreign corporation Dividend income received from a foreign corporation not doing business in the Philippines shall be treated as income from foreign sources; hence, exempt from Philippine income tax if received by a non-resident citizen, an alien, or a foreign corporation. Dividends of a domestic corporation which are delivered in cash to foreign corporations as stockholders are subject to the payment of income tax, the exemption clause in the charter of the paying corporation notwithstanding. Tax exemptions are personal to the franchise grantee. What is being taxed here is the dividend income of the foreign corporate stockholder, the income tax of which is required to be withheld by the paying corporation and remitted to the BIR (Phil. Telephone & Telegraph Co. vs. Collector, 58 Phil 639). The same rule applies to dividend income paid by a domestic corporation, registered with PEZA and enjoying income tax holiday, to its foreign parent company. The reason for the rule is that a subsidiary has a separate and distinct personality from its foreign parent company. However, branch profits remitted by a Philippine branch of a foreign corporation registered with PEZA are exempt from the branch profit remittance tax by express provision of law and because the Philippine branch is merely an extension of the foreign head office. They are one and the same foreign corporation. Cash dividend vs. Stock dividend Dividend is a corporate profit set aside, declared and ordered by the directors to be paid to the stockholders on demand or at a fixed time. A stock dividend is a dividend payable in reserve or increase of additional stock of the corporation. A cash dividend is disbursement to the stockholder of the accumulated earnings, and the corporation parts irrevocably with all interest therein. A stock dividend involves no disbursement, and the corporation parts with nothing to the stockholders who receive, not an actual dividend but a certificate of stock. When cash dividend is declared and paid to the stockholders and such cash becomes the absolute property of the stockholders and cannot be reached by creditors of the corporation in the absence of fraud. A stock dividend, however, still being the property of the corporation and not of the stockholder, may be reached by

GROSS I N C O M E

123

an execution against the corporation and may be sold as a part of the corporate property (Fisher vs. Trinidad, 43 Phil 973). Dividend is distinguished from "profits," for profits in the hands of a corporation do not become dividends until they have been set apart, or at least declared, as dividends and transferred to the separate property of the stockholders (Hyatt vs. Alen 56 NY 553). Stock dividends are generally exempt from tax A stock dividend which represents the transfer of surplus to capital account is not subject to income tax. However, a dividend in stock may constitute taxable income to the recipients thereof, notwithstanding the fact that the officers or directors of the corporation choose to call such distribution as a stock dividend. The distinction between a stock dividend which does not, and one which does, constitute income taxable to the shareholder is the distinction between a stock dividend which works no change in the corporate entity, the same interest in the same corporation being represented after the distribution by more shares of precisely the same character, and a stock dividend where there either has been a change of corporate identity or a change in the interest of the shareholders after the distribution is essentially different from his former interest. A stock dividend constitutes income, if it gives the shareholder an interest different from that which his former stockholdings represented. A stock dividend does not constitute income, if the new shares confer no different rights or interests than did the old - the new certificates plus the old representing the same proportionate interest in the net assets of the corporation as did the old. However, the receipt of tax-free stock dividends by the stockholder will reduce his cost or adjusted basis of the stocks in determining the gain or loss upon the subsequent sale or transfer thereof. 110

Stock dividends cannot be issued to a non-stockholder in payment of services rendered to the corporation for being violative of the provisions of Section 16 of the Corporation Code (Nielsen & Co., Inc. vs. Lepanto Consolidated Mining Co., L-21601, Dec. 28, 1968). 110

Sec. 252, Rev. Regs. No. 2. Sale of stock received as dividends is discussed in Sec. 253, Rev. Regs. No. 2.

124


If a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution or cancellation, in whole or in part, essentially equivalent to the distribution of a taxable dividend. - In 1967, Dona Carmen Soriano requested a ruling from the U.S. IRS, inquiring if an exchange of common with preferred shares may be considered as a tax avoidance scheme. In 1968, ANSCOR reclassified its existing 300,000 common shares into 150,000 common and 150,000 preferred shares. The U.S. IRS opined that the exchange is only a recapitalization scheme and not tax avoidance. Consequently, in March, 1968, Dona Carmen exchanged her whole 138,864 common shares for 138,860 of the newly reclassified preferred shares. The estate of Don Andres in turn exchanged 11,140 of its common shares for the remaining 11,140 preferred shares. In June, 1968, pursuant to a Board Resolution, ANSCOR redeemed 28,000 common shares from the Don Andres' estate. By November, 1968, the Board further increased ANSCOR's capital stock to P75M divided into 150,000 preferred shares and 600,000 common shares. About a year later, ANSCOR again redeemed 80,000 common shares from the Don Andres estate. As stated in the Board Resolutions, ANSCOR's business purpose for both redemptions of stocks is to partially retire said stocks as treasury shares in order to reduce the company's foreign exchange remittances in case cash dividends are declared. The court ruled that in a loose sense, stock dividends issued by the corporation, are considered unrealized gain, and cannot be subjected to income tax until that gain has been realized. Before the realization, stock dividends are nothing but a representation of an interest in the corporate properties. As capital, it is not yet subject to income. However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution or cancellation, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent it represents a distribution of earnings or profits. As explained in Eisner vs. Macomber, the exempting clause above was added because corporations found a loophole in the original provision. They resorted to devious means to circumvent the law and evade the tax. Corporate earnings would be distributed under the guise of its initial capitalization by declaring the stock dividends

GROSS INCOME

125

previously issued and later redeem said dividends by paying cash to the stockholder. This process of issuance-redemption amounts to a distribution of taxable cash dividends which was just delayed so as to escape the tax (Commissioner vs. CA, CTA and A. Soriano Corp., G.R. No. 108576, Jan. 20, 1999). The manifest intention of the parties to the trust agreement was, in sum and in substance, to treat the 24,700 shares of Reese as absolutely outstanding shares of Reese's estate until they were fully paid. Such being the true nature of the shares, their declaration as treasury stock dividend in 1958 was a complete nullity and plainly violative of public policy. A stock dividend, being one payable in capital stock, cannot be declared out of outstanding corporate stock, but only from retained earnings (Lepanto Consolidated Mining Co. vs. Commissioner, L-21601, Dec. 18, 1968, 26 SCRA 540). Treasury shares Treasury shares are stocks issued and fully paid for and re-acquired by the corporation eitl er by purchase, donation, forfeiture or other means. Although they are issued shares, they do not have the status of outstanding shares by being in the treasury. A treasury share may be re-issued or sold again. Such share, as long as it is held by the corporation as such, participates neither in dividends, because dividends cannot be declared by the corporation to itself, nor in the meetings of the corporation as voting stock, for otherwise equal distribution of voting powers among stockholders will be effectively lost and the directors will be able to perpetuate their control of the corporation though it still represent a paid-for interest in the property of the corporation. Treasury stocks distributed as stock dividends by a corporation to its stockholders in proportion to their shareholders are not taxable to the recipients upon receipt thereof, because our income tax law which was patterned after the pre-1954 U.S. Code, adopted "the change in the proportionate interests" as the test in the taxability of stock dividends. In the case of distribution of a corporation's treasury stocks as stock dividends in proportion to their stockholdings, there is no change in their proportionate interests. It worked no change in the corporate entity, the same interest in the corporation being represented after the distribution by more shares of the same character. In other words, the stockholders may realize


income only upon their subsequent sale (J. L. Manning, et al. vs. Commissioner, CTA Case No. 1626, Oct. 30, 1967).

Royalty Income RMC 77-2003 dated November 18, 2003, as amended by RMC 44-2005 dated September 1, 2005, provides the following guidelines in the tax treatment of royalties. Thus: "Software" is a program, or a series of programs, containing instructions for a computer required either for the operational processes of the computer itself (operational software) or for the accomplishment of other tasks (application software). It can be transferred through a variety of media, for example in writing or electronically, on a magnetic tape or disk, or on a laser disk or CD-ROM, or it can be downloaded through the Internet or through a network. It may be standardized with a wide range of application or be customized for specific users. It can be transferred as an integral part of the computer hardware or in an independent form available for use on a variety of hardware. "Royalties" generally means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, or films or tapes used for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for use of, or the right to use, industrial, commercial, or scientific equipment, or for information concerning industrial, commercial or scientific experience. The definition covers both payments made under a license and compensation which a person would be obliged to pay for fraudulently copying or infringing the right. The definition of "royalties" includes payments for the use of copyright over software. Software is generally assimilated as a literary, artistic or scientific work protected by the copyright laws of various countries. Thus, payments in consideration for the use of or the right to use a copyright relating to software are generally royalties. Transactions involving software may take any one or more of the following categories: a.

A (full or partial) transfer of a copyright right in software;

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127

b.

A transfer of a copy of the software (a copyrighted article);

c.

The provision of services for the development or modification of the software; or

d.

The provision of know-how relating to software programming techniques.

Any transaction involving software which consists of more than one of the transactions above shall be treated as a separate transaction, with the appropriate provisions of this Circular being applied to each such transaction. However, any transaction that is de minimis, taking into account the overall transaction and the surrounding facts and circumstances, shall not be treated as a separate transaction, but merely as a part of another transaction. Characterization of Transactions The character of payments received in a transaction involving the transfer of compute*- software depends on the nature of the rights that the transferee acquires under the particular arrangement regarding the use and exploitation of the program. a. Transfers of copyright rights.- A transfer of software is classified as a transfer of a copyright right if, as a result of the transaction, a person acquires any one or more of the rights described below: i.

The right to make copies of the software for purposes of distribution to the public by sale or other transfer of ownership, or by rental, lease or lending;

ii.

The right to prepare derivative computer programs based upon the copyrighted software;

iii.

The right to make a public performance of the software; The right to publicly display the computer program; or Any other rights of the copyright owner, the exercise of which by another without his authority shall constitute infringement of said copyright.

iv. v.

128


The determination of whether a transfer of a copyright right in a software is a sale or exchange of property is made on the basis of whether, taking into account all facts and circumstances, there has been a transfer of all substantial rights in the copyright. A transaction that does not constitute a sale or exchange because not all substantial rights have been transferred will be classified as a license generating royalty income. When only copyright rights are transferred, payments made in consideration therefore are royalties. On the other hand, when copyright ownership is transferred, payments made in consideration therefor are business income. b. Transfer of copyrighted articles. — A copyrighted article incorporating a software includes a copy of a software from which the work can be perceived, reproduced, or otherwise communicated, either directly or with the aid of a machine or device. The copy of the software may be fixed in the magnetic medium of a floppy disk or a CD—ROM, or in the main memory or hard drive of a computer, or in any other medium. If a person acquires a copy of a software but does not acquire any of the rights described above (or only acquires a de minimis grant of such rights), and the transaction does not involve the provision of services or of know-how, the transfer of the copy of the software is classified solely as a transfer of a copyrighted article and payments for which constitute business income. The determination of whether a transfer of a copyrighted article or right in a software is sale or exchange of property is made on the basis of whether, taking into account all facts and circumstances, the benefits and burdens of ownership have been transferred. A transaction that does not constitute a sale or exchange because insufficient benefits and burdens of ownership of the copyrighted article have been transferred, such that a person other than the transferee is properly treated as the owner of the copyrighted article, will be classified as a lease generating rental income. c. After-Sales Service. - Contracts for the use of software are often accompanied with the provision of services (e.g., installation, maintenance, and customization of the software) by personnel of the relevant foreign licensor/owner or of the relevant local subsidiary, reseller, and distributor. Payments

GROSS INCOME

129

as consideration for after-sales service in a mixed contract are not royalties alone, but will include income from services. The appropriate course to take with such a contract is, in principle, to break down, on the basis of the information contained in the contract or by means of a reasonable apportionment, the whole amount of the stipulated payments according to the various parts of what is being provided under the contract, and then to apply to each part of it so determined the proper tax treatment thereto. Thus, the part of the payments representing the use of the software will be treated as royalties and taxable as such, and the other part of the payments representing the provision of services will be treated as income from services and taxable as such. If, however, one part of what is being provided constitutes by far the principal purpose of the contract and the other parts stipulated therein are only of an ancillary and largely unimportant character (de minimis), then the treatment applicable to the principal part should generally be applied to the whole amount of the considers.!.' on. d. Site license/Enterprise License/Network License Arrangements. — These refer to arrangements in which the transferee obtains rights to make multiple copies of the program for operation only within its own business. Although these arrangements permit the making of multiple copies of the program, such rights are generally limited to those necessary for the purpose of enabling the operation of the program on the licensee's computers or network, and reproduction for any other purpose is not permitted under the license. Payments under such arrangements will generally be dealt with as business income. e. Supply of information. - Another type of transaction involving the transfer of computer software is the more unusual case where a software house or computer programmer agrees to supply information about the ideas and principles underlying the program, such as logic, algorithms or programming languages or techniques. In these cases, the payments may be characterized as royalties to the extent that they represent consideration for the use of, or right to use, secret formulas or for information concerning industrial, commercial or scientific experience which cannot be separately copyrighted.


130

f. Transfer of Ownership. - Where consideration is paid for the transfer of full or partial ownership of the rights in the copyright, the payments made therefor are, in general, not royalties but business income or capital gains. Computer Hardware Bundled with Software The tax treatment of payments involving the sale of computer hardware bundled with software, where the software is bundled in the Philippines, is covered by this Circular. On the other hand, computer hardware bundled with software, where the software is bundled abroad will be dealt with another revenue issuance.

Modes of Acquiring Software and the Relevant Tax Treatment Thereof A.

Acquisition of ownership over a copyright 1. From a local owner of a copyright. — Payments made to a copyright owner for a full or partial transfer of a copyright shall be subject to Philippine income tax as follows: a.

Transfer by a resident individual owner of copyright. - A resident individual owner of a copyright is subject to the graduated income tax rates (5% - 32%) under Section 24 of the National Internal Revenue Code (NIRC). The amount paid in consideration of the copyright or portions thereof transferred shall form part of the copyright owner's gross income (Sec. 32, NIRC), from which his taxable income shall be computed.

b.

Transfer by a domestic corporation owner. - The amount paid in consideration of the copyright or portions thereof transferred shall form part of the copyright owner's gross income from which his taxable income, subject to 30% income tax under Section 27 of the NIRC, shall be computed.

2. From a foreign licensor. - Payments made to a copyright owner for a full or partial transfer of a copyright shall be subject to Philippine income tax as follows: a.

Transfer by a non-resident alien individual. - A nonresident alien individual engaged in trade or business

131

in the Philippines shall be taxed in the same manner as a resident individual owner of a copyright. b.

Transfer by a foreign corporation. - The amount paid in consideration of the copyright or portions thereof transferred by a resident foreign corporation engaged in trade or business within the Philippines shall form part of the copyright's owner gross income from which his taxable income, subject to 30% income tax under Section 28 of the NIRC, shall be computed.

The amount paid in consideration of the copyright or portions thereof transferred by a non-resident foreign corporation shall be subject to a final tax of 30%, based on the gross income. However, if the foreign owner of the copyright is a resident of a country which has an existing tax treaty with the Philippines, royalties paid to such owner are subject to the reduced tax rates on royalties under the relevant tax treaty, provided the conditions prescribed therein are complied with by the owner.

Acquisition of copyright rights 1.

By a Local Subsidiary/Reseller/Distributor/Retailer. a.

From a local licensor or reseller/distributor licensee Section 31 of the Tax Code provides "[T]he term 'taxable income' means the pertinent items of gross income specified in this Code, less deduction and/or personal and additional exemption, if any, authorized for such types of income by this Code or other special laws. Payments made by a local subsidiary/reseller/ distributor/retailer to a domestic corporation owner of a copyright or a reseller/distributor licensee of a copyright shall be subject to a final income tax of 20%, based on the gross amount of royalties under Section 27(D) of the NIRC, to be withheld by the local subsidiary/reseller/distributor/retailer making the payments.

b.

From a non-resident foreign licensor Payments made by the local subsidiaries/ resellers/distributors/retailers to a non-resident


132

foreign licensor/owner of the software are royalties subject to 30 percent final income tax, based on the gross amount thereof (Sec. 28[B][1], NIRC), the full amount of which shall be withheld and collected by the subsidiary/reseller/distributor/retailer making the payments (Sec. 2.57-l[I][l], RR 2-98). However, if the foreign licensor/owner is a resident of a country which has an existing tax treaty with the Philippines, royalties paid to such licensor/ owner are subject to the reduced tax rates on royalties under the relevant tax treaty, provided the conditions prescribed therein are complied with by the licensor/ owner. 2.

By an End-user a.

From local subsidiaries, resellers, distributors of resellers Payments made by the end-user to the local subsidiaries, resellers, distributors of resellers for the purchase of copyrighted articles are business income subject to 30% income tax, based on the net taxable income of a domestic corporation (Sec. 27[A], NIRC). When making payments to the local subsidiaries, resellers, distributors of resellers, the end-user shall withhold 2% income tax of the gross amount of the payments creditable against the taxable income of the local subsidiaries, reseller or distributors (Sec. 2.57.2[E][4][m], RR 2-98, as amended by Sec. 2, RR 14-02), provided the end-user is any of the following persons (under Section 2.57.3 of RR 2-98, as amended by Section 3 of RR 14-02) required to withhold such tax: (a)

A juridical person, whether or not engaged in trade or business;

(b)

An individual, with respect to payments made in connection with his trade or business; or

(c)

A government office including a governmentowned or controlled corporation, a provincial, city, or municipal government.

GROSS INCOME

133

b. Directly from the foreign owner and/or licensor of the software A local end-user may acquire license to use software directly from the foreign licensor/owner of the software. Payments made by the end-user to the licensor/owner are royalties subject to 30% income tax, based on the gross amount thereof, imposed on royalties derived by a non-resident foreign corporation (Sec. 28[B][1], NIRC), which amount shall be withheld and collected by the end-user making the payments (Sec. 2.57-l[I][l], RR 2-98). However, if the foreign licensor/owner is a resident of a country which has an existing tax treaty with the Philippines, royalties paid thereto are subject to the reduced tax rates on royalties under the relevant tax treaty, provided the condition prescribed therein are complied with by the licensor/ owner. In General Royalty can be sold regularly and thus be considered as an active business income subject to the normal corporate income tax or passive income subject to final withholding tax. The rules on royalty as a passive income under the Philippine Tax Code are summarized hereunder: 111

Royalty paid by a domestic corporation Recipient is a citizen or a resident alien, or a non-resident alien engaged in trade or business in the Philippines, or a domestic corporation, or a resident foreign corporation Royalty income from sources within the Philippines is subject to 20% final withholding (income) tax, except royalty on books, other literary works and musical compositions received by individuals cited above which is subject to 10% final tax. 112

n l

U2

B I R Ruling No. 57-2000 (Midas Cavite). Sec. 24(B)(1) and Sec. 25(A)(2), NIRC.


134

Recipient is a non-resident alien not engaged in trade or business in the Philippines Royalty income from sources within the Philippines is subject to 25% final withholding (income) tax, unless a lower tax rate is allowed under an existing tax treaty. 113

Recipient is a non-resident foreign corporation Royalty income from sources within the Philippines is subject to the 30% final withholding tax, unless a lower tax rate is allowed under an existing tax treaty. 114

Under the Philippines-United States Tax Treaty, royalty paid by a Philippine company to a resident of the United States shall be subject to the following rates: 15%, if the payee is a firm registered with the BOI, or 25%, in all other cases. However, should the Philippines subsequently grant to a resident of another Contracting State a lower rate of tax on royalty, said lower rate of tax shall be available also to a resident of the U.S. under the most-favored-nation clause of the Philippines-U.S. Tax Treaty. Thereafter, the Philippines concluded a tax treaty with West Germany, whereby the withholding tax rate that shall be imposed on the royalty paid by a Philippine company to a corporation organized under the laws of West Germany shall be 10%, provided that it is paid under similar circumstances to a resident of a third state. Phrase "paid under similar circumstances" shall refer to payment of royalty, and not to the payment of the tax. - The Supreme Court ruled that the phrase "paid under similar circumstances" in Article 13(2)(b)(iii) of the Philippines-U.S. Tax Treaty should be interpreted to refer to payment of royalty, and not to the payment of the tax, for the reason that the phrase "paid under similar circumstances" is followed by the phrase "to a resident of a third state." Words are to be understood in the context in which they are used, and since what is paid to a resident of a third state is not a tax but a royalty, logic instructs that the treaty provision in question should refer to royalties of the same kind paid under similar circumstances. This construction is based principally on syntax or sentence structure but fails to take into account the purpose '"Sec. 25(B), NIRC. " Sec. 28(B)(1), NIRC. 4

GROSS INCOME

135

animating the treaty provisions in point. We are not aware of any law or rule pertinent to the payment of royalties, and none has been brought to our attention, which provides for the payment of royalties under dissimilar circumstances. The tax rates on royalties and the circumstances of payment thereof are the same for all the recipients of such royalties and there is no disparity based on nationality in the circumstances of such payment. On the other hand, a cursory reading of the various tax treaties will show that there is no similarity in the provisions on relief from or avoidance of double taxation as this is a matter of negotiation between the contracting parties. Given the purpose underlying tax treaties and the rationale for the most favored nation clause, the concessional tax rate of 10% provided for in the Republic of the Philippines (RP)-Germany Tax Treaty should apply only if the taxes imposed upon royalties in the RP-U.S. Tax Treaty and in the RP-Germany Tax Treaty are paid under similar circumstances. The RP-US and the RP-West Germany Tax Treaties do not contain similar provisions on tax crediting. Article 24 of the RP-Germany Tax Treaty expressly allows crediting against German income and corporation tax of 20% of the gross amount of royalties paid under the law of the Philippines. On the other hand, Article 23 of the RP-U.S. Tax Treaty does not provide for similar crediting of 20% of the gross amount of royalties paid. The reason for construing the phrase "paid under similar circumstances" as referring to taxes is anchored upon a logical reading of the text in the light of the fundamental purpose of such treaty, which is to grant an incentive to the foreign investor by lowering the tax and at the same time crediting against the domestic tax abroad a figure higher than what was collected in the Philippines. Laws are not just mere compositions, but have ends to be achieved and that the general purpose is a more important aid to the meaning of a law than any rule which grammar may lay down. It is the duty of the courts to look to the object to be accomplished, the evils to be remedied, or the purpose to be subserved, and should give the law a reasonable or liberal construction which will best effectuate its purpose (Commissioner vs. S.C. Johnson and Son, Inc. and CTA, G.R. No. 127105, June 25, 1999). u&

116

ThiB decisions overturned the decision of the CA in the case of Commissioner vs. Tire & Rubber Corp. (CA. GR 42300, Apr. 11, 1997), where the application of the preferential rate of 10% on royalties paid to a U.S. company, in view of the most-favorednation clause in the Philippines-United States Tax Treaty was upheld.


136

Under the Philippines-China Tax Treaty effective January 1, 2002, the tax on royalties shall not exceed: 1.

Fifteen per cent (15%) of the gross amount of royalties arising from the use of, or the right to use, any copyright of literary, artistic or scientific work, including cinematographic films or tapes for television or broadcasting; or

2.

Ten per cent (10%) of the gross amount of royalties arising from the use of, or the right to use, any patent, trade mark, design or model, plan, secret formula or process, or from the use of, or the right to use, industrial, commercial, or scientific equipment, or for information concerning industrial, commercial or scientific experience.

Considering that the treaty with China does not contain a 'matching credit' provision similar to that found in the treaty with Germany, the tax on royalty payments to residents of China can be considered paid under similar circumstances to a resident of the U.S. and the most-favored-nation clause in the RP-US Tax Treaty shall apply. 116

Interpretation of the Term "Engaged in Preferred Areas of Activities" 117

The term "engaged in preferred areas of activities" used under Article 12 on Royalties of the Tax Treaty between the Republic of the Philippines and the Netherlands shall have the proper interpretation as provided in BIR Ruling No. 12-02 dated January 29, 2002, hereunder quoted, viz.: "In the absence of a definition of the term 'engaged in preferred areas of activities' in the said tax treaty, it is therefore necessary to refer to Article 161 of Executive Order No. 226, as amended, otherwise known as the Omnibus Investments Code of 1987, which defines the term 'preferred areas of investments' as economic activities that the Board of Investments shall have declared as such, in accordance with Article 28 of the said Code which shall either be pioneer or non-pioneer. 116

Rev. Memo. Circular No. 46-02, Sept. 2, 2002 " R M C 15-2002, Apr. 24, 2002. 7

GROSS INCOME

137

"Moreover, it appears that the phrase 'enterprise registered and engaged in preferred areas of activities' does not refer to PEZA-registered enterprises but to BOI-registered enterprises, because the RPNetherlands Tax Treaty was signed on March 9,1989, or prior to the effectivity of Republic Act No. 7916, otherwise known as the Special Economic Zone Act of 1995. "Thus, in applying Article 12 of the RPNetherlands Tax Treaty, this Office already had the occasion to issue rulings where the phrase 'enterprise registered and engaged in preferred areas of activities' consistently referred to BOI-registered enterprise engaged in preferred areas of investments (BIR Ruling No. 129-98 and ITAD Ruling No. 54-00)." It should be noted that the term "enterprise registered and engaged in preferred areas of activities" is also found in the Philippines' tax treaties with Finlaid, Pakistan, and Sweden and shall thus be given a similar interpretation as enunciated in BIR Ruling No. 12-02, having been signed respectively on January 1,1982, January 1,1979, and January 1,1990, or prior to the effectivity of Republic Act No. 7916, otherwise known as the Special Economic Zone Act of 1995. The same or similar phrase, found in other tax treaties to which the Philippines is a signatory, shall likewise be given the same interpretation. Royalty paid by a foreign corporation Recipient is a resident citizen and a domestic corporation The royalty paid by a foreign corporation to a resident citizen and a domestic corporation is subject to tax at the graduated rates of tax ranging from 5% to 32% (in the case of resident citizens) or at 30% (in the case of domestic corporations), because they are liable to income tax on worldwide income. Recipient is a non-resident citizen, an alien, and a foreign corporation Since they are liable to Philippine income tax only on income, the source of which is from the Philippines, they are exempt from income on royalties received from a foreign corporation. Following the principle of mobilia sequuntur

138


personam, the situs of taxation of intangibles is the place where the residence or domicile of the owner is located. Distinction between Royalty income and Service income Services that do not involve the grant of a license for the use of proprietary rights nor the transfer of technology shall be treated as business profits (and not as royalties). This has been the position of the BIR in a long line of rulings issued. However, the CTA seems to have a different view on this matter. In one case, petitioner entered into a management contract with a non-resident foreign corporation, whereby the latter shall perform for the former the following services for a fee; provide advice and recommendations with respect to new products; provide assistance in the production of international business in the employee benefits, pensions and other fields; provide assistance in the sale of ordinary life business; provide training courses, seminars and other educational programs for underwriters, actuaries and other personnel; provide scholarship program for personnel; recommend standard accounting procedures and forms for financial and budgetary statements and other accounting device; provide assistance with regard to data processing; arrange and supervise internal audits; provide recommendations with respect to systems and procedures. The lower court ruled that the compensation for advisory services admittedly performed abroad by personnel of the non-resident foreign corporation is considered "rentals and royalties from properties located in the Philippines." Petitioner pointed out that it has no properties located in the Philippines from which rentals and royalties can be derived. The services call for the supply by the non-resident foreign corporation of technical and commercial information, knowledge, advice, assistance or services in connection with technical management or administration of an insurance business - a commercial undertaking. Therefore, the income derived for the services done abroad are from sources outside the Philippines. But the appellate court said that it is not the presence of any property from which one derives rentals and royalties that is controlling, but rather as expressed under the "expanded" meaning of royalties, it includes "royalties for 118

""ITAD Ruling No. 054-01, June 11, 2001; No. 032-01, Mar. 13, 2001; No. 06200, Mar. 21, 2000; No. 042-01, Apr. 10, 2001; No. 168-00, Oct. 30, 2000. These rulings are in accord with the commentaries of the OECD countries.

GROSS INCOME

139

the supply of scientific, technical, industrial, or commercial knowledge or information; and the technical advice, assistance or services rendered in connection with the technical management and administration of any scientific, industrial or commercial undertaking, venture, project or scheme (Philippine American Life Insurance Co., etal. vs. Commissioner and CTA, CA-GRSP No. 31283, Apr. 25, 1995). Royalty income paid by a domestic corporation to a nonresident foreign corporation which is a resident of a Contracting State with which the Philippines has an effective tax treaty is generally subject to 15% final withholding tax, but the rate may be reduced to 10% for certain royalty payments or under the most-favored-nation clause of the tax treaty. Rental Income

119

Rental income on property located in the Philippines paid to a non-resident alien or non-resident foreign corporation shall be subject to the 25% or 30% final withholding tax, respectively. Rental income on the lease of personal property located in the Philippines and paid to a non-resident taxpayer shall be taxed as follows: Non-Resident Corp. Vessel 4.5% Aircraft, machineries and other Equipment 7.5% Other assets 30%

Non-Resident Alien 25% 25% 25%

Under the Philippines-United Tax Treaty, rental income from lease of machinery and equipment shall be treated as business profits, such that if the foreign lessor has no permanent establishment in the Philippines in accordance with treaty rules, said rental income from sources within the Philippines shall not be subject to Philippine income tax and withholding tax. In other tax treaties, there is no similar express provision in the U.S. tax treaty with respect to rental income from lease of machinery and equipment; hence, the rental income shall be similarly treated as royalty income. Thus, if the personal property is located or used ""Rental income from financial leasing is subject to income tax. The finance company-lessor is granted accelerated depreciation on the equipment under lease (Rev. Regs. No. 19-86). However, under Rev. Regs. No. 12-2003 which implements the VAT on banks and finance companies, the interest income (not the rental income) is subject to VAT.

140


in the Philippines, the situs of the income is in the Philippines and can, therefore, be taxed in the Philippines either under the provisions of the Philippine Tax Code or under the provisions of the applicable tax treaty, whichever is lower. The purpose of tax treaties is to prevent or avoid double taxation, not to increase the rate of tax on particular incomes. Rental payments received by a domestic corporation from the offshore lessee of the container vans are subject to income tax of 30% based on net income. The firm can claim depreciation deduction against its rental income. 120

Prizes and Awards Prizes (except prizes amounting to P10,000 or less) and other winnings (except Philippine Charity Sweepstakes Office and lotto winnings) from sources within the Philippines shall be subject to 20% final withholding tax, if received by a citizen, resident alien or non-resident alien engaged in trade or business in the Philippines. However, if the recipient is a non-resident alien not engaged in trade or business in the Philippines, the prizes and other winnings shall be subject to 25% final withholding tax. And if the recipient is a corporation (domestic or foreign), the prizes and other winnings are added to the corporation's operating income and the net income is subject to 30% corporate income tax. However, prizes and awards made primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement are excluded from gross income only if (a) the recipient was selected without any action on his part to enter the contest or proceeding; and (b) the recipient is not required to render substantial future services as a condition to receiving the prize or award. Moreover, all prizes and awards granted to athletes in local and international sports competitions and tournaments whether held in the Philippines or abroad and sanctioned by their national sports associations are also excluded from gross income. 121

122

The P H P 1 million prize money won by the Filipino International Chess Grand Master from the First Pambansa 'BIR Ruling No. 004-2001, Feb. 15, 2001. Sec. 32(B)(7)(c), NIRC. 'Sec. 32(B)(7)(d), NIRC.

GROSS INCOME

141

(National) Millennium Chess Grand Prix sanctioned by the National Chess Federation is subject to the 20% final withholding tax. To be eligible for exemption, the national sports association referred to in the law that should sanction said sport activity is the Philippine Olympic Committee. 123

Prizes that winning inventors will receive from the nationwide contest for the most innovative New and Renewable Energy Systems jointly sponsored by the PNOC and other organizations are exempt from taxes during the first ten years reckoned from the date of the first sale of the invented products, provided that such sale does not exceed P200,000 during any twelve-month period. 124

The prize received by Luisito Espinosa from WBC Featherweight Championship Fight in Cotabato in 1997 is exempt from income tax, but the prize of Challenger Carlos Rios of Argentina is subject to 30% (now 25%) final withholding tax. 125

The grand prize of the Philippine Centennial Commemorative 100,000 PISO National Raffle Draw of one Jaguar Daimler is subject to the 20% final withholding tax, despite the fact that the raffle draw is a government-sponsored project. 126

Other Income Section 32(A) of the Tax Code enumerates various other sources of revenue, including but not limited to annuities, prizes and winnings, pensions, and partner's distributive share from the net income of the general professional partnership. Income from any source whatever The words "income from any source whatever" discloses a legislative policy to include all income not expressly exempted from the class of taxable income under our laws (Madrigal vs. 123

BIR Ruling No. 026-2000, June 13, 2000. Secs. 5 and 6, R.A. No. 7459 (Inventors and Inventions Incentives Act of 1991); BIR Ruling 069-2000, Dec .14, 2000. BIR Ruling No. 126-97, Dec. 3, 1997. However, the prize money of Manny Pacquiao in his fights in Las Vegas, USA shall be subject to Philippine income tax, he being a resident citizen, but the federal income tax withheld or paid to the U.S. government shall be credited against his Philippine income tax liability. BIR Ruling No. 005-2001, Feb. 15, 2001. ,24

12B

126


142

Rafferty, supra; Commissioner vs. BOAC, supra). The words "income from any source whatever" is broad enough to cover gains contemplated here. These words disclose a legislative policy to include all income not expressly exempted within the class of taxable income under our laws, irrespective of the voluntary or involuntary action of the taxpayer in producing the gains (Gutierrez vs. Collector, CTA Case 65, Aug. 31, 1955). Any economic benefit to the employee whatever may have been the mode by which it is effected is taxable. Thus, in stock options, the difference between the fair market value of the shares at the time the option is exercised and the option price constitutes additional compensation income to the employee (Commissioner vs. Smith, 324 U.S. 177). The principle underlying the taxability of an increase in the net worth of a taxpayer rests on the theory that such an increase in net worth, if unreported and not explained by the taxpayer, comes from income derived from a taxable source. In this case, the increase in net worth was not the result of the receipt by it of taxable income. It was merely the outcome of the correction of an error in the entry in its books relating to its indebtedness to the insurance company. The income tax law imposes a tax on income; it does not tax any or every increase in networth whether or not derived from income (Fernandez Hermanos, Inc. vs. Commissioner, CTA Case 787, June 10, 1963). Forgiveness of Indebtedness The cancellation and forgiveness of indebtedness may amount to a payment of income, to a gift, or to a capital transaction, dependent upon the circumstances. If, for example, an individual performs services for a creditor, who, in consideration thereof, cancels the debt, income to that amount is realized by the debtor as compensation for his service. If, however, a creditor merely desires to benefit a debtor and without any consideration therefor cancels the debt, the amount of the debt is a gift from the creditor to the debtor and need not be included in the latter's gross income. If a corporation to which a stockholder is indebted forgives the debt, the transaction has the effect of the payment of a dividend. The BIR has ruled that where the condonation or 127


GROSS INCOME

143

forgiveness of debt is done for a valid business purpose, there is no income realized. 128

The condonation of indebtedness for a consideration constitutes income derived from any source whatever. This is because when a creditor cancels a debt as part of a business transaction, the debtor is enriched or its net assets have been increased and, therefore, he realized taxable income. The fact that the indebtedness does not represent money or property received by the debtor does not militate against its being considered as income derived from any source. In the first place, Section 50 of our Income Tax Regulations, which implemented the old Section 29(a) of the Tax Code, does not distinguish between debts for money, property, or services as constituting income from other sources. In the second place, when the creditor condoned the debtor's indebtedness on account of trade acceptances and other bank services, the debtor received financial advantages thereby increasing its net assets (Phil. Fiber Processing Co. vs Commissioner, CTA Case 1407, Dec. 29, 1966). It is the general rule that when a creditor cancels a debt as a part of a business transaction, the debtor is thereby enriched and thus he realizes taxable income. The rule, however, has been held limited to cases involving the reduction of a personal liability. Thus, the reduction of a mortgage not assumed by the taxpayer (Fulton Gold Corp., 31 BTA 519) or the reduction of a special assessment against land (P.J. Hait, 35 BTA 293), does not result in the receipt of taxable income. An agreement to cancel does not result in the realization of income until the debt is actually cancelled (Walker vs. Commissioner, 88 F[2d] 170 [CCA 5th 1943]). Likewise, no income is realized from the contingent cancellation of a debt (Connell Bros Co. L. ed. BTA Memo. Op., Jan. 30, 1954). The debtor does not realize any taxable income from the settlement of a debt by compromise (N. Sobel, Inc., 40 BTA 1262). Gain from Sale of Treasury Stocks Whether the acquisition or disposition by a corporation of its own capital stock gives rise to taxable gain or deductible loss depends upon the real nature of the transaction, which is to be 126

BIR Ruling No. 078-89 (Isuzu).


144

ascertained from all its facts and circumstances. The receipt by a corporation of the subscription price of shares of its capital stock upon their original issuance gives rise to neither taxable gain nor deductible loss, whether the subscription or issue price be in excess of, or less than the par or stated value of such stock. But if a corporation deals in its own shares as it might in the shares of another corporation, the resulting gain or loss is to be computed in the same manner as though the corporation were dealing in the shares of another. So also if the corporation receives its own stock as consideration upon its sale of property, or in satisfaction of indebtedness to it, the gain or loss resulting is to be computed in the same manner as though the payment had been made in any other property. Any gain derived from such transactions is subject to tax, and any loss sustained is allowable as deduction where permitted by the provisions of Title II of the 1997 Tax Code. 129

Taxation of shares redeemed for cancellation or retirement. — When preferred shares are redeemed at a time when the issuing corporation is still in its "going-concern" and is not contemplating in dissolving or liquidating its assets and liabilities, capital gain or capital loss upon redemption shall be recognized on the basis of the difference between the amount/ value received at the time of redemption and the cost of the preferred shares. Similarly, the capital gain or loss derived shall be subject to the regular income tax rates imposed under the Tax Code on individual taxpayers or to the corporate income tax rate, in case of corporations. This section, however, does not cover situations where a corporation voluntarily buys back its own shares, in which it becomes treasury shares. In such cases, the stock transaction tax under Sec. 127(A) of the Tax Code shall apply, if the shares are listed and executed through the trading system and/or facilities of the local stock exchange. If the shares are not listed and traded in the local stock exchange, it is subject to the 5%/10% net capital gains tax. 130

'Sec. 55, Rev. Regs. No. 2. 'Sec. 9, Rev. Regs. No. 6-2008, Apr. 22, 2008.

Income of a Corporation in Liquidation vs. Liquidating Dividend 131

When a corporation is dissolved, its affairs are usually wound up by a receiver or trustee in dissolution. The corporate existence is continued for the purpose of liquidating the assets and paying the debts and such receiver or trustee stands in the stead of the corporation for such purposes. Any sales of property by them are to be treated as if made by the corporation for the purpose of ascertaining the gain or loss. 132

The basic principle for the taxation of distribution in liquidation, complete or partial, is that they are treated as a sale or exchange, rather than as ordinary dividends, even though the liquidating distribution includes earnings and profits. The stocks owned by the stockholder are the property disposed of and the liquidating distributions whether out of earnings or profits or other sources are regarded as the proceeds of the sale. Although the various resolutions mentioned in the decision speak of distribution of dividends, a distribution does not necessarily become a dividend because it is called dividend by the distributing corporation. The ordinary connotation of liquidating dividend involves the distribution of assets by a corporation to its stockholders upon dissolution. The distinction between a distribution in liquidation and an ordinary dividend is factual; the result in each case depending on the particular circumstances of the case and the intent of the parties. If the distribution is in the nature of a recurring return on stock, it is an ordinary dividend. However, if the corporation is really winding up its business or re-capitalizing and narrowing its activities, the distribution may properly be treated as in complete or partial liquidation and as payment by the corporation to the stockholder for his surrendered or relinquished stock in a corporation. The corporation is, in the latter instances, wiping out all or part of the stockholders' interest in the company. The gain realized or loss sustained by 133

"'Liquidating dividend takes place when a corporation liquidates by redeeming the outstanding stock for cash, or by distributing its assets to the stockholders in exchange for the shares of stock. The amount received in a partial or complete liquidation is treated as the proceeds from the sale of the redeemed stock by the shareholders (Sec. 331[a], U.S. IRC). When property is distributed in liquidation, the amount received is the fair market value of the property. Sec. 59, Rev. Regs. No. 2. Merten's Law of Federal Income Taxation, Vol. 1, Sec. 9. 132

133

146


the stockholder, whether individual or corporation, is a taxable income or a deductible loss pursuant to the income tax law, Act No. 2833, as amended by Act No. 3761, as if the stockholder sold his shares of stock to third persons (Wise & Co., Inc. vs. Meer, G.R. No. 48231, June 30, 1947). On the basis of the foregoing decision, some tax practitioners, including this author, strongly believe that the stockholder, in case of gain from surrender of shares treated as capital assets, shall be liable to the capital gains tax of 5% on the first P100,000 net capital gain and 10% on the net capital gain over P100,000, or in case of capital loss, the capital loss may only be deducted to the extent of capital gains during the taxable year. However, Section 8 of Revenue Regulations No. 6-2008 provides that "the capital gain or loss derived therefrom [by the investor] shall be subject to the regular income tax rates under the Tax Code, as amended, on individual taxpayers, or to the corporate income tax rate, in case of corporations." Only 50% of the capital gain of an individual investor, if he holds the shares of stock for a period longer than 12 months. There being no express provision requiring the stockholders of a corporation to be soli iarily liable for its debts, which liability must be expressed and cannot be presumed, the stockholders must be liable for the tax only in proportion to their shares in the distribution of the assets of the defunct corporation (Tan Tiong Bio, et al. vs. Collector, 4 SCRA 986). Interest Coupons and Other Income Constructively Received When interest coupons have matured and are payable, but have not been cashed, such interest payment, though not collected when due and payable, is nevertheless available to the taxpayer and should therefore be included in his gross income for the year during which the coupons matured. This is true if the coupons are exchanged for other property instead of eventually being cashed. Defaulted coupons are income for the year in which paid. The distributive share of the profits of a partner in a general co-partnership duly registered is regarded as received by him, although not distributed. Interest credited on savings bank deposits, even though the bank nominally has a rule, seldom or never enforced, that it may require so many days' notice in advance of cashing depositor's checks, is income to the

GROSS INCOME

147

depositor when credited. An amount credited to shareholders of a building and loan association, when such credit passes without restriction to the shareholder, has a taxable status as income for the year of the credit. Where the amount of such accumulation has not become available to the shareholder until the maturity of a share, the amount of any share in excess of the aggregate amount paid in by the shareholder is income for the year of the maturity of the share. 134

Creation of corporate sinking fund If a corporation in order solely to secure payment of its bonds or other indebtedness, places property in trust, or set aside certain amounts in a sinking fund under the control of a trustee who may be authorized to invest and reinvest such sums from time to time, the property or fund thus set aside by the corporation and held by the trustee is an asset of the corporation, and any gain arising therefrom is income of the corporation and shall be included as such in its annual return. 135

Acquisition or disposition by a corporation of its own capital stock Whether the acquisition or disposition by a corporation of share of its own capital stock gives rise to taxable gain or deductible loss depends upon the real nature of the transaction, which is to be ascertained from all its facts and circumstances. The receipt by a corporation of the subscription price of shares of its capital stock upon their original issuance gives rise to neither taxable gain nor deductible loss, whether the subscription or issue price be in excess of, or less than the par or stated value of such stock. But if a corporation deals in its own shares as it might in the shares of another corporation, the resulting gain or loss is to be computed in the same manner as though the corporation were dealing in the shares of another. So also if the corporation receives its own stock as consideration upon the sale of property by it or in satisfaction of indebtedness to it, the gain or loss resulting is to be computed in the same manner as though the payment had been made in any other property. Any gain derived from such transactions is subject to tax, and any '"See. 53, Rev. Regs. No. 2. Sec. 54, Rev. Regs. No. 2. 136

148


loss sustained is allowable as deduction where permitted by the provisions of Title I I . 136

Contributions by Shareholders Where a corporation requires additional funds for conducting its business and obtains such needed money through voluntary process payments by the shareholders, the amounts so received being credited to its surplus account or to a special capital account, will not be considered income, although there is no increase in the outstanding shares of stock of the corporation. The payments in such circumstances are in the nature of voluntary assessments upon, and represent an additional price paid for, in shares of stock held by the individual shareholders, and will be treated as an addition to and as a part of the operating capital of the company. 137

Receipt of Tax Credit or Refund If a taxpayer receives a tax credit certificate or refund for erroneously paid tax which was claimed as a deduction from his gross income that resulted in a lower net taxable income or a higher net operating lose that was carried over to the succeeding taxable year, he realizes taxable income that must be included in his income tax return in the year of receipt. This principle does not apply to tax credits or refunds of erroneously paid income tax, estate tax, donor's tax, and special assessments since they are not deductible from gross income.

'Sec. 55, Rev. Regs. No. 2. Sec. 56, Rev. Regs. No. 2.

CHAPTER V EXCLUSIONS FROM GROSS INCOME AND

EXEMPT CORPORATIONS

Chapter V covers exclusions from gross income (Section 32[B]) and exemptions from income tax of certain corporations (Section 30 of the Tax Code). As the items of gross income subject to tax are being determined, the exclusions under the Tax Code and the exempt income under general or special laws must at the same be ascertained. It is important to identify these exclusions and exempt income so that they are not included in the taxable income reported by the taxpayer in his/its tax return. It is generally difficult to recover from the government whatever taxes were erroneously or illegally paid to it, not to mention the inconvenience a tax audit partakes. Moreover, the burden of proving that the taxpayer is entitled to the tax credit or refund is placed on the shoulder of the taxpayer claiming it and any doubt in respect thereto is generally construed strictly against the taxpayer. Also, the right to recover erroneously or illegally paid taxes is subject to the statute of limitations, and the written claim for tax credit or refund must be filed with the BIR and the CTA within two years from the date of payment; otherwise, it shall be barred forever. 1

While the Tax Code enumerates certain non-stock, non-profit associations that are exempt from income tax on dues and assessments from members, it must be remembered that their income from property, real or personal, or from an activity conducted for profit, regardless of the disposition of the proceeds of the sale or income, shall be taxable to them based on the last paragraph of Section 30 of the Tax Code.

Sees. 204 and 229, NIRC. 149


Exclusions from Gross Income The term "gross income" does not include those items of income exempted by the statute or by the fundamental law. Such tax-free income should not be included in the income tax return, unless information regarding it is specifically called for. The exclusion of such income should not be confused with the reduction of gross income by the application of allowable deductions. Exclusions are in the nature of tax exemptions, and it behooves upon the taxpayer to establish them convincingly (Commissioner vs. Mitsubishi, 181 SCRA 214). 2

Maternity benefits advanced by the employer to his employees are excluded from gross income of the latter. 3

The term "exclusions" refers to items that are not included in the determination of gross income either because (a) they represent return of capital or are not income, gain or profit; or (b) they are subject to another kind of internal revenue tax; or (c) they are income, gain or profit that are expressly exempt from income tax under the constitution, tax treaty, Tax Code, or general or special law. Items of exclusion representing return of capital The return of capital may take many forms. The amount of capital is generally recovered through deduction of the cost or adjusted basis of the property sold from the gross selling price or consideration, or through the deduction from gross income of depreciation relating to the property used in trade or business before it is sold. It may also relate to indemnities, such as proceeds of life insurance paid to the insured's beneficiaries and return of premiums paid by the insurance company to the insured under a life insurance, endowment or annuity contract. Damages, in certain instances, may also be exempt because they represent return of capital. Item of exclusion because it is subject to another internal revenue tax The value of property acquired by gift, bequest, devise, or descent is exempt from income tax on the part of the recipient 2

3

Sec. 61, Rev. Regs. No. 2 BIR Ruling No. 012-99, Jan. 28, 1999.

EXCLUSIONS FROM GROSS INCOME

151

AND E X E M P T CORPORATIONS

4

thereof, because the receipt of such property is already subject to transfer taxes (i.e., estate tax or donor's tax). The policy of Congress is to impose only one tax - either the income tax or transfer taxes - on these transactions. Items of exclusion because they are expressly exempt from income tax Under the Constitution All assets and revenues of a non-stock, non-profit private educational institution used directly, actually and exclusively for private educational purposes shall be exempt from taxation. Under the tax treaty Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines, is exempt from income tax. Under special laws Some laws granting income tax exemptions include: a. Under R.A. No. 7916 (Philippine Export Zone Authority Law), PEZA-registered enterprises are given income tax holidays of six or four years from the date of commercial operation, depending on whether their activities are considered as pioneer or non-pioneer; after enjoying income tax holidays, they are subject to the 5% final tax on their gross income earned, in lieu of all national and local taxes. b. Under R.A. No. 6657 (Comprehensive Agrarian Reform Package Law), gain arising from the transfer of agricultural property covered under the law shall be exempt from capital gains tax for ten (10) years. c. Under R.A. N o . 7653 (New Central Bank Act), the Bangko Sentral ng Pilipinas is exempt from all national, provincial, municipal and city taxes for five (5) years. 5

4 6

Sec. 32(B)(2), NIRC. BIR Ruling No. 138-96, Dec. 12, 1996.


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d. Under R.A. No. 7279 (Urban Development Housing Act of 1992), the National Housing Authority is exempt from all fees and charges of any kind, whether local or national, such as income and realty taxes. The tax incentives of sellers of subject real properties under Section Nos. 197 and 208 of Article V, Section 25 of Article VI, and Section 32 of Article VIII of R.A. No. 7279 are: 6

A. National Housing Authority (NHA). — The NHA, being the primary government agency in charge of providing housing for the underprivileged and homeless citizens, shall be exempted from the payment of the following national internal revenue taxes: (1)

Ordinary corporate income tax and the corresponding creditable (expanded) withholding tax on the income/ gain realized from the sale, exchange or other disposition of real properties under the socialized housing program as provided in R.A. No. 7279.

(2)

Documentary stamp tax on sales transactions executed by and in favor of the N H A in connection with socialized housing projects. Since Section 19 of R.A. No. 7279 exempts "all documents or contracts executed by and in favor of the NHA," the exemption from documentary stamp tax extends to the other party (either seller or buyer) that is dealing or transacting with the NHA; Provided, however, That in the case of foreclosure sale of real property mortgaged to N H A by qualified beneficiaries of socialized housing, N H A , as statutory seller, shall be liable to the payment of capital gains tax and documentary stamp tax otherwise due from the mortgagor-debtor; Provided, further, That if the latter redeems the property within the one-year redemption period, the amount of tax paid by N H A may be collected from the mortgagor-debtor.

B

Private Sector Participating In Socialized Housing. — To encourage greater private sector participation in socialized housing and further reduce the cost of housing units for the benefit of the underprivileged and homeless citizens, the private 6

BIR Ruling No. 064-96, June 7,1996; Rev. Regs. No. 9-93, as amended by Rev. Regs. No. 11-97; RMC 42-2001, Oct. 5, 2001; RMC 46-2006, Mar. 10, 2006.


153

A N D E X E M P T CORPORATIONS

sector shall be exempt from the payment of the following national internal revenue taxes: (1)

Project-related corporate or individual income taxes on a per project basis on income directly realized from the development of socialized housing sites: Provided, That the sale or any disposition of lot and/or house and lot packages beyond the maximum amount of P400,000 (or such suggested amount as may later on be determined by the HLURB) shall be subject to the corresponding income taxes; 7

(2)

Capital gains tax on sale of raw lands for use in socialized housing project;

(3) Value added tax for the project contractor/developer/ seller or owner of socialized housing project; (4)

Donor's tax for lands certified by the proper LGU to have been donated for socialized housing purposes.

However, sale or exchange of ^he property intended for socialized housing under this category shall be subject to the documentary stamp tax in accordance with the provision of Section 196 (Stamp Tax on Deeds of Sale and Conveyance of Real Property) of the Tax Code, subject to the valuation rules as stated in Item IV of this Circular, and that upon application for exemption from the donor's tax, income tax or capital gains tax, as the case may be, an annotation at the back of the TCT that the land shall be used for socialized housing shall be made by the Register of deeds concerned; Provided, further, That the socialized housing development plan has already been approved by the HLURB or HUDCC. C. Real P r o p e r t i e s sold under the Community Mortgage Program (CMP) — Properties sold under the CMP shall be exempt from the capital gains tax or income tax, and consequently from the creditable (expanded) withholding tax, whether sold by an individual, estate or trust, or by a corporation. However, the documentary stamp tax shall be paid on every sale of property under the CMP based on whichever is higher between the actual consideration of sale stated in the document or the fair market value that shall be determined 'HUDCC Resolution No. 1, Dec. 11, 2008, as circularized in RMC 30-2009, May 14, 2009.


154

by comparing the zonal value and the Local Government Assessor's fair market value. D. Areas for Priority Development (APDs), zonal improvement program sites, and slum improvement and resettlement program sites — Properties identified as APDs, and slum improvement and resettlement program sites, when sold by private owners, shall likewise be exempt from the capital gains tax or income tax, and consequently from the creditable (expanded) withholding tax, whether sold by an individual, estate or trust, or by a corporation. However, the documentary stamp tax shall be paid on every sale of the said property based on the actual consideration of sale stated in the document or the value stated in the latest real property Tax Declaration issued by the Provincial or City Assessor, whichever is higher, but in no case shall the said documentary stamp tax be passed on to the occupants thereof as the latter are expressly exempted from the payment thereof pursuant to Section 25, Article VI of R.A. No. 7279. e. Under R.A. No. 8502 (Jewelry Industry Development Act of 1998) dated May 27, 2004, the following incentives shall be available to Qualified Jewelry Enterprises: 8

(a)

Entitlement to zero percent (0%) duty on imported raw materials, which include precious/fine metals, loose gems, precious stones, jewelry parts, accessories, and supplies for use by Qualified Jewelry Enterprise as specifically mentioned in Chapter 5 of Section I, Chapter 12 of Section I I , Chapters 25, 26 and 27 of Section V, Chapters 28, 34 and 38 of Section V I , Chapter 70 of Section X I I I , Chapter 71 of Section X I V , Chapter 83 of Section X V , and Chapter 96 of Section XX of the Tariff and Customs Code, as amended;

(b)

Exemption from the imposition of excise tax on all goods commonly or commercially known as jewelry, whether real or imitation pearls, precious and semiprecious stones and imitation thereof; all goods made of, or ornamented, mounted or fitted with precious

'RMC 33-2004, May 27, 2004.


155


metals or imitations thereof, as specifically mentioned in Section 150 (a) of the National Internal Revenue Code of the Philippines, as amended; (c)

Entitlement to zero percent (0%) duty on imported capital equipment, including spare parts and tools thereof falling within Chapter 69 of Section X I I I , Chapter 82 of Section XV, Chapters 84 and 85 of Section X V I and Chapter 90 of Section XVIII of the Tariff and Customs Code, as amended;

(d) Additional deduction from taxable income of fifty percent (50%) of expenses incurred in training schemes approved by the appropriate agency and which shall be deductible during the financial year the expenses were incurred; (e)

Gold and silver sales by the Bangko Sentral ng Pilipinas under minimal margins;

(f)

Authority to buy gold and silver directly from other sources without any specific authority from the Bangko Sentral ng Pilipinas. However, this shall not include sale of gold and silver from small-scale miners, which, as mandated by R.A. No. 7076, People's Small Scale Mining Act of 1991, are required to be sold to the Bangko Sentral ng Pilipinas;

(g) Inclusion of locally manufactured j e welry products in the government's tourist duty free shops, including the promotion, advertisement, and sale of jewelry products; and (h) Qualified Jewelry Enterprise availing of incentives provided under the Act and these Rules shall still be eligible to incentives provided for by other special laws such as: (1) Republic Act No. 7844 (Export Development Act of 1994); (2) Republic Act No. 7916 (Special Economic Zone of 1995); (3) Executive Order No. 226 (BOI Omnibus Investment Code), provided that the jewelry enterprise shall register under the aforestated laws, or that the activity is exportoriented, and that there is no double availment of the same incentives.


156

f. Under R.A. No. 8525 (Adopt-a-School Act of 1998), the following tax incentives are granted to a prequalified adopting private entity, which enters into an Agreement with a public school: 9

(a)

Deduction from the gross income of the amount of contribution/donation that were actually, directly and exclusively incurred for the Program, subject to limitations, conditions and rules set forth in Section 34(H) of the Tax Code, plus an additional amount equivalent to fifty percent (50%) of such contribution/ donation subject to the following conditions: (1)

That the deduction shall be availed of in the taxable year in which the expenses have been paid or incurred;

(2)

That the taxpayer can substantiate the deduction with sufficient evidence, such as official receipts or delivery receipt and other adequate records. (2.1) The amount of expenses being claimed as deduction; (2.2) The direct connection or relation of the expenses to the adopting private entity's participation in the Adopt-a-School Program. The adopting private entity shall also provide a list of projects and/ or activities undertaken and the cost of each undertaking, indicating in particular where and how the assistance has been utilized as supported by the Agreement; and (2.3) Proof or acknowledgment of receipt of the contributed/donated property by the recipient public school.

(3)

That the application, together with the approved Agreement endorsed by the National Secretariat, shall be filed with the Revenue District Office (RDO) having jurisdiction over the place of business of the donor/adopting private entity,

'Rev. Regs. No. 10-2003, Jan. 27, 2003.


157


copy furnished the RDO having jurisdiction over the property, if the contribution/donation is in the form of real property. (b) Exemption of the Assistance made by the donor from payment of donor's tax pursuant to Section 101(A)(2) and (B)(1) of the Tax Code of 1997. g. Under R.A. No. 7277, as amended by R.A. No. 9442, otherwise known as the "Magna Carta for Persons with Disability," persons with disability shall be entitled to claim at least 20% discount from hotels and restaurants, sports and recreation centers, all drugstores regarding purchase of medicines, etc. VAT on sales of goods or services shall be computed after deducting the 20% discount from the gross selling price. h. Under R.A. No. 9504 (July 6,2008), compensation income falling within the term "statutory minimum wage" (SMW) paid to SMW earners shall be exempt from income tax. i. Under R.A. No. 9576 (April 9, 2009), the tax obligations of Philippine Deposit Insurance Corporation (PDIC) will be charged against the Tax Expenditure Fund. Starting on the sixth year, PDIC will be exempt from income tax, final withholding tax, V A T on assessment collections as well as local taxes. Under the Tax Code Section 32 of the Tax Code enumerates the excluded items from gross income. These are as follows: 1.

Proceeds of life insurance policies, paid by reason of the death of an insured to his estate or to any beneficiary (individual, partnership, or corporation, but not a transferee for a valuable consideration), directly or in trust, are excluded from the gross income of the beneficiary. It is immaterial whether the proceeds are received in a single sum or in installments. If, however, such proceeds are held by the insurer under an agreement to pay interest thereon, the interest payments must be included in income.


2.

Amounts received (other than amounts paid by reason of the death of the insured and interest payments on such amounts) under a life insurance, endowment, or annuity contract are excluded from gross income, but if such amounts (when added to amounts already received before the taxable year under such contract) exceed the aggregate premiums or considerations paid (whether or not paid during the taxable year), then the excess shall be included in gross income. However, in the case of a transfer for a valuable consideration, by assignment or otherwise, of a life insurance, endowment, or annuity contract, or any interest therein, only the actual value of such consideration and the amount of the premiums and other sums subsequently paid by the transferee are exempt from taxation. No loss is realized on surrender of a life insurance policy for its surrender value. 10

11

It is certain that the proceeds of life insurance policies paid to individual beneficiaries upon the death of the insured are exempt. It is not so certain that the proceeds of life insurance policies paid to corporate beneficiaries upon the death of the insured are likewise exempt. But at least, it may be said that the law is indefinite in phraseology and does not permit us unequivocably to hold that the proceeds of life insurance policies received by corporations constitute income which is taxable. Life insurance is like that of fire and marine insurance - a contract of indemnity. Proceeds of life insurance, payable upon the death of the insured, are considered as indemnity rather than income to the heirs or beneficiaries who could be corporations or individuals (El Oriente Fabrica de Tabacos vs. Posadas, G.R. No. 34774, Sept. 21, 1931, 56 Phil. 147). But interest payments thereon if such amounts are held by the insurer under an agreement to pay interest shall be taxable.

Sec. 62, Rev. Regs. No. 2. Sec. 14.029(10), (15), U.S. IRC.


159


3.

12

The value of property acquired by gift, bequest, devise, or descent. If the payment of a gift or bequestis to be made at intervals, it is taxable to the donee (or beneficiary) to the extent that it is made out of income. 13

14

Gifts, bequests and devises (which are subject to estate or gift taxes) are excluded, but not the income from such property. If the amount received is on account of services rendered, whether constituting a demandable debt or not, or the use or opportunity to use of capital, the receipt is income (Pirovano vs. Commissioner, 14 SCRA 832). 4.

Amounts received through accident or health insurance or under workmen's compensation acts, as compensation for personal injuries or sickness, plus the amounts of any damages received, whether by suit or agreement, on account of such injuries or sickness. Compensations for damages to personal or family rights, damages for slander and libel, award for loss of life, damages for injuries to the goodwill of a taxpayer's business unless they exceeded its cost are not taxable. Damages received for patent infringement, breach of contract or fiduciary duty and recoveries (except punitive damages) under the Clayton Act for antitrust violations are excluded from gross income to the extent that the losses to which the damages relate did not give rise to a tax benefit either in the recovery year or earlier tax years. However, "insider profits" recovered by a corporation from the insider (major stockholder or director) under the Securities Exchange Act of 1934 or the Investment Company Act of 1940 are taxed to the corporation. 15

12

Gift is a gratuitous transfer. The essential elements of a gift are: (a) a donor competent to make the gift; (b) a clear and unmistakable intention on his part to make it; (c) a donee able to take the gift; and (d) a conveyance, assignment or transfer vesting legal title in the donee, without power of revocation at the will of the donor, and a relinquishment of dominion and control of the subject matter of the gift by delivery to the donee (Sec. 8211; 8219[5], U.S. IRC). Sec. 64, Rev. Regs. No. 2. "Sec. 102; 1.102-1, U.S. IRC. "Prentice-Hall Federal Tax Handbook, 1983, p. 141. 13


160

5.

Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines; The National Development Company (NDC) entered into contracts in Tokyo with several Japanese shipbuilding companies for the construction of twelve ocean-going vessels. Initial payments were made in cash and through irrevocable letters of credit. Promissory notes were issued. The remaining payments and interests were remitted in due time. The court ruled that C A . No. 182, as amended by C A . No. 311, does not provide such authorization exempting interest under Section 29(b)(4) of the old Tax Code, but like R.A. No. 1407, it does not exempt from taxes the interest on such securities. Tax exemptions cannot be merely implied but must be categorically and unmistakably expressed. Any doubt concerning this question must be resolved in favor of the taxing power. Moreover, there was nothing in the undertaking signed by the Secretary of Finance that the court found any inhibition against the collection of the disputed taxes. In fact, such undertaking was made by the government in consonance with and certainly not against the provisions of the Tax Code. It must be noted that NDC is not the entity being taxed here. The tax was due on the interest earned by the Japanese shipbuilders, which NDC is mandated to withhold and deduct from the payment (National Development Company vs. Commissioner, G.R. No. L-53961, June 30,1987). [NOTE: Exemption of interest on government securities is no longer provided for in R.A. No. 8424 effective January 1, 1998]. Contract on turnkey basis. — NDC awarded to Marubeni after conducting a public bidding a contract for the construction and installation of an integrated wharf/port complex on a turnkey basis. The contract price was Y12,79,389,000 and P44,327,940. The price in Japanese currency was broken down into two portions: the Japanese Yen Portion I and the Japanese Yen Portion II, while the price in Philippine currency was referred to as the


161


Philippine Pesos Portion. The Japanese Yen Portions I and II were financed in two years: (a) by Yen credit loan provided by the Overseas Economic Cooperation Fund; and (b) by supplier's credit in favor of Marubeni from the Export-Import Bank of Japan. The OECF is a Fund under the Ministry of Finance of Japan extended by the Japanese government as assistance to foreign governments to promote economic development. The price was broken down into the corresponding materials, equipment and services required for the project and their individual prices. Under the Philippine Onshore Portion, Marubeni does not deny its liability for the contractor's tax on the income from the two projects. On the Foreign Offshore Portion, Commissioner argues that since the agreement was turn key, it calls for the supply of both materials and services to the client, it is contract for a piece of work and is indivisible. The situs of the project is in .he Philippines, and the materials provided and services rendered were all done and completed within the territorial jurisdiction of the Philippines; hence, the entire receipts from the contracts, including the receipts from Offshore Portion, constitute income from Philippine sources. Marubeni argues that the work therein were not all performed in the Philippines. Machines and equipment were manufactured in Japan. They were designed, engineered and fabricated by Japanese firms in Japan sub-contracted by Marubeni. The court ruled that while the construction and installation work were completed within the Philippines, the evidence is clear that some pieces of equipment and supplies were completely designed and engineered in Japan. The two sets of ship unloader and loader, the boats and the mobile equipment for the NDC project and the ammonia storage tanks and refrigeration units were made and completed in Japan. They were already finished products when shipped to the Philippines. The other construction supplies listed under the Offshore Portion such as the steel sheets, pipes and structures, electrical and instrument apparatus, were not finished products when shipped


162

to the Philippines. They, however, were likewise fabricated and manufactured by the sub-contractors in Japan. All services for the design, fabrication, engineering and manufacture of the materials and equipment under Japanese Portion Yen I were made and completed in Japan. These services were rendered outside the taxing jurisdiction of the Philippines and are therefore not subject to tax (Commissioner vs. Marubeni Corp., G.R. No. 137377, Dec. 18, 2001). 6.

Retirement benefits, pensions, gratuities, etc. a. Retirement benefits under RA.. Nos. 4917 and 7641, and under Section 60(B) of Tax Code. — Retirement benefits received under R.A. No. 7641 and those received by officials and employees of private firms, whether individual or corporate, in accordance with a reasonable private benefit plan maintained by the employer (under R.A. No. 4917), provided that the retiring official or employee has been in the service of the same employer for at least ten years and is not less than 50 years of age at the time of his retirement, and the benefit shall be availed of by an official or employee only once. 16

17

Retirement benefits of 51-year old employee who has rendered 23 years of continuous service to the company is still subject to income tax and withholding tax, because the retirement plan of said employee requires minimum of 55 years of age and 25 years of continuous service. Retirement benefits of a lady employee of a private company who has completed ten years of employment with the firm but who was only 49 years old and ten months at the time of her retirement shall not be exempt from income tax. R.A. No. 4917 requires the presence of two conditions. 18

19

16

R.A. No. 7641 only requires the employee to render services to his employer for at least five years and that he be not less than 60 but not more than 65 years of age at the time of his retirement. See R.A. No. 4917, as implemented by Rev. Regs. No. 1-68, as amended by Rev. Regs. No. 1-83 and Rev. Regs. No. 11-2001. BIR Ruling No. 052-2000, Oct. 30, 2000. BIR Ruling No. 128-96, Nov. 26, 1996. 17

1S

19


163


Employees and Pension Trusts The tax exemption privilege of employees' trusts springs from Section 53(B) of the Tax Code [now Sec. 60(B)], which specifically exempts them from income tax. The law (R.A. No. 1983) has singled out employees' trusts for tax exemption. Employees' trusts or benefit plans normally provide economic assistance to employees upon the occurrence of certain contingencies, particularly old age, retirement, death, sickness or disability. It provides security against certain hazards to which members of the Plan may be exposed. It is an independent and additional source of protection for the working group. R.A. No. 1983 was conceived in order to encourage the formation and establishment of such private plans for the benefit of laborers and employees outside of the social security system. It is evident that tax exemption is likewise to be enjoyed by the income of the pension trust. Otherwise, taxation of those earnings would result in a diminution of accumulated income and reduce whatever the trust beneficiaries would receive out of the trust fund. This would run afoul of the very intendment of the law. Besides, P.D. No. 1959, which deleted the provisos regarding tax exemption and preferential tax rates under the old law, cannot be deemed to extend to employees' trusts. Said decree, being a general law, cannot repeal by implication a specific provision, Sec. 56(b) [now Sec. 53(b)], in relation to R.A. No. 4917, granting exemption from income tax to employees' trusts (Commissioner vs. CA and GCL Retirement Plan, 207 SCRA 487). To qualify for exemption, the employees' trust fund must refer to a definite program, scheme or plan; it must be set up in good faith and must be actuarially sound. The instant trust fund, though created in good faith and was intended for the employees' welfare, does not appear to be actuarially sound. The disputed income from dividends declared by San Miguel Brewery are not receipts, revenues or profits of the company and do not go to the general fund thereof, but to the reserve pension fund which is

164


solely for the benefit of the employees of respondent corporation. They are thus not exempt from income tax as provided in Section 8, Act 3499, the company's legislative franchise, which exempts the company's receipts, revenues and profits (Commissioner vs. Visayan Electric Company and CTA, G.R. L-22611, May 27, 1968). Any and all amounts representing return of the personal contributions of the employees, who are still in the active service of the SVD, to the funds shall not be subject to income tax, since the same are considered as mere return of capital. However, the income or earnings derived from the personal contributions by the employee members are subject to income tax since in a retirement plan under R.A. No. 4917, the employer or officials and employees or both, contribute to a trust fund for the purpose of distributing to such officials and employees or beneficiaries, the corpus or income accumulated by the trust in accordance with the plan. In the instant case, it is only upon their retirement that the total benefits which the employees of SVD shall receive consisting of their personal contribution, counterpart contributions of the employer, and the income of the fund to which the employees are entitled and are distributed to them shall be exempt from income. 20

The Philippine National Bank ( P N B ) Provident Fund is an employees' trust. Any amount received by an employee or by his heirs from his employer as a consequence of separation of such employee from the service of his employer due to death, sickness or other physical disability or for any cause beyond the control of said employee is exempt, regardless of age or length of services. Since the contemplated separation of officials and employees from the service of PNB as a result of the bank's privatization is not of their own making, the possible termination of its existing Provident Fund for the employees, and the officials and employees of PNB ceasing to be Provident 'BIR Ruling No. 051-2000, Oct. 30, 2000.


165


Fund members even if still employed with PNB as a private bank, any amount received by them from PNB as a result of its privatization, including those from the Provident Fund and the money value of the accumulated unused vacation and sick leave credits, are exempt from income tax and withholding tax. 21

Interest income derived by Private Educational Retirement Annuity Association Retirement Plan from its depository bank under the expanded foreign currency deposit system is exempt from the 7.5% final income tax. 22

b. Separation pay for causes beyond the control of employee. - Amount received by an official or employee or by his heirs from the employer as a consequence of separation of such official or employee from the service of the employer because of death, sickness or other physical disability or for any cause beyond the control of the said official or employee. The phrase "for any cause beyond the control of the said official or employee" means that the separation of the employee must be involuntary and not initiated by him. Retrenchment of the employee due to unfavorable business conditions or financial reverses is considered as involuntary. No withholding of tax is, therefore, necessary to be deducted by the employer from the separation pay. Thus, if the employee is separated under a Voluntary Separation Program of his employer, any separation pay received by the employee thereat shall be taxable. The early retirement package under the Business Process Re-engineering Program, intended to rationalize and streamline the operations of the company to cut on unnecessary cost and abolish positions that have become redundant is non-taxable to the recipients. 23

Any amount received by an official or employee or by his heirs from the employer as a consequence "BIR Ruling No. 088-1996, Aug. 6, 1996. ^BIR Ruling No. 042-2000, Sept .15, 2000. "BIR Ruling No. 105-96, Oct. 15, 1996.


166

of separation of such official or employee from the service of the employer due to death, sickness or other physical disability or for any cause beyond the control of the said official or employee is excluded. The tax exemption applies to the salary or cash equivalent of accumulated vacation and sick leaves such as the "terminal leave pays" of retiring government employees which are considered not part of the gross salary (Commissioner vs. CA & Castaneda, G.R. No. 96016, Oct. 17, 1991, 203 SCRA 72). Retirement from bank to join government service. - Mr. Ramon del Rosario, Jr. retired from Asian Bank to join the government service as the Secretary of Finance under the Ramos Administration. The non-withholding of income tax on the benefits received was based on BIR rulings which categorically ruled that "leaving the private sector to join the government service is beyond the employee/officer's control, thus, any and all amounts received as a result thereof are exempt from all taxes and consequently from the withholding taxes." On petition for review with the CTA, raising as one of the issues "whether or not Mr. Del Rosario, Jr. retirement was due to cause beyond his control" as one of the situations contemplated under then Sec. 28(b)(7)(B) of the Tax Code, as amended (now Sec. 32(B)(6)(b)l of the 1997 Tax Code, the CTA categorically held that "his separation from the company (ABCIC) by reason of his acceptance of a position as Secretary of Finance cannot be considered as something beyond his control." Hence, any and all benefits received by a retiring employee/officer from the private sector to join the government service are, therefore, subject to tax and consequently to the withholding tax (AB Capital and Investment Corporation vs. Commissioner, CTA Case No. 5233). 24

c. The provisions of any existing law to the contrary notwithstanding, social security benefits, retirement gratuities, pensions and other similar benefits received by resident or non-resident 24

RMC 48-2004, July 19, 2004.


167


citizens of the Philippines or aliens who come to reside permanently in the Philippines from foreign government agencies and other institutions, private or public; d. Payments of benefits due or to become due to any person residing in the Philippines under the laws of the U.S. administered by the U.S. Veterans Administration; e. Benefits received from or enjoyed under the SSS in accordance with the provisions of R.A. No. 8282; f. Benefits received from the GSIS under R.A. No. 8291, including retirement gratuity received by government officials and employees. 25

7.

Miscellaneous items a. Income derived from investments in the Philippines in loans, stocks, bonds or other domestic securities, or from interest on deposits in banks in the Philippines by (i) foreign governments, (ii) financing institutions owned, controlled, or enjoying refinancing from foreign governments, and (iii) international or regional financial institutions established by foreign governments (PLDT Co. vs. Commissioner, CTA Case No. 4375, Jan. 7, 1992). If the loan agreements state nothing about the loan being obtained from Eximbank of Japan nor can it be inferred or deduced from the loan agreements that foreign creditors acted for and in behalf of Eximbank of Japan, or Eximbank of Japan had to finance or guarantee the loans extended by foreign creditors, interest income is not exempt from the Philippine income tax (Asia Transmission Corp. vs. Commissioner, CTA Case No. 3380, July 27, 1988). The loan and sales contract between Mitsubishi and Atlas does not contain any direct or inferential reference to Eximbank whatsoever. The agreement is strictly between Mitsubishi as creditor in the contract of loan and Atlas as the seller of the copper

"R.A. No. 8291, which amended P.D. No. 1146, exempts GSIS from all internal revenue taxes.

168


concentrates. From the categorical language used in the document, one prestation was in consideration of the other. The specific terms and the reciprocal nature of their obligations make it implausible, if not vacuous, to give credit to the cavalier assertion that Mitsubishi was a mere agent in said transaction. Surely, Eximbank had nothing to do with the sale of the copper concentrates since all that Mitsubishi stated in its loan application with the former was that the amount being procured would be used as a loan to and in consideration for importing copper concentrates from Atlas. Such an innocuous statement of purpose could not have been intended for, nor could it legally constitute, a contract of agency. The taxability of a party cannot be blandly glossed over on the basis of a supposed "broad, pragmatic analysis" along without substantial supportive evidence, lest governmental operations suffer due to diminution of much needed funds. Nor can we close this discussion without taking cognizance of petitioner's warning, of pervasive relevance at this time, that while international comity is invoked in this case on the nebulous representation that the funds involved in the loans are those of a foreign government, scrupulous care must be taken to avoid opening the floodgates to the violation of our tax laws. Otherwise, the mere expedient of having a Philippine corporation enter into a contract for loans or other domestic securities with private foreign entities, which in turn will negotiate independently with their governments, could be availed of to take advantage of the tax exemption law under discussion (Commissioner vs. Mitsubishi Metal Corporation, et al., G.R. No. 54908, Jan. 22, 1990). Interest income arising in the Philippines and paid in respect of a loan made, guaranteed or insured by the Korea Exchange Bank, a financial institution which is 100% owned by the Government of South Korea, shall not be subject to income tax and withholding tax. Similarly, interest income on loans paid to the Commonwealth Development 26

'BIR Ruling No. 139-96, Dec. 12, 1996.


169


Corporation that is owned by the government of the United Kingdom is exempt from tax; 27

b. Income derived from any public utility or from the exercise of any essential governmental function accruing to the Government of the Philippines or to any political subdivision thereof; c. P r i z e s and awards made primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement but only if: (i) the recipient was selected without any action on his part to enter the contest or proceeding; and ( i i ) the recipient is not required to render substantial future services as a condition to receiving the prize or award; d. All prizes and awards granted to athletes in local and international sports competitions and tournaments whether held in the Philippines or abroad and sanctioned by their national sports associations; 28

e. 13th month pay and other gross benefits received by officials and employees of public and private entities, to the extent of P30,000; 29

f. GSIS, SSS, Medicare and Pag-ibig contributions, and union dues of individuals; g. Gains realized from the sale or exchange or retirement of bonds, debentures or other certificate of indebtedness with a maturity of more than 5 years. Gains cannot include interest. - Gains cannot include interest, since it clearly refers to gains from the sale of bonds, debentures and other certificates of indebtedness. Whereas the term "gains" includes "interest" in its general sense, this rule cannot be "BIR Ruling No. 013-96, Feb. 7, 1996. ^To be eligible for exemption, the national sports association referred to in the law that should sanction said sport activity is the Philippine Olympic Committee (BIR Ruling No. 026-2000, June 13, 2000). ^The AFP Retirement and Separation Benefits System created under P.D. 1909, whose members come from the military establishment, should be treated in the same manner as the GSIS and SSS.


applied to Section 32(B)(7)(g) of the Tax Code in the specific sense. Section 32(A) of the Tax Code defines "gross income" and it is clear that there is a distinction between "gains derived from dealings in property" and "interests." "Gains realized from the sale or exchange or retirement of bonds, debentures and other certificate of indebtedness" would fall under the category of "gains derived from dealings in property." On the other hand, "interests" would include interest from bonds, debentures and other certificate of indebtedness. Only citizens, resident aliens and non-resident aliens engaged in trade or business are exempt from income tax on interest from long-term deposit or investment. On the other hand, domestic and resident foreign corporations are subject to a 20% final tax on such interest. If Congress intended to exempt interest from bonds, debentures and other certificates of indebtedness under Section 32(B)(7)(g) of the Tax Code, it would have done so in clear and specific terms (Nippon Life Insurance Company vs. Commissioner, CTA Case No. 6142, Feb. 4, 2002). After all, exemptions are construed strictly against the taxpayer and liberally in favor of the government.

Exempt Corporations All corporations, agencies, or instrumentalities owned or controlled by the Government, except the Government Service Insurance System, Social Security System, the Philippine Health Insurance Corporation, and the Philippine Charity Sweepstakes Office shall pay such rate of tax upon their taxable income as are imposed upon corporations or associations engaged in a similar business, industry, or activity, the provisions of existing special or general laws to the contrary notwithstanding. 30

Interest income from long-term deposits in the form of a common trust fund established by RCBC through its Trust and Investment Division is exempt from the 20% final withholding tax. However, should the holder of the certificate pre-terminate the deposit or investment before the fifth year, a final tax shall 'Sec. 27(C), NIRC.


171


be imposed on the entire income and shall be deducted and withheld by the depository bank from the proceeds of the longterm deposit or investment certificate on the remaining maturity thereof. 31

Section 30 of the Tax Code expressly exempts from tax the income received by the following organizations as such: ( A ) Labor, agricultural or horticultural organization not organized principally for profit; (B) Mutual savings bank not having a capital stock represented by shares, and cooperative bank without capital stock organized and operated for mutual purposes and without profit; (C) A beneficiary society, order or association, operating for the exclusive benefit of the members such as a fraternal organization operating under the lodge system, or a mutual aid association or a non-stock corporation organized by employees providing for the payment of life, sickness, accident, or other benefits exclusively to the members of such society, order, or association, or non-stock corporation or their dependents; (D) Cemetery company owned and operated exclusively for the benefit of its members; (E) Non-stock corporation or association organized and operated exclusively for religious, charitable, scientific, athletic, or cultural purposes, or for the rehabilitation of veterans, no part of its net income or asset shall belong to or inure to the benefit of any member, organizer, officer or any specific person; (F) Business league, chamber of commerce, or board of trade, not organized for profit and no part of the net income of which inures to the benefit of any private stockholder or individual; (G) Civic league or organization not organized for profit but operated exclusively for the promotion of social welfare; (H) A non-stock and nonprofit educational institution; (I)

Government educational institution;

"BIR Ruling No. 063-2000, Nov. 20,2000. The BIR treats the common trust like an individual that is exempt from interest income on long-term deposits or investments.

172


(J) Farmers or other mutual typhoon or fire insurance company, mutual ditch or irrigation company, mutual or cooperative telephone company, or like organization of a purely local character, the income of which consists solely of assessments, dues, and fees collected from members for the sole purpose of meeting its expenses; and (K) Farmers, fruit growers, or like association organized and operated as a sales agent for the purpose of marketing the products of its members and turning back to them the proceeds of sales, less the necessary selling expenses on the basis of the quantity of produce finished by them. Notwithstanding the provisions in the preceding paragraphs, 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 imposed under this Code. To implement the provisions of the above law, RMC 762003 dated November 14, 2003 was issued. Non-stock, non-profit corporations Organizations enumerated under Section 30 of the Tax Code of 1997 are exempt from the payment of income tax on income received by them as such organization. However, they are subject to the corresponding internal revenue taxes imposed under the Tax Code of 1997 on their income derived from any of their properties, real or personal, or any activity conducted for profit regardless of the disposition thereof {i.e., rental payment from their building/premises), which income should be returned for taxation. In addition, their interest income from currency bank deposits and yield or any other monetary benefit from deposit substitute instruments and from trust funds and similar arrangement, and royalties derived from sources within the Philippines are subject to the 20% final withholding tax: Provided, however, That interest income derived by them from a depository bank under the expanded foreign currency deposit system shall be subject to 7-1/2% final withholding tax pursuant to Section 27(D)(1) in relation to Section 57(A), both of the Tax Code of 1997.

173

It shall also be constituted as a withholding agent for the government if they acts as an employer and any of their employee receives compensation income subject to withholding tax under Section 79(A), Chapter X I I I , Title II of the Tax Code of 1997, as implemented by Revenue Regulations No. 2-98, or if they makes income payments to individuals or corporations subject to the withholding tax provided for in Section 57 of the Tax Code of 1997, also as implemented by Revenue Regulations No. 2-98. The phrase "any of their activities conducted for profit" does not qualify the word "properties." -The phrase "any of their activities conducted for profit" does not qualify the word "properties." This makes income from the property of the organization taxable, regardless of how that income is used whether for profit or for lofty non-profit purposes. Thus, the income derived from rentals of real property owned by the Young Men's Christian Association of the Philippines, Inc. (YMCA), established as a welfare, education and charitable non-profit corporation, is subject to income tax. The rental income cannot be exempted on the solitary but unconvincing ground that said income is not collected for profit but is merely incidental to its operation. The law does not make a distinction. Where the law does not distinguish, neither should we distinguish. Because taxes are the lifeblood of the nation, the Court has always applied the doctrine of strict interpretation in construing tax exemptions. Y M C A is exempt from the payment of property taxes only but not income taxes because it is not an educational institution devoting its income solely for educational purposes. The term "educational institution" has acquired a well-known technical meaning. Under the Education Act of 1982, such term refers to schools. The school system is synonymous with formal education which refers to the hierarchically structured and chronologically graded learnings organized and provided by the formal school system and for which certification is required in order for the learner to progress through the grades or move to higher levels (Commissioner vs. Court of Appeals and YMCA of the Phils., G.R. No. 124043, Oct. 14, 1998). Non-stock, non-profit educational institutions 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,


174

directly and exclusively for educational purposes (Paragraph 3, Section 4, Article XPV of the 1987 Constitution). 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. Pursuant to Section 109(m) of the Tax Code of 1997, private educational institutions shall be exempt from value-added tax provided they are accredited as such either by the Department of Education, Culture and Sports or by the Commission on Higher Education. However, this exemption does not extend to their other activities involving sale of goods and services. However, they shall be subject to internal revenue taxes on income from trade, business or other activity (e.g., rental payment from their building/premises), 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). 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 an annual basis submit to the Revenue District Office concerned an annual information return and duly audited financial statement together with the following: (a) 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; (b) and

Certification of actual utilization of the said income;


175


(c) Board Resolution by the school administration on proposed projects (i.e., construction 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). 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. In both cases, in order to monitor the activities being conducted by these institutions, it is mandatory that they should maintain their respective set of books of accounts as prescribed in Section 235 of the Tax Code of 1997. Furthermore, both institutions are subject to the payment of the annual registration fee of P500.00 as prescribed in Section 236(B) of the Tax Code of 1997. They are also required under Section 6(C), in relation to Section 237, of the same Code to issue duly registered receipts or sales or commercial invoices for each sale or transfer of merchandise or for services rendered which are not directly related to the activities for which they are registered. Private educational institution which deviates from its purely educational purposes and activities shall be treated like any private domestic corporation engaged in business for profit. — A private educational institution which deviates from its purely educational purposes and activities shall be treated like any private domestic corporation engaged in business for profit with respect to income derived therefrom. The protective mantle of income tax benefit or exemption cannot be extended to a private educational institution which chooses to descend from its high pedestal of tax preference or immunity to the level of an ordinary private corporation engaged in profitable undertaking or business (Xavier School, Inc. us. Commissioner, CTA Case 1682, Oct. 8, 1969). Interests from savings and time deposits are exempt from the 20% final withholding tax, if earned by non-stock,


176

non-profit educational institutions as all revenues and assets of these institutions which are actually, directly and exclusively used for educational purposes are exempt from taxation. - The Gregorio Araneta University Foundation (GAUF) is a non-stock, non-profit organization. On April 25, 1998, a Deed of Absolute Sale was executed between GAUF, as seller, and Spouses Callangan, as buyers, involving a real property together with improvements thereon, in the total sum of PI.3 million. All the proceeds of sale will be used for the construction and improvement of the Golden Pavilion Building, which is an expansion program of GAUF where the service offices of the Registrar, Business and Finance, Accounting, Cashier and Treasurer are now presently located. It also houses a multipurpose recreational center for the students and personnel of the University. The sale of the land with improvements is exempt from the capital gains tax, considering that the income derived therefrom did not result from the productive use of real properties but from a single transaction which is merely incidental to the purpose for which GAUF was organized; hence, said income is not within the contemplation of the last paragraph of Section 30 of the 1997 Tax Code. This opinion has been sustained and adopted by the CTA in Congregacion de la Mission de San Vicente de Paul vs. Collector, CTA Case No. 1468, Oct. 14, 1968. 32

33

The fact that a college is administered to assure that it will not incur a deficit should not subject it to income tax. Every responsible organization must be so run as to, at least insure its existence, by operating within the limits of its own resources, specially its regular income. It should strive, whenever possible to have a surplus. In other words, the making of a profit does not destroy the tax exemption of charitable, benevolent or educational institutions (Jesus Sacred Heart College vs. Collector, 95 Phil. 16). The mere charging of medical and hospital fees for those who can afford to pay does not make the non-profit institution established for profit or gain. It has to meet expenses for operation and maintenance in order to carry out its lofty purposes to serve humanity (UST Hospital Employees vs. Santo Tomas Hospital, G.R. No. L-6988, Oct. 29, 1955; Collector vs. St. Paul Hospital in Iloilo, L-12127, May 25, a2

33

BIR Ruling No. 115-92, Apr. 2, 1992. BIR Ruling DA-172-03-19-99.


177


1958; University of San Agustin vs. Commissioner, L-12222, May 28, 1958). Interests from savings and time deposits are exempt from the 20% final withholding tax, if earned by non-stock, non-profit educational institutions as all revenues and assets of these institutions which are actually, directly and exclusively used for educational purposes are exempt from taxation. The relief given to such schools is expected to be passed on to students in the form of lower tuition fees. The specification that these institutions must be non-stock has been added as a safeguard because the moment a stock corporation is formed, there is expectation of dividends or profits (Southeast Asian Regional Center for Graduate Study and Research in Agriculture [SEARCA] vs. Commissioner, CTA Case No. 4982, Oct. 6, 1995).

CHAPTER VI COSTS AND

DEDUCTIONS FROM GROSS

INCOME, NON-DEDUCTIBLE ITEMS, A N D PERSONAL

EXEMPTIONS

Chapter VI covers cost, deductions from gross income, and nondeductible items in the case of corporations, as well as personal and additional exemptions in the case of individuals. This Chapter will discuss the following sections of the Tax Code:

A.

1.

Section 34 - Deductions from gross income;

2.

Section 35 - Allowance of personal exemption for individual taxpayer;

3.

Section 36 — Items not deductible;

4.

Section 37 - Special provisions regarding income and deductions of insurance companies; and

5.

Section 38 - Losses from wash sales of stock or securities.

Return of Capital

1

Since income tax is levied by law only on income, gain or profit, which may be gross income or net income, the cost to acquire the asset (or the amount representing return of capital) should be deducted from the sales proceeds and not be subject to income tax. In sales of inventory of goods or merchandise (bv a manufacturer, wholesaler, retailer, or dealer of goods or merchandise) or of stock in trade primarily for sale to customers in the course of trade or business of the taxpayer (by a real estate dealer or dealer in securities), the amount received by 'Costs of goods purchased for resale, with proper adjustment for opening and closing inventories, is deducted from gross sales in computing gross income - Sec. 65, Rev. Regs. No. 2.

178

COSTS AND DEDUCTIONS FROM GROSS INCOME,

179

N O N - D E D U C T I B L E I T E M S , AND PERSONAL EXEMPTIONS

the seller consists of return of capital (cost) and gain from sale of goods or properties. Cost of goods manufactured and sold (in the case of manufacturers) or cost of sales (in the case of wholesalers and dealers) is deducted from gross sales and is reflected above the gross income line. We cannot generally do the same thing, however, for sales of services, for they do not carry nor sell any inventory or stock in trade, except may be of contractors. Illustrations Sale of real property Vincent Santos bought a parcel of idle land in 1970 at the price of P100,000. In 1998, he made certain improvements on the land costing P200,000 and used the land as parking spaces of employees of a company. In 2009, he sold said land for P I million, which was equal to the fair market value per schedule of values prepared by the BIR. The taxable gain from sale is computed as follows: Gross selling price Less: Cost of land P100,000 + 200,000 Cost of improvement Gain from sale (or Gross Income))

PI,000,000 - 300,000 P 700.000

Sale of goods by a dealer ABC Corporation is a dealer of furniture. At the beginning of 2008, it has inventory of unsold furniture of P2,000. It bought in 2008 furniture for P10,000, which it was able to sell during the year at P12,000. At year end, its inventory balance was P4,000. Its gross income for the year is P4,000. The amount of P8,000 received by the corporation is exempt from income tax because it represents merely a return of its capital or cost of sales. Thus, the income statement will show the following: Gross selling price Less: Cost of sales: Beginning inventory Purchases Total available for sale Less: Ending inventory Gross income

P 12,000 P 2,000 + 10,000 P 12,000 - 4,000

P

8,000 4.000

180


Sale of goods by a manufacturer (Figures are in thousand pesos) Gross sales Less: Sales discounts Sales returns and allowances Net sales Less: Cost of goods manufactured and sold: Materials used: Beginning inventory of raw materials Add: Purchases Freight in Less: Purchase discounts Purchase returns Materials available for use Less: Ending inventory of raw materials Cost of materials used Add: Direct labor Manufacturing overhead Total manufacturing cost Add: Beginning inventory, goods in process Total cost of goods in process Less: Ending inventory, goods in process Cost of goods manufactured Add: Beginning inventory, finished goods Goods available for sale Less: Ending inventory, finished goods Cost of goods sold Gross income

F265 5 10.

15 P 250

49 177 5 (8) (20)

154. 203 33 170 18 1Q 198 15 183 19 164 54 218 33 185 P 65

To arrive at the amount representing return of capital of a manufacturer, accountants use the above accounting formula to determine the cost of goods manufactured and sold. The difference between the gross sales and the cost of goods manufactured and sold represents the taxable gross income. It must be noted that while the above accounting formula in determining the amount representing return of capital is accepted for tax purposes, the items in the cost of sales or cost of goods manufactured and sold must be based on actual cost, properly accounted for, and supported by adequate records and receipts. Computation of cost based on standard cost accounting is not acceptable for income tax purposes. Thus, accounting and tax rules require that the inventory in transit and not yet in the possession of the taxpayer must be included in the ending inventory of the taxpayer for purposes of computing the cost of sales or cost of goods manufactured and sold, where title to such inventory in transit has been transferred to the taxpayer on the last day of the taxable year. For example, a Philippine

COSTS A N D DEDUCTIONS FROM GROSS INCOME,

181

N O N - D E D U C T I B L E ITEMS, AND PERSONAL EXEMPTIONS

importer buys goods from a Hong Kong exporter under "FOB shipping point." Upon loading of the goods by the exporter in a vessel in Hong Kong, such goods belong to the importer and must be included as part of the ending inventory of the importer for the year.

Deductions from Gross Income Deductions are strictly construed against the taxpayer. - He who claims a deduction must point to the specific provision of the statute authorizing it, and he must be able to prove that he is entitled to it. As a general rule, deductions are strictly construed against the taxpayer claiming them and it is incumbent upon the taxpayer to establish a clear right to tax exemption. Tax exemptions are looked upon with disfavor (Western Minolco Corporation vs. Commissioner, 124 SCRA 121). If the exemption is not expressly stated in the law, the taxpayer must at least be within the purview of the exemption by clear legislative intent (Commissioner of Customs vs. Philippine Acetylene Co., 39 SCRA 70). However, if there is an express mention or if the taxpayer falls within the purview of the exemption by clear legislative intent, the rule on strict construction will not apply (Commissioner vs. Arnoldus Carpentry Shop, L-71122, Mar. 25, 1988). Exemption claimed merely on the ground that another person situated in the same circumstances has not been required to pay or has not paid similar taxes is unjustifiable and should be ignored (Bank of the Phil Islands vs. Trinidad, 45 Phil 384). Types of Deductions There are three (3) types of deductions from gross income. These are: (a) the itemized deductions in Section 34(A) to (J) and (M) available to all kinds of taxpayers engaged in trade or business or practice of profession in the Philippines; (b) the optional standard deduction in Section 34(L) available only to individual taxpayers deriving business, professional or other incomes; and (c) special deductions for insurance companies in Sections 37 and 38, all of the Tax Code, and in special laws where the qualified taxpayer is allowed to deduct 150% of the amount actually paid as deduction from gross income. Except for those taxpayers engaged in trade or business, or practice of profession in the Philippines, or receive capital gains or passive


182

income not subject to final tax or other income, who select the optional standard deduction, any other taxpayer (individual or corporation) who claims the itemized deductions under the Tax Code and deductions under special laws must present and submit adequate receipts or invoices in support of such deductions; otherwise, the claimed deductions may be disallowed by the BIR.

C.

Itemized Deductions The itemized deductions are enumerated in Section 34 of the Tax Code. Additional deductions are granted to insurance companies in Section 37, while losses from wash sales of stock or securities by a dealer in securities are provided for in Section 38, both of the Tax Code. Other itemized deductions could be granted under general or special laws. For example, additional training expenses are allowed enterprises registered with PEZA. 1.

Business Expenses

2

Conditions for Deductibility of Business Expenses 1.

The expense must be ordinary and necessary;

2.

Paid or incurred during the taxable year;

3.

In carrying on or which are directly attributable to the development, management, operation and/or conduct of the trade, business or exercise of profession;

4.

Supported by adequate invoices or receipts;

5.

Not contrary to law, public policy or morals. Operating expenses of an illegal or questionable business are deductible, but expenses of an inherently illegal nature, such as bribery and protection payments, are not. 3

6.

The tax required to be withheld on the amount paid or payable is shown to have been paid to the BIR. Any income payment which is otherwise deductible under the Code shall be allowed as a deduction from the payor's gross income only if it is shown that the 4

2

3

4

Sec. 65, Rev. Regs. No. 2. Prentice-Hall Federal Tax Handbook, 1983, p. 239. Sec. 2.58.5, Rev. Regs. No. 2, Apr. 17, 1998.


183

N O N - D E D U C T I B L E ITEMS, A N D PERSONAL EXEMPTIONS

income tax required to be withheld has been paid to the Bureau in accordance with Sections 57 and 58 of the Tax Code. A deduction will also be allowed in the following cases where no withholding of tax was made, provided that: ( A ) The payee reported the income and pays the tax due thereon and the withholding agent pays the tax, including the interest incident to the failure to withhold the tax, and surcharges, if applicable, at the time of the audit/investigation or reinvestigation/reconsideration; (B) The recipient/payee failed to report the income on the due date thereof, but the withholding agent/taxpayer pays the tax, including the interest incident to the failure to withhold the tax, and surcharges, if applicable, at the time of the audit/investigation or reinvestigation/ reconsideration; (C) The withholding agent erroneously underwithheld the tax but pays the difference between the correct amount and the amount of tax withheld, including the interest, incident to such error, and surcharges, if applicable, at the time of the audit/investigation or reinvestigation/ reconsideration (Sec. 2.58.5, Rev. Regs. No. 2-98, as amended by Sec. 6, Rev. Regs. No. 14-2002). Business expenses deductible from gross income include the ordinary and necessary expenditures directly connected with or pertaining to the taxpayer's trade or business. The cost of goods purchased for resale, with proper adjustment for opening and closing inventories, is deducted from gross sales in computing gross income. Among the items included in business expenses are management expenses, commissions, labor, supplies, incidental repairs, operating expenses of transportation, travelling expenses while away from home solely in the pursuit of a trade or business, advertising and other selling expenses, together with insurance premiums against fire, storm, theft, accident, or other similar losses in the case of a business, and rental for the use of business property. A taxpayer is entitled to


184

deduct the necessary expenses paid in carrying on his business from his gross income from whatever source. 5

Ordinary and necessary expenses An expense is ordinary when it connotes a payment which is normal in relation to the business of the taxpayer and the surrounding circumstances. An expense is necessary where the expenditure is appropriate or helpful in the development of the taxpayer's business or that the same is proper for the purpose of realizing a profit or minimizing a loss (General Electric [P.I.], Inc. vs. Collector, CTA Case 1117, July 14, 1963). Without necessarily deciding on such profit, we believe that the case is different from other instances in which entertainment expenses had been allowed, because in those cases, the entertainment constituted part of the duties assigned to the employee, for which no reimbursement was provided by the employer, or that the entertainment was necessary incident to the business or acquisition of the income returned (VisayanCebu Terminal Co. vs. Collector, CTA Case 128, June 29, 1957; Hicks vs. Collector, CTA Case 38, Oct. 19, 1955). Professional feec - Professional expenses are deductible in the year the professional services are rendered, not in the year they are billed, provided that the "all events test" is present. In 1984 and 1985, legal services were rendered by the lawyer, but they were billed by the lawyer and paid by the respondent in 1986. In 1985, auditing services were rendered by the accountant but billed and paid in 1986. In the audit of the books for 1986, the BIR disallowed the expenses for 1986 pursuant to the "all events test." The CTA and CA ruled in favor of the respondent. However, the Supreme Court reversed their decisions. The court ruled that accrual of income and expense is permitted when the all events test has been met. This test requires (1) fixing a right to income or liability to pay, and (2) the availability of reasonably accurate determination of such income or liability. It added that it does not, however, demand that the amount of income or liability be known absolutely; it only requires that a taxpayer has at its disposal the information necessary to compute the amount with reasonable accuracy, which implies something less than an exact or completely 6



185

NON-DEDUCTD3LE I T E M S , A N D P E R S O N A L EXEMPTIONS

accurate amount. Moreover, deduction takes the nature of tax exemption; it must be construed strictly against the taxpayer (Commissioner vs. Isabela Cultural Corporation, G.R. No. 172231, Feb. 12,2007). Commission expenses. — Commission payment by Asset Management Company, a company set up to manage the portfolio of mutual fund companies, may be amortized over the period to which it relates under certain conditions. 6

Compensation for personal services. - Among the ordinary and necessary expenses paid or incurred in carrying on any trade or business may be included a reasonable allowance for salaries or other compensation for personal services actually rendered. Employer-employee relationship must exist between the person who renders the services and the person to whom such services are performed. The test of deductibility in the case of compensation payments is whether they are reasonable and are, in fact, payments purely for service. This test and its practical application may be further stated and illustrated as follows: a.

6

Any amount paid in the form of compensation, but not in fact as the purchase price of services, is not deductible. An ostensible salary paid by a corporation may be a distribution of dividend on stock. This is likely to occur in the case of a corporation having few shareholders, practically all of whom draw salaries. If in such a case the salaries are in excess of those ordinarily paid for similar services, and the excessive payment correspond or bear a close relationship to the stockholdings of the officers or employees, it would seem likely that the salaries are not paid wholly for services rendered, but that the excessive payments are a distribution of earnings upon the stock. An ostensible salary may be in part payment for property. This may occur where a partnership sells out to a corporation, the former partners agreeing to continue in the service of the corporation. In such a case, it may be found that the salaries of the former partners are not merely for services, but in part constitute payment for the transfer of their business.

BIR Ruling No. 009-2001, Mar. 5, 2001.


186

b.

The form or method of fixing compensation is not decisive as to deductibility. While any form of contingent compensation invites scrutiny as a possible distribution of earnings of the enterprise, it does not follow that payments on a contingent basis are to be treated fundamentally on any basis different from that of applying to compensation at a flat rate. Generally speaking, if contingent compensation is paid pursuant to a free bargain between the employer and the individual made before the services are rendered, not influenced by any consideration on the part of the employer other than that of securing on fair and advantageous terms the services of the individual, it should be allowed as a deduction even though in the actual working out of the contract, it may prove to be greater than the amount which would ordinarily be paid.

c.

Reasonable compensation. — In any event, the allowance for compensation paid may not exceed what is reasonable in all the circumstances. It is in general just to assume that reasonable and true compensation is only such amount as would ordinarily be paid for like services by like enterprises in like circumstances. The circumstances to be taken into consideration are those existing at the date when the contract for services was made, not those existing at the date when the contract is questioned. 7

The basis upon which the remuneration is paid is immaterial in determining whether the remuneration constitutes compensation. Thus, it may be paid on the basis of piecework, or a percentage of profits, and may be paid hourly, daily, weekly, monthly, or annually. Compensation may be paid in money or in some medium other than money, such as stocks, bonds, or other forms of property. If services are paid for in a medium other than money, the fair market value of the thing taken in payment is the amount to be included as compensation. If the services are rendered at a stipulated price, in the absence of evidence to the contrary, such price will be presumed to be the fair market value 'Sec. 70, Rev. Regs. No. 2.


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N O N - D E D U C T I B L E ITEMS, A N D P E R S O N A L EXEMPTIONS

of the remuneration received. If a corporation transfers to its employees its own stock as remuneration for services rendered by the employee, the amount of such remuneration is the fair market value of the stock at the time of the transfer. If a person receives as remuneration for services rendered a salary and in addition thereto living quarters or meals, the value to such person of the quarters and meals so furnished shall be added to the remuneration otherwise paid for the purpose of determining the amount of compensation. If, however, living quarters or meals are furnished to an employee for the convenience of the employer, the value thereof need not be included as compensation. 8

The deductibility of salaries from gross income must meet and comply with the following requisites: (a) The expense must be both ordinary and necessary; (b) The salaries must be paid or incurred within the taxable year; (c) The salaries must be incurred in carrying on a trade or business; (d) The expense must in fact be salaries or other compensation; (e) The salaries must be for personal services actually rendered; and (f) The salaries must be reasonable in amount (Brixton Investment Corp. vs. Tabios, CTA Case 1681, Apr. 18, 1967; Algue, Inc. vs. Commissioner, CTA Case 1620, Jan. 16, 1968). There is no evidence of a particular service rendered by these officers to petitioner to warrant payment of commissions. The services mentioned by counsel of petitioner have been more than adequately compensated in the form of salaries and bonuses. We cannot see any justification for payment of director's fees of about P10,000 for each of said officers for coming to the Philippines to visit their corporation once in two years. Being non-residents, the President and Vice President of petitioner corporation of which they are the controlling stockholders, we are more inclined to believe that said commission and director's fees, payment of which was based on a certain percentage of the annual profits, are in the nature of dividend distributions (Alhambra Cigar & Cigarette Mfg. Co. vs. Commissioner, 21 SCRA 1111). In the examination of the taxpayer's tax liabilities for previous years, the BIR disallowed salaries expenses which the taxpayer did not protest. However, in the examination of "Rev. Regs. Nos. 2-86 and 3-98, as amended.


188

the current or subsequent year's tax liabilities, the taxpayer is not precluded from disputing the BIR findings in subsequent or succeeding years disallowing such salaries (Associated Sugar, Inc. vs. Collector, CTA Case 1405, Apr. 7, 1966). Treatment of excessive compensation. - The income tax liability of the recipient in respect of an amount of ostensibly paid to him as compensation, but not allowed to be deducted as such by the payer, will depend upon the circumstances of each case. Thus, in the case of excessive payments by corporations, if such payments correspond or bear a close relationship to stockholdings, and are found to be distribution of earnings or profits, the excessive payments will be treated as dividend. If such payments constitute payment for property, they should be treated by the payer as a capital expenditure and by the recipient as part of the purchase price. 9

There are good reasons for limiting the additional compensation in the form of percentage of the profits from the business operation of the company. The policy of agreeing to pay additional compensation on the percentage basis before it is earned is based on sound business principles. Its object is to stimulate the activity, diligence, and ambition of the officers or employees and to enable the employer to justly compensate its deserving officers and employees. The provision of the by-laws of the corporation granting to its officers a certain percentage of the profit from the business should be limited to the profit derived from the corporation of its furniture and fish net business. To allow officers to receive additional compensation although a company suffered losses from operation through their inefficiency or negligence, as long as the profits from the sale of its capital investments are more than its losses from operation, would be a violation of the purposes of bonuses and additional compensation (Aguinaldo Industries Corporation vs. Collector, CTA Case 1636, June 29, 1968). Bonuses to employees. — Bonuses to employees will constitute allowable deductions from gross income when such payments are made in good faith and as additional compensation for the services actually rendered by the employees, provided such payments, when added to the stipulated salaries, do not exceed a reasonable compensation for the service rendered. 9



189


It is immaterial whether such bonuses are paid in cash or in kind or partly in cash and partly in kind. Donations made to employees and others, which do not have in them the element of compensation or are in excess of reasonable compensation for services, are not deductible from gross income. 10

The employer has the right to fix the compensation of its officers and employees and pay the bonuses. However, said employer cannot legally deduct bonuses from gross income unless they are shown to be reasonable expenses. To hold otherwise would open the gate to rampant tax evasion (Kuenzle & Streiff, Inc. vs. Commissioner, G.R. No. L-18840, May 29, 1969). In short, the right of petitioner to fix the salaries and bonuses of its officers is not absolute where the same was availed of to avoid payment of corporate income tax due to the government. Large commissions and fees to a controlling stockholder which are unreasonable would obviously not be deductible. There is no fixed test for determining the reasonableness of a given bonus as compensation. This depends upon many factors, one of them being the amount and quality of the services performed with relation to the business. Other tests suggested are: payment must be made in good faith, the character of the taxpayer's business, the volume and amount of its net earnings, its locality, the type and extent of the services rendered, the salary policy of the corporation, the size of the particular business, the employee's qualifications and contributions to the business venture, and general economic conditions. However, in determining whether the particular salary or compensation payment is reasonable, the situation must be considered as a whole. Ordinarily, no single factor is decisive. It is important to keep in mind that it seldom happens that the application of one test can give satisfactory answer, and that ordinarily, it is the interplay of several factors, properly weighed for the particular case, which must furnish the final answer (CM. Hoskins & Co., Inc. vs. Commissioner, L-24059, Nov. 28, 1969; Pacific Banking Corp. vs. Commissioner, CTA Case 1667, Oct. 29, 1970). Christmas bonuses are deductible if intended as additional compensation. But where such bonuses are considered as "out-and-out gifts," they are gratitude and are not deductible (Greenville Textile Supply Co., 1 BTA 1952). l0


190


Separation bonuses of directors shall be disallowed where there were no past services rendered warranting the payment thereof. The recipients were members of the Board of Directors (Talisay-Silay Milling Co. us. Collector, supra). Compensation for injuries.—Amounts paid for pensions to retired employees or to their families or others dependent upon them, or on account of injuries received by employees, and lump-sum amounts paid or accrued as compensation for injuries, are proper deductions as ordinary and necessary expenses. Such deductions are limited to the amount not compensated for by insurance or otherwise. When the amount of the salary of an officer or employee is paid for a limited period after his death to his widow or heirs, in recognition of the services rendered by the individual, such payments may be deducted. Salaries paid by employers to employees who are absent in the military, naval, or other service of the Government, but who intend to return at the conclusion of such service, are allowable deductions. 11

Advertising expenses. — In 1995, respondent paid P9.4 million for advertising a product, which was deducted from its gross income for the year. This was disallowed by the BIR as ordinary and necessary expense, which considered the same as capital expenditure, since the amount was staggering and it was incurred 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. The court held that "goodwill" generally denotes the benefit arising from connection and reputation, and efforts to establish reputation are akin to acquisition of capital assets. Therefore, expenses related thereto are not business expenses but capital expenditures (Commissioner vs. General Foods Phil., G.R. No. 143672, Apr. 24, 2003). Being capital expenditures, the amount should be allocated among the taxable years for which benefits of advertising shall accrue. Cost of materials. - Taxpayers carrying materials and supplies on hand should include in expenses the charges for materials and supplies only to the amount that they are actually consumed and used in operation during the year for which the return is made, provided that the cost of such materials and supplies has not been deducted in determining the net income "Sec. 73, Rev. Regs. No. 2.


191


for any previous year. If a taxpayer carries incidental materials or supplies on hand for which no record of consumption is kept or of which physical inventories at the beginning and end of the year are not taken, it will be permissible for the taxpayer to include in his expenses and deduct from gross income the total cost of such supplies and materials as were purchased during the year for which the return is made, provided the net income is clearly reflected by this method. 12

Club dues. — Where a corporation requires its officers to be members of social or athletic clubs to promote its business, and the club dues are paid by the corporation, such dues are deductible by the corporation as ordinary and necessary business expenses. The club dues paid by petitioner on account of its staff officers who were required to be members of said clubs are deductible (Goodrich International Rubber Co. vs. Collector, CTA Case 468, June 8, 1965). However, membership fees, dues and other expenses borne by the employer for the employee in social and athletic clubs or other similar organizations are treated as fringe benefits subject to the fringe benefits tax if paid to supervisory or managerial employees of the company beginning January 1, 1998. The fringe benefit tax paid by the employer is deductible from its gross income as ordinary and necessary business expense. 13

14

Expenses of farmers. — A farmer who operates a farm for profit is entitled to deduct from gross income as necessary expenses all amounts actually expended in the carrying on of the business of farming. The cost of ordinary tools of short life or small cost, such as hand tools, including shovels, rakes, etc., may be included. The cost of feeding and raising livestock may be treated as an expense deduction, in so far as such cost represents actual outlay, but not including the value of farm produce grown upon the farm or the labor of the taxpayer. Where a farmer is engaged in producing crops which take more than a year from the time of planting to the process of gathering and disposal (e.g., growing of pineapples which normally takes eighteen (18) months to bear and harvest the fruits), expenses deducted may be determined upon the crop basis, and such deductions must be taken in the year in which the gross income from the crop 12

Sec. 67, Rev. Regs. No. 2. Sec. 33, NIRC. Sec. 34(A)(l)(a)(i), NIRC.

l3 u


192

has been realized. The cost of farm machinery, equipment, and farm buildings represents a capital investment and is not an allowable deduction as an item of expense. Amounts expended in the development of farms, orchards, and ranches, prior to the time when the productive state is reached may be regarded as investments of capital, and may be depreciated unless such animals are included in an inventory in accordance with Section 149 of these regulations. The purchase price of transportation equipment, even when wholly used in carrying on farm operation, is not deductible but is regarded as an investment of capital. The cost of gasoline or fuel, repairs, and upkeep of the transportation equipment if used wholly in the business of farming is deductible as an expense; if used partly for business purposes and partly for the pleasure or convenience of the taxpayer or his family, such cost may be apportioned according to the extent of the use for purposes of business and pleasure or convenience, and only the proportion of such cost justly attributable to business purposes is deductible as a necessary expense. If a farm is operated for recreation or pleasure and not on a commercial basis, and if the expenses incurred in connection with the farm are in excess of the receipt therefrom, the entire receipts from the sale of products may be ignor jd in rendering a return of income, and the expenses incurred, being regarded as personal expenses, will not constitute allowable deduction. 15

Expenses of professionals. - A professional may claim as deductions the cost of supplies used by him in the practice of his profession, expenses paid in the operation and repair of transportation equipment used in making professional calls, dues to professional societies and subscriptions to professional journals, the rent paid for office rooms, the expenses of the fuel, light, water, telephone, etc., used in such offices, and the hire of office assistants. Amounts currently expended for books, furniture, and professional instruments and equipment, the useful life of which is short, may be deducted. But amounts expended for books, furniture, and professional instruments and equipment of a permanent character are not allowable as deductions. 16

Expenses partly for business purposes. - Expenses incurred partly for the taxpayer's trade or business and in part 15

I6



193


for other purposes shall be apportioned correspondingly (Jamir vs. Collector, 4 SCRA 718). Since the taxpayer's car was utilized both for personal and business needs, it is reasonable to allow as deduction one-half of the driver's salary, car expenses and depreciation. Litigation expenses defrayed by the taxpayer to collect apartment rentals and to eject delinquent tenants are ordinary and necessary expenses in pursuing his business (Gutierrez vs. Collector, 14 SCRA 33). Expenses contrary to law or public policy. - Deductions shall not be allowed if the expense is contrary to law, public policy or for immoral purposes (3MPhilippines, Inc. vs. Commissioner, G.R. No. 82833, Sept. 26, 1988; Zamora vs. Collector, 5 SCRA 163; Roxas vs. CTA, 23 SCRA 276). Expenses to obtain contracts with private firms or individuals are deductible, but those spent for government officials to procure government contracts are not deductible for being contrary to public policy (Nava vs. Collector, CTA Case No. 568, Sept. 25,1961). Expenses on passive investments. — Petitioner is engaged in both taxable and non-taxable operations. The income derived from the operations of the hospital and nursing school are exempt from income tax, while the rest of the petitioner's income are subject thereto. Its taxable or non-operating income consists of rentals, interests and dividends received from its properties and investments. The court ruled that interest and dividends received by petitioner were merely incidental income to petitioner's main activity, which is the operation of its hospital and nursing school; hence, the conclusion is inevitable that petitioner's activities never went beyond that of a passive investor, which under existing jurisprudence do not come within the purview of carrying on any trade or business. As the principle of allocating expenses is grounded on the premise that the taxable income was derived from carrying on a trade or business, as distinguished from mere receipt of interests and dividends from one's investments, the Court of Tax Appeals correctly ruled that said income should not share in the allocation of administrative expenses (Hospital de San Juan de Dios vs. Commissioner, G.R. No. 31305, May 10, 1990, 185 SCRA 273). Overhead expenses incurred by foreign head office. - Where an expense is clearly related to the production of

194


Philippine-derived income or to Philippine operations (e.g., salaries of Philippine personnel, rental of office building in the Philippines), that expense can be deducted from the gross income in the Philippines by the Philippine branch without resorting to apportionment. Under the same provisions, where there are items included in the overhead expenses incurred by the parent company, all of which directly benefit its branches, including the Philippines, which cannot be definitely allocated or identified with the operations of the Philippine branch, the company may claim as its deductible share a ratable part of such expenses based upon the ratio of the local branch's gross income to the total gross income worldwide of the multinational corporation (Commissioner vs. Smith Kline & French Overseas Co. [Phil. Branch], G.R. No. L-54108, Jan. 17, 1984). Political campaign expenses. — Amounts expended for political campaign purposes or payments to campaign funds are not deductible either as business expenses or as contribution (Felix Montenegro, Inc. vs. Commissioner, CTA Case 695, Apr. 30, 1969). [NOTE: Under the New Election Code, contributions to political parties registered with the COMELEC are deductible.] Professional fees." — Legal fees for monthly retainers, including reimbursement of out-of-pocket expenses like rentals, clerical help, stationery, expenses for light and other services, incurred by the lawyer for the account of the corporation are expenses incurred in the carrying on of a trade or business (Gold Green Mining Corp. vs. Tabios, CTA Case 1497, Apr 29, 1967). Expenses incurred by a business firm in employing accountants to prepare and prove its war damage claim to enable it to recover its lost assets occasioned by the war and to carry on to its business are ordinary and necessary expenses (Collector vs. Philippine Education Co., Inc., 99 Phil. 319). Promotion expenses. — Since promotion expenses constitute one of the deductions in conducting a business, the same must satisfy or substantiate by records showing in detail the amount and nature of the expenses incurred. Representation expenses are business expenses. Where taxpayer's application for CB dollar allocation shows that she went abroad on a combined business and medical trip, not all of her expenses "Sec. 2.57.5, Rev. Regs. No. 14-2002 expressly exempts from withholding payment of professional fees to general professional partnerships.


195


came under business expenses. The determination thereof shall bear heavily on the taxpayer for his own inexactitude. Where they are allegedly made but it is not possible to determine the actual amount covered by supporting vouchers and those without supporting vouchers or papers, the Court shall determine from all sources or available data the amount properly deductible as representation expenses. The Commissioner of Internal Revenue and Court of Tax Appeals considered 50% as business expenses (Zamora vs. Commissioner, 8 SCRA 163). Regional management fees. - Regional management fees paid by a domestic corporation to the headquarters abroad is a deductible item in computing its net income, subject to the test of reasonableness and substantiation requirements. 18

Rentals. — Where a leasehold is acquired for business purposes for a specified sum, the purchaser may take as a deduction in his return an adequate part of such sum each year, based on the number of years the lease has to run. Taxes paid by a tenant to or for a landlord for business property are additional rent and constitute a deductible item to the tenant and taxable income to the landlord; the amount of the tax being deductible by the latter. The cost borne by lessee in erecting buildings or making permanent improvements on ground of which he is lessee is held to be a capital investment and not deductible as a business expense. In order to return to such taxpayer his investment of capital, an annual deduction may be made from gross income of an amount equal to the cost of such improvements divided by the number of years remaining of the term of lease, and such deduction shall be in lieu of a deduction for depreciation. If the remainder of the term of lease is greater than the probable life of the buildings erected, or of the improvements made, this deduction shall take the form of an allowance for depreciation. 19

Repairs and maintenance. - The cost of incidental repairs which neither materially add to the value of the property nor appreciably prolong its life, but keep it in an ordinarily efficient operating condition, may be deducted as expense, provided the plant or property account is not increased by the amount of such expenditure. Repairs in the nature of replacement, to the extent 18 l9

BIR Ruling No. 079-99, June 20, 1999. Sec. 74, Rev. Regs. No. 2.


196

that they arrest deterioration and appreciably prolong the life of the property should be charged against the depreciation reserves if such account is kept. 20

Incidental repairs, to be deductible, must not appreciably prolong the life of the property. The life referred to is the probable, normal, useful life for the purpose of the allowance for the return of the capital investment - not what the life would have been if no repairs had been made after the property was damaged by a casualty. Since the repairs prolonged the lives of the said vessels of petitioners, the disallowance must be sustained (Visayan Transportation Co., Inc. vs. Domingo, CTA Case 1119, Sept. 30, 1964). Representation or entertainment, amusement and recreation expenses are subject to limitations. - Entertainment, amusement and recreation expenses that are directly connected to the development, management and operation of the trade, business or profession of the taxpayer, or that are directly related to or in furtherance of the conduct of his trade, business or exercise of a profession not to exceed such ceilings prescribed by the Secretary of Finance, taking into consideration the needs as well as the circumstances, nature and character of the industry, trade, business, or profession of the taxpayer shall be deductible from gross income. However, any amount incurred for entertainment, amusement or recreation that is contrary to law, morals, public policy or public order shall in no case be allowed as a deduction. In this connection, sellers of goods or properties are allowed to deduct one-half percent (0.5%) of their net sales as representation expenses, while sellers of services are granted one percent (1%) of their net revenues as representation expenses. 21

22

Proof of representation expenses may require evidence other than mere words. Thus, if a taxpayer failed to prove that an allowance was given to him by the company but also the 20

Sec. 68, Rev. Regs. No. 2. "Effective Sept. 1, 2002, Sec. 5, Rev. Regs. No. 10-2002 placed a cap on entertainment, amusement and recreation expenses, in an amount equivalent to the actual entertainment, amusement and recreation expense paid or incurred within the taxable year, but in no case to exceed 0.50 percent of net sales (gross sales less sales/ allowances and sales discounts) for sellers of goods or properties, or 1% of net revenue (gross revenue less discounts) for sellers of services. For sellers of goods and services, an allocation based on the apportionment formula prescribed shall be followed. Rev. Regs. No. 10-2002 effective Sept. 1, 2002. 22


197


nature of the expenses claimed, the representation expense must be disallowed (Vito vs. Collector, CTA Case 1186, Apr 30 1966). A corporation engaged in the real estate business gave luncheons and dinners attended by its Board of Directors, the members of their families, engineers and architects connected with its construction program, and members of its office and field personnel. These luncheons and dinners were given purportedly to improve its image and to afford opportunities to its employees to know the directors. In view of the purpose for which the expenses were made, they have some definite reasonable purpose connected with the business of the corporation. However, the mere allegation that the expenses were made for the purpose of creating goodwill unaccompanied by evidence they were necessary business expenses does not justify their deduction. Similarly, donations made to employees and others which do not have in them the element of compensation for services are not deductible from gross income. For this reason and the fact that the gifts were given indiscriminately to employees and nonemployees warrant the disallowance of the deduction (Limpan Investment Corporation vs. Collector, CTA Case 1358, Sept. 20, 1967). A corporation deducted the allowance and representation expenses given to one of its officers, claiming that the allowances were given for the purpose of gathering information from stockbrokers and businessmen as to what investments were profitable. But no information gathered was cited or an explanation as to how the information would be gathered was given. With respect to the representation expenses, they were incurred in connection with the parties given to stockbrokers by the same officer. The allowances and representation expenses had overlapping purposes because the gathering of the information can very well be made during one of the parties. Moreover, there was no reasonable explanation as to how those expenses helped the business of the corporation or enhanced its income. It did not make any investment when the disbursements in question were made. Without these expenses, the corporation would have received the dividends just the same. From all indications, the expenses are either disguised distribution of dividends or disguised compensation. As dividends, they are not deductible, for they appear to have no reasonable relation to the

198


services rendered by said officer of the corporation (C. Soriano, Inc. vs. Collector, CTA Case No. 1550, Dec. 19, 1966). Petitioner refers to these representation expenses an "additional compensation just like salaries and bonuses for which they (officers) need not make an accounting to petitioner." The assertion is considered gratuitous and the court deems it unnecessary to pass upon the deductibility of these items as additional compensation (El Porvenir Rubber Products vs. Vera, CTA Case 1702, July 26, 1969). Representation expenses incurred by the company officers must be supported by receipts or chits of the entities to whom they were paid in order to be deductible. Receipts signed by the company officers themselves are not sufficient, for while they may show that they received the amounts from the company, they do not prove payment of the alleged representation expenses to the entity in which the same is incurred or that they were incurred (Collector vs. Goodrich International Rubber Co., 21 SCRA 1336). The lack of supporting vouchers, receipts and other documentary proof, however, may be excused under Section 337 (now Sec. 235) of the Tax Code. This provision requires the preservation of the books of accounts and other accounting records for a period of three (3) years from date of last entry (Basilan Estates, Inc. vs. Commissioner, supra). Ordinarily, receipts and vouchers should be presented by a taxpayer, so that if he fails to present the same, the expenses cannot be allowed as deduction. However, if the taxpayer did not adduce evidence of payment because fact of payment was never raised as a vital issue by the Commissioner in his answer, we agree with the CTA that the Commissioner cannot adopt a theory different and distinct from that he has previously pursued. There is a presumption that the Commissioner has either abandoned or declined to assert it (Atlas Consolidated Mining Corp. vs. Commissioner, supra). Sample room payment. - A payment for the use of a sample room at a hotel for the display of goods is a business expense. Only such expenses as are reasonable and necessary in the conduct of the business and directly attributable to it may be deducted. A taxpayer claiming the benefit of the deductions referred to herein must attach to his return a statement showing


199

N O N - D E D U C T I B L E I T E M S , A N D PERSONAL EXEMPTIONS

(a) the nature of the business in which he is engaged; (b) the number of days away from home during the taxable year on account of business; (c) the total amount of expenses incident to meals and lodging while absent from home and business during the taxable year; (d) the total amount of other expenses incident to travel and claimed as a deduction. Claim for the deductions referred to herein must be substantiated, when required by the Commissioner by record showing in detail the amount and nature of the expenses incurred. 23

Stock transfer agent fees. - Where a corporation engages the services of stock transfer agents, both domestic and foreign, the fees paid for such services are deductible because they are both ordinary and necessary expenses. The shares of stocks are listed in domestic as well as foreign stock exchanges (Atlas Consolidated Mining & Development Co. vs. Commissioner, CTA Case 1312, Oct. 25, 1966). 24

Training expenses. - Training expenses constitute ordinary and necessary business expenpes of a taxpayer. However, a "Qualified Jewelry Enterprise" providing training to its employees may avail of the additional deduction equivalent to fifty percent (50%) of the expenses incurred in training schemes for the purpose of computing the taxable income. The additional deduction of fifty percent (50%) shall be in addition to the allowable ordinary and necessary expenses on training which are fully deductible as a business expense in accordance with the provision of the NIRC. However, the benefit arising from the said 50% additional deduction shall not be treated as a taxable income of the enterprise in computing for its taxable income. 25

Traveling expenses. -Traveling expenses, as ordinarily understood, include transportation expenses and meals and lodging. If the trip is undertaken for other than business purposes, the transportation expenses are personal expenses, and the meals and lodging are living expenses, and therefore, not deductible. If the trip is solely on business, the reasonable and necessary traveling expenses, including transportation expenses, meals and lodging, become business expenses instead of personal expenses. If an individual whose business requires 23

Sec. 66, Rev. Regs. No. 2. "Rule 4, Sec. 1, Rev. Regs. 1-99, Jan. 6, 1999. ^Sec. 66, Rev. Regs. No. 2.

200


him to travel receives a salary as full compensation for his services, without reimbursement for traveling expenses, or is employed on a commission basis with no expense allowance, his traveling expenses, including the entire amount expended for meals and lodging, are deductible from gross income. Expenses allowable to non-resident aliens and foreign corporation. — The expenses allowable to a nonresident alien or a foreign corporation consist of only such expenses as are incurred in carrying on any business or trade conducted within the Philippines exclusively. 26

Business expenses and depreciation can be claimed by and granted only to those who are actually engaged in trade or business in the Philippines. Since petitioner is a non-resident foreign corporation, it cannot claim said deductions (Home Products Intl, Ltd vs. Collector, CTA Case 725, Feb. 26, 1962). Since the items of income not belonging to the Philippine business are not taxable to its Philippine branch, they should be excluded in determining the head office expenses allocable to said Philippine branch (Commissioner vs. Phoenix Assurance Co., 1965). Adequate proof. - No evidence has been presented as to the nature of the farming expenses other than the bare statement of the taxpayer that they were spent for the development and cultivation of his property. No specification has been made as to the actual amount spent for the purchase of tools, equipment or materials, or the amount spent for improvement. The well known relief in taxation known as Cohan Rule will apply only if the taxpayer has successfully shown that it is usual and necessary in the trade to entertain and to incur similar kinds of expenditures, there being evidence to show the amounts spent and the persons entertained, though not itemized (Gancayco vs. Collector, 1 SCRA 980). Verbal assertions are considered gratuitous and the court deems it unnecessary to pass upon the deductibility of salaries and bonuses as additional compensation (El Porvenir Rubber Products vs. Vera, CTA Case No. 1702, July 26, 1969). Proof of representation expenses may require evidence other than mere words (Vito vs. Collector, CTA Case No. 1186, Apr. 30, 1966). Representation expenses incurred by the company officers must be supported by receipts of the entities to which ^Sec. 77, Rev. Regs. No. 2.


201


they were paid in order to be deductible (Collector vs. Goodrich International Rubber Co., 21 SCRA 1336). When charges are deductible.-Each year's return, so far as practicable, both as to gross income and deductions therefrom, should be complete in itself, and taxpayers are expected to make every reasonable effort to ascertain the facts necessary to make a correct return. The expenses, liabilities, or deficit of one year cannot be used to reduce the income of a subsequent year. A taxpayer has the right to deduct all authorized allowances and it follows that if he does not within any year deduct certain of his expenses, losses, interests, taxes, or other charges, he cannot deduct them from the income of the next or any succeeding year. If it is recognized, however, that particularly in a going business of any magnitude there are certain overlapping items do not materially distort the income, and so long as these overlapping items do not materially distort the income, they may be included in the year in which the taxpayer, pursuant to a consistent policy, takes them into his accounts. Judgments or other binding judicial adjudication, on account of damages for patent infringement, personal injuries, or other cause, are deductible from gross income when the claim is so adjudicated or paid, unless taken under other methods of accounting which clearly reflect the correct deduction, less any amount of such damages as may have been compensated for by insurance or insurance. If subsequent to its occurrence, however, a taxpayer first ascertain the amount of a loss sustained during a prior taxable year which has not been deducted from gross income, he may render an amended return for such preceding taxable year, including such amount of loss in the deduction from gross income and may in proper cases file a claim for refund of the excess tax paid by reason of the failure to deduct such loss in the original return. A loss from theft or embezzlement occurring in one year and discovered in another is ordinarily deductible for the year in which sustained. 27

2.

Interest Expense

28

Requisites for Deductibility of Interest Expense

29

In general, subject to certain limitations, the following are "Sec. 76, Rev. Regs. No. 2. Sec. 78, Rev. Regs. No. 2. "Rev. Regs. No. 13-2000, Nov. 20, 2000. M

202


the requisites for the deductibility of interest expense from gross income, viz.: (a)

There must be indebtedness. "Indebtedness" is something owned by one who is unconditionally obligated or bound to pay. It well-settled rule that tax obligations constitute indebtedness for purposes of deduction from gross income of the amount of interest paid on indebtedness (Commissioner vs. Palanca, L-1662G, Oct 29, 1966, 18 SCRA 496; Sambrano vs. CTA, G.R. No. L-8652, Mar. 30,1957, 53 O.G. 4839, Aug. 1957). Interest on indebtedness arising from law is equally entitled to deductibility (Collector vs. Prieto, G.R. No. L-13912, Sept. 30,1960). Although interest payment for delinquent taxes is not deductible as tax, the taxpayer is not precluded from claiming said interest payment as deduction as such (Collector vs. Magalona, et al., L-15802, Sept. 30,1960). Advances given without any expectation of repayment do not give rise to a valid and subsisting debt. 30

31

(b)

There should be an interest expense paid or incurred upon such indebtedness;

(c)

The indebtedness must be that of the taxpayer. A corporation may not deduct interest paid for a stockholder, and a stockholder may not deduct interest paid for the corporation. The corporation has a separate and distinct personality from the stockholders.

(d) The indebtedness must be connected with the taxpayer's trade, business or exercise of profession. (e)

The interest expense must have been paid or incurred during the taxable year;

(f)

The interest must have been stipulated in writing. Where there is an absence of stipulation in writing concerning interest, interest is properly denied (Limpan Investment Corp. vs. Collector, CTA Case 1397, Dec. 11, 1967).

^Collector vs. Prieto, supra. •"Fernandez Hermanos, Inc. vs. Commissioner, supra. Art. 1956, New Civil Code of the Philippines. 32

32

COSTS A N D DEDUCTIONS FROM GROSS I N C O M E ,

203


(g) The interest must be legally due. If there exists no obligation or where the obligation is unenforceable, interest paid thereon is not deductible. It is an unconditional and legally enforceable obligation for the payment of money (Collector vs. Prieto, L-13912, Sept. 30, 1960). (h) The interest payment arrangement must not be between related taxpayers as mandated in Section 34(B)(2)(b), in relation to Sec. 36(B), both of the Tax Code of 1997; 33

(i)

The interest must not be incurred to finance petroleum operations; and

(j)

In case of interest incurred to acquire property used in trade, business or exercise of profession, the same was not treated as a capital expenditure.

Rules on the Deductibility of Interest Expense (a) General Rule. - In general, the amount of interest expense paid or incurred within a taxable year on indebtedness in connection with the taxpayer's trade, business or exercise of profession shall be allowed as a deduction from the taxpayer's gross income. (b) Limitation. — The amount of interest expense paid or incurred by a taxpayer in connection with his trade, business or exercise of a profession from an existing indebtedness shall be reduced by an amount equal to the following percentages of the interest income earned which had been subjected to final withholding tax depending on the year when the interest income was earned, viz.: 34

Forty-one percent (41%) beginning January 1, 1998; Thirty-nine percent (39%) beginning January 1, 1999; Thirty-eight percent (38%) beginning January 1, 2000; Forty-two percent (42%) beginning November 1,2005; and 33

Sec. 36(B)(3) of the Tax Code provides that no deduction shall be allowed if either one of the corporations is a personal holding company or a foreign personal holding company. ^The rate is arrived at by using the following formula: Applicable rate of tax less 20% divided by the applicable rate of tax is equal to the rate. Thus, 34% - 20% = 14%/34% = 41%; 33% - 20% = 13%/33% = 39%; 32% - 20% = 12%/32% = 38%; 35% - 20% = 15%/35% = 42%; 30% - 20% = 10%/30% = 33%.


204

Thirty-three percent (33%) beginning January 1,2009 and thereafter. This limitation shall apply regardless of whether or not a tax arbitrage scheme was entered into by the taxpayer or regardless of the date when the interest bearing loan and the date when the investment was made for as long as, during the taxable year, there is an interest expense incurred on one side and an interest income earned on the other side, which interest income had been subjected to final withholding tax. This rule shall be observed irrespective of the currency the loan was contracted and/or in whatever currency the investments or deposits were made. Illustration Supposing on January 15, 1998, Company A, who has a deposit account with BCD Bank, obtained a loan from XYZ Financing Corporation in connection with the operation of its business. Assume that Company A's net income for the year 1998 before the deduction of the interest expense amounted to PI,000,000. For the year 1998, the interest income it derived from the said deposit with BCD Bank amounted to P180,000.00 on which a final tax of P36,000.00 had been withheld. Its interest expense on the loan obtained from XYZ Financing Corporation during the same year amounted to P150,000.00. Under this illustration, the deductible interest expense, the taxable income and the income tax due of Company A shall be computed as follows: 1998 Net income before interest expense Less: Interest expense Less: 4 1 % of interest income from deposit ( 4 1 % x P 1 8 0 , 0 0 0 ) Deductible interest expense Taxable income Income tax due for taxable year 1 9 9 8 ( 3 4 % )

P1,000,000 P150.000

73,800 76,200 P 923.800 P

314.092

Tax leverage Some tax practitioners point out that the objective of the reduction of the deductible interest expense is only to remove


205


the tax advantage obtained by a taxpayer who is subject to 20% final withholding tax on his interest income on peso bank deposits, yet entitled to 30% deduction on his interest expense. Example: On January 2, 1997, Alpha Corporation borrowed P I million from ABC Savings Bank at 10% interest per annum. Since it did not really need the money, it placed the proceeds of the loan in a time deposit which earns interest at 10% per annum with the same bank. The interest income in the amount of P100,000 of Alpha Corporation was subjected to 20% final withholding tax, but the interest expense of Alpha Corporation in the amount of P100,000 was deducted from its gross income during the taxable year. The tax benefit of Alpha Corporation on such interest expense deduction was 35% (now 30% effective January 1, 2009). In order to plug the loophole in the tax law and stop further revenue loss, Congress reduced the amount of interest expense that may be deducted by the taxpayer from its gross income in an amount equal to the applicable percentage of the interest income subjected to final tax. This provision on the reduction of allowable interest expense, however, must be subject to a limitation; otherwise, a strict interpretation of said provision may lead to absurdity that was not the intention of the lawmakers. Example: We will use the same facts given in the example above, except that the transactions took place in 2002. Furthermore, aside from the deposit of P I million that came from the loan obtained by it from ABC Savings Bank, Alpha Corporation also had a big deposit of P49 million earning 10% interest per annum with the same bank. Applying literally the provision of the Tax Code would result in the following: P100,000 Interest expense Less: Interest income subject to final tax P5,000,000 (P50 million times 10%) Multiplied by applicable rate x 38% 190,000 Interest expense not deductible P 0 Deductible interest expense


206

Since the purpose of the law is to remove only the tax advantage enjoyed by taxpayers on the tax leverage scheme under the old income tax law, the amount of reduction in the interest expense should be computed only on the interest income earned by Alpha Corporation on the loan obtained from ABC Savings Bank. Thus, Interest expense Less: Interest income subject to final tax Multiplied by applicable rate Interest expense not deductible Deductible interest expense Multiplied b y income tax rate ( 3 2 % ) Tax benefit to Alpha Corporation

PIOO.OOO P100,000 x 38% 38,000 P 62,000 x32% P19.840

The amount of tax benefit of P19,840 or P20,000, when rounded off, is exactly the same amount paid by Alpha Corporation on his interest income subjected to 20% final withholding tax. (c) Interest on unpaid taxes. - Provisions of Section 4(b) of Revenue Regulations No. 13-2000 to the contrary notwithstanding, interest incurred or paid by the taxpayer on all unpaid business-related taxes shall be fully deductible from gross income and shall not be subject to the limitation on deduction heretofore mentioned. Thus, such interest expense incurred or paid shall not be diminished by the percentage of interest income earned which had been subjected to final withholding tax. (d) Other cases where interest expense is not deductible from gross income. - No interest expense shall be allowed as deduction from gross income in any of the following cases: (1)

If within the taxable year, an individual taxpayer reporting income on the cash basis incurs an indebtedness on which an interest is paid in advance through discount or otherwise. Such interest shall be allowed as a deduction in the year the indebtedness is paid. If the indebtedness is payable in periodic amortization, the amount of interest which corresponds to the amount of the principal amortized or paid during the year shall be allowed as deduction in such taxable year.


207


(2)

If both the taxpayer and the person to whom the payment has been made or is to be made are "related" persons specified under Section 36(B) of the 1997 Tax Code, viz.: (i)

Between members of a family. For purposes of this paragraph, the "family of an individual" shall include only his brothers and sisters (whether by the whole or half-blood), spouse, ancestors and lineal descendants; or

(ii) Between an individual and a corporation more than fifty percent (50%) in value of the outstanding stock of which is owned, directly and indirectly, by or for such individual; or (iii) Between two corporations more than fifty percent (50%) in value of the outstanding stock of each of which is owned, directly or indirectly, by or for the same individual; or (iv) Between the grantor and a fiduciary of any trust; or (v) Between the fiduciary of a trust and the fiduciary of another trust if the same person is a grantor with respect to each trust; or (vi) Between a fiduciary of a trust and a beneficiary of such trust. (3)

If the indebtedness on which the interest expense is paid is incurred to finance petroleum exploration in the Philippines. The non-deductible interest expense herein referred to pertains to interest or other consideration paid or incurred by a service contractor engaged in the discovery and production of indigenous petroleum in the Philippines in respect of the financing of its petroleum operations, pursuant to Section 23 of P.D. No. 8, as amended by P.D. No. 87, otherwise known as "The Oil Exploration and Development Act of 1972;"

(4)

Interest on indebtedness incurred or continued to purchase or carry obligations the interest on which is exempt from tax;

208


Interest which was paid on unpaid salaries and bonuses, not being an existing indebtedness which gave rise to an interest charge, was not deductible. The interest was not contracted by the corporation for the use or forbearance of unpaid salaries and bonuses; they were merely not paid or claimed at the time they were placed at their disposal (Kuenzle & Streiff, Inc. vs. Commissioner, 106 Phil. 355). The records do not show that the preferred shares issued by the taxpayer are in reality mere evidence of indebtedness. It does not appear that the so-called interest on preferred shares is payable only out of the profits or earnings of the taxpayer, or that it is payable regardless of any such profits or earnings. It is not also shown whether or not there is a definite date of maturity of the preferred shares. Hence, disallowance should be sustained (Phil Trust Co. vs. Collector, CTA Case 367, Jan. 30, 1961). (e) 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 deduction in full in the year when incurred, the provisions of Section 36(A)(2) and (3) of the 1997 Tax Code to the contrary notwithstanding, or may be treated as a capital expenditure for which the taxpayer may claim only as a deduction the periodic amortization of such expenditure. However, should the taxpayer elect to deduct the interest payments against its gross income, the taxpayer cannot at the same time capitalize the interest payments because that would constitute double tax benefits which is not authorized by law (Paper Industries Corp. of the Philippines vs. CA, CTA and Commissioner, G.R. No. 106949, Dec. 1, 1995, 250 SCRA 434). Interest paid or accrued within the taxable year on indebtedness may be deducted from gross income, except that interest on indebtedness incurred or continued to purchase bonds and other securities, the interest upon which is exempt from tax, is not deductible. Interest paid by the taxpayer on a mortgage upon real estate of which he is the legal or equitable owner, even though the taxpayer is not directly liable upon the bond or not secured by such mortgage, may be deducted as interest on his indebtedness.


209


In the case of a nonresident alien individual or foreign corporation, the allowable deduction will be the proportion of such interest that the amount of gross income from sources within the Philippines bears to the amount of gross income from all sources within and without the Philippines. However, to avail of this deduction, such nonresident alien individual or foreign corporation shall include in the return all the information necessary for its calculation. Interest paid by a corporation on scrip dividends is an allowable deduction. So-called interest on preferred stock, which in reality is a dividend income, cannot be deducted in computing net income. In the case of banks and loan or trust companies, interest paid within the year on deposits or on moneys received for investments and secured by interest-bearing certificates of indebtedness issued by such bank or loan or trust company may be deducted from gross income. 35

Interest on capital. - Interest calculated for cost-keeping or other purposes on account of capital or surplus invested in the business, which does not represent a charge arising under an interest-bearing obligation, is not allowable deduction from gross income. 36

It is unfair and unjust for the Commissioner to exact an interest on the said sum which after all was paid to and received by the government even before the incidence of the tax in question. The imposition of such interest is not supported by law (Castro vs. Collector, G.R. No. 12174, Dec. 28,1962, 6 SCRA 886). The imposition of the monthly interest was considered as not constituting a penalty but a just compensation to the State for the delay in paying the tax, and for the concomitant use by the taxpayer of funds that rightfully should be in the government. What is sought to be avoided is for the taxpayer to make use of funds that should have been paid to the government (Commissioner vs. Itogon-Suyoc Mines, Inc., G.R. No. 25399, July 29, 1969). In the absence of statutory provisions clearly or expressly directing or authorizing such payment, the National Government 35

Sec. 78, Rev. Regs. No. 2. ^Sec. 79, Rev. Regs. No. 2.


210

cannot be required to pay interest on overpaid taxes made by the taxpayer (Collector vs. Douglas Fisher, et al., 1 SCRA 93). 3.

Taxes

37

In general All taxes, national or local, paid or accrued during the taxable year in connection with the trade or business or profession of the taxpayer are deductible from gross income, except (a) Philippine income tax; (b) foreign income tax; (c) estate and donor's taxes; (d) special assessments on real property; and (e) electric energy consumption tax under BP 36. However, in the case of a nonresident alien individual and a foreign corporation, deduction is allowed only if and to the extent that the taxes for which deduction is claimed are connected with income from sources within the Philippines. 38

39

40

41

Import duties paid to the proper customs officers, and business, occupation, license, privilege, excise and stamp taxes and any other taxes of every name or nature paid directly to the Government of the Philippines or to any political subdivision thereof, are deductible. The word "taxes" means taxes proper and no deduction should be allowed for amounts representing interest, surcharge, or penalties incident to delinquency. Postage is not a tax. Automobile registration fees are considered taxes. While Section 30 (now Section 34) of the Tax Code allows taxes to be deducted from gross income, it does not specifically allow fines and penalties to be so deducted. What is not expressly granted by Congress is withheld. Moreover, when acts are condemned by law and their commission is made punishable by fines or forfeitures, to allow them to be deducted from the wrongdoer's gross income reduces, and so in part defeats, the prescribed punishment (Gutierrez vs. Collector, 14 SCRA 33). Taxes are deductible as such only by the persons upon whom they are imposed by law. Indirect taxes like the value 37

Sec. 80, Rev. Regs. No. 2. Sec. 81, Rev. Regs. No. 2. Sec. 82, Rev. Regs. No. 2. "Sec. 83, Rev. Regs. No. 2. "Sec. 84, Rev. Regs. No. 2. 38

39


211


added tax passed on by sellers are not deductible by the buyer. Thus, value added tax is not deductible by the customer upon whom the burden of the tax is shifted by the seller. The customer, however, may consider the tax burden as part of his cost as an ordinary or capital expenditure, as the case may be, if incurred in trade or business. These rules are not to be confused with the question on the right of refund where the taxpayer may seek refund even if such taxpayer shifts the burden of the tax, as ruled in Commissioner vs. American Rubber Co. (18 SCRA 82) and Cebu Portland Cement Co. vs. Collector (25 SCRA 789). In computing the net income of an individual, no deduction is allowed for taxes imposed upon his interest as shareholder of a bank or other corporation, which are paid by the corporation without reimbursements from the taxpayer. However, the amount so paid by the corporation should not be included in the income of the shareholder. In the case of corporate bonds or other obligations containing a tax-free covenant clause, the corporation paying a tax or any part of it for someone else pursuant to its agreement is not entitled to deduct si ch payment from gross income on any ground. 42

Income tax imposed by the government of the Philippines. — The law does not permit the deduction of the income tax paid to or accrued in favor of the Government of the Philippines, and in no case may the taxpayer avail of such deduction. 43

Income, war-profits and excess-profits taxes imposed by the authority of a foreign country. - Income, war-profits, and excess-profits taxes imposed by the authority of a foreign country are allowed as deductions only if the taxpayer does not signify in his return his desire to have to any extent the benefits of the provisions of law allowing credits against the tax for taxes of foreign countries. In the case of a citizen of a foreign country residing in the Philippines whose income from sources within such foreign country is not subject to income tax, only that portion of the taxes paid to such foreign country which corresponds to his net income subject to the Philippine income tax shall be allowed as deduction. 44

"Sec. 80, Rev. Regs. No. 2; See B.P. Big. 135 and Rev. Regs. No. 6-82. Sec. 81, Rev. Regs. No. 2. "Sec. 82, Rev. Regs. No. 2. <3


212

Estate and donor's taxes; taxes assessed against local benefits. — Estate and donor's taxes are not deductible. Socalled taxes, more properly assessments, paid for local benefits inuring directly to the property against which the assessment is levied, do not constitute an allowable deduction from gross income. A tax is considered assessed against local benefits when the property subject to the tax is limited to the property benefited. Special assessments are not deductible, even though an incidental benefit may inure to the public welfare. The taxes deductible are those levied for the general public welfare, by the proper taxing authorities at a like rate against all property in the territory over which such authorities have jurisdiction. When assessments are made for the purpose of maintenance or repair of local benefits, the taxpayer may deduct assessments paid as an expense incurred in business, if the payment of such assessments is necessary to the conduct of his business. When the assessments are made for the purpose of construction and maintenance or repairs, the burden is on the taxpayer to show the allocation of the amounts assessed to different purposes. If the allocation cannot be made, none of the amounts so paid is deductible. 45

Analysis of credit for taxes. — If the taxpayer signifies in his return his desire to claim a credit for taxes, the basis of such credit, in the case of a citizen of the Philippines, whether resident or nonresident, and in the case of a domestic corporation, is as follows: (a) The amount of any (federal or national) income, war-profits and excess-profits taxes paid or accrued during the taxable year to any foreign country; and (b) an individual's proportionate share of any such taxes of which he is a partner or of an estate or trust of which he is a beneficiary paid or accrued during the taxable year to a foreign country, if his distributive share of the income of such partnership or trust is reported for taxation under Title II of the Tax Code. If a taxpayer signifies in his return his desire to claim credit for taxes, such action will be considered to apply to income, warprofits, and excess-profits taxes paid to all foreign countries, and no portion of any such taxes shall be allowed as a deduction from gross income. 46

46

Sec. 83, Rev. Regs. No. 2. The law imposing inheritance and donee's taxes had been repealed by P.D. No. 69, effective Jan. 1, 1983. Sec. 84, Rev. Regs. No. 2. w


213


Amount of any income, war-profits, and excess-profits taxes paid or accrued during the taxable year. - Said term means taxes proper (no credit being given for amounts representing interest or penalties) paid or accrued during the taxable year on behalf of the taxpayer claiming credit. "Foreign country" means any foreign state or political subdivision thereof, or any foreign political entity, which levies and collects income, war-profits, or excess-profits taxes. Where both the federal government and the statement government impose income taxes, only the amount of income tax paid to the federal government shall be allowed for purposes of computing the maximum amount of tax credit. 47

Conditions for allowance of credits. - If the taxpayer signifies in his return his desire to claim credit for income, warprofits, or excess-profits taxes paid other than to the Philippines, the income tax return must be accompanied by the appropriate form prescribed by the Commissioner. The form must be carefully filled in with all the information there called for and with the calculation of credits there indicated, and must be duly signed and sworn to or affirmed. If credit is sought for taxes already paid the form must have attached to it the return on which each such accrued tax was based. This receipt or return so attached must either be the original, a duplicate original, a duly certified or authenticated copy, or a sworn copy. In case only a sworn copy of a receipt or return is attached, there must be kept readily available for comparison on request the original, a duplicate original, or a duly certified or authenticated copy. If the receipt of the return is in a foreign language, a certified translation thereof must be furnished by the taxpayer. Any additional information necessary for the determination of the amount of income derived from sources without the Philippines and from each foreign country shall, upon the request of the Commissioner, be furnished by the taxpayer. In the case of a credit sought for tax accrued but not paid, the Commissioner may in addition require as a condition precedent to the allowance of credit, a bond from the taxpayer. It shall be in such sum as the Commissioner may prescribe, and shall be conditioned for the payment by the taxpayer of any amount of tax found due upon any re-determination of the tax made necessary by such credit proving incorrect, with such "Sec. 85, Rev. Regs. No. 2.


214

further conditions or the agent or representative of the taxpayer, as principal, and by sureties satisfactory to and approved by the Commissioner. 48

9

Tax credits for foreign corporations.* - The 5% tax on gross income earned paid herein by foreign corporations that are registered as Subic Bay Regional Enterprises shall be considered as payment of income tax. Said tax shall be in lieu of income tax, for purposes of application for tax credits by said foreign corporations in their respective home countries. In addition, no other national or local taxes shall be imposed on the Subic Bay Regional Enterprises. While the taxpayers would have to pay two taxes on the same income, the Philippine government only receives the proceeds of one tax. As between the Philippines where the income was earned and where the taxpayer is domiciled, and the United States where the income was not earned and where the taxpayer did not reside, it is indisputable that justice and equity demand that the tax on the income should accrue to the benefit of the Philippines. Any relief from the alleged double taxation should come from the United States, since its right to burden the taxpayer is solely predicated on his citizenship, without contributing to the production of the wealth that is being taxed. To allow alien resident to deduct from his gross income whatever taxes he pays to his own government amounts to conferring on the latter the power to reduce the tax income of the Philippine government simply by increasing the tax rates on the alien resident. Every time the rate of taxation imposed upon an alien resident is increased by its own government, his deduction from Philippine taxes would correspondingly increase, and the proceeds from the Philippines diminished, thereby subordinating our own taxes to those levied by a foreign government. Such result is incompatible with the status of the Philippines as an independent and sovereign state. In sum, where a resident alien is subjected to an income tax by his country where he derives no income, he will not be entitled to tax credit. Tax credits for foreign taxes are allowed only for income derived from sources within the Philippines. An alien is allowed an alternative under the law so that if he is not entitled to tax credit, he cannot also 48

Sec. 86, Rev. Regs. No. 2. Sec. 5(b), Rev. Regs. 16-99, Sept. 27, 1999 applies to SBMA-registered companies; Rev. Regs. No. 1-2000, Nov. 12,1999 applies to PEZA-registered companies. 49


215


be allowed to use as deduction the foreign income tax paid from his Philippine gross income (Commissioner vs. Lednicky, L-18169, July 31,1964). Accordingly, the following taxpayers are not entitled to tax credit: (a) non-resident citizens; (b) resident aliens, if without reciprocity; (c) foreign corporations; and (d) resident aliens whose income is derived solely from sources within the Philippines. A taxpayer who does not indicate in his return a desire to have the benefits of credit for income tax imposed by authority of a foreign country and paid or accrued within the taxable year losses the benefits of tax credit. When credit for taxes may be taken. - The credit for taxes provided by Section 30(C)(3) to (9) may ordinarily be taken either in the return for the year in which the taxes accrued or on which the taxes were paid, dependent upon whether the accounts of the taxpayer are kept and his returns filed upon the accrual basis or upon the cash receipts and disbursements basis. Section 30(C)(6) allows the taxpayer, at his option and irrespective of the method of accounting employed in keeping his books, to take such credit for taxes as may be allowable in the return for the year in which the taxes accrued. An election thus made must be followed in returns for all subsequent years, and no portion of any such taxes will be allowed as a deduction from gross income. 50

Domestic corporation owning a majority of the stock of foreign corporation. — In the case of a domestic corporation which owns a majority of the voting stock of foreign corporation from which it received dividends in any taxable year, the credit for foreign taxes includes not only the income, war-profits, and excess-profits taxes paid or accrued during the taxable year to any foreign country by such domestic corporation, but also income, war-profits, and excess-profits taxes deemed to have been paid determined by taking the same proportion of any income, war-profits, and excess-profits taxes paid or accrued by such controlled foreign corporation to any foreign country upon or with respect to the accumulated profits of such foreign corporation from which such dividends were paid, which the amount of any such dividends received bears to the amount of such accumulated profits. The amount of taxes deemed to have been paid is limited, however, to an amount of the tax against "Sec. 89, Rev. Regs. No. 2.


216

which the credit for foreign taxes is taken, which the amount of such dividends bears to the amount of the entire net income of the domestic corporation in which such dividends are included. If the dividends are received from more than one controlled foreign corporation, the limitation is to be computed separately for the dividends received from each controlled foreign corporation If the credit for foreign taxes includes taxes deemed to have been paid, the taxpayer must furnish the same information with respect to the taxes deemed to have been paid as it is required to furnish with respect to the taxes actually paid or accrued by it. Taxes paid or incurred by a controlled foreign corporation are deemed to have been paid by the domestic corporation for purposes of credit only. 51

Nonresident aliens and foreign corporations not allowed credits against the tax. — Resident and nonresident aliens and foreign corporations may not claim credits against the tax from taxes of foreign countries. 52

Limitation on credit for foreign taxes. — The amount of credit for foreign taxes shall be subject to the following limitations: The amount of the credit in respect to the tax paid or accrued to any country shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer's net income from sources within such country taxable under Title II (Income Tax) bears to his entire net income for the same taxable year; and the total amount of the credit shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer's net income from sources without the Philippines taxable under Title II bears to his entire net income for the same taxable year. 53

4.

Losses

54

Losses are generally classified into: (a) those incurred in a trade or business for profit; (b) those incurred in any transaction 51

Sec. 90, Rev. Regs. No. 2. "Sec. 91, Rev. Regs. No. 2. Resident aliens may not claim tax credits against the Philippine tax from taxes of foreign countries because they are not subject to Philippine income tax on foreign-source income. Sec. 92, Rev. Regs. No. 2. Sec. 96, Rev. Regs. No. 2. 63

M


217

N O N - D E D U C T I B L E I T E M S , A N D P E R S O N A L EXEMPTIONS

entered into for profit, although not connected with the trade or business; and (c) casualty losses that arise from fire, storm, shipwreck, or other casualty, or from theft or robbery, even though not connected with the trade or business of the taxpayer. Conditions for Deductibility

55

a. The loss must be that of the taxpayer. The loss is personal to the taxpayer and is not transferable or usable by another. The loss of predecessor partnership is not deductible by a successor corporation. The loss of the parent company may not be deducted by its subsidiary. But the loss of a branch within or outside the Philippines is deductible from the gross income of the head office located in the Philippines, since the branch is only an extension of its head office; b.

Actually sustained and charged off within the taxable

c.

Evidenced by a closed and completed transaction;

year;

f

d. Not claimed as a deduction or estate tax purposes; e. In the case of an individual, the loss must be connected with his profession, trade or business, or incurred in any transaction entered into for profit though not connected with his trade or business; f. In the case of casualty loss, declaration of loss is filed within 45 days from the occurrence of the casualty loss; 56

g. Loss does not arise from a sham sale. When a taxpayer transfers assets for the sole purpose of realizing a loss, the loss is deductible only if the sale is bona fide. A sham transaction made only for record purposes will not do. An agreement to repurchase generally makes the loss non-deductible. Friendship, a business relationship between the parties, or an actual repurchase will cast doubt on the good faith of the transaction; and 57

h.

Loss is not compensated by insurance or otherwise.

Losses are deductible only by the person sustaining them. They are purely personal and cannot be used as deductions by another (Estate of Jacob S. Hoffman, 36 BTA 972). In this case, "See also Rev. Regs. No. 12-77 and Rev. Regs. No. 10-79. Rev. Regs No. 12-77. "Prentice-Hall Federal Tax Handbook, 1983, p. 355. 56


218

the estate may not deduct the loss sustained by the trust on the payment made upon the obligations of the decedent and the beneficiaries. Loss from one department is deductible from the profit of the other department under the single entity concept. However, where one business operation is taxable and the other is exempt, the intendment of the law is to treat the two operations distinct and separate from each other for income tax purposes. The loss in the latter operation is not deductible from the profits of the former (Marcelo Steel Corporation vs. Collector, L-13401, Oct 31, 1960, 109 Phil. 921). Losses by corporations. - Domestic corporations may deduct losses actually sustained and charged off within the year and not compensated for by insurance or otherwise. Loss from the destruction of inventory of medicines or food and other similar items that have expired and thus cannot be consumed by persons should be reported in writing to, and witnessed by representatives of, the BIR in order to ensure its deductibility from gross income. 58

Losses arising from pilferages, shrinkages and wrong pricing are clearly deductible. Similarly, the claimed deductions on materials and supplies delivered to various departments of the corporation engaged in manufacturing for operational use without having been entered in the stock cards are allowable expenses, because they formed part of the cost of manufacturing (Ma-ao Sugar Central Co. vs. Commissioner, CTA Case 1434, Sept. 21, 1967). The deduction may be claimed only in 1945 and not in 1947, if the Japanese war notes received in payment of said property remained in petitioner's possession after the war, said war notes having been invalidated in 1945. As a rule, losses are deductible only in the year when actually sustained; deductibility cannot be postponed to a later year (Phil. Trust Co. vs. Collector, CTA Case 367, Jan. 30, 1961). Where the taxpayer who records its income and expenses on the accrual basis paid, upon mutual agreement and debited in its books, the amount of P80.000 as loss sustained, said loss is deductible in 1951 when the agreement to pay was made, for 58



219


it was then that the liability thereof became fixed. Deduction for losses sustained are proper only in the year in which liability therefor becomes fixed, regardless of whether payment has been made or postponed (Yek Hua Trading Corp. vs. Collector, CTA Case 580, Jan. 25, 1963). A loss sustained in 1945 as a result of military operation by the U.S. for the liberation of the Philippines was not "compensated for by insurance or otherwise," within the meaning of Section 30(d) of the Tax Code. Therefore, the loss is deductible only in the year sustained, not in 1950 when the taxpayer was definitely advised that the U.S. would not pay the amount claimed (Yulo vs. Araneta, CTA Case No. 84, July 8, 1958; Consolidated Mines, Inc. vs. Collector, CTA Case 565, May 6, 1961). Petitioner claimed deduction in 1957 for losses of materials and supplies which were considered obsolete, unserviceable and unusable. The competence and credibility of petitioner's engineer to testify on the obsolescent condition of those materials and supplies were not impugned. Under the bad debt theory, loss from theft or embezzlement occurring in the year and discovered in another year is ordinarily deductible for the year in which sustained. In a case, however, where the taxpayer had no means of determining the actual date of the embezzlement, a loss was sustained in the year of discovery. The rule is now modified by the bad debt theory which holds that since the embezzlement of funds creates a debtor-creditor relationship, the loss is deductible as bad debt in the year when the right of recovery becomes worthless (Talisay-Silay Milling Co. vs. Commissioner, CTA Case 1399, Dec. 29, 1965). The rule is that loss deduction will be denied if there is a measurable right to compensation for the loss, with ultimate collection reasonably clear. So, where there is reasonable ground for reimbursement, the taxpayer must seek his redress and may not secure a loss deduction until he establishes that no recovery may be had. In other words, the taxpayer must first exhaust his remedies to recover or reduce his loss (Plaridel Surety & Insurance Co. vs. Collector, 21 SCRA 1187). Losses must be evidenced by closed and completed transaction. - Losses must usually be evidenced by closed and completed transactions. Proper adjustment must be made in

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each case for expenditures or items of loss properly chargeable to capital account, and for depreciation, obsolescence, amortization, or depletion. Moreover, the amount of the loss must be reduced by the amount of any insurance or other compensation received, and by the salvage value, if any, of the property. A loss on the sale of residential property is not deductible unless the property was purchased or constructed by the taxpayer with a view to its subsequent sale for pecuniary profit. No loss is sustained by the transfer of property by gift or death. Losses sustained in illegal transaction are not deductible. 59

The law contemplates the deduction from gross income of losses only which are fixed by identifiable events. The income tax law is concerned only with realized losses and it was only in 1949 that petitioner reasonably ascertained the fact of and the amount of the loss was not yet evidenced by a closed and completed transaction as the possibility of reimbursement was still real and substantial (Alhambra Cigar & Cigarette Mfg. Co. vs. Collector, CTA Case 143, July 31, 1956). Petitioner took every step to mitigate, if not to recover, its loss. While it does not appear that an action was brought for the recovery thereof, an investigation was conducted by petitioner and the facts brought out therein were such that the salesman was not entirely to be blamed. Respondent admits that the loss resulted from the robbery, and although the liability for the salesman was found by the corporation to be doubtful, petitioner was able to reduce its loss by one-half. On the contention of respondent that the loss should have been claimed in 1948, it will be noted that the law contemplates the deduction of losses only which are fixed by identifiable events (Alhambra Cigar & Cigarette Mfg. Co. vs. Collector, CTA Case 143, July 31, 1956). The conduct of petitioner in not reporting the loss in his books of account or in his income tax return proves that the alleged loss had not been suffered (The City Lumber, Inc. vs. Domingo, L-18611, Jan. 30, 1964). The disbursement consisted of engineer's and men's payroll, supplies, tools, taxes and other construction costs. As there was no road or outlet through which coal products could be transported from the mines to the provincial road, it 'Sec. 96, Rev. Regs. No. 2.


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became necessary to abandon the mines, and they were actually abandoned in 1952. Losses are deductible in 1952, when the mines were abandoned, and not in 1951 when the mines were still in operation. When the company ceased to operate, it had no assets; it was completely insolvent. This information as to the insolvency of the company having reached petitioner in 1950, it took immediate steps to write off the investment as worthless and consequently claimed the loss for 1950. These facts are supported by evidence (Fernandez Hermanos, Inc. vs. Collector, CTA Case 787, June 10, 1963). Generally, losses must be claimed as deduction in the year actually sustained. However, this is subject to the qualification that losses must be evidenced by a closed and completed transaction. Thus, loss may be claimed as deduction in 1963, when the insurance recovery was definitely established, not in 1960 when the loss was actually sustained. The same rule applies as regards losses on account of theft or embezzlement. In such case, the loss may be deducted in the year of discovery of the loss. The loss was allowed to be de Jucted in the year of the taxpayer's discovery of the loss (Phil. Sugar Estate vs. Collector, 60 Phil. 565). In order to be entitled to defer deduction for losses materially sustained within a given year, the right to compensation therefor, by way of insurance or otherwise, must exist prior to the conclusion of said year (Cu Unjieng Sons, Inc. vs. Collector, 1956). Voluntary removal of buildings. — Loss due to the voluntary removal or demolition of old buildings, the scrapping of old machinery, equipment, etc., incident to renewals and replacements will be deductible from gross income. When a taxpayer buys real estate upon which is located a building, which he proceeds to raze with a view to erecting thereon another building, it will be considered that the taxpayer has sustained no deductible expense on account of the cost of such removal, 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. 60

The removal of the "barong-barong" instead of being voluntary, was forced upon the corporation by the city engineer, "Sec. 97, Rev. Regs. No. 2.


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because the structure was a fire hazard; that the rental income of the old building was about P3,730 per month, and that the corporation had no funds but had to borrow, in order to construct a new building. All these belie any intention on the part of the corporation to demolish the old building merely for the purpose of erecting another in its place. Since the demolished building was not compensated for by insurance or otherwise, its loss should be charged off as deduction from gross income (Priscilla Estate, Inc. vs. CTA & Commissioner, L-18282, May 29, 1964). Loss of useful value. — When, through some change in business conditions, the usefulness in the business of some or all of the capital assets is suddenly terminated, so that the 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 the loss, adjustment must be made, however, for improvements, depreciation and the salvage value of the property. This exception to the rule requiring a sale or other disposition of property in order to establish a loss requires proof of some unforeseen cause by reason of which the property has been prematurely discarded, as, for example, where an increase in the cost or change in the manufacture of any product makes it necessary to abandon such manufacture, to which special machinery is exclusively devoted, or where new legislation directly or indirectly makes the continued profitable use of the property impossible. This exception does not extend to a case where the useful life of property terminates solely as a result of those gradual processes for which depreciation allowance are authorized. It does not apply to inventories or to other than capital assets. The exception applies to buildings only when they are permanently abandoned or permanently devoted to a radically different use, and to machinery only when its use as such is permanently abandoned. Any loss to be deductible under this exception must be charged off in the books and fully explained in returns of income. 61

Shrinkage in value of stocks. - A person possessing stock of a corporation can not deduct from gross income any amount claimed as a loss merely on account of shrinkage in value of such stock through fluctuation of the market or otherwise. The loss allowable in such case is that actually suffered when the stock is 61



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disposed of. If stock of a corporation becomes worthless, its cost or other basis determined in accordance with these regulations may be deducted by the owner in the taxable year in which the stock became worthless, provided a satisfactory showing of its worthlessness be made, as in the case of bad debts. 62

Losses of farmers. - Losses incurred in the operation of farms as business enterprises are deductible from gross income. If farm products are held for favorable markets, no deduction on account of shrinkage in weight or physical value or by deterioration in storage shall be allowed, except as such shrinkage may be reflected in an inventory if used to determine profits. The total loss by storm, flood, or fire of a prospective crop is not deductible loss in computing net income. A farmer engaged in raising and selling stock, cattle, sheep, horses, etc. is not entitled to claim as a loss the value of animals that perish from among those animals that were raised on the farm, except as such loss is reflected in an inventory if used. If livestock has been purchased for any purpose, and afterwards dies from disease, exposure, or injury, or is killed by order of the authorities, the actual purchase price of such stock, less any depreciation allowable as a deduction in computing net income, with respect to such perished livestock, and also any insurance or indemnity recovered, may be deducted as a loss. The actual cost of other property (with proper adjustment for depreciation), which is destroyed by order of the authorities, may in like manner be claimed as a loss; but if reimbursement is made in whole or in part on account of stock killed or property destroyed, the amount received shall be reported as income for the year in which reimbursement is made. The cost of any feed, pasturage, or care which has been deducted as an expense of operation shall not be included as part of the cost of the stock for the purpose of ascertaining the amount of a deductible loss. If gross income is ascertained by inventories, no deduction can be made for livestock or products lost during the year, whether purchased for resale, produced on the farm, as such losses will be reflected in the inventory by reducing the amount of livestock or products on hand at the close of the year. If an individual owns and operate a farm, in addition to being engaged in another trade, business, or calling, and sustains a loss from each operation of the farm, then the amount of loss sustained 62



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may be deducted from gross income received from all sources, provided the farm is not operated for recreation or pleasure. 63

Capital losses; losses on wash sales of stock or securities. — Losses on sales or exchanges of capital assets are allowed to the extent provided in Section 39 of the Tax Code. If any securities which are capital assets become worthless during the taxable year, the loss resulting therefrom shall be considered as a loss from the sale or exchange, on the last day of such taxable year, of capital assets. Losses on wash sales of stock or securities are treated in Section 38 of the Tax Code. 64

Net Operating Loss Carry Over ( N O L C O )

65

The net operating loss of the business or enterprise for any taxable year immediately preceding the current taxable year which had not been previously offset as deduction from gross income shall be carried over as a deduction from gross income for the next three (3) consecutive taxable years immediately following the year of such loss. However, any net loss incurred in a taxable year during which the taxpayer was exempt from income tax shall not be allowed as a deduction under this Subsection. Further, i net operating loss carry-over shall be allowed only if there has been no substantial change in the ownership of the business or enterprise in that (i) Not less than seventy percent (70%) in nominal value of outstanding issued shares if the business is in the name of a corporation is held by or on behalf of the same persons; or (ii) Not less than seventy-five percent (75%) of the paid up capital of the corporation if the business is in the name of a corporation, is held by or on behalf of the same persons. For purposes of this Subsection, the term 'net operating loss' shall mean the excess of allowable deduction over gross income of the business in a taxable year. For mines other than oil and gas wells, a net operating loss without the benefit of incentives provided for under Executive Order No. 226, as amended otherwise known as the Omnibus Investments Code of 1987, incurred in any of the first ten (10) years of operation 63

Sec. 100, Rev. Regs. No. 2. "Sec. 101, Rev. Regs. No. 2. ""Sec. 34(DX3), NIRC. A NOLCO deduction allows the taxpayer to average his profits losses, by letting him offset the profits or one year with the losses of another year.


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may be carried over as a deduction from taxable income for the next five (5) years immediately following the year of such loss. The entire amount of the loss shall be carried over to the first of the five (5) taxable years following the loss and any portion of such loss which exceeds the taxable income of such first year shall be deducted in like manner from the taxable income of the next remaining four (4) years. Loss incurred by the financial institution from the transfer of non-performing assets to a special purpose vehicle within the two-year period from the effectivity of the implementing regulations may be carried over for a period of five consecutive taxable years immediately following the year of such loss. 66

General Principles and Policies on N O L C O 67

For purposes of these Regulations, the allowance for deduction of NOLCO shall be limited only to net operating losses accumulated beginning January 1, 1998. In general, NOLCO shall be allowed as a deduction from the gross income of the same taxpayer who sustained and accumulated the net operating losses regardless of the change in its ownership. This rule shall also apply in the case of a merger where the taxpayer is the surviving entity. Unless otherwise provided in these Regulations, NOLCO of the taxpayer shall not be transferred or assigned to another person, whether directly or indirectly, such as, but not limited to, the transfer or assignment thereof through a merger, consolidation or any form of business combination of such taxpayer with another person. N O L C O shall also be allowed if there has been no substantial change in the ownership of the business or enterprise in that not less than 75% in nominal value of outstanding issued shares or not less than 75% of the paid up capital of the corporation, if the business is in the name of the corporation, is held by or on behalf of the same persons. The 75% equity, ownership or interest rule prescribed in these Regulations shall only apply to a transfer or assignment of the taxpayer's net operating losses as a result of or arising "•Sec. 17, R.A. No. 9182. Rev. Regs. No. 14-2001, Oct. 10, 2001. 67

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from the said taxpayer's merger or consolidation or business combination with another person. In case the transfer or assignment of the taxpayer's net operating losses arises from the said taxpayer's merger, consolidation or combination with another person, the transferee or assignee shall not be entitled to claim the same as deduction from gross income unless, as a result of the said merger, consolidation or combination, the shareholders of the transferor/assignor, or the transferor (in case of other business combinations) gains control of at least 75% or more in nominal value of the outstanding issued shares or paid up capital of the transferee/assignee (in case the transferee/ assignee is a corporation) or 75% or more interest in the business of the transferee/assignee (in case the transferee/assignee is other than a corporation). Unless otherwise provided in these Regulations, an individual (including estate or trust) engaged in trade or business or in the exercise of profession, or a domestic or resident foreign corporation may be allowed to claim deduction of his/its corresponding NOLCO. However, an individual who claims the 10% optional standard deduction shall not simultaneously claim deduction of the NOLCO. The three-year reglementary period shall continue to run notwithstanding the fact that the aforesaid individual availed of the 10% optional standard deduction during the said period. The three-year reglementary period on the carry-over of NOLCO shall continue to run notwithstanding the fact that the corporation paid its income tax under the "Minimum Corporate Income Tax" computation. NOLCO shall be availed of on a "first-in, first-out" basis. The net operating loss incurred by a taxpayer in the year in which a substantial change in ownership in such taxpayer occurs shall not be affected by such change in ownership, notwithstanding Subsections 2.3 and 2.4 of Revenue Regulations No. 14-2001. Definition of Terms. - For purposes of these regulations, the words and phrases herein provided shall mean as follows: Gross Income - Except as otherwise provided in these regulations, the term "gross income" means the pertinent items of income referred to in Section 32(A) of the Tax Code of 1997


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which are required to be declared in the taxpayer's income tax return for purposes of computing his taxable income as denned in Section 31 of the same Code. All exempt income and other items of income subject to final tax shall not form part of the gross income. Allowable Deductions. - The term "allowable deductions" means the items of deduction enumerated under Section 34(A) to (J) and Section 34(M) of the Tax Code, including the special deductions allowed to insurance companies under Section 37 of the Code, but excluding NOLCO and any item of incentive deduction allowable under any special law that does not actually involve cash outlay. In the case of an individual entitled to claim the Optional Standard Deduction (OSD) under Section 34(L), in lieu of the deductions enumerated under Section 34(A) to ( K ) of the Tax Code, the term "allowable deductions" shall mean the aforesaid OSD plus deduction of premium payments on health and/or hospitalization insurance as provided under Section 34(M) of the Tax Code, if applicable. Net Operating Loss - The term "net operating loss" shall mean the excess of allowable deduction over gross income of the business in a taxable year. Nominal Value of Outstanding Issued Shares - The term "nominal value of outstanding issued shares" shall refer to the par value (in case of par value shares of stock) or stated value (in case of no par value shares of stock) of shares of stock issued to the stockholders of the corporation. Paid- Up Capital of the Corporation - The term "paid-up capital of the corporation" shall refer to the total amount paid by stockholders for their subscriptions in the shares of stock of the corporation, including any amount paid over and above the par value or stated value of the share of stock (e.g., premium on capital). For this purpose, the taxpayers shall maintain complete and accurate records of the paid-up capital of the shareholders. Taxable Income - The term "taxable income" means the excess amount of the pertinent items of gross income over the allowable deductions and/or personal and additional exemptions, if any, authorized under the Code or under any special law. Taxable Year - The term "taxable year" means the calendar year, or the fiscal year ending during such calendar

228


year, upon the basis of which the net income is computed under Title II of the Tax Code. Taxable year includes, in the case of a return made for a fractional part of a year, the period for which such return is made. The term "fiscal year" means an accounting period of twelve (12) months ending on the last day of any month other than December. Substantial Change in the Ownership of the Business or Enterprise - The term "substantial change in the ownership of the business or enterprise" shall refer to a change in the ownership of the business or enterprise as a result of or arising from its merger or consolidation or combination with another person in the manner as provided in Subsection 2.4 of these regulations. Any change in ownership as a result of or arising thereunder shall not be treated as a substantial change for as long as the stockholders of the party thereto, to whom the net operating loss is attributable, gains or retains 75% or more interest after such merger or consolidation or combination. Merger - For purposes of these regulations, the term "merger" shall refer to the absorption of a corporation by another corporation, the latter retaining its own name and identity and acquiring the assets, liabilities, franchises and powers of the former, and the absorbed corporation ceasing to exist as a separate juridical person. Consolidation - For purposes of these regulations, the term "consolidation" shall refer to a situation when two or more corporations are extinguished, and by the same process a new one is created, taking over the assets and assuming the liabilities of the said extinguished corporations; or the unification of two or more corporations into a single new corporation, having the combined capital, franchises and powers of all its constituents. Combination - For purposes of these regulations, the term "combination" shall refer to a situation when an owner of a business, organized as a sole proprietorship, admits a partner in his business for the purpose of forming a co-partnership, or any such business combination which, in effect, is similar or synonymous thereto. By or on Behalf of the Same Persons - The term "by or on behalf of the same persons" shall refer to the maintenance of ownership despite change as when:


229


1.

No actual change in ownership is involved in casp fhp transfer involves change from direct ownership to indirppf ownership, or vice versa. Illustration: Facts: P Corporation owns Q Corporation that has NOLCO. P Corporation transfers Q Corporation's shares to R Corporation in exchange for 100% of R Corporation shares. Held: Q Corporation's NOLCO is retained because Q Corporation's shares arc held "by" R Corporation "on behalf of" P Corporation, the original owner.

2.

No actual change in ownership is involved as in the case of merger of the subsidiary into the parent company. Illustration: Facts: X Corporation owns 100% of Y Corporation. Y Corporation owns 100%, of Z C orporation. Z Corporation has NOLCO. Z Corporation is merged into Y Corporation. Held: Z Corporation's NOLCO should be retained and transferred to Y Corporation. Prior to the merger, X Corporation already indirectly owned Z Corporation, i.e., Z Corporation's shares were held "by" Y Corporation "on behalf o r X Corporation. After the merger, X now directly owns Z Corporation [absorbed corporation] which continues to exist in Y Corporation. Any reference in these Regulations to the "75% equity, ownership, or interest rule", "75% or more in nominal value," "75% or more interest", and other similar terms shall be construed within the context of this definition. Notwithstanding the above, in determining whether there is actual change in ownership in the above-mentioned and similar cases, each and every step of the transaction shall be considered and the whole transaction or series of transactions shall be treated as a single unit.

Taxpayers entitled to deduct NOLCO from gross income. - Any individual (including estates and trusts) engaged in trade or business or in the exercise of his profession, and domestic and resident foreign corporations subject to the normal

230


income tax (e.g., manufacturers and traders) or preferential tax rates under the Code (e.g., private educational institutions, hospitals, and regional operating headquarters) on their taxable income as denned in Section 3 of these Regulations shall be entitled to deduct from his/its gross income for the current year his/its accumulated net operating losses for the immediately preceding three (3) consecutive taxable years. However, that net operating losses incurred or sustained prior to January 1,1998 shall not qualify for purposes of the NOLCO. Any provision of these Regulations notwithstanding, the following shall not be entitled to claim deduction of NOLCO: 1. Offshore Banking Unit (OBU) of a foreign banking corporation, and Foreign Currency Deposit Unit (FCDU) of a domestic or foreign banking corporation, duly authorized as such by the Bangko Sentral ng Pilipinas (BSP); 2. An enterprise registered with the Board of Investments ( B O I ) with respect to its BOI-registered activity enjoying the Income Tax Holiday incentive. Its accumulated net operating losses incurred or sustained during the period of such Income Tax Holiday shall not qualify for purposes of the NOLCO; 3. An enterprise registered with the Philippine Economic Zone Authority (PEZA), pursuant to R.A. No. 7916, as amended, with respect to its PEZA-registered business activity. Its accumulated net operating losses incurred or sustained during the period of its PEZA registration shall not qualify for purposes of the NOLCO; 4. An enterprise registered under R.A. No. 7227, otherwise known as the Bases Conversion and Development Act of 1992, e.g., SBMA-registered enterprises, with respect to its registered business activity. Its accumulated net operating losses incurred or sustained during the period of its said registered operation shall not qualify for purposes of the NOLCO; 5. Foreign corporations engaged in international shipping or air carriage business in the Philippines; and 6. In general, any person, natural or juridical, enjoying exemption from income tax, pursuant to the provisions of the Code or any special law, with respect to its operation during the period for which the aforesaid exemption is applicable. Its


231

N O N - D E D U C T I B L E ITEMS, AND P E R S O N A L EXEMPTIONS

accumulated net operating losses incurred or sustained during the said period shall not qualify for purposes of the NOLCO. Determination of substantial change in the ownership of the business Time of determination of substantial change in the ownership of the business: determined as of the end nf the taxable year - The substantial change in the ownership of the business or enterprise shall be determined as of the end of the taxable year when NOLCO is to be claimed as deduction. Whether or not substantial change in ownership occurred shall be determined on the basis of any change in the ownership of interest in the said business or enterprise arising from or incident to its merger, or consolidation, or combination with another person (e.g., in the case of merger or consolidation of two or more corporations, such change shall be determined based on the ownership of the outstanding shares of stock issued or based on paid-up capital as of the end of the taxable year, and as a result of or arising from the said merger or consolidation). When change occurs — A change in the ownership of the business occurs when the person who sustained net operating losses enters into a merger, or consolidation or combination with another person, thereby resulting to the transfer or conveyance of the said net operating losses, to another person, in the course of the said merger or consolidation or combination. (a) When No Substantial Change Occurs - No substantial change in ownership of the business occurs if, as a result of the said merger or consolidation or combination, the stockholders of the transferor, or the transferor, in case of other business combinations, gains control of at least 75% or more in nominal value of the outstanding issued shares or paid-up capital of the transferee-assignee (in case the transferee-assignee is a corporation) or 75% or more interest in the business of the transferee-assignee (in case the transferee-assignee is other than a corporation). (b) When Substantial Change Occurs - A substantial change in ownership of the business occurs if, as a result of the transaction referred to in Subsection 5.2 (a) hereof, the stockholders of the transferor or the transferor, in case of other

232


business combinations, gains control of the aforesaid transfereeassignee only to the extent of less than 75%. Transitory apportionment of NOLCO, in case of corporation using the fiscal year accounting period - In general, only net operating losses incurred beginning January 1, 1998 may be claimed as a NOLCO deduction. In the case of a corporation using a fiscal year accounting period as of the said dates whose result of operations for the fiscal year 19971998 shows a net operating loss, the allowable NOLCO for the succeeding fiscal years shall be determined, as follows: N O L C O for the entire fiscal year (1997-1998) Multiplied by the ratio of:

xxx

N o . of months in 1998 12 mos. covering FY 97-98 N O L C O to be carried over to F Y s 1998-1999, 1999-2000, and/or 2000-2001

xxx

xxx

Where taxpayer is exempt, or partly exempt from income tax, or enjoying preferential tax treatment under special laws - Net operating loss or losses incurred by any person who is exempt from income tax, or enjoying preferential tax treatment pursuant to the provisions of special laws, shall not be allowed a NOLCO deduction (e.g., any BOI-registered enterprise enjoying income tax holiday pursuant to E.O. No. 226, as amended, otherwise known as the Omnibus Investments Code of 1987; or any PEZA-registered enterprise enjoying preferential tax treatment or income tax holiday pursuant to R.A. No. 7916, as amended; any person enjoying preferential tax treatment pursuant to R.A. No. 7227, otherwise known as the Bases Conversion and Development Act of 1992. In case any of the aforementioned persons is engaged in both registered and unregistered business activities under any of the aforesaid laws (e.g., a corporation with a BOI-registered activity enjoying income tax holiday; and other unregistered business activities not enjoying any BOI incentive) the net operating loss or losses sustained or incurred by the said BOIenterprise from its registered activities shall not be allowed as NOLCO deduction from its gross income derived from the unregistered business activities.


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Quarterly and annual availment of NOLCO - NOLCO shall be allowed as deduction in computing the taxpayer's income taxes per quarter and annual final adjustment income tax returns. If per the taxpayer's final annual adjustment income tax return, the entire operations for the year resulted to a net operating loss, such net operating loss may be claimed as NOLCO deduction in the immediately succeeding taxable year. NOLCO may be claimed as deduction only within a period of three (3) consecutive taxable years immediately following the year the net operating loss was sustained or incurred. In order that compliance with this three-year statutory requisite may be effectively monitored, the taxpayer shall, at all times, show its NOLCO deduction, in its income tax return, as a separate item of deduction. In no case may NOLCO be claimed, as a part of the taxpayer's other itemized deductions, like under deduction of "losses," in general. NOLCO in relation to the Minimum Corporate Income Tax (MCIT) - In general, domestic and resident foreign corporations subject to the normal income tax rate are liable to the 2% MCIT, if applicable, computed based on gross income, whenever the amount of the MCIT is greater than the normal income tax due (computed with the benefit of NOLCO, if any), pursuant to Section 27 or 28 of the Code. Thus, such corporation cannot enjoy the benefit of NOLCO for as long as it is subject to MCIT in any taxable year. However, that the running of the three-year period for the expiry of NOLCO is not interrupted by the fact that such corporation is subject to MCIT in any taxable year during such three-year period. Presentation of NOLCO in tax return and unused NOLCO in the income statement. - The NOLCO shall be separately shown in the taxpayer's income tax return (also shown in the Reconciliation Section of the Tax Return) while the Unused NOLCO shall be presented in the Notes to the Financial Statements showing, in detail, the taxable year in which the net operating loss was sustained or incurred, and any amount thereof claimed as NOLCO deduction within three (3) consecutive years immediately following the year of such loss. Failure to comply with this requirement will disqualify the taxpayer from claiming the NOLCO. Losses by nonresident foreign corporations.—Foreign corporations are allowed only losses sustained in business or


234

trade conducted within the Philippines, losses of property within the Philippines arising from fires, storms, shipwreck, or other casualty and from robbery, theft, or embezzlement, and losses actually sustained in transactions entered into for profit in the Philippines, although not connected with their trade or business, not compensated by insurance or otherwise. 68

RPPM and PICOP merged in 1977, with PICOP being the surviving corporation. As a result of the merger, the accumulated losses of RPPM became the losses of PICOP and were deducted from its gross income. The court said that to allow the deduction of NOLCO by PICOP would be to permit one corporation to benefit from the operating losses accumulated by another corporation, RPPM. RPPM, far from benefiting from the tax incentive granted by the BOI statute, in fact gave up the struggle and went out of existence and its former stockholders joined the much larger group of PICOP's stockholders. To grant PICOP's claimed deduction would be to permit PICOP to shelter its otherwise taxable income which had not been earned by the registered enterprise which had suffered the accumulated loss. In effect, to grant PICOP's claimed deduction would be to permit PICOP to purchase r tax deduction and R P P M to peddle its accumulated operating loss. Under the U.S. law, operating loss carry-over and carry-back are expressly provided and regulated in great detail by statute. In our jurisdiction, save for Section 7(C) of R.A. No. 5186, no statute recognizes or permits loss carry-overs and loss carry-backs (Paper Industries Corp of the Philippines vs. Commissioner, GR 106949, Dec 1, 1995). 5.

Bad Debts

69

10

Bad debts shall refer to those debts resulting from the worthlessness or uncollectibility, in whole or in part, of amounts due the taxpayer by others, arising from money lent or from uncollectible amounts of income from goods sold or services rendered. A bad debt arises when a loan or debt for services or sale or rental of property becomes worthless or uncollectible. The debt must have had a value when acquired or created. If a 'Sec. 95, Rev. Regs. No. 2. 'Sec. 102, Rev. Regs. No. 2. 'Sec. 2, Rev. Regs. No. 5-99, Mar. 10, 1999.


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N O N - D E D U C T I B L E ITEMS, A N D P E R S O N A L EXEMPTIONS

worthless debt arises from unpaid wages, rents, etc., there is no deduction, unless the unpaid amount has been included in income. A genuine creditor-debtor relationship must exist. 71

Conditions for Deductibility of B a d Debts In general, the requisites for deductibility of bad debts under the 1997 Tax Code are: 1.

There must be an existing indebtedness due to the taxpayer which must be valid and legally demandable;

2.

The same must be connected with the taxpayer's trade, business or practice of profession;

3.

The same must not be sustained in a transaction entered into between related parties enumerated under Section 36(B) of the Tax Code of 1997;

4.

The same must be actually charged off the books of accounts of the taxpayer as of the end of the taxable year; and

5.

The same must be actually ascertained to be worthless and uncollectible as of the end of the taxable year.

Before a taxpayer may charge off and deduct a debt, he must ascertain and be able to demonstrate with reasonable degree of certainty the uncollectibility of the debt. The Commissioner of Internal Revenue will consider all pertinent evidence, including the value of the collateral, if any, securing the debt and the financial condition of the debtor in determining whether a debt is worthless, or the assigning of the case for collection to an independent collection lawyer who is not under the employ of the taxpayer and who shall report on the legal obstacle and the virtual impossibility of collecting the same from the debtor and who shall issue a statement under oath showing the propriety of the deductions thereon made for alleged bad debts. Thus, where the surrounding circumstances indicate that a debt is worthless and uncollectible and that legal action to enforce payment would in all probability not result in the satisfaction of execution on a judgment, a showing of those facts will be sufficient evidence of the worthlessness of the debt for the purpose of deduction.

"Prentice-Hall Federal Tax Handbook, 1983, p. 361.


236

Good faith on the part of the taxpayer is not enough. He must show also that he had reasonably investigated the relevant facts and had drawn a reasonable inference from the information thus obtained by him. Thus, where a taxpayer has failed to attach to his tax returns a statement showing the propriety of the deductions therein made for alleged bad debts, the account written off will be disallowed (Collector vs. Goodrich International Rubber Co., 21 SCRA 1336). Exceptions: 1. In the case of banks, the Bangko Sentral ng Pilipinas (BSP), thru its Monetary Board, shall ascertain the worthlessness and uncollectibility of the bad debts and it shall approve the writing off of the said indebtedness from the banks' books of accounts at the end of the taxable year. This is without prejudice to the Commissioner's determination of the worthlessness and uncollectibility of debts. The taxpayer shall then submit a Bangko Sentral ng PilipinasfMonetary Board written approval of the writing off of the indebtedness from the banks' books of accounts. The bank though should still comply with requisites Nos. 1-4 as enumerated above before it can avail of the benefit of deduction. 72

2. In no case may a receivable from an insurance or surety company be written-off from the taxpayer's books and claimed as bad debts deduction unless such company has been declared closed due to insolvency or for any such similar reason by the Insurance Commissioner. Securities shall mean shares of stock in a corporation and rights to subscribe for or to receive such shares. The term includes 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. Actually ascertained to be worthless. - In general, a debt is not worthless simply because it is of doubtful value or difficult to collect. Worthlessness is not determined by an inflexible formula or slide rule calculation but upon the exercise of sound business judgment. The determination of worthlessness 72

Rev. Regs. No. 25-2002, Nov. 19, 2002.


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in a given case must depend upon the particular facts and the circumstances of the case. A taxpayer may not postpone a bad debt deduction on the basis of a mere hope of ultimate collection or because of a continuance of attempts to collect notes which have long become overdue, and where there is no showing that the surrounding circumstances differ from those relating to other notes which were charged off in a prior year. While a mere hope probably will not justify postponement of the deduction, a reasonable possibility of recovery will permit the account to be carried along notwithstanding that the probabilities are that the debt may not be collected at all. The creditor may offer evidence to show some expectation that the debt would have been paid in the intervening years, and that subsequently, the hope was shattered or appeared to have been unfounded. If, for example, 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 tnat there was no genuine ascertainment of worthlessness. Thus, accounts receivable, the amount whereof is insignificant and the collection of which through court action may be more costly to the taxpayer, may be written-off as bad debts even without conclusive evidence that the taxpayer's receivable from a debtor has definitely become worthless. Good faith does not require that the taxpayer be an "incorrigible optimist" but on the other hand, he may not be unduly pessimistic. Creditors do not have to wait until some turn of the wheel of fortune may bring their debtors into affluence. The taxpayer may strike a middle course between pessimism and optimism and determine debts to be worthless in the exercise of sound business judgment based upon as complete information as is reasonably ascertainable. The taxpayer need not have perfect discernment. Bad debt and loss distinguished. - Voluntary cancellation or forgiveness of a debt does not give rise to a deductible loss. However, if the debt is actually worthless, there may be a bad debt deduction. That deduction would be allowed because the debt was worthless, not because it was forgiven. 73

73

Prenctice-Hall Federal Tax Handbook, 1983, p. 365.


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Actually charged off from the taxpayer's books of accounts. - The phrase means that the amount of money lent by the taxpayer (in the course of his business, trade or profession) to his debtor had been recorded in his books of account as a receivable has actually become worthless as of the end of the taxable year, that the said receivable has been cancelled and written-off from the said taxpayer's books of account. A mere recording in the taxpayer's books of account of estimated uncollectible accounts does not constitute a write-off of the said receivable, hence, shall not be a valid basis for its deduction as a bad debt expense. In no case may any bad debt deduction be allowed unless the facts pertaining to the money or property lent and its cancellation or write-off from the taxpayer's accounting records, after having been determined that the same has actually become worthless, have been complied with by the taxpayer. 14

Securities Becoming Worthless.' - If securities, as denned under Section 2(b) of Revenue Regulations No. 5-99, held as capital asset, are ascertained to be worthless and charged off within the taxable year, the loss resulting therefrom shall be considered as a loss from the sale or exchange of capital asset made on the last day of such taxable year. The taxpayer, however, has to prove through clear and convincing evidence that the securities are in fact worthless. This rule, however, is not true in the case of banks or trust companies incorporated under the laws of the Philippines, a substantial part of whose business is the receipt of deposits. Where all the surrounding circumstances indicate that a debt is worthless, and the debt is charged off on the books of the taxpayer within the year, the same may be allowed as a deduction in computing net income. There should accompany the return a statement showing the propriety of any deduction claimed for bad debts. Before a taxpayer may charge off and deduct a debt, he must ascertain and be able to demonstrate with a reasonable degree of certainty, the uncollectibility of the debt. Any amount subsequently received on account of a bad debt previously charged off, and allowed as deduction for income tax purposes, must be included in gross income for the taxable year in which received. In determining whether a debt is worthless, the Commissioner will consider all pertinent evidence, including 74



239


the value of the collateral, if any, securing the debt and the financial condition of the debtor. When the surrounding circumstances indicate that a debt is worthless and uncollectible and that legal action to enforce payment would in all probability not result in the satisfaction of execution on a judgment, a showing of those facts will be sufficient evidence of the worthlessness of the debt for the purpose of deduction. Bankruptcy is generally an indication of the worthlessness of at least a part of an unsecured and un-preferred debt. Actual determination of worthlessness in bankruptcy is sometimes possible before and at other times only when a settlement in bankruptcy shall have been had. Where a taxpayer ascertained a debt to be worthless and charged it off in one year, the mere fact that bankruptcy proceedings instituted against the debtor are terminated in a later year, confirming the conclusion that the debt is worthless, will not authorize shifting the deduction to such later year. If a market value was received which may be less than their face value, the amount deductible for bad debts in any case is limited to juch original valuation. 75

Examples of bad debts. — Worthless debts arising from unpaid wages, salaries, rents, and similar items of taxable income will not be allowed as a deduction unless the income such items represent has been included in the return of income for the year in which the deduction as a bad debt is sought to be made or in a previous year. Only the difference between the amount received in distribution of the assets of a bankrupt and the amount of the claim may be deducted as a bad debt. The difference between the amount received by a creditor of a decedent in distribution of the assets of the decedent's estate and the amount of his claim may be considered a worthless debt. A purchaser of accounts receivable which can not be collected and are consequently charged off the books as bad debts is entitled to deduct them, the amount of deduction to be based upon the price he paid for them and not upon their face value. Where under foreclosure of a mortgage, the mortgagee buys the mortgaged property and credits the indebtedness with the purchase price, the difference between the purchase price and the indebtedness will not be allowable as a bad debt, for the property which was security for the debt stands in the place 76


240


of the debt. The determination of loss in such case is deferred until the disposal of the property. 76

The law requires that debts must be charged off in the year in which they are ascertained to be worthless. Nevertheless, the statutory requirement is sufficiently complied with in the case of a debt which was charged off in a prior year, but disallowed as deduction. In such a case, further physical charged off on the books of the taxpayer in a later year when the debt is actually ascertained to be worthless is not necessary (George Engineering Co., 21 BTA 532; Mason Machine Works Co., 3 BTA 745). The law, however, does not require actual physical charged off on the books of the taxpayer. There is sufficient compliance if the debt is deducted in the return for the taxable year of the taxpayer who does not keep books (William Redfield, 34 BTA 967). In ascertaining worthlessness, the taxpayer-creditor must act in good faith, must show that it had reasonably investigated relevant facts and had drawn a reasonable inference from the information obtained that the debts were worthless. The court cited that some debtors made subsequent payments as showing undue haste of creditor in charging off the debts. The court added there was lack of proof that those debtors lacked ability to pay. Finally, the court observed that the petitioner did not attach to its income tax return a statement showing the propriety of the alleged deduction as required by the income tax regulations. To warrant a deduction for bad debts, the law requires only that the taxpayer establishes that, during the year for which the deduction is sought, a situation developed as a result of which it become evident in the exercise of sound, objective business judgment that there remained no practical, but only a vaguely theoretical, prospect that the debt would ever be paid (Commissioner vs. Goodrich International Rubber Co., supra). When the account was not paid for sometime, one of the lawyers of the petitioner went to the employee to collect. Later, it was ascertained by petitioner's auditor that the employee neither had property nor visible income. Evidently, the worthlessness of the debts was determined in 1959; hence, the debt was deductible in 1959 (Talisay-Silay Co., Inc. vs. Collector, CTA Case 1399, Dec. 29, 1965). •Sec. 103, Rev. Regs. No. 2.


241


The futile attempts to collect extrajudicially the debts in question and the destruction during a conflagration of the original invoices evidencing the indebtedness justify an ascertainment of the debts worthlessness (Western Pacific Corp. vs. Collector, CTA Case 720). The contract of rescission was not so comprehensive as to include articles sold. Those which could not be recovered, either because they could not be ascertained or were consumed, remain an indebtedness of the buyer, with respect to debt worthlessness, the buyer was in bad financial condition. Its sawmill ceased to operate. A foreclosure case was filed against it and a receiver was appointed by the court to take possession of the company's properties. Furthermore, its assets were insufficient to pay all creditors and the unsecured creditors, like the taxpayer, could no longer expect payment (Connell Bros Co [Phil.] vs. Collector, CTA Case 411, supra). The circumstances which might justify the writing off of bad debts are the following: debtor-employees are so numerous; their individual indebtedness is very meager; and further action on the accounts would entail expenses exceeding the amounts sought to be collected (Phil. Fiber Processing Co. vs. Collector, supra). Considering that the amounts involved are small, mostly ranging from P5 to P350, and that the debtors were scattered in different parts of the country, petitioner was justified in believing that unsuccessful efforts exerted to collect the same sufficed to warrant their being written off. Indeed, it would have been "foolish to spend good money after bad" (El Porvenir Rubber Products, Inc. vs. Vera, CTA Case 1702, July 26, 1969). The futile attempts to collect extrajudicially the debts in question and the destruction during a conflagration of the original invoices evidencing the indebtedness justify an ascertainment of the debts worthlessness. Petitioner has exerted diligent efforts to collect the debts. Under these circumstances, it was not necessary for petitioner to investigate for the purpose of determining the solvency of the debtors. The fact that petitioner did not institute a judicial action against any of the debtors does not militate against the good faith of petitioner nor attribute to petitioner negligence in enforcing collection, for in determining the worthless of a debt previous court action is not necessary.

242


It is enough that the taxpayer exerted diligent efforts to enforce collection and exhausted all reasonable means of collecting the debts. Petitioner is not required to be an "incorrigible optimist" in enforcing collection of a debt (Western Pacific Corporation vs. Commissioner, CTA Case 720, May 22, 1961). Petitioner's conclusion that these debts were worthless or uncollectible because the debtors told his collector that they were poor and could not pay the same is not sufficient to establish their worthlessness or uncollectibility (Querol vs. Collector, CTA Case 320, Oct. 7, 1959). While the debt may be secured by shares of stock of San Juan Plantation Co., which are still held by petitioner, it has been shown, however, that these shares of stock are worthless. It would be unreasonable to require petitioner to continue to maintain this account in its books. However, debts previously found worthless and written off in a prior year and subsequently collected do not render the deduction unallowable or illegal (Phil. Trust Co. vs. Collector, CTA Case 367, Jan. 30, 1961). The sale of the debtor's properties is the identifiable event that established the worthlessness of the debt. Undoubtedly, the debt in question has lost its intrinsic or potential value in 1958 (Esso Standard Eastern Inc. vs. Collector, CTA Case 1530, Nov. 11, 1968). Generally, the fact that a debt has been collected after the deduction has been taken does not invalidate the deduction. The taxpayer need not await uncertain future events, nor wait until some turn of the wheel of fortune may bring the debtor into affluence. Where the taxpayer deducts bad debts and thereafter the validity of the deduction is litigated, and by that time the debts have been paid, it seems unfair and erroneous to test the validity of the deduction by the use of hindsight. Thus, where the facts which the taxpayer sets forth as indications of uncollectibility are in themselves weak, subsequent collection, shortly after the year in which the deduction is claimed, tends to cast a stronger doubt on the fact of worthlessness (Lee Live Stock Commission Co., 7 BTA 532). There is adequate basis for writing off as worthless securities the stock of a lumber company which had ceased operations even if it still had its sawmill and equipment of some value. Assuming that the company would later somehow


243


realize some proceeds from its sawmill and equipment and such proceeds would later be distributed to its stockholders, the amount so received by the taxpayer would then properly be reportable as income of the taxpayer in the year it is received. In the meantime, it may properly be claimed as loss. The debt or investment of the corporation is not considered worthless if such corporation is still in operation, specially if the taxpayer continues to give the corporation advances in those years. Moreover, there can be no partial writing off of a loss or bad debts. They are deductible in full or not at all, in the absence of any express provision in the Tax Code authorizing partial deductions (Fernandez Hermanos, Inc. vs. Collector, G.R. No. L-21551, Sept. 30, 1969, 29 SCRA 552; Phil. Refining Co. vs. CA, et al., G.R. No. 118794, May 8, 1996, 256 SCRA 667). Tax Benefit Rule. - The recovery of bad debts previously allowed as deduction in the preceding year or years shall be included as part of the taxpayer's gross income in the year of such recovery to the extent of the income tax benefit of said deduction. Example: If in the year the taxpayer claimed deduction of bad debts written-off, he realized a reduction of the income tax due from him on account of the said deduction, his subsequent recovery thereof from his debtor shall be treated as a receipt of realized taxable income. Conversely, if the said taxpayer did not benefit from the deduction of the said bad debt written-off because it did not result to any reduction of his income tax in the year of such deduction (i.e., where the result of his business operation was a net loss even without deduction of the bad debts written-off), then his subsequent recovery thereof shall be treated as a mere recovery or a return of capital, hence, not treated as receipt of realized taxable income. Under the "Tax Benefit Rule or Equitable Doctrine of Tax Benefit," the recovery of amounts deducted in previous years from gross income become taxable income unless to the extent thereof, the deduction did not result in any tax benefit to the taxpayer. Revenue Regulations No. 2 provides that any amount subsequently received on account of a bad debt previously charged off and allowed as deduction for prior years must be included in the gross income for the taxable year in which received. But construing a similar provision in the Federal Income Tax Regulations, it was ruled that recoveries of bad debts


244

previously deducted do not constitute taxable income unless the deductions of bad debts in prior years resulted in a reduction of income tax liability. This doctrine can only be availed of by a creditor but never by a debtor (Philippine Fiber Processing Co. vs. Commissioner, 1966). Provision for bad debt is not deductible, considering that the law requires that the debt must actually be ascertained to be worthless and charged off within the taxable year (Shangkuan vs. Collector, CTA Case 19, Mar. 23, 1955; Phil. National Bank vs. Blaquera, CTA Case 250, May 20, 1960). Expenses incurred on goods in the hands of a receiver are not deductible as bad debts. However, these are allowable as business expenses (Connell Bros. Co. [Phil.] vs. Collector, supra). 6.

Depreciation

77

Conditions for Deductibility of Depreciation a.

The allowance for depreciation must be reasonable (Zamora vs. Commissioner);

b.

It must be for property arising out of its use in the trade or business, or out of its not being used temporarily during the year (Connell Bros. Co. vs. Collector, 1966);

c.

It must be charged off during the taxable year from the taxpayer's books of accounts;

d.

A statement on the allowance must be attached to the return.

A reasonable allowance for the exhaustion, wear and tear, and obsolescence of property used in the trade or business may be deducted from gross income. For convenience, such an allowance will usually be referred to as depreciation, excluding from the term any idea of a mere reduction in market value not resulting from exhaustion, wear and tear, or obsolescence. The proper allowance for such depreciation of any property used in the trade or business is that amount which should be set aside for the taxable year in accordance with a reasonable consistent 77

See Rev. Regs. No. 1-91 on depreciation of service contractors engaged in petroleum operations.


245


useful life of the property in business, equal the basis of the property. Due regard must also be given to expenditures for current upkeep. 78

Depreciation is the gradual diminution in the useful value of tangible property resulting from wear and tear and normal obsolescence. The term is also applied to amortization of the value of intangible assets, the use of which in the trade or business is definitely limited in duration. Depreciation commences with the acquisition of the property and its owner is not bound to see his property gradually wasted without making provision out of earnings for its replacement. He is entitled to see that from earnings, the value of the property invested is kept unimpaired so that at the end of any given term of years, the original investment remains as it was in the beginning. It is not only the right of a company to make such a provision, but it is its duty to its bond and stockholders, and in the case of a public service corporation, at least, its plain duty to the public. The income tax law does not authorize the depreciation of an asset beyond its acquisition cost. The reason is that deductions from gross income are privileges, not matters of right. They are not created by implication but upon clear expression in the law. Moreover, the recovery, free of income tax, of an amount more than the invested capital in an asset will transgress the underlying purpose of a depreciation allowance. For then what the taxpayer would recover will be, not only the acquisition cost, but also some profit. Recovery in due through depreciation of investment made is the philosophy behind depreciation allowance; the idea of profit has never been the underlying reason for the allowance. Hence, depreciation on re-appraisal value is not allowed (Basilan Estates, Inc. vs. Collector, 21 SCRA 17; Gutierrez vs. Collector, L-19537, May 20, 1965). Depreciable property. — The necessity for a depreciation allowance arises from the fact that certain property used in the business gradually approaches a point where its usefulness is exhausted. The allowances should be confined to property of this nature. In the case of tangible property, it applies to that which is subject to wear and tear, to decay or decline from natural causes, to exhaustion and to obsolescence due to the normal progress of the art, as where machinery or other property must be replaced by a new invention, or due to the inadequacy of the "See. 105, Rev. Regs. No. 2.

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property to the growing needs of the business. It does not apply to inventories or to stock in trade, nor to land apart from the improvements or physical development added to it. It does not apply to bodies of minerals which through the process of removal suffer depletion. Property kept in repair may, nevertheless, be the subject of a depreciation allowance. The deduction of an allowance for depreciation is limited to property used in the taxpayer's trade or business. No such allowance may be made in respect to automobiles or other transportation equipment solely used as his residence, nor in respect of furniture or furnishings therein, personal effects, or clothing; properties and costumes used exclusively in a business, such as theatrical business, may be the subject of a depreciation allowance. 79

The determination of the length of the useful life of property used in business is generally made by the taxpayer himself. The policy is not to disturb depreciation deductions unless there is a clear and convincing basis for a change. Taxpayer should be afforded freedom from annoying minor changes which would disturb the original estimates of useful life of depreciable assets. But where the Commissioner has determined that the deduction should be less than the amount claimed, the taxpayer must introduce evidence that the Commissioner is wrong. In case of doubt as to the useful life of property, Bulletin "F" is generally regarded as controlling. The reasonableness of the determination of the useful lives of property in Bulletin "F" has been recognized by the Supreme Court. Normally, an average hotel building is estimated to have a useful life of 50 years, but inasmuch as the useful life of a building for business purposes "depends to a large extent on the suitability of the structure to its use and location, its architectural quality, the rate of change in population, the shifting of land values, as well as the extent of maintenance and rehabilitation," it is allowed a depreciation rate of 1-1/2% corresponding to a normal useful life of 40 years only (Zamora vs. Collector, 8 SCRA 163). 80

S1

From the evidence, it appears that the car of petitioner was used more for business than for personal purposes. He was, and 79

Sec. 106, Rev. Regs. 2 Sec. 109, Rev. Regs. 2 "'Bulletin "F" is a schedule or guide issued by the U.S. IRS for purposes of determining the estimated useful life or the rate of depreciation of fixed assets. The U.S. has shifted to more sophisticated guides like the Accelerated Cost Recovery System (ACRS). This guide was adopted by the BIR and has been used as reference up to the present. 80


247


is until now, a law practitioner, a law professor in two law schools and was, during the year in question, engaged in business as importer. He had only one car at the time. Consequently, 1/2 of the value of the depreciation of the car may be considered as business related, while 1/2 thereof represents non-deductible personal expense. The same is true as regards the salary of petitioner's driver (Jamir vs. Collector, CTA Case 443, Nov. 28, 1959). Depreciation of intangible property. - Intangibles, the use of which in the trade or business is definitely limited in duration, may be the subject of a depreciation allowance. Examples are patents, copyrights, and franchises. Intangibles, the use of which in the business or trade is not so limited, will not usually be a proper subject of such an allowance. If, however, an intangible asset acquired through capital outlay is known from experience to be of value in the business for only a limited period, the length of which can be estimated from experience with reasonable certainty, such intangible asset may be the subject of a depreciation allowance, provided the facts are fully shown in the return to the satisfaction of the Commissioner. 82

Capital sum recoverable through depreciation allowance. — The capital sum to be replaced by depreciation allowances is the cost or other basis of the property in respect of which the allowance is made. To this amount should be added from time to time the cost of improvements, additions, and betterment and from it should be deducted from time to time the amount of any definite loss or damage sustained by the property through casualty, as distinguished from the gradual exhaustion of its utility which is the basis of the depreciation allowance. Where the lessee of real property erects buildings, or makes permanent improvements which become part of the realty and income has been returned by the lessor as a result thereof, as provided in Section 49 of these regulations, the capital sum to be replaced by depreciation allowance is the same as though no such buildings had been erected or such improvements made. No depreciation deduction will be allowed in the case of property which has been amortized to its scrap value and is no longer in use. 83

"Sec. 107, Rev. Regs. 2 ^Sec. 108, Rev. Regs. 2


248

In case the lease is terminated prior to the expiration of the lease contract or before the improvements have been fully depreciated, the unclaimed balance of the cost of the improvements may be deducted in the year of termination of the lease (De Vera vs. Collector, CTA Case 167, Mar 23, 1959). Who may take depreciation. — The person who sustains an economic loss from the decrease in property value due to depreciation gets the deduction. Ordinarily, this is the person who owns and has a capital investment in the property. When to deduct depreciation.—The period of depreciation starts when the asset is placed in service. A new building is placed in service when it is completed and capable of being used. Generally, depreciation can be deducted for the year in which the asset is disposed of. If property acquired for personal use is converted into business or investment use, depreciation is allowable from the time of conversion. 84

Method of computing depreciation allowance. — The capital sum to be replaced should be charged off over the useful life of the property, either in equal annual installments or in accordance with any other recognized trade practice, such as an apportionment of the capital sum over units of production. Whatever plan or method of apportionment is adopted must be reasonable and must have due regard to operating conditions during the taxable period. While the burden of proof must rest upon the taxpayer to sustain the deductions taken by him, such deductions must not be disallowed unless shown by clear and convincing evidence to be unreasonable. The reasonableness of any claim for depreciation shall be determined upon the conditions known to exist at the end of the period for which the return is made. If it develops that the useful life of the property will be longer or shorter than the useful life as originally estimated under all the then known facts, the portion of the cost or other basis of the property not already provided for through depreciation allowances should be spread over the remaining useful life of the property as re-estimated in the light of the subsequent facts, and depreciation deductions taken accordingly. 85

It appearing that the Tax Court applied rates of depreciation in accordance with Bulletin "F" of the U.S. IRS, which this "Prentice-Hall Federal Tax Handbook, 1983, p. 297 Sec. 109, Rev. Regs. 2 85


249


Court pronounced as having strong persuasive effect in this jurisdiction, for having been the result of scientific studies and observation for a long period in the United States, after whose income tax law ours is patterned (Limpan Investment Corp. vs. Collector, 17 SCRA 703). Taxpayer claimed that higher rates were applicable, since the property were old style. The Tax Court sustained the disallowance of excess depreciation, observing that depreciation is a question of fact and is not measured by theoretical yardstick. It should be determined by a consideration of actual facts (Commissioner vs. Priscila Estate, Inc., L-18282, May 29, 1964). Petitioner contended that the depreciation charges were based on the salvage value of pre-war assets after the war, after considering costs, the accumulated depreciation and damage to the assets on account of the war, and the entry crediting reserve for depreciation to capital surplus was made not to appraise the fixed assets but to correct an erroneous entry. However, petitioner did not present breakdown of depreciation and the basis upon which they were computed. Furthermore, no satisfactory explanation was offered by petitioner as to the erroneous entry adjusted by the debt to serve for depreciation and the credit to capital surplus. Under the circumstances, the assessment was presumed correct. The fact that a company was depreciating similar assets at a lower rate did not mean that another company within the same vicinity should use the same rate. A taxpayer may adopt the rate of depreciation it deemed reasonable. While the burden of sustaining the deductions rest upon the taxpayer, such deductions must not be disallowed unless shown by clear and convincing evidence to be unreasonable (Talisay-Silay Milling Co. vs. Commissioner, supra). The adoption of a depreciation rate upon an asset does not foreclose the application of a different or even a higher rate on similar assets used during the same period, in the same locality, and under the same conditions, if other attendant circumstances warrant (Ma-ao Sugar Central Co., Inc. vs. Commissioner, CTA Case 1434, Sept 21, 1967). For purposes of determining the Philippine peso cost of imported articles which will serve as the basis for depreciation,


250

the value and prices of said imported articles quoted in foreign currency shall be converted into Philippine currency at the current rate of exchange of value specified or published, from time to time, by the Bangko Sentral ng Pilipinas plus additional financial charges not exceeding an amount determined by the Bureau of Internal Revenue, in consultation with the Bangko Sentral ng Pilipinas and the Philippine Chamber of Commerce. 86

Obsolescence. — With respect to physical property whole or any portion of which is clearly shown by the taxpayer as being affected by economic conditions that will result in its being abandoned at a future date prior to the end of its normal useful life, so that depreciation deductions alone are insufficient to return the cost (or other basis) at the end of its economic term of usefulness, a reasonable deduction for obsolescence, in addition to depreciation, may be allowed in accordance with the facts obtaining with respect to each item of property concerning which a claim for obsolescence is made. No deductions for obsolescence will be permitted merely because, in the opinion of a taxpayer, the property may become obsolete at some later date. This allowance will be confined to such portion of the property on which obsolescence is definitely shown to be sustained and can not be held applicable to an entire property unless all portions thereof are affected by the conditions to which obsolescence is found to be due. 87

Depreciation of patent or copyrights. — In computing a depreciation allowance in the case of a patent or copyright, the capital sum to be replaced is the cost or other basis of the patent or copyright. The allowance should be computed by an apportionment of the cost or other basis of the patent or copyright over the life of the patent or copyright since its grant or since its acquisition by the taxpayer. If the patent or copyright was acquired from the Government, its cost consists of the various Government fees, cost of drawings, experimental models, attorney's fees, development or experimental expenses, etc., actually paid. Depreciation of a patent can be taken on the basis of the fair market value only when affirmative and satisfactory evidence of such value is offered. Such evidence should whenever practicable be submitted with the return. If the patent becomes m

See Rev. Regs. No. 11-84 implementing M A A B 50 Sec. 110, Rev. Regs. No. 2.

87


251


obsolete prior to its expiration, such proportion of the amount on which its depreciation may be based as the number of years of its remaining life bears to the whole number of years intervening between the basic date when it legally expires may be deducted, if permission to do so is specifically secured from the Commissioner. Owing to the difficulty of allocating to a particular year the obsolescence of a patent, such permission will be granted only if affirmative and satisfactory evidence that the patent became obsolete in the year for which the return is made is submitted to the Commissioner. The fact that depreciation has not been taken in prior years does not entitle the taxpayer to deduct in any taxable year a greater amount for depreciation than would otherwise be allowable. 88

Depreciation of drawings and models. - Where a taxpayer has incurred expenditures in his business for designs, drawings, patterns, models, or work of an experimental nature calculated to result in improvement of his facilities or his product, if the period of usefulness of any such asset may be estimated from experience with reasonable accuracy, it may be the subject of depreciation allowances spread over such estimated period of usefulness. The facts must be fully shown in the return or prior thereto to the satisfaction of the Commissioner. Except for such depreciation allowances, no deduction shall be made by the taxpayer against any sum so set up as an asset except on the sale or other disposition of such asset at a loss or on proof of a total loss thereof. 89

Charging off depreciation. — A depreciation allowance, in order to constitute an allowable deduction from gross income, must be charged off. The particular manner in which it shall be charged off is not material, except that the amount measuring a reasonable allowance for depreciation must be either deducted directly from the book value of the assets or preferably credited to a depreciation reserve account, which must be reflected in the annual balance sheet. The allowances should be computed and charged off with express reference to specific items, units, or groups of property, each item or unit being considered separately or specifically included in a group with others to which the same factors apply. The taxpayer should keep such records to each item or unit of depreciable property as will permit the ready ""Sec. I l l , Rev. Regs. No. 2. "See. 112, Rev. Regs. No. 2.


252

verification of the factors used in computing the allowance for each year for each item, unit, or group. 90

Since it is a generally accepted accounting procedure to deduct depreciation directly from the value of the asset involved, rather than carry the depreciation as a liability in the statement of assets and liabilities, the separate items for depreciation of depreciable assets should be disregarded (Reyes vs. Collector, CTA Case 42, July 26, 1956). Depreciation in the case of farmers. — A reasonable allowance for depreciation may be claimed on farm buildings (other than a dwelling occupied by the owner), farm machinery, and other physical property. A reasonable allowance for depreciation may also be claimed on livestock acquired for work, breeding, or dairy purposes, unless they are included in an inventory used to determine profits in accordance with these regulations. Such depreciation should be based on the cost or other basis and the estimated life of the livestock. If such livestock is included in an inventory, no depreciation thereof will be allowed, as the corresponding reduction in their value will be reflected in the inventory. 91

Statement to be attached to the return. — To each return in which depreciation charges are claimed, there should be attached a statement showing the item, unit, or group of depreciable property, the cost, the rate of charge, amount previously deducted, and the amount claimed in the return. These data must agree with those appearing in the books of the taxpayer. 92

7.

Depletion

93

No evidence was shown to show the product mined and for how much they were sold during the year for which the return and computation were made. This is necessary in order to determine the amount of depletion that can be legally deducted from petitioner's gross income. The sole basis of petitioner in claiming contractual rights as a deduction was the memorandum of its mining engineer, who stated that the ore reserves would ""Sec. 113, Rev. Regs. No. 2. "'Sec. 114, Rev. Regs. No. 2. Sec. 115, Rev. Regs. No. 2. See Gen. Circular No. V-322, Jan. 6, 1961; Rev. Regs. Nos. 7-79, 15-81 re ntangible drilling expenses of uncompleted wells, and 1-93, amending Rev. Regs. No. :-92, 4-92, and 8-92; and Rev. Regs. No. 5-76 regarding cost depletion. 92

93


253


be exhausted in five years (Fernandez Hermanos vs. Collector G.R. No. L-21551, Sept. 30, 1969). 8.

Charitable and other contributions

94

Conditions for Deductibility of Charitable Contributions a. Actually paid or made to the Philippine government or any political subdivision thereof, or any of the domestic corporation or association specified in the Tax Code; b.

Made within the taxable year;

c.

Not exceeding 10% (individual) or 5% (corporation) of taxpayer's taxable income before charitable contributions;

d.

Evidenced by adequate receipts or records. Non-stock, non-profit corporation or organization - shall refer to a corporation or association/organization referred to under Section 30(E) and (G) of the Tax Code created or organized under Philippine laws exclusively for one or more of the following purposes: 95

(i)

religious;

(ii) charitable; (iii) scientific; (iv) athletic; (v) cultural; (vi) rehabilitation of veterans; and (vii) social welfare No part of the net income or asset of which shall belong to or inure to the benefit of any member, organizer, officer or any specific person.

"See Rev. Regs. No. 2-93; BIR-NEDA Regs. No. 1-81, as amended by Rev. Regs. No. 10-82; Rev. Memo. Circular No. 48-91 on cooperatives "Rev. 13-98, Dec. 8, 1998. RMC 14-2008 dated Jan. 22, 2008 circularizes E.O. No. 761 relative to the deductibility of donations to charitable organizations to doneeinstitutions duly accredited.


254

Non-Government Organization (NGO) shall refer to a non-stock, non-profit domestic corporation or organization as defined under Section 34(H)(2)(c) of the Tax Code organized and operated exclusively for scientific, research, educational, character-building and youth and sports development, health, social welfare, cultural or charitable purposes, or a combination thereof, no part of the net income of which inures to the benefit of any private individual. (i)

Which, not later than the fifteenth (15th) day of the third month after the close of the NGO's taxable year in which contributions are received, makes utilization directly for the active conduct of the activities constituting the purpose or function for which it is organized and operated, unless an extended period is granted by the Secretary of Finance, upon recommendation of the Commissioner;

(ii) The level of administrative expenses of which shall, on an annual basis, not exceed thirty percent (30%) of the total expenses for the taxable year; and (iii) The assets of which, in the event of dissolution, would be distributed to another accredited NGO organized for similar purpose or purposes, or to the State for public purpose, or purposes, or to the state for public purpose, or would be distributed by a competent court of justice to another accredited NGO to be used in such manner as in the judgment of said court shall best accomplish the general purpose for which the dissolved organization was organized. "Utilization" by an accredited NGO shall refer to (i)

Any amount in cash or in kind, including administrative expenses, paid or utilized by an accredited NGO to accomplish one or more purposes for which it was created or organized; or

(ii) Any amount paid to acquire an asset used, or held for use, directly in carrying out one or more purposes for which the accredited NGO was created or organized; or

COSTS AND DEDUCTIONS FROM GROSS INCOME, N O N - D E D U C T I B L E ITEMS, AND PERSONAL EXEMPTIONS

(iii) Any amount set aside for a specific project which comes within one or more purpose or purposes for which the accredited NGO was created, but only if at the time such amount is set aside, the accredited NGO has established to the satisfaction of the Commissioner of Internal Revenue that the amount will be utilized for a specific project within a period not to exceed five (5) years, and the project is the one which can be better accomplished by setting aside such amount than by immediate payments of funds: Provided, That, the utilization requirements prescribed under Section 5 of these Regulations shall be complied with; or (iv) Any amount in cash or in kind invested in any activity related to the purpose for which it was created or organized; (v) Any amount in cash or in kind invested in capital sustaining and generating activities, such as but not limited to, endowment funds, trust funds, money market placements, shares of stock and similar instruments: Provided, That, any income derived from these investments shall be exclusively used in activities directly related to one or more purposes for which the accredited NGO was created or organized. "Accrediting Entity" shall refer to a non-stock, nonprofit organization composed of NGO networks, duly designated by the Secretary of Finance to establish and operationalize a system of accreditation to determine the qualification of non-stock, non-profit corporations or organizations and NGOs for accreditation as qualifieddonee institutions. The Secretary of Finance and the Commissioner of Internal Revenue shall oversee, monitor and coordinate with the Accrediting Entity to ensure that the provisions of these Regulations are complied with. In this connection, the Secretary of Finance or the Commissioner of Internal Revenue or their duly authorized representative shall sit as ex-officio member of the Board of Trustees of the Accrediting entity with the right to vote The Secretary of Finance may also designate an official of a concerned government agency, e.g., Department of Science and Technology, to assist the Board of Trustees in the accreditation of foundations.

256


The Secretary of Finance shall designate an entity as an Accrediting Entity, provided it has a countrywide membership composed of: (a) NGOs which belong to the sector that the Private Accrediting Entity intends to certify; (b) NGOs which have been in existence for at least five (5) years; and (c) NGOs not more than 50% of the members of which belong to other existing NGOs or Private Accrediting Agencies. The Philippine Council for N G O Certification, Inc. ( P C N C ) , a non-stock, non-profit corporation which was established by several NGO networks (e.g., Caucus of Development NGO Networks (CODE-NGO); Philippine Business for Social Progress (PBSP); Association of Foundations ( A F ) ; League of Corporate Foundations (LCF); Bishops-Businessmen's Conference for Human Development (BBC); and the National Council for Social Development Foundation (NCSD), has been duly designated by the Secretary of Finance as an Accrediting Entity pursuant to Memorandum of Agreement dated January 29,1998 executed by and between the Secretary of Finance and PCNC's Interim Chairman. However, Executive Order No. 671 dated October 22, 2007 designated several Accrediting Entities to determine the qualification of non-stock, non-profit corporations, nongovernmental organizations, associations, and foundations for accreditation as qualified donee-institutions, to wit: a. Department of Social Welfare and Development for charitable and/or social welfare organizations, foundations and associations including but not limited to those engaged in youth, child, women, family, disabled persons, older persons, welfare and development; b. Department of Science and Technology - for organizations, associations and foundations primarily engaged in research and other Scientific activities; c. Philippine Sports Commission - for organizations, foundations and associations primarily engaged in sports development; d. National Council for Culture and Arts - for organizations, foundations and associations primarily engaged in cultural activities; and


257


e. Commission on Higher Education - for organizations, foundations and association primarily engaged in educational activities. The above accrediting entities must comply with the Standards and Guidelines set by the Department of Finance relative to accreditation of non-stock, non-profit corporations/ NGOs as provided for in Revenue Regulations No. 13-98. The Certificates of Accreditation issued by PCNC as of November 15, 2007 are still valid until March 31,2008. Accordingly, holders of* such certificates are hereby directed to renew their accreditation with the proper accrediting government entity on o r before the said date. 96

97

"Religious purpose" shall refer to the promotion, propagation and accomplishment of any form of religion, creed or religious belief recognized by the Government of the Republic of the Philippines. "Charitable Activity" shall refer to extending relief to the poor, distressed and underprivileged and shall include fighting against juvenile delinquency and community deterioration. "Scientific and research purpose" shall refer to undertaking or assisting in pure or basic, applied and scientific research in the field of agriculture, forestry, fisheries, industry, engineering, energy development, food and nutrition, medicine, environment and biological, physical and natural sciences for the public interest. "Basic research" shall refer to an experimental or theoretical work undertaken primarily to acquire new knowledge of the underlying foundations of phenomena and observable facts without any particular application or use in view. It analyzes properties, structures or relationships with a view to formulating and testing hypothesis, theories or laws. The results of basic research are not generally sold but are usually published in scientific journals or circulars to interested colleagues. "Applied research" shall refer to an original investigation undertaken in order to acquire new knowledge. It is directed primarily towards a specific practical aim or objective. It is undertaken either to determine possible uses for the findings of "'RMC 88-2007, Dec. 7, 2007. "RMC 14-2008, Jan. 22, 2008.


258

basic research or to determine new methods or ways of achieving some specific and predetermined objectives. It involves the consideration of the available knowledge and its extension in order to solve particular problems. Applied research develops ideas into operational form. "Scientific research" will be regarded as carried on for public interest if the results of such research are made available to the public on a non-discriminatory basis; or if such research is performed for the Government of the Philippines or any of its agencies or political subdivisions; or if such research is directed to benefit the public. "Character building and youth and sports development (or athletic) purposes" - shall refer to and include conducting basic and applied research on youth development, initiating and establishing youth organizations to promote and develop youth activities, including the establishment of summer camps or centers for leadership training, conducting a program on physical fitness and amateur sports development for the country; developing and maintaining recreational facilities, playgrounds and sports centers; and conducting training programs for the development of youth and athletes for national and international competitions. "Cultural activity" shall refer to and include undertaking and/or assisting in research activities on all aspects of history, social system, customs and traditions; developing, enriching and preserving Filipino arts and culture; developing and promoting the visual and performing arts; and participating in vigorous implementation of bilingual policy through translation and wider use of technical, scientific and creative publications, development of an adaptive technical dictionary and use of Filipino as the medium of instruction. "Educational activity" shall refer to and include the granting of scholarships to deserving students and professional chairs for the enhancement of professional courses, and instructing or training of individuals either through formal and informal methods, viz.: (i)

Formal method of instruction refers to the institutionalized, chronologically graded and hierarchically structured educational system at all levels of education;


259


(ii)

Non-formal method of instruction refers to any deliberately organized, systematic educational activity carried on outside the framework of the formal system to provide selected types of learning to particular subgroups of the population, particularly out-of-school youths and adults, for the purpose of communicating ideas, developing skills, changing attitudes or modifying behavior or improve their character and to provide them with tools necessary for the achievement of a higher standard of living. For the purpose of this section, a certification from the Technical Education and Skills Development Authority (TESDA) is required for the accreditation of the non-formal educational program which is implemented or carried out by a non-stock, non-profit corporation, organization or an NGO.

It also includes upgrading of existing facilities to support the conduct of the above activities. "Rehabilitation of veterans" shall include services extended to Philippine veterans and members of their families because of financial difficulties and attendant problems; and services extended to disabled veterans towards productive life. "Social welfare purposes" shall refer to and include: (i)

Undertaking and/or assisting in the amelioration of the living conditions of distressed citizens particularly those who are handicapped by reasons of poverty, youth, physical and mental disability, illness, old age, and natural disasters, including assistance to cultural minorities;

(ii)

Pursuing a program for the protection and development of children and youth, such as providing services for drop-outs, pre-school children of low-income working mothers, and physically handicapped children;

(iii) Providing for the rehabilitation of the youth and disabled adults, released prisoners, drug addicts, alcoholics, mentally retarded, hansenites and similar cases; and (iv) Providing for services to squatter families and to displaced workers.


260

"Health purposes" shall refer to include the pursuit of any of the following: (i)

Control, prevention and treatment of communicable and degenerative diseases, accidents and other health disabilities;

(ii) Family planning program designed to indicate knowledge and understanding of population, human growth and development of family life; (iii) Environment sanitation, such as, public sewerage system and sanitary toilets; and (iv) Nutrition, which aims to reduce the prevalence of malnutrition and increase the energy and protein intake among households. Donations to Accredited Non-stock, Non-profit CorporationslNGOs. - Donations to accredited non-stock, non-profit corporations/NGOs shall be entitled to the following benefits: (1)

Limited Deductibility. — Donations, contributions or gifts actually paid or made within the taxable year to accredited non-stock, non-profit corporations shall be allowed limited deductibility in an amount not in excess of ten percent (10%) for an individual donor, and five percent (5%) for a corporate donor, of the donor's income derived from trade, business or profession as computed without the benefit of this deduction.

(2) Full Deductibility. - Donations, contributions or gifts actually aid or made within the taxable year to accredited NGOs shall be allowed full deductibility, subject to the following conditions: (i)

The accredited NGO shall make utilization directly for the active conduct of the activities constituting the purpose or function for which it is organized and operated, not later than the fifteenth (15th) day of the third month after the close of the accredited NGOs taxable year in which contributions are received, unless an extended period is granted by the Secretary of Finance, upon recommendation of the Commissioner.


261

N O N - D E D U C T I B L E I T E M S , A N D P E R S O N A L EXEMPTIONS

For this purpose, the term "utilization" shall have the meaning as denned under Section 1(c) of these Regulations. (ii) The level of administrative expenses of the accredited NGO, shall, on an annual basis, not exceed thirty percent (30%) of the total expenses for the taxable year. (iii) In the event of dissolution, the assets of the accredited NGO, would be distributed to another accredited NGO organized for similar purpose or purposes, or to the State for public purpose, or would be distributed by a competent court of justice to another accredited NGO to be used in such manner as in the judgment of said court shall best accomplished the general purpose for which the dissolved organization was organized. (iv) The amount of any charitable contribution of property other than money shall be based on the acquisition cost of said property. (v) All the members of the Board of Trustees of the nonstock, non-profit corporation, organization or NGO do not receive compensation or remuneration for their service to the aforementioned organization. Exemption from Donor's Tax. - Donations and gifts made in favor of accredited non-stock, non-profit corporations/ NGOs shall be exempt from donor's tax: Provided, however, That not more than thirty percent (30%) of the said donations and gifts for the taxable year shall be used by such accredited non-stock, non-profit corporations/NGOs institutions qualifieddonee institution for administration purposes pursuant to the provisions of Section 101 (A)(3) and (B)(2) of the Tax Code. A high executive may be allowed deduction of reasonable charitable contributions (P800) which are inevitable. The absence of receipts or records will not justify total disallowance, provided there is some evidence of contribution having been made. The taxpayer may prove his contributions in accordance with the rules of evidence (Nava vs. Collector, CTA Case 568, Sept. 25, 1961). Contributions made to the Manila Police Trust Fund (considered a governmental institution) and to a group of civic


262

spirited citizens (considered a charitable organization) for the benefit of the needy families in the City of Manila were held to be deductible (Roxas vs. CTA, 23 SCRA 276). But donations to the chapel owned by a private university that distributes dividends to its stockholders are not deductible (ibid). 9.

Research and Development

This is a new deduction introduced under R.A. No. 8424, effective January 1, 1998, in recognition of the importance of research and development (R&D) in the economic development of the country. The amount spent for R&D during the year may be substantial, yet this provision allows the full deductibility of said amount for R&D in the year paid or incurred, even if it will definitely benefit future periods. 10. Pension Trusts

98

Payments to employees' pension trusts. - An employer who adopts or has adopted a reasonable pension plan, actuarially sound, and who establishes, or has established, and maintains a pension trust for Vie payment of reasonable pensions to his employees shall be allowed to deduct from gross income reasonable amounts paid to such trust, in accordance with the pension plan (including any reasonable amendment thereof) as follows: a. If the plan contemplates the payment to the trust, in advance of the time when pensions are granted, of amounts to provide for future pension payments, then (1) reasonable amounts paid to the trust during the taxable year representing the pension liability applicable to such year, determined in accordance with the plan, shall be allowed as a deduction for such year as an ordinary and necessary business expense, and in addition (2) one-tenth of a reasonable amount transferred or paid or in part the pension liability applicable to the years prior to the taxable year, or so transferred or paid to place the trust on a sound financial basis, shall be allowed as a deduction for the taxable years and for each of the nine succeeding taxable years. b. If the plan contemplates the payment to the trust, in advance of the time when pensions are granted, of amounts 'See Rev. Regs. No. 1-68 (retirement plans) and Rev. Regs. No. 1-83.


263


to provide for future pension payments, then (1) reasonable amounts paid to the trust during the taxable year representing the present value of the expected future payments in respect of pensions granted to the employees retired during the taxable year shall be allowed as a deduction for such year as an ordinary and necessary business expense, and in addition (2) one-tenth of a reasonable amount transferred or paid to the trust during the taxable year to cover in whole or in part the present value of the expected future payments in respect of pensions granted to employees retired prior to the taxable year, or so transferred or paid to place the trust on a sound financial basis, shall be allowed as a deduction for the taxable year and for each of the nine succeeding taxable years."

D.

Optional Standard Deduction (OSD) The important guidelines relating to optional standard deductions are:

M

a.

Privilege is available only to citizens or resident aliens as well corporations subject to the regular corporate income tax; thus, non-resident aliens and non-resident foreign corporations are not entitled to claim the optional standard deduction.

b.

Standard deduction is optional; i.e., unless taxpayer signifies in his/its return his/its intention to elect this deduction, he/it is considered as having availed of the itemized deductions;

c.

Such election when made by the qualified taxpayer is irrevocable for the year in which made; however, he can change to itemized deductions in succeeding year(s);

d.

Amount of standard deduction is limited to 40% of taxpayer's gross sales or receipts (in the case of an individual) or gross income (in the case of a corporation). If the individual is on the accrual basis of accounting for his income and deductions, OSD

100

Sec. 118, Rev. Regs. No. 2. " T h e law allows only 10% OSD for individuals engaged in trade or business or exercising a profession. The 10% rate was increased to 40% under R.A. No. 9504, effective July 6, 2008, as implemented by Rev. Regs. No. 16-2008, Nov. 26, 2008.


shall be based on the gross sales during the year. If he employs the cash basis of accounting, OSD shall be based on his gross receipts during the year. It should be noted that cost of sales or cost of services shall not be allowed to be deducted from gross sales or receipts. e.

A general professional partnership (GPP) may claim either the itemized deductions or in lieu thereof, the OSD allowed to corporations in claiming the deductions in an amount not exceeding 40% of its gross income. The net income determined by either the itemized deduction or OSD from the GPP's gross income is the distributable net income from which the share of each share is to be ascertained.

f.

Proof of actual expenses is not required; hence, he is not also required to keep books of accounts and records with respect to his deductions during the year.

Special Additional Deductions Special Provisions Regarding Income and Deductions of Insurance Companies, Whether Domestic or Foreign 101

(A) Special Deductions Allowed to Insurance Companies. - In the case of insurance companies whether domestic or foreign doing business in the Philippines, the net additions, if any, required by law to be made within the year to reserve funds and the sums other than dividends paid within the year on policy and annuity contracts may be deducted from their gross income: Provided, however, That the released reserve be treated as income for the year of release. (B) Mutual Insurance Companies. - In the case of mutual fire and mutual employers liability and mutual workmen's compensation and mutual casualty insurance companies requiring their members to make premium deposits to provide for losses and expenses, said companies shall not return as income any portion of the premium deposits returned to their policyholders, but shall return as taxable income all income received by them from all other sources plus such portion of the premium deposits as are retained by the companies for Sec. 37, NIRC.


265


purposes other than the payment of losses and expenses and reinsurance reserves. (C) Mutual Marine Insurance Companies. - Mutual marine insurance companies shall include in their return of gross income, gross premiums collected and received by them less amounts paid for reinsurance, but shall be entitled to include in the deductions from gross income amounts repaid to policyholders on account of premiums previously paid by them and interest paid upon those amounts between the ascertainment and payment thereof. (D) Assessment Insurance Companies. - Assessment insurance companies, whether domestic or foreign, may deduct from their gross income the actual deposit of sums with the officers of the Government of the Philippines pursuant to law, as additions to guarantee or reserve funds. Insurance companies are entitled to the same deductions from gross income as other corporations, and also to the deduction of the net addition required by law to be made within the taxable year to reserve funds and of the sums other than dividends paid within the taxable year on policy and annuity contracts. "Paid" includes "accrued" or "incurred" (construed according to the method of accounting upon the basis of which the net income is computed) during the taxable year, but does not include any estimate for losses incurred but not reported during the taxable year. As payments on policies there should be reported all death, disability and other policy claims (other than dividends as above specified) paid within the year, including fire, accident and liability losses, matured endowments, annuities, payments on installment policies and surrender values actually paid. 102

Net addition to reserve funds. - All policy premiums on which net addition to reserve is computed must be included in gross income. Insurance companies may deduct from gross income the net addition required by law to be made within the taxable year to reserve funds. When the reserve at the end of the year is less than at the beginning of the year, there is a "released reserve," and the amount so released must be included in gross income. In the case of assessment insurance companies, whether domestic or foreign, the actual deposit of sums with l02


266


the officers of the Government, pursuant to law, as addition to guaranty or reserve funds shall be treated as being payments required by law to reserve funds. In the case of life insurance companies, the net addition to the "reinsurance reserve" and the "reserve for supplementary contracts," and in the case of fire, marine, accident, liability, and other insurance companies, the net addition to the "unearned premium reserves," and only such other reserves as are specifically required by the statute will be allowed as deductions. 103

Losses from Wash Sales of Stock or Securities

104

(A) In the case of any loss claimed to have been sustained from any sale or other disposition of shares of stock or securities where it appears that within a period beginning thirty (30) days before the date of such sale or disposition and ending thirty (30) days after such date, the taxpayer has acquired (by purchase or by exchange upon which the entire amount of gain or loss was recognized by law), or has entered into a contract or option so to acquire, substantially identical stock or securities, then no deduction for the loss shall be allowed under Section 34, unless the claim is made by a dealer in stock or securities and with respect to a transaction made in the ordinary course of the business of such dealer. (B) If the amount of stock or securities acquired (or covered by the contract or option to acquire) is less than the amount of stock or securities sold or otherwise disposed of, then the particular shares of stock or securities, the loss from the sale or other disposition of which is not deductible, shall be determined under rules and regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner. (C) If the amount of stock or securities acquired (or covered by the contract or option to acquire) is not less than the amount of stock or securities sold or otherwise disposed of, then the particular shares of stock or securities, the acquisition of which (or the contract or option to acquire which) resulted in the non-deductibility of the loss, shall be determined under rules and regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner. 'Sec. 129, Rev. Regs. No. 2. 'Sec. 38, NIRC as implemented by Sec. 131, Rev. Regs. No. 2.


267


A taxpayer cannot deduct any loss claimed to have been sustained from the sale or other disposition of stock or securities, if within a period beginning thirty days before the date of such sale or disposition and ending thirty (30) days after such date (referred to in this section as the sixty-one-day period), he has acquired (by purchase or by an exchange upon which the entire amount of gain or loss was recognized by law), or has entered into a contract or option so to acquire, substantially identical stock or securities. However, this prohibition does not apply in the case of a dealer in stock or securities if the sale or other disposition of stock or securities is made in the ordinary course of its business as such dealer. Where more than one loss is claimed to have been sustained within the taxable year from the sale or other disposition of stock or securities, the provisions of this section shall be applied to the losses in the order in which the stock or securities the disposition of which resulted in the respective losses were disposed of (beginning with the earliest disposition). If the order of disposition of stock or securities disposed of at a loss on the same day cannot be determined, the stock or securities will be considered to have been disposed of in the order in which they were originally acquired (beginning with earliest acquisition). a. Where the amount of stock or securities acquired within the sixty-one-day period is less than the amount of stock or securities sold or otherwise disposed of, then the particular shares of stock or securities the loss from the sale or other disposition of which is not deductible shall be those with which the stock or securities acquired are matched in accordance with the following rule: The stock or securities acquired will be matched in accordance with the order of their acquisition (beginning with the earliest acquisition) with an equal number of the shares of stock or securities sold or otherwise disposed of. b. Where the amount of stock or securities acquired within the sixty-one-day period is not less than the amount of stock or securities sold or otherwise disposed of, then the particular shares of stock or securities the acquisition of which resulted in the non-deductibility of the loss shall be those with which the stock or securities disposed of are matched in accordance with the following rule: The stock or securities sold or otherwise disposed of will be matched with an equal number of the shares of stock or securities acquired in accordance with


the order of acquisition (beginning with the earliest acquisition) of the stock or securities acquired. The acquisition of any share of stock or any security which results in the non-deductibility of a loss under the provisions of this section shall be disregarded in determining the deductibility of any other loss. The word "acquired" as used in this section means acquired by purchase or by an exchange upon which the entire amount of gain or loss was recognized by law, and comprehends cases where the taxpayer has entered into a contract or option within the sixty-one-day period to acquire by purchase or by such an exchange. 105

Personal and Additional Exemptions Exemptions are fixed at arbitrary amounts intended to substitute for personal and living expenses. They are roughly the equivalent of the taxpayer's minimum subsistence and those of his dependents (Madrigal vs. Rafferty, 38 Phil. 414). a.

Basic personal exemptions. —

For single individual or married individual judicially decreed as legally separated with no qualified dependents, including estates and trusts, the amount of personal exemption allowed is twenty thousand pesos (P20,000.00). The amount was increased to Fifty thousand pesos (P50,000.00) effective July 6, 2008 under R.A. No. 9504. 106

For each legally married employee, the amount of personal exemption allowed is thirty two thousand pesos (P32,000.00). A married individual deriving income within the Philippines whose spouse is unemployed or is a non-resident citizen deriving income from foreign sources, shall be entitled to a personal exemption of thirty two thousand pesos (P32,000.00) only. The amount was increased to Fifty thousand pesos (P50,000.00) effective July 6, 2008 under R.A. No. 9504. For head of a family, the amount of personal exemption allowed is twenty five thousand pesos (P25,000.00). The amount was increased to Fifty thousand pesos (P50,000.00) effective July 106

106

Sec. 131, Rev. Regs. No. 2. Sec. 62, NIRC.


269


6, 2008 under R.A. No. 9504. Head of the family means an unmarried or legally separated man or woman with one or both parents or one or more brothers or sisters whether of the whole or half blood or with one or more legitimate, recognized natural or legally adopted children living with and dependent upon him for their chief support, where such brothers or sisters or children are not more that twenty-one (21) years of age, unmarried and not gainfully employed or where such children, brothers, or sisters, regardless of age are incapable of self-support because of mental or physical defect. The term also includes an unmarried or legally separated man or woman who is the benefactor of a qualified senior citizen. Asenior citizen is any resident citizen of the Philippines of at least sixty (60) years old, including those who have retired from both government offices and private enterprises, and has an income of not more than Sixty thousand pesos (P60,000) per annum subject to the review of the National Economic Development Authority (NEDA) every three years. Effective July 6, 2008, a benefactor of a person with disability whose civil status is single could no longer be considered as "head of family" and therefore shall no longer be allowed to avail himself/herself the old P25,000 personal exemption as "head of family," but rather he/she would be entitled to the new personal exemption of P50,000 just like any other individual taxpayer, whether single or married, with or without qualified dependent. 107

108

For an unmarried individual to fall within the term "head of a family," it is enough that he has either of the qualified dependents he supports. The fact that the father is still alive and continues to exercise parental authority over his minor children is of no moment. All that the law requires is that the relatives enumerated be dependent upon the taxpayer for their chief support (Collector vs. Calsado and CTA, G.R. No. L-10293, Feb. 27, 1959). The only valid adoption in this jurisdiction is that one made through court, or in pursuance of the procedure laid down by the Rules of Court. The purpose of adoption is to afford to persons who have no child of their own the consolation of having one by creating, through legal fiction, the relation of paternity and filiation where none exists by blood relationship. This purpose ""See Republic Act No. 7432. Sec. 7, Rev. Regs. No. 1-2009, Dec. 9, 2008. loe

270


rejects the idea of adoption by persons who have children of their own, for otherwise, conflicts, friction, and differences may arise resulting from the infiltration of foreign element into a family which already counts with children upon whom the parents can shower their paternal love and affection (Martial Eleuterio Resaba, et al. vs. Republic, G.R. No. L-6294, June 28, 1954). Additional exemptions for taxpayer with dependents. - A married individual or a head of family shall be allowed an additional exemption of eight thousand pesos (P8,000) for each qualified dependent child; Provided, That the total number of dependents for which additional exemptions may be claimed shall not exceed four (4) dependents. The additional exemptions for qualified dependent children shall be claimed by only one of the spouses in the case of married individuals. The additional exemption for each dependent child was increased to Twenty-five thousand pesos (P25,000.00) effective July 6,2008 under R.A. No. 9504. Under this law, the benefactor of a person with disability may only be entitled to claim the new additional exemption of P25,000 per qualified dependent child (not exceeding four), if the person with disability is his/her legitimate, illegitimate or legally-adopted child, whether minor or of legal age. In other words, for purposes of exemption, the "benefactor" will not be entitled to the additional exemption unless that benefactor is a "parent" of the person with disability. 109

A dependent means a legitimate, illegitimate or legally adopted child chiefly dependent upon and living with the taxpayer if such dependent is not more than twenty-one (21) years of age, unmarried and not gainfully employed or if such dependent, regardless of age, is incapable of self-support because of mental or physical defect. For an individual to qualify as a head of family, his dependent child must be a legitimate, recognized natural or legally adopted child. However, to qualify for additional exemption, the law considers an illegitimate child as a dependent. The husband shall be the proper claimant of the additional exemption for qualified dependent children unless he explicitly waives his right in favor of his wife in the application for registration (BIR Form 1902) or in the withholding exemption loe

Ibid.


271


certificate (BIR Form 2305). However, where the spouse of the employee is unemployed or is a non-resident citizen deriving income from foreign sources, the employed spouse within the Philippines shall be automatically entitled to claim the additional exemptions for children. 110

Status-at-the-end-of-the-year rule generally applies. This means that whatever is the status of the taxpayer at the end of the calendar year shall be used for purposes of determining his personal and additional exemptions. A change of status of the taxpayer during the taxable year generally benefits, but does not prejudice, him. Thus, if he marries at the end of the year, he shall be entitled to personal exemption of P32,000. If a child is born at any time during the calendar year, even on the last day of the year, the taxpayer is entitled to claim his child as a dependent entitling him to deduct additional exemption of P8,000 for that year. On the other hand, if one of his qualified dependent children dies during the year, the law considers that the child died on the last day of the year; hence, he is entitled to claim the full amount of additional exemption of P8,000 for the deceased child for the year. In case an individual derives mixed income during the year, his personal and additional exemptions are first deducted from compensation income and the excess, if any, is deducted from his business and professional income.

G.

Items Not Deductible

111

In general, in computing net income, no deduction shall in any case be allowed in respect to (1)

Personal, living or family expenses;

(2) Any amount paid out for new buildings or for permanent improvements, or betterments made to increase the value of any property or estate; ,10

See Sec. 35(B), 1997 NIRC. Since R.A. No. 9504 increased the personal and additional exemptions of individuals, but did not amend Section 35(B) thereof, taxpayers opine that said law must be made effective for the whole year of 2008 (and not just from July 6, 2008 as interpreted by the BIR) to benefit individuals from the effects of rising prices of goods and to implement the objective of the law of giving tax relief to individual taxpayers, particularly those receiving the "statutory minimum wage." This legal issue was raised to the highest court in 2008. Sec. 36, NIRC. ul


272

This Subsection shall not apply to intangible drilling and development costs incurred in petroleum operations which are deductible under Subsection (G)(1) of Section 34 of this Code. (3) Any amount expended in restoring property or in making good the exhaustion thereof for which an allowance is or has been made; or (4) Premiums paid on any 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. 112

(B) Losses from Sales or Exchanges of Property. — In computing net income, no deduction shall in any case be allowed in respect of losses from sales or exchanges of property directly or indirectly (1) Between members of a family. For purposes of this paragraph, the family of an individual shall include only his brothers and sisters (whether by the whole or half-blood), spouse, ancestors, and lineal djscendants; or (2) Except in the case of distributions in liquidation, between an individual and a corporation more than fifty percent (50%) in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual; or (3) Except in the case of distributions in liquidation, between two corporations more than fifty percent (50%) in value of the outstanding stock of each of which is owned, directly or indirectly, by or for the same individual, if either one of such corporations, with respect to the taxable year of the corporation preceding the date of the sale or exchange was, under the law applicable to such taxable year, a personal holding company or a foreign or a foreign personal holding company; (4)

Between the grantor and a fiduciary of any trust; or

(5) Between the fiduciary of a trust and the fiduciary of another trust if the same person is a grantor with respect to each trust; or 112



273


(6) Between a fiduciary of a trust and a beneficiary of such trust. Personal, living, and family expenses. - Personal, living, and family expenses are not deductible. Insurance paid on a dwelling owned and occupied by a taxpayer is a personal expense. Premiums paid for life insurance by the insured are not deductible. In the case of a professional man who rents a property for residential purposes, but incidentally receives his clients, patients, or callers in connection with his professional work (his place of business being elsewhere), no part of the rent is deductible as a business expense. If, however, he uses part of the house for his office, such portion of the rent as is properly attributable to such office is deductible. Where the father is legally entitled to the services of his minor children, any allowance which he gives them, whether paid in consideration for services or otherwise, is not allowable deduction in his return of income. Alimony and an allowance paid under a separation agreement are not deductible from gross income. 113

Expenses incurred in going to the US to study and survey the American Educational System cannot be allowed as deduction, because the benefits derived in such trip did not have any proximate relationship with his earnings in said year; hence, they partake more of personal expense. A payment may be highly commendable from an ethical standpoint or expedient and still not be deductible (White vs. Commissioner, 61 F[2d] 726 CCA 95th, 1935). Capital expenditures. — No deduction from gross income may be made for any amounts paid out for new buildings or for permanent improvements or betterments made to increase the value of the taxpayer's property, or for any amount expended in restoring property or in making good the exhaustion thereof for which an allowance for depreciation expended for securing a copyright and plates, which remain the property of the person making the payments, are investments of capital. The cost of defending or perfecting title to property constitutes a part of the cost of the property and is not a deductible expense. The amount expended for architect's services is part of the cost of the building. Commissions paid in purchasing securities are an offset against the selling price. Expenses of the administration ll3



274

of an estate, such as court costs, attorney*s fee and executor's commissions, are chargeable against the "corpus" of the estate and are not allowable deductions. Amounts to be assessed and paid under an agreement between bondholders or shareholders of a corporation, to be used in a reorganization of the corporation, are investments of capital and not deductible for any purpose in return of income. In the case of a corporation, expenses for organization, such as incorporation fees, attorney's fees and accountant's charges, are ordinarily capital expenditures, but where such expenditures are limited to purely incidental expenses, a taxpayer may charge such items against income in the year in which they are incurred. A holding company which guarantees dividends at a specified rate on the stock of a subsidiary corporation for the purpose of securing new capital for the subsidiary and increasing the value of its stockholdings in the subsidiary may not deduct amounts paid in carrying out this guaranty in computing its net income, but such payments may be added to the cost of its stock in the subsidiary. 114

There is no question that by this expenditure, there was an original construction of a hollow block fence with iron grills around the compound occupied by petitioner and in the subsequent improvement thereof. The record is clear that the amount in question did not merely involve the cost of incidental repairs for the purpose of keeping the property of the corporation in an ordinarily efficient operating condition, but an addition which prolonged the life of such property and which materially increased its value (Alhambra Cigar & Cigarette Mfg. Co. vs. Collector, CTA Case 143, July 31, 1956). The expenditures cover both repairs deductible as business expenses and capital expenditures. While the corporation presented a breakdown of those expenses, it, however, failed to make a proper segregation of the deductible from the non-deductible repairs. Where an expenditure covers both repairs deductible as business expenses and capital items, it is incumbent on the taxpayer to make a proper segregation; otherwise, the entire expenditure will be disallowed (Limpan Investment Corporation vs. Collector, supra).

1,4



275


Driving of piles and contractor's and architect's fees are capital expenditures that formed part of the cost of the taxpayer's property, since they increased the value of the property. That payment of the items was made only in 1961 does not alter the fact that the contracts from which the obligation to pay arose were entered into in 1960 and the service contracted for were rendered in the same year (Collector vs. Soriano y Cia & CTA, G.R. L-24893, Mar. 26, 1971). Litigation expenses incurred in the defense or protection of title to its mining properties are capital expenditures. They constitute a part of the cost of the property and are not deductible. Expenditures to promote the sales of additional capital stock or the cost, commissions and fees for obtaining stock subscriptions are still capital expenses. Expenses relating to re-capitalization and reorganization of a corporation, the cost of obtaining stock subscriptions, promotion expenses, and commissions or fees paid for the sale of stock after reorganization are capital expenditures (Atlas Consolidated Mining Co. vs. Commissioner, L-20911, Jan. 27, 1981, 102 SCRA 246). Margin fees on the remittance of foreign exchange abroad are not deductible by a foreign corporation since to be deductible, the expense must be incurred for realizing profits or minimizing losses in the Philippines exclusively. Oil drilling and exploration expenses are capital expenditures (Esso Standard Eastern vs. Commissioner, G.R. No. 28508, July 7, 1989). Statutorily, capital expenditures are specified as amounts paid out for new buildings or for improvements or betterments made to increase the value of any property or estate or amounts expended in restoring property or in making good exhaustion thereof for which an allowance is or has been made. The cost of a topographical survey made for the purpose of estabhshing boundary lines of the land, and of recording the location on the property of valuable shrubs and shade trees is a capital expenditure. Amounts expended for maps, abstracts, legal title opinions, recording fees and surveys are capital expenditures (Hopewell Power [Phils.] Corp. vs. Commissioner, CTA Case No. 5321, Oct. 7, 1998). Capitalized interest A bona fide debt is one which arises from a debtor-creditor relationship based upon a valid and enforceable obligation to


276

pay a fixed or determinable sum of money. The basic test of the existence of debtor-creditor relationship is whether the debtor is under unconditional obligation to repay the creditor. In deciding whether a relationship represents a bona fide debt, a fact and circumstances approach which examines the substantive nature of the relationship on a case to case basis is employed (Philex Mining Corporation vs. Commissioner, CTA Case No. 5200, Aug. 21, 1998). Should the taxpayer elect to deduct interest payments against its gross income, he cannot at the same time capitalize such interest and claim depreciation on the undepreciated cost which includes the interest (PICOP vs. Commissioner, G.R. No. 106949-50, Dec. 1, 1995). Any amount paid for premiums on any life insurance policy covering the life of an officer or employee or of any person financially interested in the business of the taxpayer when the taxpayer is directly or indirectly a beneficiary under such policy is not deductible (Adams, 18 BTA 391). A person is said to be "financially interested" in the taxpayer's business, if he is a stockholder thereof or he is to receive as his compensation a share of the profits of the business (Merrimac Hat Corp., 29 BTA 690). Losses from sales or exchanges of property. — No deduction is allowed in respect of losses from sales or exchanges of property, directly or indirectly: 1.

Between members of a family. As used in Section 36 of the Tax Code, the family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants;

2.

Except in the case of distributions in liquidation, between an individual and a corporation more than fifty per centum in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual;

3.

Except in the case of distributions in liquidations, between two corporations more than fifty per centum in value of the outstanding stock of each of which is owned, directly or indirectly, if either one of such


277


corporations with respect to the taxable year of the corporation preceding the date of the sale or exchange was, under the law applicable to such taxable year, a personal holding company or a foreign personal holding company; 4.

Between a grantor and a fiduciary of any trust;

5.

Between a fiduciary of a trust and the fiduciary of another trust, if the same person is a grantor with respect to each trust; or

6.

Between a fiduciary of a trust and a beneficiary of such trust. 115

A loss claimed by a parent company from the sale of stock investments to a wholly owned subsidiary was disallowed where the transfer was not warranted by a business purpose other than to save income tax (Crown Cork International Corp., 4 T.C. 19, affirmed 194 F[2d] 968). Losses arising from distributions to an individual by a corporation in liquidation are excluded from the operation of Section 31(b)(2) and (3), but not the losses from the sales of corporate assets in aid of distribution (Mathews vs. Squire, 59 F. Supp. 827).

116


CHAPTER V I I TAXABLE BASES A N D TAX RATES

Chapter V I I deals with the different taxable bases and income tax rates. The following sections of the Tax Code will be discussed here: 1.

Section 24 - Income tax rates on citizens and resident aliens;

2.

Section 25 - Tax on non-resident alien individuals;

3.

Section 27 - Tax on domestic corporations;

4.

Section 28 - Tax on foreign corporations;

5.

Section 29 - Imposition of improperly accumulated earnings tax; and

6.

Section 33 - Special treatment of fringe benefits.

In Chapter I of this book, we discussed that the Philippines has adopted the semi-schedular or semi-global income tax system. For this reason, each type or group of income is subject to one set of graduated income tax rates (on the part of an individual), or normal or minimum corporate income tax rates (on the part of a corporation), or preferential tax rates. These tax rates are, however, applied to different tax bases depending on the type or group of income.

TAXABLE BASES Compensation income, business and/or professional income, capital gain, passive income, and other income not subject to final withholding taxes We follow the global tax system insofar as compensation income, business and professional income, capital gains, passive incomes, and other incomes that is not subject to final income tax. This means that allowable deductions under Sections 34, 37, and 38 of the Tax Code as well as personal and additional exemptions under Section 278

T A X A B L E BASES AND T A X R A T E S

279

35 of the Tax Code with respect to individuals, are deducted from the taxable gross income (except capital gains from sale or exchange of shares of stock of a domestic corporation and real property located in the Philippines, and passive incomes subject to final withholding taxes). The resulting figure is the net "taxable income." It must be noted that no deductions (whether itemized or optional standard) are allowed by law to be deducted from the gross compensation income of an individual. 1

However, there are certain alien individuals employed by regional or area headquarters, regional operating headquarters, offshore banking units, and petroleum service contractors and sub-contractors, whose taxable base is their gross compensation income without any deduction of their personal and additional exemptions. The same treatment is accorded to Filipinos employed and occupying the same positions as those of aliens employed by the above-enumerated entities. 2

Filipinos employed in Asian Development Bank occupying managerial/technical positions as those jccupied by their foreign counterparts employed in the same bank are subject to the preferential rate of 15%. 3

Gain from Sale of Property In general, the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis or adjusted basis, and the loss shall be the excess of the basis or adjusted basis over the amount realized for determining loss. The amount realized from the sale or other disposition of property shall be the sum of money received plus the fair market value of the property (other than money) received. 4

The basis of property shall be: a.

The cost thereof, if such property was acquired by purchase; or

b.

The fair market price or value as of the date of acquisition, if the same was acquired by inheritance; or

'Sec. 31, NIRC. Sec. 25(C), (D), and (E), NIRC. Their gross compensation income is subject to 15% final withholding tax. BIR Ruling No. 029-99, Mar. 10, 1999. «Sec. 40(A), NIRC. 2

3


280

c.

If the property was acquired by gift, the basis shall be the same as if it would be in the hands of the donor or the last preceding owner by whom it was not 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 loss, the basis shall be such fair market value; or

d.

If the property was acquired for less than an adequate consideration in money or money's worth, the basis of such property is the amount paid by the transferee for the property; or

e.

The basis as denned in paragraph (c)(5) of Section 40 of the Tax Code, if the property was acquired in a transaction where gain or loss is not recognized under paragraph (c) (2) also of this section.

In formula form, the gain or loss from sale of property is arrived at as follows: Gross selling price Less: Cost or adjusted basis Gain/(Loss)

P100 P20

P100 150 (P 50)

It must be noted that in determining the gain or the loss, it does not matter whether the property sold is an ordinary asset or a capital asset (except capital gains from the sale of shares of stock of a domestic corporation and real property classified as a capital asset). The same rules are followed, whether the seller is an individual or a corporation. However, in the case of sale or exchange of shares of stock of a domestic corporation or real property located in the Philippines that is considered as a capital asset, the amount of the gross selling price or fair market value as determined by the Commissioner on the date of sale, whichever is higher, shall be used in determining the gain or loss. The term "adjusted basis" means the original cost to acquire the property plus amounts spent for new buildings, improvements, betterments, and other capital expenditures made to increase the value of any property or materially prolong the life of the property less accumulated depreciation up to the date of sale. Nature of Asset or Property The kind of income tax applicable on the property transaction depends on the nature of the property sold or exchanged. The nature


281

of the asset is, however, not material with respect to certain passive investment incomes subject to final taxes at preferential tax rates. a.

Ordinary asset. - If the property sold is classified as an ordinary asset, income tax due is the normal corporate income tax computed at 30% of its net taxable income (in the case of corporations), or the graduated income tax rates ranging from 5% to 32% applied on his net taxable income (in the case of individuals other than a non-resident alien not engaged in trade or business in the Philippines). Actual income or gain. - The actual gain from the sale of real property classified as an ordinary asset by an individual or corporation is subject to income tax at the graduated income tax rates (in the case of individuals), or at 30% of its net taxable income (in the case of a corporation). The gain is arrived at by deducting the cost or adjusted basis of the property sold from the amount realized (i.e.. amount of cash and/or fair market value of property received). As a general rule, the income tax law imposes the tax only when there is actual income, gain or profit. 5

6

b.

Capital asset. - In general, if the real property located in the Philippines is classified as a capital asset, the income tax due from the sale or exchange thereof is the capital gains tax computed at 6% of the actual consideration or fair market value of the real property at the time of sale as determined by the Commissioner, whichever is higher. If the shares of stock of a domestic corporation sold are unlisted, or if the shares of stock of a domestic corporation sold are listed but not traded in the local stock exchange, and they are classified as capital assets because the seller is not a dealer in securities, the income tax due is the capital gains tax computed at 5% on the first P100,000 net capital gain and 10% on the net capital gain in excess of P100,000. Presumed income or gain. - Where an individual or a corporation sold real property (land and/or building) classified as a capital asset, the law presumes that there was a capital gain realized, and the capital gains tax is computed at 6% of the actual consideration or the fair

6

Sec. 24(A) and Sec. 25(A), NIRC. "Sec. 27(A) and Sec. 28(A), NIRC.


282

market value at the time of sale of the real property, whichever is higher. In other words, regardless of whether or not the seller makes a profit or incurs a loss from the transaction, the capital gains tax must be paid thereon by the seller. However, no donor's tax is due on the transfer of said real property for less than its full and adequate consideration pursuant to Section 100 of the Tax Code because the basis for computing the capital gains tax is the higher amount between the consideration and the fair market value. This is an exception to the general rule that there must be actual income, gain or profit realized by the taxpayer in order that income tax may be imposed thereon. 7

The rule described above on the presumed income or gain in the sale of real property classified as capital asset and located in the Philippines is not applicable, however, to the sale of shares of stock of a domestic corporation. Passive Investment Incomes Passive investment incomes subject to final withholding taxes are taxed on the gross amount, without any deduction of cost and expenses of sale.

TAX RATES Graduated Income Tax Rates on Taxable Income of Individuals In relation to Section 23 of the Tax Code, the taxable income (i.e., the pertinent items of gross income less deductions and/or personal and additional exemptions authorized for such types of income by the Tax Code or other special laws) derived for each taxable year: 1.

From all sources within and without the Philippines, by every individual citizen of the Philippines residing therein;

2.

From all sources within the Philippines only, by an individual citizen of the Philippines who is residing outside of the Philippines, including overseas contract workers;

3.

From all sources within the Philippines only, by an individual alien who is a resident of the Philippines, or who is not residing but engaged in trade or business in the Philippines, shall be subject to the graduated income tax

7

Sec. 24(D)(1), Sec. 25(B)(3), and Sec. 27(DX5), NIRC.


283

in accordance with the following schedule in Section 24(A) of the Tax Code: N o t over PIO.OOO O v e r P10,000 but not over P30.000 O v e r P30.000 but not over P70.000 O v e r P70.000 but not over P140.000 O v e r P140,000 but not over P250,000 O v e r P250,000 but not over P500,000 O v e r P500.000

5% P500 + 10% of the excess O v e r P10.000 P2,500 + 15% of the excess O v e r P30,000 P8.500 + 20% of the excess O v e r P70,000 P22,500 + 25% of the excess O v e r P140,000 P50.000 + 30% of the excess O v e r P250,000 P125.000 + 34% (1998), 33% (1999), 32% (beginning 2000) e

With respect to compensation income of alien and Filipino employees of regional area headquarters, regional operating headquarters, offshore banking units, and foreign petroleum service contractors and sub-contractors, the applicable rate of tax on their gross income from sources within the Philippines is 15%. Capital gains from sale of shares of stock of a domestic corporation of an individual subject to the final capital gains tax 1.

Shares of stock of a domestic corporation listed and traded in a local stock exchange Gross selling price Multiplied by rate of tax Stock transaction tax

2.

P 500,000 x h of 1% P 2.500 x

Unlisted shares of stock of a domestic corporation, or listed shares but not traded in a local stock exchange (or traded over the counter) Gross selling price Less: Cost Gain Multiplied by rates

P

of

tax

500,000

300,000 P 200,000 x (5%/10%)

"Since the regular corporate income tax rate has been reduced from 35% to 30% beginning Jan. 1, 2009 pursuant to R.A. No. 9337, it appears that doing business in corporate form is preferable than through a single proprietorship, who is taxed at the progressive maximum tax rate of 32%.


284

Capital gains tax: P100,000x5% = P 5,000 100,000x10% = 10,000 3.

P 15.000

Shares of stock of a foreign corporation (whether or not listed in a foreign bourse) held for more than 12 months: Gross selling price Less: Cost Gain Taxable gain (50%) Multiplied by rate of tax

P 500,000 300,000 P 200,000

Ordinary income tax due

P 14.500

P 100,000 x 5%-3%

Passive Income of an Individual Subject to Preferential Tax Rates As a general rule, income, gain, or profit derived by an individual during the taxable year shall be subject to the graduated income tax rates. However, certain income subject to tax under Subsection (B) (1) - interests, royalties, prizes, and other winnings, and Subsection (B)(2) — cash and/or property dividends; Subsection (C) — capital gains from sale of shares of stock not traded in the stock exchange; and Subsection (D) - capital gains from sale of real property, all of Section 24, received by a citizen or resident alien shall not be subject to the graduated tax rates stated above. Interests, Royalties, Prizes and Winnings As a general rule, the graduated income tax rates shall apply on all taxable income of a citizen or resident alien. However, certain passive incomes such as interests from any currency bank deposit and yield or any other monetary benefit from deposit substitutes and from trust funds and other similar arrangements, royalties, prizes, and other winnings received by a citizen or resident alien are subject to preferential tax rate of twenty percent (20%), except (a) interest income from a depository bank under the expanded foreign currency deposit system which is subject to seven and one-half percent (7.5%), (b) interest income from long-term deposit or investment which is exempt from income tax, (c) royalty on books as well as other literary works and musical compositions, which shall be subject to ten percent (10%), (d) prizes amounting to P10,000 or less which shall be subject to the graduated income tax rates shown above, and (e) winnings from

T A X A B L E BASES A N D T A X R A T E S

285

Philippine Charity Sweepstakes and Lotto which shall be exempt from income tax. 9

When the recipient of the above passive incomes (i.e., cash and/ or property dividend, interest, royalties (in any form), and prizes) is a non-resident alien engaged in trade or business in the Philippines, the applicable rate of final tax is twenty percent (20%) on the total amount thereof, except (a) royalties on books as well as other literary works and musical compositions which shall be subject to 10%, but cinematographic films and similar works payable to a non-resident person shall be subject to 25% tax under Section 28 of this Code; (b) interest income from long-term deposit or investment which shall be exempt from income tax, unless pre-terminated; (c) prizes amounting to P10,000 or less which shall be subject to the graduated income tax rates; and (d) winnings from PCSO and Lotto which shall be exempt from income tax. However, if the recipient of the above passive incomes is a non-resident alien not engaged in trade or business in the Philippines, the applicable rate of final tax is twenty-five percent (25%) on the total amount thereof. 10

11

Cash prizes won by local players/participants in golf tournaments are not passive incomes inasmuch as participating in golf tournaments is their profession and/or occupation. Such being the case, the cash prizes are subject to the rates under Section 24(A) and not to 20% final withholding tax imposed by Section 24(B). 12

Cash and Property Dividends The cash and/or property dividends actually or constructively received by a citizen or resident alien from a domestic corporation or from a joint stock company, insurance or mutual fund company and a regional operating headquarters of a multinational company, or on the share of an individual in the distributable net income after tax of a partnership (except a general professional partnership) of which he is a partner, or on the share of an individual in the net income after tax of an association, a joint account, or a joint venture or consortium taxable as a corporation of which he is a member or co-venturer, shall be subject to the following rates: 6% beginning January 1,1998; 8% beginning January 1,1999; and 10% beginning 9

Sec. 24(B)(1), NIRC. Sec. 25(A)(2), NIRC. "Sec. 25(B), NIRC. "BIR Ruling No. 052, Feb. 19, 1988.

10


286

January 1, 2000. However, the tax on dividends shall apply only on income earned on or after January 1, 1998. Thus, income forming part of retained earnings as of December 31, 1997 shall not, even if declared or distributed on or after January 1, 1998, be subject to this tax. 13

Sale of Real Property Classified as Capital Asset by an Individual A citizen, including estates and trusts, is presumed to have realized capital gain from the sale, exchange, or other disposition of real property located in the Philippines, classified as capital asset, including pacto de retro sales and other forms of conditional sales. Such transaction shall be subject to the final tax of six percent (6%) based on the gross selling price or current fair market value as determined by the Commissioner in accordance with Section 6(E) of the Tax Code, whichever is higher, notwithstanding the provisions of Section 39(B) of the Tax Code. However, if the buyer of real property classified as capital asset is the government or any of its political subdivisions or agencies, or to government owned or controlled corporations, the tax liability shall be determined either under Section 24(A) - graduated income tax rates applied on taxable income, or under this Subsection - 6% final tax based on gross selling price or fair market value, whichever is higher. If the recipient of the presumed capital gain from sale or disposition of real property classified as capital asset is an alien (whether or not engaged in trade or business in the Philippines), he shall be subject to the 6% final tax based on the gross selling price or fair market value, whichever is higher. 14

15

Zonal Value or Fair Market Value of Real Property Zonal valuation has been determined for the purpose of establishing a more realistic basis for real property valuation and since internal revenue taxes, one of which is capital gains tax, shall be assessed on the basis of said zonal valuation, the valuation existing at the time of sale should be taken into account. The zonal valuation prescribed in RAMO No. 3-87 took effect on June 3, 1987. The zonal valuation in force prior thereto is RAMO No. 3-86, as amended by "Sec. 24(B)(2), NIRC. Sec. 25(A)(3) and (B), NIRC. Sec. 6(E), NIRC authorizes the Commissioner to prescribe zonal values of real property 14

15

16

RAMO No. 3-86A. Reference to zonal value in the 1997 Tax Code, except in Section 6 thereof, was removed and fair market value is used instead in order to prevent confusion arising from the use of both terminologies and also to remove discretion of revenue officers and taxpayers alike in computing the national internal revenue taxes. Formula in Determining Fair Market Value of Improvements

17

Determine the value of improvements by using the formula shown below: Total selling price/consideration per deed of sale (land and improvement) Less: Zonal value of land Value of improvement

Pxxx xxx Pxxx

The value of the improvement arrived at under this computation shall not be lower than the fair market value appearing in the latest tax declaration, covering said improvement, at the time of the aforesaid improvement transaction/transfer. The fair market value per latest tax declaration at the time of sale or disposition, duly certified by the city/municipal assessor, shall be used. No adjustments shall be added on said value, provided that the tax declaration bears the upgraded fair market value of said property pursuant to R.A. No. 7160 and the last paragraph of the Local Assessment Regulations No. 1-92 dated October 6, 1992. In case the tax declaration being presented was issued three or more years prior to the date of sale or disposition of the real property, the seller/transferor shall be required to submit a certification from the assessor whether or not the same is still the latest tax declaration covering said property; otherwise, the taxpayer shall secure its latest tax declaration and submit a copy thereof, duly certified by said assessor. Sale of Principal Residence When the real property sold or disposed by a natural person (e.g., citizen or resident alien) is a capital asset and is used as his principal residence, the capital gains presumed to have been realized from the sale or disposition thereof, shall be exempt from the 6% capital gains tax, provided that (a) the proceeds of sale is fully utilized in 16 17

BIR Ruling No. 174, May 4, 1988. Rev. Audit Memo Order No. 1-01, Feb. 15, 2001.


288

acquiring or constructing a new principal residence within 18 calendar months from the date of sale or disposition, (b) the Commissioner is duly notified by the taxpayer within 30 days from the date of sale or disposition through a prescribed return of his intention to avail of the tax exemption, and (c) the tax exemption is availed only once every 10 years. The historical cost or adjusted basis of the real property sold or disposed shall be carried over to the new principal residence built or acquired. If there is no full utilization of the proceeds of sale or disposition, the portion of the gain presumed to have been realized from the sale or disposition shall be subject to the capital gains tax. For this purpose, the gross selling price or fair market value at the time of sale, whichever is higher, shall be multiplied by a fraction which the unutilized amount bears to the gross selling price in order to determine the taxable portion and the tax prescribed under paragraph (1) of this Subsection shall be imposed thereon. 18

Regular Corporate Income Tax (RCIT) Unless otherwise provided for in the Tax Code, the rates of normal corporate income tax on net taxable income from worldwide sources of a domestic corporation, or from sources within the Philippines of a resident foreign corporation during the calendar year are as follows: R A No. 8424: 35% - up to December 31, 1997; 34% - effective January 1, 1998; 33% - effective January 1, 1999; 32% - effective January 1, 2000; RJL. N O . 9337: 35% - effective November 1, 2005; and 30% - effective January 1, 2009 and thereafter. In the case of corporations adopting the fiscal year accounting period, the taxable income shall be computed without regard to the specific date when specific sales, purchases, and other transactions occur. Their income and expenses for the fiscal year shall be deemed earned and spent equally for each month of the period. The reduced 18

Sec. 24(D), NIRC; Rev. Regs. Nos. 13-2000 and 14-2000.

TAXABLE BASES AND T A X RATES

289

corporate income tax rates shall be applied on the amount computed by multiplying the number of months covered by the new rates within the fiscal year by the taxable income of the corporation for the period, divided by twelve. 19

If a corporation is under the fiscal year accounting period (April, 2005 to March 2006), how shall the Income tax due for fiscal year 2005 be computed if the taxable income for the year is P100,000.00? The income tax due for the year shall be computed as follows: Formula:

20

No. of months covered by 32%

Taxable Income x — T T — F T Z - — X 32% = No. of months covered by 35% Taxable Income x ^ x 35% =

P xx

TOTAL TAX DUE PER ITR

P xxx

?

xx

Example: A corporation has an income for calendar year 2005 of P200,000.00. How shall the Income tax due for 2005 be computed? The income tax due for the year shall be computed as follows: P200,000.00xl0 12 P200,000.00x2 12

3

x

3

2

5

% =

%

p

P200,000.00x5 12

ii.666.67

=

Tax Due for 2005 Before any claim For tax credits P200,000.00x7 12

5 3 333.33

P 65.000.00 37,333.33

x

3

2

%

=

P

x

3

5

%

=

P29.166.67

Tax Due for fiscal year 2005 before claim of available Tax credits "Sec. 27(AXD and Sec. 28(A)(1), NIRC. »RMC 16-2006, Feb. 21, 2006.

P 66.500.00


290

Minimum Corporate Income Tax (MCIT)

21

A minimum corporate income tax of two percent (2%) of the gross income as of the end of the taxable year is imposed on a corporation taxable under Title II (Income Tax), beginning on the fourth taxable year immediately following the year in which such corporation commenced its business operations, when the minimum income tax is greater than the (normal corporate income) tax computed Subsection (A) of this Section for the taxable year. Any excess of the minimum corporate income tax over the normal income tax shall be carried forward and credited against the normal income tax for the three immediately succeeding taxable years. For purposes of applying the minimum corporate income tax, the term "gross income" shall mean 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. For trading or merchandising concern, "cost of goods sold" shall include the invoice cost of the 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" shall include 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. In the case of taxpayers engaged in the sale of service, "gross income" means gross receipts less sales returns, allowances, discounts and cost of services. "Cost of services" shall mean all direct costs and expenses necessarily incurred to provide the services required by the customers and clients, including (a) salaries and employee benefits of personnel, consultants and specialists directly rendering the service, and (b) cost of facilities directly utilized in providing the service, such as depreciation or rental of equipment used and cost of supplies. In the case of banks, "cost of services" shall include interest expense. "Direct costs and expenses" shall only pertain to those costs exclusively and directly incurred in relation to the revenue realized by the sellers of services. In fine, these refer to costs which are considered 22

21

RMC 4-2003 clarified the different items of direct costs and expenses of various sellers of services for purposes of MCIT. Sec. 27(E) and Sec. 28(A)(2), NIRC. 22


291

indispensable to the earning of the revenue such that without such costs, no revenue can be generated. Thus, expenses and other costs dispensed outside the ambit of what has been denned herein as 'direct costs and expenses' are not items allowed for inclusion to "cost of services." 23

MCIT for insurance companies. — The gross revenue of insurance companies (life and non-life) shall include direct premium and reinsurance assumed (net of returns, cancellations); miscellaneous income; investment income not subject to final tax; released reserve; and all other items treated as gross income under Section 32 of the Tax Code. Their costs of services or direct cost and identifiable direct revenue-related deductions shall refer to those incurred costs which are exclusively related or otherwise considered indispensable to the creation of the revenue from their business activity as an insurance company, including the generation of investment income not subject to final taxes, and shall be limited to the following: (a) claims, losses, maturities and benefits, net of reinsurance recoveries; (b) additions required by law to reserve fund; and (c) reinsurance ceded. 24

25

For purposes of the regulations, the term "normal income tax" means the income tax rates prescribed under Section 27(A) and Section 28(A)(1) of the Tax Code at 34% on January 1, 1998; 33% effective January 1,1999; 32% effective January 1,2000 until October 31, 2005; 35% effective November 1, 2005; and 30% effective January 1, 2009 and thereafter. In the case of a domestic corporation whose operations or activities are partly covered by the regular income tax system and partly covered under a special income tax system such as BOI-registered firm, the MCIT shall apply on operations covered by the regular income tax system The MCIT shall apply only to domestic corporations subject to the normal corporate income tax; hence, proprietary educational institutions and non-profit hospitals, FCDU, and firms under R.A. No. 7916 (PEZA Law) and R.A. No. 7227 (BCDA Law) are exempt from this tax. The Manila Banking Corporation which just re-opened in July, 1999 after the cessation of business activities since 1987, is entitled 23 24 26

RMC 24-2008, Mar. 18, 2008. RMC 30-2008, Apr. 1, 2008. Sec. 2.27(E), Rev. Regs. No. 9-98, Aug. 25, 1998.


292

to the four-year leeway granted to similarly situated companies reckoned from 1999 relative to the imposition of the 2% MCIT. 26

In the case of resident foreign corporations, only their income from sources within the Philippines subject to the normal corporate income tax rate shall be liable to MCIT. The tax shall not apply to the following: 1.

International carriers subject to 2.5% on their gross Philippine billings;

2.

Offshore Banking Units;

3.

Regional Operating Headquarters;

4.

Firms registered with PEZA and SBMA, CDA, CJHDA, and other similar ecozones and freeport zones.

For more information about MCIT, please go to Chapter XI (FBT, IAET, MCIT, and Final Tax on Income of Enterprises Registered with Special Economic and Freeport Zone Authorities). Domestic Corporations Subject to Preferential Tax Rates Domestic corporations' enjoying preferential tax rates include: a.

Proprietary educational institutions and hospitals. - Proprietary educational institutions and hospitals which are nonprofit shall pay a tax often percent (10%) on their taxable income, except those items of income covered by Subsection (D) hereof, which are interest income from deposits and yield or any other monetary benefit from deposit substitutes and from trust funds and similar arrangements; capital gains from sale of shares of stock not traded in the stock exchange; tax on income derived under the expanded foreign currency deposit system; intercorporate dividends; and capital gains realized from the sale, exchange or disposition of lands and/or buildings.

b.

Foreign currency deposit unit of a local universal or commercial bank. - Income derived by a depository bank under the expanded foreign currency deposit system from foreign currency transactions with local commercial banks, including branches of foreign banks that may be authorized by the Bangko Sentral ng Pilipinas (BSP) from

^BIR Ruling 007-2001, Feb. 22, 2001.


293

foreign currency transactions with local commercial banks, including branches of foreign banks that may be authorized by the BSP to transact business with offshore banking units, including any interest income derived from foreign currency loans granted to residents, shall be subject to a final income tax at the rate of ten percent (10%) of such income. 27

c.

Firms that are taxed under a special income tax regime, such as enterprises registered with the PEZA Law (R.A. No. 7916, as amended) and the Bases Conversion and Development Act (R.A. No. 7227), are subject to the 5% final tax on gross income earned after the expiration of the income tax holiday, if qualified. 28

d.

Private educational institutions. — All revenue and assets of a non-stock, non-profit private educational institution shall be exempt from taxation, provided that they are used directly, exclusively and actually for educational purposes. The educational institution must not only be a non-stock corporation. There must be a showing that it is a non-profit corporation which means that no part of its income inures directly or indirectly to any individual or member. Thus, if under its Articles of Incorporation, it is also engaged in charitable and socio-civic activities for the betterment of the Philippine masses, this shows that its revenues and assets are not used actually, directly and exclusively for educational purposes. 29

30

31

Revenues derived from and assets used in the operation of cafeterias/canteens, dormitories, hospitals, 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. Accordingly, the tax exemption does not "Sec. 27(D)(3), NIRC. Before the amendment introduced by R.A. No. 8424, FCDUs were exempt from other percentage taxes and documentary stamp tax because of the "in lieu o r provisions in the previous law. R.A. No. 8424 removed said "in lieu of" provisions; hence, they are now subject to GRT and DST. BIR Ruling No. 038-2001, Sept. 10, 2001 (Clark Development Corporation). Sec. 4(3), Art. XTV, Philippine Constitution. Sec. 1.4, Dept. Order No. 137-87, implementing Sec. 4(3), Art. XTV of the Constitution. "BIR Ruling No. 047-88, June 6, 1988. 28

29

M


294

include the canteen owned by the school operated by a concessionaire. The incomes from miscellaneous schoolrelated operations like car stickers are likewise exempt from income tax. 32

e.

Hospitals. - Revenues derived from and assets used in the operation of hospitals are exempt from taxation, provided they are owned and operated by the educational institution as an indispensable requirement in the operation and maintenance of its medical school or college. Earnings or yields realized from its passive investments arising from deposit substitute instruments {e.g., money market placements, treasury bills, etc. not derived in pursuance of its purpose as an educational institution) are subject to the 20% final tax. However, if the earnings from such passive investments are to be used directly, exclusively and actually for its educational purpose or function, then such earnings are exempt from the 20% final withholding tax, pursuant to Section 4(3), Article XTV of the Constitution. 33

34

Inter-corporate Dividends Inter-corporate dividends are not subject to tax. Dividend exclusion has always been a dominant feature of corporate income tax. It is a device for reducing extra or double taxation of distributed earnings. Since a corporation cannot deduct from its gross income the amount of dividends distributed to its shareholders during the taxable year, any distributed earnings are necessarily taxed twice, initially, at the corporate level when they are included in the corporation's taxable income, and again, at the corporation-shareholder level when they are received as dividend. Thus, without exclusion, the successive taxation of the dividend as it passes from corporation to corporation would result in repeated taxation of the same income and would leave very little for the ultimate shareholder. Before, they were subject to a final tax of only 10%. The decision to impose a final tax of only 10% on the total amount thereof "reflects the policy of discouraging complicated corporate structures as well as corporate divisions in the form of parent-subsidiary arrangements adopted to achieve a lower 35

32

BIR Ruling No. 173-88, May 3, 1988. BIR Ruling No. 009-90, Jan. 31, 1990. BIR Ruling No. 197-90, Oct. 16, 1990. Sec. 27(D)(4), NIRC currently does not subject to tax dividends received by a domestic corporation from another domestic corporation. 33

34

36


295

effective corporate income tax rate" (Filipinas Life Assurance Co. vs. Court of Tax Appeals, 21 SCRA 622, Oct. 31, 1967). Resident Foreign Corporations As a general rule, a resident foreign corporation is subject to Philippine income tax on its sources within the Philippines at 30% of its net taxable income. Its foreign-source income shall be exempt from Philippine income tax. There are, however, certain exceptions to the general rule. These are discussed hereunder: Resident Foreign Corporations Exempt from Philippine Income Tax a.

Regional or area headquarters ( R H Q ) shall mean a branch established in the Philippines by multinational companies and which headquarters do not earn or derive income from the Philippines and which act as supervisory, communications and coordinating center for their affiliates, subsidiaries, or branches in the Asia-Pacific Region and other foreign markets. 36

b.

Representative office is a branch in the Philippines of a foreign multinational corporation whose activities are limited to information dissemination, product promotion, and the performance of quality control of goods for export to its head office or affiliates.

Regional area headquarters and representative offices of multinational corporations in the Philippines are exempt from income tax since they are not engaged in business in the Philippines nor derive any active business income from sources within the Philippines. However, income from passive investments like interest income on bank deposits or deposit substitutes in the Philippines is subject to the final withholding tax. Resident Foreign Corporations Subject to Preferential Tax Rates a.

International carriers by air or water. - An international carrier doing business in the Philippines shall pay

^Sec. 22(DD), NIRC and Art. 50, E.O. No. 226. The organization of an RHQ in the Philippine will not create a permanent establishment for the non-resident foreign corporation within the purview of the tax treaty (BIR Ruling No. 094-96, Aug. 10,1996).


296

a tax of two and one-half percent (2-1/2%) on its "Gross Philippine Billings." Philippine tax treaties generally reduce the rate to 1.5%. 37

b.

Offshore banking units. - The provisions of any law to the contrary notwithstanding, income derived by offshore banking units authorized by the Bangko Sentral ng Pilipinas (BSP) from foreign currency transactions with local commercial banks, including branches of foreign banks that may be authorized by the BSP to transact business with offshore banking units, including any interest income derived from foreign currency loans granted to residents, shall be subject to a final income tax at the rate of ten percent (10%) of such income. 38

Income derived by an FCDU or an OBU from foreign currency transactions with residents of the Philippines, including local commercial banks, local branches of foreign banks, and other depository banks under the foreign currency deposit system, shall be subject to a final withholding tax often percent (10%). Income from foreign currency transactions shall include interest from lending operations, including bank charges, commissions, service fees, and net foreign exchange transactions gains. Income foreign currency transactions with non-residents of the Philippines shall not be subject to income tax by express provision of the law. The person making the income payment shall withhold and remit the tax pursuant to the provisions of Sections 57 and 58 of the Tax Code. 39

Income derived by an FCDU or an OBU from activities other than foreign currency transactions shall be subject to the pertinent income taxes prescribed under Sections 27 or 28 of the Tax Code. c.

Regional operating headquarters (ROHQ) shall pay a tax often percent (10%) of their net taxable income from sources within the Philippines. 40

37

Sec. 28(A)(3), NIRC. Sec. 28(A)(4), NIRC. Before the amendment introduced by R.A. No. 8424, OBUs were exempt from other percentage taxes and documentary stamp tax because of the "in lieu o r provisions in the previous law. R.A. No. 8424 removed said "in lieu o r provisions; hence, they are now subject to GRT and DST. Sec. 2.27, Rev. Regs. No. 10-98, Aug. 25, 1998. "Sec. 28(A)(6)(b), NIRC. 38

3s


297

Coca-Cola Far East, Ltd as a regional operating headquarters rendering services to its affiliates, branches and subsidiaries is subject to the 5% (now 10%) creditable withholding tax. 41

d.

Foreign currency deposit unit in the Philippines of a foreign bank. - Income derived by a depository bank under the expanded foreign currency deposit system from foreign currency transactions with local commercial banks, including branches of foreign banks that may be authorized by the Bangko Sentral ng Pilipinas (BSP) from foreign currency transactions with local commercial banks, including branches of foreign banks that may be authorized by the BSP to transact business with offshore banking units, including any interest income derived from foreign currency loans granted to residents, shall be subject to a final income tax at the rate of ten percent (10%) of such income. 42

e.

Branch of foreign corpora Hons registered with PEZA, SBMA, CDA, CJHDA, etc. - After the income tax holiday of PEZA-registered firms, their gross income earned shall be subject to the 5% final tax. However, enterprises registered under R.A. No. 7227 (BCDA law) are not entitled to income tax holiday; hence, immediately subject to the 5% final tax on their gross income earned. Subic Bay Regional Enterprises are entitled to additional deductions, which deductions are not available to ordinary enterprises registered with SBMA. 43

f.

Qualified service contractor and sub-contractor engaged in petroleum operations in the Philippines. — By furnishing by charter or otherwise specialized offshore service and supply vessels to offshore oil drilling rigs, petitioner is not an international carrier subject to the gross Philippine billings. "Gross income" means all income earned or received as a result of the contract entered into 44

41

BIR Ruling No. 040-2001, Sept 18,2001. Imposing a 10% expanded withholding tax on the services fees paid to an ROHQ which is subject to its net income at 10% is clearly unreasonable, because the creditable withholding tax will always be higher than its income tax based on net taxable income. «Sec. 28(A)(7)(b), NIRC. "Rev. Regs. No. 1-90 and 16-99, Sept. 27, 1999. "P.D. Nos. 87 and 1354.


298

by the sub-contractor with a service contractor engaged in petroleum operations in the Philippines under PD 87. Hence, aside from being subject to the regular tax on income from all other sources within the Philippines, petitioner is also subject to the final tax equivalent to 8% of its gross income derived from its contract with the service contractors engaged in petroleum operations (Zapata Marine Services Ltd vs. CTA, et al., G.R. No. 80046, Apr. 18, 1988). The term "subcontractor" as used in P.D. No. 1354 includes subcontractor at whatever tier, who performs petroleum operations as defined under P.D. No. 87. Therefore, the 8% final tax which is in lieu of all national and local taxes is applicable to subcontractors at whatever tier. 45

Income of a domestic corporation or resident foreign corporation subject to preferential tax rates As a general rule, all taxable income of a domestic corporation or resident foreign corporation is subject to the flat tax rate of 30%. However, the following incomes are subject to preferential tax rates: 1.

Certain passive incomes such as interests from any currency bank deposit and yield or any other monetary benefit from deposit substitutes and from trust funds and other similar arrangements, and royalties derived from sources within the Philippines by a domestic corporation or resident foreign corporation are subject to preferential tax rate of twenty percent (20%), except interest income from a depository bank under the expanded foreign currency deposit system which is subject to seven and one-half percent (7.5%). 46

2.

45

46

Net capital gains realized by a domestic corporation or resident foreign corporation during the taxable year from the sale, exchange or other disposition of shares of stock in a domestic corporation, except shares sold or disposed of through the stock exchange, shall be subject to the final tax at the following rates: (a) 5% on net capital gains not

BIR Ruling No. 024-2000, May 24, 2000. Sec. 27(D)(1) and Sec. 28(A)(7)(a), NIRC.


299

over P100,000; and (b) 10% on net capital gains in excess ofP100,000. 47

3.

Dividends actually or constructively received by a domestic corporation or resident foreign corporation from another domestic corporation shall not be subject to tax. 48

4.

Presumed capital gain from sale or disposition of lands and/ or buildings which are not actually used in the business of a corporation and are treated as capital assets is subject to the 6% final tax based on the gross selling price or fair market value, whichever is higher. 49

Income of Non-resident Foreign Corporation Subject to Preferential Tax Rates The following incomes of a non-resident foreign corporation are subject to the preferential tax rates and final withholding taxes: 1.

Non-resident cinematographic film owner, lessor, or distributor shall pay a tax of tw enty-five percent (25%) of its gross income from sources within the Philippines. 50

2.

Non-resident owner or lessor of vessels chartered by Philippine nationals shall be subject to a tax of four and one-half percent (4-1/2%) of gross rentals, lease or charter fees from leases or charters to Filipino citizens or corporations, as approved by the Maritime Industry Authority. 51

3.

Non-resident owner or lessor of aircraft, machineries and other equipment shall pay a tax of seven and one-half percent (7-1/2%) of their gross rentals or fees. 52

4.

Interest income on foreign loans contracted on or after August 1, 1986 shall be subject to a final withholding tax of twenty percent (20%). 53

5.

47 48

Sec. 27(D)(1) and Sec. 28(A)(7)(a), NIRC. Sec. 27(D)(4) and Sec. 28(A)(7)(d), NIRC. Sec. 27(D)(5), NIRC. Sec. 28(B)(2), NIRC. Sec. 28(B)(3), NIRC. Sec. 28(B)(4), NIRC. Sec. 28(B)(5)(a), NIRC.

49 M

Cash and/or property dividends received from a domestic corporation shall be subject to a final withholding tax at the

61

62

63

300


rate of fifteen percent (15%), subject to the condition that the country in which the nonresident foreign corporation is domiciled shall allow a credit against the tax due from the nonresident foreign corporation taxes deemed to have been paid in the Philippines equivalent to seventeen percent (17%), which represents the difference between the regular income tax of thirty-two percent (32%) on corporations and the fifteen percent (15%) tax on dividends as provided in this subparagraph. When the country of residence of the non-resident foreign corporation does not impose income tax on dividends paid by a domestic corporation, there is substantial compliance with the above condition on "deemed paid" tax credit, and only 15% shall be withheld by the domestic corporation paying the dividend to the foreign corporation. 54

55

Net capital gains realized by a non-resident foreign corporation during the taxable year from the sale, exchange or other disposition of shares of stock in a domestic corporation, except shares sold or disposed of through the stock exchange, shall be subject to the final tax at the following ra^es: (a) 5% on net capital gains not over P100,000; and (b) 10% on net capital gains in excess of P100,000. 56

"Sec. 28(B)(5)(b), NIRC. Beginning Jan. 1, 2009, RCIT has been reduce to 30% under R.A. No. 9337. ^Wander Philippines vs Commissioner, supra. Sec. 28(B)(5)(c), NIRC. M

CHAPTER V I I I ORDINARY ASSETS A N D CAPITAL ASSETS A N D TAX-FREE EXCHANGES

Chapter VIII will discuss the two (2) types of assets - capital asset and ordinary asset - recognized under Sections 39 (Capital Gains and Losses) and 40 (Determination of Amount and Recognition of Gain or Loss) of the Tax Code as well as the tax-free exchanges allowed under Section 40(C)(2) of the Tax Code. Importance of Knowing the Nature of the Asset Knowledge of the nature of the asset sold or exchange is very important to determine the kind of income tax applicable on the transaction as well as the tax rate(s) on the proper tax base {i.e., gross selling price, fair market value, or net taxable income). The character of the asset is crucial also in lessening the tax liability of the taxpayer in a legal manner upon its sale or disposition. It is worthwhile to know that where the gain from sale of property is small or when the sale results in a loss, it is best that the character of the property sold is an ordinary asset, because the cost or adjusted basis of the asset is deducted from the gross selling price and only the gain, if any, shall be subject to income tax at the graduated tax rates (if an individual) or at 30% (if a corporation). When there is a loss from sale of ordinary asset, such loss is carried forward and may be deducted from the gross income of the taxpayer for the next three succeeding taxable years. On the other hand, if the gain from the sale or transfer of property is huge, it is best to transfer the property as a capital asset, because the preferential rates are applied on the gross selling price or fair market value, whichever is higher. It is also important to determine the nature of the asset sold in order to deduct and withhold the correct withholding taxes, if any, on the transaction. For example, real property classified as ordinary asset is subject to the 0% to 6% expanded withholding tax, depending on the gross selling price, to be deducted by the buyer-withholding 301

302


agent from the gross selling price, while real property classified as capital asset is liable to the 6% final capital gains tax, which is not required to be withheld by the buyer-withholding agent. Moreover, sale of other properties are generally exempt from creditable withholding taxes, except in a few instances where such withholding of tax is required, such as money payments by the government or payment by one of the top 20,000 Corporations.

Sale or Exchange In order to have tax consequences, the sale or exchange of property must be consummated and not just perfected. There is a sale or exchange of property when there is an effective and actual transfer of ownership of the property to another as would divest the transferor of the benefits accruing from the ownership of the property, for a valuable consideration. Thus, a mere cancellation of shares of stock by a corporation, previously received by it (Winston Bros. Co. vs. Commissioner, 76 F [2d] 381), nor the receipt of liquidated damages for failure to complete a transaction (A.M. Johnson, 32 B.T.A. 156) considered as sale or disposition. The terms "sale" or "exchange" are to be considered in the light of their ordinary meaning from a consideration of the substance of the transaction. Courts often rely on the significance of the words in common usage, assuming thereby that the legislature intended that meaning to prevail (Helvering vs. Hammel, 311 U.S. 504). Thus, forced sales, such as foreclosure sales and tax sales, have been held to be embraced within the meaning of the law. A distribution in complete liquidation has been held to be an "exchange" for the purposes of determining gain or loss (Helvering vs. Chester N. Weaver Co., 305 U.S. 293). 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. What is generally taken into account is not the perfection of the contract but the consummation thereof (U.S. Industrial Alcohol Co. vs. Helvering, 137 F. [2d] 511). However, in condemnation proceedings, the sale occurs at the time of taking of the property rather than when the proceeds of the judgment are received (Kieselback vs. Commissioner, 317 U.S. 399, 87 L. ed. 358, 63 S. Ct. 303). Dacion en pago is the transmission of the ownership of a thing by the debtor to the creditor at an accepted equivalent of the performance

O R D I N A R Y ASSETS A N D C A P I T A L ASSETS

303

A N D T A X - F R E E EXCHANGES

1

of an obligation. In dacion en pago, the debtor offers another thing to the creditor who accepts it as equivalent of payment of an outstanding debt. The undertaking really partakes in one sense of the nature of sale, that is, the creditor is really buying the thing or property of the debtor, payment for which is to be charged against the debtor's debt (Filinvest Credit Corporation vs. Philippine Acetylene Co., G.R. No. L-50449, Jan. 30,1982).

Capital Assets The term "capital assets" means property held by the taxpayer (whether or not connected with his trade or business), but does not include: 1.

Stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year; or

2.

Property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business; or

3.

Property used in trade or business, of a character which is subject to the allowance for depreciation provided in Subsection (F) of Section 34; or

4.

Real property used in trade or business of the taxpayer.

2

Since the enumeration of capital assets is made in the negative manner, the four (4) general types of assets listed are "ordinary assets." The exclusion from the term "capital assets" of property used in the trade or business of a taxpayer of a character which is subject to the allowance for depreciation is limited to property used by the taxpayer in the trade or business at the time of the sale or exchange. It has no application to gains or losses arising from the sale of real property used in the trade or business to the extent that such gain or loss is allocable to the land, as distinguished from depreciable improvements upon the land. 3

For example, a manufacturer of cement sells a vacant industrial lot. The seller of real property is certainly not a dealer of real property. The real property sold will be treated as a capital asset because it '8 Manresa 324. Sec. 39(A), NIRC. Sec. 132, Rev. Regs. No. 2.

2

3


304

is not being used in its business of manufacturing cement nor does it form part of the company's stock in trade primarily for sale in the course of its trade or business. Accordingly, the capital gains tax equivalent to 6% of the gross selling price or fair market value, whichever is higher, shall apply. However, if the real property sold is a warehouse for its raw materials and finished goods, the nature of the real property is an ordinary asset. The ordinary gain, if any, from the sale of the subdivision lot will be added to its operating and other taxable income to arrive at its gross income. After deducting allowable deductions from gross income, the resulting net taxable income will be subject to the regular corporate income tax of 30%. The expanded withholding tax deducted by the buyer-withholding agent will be credited against the income tax due. On the other hand, if the seller of real property is a subdivision developer and it sells one of the subdivision lots to another, it will be considered as a real estate dealer and the lot sold will be treated as an ordinary asset. The ordinary gain, if any, from the sale of the subdivision lot will be added to its operating and other taxable income to arrive at its gross income. After deducting allowable deductions from gross income, the resulting net taxable income will be subject to the normal corporate income tax of 30%. Sale of real property with improvements (5-door apartment) classified as commercial per tax declaration issued by the assessor is an ordinary asset. 4

Where the real property is located outside the Philippines, the regular corporate income tax of 30% shall apply, even though such property is classified as a capital asset. The preferential rate of 6% applies only when such real property is situated within the Philippines. This rule is clearly set forth in Section 24(D) of the Tax Code, with respect to sales of real property by individuals, and it is believed that when the preferential rate was extended to corporations, it was made under the same conditions granted to individuals. 5

Material Distinctions between Sale of Capital Asset and Ordinary Asset 1. Seller of real property. — The seller of real property may be: (a) an individual or a corporation, (b) he/it may be engaged in business as a real estate dealer or engaged in business other than 4

5

BIR Ruling No. 061-1996, May 22, 1996. See Rev. Memo. Circular No. 41-86.


305


real estate, and (c) it may be engaged in trade or business or not engaged in trade or business. An individual or a corporation engaged in trade or business as a real estate dealer usually sells in the ordinary course of his/its trade or business real property forming part of his/its stock in trade. He/it, therefore, sells ordinary assets. If he/it is engaged in trade or business other than real estate, the real property sold may or may not be treated as ordinary asset, depending on whether the property is used in his/its trade or business. If it is used in his/its trade or business, it is an ordinary asset; otherwise, it is a capital asset. If the individual is not engaged in any trade or business, the real property sold will be considered as a capital asset. A corporation will always be considered as engaged in trade or business. Its real property then may be a capital asset or ordinary asset, as explained above. 2. Nature of asset sold. — The nature of the real property sold will depend on whether or not it is forming part of the stock in trade primarily for sale in the course of trade or business of the seller, or it is being used in its trade or business. Only one condition of the two is enough to make the real property an ordinary asset. If both conditions above are not present, the real property is a capital asset. 3. Type of capital asset sold. — The asset, except those enumerated in Section 39(A) of the Tax Code, may be used in trade or business of the taxpayer, yet it is classified as a capital asset, or it is a capital asset being used as the principal residence of a natural person. The term "capital assets" means property held by the taxpayer (whether or not connected with his trade or business), except inventory if on hand at the end of the taxable year, stock in trade primarily for sale in the course of his trade or business, fixed assets used in his trade or business subject to depreciation, and real property used in his trade or business. 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. 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 asset. Although several

306


factors or indices have been recognized as helpful guides in making a determination, none of these is decisive; neither is the presence nor the absence of these factors conclusive. Each case must in the last analysis rest upon its own peculiar facts and circumstances (Calasanz vs. Commissioner, 144 SCRA 664, 669-670). A special type of capital asset of an individual that needs particular attention is his principal residence. As a general rule, sale of real property by an individual, classified as a capital asset, shall be subject to the 6% final tax based on the gross selling price or fair market value, whichever is higher. However, an individual selling his principal residence is exempted from the 6% capital gains tax, provided certain statutory conditions are present. 4. Tax base and tax rate as well as gain or loss from sale. — The tax base in the sale of real property classified as capital asset is the gross selling price or fair market value, whichever is higher. The law presumes that the seller (natural or juridical person) makes a gain from the sale of the real property, and such gain is subject to the 6% final tax. Thus, whether or not the seller makes a profit from the sale of real property, he has to pay the 6% capital gains tax. In fact, he has to pay the tax, even if he incurs an actual loss from the sale thereof. On the other hand, the tax base in the sale of real property classified as ordinary asset is the gain, if any, and if he incurs a loss from the sale thereof, such loss may be deducted from his gross income during the taxable year. The ordinary gain shall be added to the operating income, and the net taxable income (gross income less allowable deductions) shall be subject to: (a) the 30% regular corporate income tax, or the gross income will be subject to the 2% minimum corporate income tax, if it is higher than the normal corporate income tax due for the taxable year, in the case of a corporation, or (b) the graduated income tax rates ranging from 5% to 32%, in the case of an individual. 5. Person liable to income tax. - The person liable to pay the income tax (graduated income tax on individuals and normal or minimum corporate tax on corporations) on the gain from sale of real property classified as ordinary asset is the individual or corporation, while the person liable to pay the 6% capital gains tax on the capital gain from sale of capital asset is also the individual or corporation. 6. Obligation of buyer of asset. - In the case of sale of capital asset, the seller is responsible for the filing of the capital gains tax return and the payment of the 6% capital gains tax. The


307

AND T A X - F R E E EXCHANGES

buyer has no obligation to withhold and deduct any creditable tax, since the capital gains tax is a final tax. However, in the case of sale of an ordinary asset, the buyer is constituted as a withholding agent of the government and is required to deduct the proper expanded withholding tax from the consideration, to file the withholding tax return and to pay the tax to the BIR within the prescribed period. 7. Cost or adjusted basis upon subsequent sale. - In the case of sale of capital asset, the cost or adjusted basis of the real property sold becomes immaterial, because the tax base is the gross selling price or the fair market value, whichever is higher. However, in the case of sale of ordinary asset, the cost or adjusted basis must be duly supported with receipts and other documentary evidence in order to be deductible from gross selling price. 8. Donor's tax due on transfers for insufficient consideration. - Where the property, other than real property referred to in Section 24(D), is transferred for less than adequate and full consideration in money or money's worth, then the amount by which the fair market value of the property exceeded the value of the consideration shall, for the purpose of the donor's tax law, be deemed a gift, and shall be included in computing the amount of gifts made during the calendar year. Based on this provision, if the real property transferred is a capital asset, the capital gains tax based on the gross selling price or fair market value, whichever is higher, shall be paid by the transferor (individual or corporation). No donor's tax is due on the excess of the fair market value over the consideration since the capital gains tax is already computed on the higher amount between gross selling price or fair market value. However, if the real property transferred is classified as an ordinary asset, the excess of the fair market value over the amount of consideration shall be treated as a gift, subject to the donor's tax under Section 99 of the Tax Code. The gain or loss from sale of the real property classified as ordinary asset shall be computed as follows: amount realized less cost or adjusted basis. 6

1

9. Date of filing of tax return and payment of tax. - The capital gains tax return shall be filed and the capital gains tax paid on or before the 30th day counted from the date of sale with the Revenue District Office having jurisdiction over the location of property. Ordinary gain is reported in the regular income tax return of the 6

Sec. 100, NIRC. Sec. 40, NIRC.

7


308

seller and filed in the Revenue District Office that has jurisdiction over the principal place of business of the seller. Significance of Status of Taxpayer as Dealer of Real Property Considering that the system of income tax (global or schedular) applicable on the transaction will depend on whether or not the taxpayer-seller (individual or corporation) is a dealer of real property, and corollarily, whether or not the real property he sells or exchanges is an ordinary asset or a capital asset, it is important to know the seller's tax status as well as the nature of the real property sold. It is equally important to know the status of the seller of real property because the rate of expanded withholding tax applicable on sale of ordinary assets by a real estate dealer is subject to the graduated tax rates from 1.5% to 5%, depending on the amount of gross selling price, while sale of real property by a non-dealer of real property is pegged at 6% expanded withholding tax rate, regardless of the amount of gross selling price. A "real estate dealer" includes any person engaged in the business of buying, developing, selling, exchanging real properties as principal and holding himself out as a full or part-time dealer in real estate. 8

Guidelines in Determining whether Real Property is Capital Asset or Ordinary Asset 9

Real properties acquired by banks through foreclosure sales are considered as their ordinary assets. However, banks shall not 10

e

Sec. 4.106-1, Rev. Regs. No. 7-95, as amended. Sec. 3, Rev. Regs. No. 7-2003, Dec. 27, 2002. The statement should be qualified as follows: (1) ROPOA is not limited to real properties but may include shares of stock, loan receivables, and other properties acquired by the bank in connection with its lending transactions. Certainly, these shares of stocks, loan receivables, and other properties are capital assets of the bank based on the definition of the term "capital assets" in Section 39(A)(1) of the Tax Code. (2) With respect to the real property of the bank, it may either be an ordinary asset or a capital asset. Under Section 39(A)(1) of the Tax Code, there are three possible instances when the real property owned by the bank may be considered as ordinary asset, namely: it is held as stock in trade primarily for sale in the course of trade or business of the bank; it is a fixed asset used in its trade or business subject to depreciation; or it is real property used in trade or business. Applying these rules, a real property used in trade or business of the bank, including leased real properties, shall be treated as ordinary assets. However, an idle land is a capital asset because it is not used in the trade or business of the bank and because it cannot be considered as a stock in trade held by the bank primarily for sale in the course of its business 9

10


309


be considered as habitually engaged in the real estate business for purposes of determining the applicable rate of withholding tax. A.

Taxpayer is Engaged in Real Estate Business

Real property shall be classified with respect to taxpayers engaged in the real estate business as follows: Real estate dealer. - All real properties acquired by the real estate dealer shall be considered as ordinary assets. 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. Real estate lessor. — All real properties of the real estate lessor, whether land and/or improvements, which are for lease/rent 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. Taxpayers habitually engaged in the real estate business. — All real properties acquired in the course of trade or business by a taxpayer habitually engaged in the sale of real estate shall be considered as ordinary assets. Registration with HLURB or HUDCC as a real estate dealer or developer shall be sufficient for a taxpayer to be considered as habitually engaged in the sale of real estate. If the taxpayer is not registered with the HLURB or HUDCC as a real estate of banking. The number of real property transactions during the year is immaterial and it does not make the bank a real estate dealer because the sales are made only in compliance with the legal requirements under the Central Bank law that those real properties be disposed of within a period of five years. While a regulation has the force and effect of a law, it does so only when it is consistent with the law which it implements. It cannot go against nor modify said law. (3) Since some bank real properties that are not income-producing are classified as capital assets, their sales should not be subject to the 6% expanded withholding taxes under Rev. Regs. No. 2-98, as amended, which is credited against the corporate income tax, but rather to the 6% final capital gains tax based on the gross selling price or fair market value, whichever is higher. ( 4 ) The regulation singles out and discriminates against the banks, by excluding finance companies and insurance companies from its coverage. Previous regulations and other issuances treat these three financial institutions as a group for purposes of the capital gains tax and expanded withholding tax.


310

dealer or developer, he/it may nevertheless be deemed to be engaged in the real estate business through the establishment of substantial relevant evidence (such as consummation during the preceding year of at least six (6) taxable real estate sale transactions, regardless of amount; registration as habitually engaged in real estate business with the Local Government Unit or the Bureau of Internal Revenue, etc.). A property purchased for future use in the business, even though this purpose is later thwarted by circumstances beyond the taxpayer's control, does not lose its character as an ordinary asset. Nor does a mere discontinuance of the active use of the property change its character previously established as a business property. B.

Taxpayer Not Engaged in the Real Estate Business

In the case of a taxpayer not engaged in the real estate business, real properties, whether land, building, or other improvements, which are used or being used or have been previously used in the trade or business of the taxpayer shall be considered as ordinary assets. These include buildings and/or improvements subject to depreciation and lands used in the trade or business of the taxpayer. A depreciable asset does not lose its character as an ordinary asset, even if it becomes fully depreciated, or there is failure to take depreciation during the period of ownership. Monetary consideration or the presence or absence of profit in the operation of the property is not significant in the characterization of the property. So long as the property is or has been used for business purposes, whether for the benefit of the owner or any of its members or stockholders, it shall still be considered as an ordinary asset. Real property used by an exempt corporation in its exempt operations, such as a corporation included in the enumeration of Section 30 of the Tax Code, shall not be considered used for business purposes, and therefore, considered as capital asset under these regulations. Real property, whether single detached; townhouse; or condominium unit, not used in trade or business as evidenced by a certification from the Barangay Chairman or from the head of administration, in the case of condominium unit, townhouse or apartment, and as validated from the existing available records of the BIR, owned by an individual engaged in business, shall be treated as capital asset.

O R D I N A R Y ASSETS AND C A P I T A L ASSETS

311


C. Taxpayer Changing Business Business to Non-real Estate Business.

from

Real

Estate

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.

Treatment of Abandoned and Idle Real Properties.

Real properties formerly forming part of the stock in trade of a taxpayer engaged in 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. Real estate initially acquired by a taxpayer engaged in the real estate business shall not result in its conversion into a capital asset even if the same is subsequently abandoned or becomes idle. Properties classified as ordinary assets for being used in business by a taxpayer engaged in business other than real estate business are automatically converted into capital assets upon showing of proof that the same have not been used in business for more than two years prior to the consummation of the taxable transactions involving said properties. E. Treatment of real properties that have been transferred to a buyer/transferee, whether the transfer is through sale, barter or exchange, inheritance, donation or declaration of property dividends Real properties classified as capital or ordinary asset in the hands of the seller/transferor may change their character in the hands of the buyer/transferee. The classification of such property in the hands of the buyer/transferee shall be determined in accordance with the following rules: 1. Real property transferred through succession or donation to the heir or donee who is not engaged in the real estate business with respect to the real property inherited or donated, and who does not subsequently use such property in trade or business, shall be considered as a capital asset in the hands of the heir or donee.


312

2. Real property received as dividend by the stockholders who are not engaged in the real estate business and who do not subsequently use such real property in trade or business shall be treated as capital assets in the hands of the recipients, even if the corporation which declared the real property dividend is engaged in real estate business. 3. The real property received in an exchange shall be treated as ordinary asset in the hands of the transferee in the case of a taxfree exchange by taxpayer not engaged in real estate business to a taxpayer who is engaged in real estate business, or to a taxpayer who, even if not engaged in real estate business, will use in business the property received in the exchange. F. transfer

Treatment of real property subject of involuntary

In the case of involuntary transfers of real 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. Illustrative cases: The term "capital assets" is defined by exclusion rather than by inclusion. - Thus, the definition of capital asset must be narrowly construed, while the exclusions from such definition must be interpreted broadly. If the taxpayer sells or exchanges any of the properties enumerated, any gain or loss relative thereto is an ordinary gain or ordinary loss; the gain or loss from the sale or exchange of all other properties of the taxpayer is a capital gain or a capital loss. In the determination of whether a piece of property is a capital asset or an ordinary asset, a careful examination and weighing of all circumstances revealed in each case must be made. The following circumstances in combination show unequivocably that the petitioner was, at the time material to this case, engaged in the real estate business: (a) the parcels of land involved have in totality a substantially large area, nearly seven hectares, big enough to be transformed into a subdivision, and in the case at bar, the said properties are located in the heart of Metropolitan Manila; (b) they were subdivided into small lots and then sold on installment basis (this manner of selling residential lots is one of the basic earmarks of a real estate business); (c) comparatively valuable improvements were introduced in the subdivided lots for the unmistakable purpose of


313


not simply liquidating the estate but of making the lots more saleable to the general public; (d) the employment of J. Antonio Araneta, for the purpose of developing, managing, administering and selling the lots indicates the existence of owner-realty broker relationship; (e) the sales were made with frequency and continuity, and from these, the petitioner received substantial income periodically; (f) the annual sales volume from said lots was considerable; and (g) the petitioner, by his own tax returns, was not a person who can be indubitably adjudged as a stranger to the real estate business (Tuazon vs. Lingad, G.R. No. L-24248, July 31,1974, 58 SCRA 170). A property initially classified as a capital asset may thereafter be treated as an ordinary asset, if a combination of the factors indubitably tends 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. One strong factor against petitioner's contention is the business element of development that is very much in evidence. Petitioner did not sell the land in the condition in which they acquired it. While the land was originally devoted to rice and fruit trees, it was subdivided into small lots and in the process converted into a residential subdivision and given the name Don Mariano Subdivision. Extensive improvements like the laying out of streets, construction of concrete gutters and installation of lighting system and drainage facilities, among others, were undertaken to enhance the value of the lots and make them more attractive to prospective buyers. The audited financial statements submitted, together with the tax return in question, disclosed that a considerable amount was expended to cover the cost of improvements. There is authority that a property ceases to be a capital asset if the amount expended to improve it is double its original cost, for the extensive improvement indicates that the seller held the property primarily for sale to customers in the ordinary course of his business. Another distinctive feature of the real estate business is the existence of contracts receivables. The sizable amount of receivables in comparison with the sales volume during the same period signifies that the lots were sold on installment basis and suggests the number, continuity and frequency of the sales. 11

u

34 Am. Jur. 2d., p. 92.

314


Also, of significance is the circumstance that the lots were advertised for sale to the public and that the sales and collection commissions were paid out during the period (Calasanz. vs. Commissioner, G.R. L-26284, Oct. 9, 1986). Sale of bakery business. - An existing bakery business is not to be considered as a single piece of property but must be separated into its component parts. The sale of bakery was not a single asset but of individual assets that made up the business. Thus, it was incumbent upon the owner to point out what part of the price he had received could be fairly attributed to each asset so that the capital and/or ordinary gains taxes properly payable upon the sale of the business could be ascertained (Antonio Porta Ferrer vs. Collector, G.R. No. L-16021, Aug. 31, 1962, 5 SCRA 1022). Sale of the Nasugbu farm lands to the very farmers who tilled them. - Roxas & Company, Inc. is the owner of parcels of land located in Nasugbu, Batangas. They are part of properties originally acquired by the Roxas family. A sociedad mercantile regular, Viuda de Hijo de Pedro P. Roxas, formed in 1914, held the properties. Some in 1930, the Roxas family established a partnership known as Roxas y Compania, Limitada, and transferred the lands to the partnership. In 1981, Roxas y Compania was converted into a corporation, Roxas & Company, Inc., and the latter took over the business, properties, assets, rights, privileges, debts and liabilities of the partnership, including the lands previously owned by the Roxas family. Pursuant to the agrarian reform laws, substantial portions of the lands were acquired by the Philippine government. The remaining portions (i.e., those exempt from or not covered by the agrarian reform laws) and residential lands constitute the subject properties and remain with Roxas & Company, Inc. Up to the present, said properties remain idle or not devoted to any profitable use. The Roxas family, the partnerships and Roxas & Company, Inc. have not actually used said properties in their businesses, and some of the residential lands are already occupied by squatters. The sale of the Nasugbu farm lands to the very farmers who tilled them for generations was not only in consonance with, but more in obedience to the request and pursuant to the policy of our Government to allocate lands to the landless. It was the bounden duty of the Government to pay the agreed compensation after it had persuaded Roxas y Cia to sell its haciendas, and to subsequently subdivide them among the farmers at very reasonable terms and prices. However, the Government could not comply with its duty for


315


lack of funds. Obligingly, Roxas y Cia shouldered the Government's burden, went out of its way and sold the lands directly to the farmers in the same way and under the same terms as would have been the case had the Government done it itself. For this magnanimous act, the municipal council of Nasugbu passed a resolution expressing the people's gratitude. The power of taxation is sometimes called also the power to destroy. Therefore, it should be exercised with caution to minimize the injury to the proprietary rights of a taxpayer. It must be exercised fairly, equally and uniformly, lest the tax collector kill the "hen that lays the golden egg." And, in order to maintain the general public's trust and confidence in the Government, this power must be used justly and not treacherously. It does not conform with our sense of justice in the instant case for the Government to persuade the taxpayer to lend it a helping hand and later on to penalize him for duly answering the urgent call. Thus, Roxas y Cia cannot be considered as a real estate dealer (Roxas vs. CTA and Commissioner, G.R. No. L-25043, Apr. 26, 1968). From the foregoing, it is clear that said properties are being held by Roxas & Company as capital assets, since: (a) it is not used in its business; (b) it does not form part of its inventory; (c) it is not held for speculative purposes; and (d) it is not subject to depreciation (BIR Ruling No. 133-98, Sept. 15, 1998; BIR Ruling BA-175-03-2299). The following factors could be used in justifying that the real property is a capital asset: a.

The tax declaration clearly shows that the land was classified as residential;

b.

TCT clearly states that "all points referred to are indicated on the plan and on the ground by a corner of stone/concrete wall." This description gives truth to the taxpayer's claim that the properties sold were secured by a high hollow block fence and had been used as a family compound or purely for residential purposes, for if the land was used for commercial purposes, then it should not have been enclosed by a high concrete fence as this would hamper access into the land and building by customers;

c.

The findings submitted by the revenue officer, after an ocular inspection conducted on the properties sold, which


316

were agreed to by the group supervisor, clearly point to the fact that the land/improvement was a capital asset. On the other hand, the reviewing examiner classified the property sold located in Adriatico Street, Manila, as an ordinary asset, since it was a located in a busy thoroughfare, so the land and building located therein are presumed used for commercial purposes. The general conclusion of the reviewing examiner is baseless and constitutes a blatant disregard of the reality that even in the heart of far more busy Binondo district, there are still lots and buildings actually used for residential purposes by the rich and affluent businessmen. Between the findings of the investigating examiner and the conclusion of the reviewing examiner which was arrived at without caring to examine the real properties in question, the former deserves more evidentiary weight for the issue involved is factual.

Six percent (6%) Capital Gains Tax on Presumed Gain

12

The rate of six percent (6%) shall be imposed on capital gains presumed to have been realized by the seller from the sale, exchange or other disposition of real properties located in the Philippines, classified as capital assets, including pacto de retro sales and other forms of conditional sales based on the gross selling price or fair market value as determined by the Commissioner of Internal Revenue in accordance with Section 6(E) of the 1997 Tax Code, whichever is higher. 13

In case of disposition of real property made by individuals to the government or to any of its political subdivisions or agencies or to government-owned or controlled corporations, the tax to be imposed shall be determined either under the normal income tax rate imposed in Section 24(A) or under a final capital gains tax of six percent (6%) imposed under Section 24(D)(1), both of the 1997 Tax Code, at the option of the taxpayer. Within thirty (30) days following each sale or disposition, the capital gains tax return shall be filed by the seller and payment made to an authorized agent bank located within the Revenue District 12

See Batas Pambansa Big. 37, Pres. Decree No. 1994, and Exec. Order No. 37. "R.A. No. 9182, otherwise known as the Special Purpose Vehicle Act, exempts transfers of non-performing assets, composed of non-performing loans and ROPOA, by financial institutions from capital gains tax.


317


Office having jurisdiction over the place where the property being transferred is located. 14

Foreclosure Sales of Real Property

15

In case the mortgagor exercises his right of redemption within one year from the issuance of the certificate of sale, no capital gains tax shall be imposed because no capital gains has been derived by the mortgagor and no sale or transfer of real property was realized. A certificate to that effect or the deed of redemption shall be filed with the RDO having jurisdiction over the place where the property is located, which certificate or deed shall likewise be filed with the Register of Deeds and a brief memorandum thereof shall be made by the Register of Deeds on the Certificate of Title of the mortgagor. In case of non-redemption, the capital gains tax on the foreclosure sale shall become due based on the bid price of the highest bidder but only upon the expiration of the one year period of redemption provided for under Section 6 of Act No. 3135, as amended by Act No. 4118, and shall be paid within thirty (30 days from the expiration of the said one-year redemption period. N

On January 12, 1994, Spouses Chan executed a Real Estate Mortgage over a parcel of land in Makati to guarantee the payment of a credit accommodation extended to them by Philippine American Life Insurance Company in the amount of P6.8 million Spouses Chan defaulted on their monthly amortizations prompting Philamlife to extrajudicially foreclose the property. At the auction sale held on March 20, 1995, Philamlife emerged as the highest bidder for the sum of P8.953 million, and on March 27, 1995, a Certificate of Sale was issued by the Sheriff of the RTC, Makati. On March 28, 1995, Philamlife paid the documentary stamp tax due. Without registering and annotating the Certificate of Sale on the TCT of the foreclosed property, Philamlife executed on April 21,1997 a Deed of Assignment, transferring all its rights and interests on the property to PERF, for the exact amount of Philamlife's bid price. On the same date, PERF paid the documentary stamp tax. On April 22,1997, it paid the capital gains tax, including the surcharge, interest and other penalties for late payment beginning March, 1996, one year from the date of sale, of the extrajudicial foreclosure sale.

14 ,6

Rev. Regs. No. 8-98, Aug. 25, 1998. Sec. 3, Rev. Regs. No. 4-99, Mar. 9, 1999.

318


Can PERF be assessed for capital gains tax on the Deed of Assignment executed on April 21,1997? The answer is in the positive, despite the fact that no gain was realized by Philamlife on the transfer. The capital gains tax presumed to have been realized from the sale, exchange or other disposition of real property located in the Philippines classified as capital assets, includingpacto de retro sales and other forms of conditional sales, by individuals, including estates and trusts, shall be taxed at the rate of 5% (now 6%) based on the gross selling price or fair market value prevailing at the time of sale, whichever is higher. The tax is due from the date of the issuance of the Sheriffs Certificate of Sale. Then Section 21(e) of the 1977 Tax Code was amplified by Section 2.2 of Revenue Memorandum Order No. 29-86, as amended by Revenue Memorandum Order Nos. 16-88, 27-89, and 6-92 as follows: "SECTION 2.2. The tax applies not only to ordinary sale transaction but also to pacto de retro sales and other forms of conditional sales, which necessarily includes mortgage foreclosure sales (judicial and extrajudicial foreclosure sales)." Considering that in the extra-judicial foreclosure sales under Act No. 3135, as amended by Act No. 4118, the creditor-financial institution (bank, finance or insurance company) is the statutory seller, representing the owner-mortgagor of the real property, said financial institution becomes liable for the payment of capital gains tax due on such foreclosure sale based on the bid price in the auction sale. The financial institution, however, may get reimbursement or recover the capital gains tax paid, if the right of redemption is exercised by the debtor-mortgagor or when the property is sold to any party whatsoever. Based on the foregoing, since the capital gains tax due on the extrajudicial foreclosure sale, together with the penalties, have been paid on April 22,1997 by PERF, the Deed of Assignment executed on April 21, 1997 by Philamlife in favor of PERF, whereby the former transferred to the latter all its rights and interests on the foreclosed property, the effect of that merely makes the assignee step into the shoes of the assignor without acquiring a better right than what the assignor had in the property to which the rights assigned pertain. Consequently, PERF representing the owner-mortgagor is the one liable to pay the capital gains tax due on such foreclosure sale based on the bid price in the auction sale. However, it could get reimbursement of the capital gains tax payment, if the right of redemption is exercised


319


by the debtor-mortgagor or when the property is sold to any party whatsoever. The Deed of Assignment is subject to the 6% creditable withholding tax. 16

Redemption Period As a general rule, the mortgagor-owner is given one (1) year from the date of sale within which to redeem the property sold at public auction sale from the winning bidder. The period of redemption allowed to a mortgagor-owner to redeem the real property acquired by a bank through extrajudicial foreclosure sale was, however, shortened to ninety (90) days pursuant to the General Banking Law of 2000. It must be pointed out that the period of redemption starts to run only upon the annotation of the sheriffs certificate of sale at the back of the Original or Transfer Certificate of Title with the Register of Deeds. 17

Tax-Free Exchanges

18

The entire amount of the gain or loss shall be recognized upon the sale or exchange of property, except as herein provided: 1. No gain or loss shall be recognized if in pursuance of a plan of merger or consolidation -

l6

a.

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; or

b.

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; or

c.

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.

BIR Ruling Nos. 101-89 and 118-91; RMO 41-91, par 2(d). This is already modified by the provisions of R.A. 9182 otherwise known as the Special Purpose Vehicle Act of 2002. "R.A. No. 8791, May 23, 2000. Sec. 40(C)(2), NIRC. 18


320

2.

No gain or shall be recognized if property is transferred to a corporation by a person in exchange for stock or unit of participation in such a corporation of which as a result of such exchange, said person, alone or together with others, not exceeding four (4) persons, gains control of said corporation, provided that stocks issued for services shall not be considered as issued in return for property.

While the law refers to the merger or consolidation and the exchange of property (e.g., real property, shares of stocks, receivables, etc.) for shares of stock of a corporation as a result of which the transferor gains control or further control of the corporation, the law merely defers the recognition of the gain or the loss at the time of the merger, consolidation or tax-free exchange insofar as the transferor and transferee is the concerned. Thus, upon the subsequent sale or disposition of the property covered by the merger, consolidation or tax-free exchange by the transferor or the transferee, the historical cost or basis shall be used for purposes of determining the gain or loss from the subsequent sale or transfer. In order that the historical cost or basis may be monitored upon the subsequent sale of transfer of the property, the same is required to be annotated at the back of the title of the land or the certificate of stock of the corporation and special books or records are also mandated to be maintained by the parties to the tax-free exchange. It is important to note that the taxfree exchange provision applies not only to domestic corporations and entities but also to foreign corporations and entities. The exchange of shares where plaintiffs earned as profits the difference between the market value per share of the Motor Service Company and the value per share of the Central Motor Supply Company falls within the purview of Act No. 2833, as amended by Act No. 2926, because plaintiffs exchanged their property (shares of stock of Central Motor Supply valued at P100 per share) of another property (shares of stock of Motor Service Company), which property thus received should be "considered as equivalent of money in a sum equal to its market value on the date of which the exchange was made" (W.C. Ogan and Bohol Land Transportation Co vs. Meer, G.R. No. 49102, May 30, 1949). Merger or Consolidation The plan of merger was evolved through the series of transactions, all of which could be treated as a single unit. Obviously, all these steps did not have to be completed at the time of the merger,


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as there were some of them, such as the increase and distribution of the stock of the New Corporation, which necessarily had to come afterwards. In determining whether the merger was done for a bona fide business purpose, the intention of the parties in the light of their conduct contemporaneously with, and especially after, the questioned merger should be considered. One certain indication of the scheme to evade the capital gains tax is the subsequent dissolution of the new corporation after the transfer to it of the properties of the old corporation and the liquidation of the former soon thereafter. There was a valid merger although the actual transfer of the properties subject of the Deed of Assignment was not made on the date of the merger. The Court finds no impediment to the exchange of property for stock between the two corporations being to have been effected on the date of the merger. That, in fact, was the intention, and the reason why the Deed of Assignment was made retroactive to January 1, 1959. Such retroaction provided in effect that all transactions set forth in the merger agreement shall be deemed to be taking place simultaneously on January 1, 1959, when the Deed of Assignment became operative. The certificates of stock subsequently delivered by the new corporation to the private respondents were only evidence of the ownership of such stocks. Although these certificates could be issued to them only after the approval by the SEC of the increase in capitalization of the new corporation, the title thereto, legally speaking, was transferred to them on the date the merger took place, in accordance with the Deed of Assignment. Our ruling then is that the merger in question involved a pooling of resources aimed at the continuation and expansion of business and so came under the latter and intendment of the Tax Code, as amended, exempting from the capital gains tax exchanges of property effected under lawful corporate combinations. The purpose of the legislature in granting tax exemption of gains derived from exchanges of stocks resulting from corporate mergers or consolidations was to encourage corporations in pooling, combining or expanding their resources conducive to the economic development of the country (Commissioner us. Rufino, G.R. No. L-33665-68, Feb. 27, 1987, 148 SCRA 42). 19

The reorganization of Rico Philippines Industrial Corporation and Philippine Carrageenan Manufacturing Corporation is a merger within the contemplation of Section 40(C)(2) and (6)(b) of the 1997 Tax Code. No gift tax is payable since there is no intent to donate and the transaction is effected purely for business reasons. 20

19

HB 7233, enacted into R.A. No. 1921. ^BIR Ruling DA-196-03-30-99.


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Exchange of property for shares of stock Exchange of property. - Gain or loss arising from the acquisition and subsequent disposition of property is realized only when as the result of a transaction between the owner and another person, the property is converted into another property that has a market value. The term "market value" means the fair value of the property in money as between the one who wishes to purchase and one who wishes to sell. It is not, however, what can be obtained from the property when the owner is under peculiar compulsion to sell or the purchaser to buy; nor is it a purely speculative value which an owner could not reasonably expect to obtain for the property although he might possibly be fortunate enough to do so. "Market value" is the price at which a seller willing to sell at a fair price and a buyer willing to buy at a fair price, both having reasonable knowledge of the facts, will trade. Evidence as to the assets and liabilities of a corporation and as to its earnings may furnish definite indications of the market value of its stock. 21

The transfer of properties to a corporation in exchange for shares of stock of the corporation pursuant to Section 40(C)(2) of the Tax Code, where the transferors gain control of the said corporation does not constitute a sale of properties. The transaction merely involves a change in the nature of the ownership of properties from unincorporated to incorporated entity. Ownership over the properties remains the same. 22

The Deed of Exchange of property between the Pachecos and Delpher Trades Corporation cannot be considered a contract of sale. There was no transfer of actual ownership interests by the Pachecos to a third party. The Pacheco family merely changed their ownership from one form to another. The ownership remained in the same hands. Hence, the private respondent has no basis for its claim of a right of first refusal under the lease contract. The legal right of a taxpayer to decrease the amount of what otherwise could be his taxes or altogether avoid them, by means which the law permits, cannot be doubted (Liddell & Co., Inc. vs. Collector, 2 SCRA 632). Sec. 34(C)(2) merely defers recognition of gain or loss from exchange of property. - Section 34(C)(2) (now Section 409[C][2]) of the 1997 Tax Code merely defers recognition of the gain or loss from 21

Sec. 140, Rev. Regs. No. 2. Dolpher Trades Corporation vs. Intermediate Appellate Court, 157 SCRA 349 11988). i2


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the exchange of properties, for in determining the gain or loss from a subsequent transaction of the real properties or of the stocks involved in the exchange, the original or historical cost of the properties or the stocks is considered. The amount of income derived or loss sustained from an exchange of property is the difference between the market value at the time of the exchange of the property received in exchange and the original cost or other basis, of the property exchanged. 23

24

Substituted basis of stock or securities received by the transferor The substituted basis of the stock or securities received by the transferor on a tax-free exchange shall be as follows: 25

The original basis of the property, stock or securities to be transferred; Less: Money received, if any; and Fair market value of the other property received, if any Add: Amount treated as dividend of the shareholder, if any; and Amount of any gain that was recognized on the exchange, if any. However, the property received as "boot" shall have as basis its fair market value. The term "boot" refers to the money received and other property received in excess of the stock or securities received by the transferor on a tax-free exchange. If the transferee of property assumes, as part of the consideration to the transferor, a liability of the transferor or acquires from the latter property subject to a liability, such assumption or acquisition (in the amount of the liability) shall, for purposes of computing the substituted basis, be treated as money received by the transferor on the exchange. Finally, if the transferor receives several kinds of stock or securities, the Commissioner is authorized to allocate the basis among the several classes of stocks or securities. Substituted basis of the transferred property in the hands of the transferee The substituted basis of the property transferred in the hands of the transferee shall be as follows: 23

BIR Ruling No. 038-96, Mar. 7, 1996. "Sec. 141, Rev. Regs. No. 2. Rev. Regs. No. 18-2001, Nov. 14, 2001. 26


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(a) The original basis in the hands of the transferor; (b) Plus: the amount of the gain recognized to the transferor on the transfer. Original basis of property to be transferred The original basis of the property to be transferred shall be the following, as may be appropriate: (a) The cost of the property, if acquired by purchase on or after March 1, 1913; (b) The fair market price or value as of the moment of death of the decedent, if acquired by inheritance; (c) The basis in the hands of the donor or the last preceding owner by whom the property was not acquired by gift, if the property was acquired by donation. If the basis, however, is greater than the fair market value of the property at the time of donation, then, for purposes of determining loss, the basis shall be such fair market value; or, (d) The amount paid by the transferee for the property, if the property was acquired for less than an adequate consideration in money or money's worth; (e) The adjusted basis of (a) to (d) above, if the acquisition cost of the property is increased by the amount of improvements that materially add to the value of the property or appreciably prolong its life less accumulated depreciation; (f)

The substituted basis, if the property was acquired in a previous tax-free exchange under Section 40(C)(2) of the Tax Code of 1997.

Basis for determining gain or loss on a subsequent sale or disposition of property subject of the tax-free exchange The substituted basis as denned in Section 40(C)(5) of the Tax Code, and implemented in Section 2.A and 2.B above, shall be the basis for determining gain or loss on a subsequent sale or disposition of property subject of the tax-free exchange. Submission of information on the basis of properties The parties to a tax-free exchange of property for shares under Section 40(C)(2) of the Tax Code of 1997 who are applying


325


for confirmation that the transaction is indeed a tax-free exchange shall, together with such information as the Commissioner of Internal Revenue may require, submit the following: (a) A sworn certification on the basis of the property to be transferred pursuant to such exchange. The basis of each real property/share of stock or other property transferred must be itemized in the certification in order to enable the BIR to determine the basis for subsequent disposition and to make it possible for the Register of Deeds or the corporate secretary, as the case may be, to annotate the information on such basis for each property/share of stock on the reverse side of the Transfer Certificate of Title/ Condominium Certificate of Title of the real property involved, or of Certificate of Stock. The sworn declaration must be executed by the transferor himself, or in case the transferor is a juridical entity, by an official with rank of no less than the Chief Financial Officer or his equivalent. The Commissioner of Internal Revenue is authorized to prescribe the form in which such sworn declaration shall appear; (b) Certified true copies of the Transfer Certificates of Title and/or Condominium Certificates of Title of the real properties to be transferred; (c) Certified true copies of the corresponding latest Tax Declaration of the real properties to be transferred. It is understood that any improvement is separately declared and therefore, covered by a Tax Declaration distinct from the Tax Declaration on the land. Further, if the tax declaration was issued three (3) or more years prior to the exchange transaction, the Transferor shall include in the certification by the local government unit's Assessor that such tax declaration is the latest tax declaration covering the real property; (d) Certified true copies of the certificates of stocks evidencing shares of stock to be transferred; and (e) Certified true copy of the inventory of other property/ies to be transferred. No certification/ruling will be issued by the Bureau of Internal Revenue, unless the foregoing requirements, in addition to such other documents that the Commissioner of Internal Revenue may require, are submitted.

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Other Tax-Exempt Transactions Sale of Principal Residence The term "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 in which, whenever absent, the said individual intends to return. Where ownership of the land and the dwelling house thereon belongs to different persons, e.g., where the land is leased to the dwelling house owner, only the dwelling house shall be treated as Principal Residence of the dwelling house owner. Thus, if the said land and the dwelling house thereon be jointly sold or disposed by the said owners, only the-sale or disposition of the dwelling house shall be entitled to the benefit of exemption from the capital gains tax herein prescribed: Provided, however, That where both the owner of the land and owner of the dwelling house actually reside in the said dwelling house, then both the said land and dwelling house shall be treated as their Principal Residence (e.g., owner of the land is the parent while owner of the house is his child, or vice versa). Where the land and the dwelling house thereon be owned by several co-owners, e.g., inherited by two or more heirs through hereditary succession, and where the said property is actually used as "Principal Residence" by one or more of the said co-owners, including the members of his/their family, the said property shall be treated as the Principal Residence of the co-owner/s actually occupying and using the same as his/their Principal Residence but to the extent of his/their proportionate share in the value of the principal residence. Conversely, the capital gains tax exemption benefit herein prescribed shall not apply in respect of the other co-owners who do not actually use and occupy the same as their Principal Residence. The residential address shown in the latest income tax return filed by the vendor/transferor immediately preceding the date of sale of the said real property shall be treated, for purposes of these Regulations, as a conclusive presumption about his true residential address, the certification of the Barangay Chairman, or Building


327


Administrator (in case of a condominium unit), to the contrary notwithstanding, in accordance with the doctrine of admission against interest or the principle of estoppel (e.g., if the property was sold on May 1, 2000, the vendor's annual income tax return for the year 1999, which he filed on or before April 15, 2000, showing his residential address, shall be treated as a conclusive presumption that his true residential address is that which is shown in his aforesaid income tax return). If the vendor is exempt from filing any tax return, in which case, he has no tax record immediately prior to the sale of his property, then the aforementioned certification from the Barangay Chairman or Building Administrator, as the case may be, shall suffice. When the real property sold or disposed by a natural person (e.g., citizen or resident alien) is a capital asset and his principal residence, the capital gains presumed to have been realized from the sale or disposition thereof shall be exempt from the 6% capital gains tax, provided that: (a) the proceeds of sale is fully utilized in acquiring or constructing a new principal residence within 18 calendar months from the date of sale or disposition; (b) the Commissioner is duly notified by the taxpayer within 30 days from the date of sale or disposition through a prescribed return of his intention to avail of the tax exemption; and (c) the tax exemption is availed only once every 10 years. The historical cost or adjusted basis of the real property sold or disposed shall be carried over to the new principal residence built or acquired. If there is no full utilization of the proceeds of sale or disposition, the portion of the gain presumed to have been realized from the sale or disposition shall be subject to the capital gains tax. For this purpose, the gross selling price or fair market value at the time of sale, whichever is higher, shall be multiplied by a fraction which the unutilized amount bears to the gross selling price in order to determine the taxable portion and the tax prescribed under paragraph (1) of this Subsection shall be imposed thereon. 26

In order to ensure payment of the 6% capital gains tax on sale or exchange of real property classified as capital asset, and to prevent tax leakages arising from non-compliance with the conditions for tax exemption discovered by the tax authority at a later time, payment of the capital gains tax under escrow is then required. Thus, the six percent (6%) capital gains tax otherwise due on the presumed capital gains derived from the sale, exchange or disposition of his principal residence shall be deposited in cash or manager's check in interestbearing account with an Authorized Agent Bank (AAB) under an ^Sec. 24(D), NIRC.


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Escrow Agreement between the concerned Revenue District Officer, the Seller/Transferor and the AAB to the effect that the amount so deposited, including its interest yield, shall only be released to such Seller/Transferor upon certification by the said RDO that the proceeds of sale or disposition thereof has, in fact, been utilized in the acquisition or construction of the Seller/Transferor's new Principal Residence within eighteen (18) calendar months from date of the said sale or disposition. The date of sale or disposition of a property refers to the date of notarization of the document evidencing the transfer of said property. In general, the term "Escrow" means "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. 27

Partial utilization of the proceeds of sales, exchange or disposition. - If there is no full utilization of the proceeds of sale, exchange or disposition of his old Principal Residence for the acquisition or construction of his new Principal Residence, he shall be liable for deficiency capital gains tax, inclusive of 20% interest per annum, computed from the 31st day after the date of sale or disposition of the said old Principal Residence.

Community Mortgage Program Definition of terms. - As used in these Regulations, following terms shall have the following meaning:

28

the

Community Mortgage Program (CMP) - a mortgage financing program of the National Home Mortgage Finance Corporation (NHMFC) which assists legally organized associations of underprivileged and homeless citizens to purchase and develop a tract of land under the concept of community ownership. The primary objective of the program is to assist residents of blighted areas to own the lots they occupy, or where they choose to relocate to and eventually improve their neighborhood and homes to the extent of their affordability. Socialized Housing - refers to housing programs and projects covering houses and lots or homelots only that are undertaken by the government or the private sector for the underprivileged and homeless 27

Rev. Regs. No. 14-2000, Nov. 20, 2000. Rev. Regs. No. 9-93, as amended by Rev. Regs. No. 11-97 and Rev. Regs. No. 17-2001 and RMC 3-2001. 28


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citizens, which shall include sites and services development, long-term financing, liberalized terms on interest payments, and as such other benefits in accordance with the provisions of Republic Act No. 7279. A socialized housing unit shall not exceed P400,000.00 for a house and lot package, subject to periodic adjustment or increase as the Housing and Land Use Regulatory Board (HLURB) may effect from time to time. In the case of sale of homelots only, the price shall not exceed forty percent (40%) of the maximum limit prescribed for the house and lot package. Tax Treatment of Sale of Real Properties under the Community Mortgage Program. - Properties sold under the CMP shall be exempt from the capital gains tax or ordinary income tax, and consequently from the creditable (expanded) withholding tax, whether sold by an individual, estate or trust, or by a corporation. The foregoing exemption notwithstanding, as a general rule, the documentary stamp tax shall be paid on every sale of property under the CMP, based on the higher of the actual consideration of sale stated in the document or of the fair market value to be determined by comparing the zonal value as determined by the Bureau of Internal Revenue and the Local Government Assessor's fair market value. When one of the contracting parties is the government, the documentary stamp shall be based on the actual consideration paid for the real property. Pursuant to Sections 19, 20 and 32 of R.A. No. 7279, the conveyance to the N H A by the landowner of the parcel of land under the socialized housing program is exempt from the payment of capital gains tax and documentary stamp tax. A lien on the Certificate of Title of the parcel of land, which shall be issued in the name of N H A , shall be caused to be annotated by the Register of Deeds to the effect that said property shall be used for socialized housing purposes. 29

Purok 20 Homeowner's Agri-Development & Community Association, Inc. is duly registered with the Securities and Exchange Commissioner. It serves as a facilitator and, through the CMP program of the government, it acquired a parcel of land in Antipolo, Rizal, by virtue of a loan from the National Home Mortgage Finance Corporation. The land was subdivided into homelots. The transfer 29

BIR Ruling DA-102-98, June 22, 1998; DA-184-03-25-99.


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in favor of the Association's individual member-beneficiaries of the subdivided property is not subject to either the capital gains tax or the creditable withholding tax, considering that the transfer is without any consideration it is merely a formality to finally effect transfer of said property to your member-beneficiaries who actually bought the same from the former owner through the Association. Said transfer is not subject to the donor's tax imposed under Section 93 of the 1997 Tax Code, since there is no donative intent on the part of the Association to donate said property to its memberbeneficiaries. Indeed, the Association could not donate property the ownership of which belongs to the donees (member-beneficiaries) themselves. It is noted that under Section 196 of the 1997 Tax Code, the deeds or documents subject to the documentary stamp tax are those where the realty sold shall be granted, assigned, transferred or otherwise conveyed to a purchaser or purchasers, or to any person or persons designed by such purchaser or purchasers, thereby excluding from its purview the transfer by Purok 20 Homeowner's Agri-Development & Community Association, Inc. to its member-beneficiaries under the CMP program of the government, considering that no consideration is involved in said transaction upon which the tax imposed could be based. Accordingly, the transfer of title of said property in favor of the member-beneficiaries is not subject to documentary stamp tax imposed under Section 196 of the 1997 Tax Code. However, the notarial acknowledgment to said deed of conveyance is subject to the documentary stamp tax of P15 pursuant to Section 188 of the 1997 Tax Code. 30

Deeds of Trusts The conveyance by the trustee in favor of the trustor of the shares of stock which the former acquired by virtue of a trust agreement is not to be treated as another transfer separate and distinct from the sale between the original owner and the trustee. The transfer of the shares of stock should be treated as a continuation and confirmation of title in favor of the beneficial owners and without monetary consideration. 31

™BIR Ruling DA-218-04-12-99; BIR Ruling No. CMP 171-98, Sept. 16, 1998, citing BIR Ruling No. 398-93, Oct. 11, 1993. BIR Ruling No. 013-99, Mar. 19, 1999; BIR Ruling No. 115-94; BIR Ruling DA-125-3-21-97. 31


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Transfers by Mistakes Messrs. Diamante and Anyayahan inadvertently constructed their respective houses in Lot 5, instead of Lots 4-A and 4-B, while Cynthia Pet constructed hers at Lot 6, instead of at Lot 5, and Marino Umali, Quirino Tan and Salvador Tan have built their houses at Lot 7. The execution of the M O A and Deed of Reconveyance designed to correct the series of mistakes without consideration and not to sell, exchange or otherwise dispose of real properties for the purpose of conveying title to the purchasers for a consideration is not subject to the capital gains tax and to documentary stamp tax under Section 196 of the 1997 Tax Code, since its execution is merely a formality being undertaken to place the rightful owners thereof to their respective real property. 32

A new certificate for one proprietary share of stock issued by the Tagaytay Highlands International Golf Club solely to Helen Go Chua to rectify error of joint ownership with King Go, who was listed as co-owner of the same proprietary share, without consideration, is not subject to capital gains tax. 33

Transfers of Rights The buyer of a parcel of land on installment who later paid said real property in full for his daughter did not lose his right to transfer the property, considering that title to the same lot as of the time of full payment remains in the name of the seller. Transfer of rights over real property is not subject to capital gains tax. 34

Rescinded Contracts Reconveyance of property by the buyer of a lot to ownerdeveloper, after said buyer decided to cancel said purchase is exempt from capital gains tax. 35

The amount of capital gains tax paid on a previously rescinded sale transaction may be credited against the capital gains tax on the new Deed of Sale involving the same real property. However, the DST cannot be credited any more since there was a previous valid sale transaction. 36

32

BIR Ruling DA-229-04-13-99; DA-229-04-13-99; DA-068-03-02-98. BIR Ruling No. 096-1996, Sept. 3, 1996. "BIR Ruling No. 083-1999, June 28, 1999. BIR Ruling No. 068-2000, Dec. 14, 2000. BIR Ruling No. 148-1998, Oct. 16, 1998.

33

36

36


332

Equitable Mortgages Contracts (i.e., Deed of Absolute Sale and Release from Liens and Encumbrances, Deed of Conditional Sale) entered into between Northern Cement Corporation and Development Bank of the Philippines and later, with Asset Privatization Trust, are in reality in the nature of equitable mortgage, intended to help Northern Cement Corporation retain its ownership of the company without transferring its properties to the creditors (DBP and A P T ) . Hence, said contracts are not subject to capital gains tax and DST. 37

Agreement between the Bangko Sentral ng Pilipinas, Board of Liquidators and Manila Banking Corporation calling for the transfer of certain properties in favor of BSP is in reality an equitable mortgage. Hence, payment of the capital gains tax is not yet applicable, since the sale of said property is not yet consummated. Only upon the execution of the final or absolute deed of sale covering any of the properties mortgaged by the bank subject of the pacto de retro sale will the payment of the capital gains tax apply. 38

Condominium Corporations The Deed of Assignment by KSYLDC, developer/assignor, of the common areas, including the machineries, and the land is exempt from the creditable withholding tax and documentary stamp tax, since it is without consideration and is not in connection with a sale made to the condominium corporation. Since there is no income, there shall be no creditable withholding tax. 39

Miscellaneous Exempt Transactions Where the reconveyance is without any monetary consideration (e.g., separation of title to real property between spouses, conveyance of a real estate firm of the common area of a condominium to a condominium corporation), or the contract is rescinded or annulled, it is not subject to income tax and consequently to withholding tax, capital gains tax, donor's tax, nor documentary stamp tax. The redemption of real property under a pacto de retro sale is not subject to capital gains tax and documentary stamp tax. Under Section 24(D), only the pacto de retro sale is subject. 40

37

38

39

40

BIR Ruling No. 056-2001, Dec. 5, 2001. BIR Ruling No. 091-99, Aug. 8, 1999. BIR Ruling DA-189-03-25-99. BIR Ruling No. 158, Nov. 21, 1994

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O R D I N A R Y ASSETS A N D C A P I T A L ASSETS AND T A X - F R E E EXCHANGES

Transactions under R.A. No. 6657 (Comprehensive Agrarian Reform Law) involving transfer of ownership, whether from natural or juridical persons, shall be exempt from taxes arising from capital gains and the payment of registration fees, and all other taxes and fees for the conveyance or transfer thereof. "Other taxes" include documentary stamp tax imposed under Section 196 because such tax is substantially a tax on the transaction than on the document. 41

CHAPTER IX ACCOUNTING METHODS A N D PERIODS, A N D FILING OF I N C O M E TAX R E T U R N S

Chapter IX focuses on the accounting methods and the accounting periods allowed to be used under the Tax Code as well as the filing of income tax returns and payment of income taxes. These can be found in the following sections of the Tax Code: 1. Section 43 - General rule; 2. Section 44 - Period in which items of gross income included; 3. Section 45 - Period for which deductions and credits taken; 4. Section 46 - Change of accounting period; 5. Section 47 - Final or adjustment returns for a period less than 12 months; 6. Section 48 - Accounting for long-term contracts; 7. Section 49 - Installment basis; 8. Section 50 - Allocation of income and deductions; 9. Section 51 - Individual return; 10. Section 52 - Corporation returns; 11. Section 54 - Returns of receivers, trustees in bankruptcy or assignee; 12. Section 5 5 - Returns of general professional partnerships; 13. Section 56 - Payment and assessment of income tax for individuals and corporations; 14. Section 58 - Returns and payment of taxes withheld at source; 15. Section 59 - Tax on profits collectible from owner or other persons; 16.

Section 65 - Fiduciary returns; 334

A C C O U N T I N G M E T H O D S A N D PERIODS, AND

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F I L I N G O F INCOME T A X R E T U R N S

17. Section 67 - Collection of foreign payments; 18. Section 68 — Information at source as to income payments; 19. Section 69 - Return of information of brokers; 20. Section 70 - Returns of foreign corporations; 21. Section 74 - Declaration of income tax for individuals; 22. Section 75 - Declaration of quarterly corporate income tax; 23. Section 76 - Final adjustment return; and 24. Section 77 - Place and time of filing and payment of quarterly corporate income tax.

Accounting Methods There are several methods of accounting revenues and expenses that may be used by taxpayers under the 1997 Tax Code. These are: 1.

Cash receipts and disbursements method;

2.

Accrual method;

3.

Installment method;

4.

Percentage of completion method; or

5.

Crop year basis.

The rule is that a taxpayer may use any one method of accounting mentioned above but not a combination of two or more methods (hybrid or mixed method) of accounting for each type of business during the taxable year. Cash method. — Cash method is a method of accounting whereby all items of gross income received during the year shall be accounted for in such taxable year and that only expenses actually paid shall be claimed as deductions during the year. Under this method, income is realized upon actual or constructive receipt of cash or its equivalent, and expenses are deductible only upon actual payment thereof, regardless of the taxable year when the service is performed or the expense is incurred. Accrual method. — Accrual method is a method of accounting for income in the period it is earned, regardless of whether it has been received or not. In the same manner, expenses are accounted for in the period they are incurred and not in the period they are paid. Under this method, net income is being measured by the excess of the


336

income earned during the period over the expenses incurred during the same period. The income that has been earned and the expenses that have been incurred are to be reported during the year, although they have not been collected or paid. In the succeeding year of receipt or payment, no additional income or expenses shall be reported by the taxpayer. Installment method. — Installment method is a method considered appropriate when collections of the proceeds of sales and incomes extend over relatively long periods of time and there is strong possibility that full collection will not be made. As customers make installment payments, the seller recognizes the gross profit on sale in proportion to the cash collected during the year. Percentage of completion method. — This method is applicable in the case of a building, installation or construction contract covering a period in excess of one year, whereby gross income derived from such contract may be reported upon the basis of percentage of completion. In determining the percentage of completion of a contract, one of the following methods is generally used: a.

The costs incurred under the contract as of the end of the tax year are compared with the estimated total to be performed; or

b.

The work performed on the contract as of the end of the tax year is compared with the estimated work to be performed.

In such a case, the return should be accompanied by a certificate of the architect or engineer showing the percentage of completion during the taxable year of the entire work performed under the contract. There should be deducted from such gross income all expenditures made during the taxable year on account of the contract, account being taken of the materials and supplies on hand at the beginning and end of the taxable year for use in connection with the work under the contract but not yet so applied. Long-term contracts are no longer allowed to be reported based on the completed method basis beginning January 1, 1998 pursuant to R.A. No. 8424; hence, all long-term contracts must be reported using the percentage of completion method. However, the completed contract method of income recognition may still be used, provided that the same is strictly applied for long-term construction contract entered into and started prior to 1998; the project was previously reported and recorded under the completed method basis; the project


337


was not completed in 1998; the allowable deductions already incurred in relation to the project were not yet claimed and recognized in 1998 or for the duration of the project. 1

Crop year. — It is a method applicable only for farmers engaged in the production of crops which take more than a year from the time of planting to the process of gathering and disposal of the harvest. Expenses paid or incurred are deductible in the year the gross income from the sale of the crops is realized. The method of accounting regularly employed by the taxpayer in keeping his books, if such method clearly reflects his income is to be followed with respect to the time as of which items of gross income and deductions are to be accounted for. If the taxpayer does not regularly employ a method of accounting that clearly reflects his income, the computation shall be made in such manner as in the opinion of the Commissioner of Internal Revenue clearly reflects it. 2

Tax Code provisions prevail over generally accepted accounting principles. - In view of this express mandate in the law that the method regularly employed by the taxpayer in keeping his books must clearly reflect his income for the year, the Tax Code provision and regulation used in preparing the taxpayer's income tax return and in computing his tax liability will prevail over the generally accepted accounting principles used by taxpayers in keeping their books of accounts and by external auditors in conducting the statutory audit and in preparing the audited financial statements, which are required to be attached to the income tax return of the taxpayer. Whenever there are differences between the provisions of the Tax Code and its implementing rules and regulations, on one hand, and the generally accepted accounting principles (GAAP) and generally accepted auditing standards (GAAS), on the other hand, the same must be fully disclosed in the financial statements and/or income tax returns. For this purpose, that portion of the income tax return intended for the reconciling items shall always be properly accomplished. In any event, the income tax return and all other tax returns, for that matter, shall always conform to internal revenue laws, rules, regulations and other issuances. 3

It is recognized that no uniform method of accounting can be prescribed for all taxpayers, and the law contemplates 'BIR Ruling No. DA-199-03-30-99 (DM Consunji, Inc.). Sec. 166, Rev. Regs. No. 2. RMC 44-2002, Sept. 17, 2002.

2

3


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that each taxpayer shall adopt such forms and systems of accounting as are in his judgment best suited to his purpose. — Each taxpayer is required by law to make a return of his true income. He must, therefore, maintain such accounting records as will enable him to do so. Any approved standard method of accounting that reflects taxpayer's income may be adopted. Among the essentials are the following: 1.

In all cases in which the production, purchase, or sale of merchandise of any kind is an income-producing factor, inventories of the merchandise on hand (including finished goods, work in process, raw materials, and supplies) should be taken at the beginning and end of the year and used in computing the net income of the year;

2.

Expenditures made during the year should be properly classified as between capital and income; that is to say, expenditures for items of plant, equipment, etc., which have a useful life extending substantially beyond the year should be charged to a capital account and not to an expense account; and

3.

In any case in which the cost of capital assets is being recovered through deductions for wear and tear, depletion, or obsolescence, any expenditure (other than ordinary repairs) made to restore the property or prolong its useful life should be added to the property account or charged against the appropriate reserve and not to current expenses. 4

A taxpayer engaged in two or more separate and distinct businesses may use a different method of accounting for each trade or business. Complete and separate books and records must be kept for each business. An individual taxpayer whose income is solely from compensation income is not required to keep formal books of accounts. There is no symmetry required to be followed by the contracting parties in accounting for their income or expenses in a transaction. - For example, the seller may adopt the accrual method in reporting his sales of his products, but the buyer may use the cash method in reporting his purchases and expenses in the same transaction. However, if the taxpayer (seller or buyer) accounts for his income on the accrual method, he should also adopt the accrual 4


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method in accounting for his expenses in order that there can proper matching of his income and expenses. He is not allowed to adopt the cash method for his income (and in effect defer the recognition of such income) and the accrual method for his expenses (and in effect advancing the recognition of such expenses), because it will not clearly reflect the taxable income of the taxpayer. Use of hybrid method of accounting is not allowed. The company used the accrual method of accounting in computing its income. One of its expenses is the amount paid to Benguet as mine operator, which amount is computed as 50% of "net income." The company deducts as an expense 50% of cash receipts minus disbursements, but does not deduct at the end of each calendar year what the Commissioner alleges is "50% of the share of Benguet" in the "accounts receivable." However, it deducts Benguet's 50% if and when the "accounts receivable" are actually paid. BIR claimed that taxpayer used the hybrid method of accounting. The Supreme Court ruled that here, we have to distinguish between (a) the method of accounting used by the company in determining its net income for tax purposes; and (b) the method of computation agreed upon between the company and Benguet in determining the amount of compensation that was to be paid by the former to the latter. The parties, being free to do so, had contracted that in the method of computing compensation, the basis were cash receipts and cash payments. Once determined in accordance with the stipulated bases and procedure, then the amount due Benguet for each month accrued at the end of that month, whether the company had made payment or not. To make the company deduct as an expense one-half of the "accounts receivable" would, in effect, be equivalent to giving Benguet the right which it did not have under the contract, and to substitute for the parties' choice a mode of computation of compensation not contemplated by them. Since Benguet had no right to one-half of the "accounts receivable," the company was correct in not accruing said one-half as a deduction. The company was not using a hybrid method of accounting, but was consistent in its use of the accrual method of accounting (Consolidated Mines vs. CTA and Commissioner, G.R. No. L-18843, Aug. 29, 1974).

Changes in Accounting Methods The true income, computed under the law, shall in all cases be entered in the return. If for any reason the basis of reporting income subject to tax is changed, the taxpayer shall attach to his return a


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separate statement setting forth for the taxable year and for the preceding year the classes of items differently treated under the two systems, specifying in particular all amounts duplicated or entirely omitted as the result of such change. A taxpayer who changes the method of accounting employed in keeping his book shall, before computing his income upon such new method for purposes of taxation, secure the consent of the Commissioner of Internal Revenue. For the purposes of this section, a change in the method of accounting employed in keeping books means any change in the accounting treatment of items of income or deductions, such as a change from cash receipts and disbursements method to the accrual method, or vice versa; a change involving the basis of valuation employed in the computation of inventories; a change from the cash or accrual method to the long-term contract method, or vice versa; a change in the long-term contract method from the percentage of completion basis to the completed method contract basis, or vice versa; or a change involving the adoption of, or a change in the use of, any other specialized basis of computing net income such as the crop basis. Application for permission to change the method of accounting employed and the basis upon which the return is made shall be filed within 90 days after the beginning of the taxable year to be covered by the return. The application shall be accompanied by a statement specifying all amounts which would be duplicated or entirely omitted as a result of the proposed change. Permission to change the method of accounting will not be granted, unless the taxpayer and the Commissioner of Internal Revenue agree to the terms and conditions upon which the change will be effected. In view thereof, it is necessary that the request for change in the accounting method should be filed way ahead of the start of the new taxable year. 5

Inventory of Goods or Merchandise In order to reflect the net income correctly, inventories of unsold goods on hand at the beginning and end of each year are necessary in every case in which the production, purchase or sale of merchandise is an income-producing factor. The inventory should include raw materials and supplies on hand that have been acquired for sale, consumption, or use in productive processes together with all finished 5

Sec. 168, Rev. Regs. No. 2. The 1997 Tax Code does not allow the use of completed contract method effective January 1, 1998.


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or partly finished goods. Only merchandise title to which is vested in the taxpayer should be included in his inventory. Accordingly, the seller should include in his inventory goods under contract and goods out upon consignment, but should exclude from inventory goods sold, title to which has passed to the purchaser. A purchaser should include in inventory merchandise purchased, title to which has passed to him although such merchandise is in transit or for other reasons has not been reduced to physical possession, but should not include goods ordered for future delivery transfer of title to which has not yet been effected. Goods (including containers) out on consignment are not inventoried by the buyer-consignee but by the seller-consignor. The inventory at the start of the taxable year should be identical with that of last year's ending inventory. 6

The inventory of raw materials, goods in process, finished goods, and supplies as of December 31 must be filed with the appropriate Revenue District Office not later than January 30 of the following year. In some businesses, such as flower growers and real estate dealers, the use of inventories is not a practical method of figuring income and is not permitted. Thus, they report gains from sales or exchanges of property either on the cash method or installment basis, but report expenses on the accrual method. 7

Valuation of Inventories The law provides two tests to which each inventory must conform. It must conform as nearly as possible to the best accounting practice in the trade or business, and it must clearly reflect the income. It follows, therefore, that inventory rules cannot be uniform but must give effect to trade customs that come within the scope of the best accounting practice in the particular trade or business. In order to clearly reflect income, the inventory practice of a taxpayer should be consistent from year to year, and greater weight is to be given to consistency than to any particular method of inventory or basis of valuation, as long as the method or basis used is substantially in accord with these regulations. An inventory that can be used under the best accounting practice in a balance sheet showing the financial position of the taxpayer is, as a general rule, regarded as clearly reflecting his income. 6

Sec. 144, Rev. Regs. No. 2. Prentice-Hall Federal Tax Handbook, 1983, p. 400.

7

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The bases of valuation most commonly used by business concerns and which meet the requirements of the Income Tax Law are (a) cost price, or (b) cost or market price, whichever is the lower. Any goods in an inventory which are un-saleable at normal prices or unusable in the normal way because of damage, imperfections, shop wear, changes of style, odd or broken lots, or other similar causes, including second hand goods taken in exchange, should be valued at "bona fide" selling prices whether basis (a) or (b) is used, or if such goods consist of raw materials or partly finished goods held for use or consumption, they should be valued upon a reasonable basis, taking into consideration the usability and the condition of the goods, but in no case shall such value be less than the scrap value. "Bona fide" selling price means actual offerings of goods during a period ending not later than thirty days after inventory date. The burden of proof will rest upon the taxpayer to show that such exceptional goods as are valued upon such selling bases come within the classifications indicated above, and he shall maintain such records of the disposition of the goods as will enable a verification of the inventory to be made. In respect to normal goods, whichever basis (a) or (b) is adopted must be applied with reasonable consistency to the entire inventory. Taxpayers given the option to adopt either basis (a) or (b) for their inventories, and the basis adopted for that year is controlling and a change can now be made after permission is secured from the Commissioner of Internal Revenue. Goods taken in the inventory which have been so intermingled that they can not be identified with specific invoices will be deemed to be either (a) the goods most recently purchased or produced and the cost thereof will be the actual goods purchased or produced during the period in which the quantity of goods in the inventory has been acquired, or (b) where the taxpayer maintains book of inventories in a sound accounting system in which the respective inventory accounts are charged with the actual cost of the goods purchased or produced and credited with the value of the goods used, transferred, or sold, calculated upon the basis of the actual cost of the goods acquired during the taxable year, including the inventory at the beginning of the year. The net value as shown by such inventory accounts will be deemed to be the cost of the goods on hand. The balances shown by such inventories should be ratified by physical inventories at reasonable intervals and adjusted to conform therewith. Inventories should be recorded in a legible manner, properly computed and summarized, and should be preserved as a part of

343

the accounting record of the taxpayer. The inventories of taxpayers on whatever basis taken will be subject to investigation by the Commissioner of Internal Revenue and the taxpayer must satisfy the Commissioner of Internal Revenue of the correctness of the price adopted. The following methods, among others, that are something used in taking or valuing inventories, are not in accord with these regulations and therefore, their use for income tax purposes is prohibited, viz.: a.

Deducting from the inventory a reserve for price changes, or an estimated depreciation in the value thereof;

b.

Taking work in process, or other parts of the inventory, at a nominal price or at less than its proper value;

c.

Omitting portions of the stock on hand;

d.

Using a constant price or nominal value for a so-called normal quantity of materials or goods in stock;

Including stock in transit, either shipped to or from the taxpayer, title to which is not vested in the taxpayer. 8

Inventories at cost price Cost means: (1) In the case of merchandise on hand at the beginning of the taxpayer year, the inventory price of such goods. (2) In the case of merchandise purchased since the beginning of the taxable year, the invoice price less trade or other discounts, except strictly cash discounts, approximating a fair interest rate, which may be deducted or not at the option of the taxpayer, provided a consistent course is followed. To this net invoice price should be added transportation or other necessary charges incurred in acquiring possession of the goods. (3) In the case of merchandise produced by the taxpayer since the beginning of the taxable year: (a) the cost of raw materials and supplies entering into or consumed in connection with the products; (b) expenditures for direct labor; (c) indirect expenses incident to and necessary for the production of the particular article, including therein indirect expenses, a reasonable proportion of management "Sec. 145, Rev. Regs. No. 2.


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expenses, but not including any cost of selling or return on capital, whether by way of interest or profit. (4) In any industry in which the usual rules for computation of costs of production are inapplicable, costs may be approximated upon such basis as may be reasonable and in conformity with established trade practice in the particular industry. Among such cases are: (a) farmers and raisers of livestock; (b) miners and manufacturers who by a single process or uniform series of processes derive a product of two or more kinds, size or grade, the unit cost of which is substantially alike; and (c) retail merchants who use what is known as the "retail method" in ascertaining approximate cost. Inventories at market price Under ordinary circumstances, and for normal goods in an inventory, "market price" means the current bid price prevailing at the date of the inventory for the particular merchandise in the volume in which usually purchased by the taxpayer and is applicable in the cases (a) of goods purchased and on hand, and (b) of basic elements of cost (materials, labor and burden) in goods in process of manufacture and in finished goods on hand; exclusive, however, of goods on hand or in process of manufacture for delivery upon firm sales contracts {i.e., those not legally subject to cancellation by either party) at fixed prices entered into before the date of the inventory, which goods must be inventoried at cost. Where no open market exists or where quotations are nominal due to stagnant market condition, the taxpayer must use such evidence of a fair market price at the date or dates nearest the inventory as may be available, such as specific purchases or sales by the taxpayer or others in reasonable volume and made in good faith, or compensation paid for cancellation of contracts for purchase commitments. Where the taxpayer in the regular course of business has offered for sale such merchandise at prices lower than the current price as above defined, the inventory may be valued at such prices and the correctness of such prices will be determined by reference to the actual sales of the taxpayer for a reasonable period before and after the date of the inventory. Prices which vary materially from the actual prices so ascertained will not be accepted as reflecting the market price. 9

u


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Inventories of miners and manufacturers A taxpayer engaged in mining or manufacturing who by a single process or uniform series of processes derives a product of two or more kinds, sizes or grades, the unit cost of which is substantially alike, and who in conformity to a recognized trade practice allocates an amount of costs to each kind, size, or grade of product which in the aggregate will absorb the total cost of production, may use such allocated cost as the basis for pricing inventories, provided such allocation bears a reasonable relation to the respective selling values of the different kinds of products. 10

Accounting Period Taxable income of a taxpayer is figured on the basis of his annual accounting period. Income tax returns, whether for individuals or for corporations, associations, or partnerships, are required to be made and their income computed for each calendar year ending on December 31st of every year. However, corporations, associations, or partnerships may with the approval of the Commissioner of Internal Revenue first secure, file their returns and compute their income on the basis of a fiscal year which means an accounting period of twelve months ending on the last day of any month other than December. But in no instance shall individual taxpayers be authorized to establish a fiscal year as basis for filing their returns and computing their income. 11

When income is to be reported Gains, profits, and income are to be included in the gross income for the year in which they are received by the taxpayer, unless they are included when they accrue to him in accordance with the approved method of accounting followed by him. If a person sues in one year on a pecuniary claim or for property, and money or property is recovered on a judgment therefore in a later year, income is realized in that year, assuming that the money or property would have been income in the earliest year if then received. This is true of a recovery for patent infringement. Bad debts or accounts charged off because of the fact that they were determined to be worthless, 10

Sec. 150, Rev. Regs. No. 2. "Sec. 169, Rev. Regs. No. 2.


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which are subsequently recovered, whether or not by suit, constitute income for the year in which recovered, regardless of the date when amounts were charged off. 12

When included in income Except as otherwise provided in Section 43 (General Rule) of the Tax Code, gains, profits, and income are to be included in the gross income for the taxable year in which they are received by the taxpayer, unless they are included as of a different period in accordance with the approved method of accounting followed by him. If a taxpayer died, there shall also be included in computing net income for the taxable period in which he died amounts accrued up to the date of his death, if not otherwise properly includible in respect of such period or a prior period, regardless of the fact that the decedent may have kept his books and made his returns on the basis of cash receipts and disbursements. 13

14

The fundamental support for the sale basis is found in legal considerations. In giving the vendee title to valuable goods, the vendor acquires a claim that is in itself recognized property and that is quite distinct from any asset possessed prior to sale. Accordingly, the shipment of merchandise to the customer is generally regarded as the time for recognizing the sale. Generally, revenue is recognized at the point of sale. However, revenue may also be recognized subsequent to the time of sale. This is common practice in connection with installment sales where the customer receives the goods and agrees to pay for them in a series of periodic payments or installments and the vendor usually retains protective title to the goods. When a company is primarily a service enterprise, the act or process of furnishing the service to the customer constitutes the "sale" and marks the time for revenue recognition. 15

As lessor of condominium building, a domestic corporation may report as gross income by using the accrual method of accounting, only those rentals actually earned and advance payments which constitute taxable income in the year of receipt. 16

12

Sec. 51, Rev. Regs. No. 2. Sec. 44, NIRC. "See. 170, Rev. Regs. No. 2. "Accountant's Handbook, 5 ed., Wixon, Kell & Bedford, pp 6.2 - 6.5. B I R Ruling No. 003-2000, Jan 5, 2000. 13

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Income constructively received Income which is credited to the account of or set apart for a taxpayer and which may be drawn upon by him at any time is subject to tax for the year during which so credited or set apart, although not then actually reduced to possession. To constitute receipt in such a case, the income must be credited to the taxpayer without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made. A book entry, if made, should indicate an absolute transfer from one account to another. If the income is not credited, but is set apart, such income must be unqualifiedly subject to the demand of the taxpayer. Where a corporation contingently credits its employees with bonus stock, but the stock is not available to such employees until some future date the mere crediting on the books of the corporation does not constitute receipt. 17

The doctrine of constructive receipt is designed to prevent the exclusion from taxable income of items, the actual receipt of which could, at the option of a taxpayer on a cash basis, be deferred or indefinitely postpone. There is constructive receipt of an income by a taxpayer, if: (a) the income is available to him; (b) the debtor is able and ready to pay him; (c ) his right to receive is not restricted; and (d) his failure to receive is the result of the exercise of his own choice (Araneta vs. Collector, CTA Case No. 1699, Nov. 6, 1970). 18

Paid or Incurred and Paid or Accrued a. The terms "paid or incurred" and "paid or accrued" will be construed according to the method of accounting upon the basis of which the net income is computed by the taxpayer. The deductions and credits must be taken for the taxable year in which "paid or accrued" or "paid or incurred," unless in order clearly to reflect the income, such deductions or credits should be taken as of a different period. If a taxpayer desires to claim a deduction or a credit as of a period other than the period in which it was "paid or accrued" or "paid or incurred," he shall attach to his return a statement setting forth his request for consideration of the case by the Commissioner of Internal Revenue, together with a complete statement of the facts upon which he relies. However, in his income tax return he shall take the deduction or credit only for the taxable period in which it was "Sec. 52, Rev. Regs. No. 2. "Montgomery's Taxes, Vol. I, 1946-47, p. 1007.


348

actually "paid or incurred" or "paid or accrued," as the case may be. Upon the audit of the return, the Commissioner of Internal Revenue will decide whether the case is within the exception provided by the law, and the taxpayer will be advised as to the period for which the deduction or credit is properly allowable. b. The provisions of paragraph (a) of this section in general are not applicable with respect to the taxable period during which the taxpayer dies. In such case, there shall be allowed as deductions and credits for such taxable period amounts accrued and credits for such taxable period amounts accrued up to the date of his death, if not otherwise allowable with respect to such period or a prior period, regardless of the fact that the decedent was required to keep his books and make his returns on the basis of cash receipts and disbursements. 19

Under the realization principle, revenue is generally recognized when both of the following conditions are met: (a) the earning process is complete or virtually complete; and (b) an exchange has taken place. This principle requires that revenues must be earned before it is earned. Amounts received in advance are not treated as revenue of the period in which they are received but as revenue of the future period or periods in which they are earned. These amounts are carried as unearned revenue, that is, liabilities to transfer goods or render services in the future - until the earning process is complete (Manila Mandarin Hotels, Inc. us. Commissioner of Internal Revenue, CTA Case No. 5046, Mar. 24, 1997). Under the accrual method of reporting income, taxable income comes into existence when all the events have occurred which fix the right to receive the income and the amount can be determined with reasonable accuracy. Taxpayer employs the accrual method of accounting. Following such accounting method, the copra outturn outstanding as of December 31, 1951, should have been treated as accrued income for 1951, instead of as stock on hand on January 1, 1952. Said beginning inventory, together with expenses, copra purchased during the year and copra on hand as of December 31, 1952 were deducted as "cost of goods sold" from the total gross sales for the purpose of determining the net sales. Since the copra outturn formed part of the cost of goods sold, it diminished the net sales, thereby also decreasing defendant's net taxable income by the same 20

,9

Sec. 171, Rev. Regs. No. 2. "'Montgomery's Federal Taxes, Sec. 8.91, 38th Ed., 1961.


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amount. This procedure is inconsistent with defendant's accounting method. The taxpayer's beginning inventory for 1952 did not state the truth, for such copra outturn was no longer in taxpayer's bodega. It was in transit to a foreign port. And the taxpayer no longer owned the copra. As a matter of fact, it already received payment for the same. Under the accrual method of reporting income, taxable income comes into existence when all the events have occurred which fix the right to receive the income and the amount can be determined with reasonable accuracy. Thus, a taxpayer on accrual basis was deemed to have derived income for the taxable year from copra sold and shipped in said year to a foreign copra buyer, notwithstanding that the taxpayer had not yet received the price in full (Republic vs. Lim Tian Teng Sons & Co., G.R. No. L-21731, Mar. 31, 1966, 16 SCRA 584). Accrued income during the year shall be reported as income. - Petitioner reported its income and expenses on the accrual basis. It is the right to receive the corresponding portion of the storage fees which determines the inclusion of this portion in petitioner's income. It is not necessary that the petitioner receives a credit memo or notice of the storage fees. Since the right to receive the portion of the storage fees became fixed in 1959, the same accrued in the said year and should be included as income earned in 1959. One-third (1/3) of the storage fees should be reported as income in 1959 because it is only one of the three owners of the Associated Sugar Central (Talisay Silay Milling Co. vs. Commissioner, supra). Change of accounting period. — If a corporation, including a duly registered general co-partnership, desires to change its accounting period from fiscal year to calendar year or from calendar year to fiscal year, or from one fiscal year to another, it shall at any time not less than thirty days prior to the date fixed for the filing of its return on the basis of its original accounting period submit a written application to the Commissioner of Internal Revenue, designating the proposed date for the closing of its new taxable year, together with a statement of the date on which the books of account were opened and closed each year for the past three years, the date on which the taxable year began and ended as shown on the returns filed for the past three years, and the reasons why the change in accounting period is desired. 21

In the following cases, however, a return may be filed for a period less than 12 months: "Sec. 172, Rev. Regs. No. 2.


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22

1.

In case of change of accounting period;

2.

The final personal income tax return of a decedent;

3.

The income tax return of the Estate of a decedent;

4.

Newly organized corporations; and

5.

Dissolving corporations.

23

Installment Sales Sale of personal property on installment plan Dealers in personal property ordinarily sell either for cash or on the personal credit of the purchaser or on the installment plan. The general rule prescribed is that a person who regularly sells or otherwise disposes of personal property on the installment plan, whether or not title remains in the vendor until the property is fully paid for, may return as income therefrom in any taxable year that proportion of the installment payments actually received in that year which the total installment payments actually received in that year which the total or gross profit (that is, sales less cost of goods sold) realized or to be realized when the property is paid for, bears to the total contract price. Thus, the income of a dealer in personal property on the installment plan may be ascertained by taking as income that proportion of the total payments received in the taxable year from installment sales (such payments being allocated to the year against the sale of which they apply) which the total or gross profit realized or to be realized on the total installment sales made during each year bears to the total contract price of all such sales made during that respective year. No payments received in the taxable year shall be excluded in computing the amount of income to be returned on the ground that they were received under a sale the total profit from which was returned as income during a taxable year or years prior to the change by the taxpayer to the installment basis of returning income. Deductible items are not to be allocated to the years in which the profits from the sales of a particular year are to be returned as income, but must be deducted for the taxable year in which the items are "paid or incurred" or "paid or accrued." A dealer who desires to compute his income on the installment basis shall maintain books of account in such a manner as to enable an accurate computation :

Sec. 46, NIRC. 'Sec. 224, Rev. Regs. No. 2.


351


to be made on such basis in accordance with the provisions of this section. 24

Sale of real property on installment plan In transactions included in class (1) in the preceding section, the vendor may return as income from such transactions in any taxable year that proportion of the installment payments actually received in that year which the total profit realized or to be realized when the property is paid for bears to the total contract price. If the purchaser defaults in any of his payments, and the vendor returning income on the installment basis reacquires the property sold, whether title thereto had been retained by the vendor or transferred to the purchaser, gain or loss for the year in which the reacquisition occurs is to be computed upon any installment obligations of the purchaser which are satisfied or discharged upon the reacquisition or are applied by the vendor to the purchase or bid price of the property. Such gain or loss is to be measured by the difference between the fair market value of the property acquired (including the fair market value of any fixed improvements placed on the property by the purchaser) and the basis in the hands of the vendor of the obligations of the purchaser which are so satisfied, discharged, or applied, with proper adjustment for any other amounts realized or costs incurred in connection with the reacquisition. The basis in the hands of the vendor of the obligations of the purchaser satisfied, discharged, or applied, upon the reacquisition of the property will be the excess of the face value of such obligations over an amount equal to the income which would be returnable were the obligations paid in full. No deduction for a bad debt shall in any case be taken on account of any portion of the obligations of the purchaser which are treated by the vendor as not having been satisfied, discharged or applied upon the reacquisition of the property, unless it is clearly shown that after the property was reacquired the purchaser remained liable for such portion; and in no event shall the amount of the deduction exceed the basis in the hands of the vendor of the portion of the obligations with respect to which the purchaser remained liable after the reacquisition. If the property reacquired is subsequently sold, the basis for determining gain or loss is the fair market value of the property at the date of reacquisition (including the fair "Sec. 174, Rev. Regs. No. 2. Rules on repossession are also discussed in the same section.


352

market value of any fixed improvements placed on the property by the purchaser). If the vendor chooses as a matter of consistent practice to return the income from installment sales on the straight accrual or cash receipts and disbursements basis, such a course is permissible, and the sales will be treated as deferred payment sales not on the installment plan. 25

Sale of real property involving deferred payments Under Section 49(B) (Installment Basis) of the Tax Code, deferred payment sales of property include (a) agreements of purchase and sale which contemplate that a conveyance is not to be made at the outset, but only after all or a substantial portion of the selling price has been paid, and (b) sales in which there is an immediate transfer of title, the vendor being protected by a mortgage or other lien as to deferred payments. Such sales under (a) or (b) fall into two classes when considered with respect to the terms of sale, as follows: 1.

Sales of property on the installment plan, that is, sales in which the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable year in which the sale is made do not exceed 25 per cent of the selling price; or

2.

Deferred-payment sales not on the installment plan, that is, sales in which the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable year in which the sale is made exceed 25 per cent of the selling price.

In the sale of mortgaged property, the amount of the mortgage, whether the property is merely taken subject to the mortgage or whether the mortgage is assumed by the purchaser, shall be included as a part of the "selling price," but the amount of the mortgage, to the extent it does not exceed the basis to the vendor of the property sold, shall be considered as a part of the "initial payments" or of the "total contract price," as those terms are used in Section 49(B) of the Tax Code. The term "initial payments" does not include amounts received by the vendor in the year of sale from the disposition to a third person of notes given by the vendee as part of the purchase price which are due and payable in subsequent years. Commissions "Sec. 176, Rev. Regs. No. 2.


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and other selling expenses paid or incurred by the vendor are not to be deducted or taken into account in determining the amount of the "initial payments," or the "total contract price," or "selling price." The term "initial payments" contemplates at least one other payment in addition to the initial payment. If the entire purchase price is to be paid in a lump sum in a later year, there being no payment during the year, the income may not be returned on the installment basis. Income may not be returned on the installment basis where no payment in cash or property, other than evidences of indebtedness of the purchaser, is received during the first year, the purchaser having promised to make two or more payments, in later years. 26

Deferred payment sale of real property not on installment plan. - In transactions included in class (2) in Section 175 of these regulations, the obligations of the purchaser received by the vendor are to be considered as the equivalent of cash. If the vendor has retained title to the property and the purchaser defaults in any of his payments, and the vendor repossesses the property, the difference between (1) the entire amount of the payments actually received on the contract and retained by the vendor plus the fair market value at the time of repossession of fixed improvements placed on the property by the purchaser, and (2) the sum of the profits previously returned as income in connection therewith and an amount representing what would have been a proper adjustment for exhaustion, wear and tear, obsolescence amortization and depletion of the property during the period the property was in the hands of the purchaser had the sale not been made will constitute gain or loss, as the case may be, to the vendor for the year in which the property is repossessed, and the basis of the property in the hands of the vendor will be the original basis at the time of the sale plus the fair market value at the time of repossession, of fixed improvements placed on the property by the purchaser. If the vendor has previously transferred title to the purchaser, and the purchaser defaults in any of his payments and the vendor reacquired the property, such reacquisition shall be regarded as a transfer by the vendor, in exchange for the property for such of the purchaser's obligations as are applied by the vendor to the purchase or bid price of the property. Such an exchange will be regarded as having resulted in the realization by the vendor of gain or loss, as the case may be, for the year of reacquisition, measured by the difference between 26



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the fair market value of the property, including fixed improvements placed by the purchaser on the property, and the amount of the obligations of the purchaser which were applied by the vendor to the purchase or bid price of the property. The fair market value of the property reacquired shall be presumed to be the amount for which it is bid in by the vendor in the absence of clear and convincing proof to the contrary. If the property reacquired is subsequently sold, the basis for determining the gain or loss is the fair market value of the property at the date of reacquisition, including the fair market value of the fixed improvements placed on the property by the purchaser.

27

Sale of real estate in lots. — Where a tract of land is purchased with a view to dividing it into lots or parcels of ground to be sold as such, the entire cost shall be equitably apportioned to the several lots or parcels and made a matter of record on the books of the taxpayer, to the end that any gain derived from the sale of any such lots or parcels may be returned as income for the year in which the sale was made. This rule contemplates that there will be a measure of gain or loss on every lot or parcel sold, and not that the capital invested in the entire tract shall be extinguished before any taxable income shall be returned. The sale of each lot or parcel will be treated as a separate transaction and the gain or loss will be accounted for accordingly. 28

In all cases where a taxpayer sells during the year real or personal property on the installment basis, there should be attached to the income tax return, a statement of each sale made during the year containing the following information: name of buyer, address of buyer, date of sale, selling price, payments received during the year corresponding to each sale. 29

Filing of Tax Returns and Payment of Taxes The frequency of filing income tax returns depends on the person and the nature of income received. The rules are summarized as follows: Income tax returns covering income, profits and gains 1. Individual deriving purely compensation income must file his income tax return (BIR Form 1701) not later than April 15 of the following year. This requirement of filing tax returns is no "Sec. 177, Rev. Regs. No. 2. ^Sec. 178, Rev. Regs. No. 2. Sec. 178-A, Rev. Regs. No. 2, as amended by Rev. Regs. No. 8-65, June 1,1965. 29


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longer required beginning for the calendar year 2002. Substituted filing of tax returns is allowed where an employee receives purely compensation income from a single employer who deducted and remitted to the BIR the correct amount of withholding tax from the employee's compensation income during the year. In lieu of the regular tax returns to be filed by the employees, BIR Form 1643 shall be filed by the employer with the BIR. However, non-resident citizens who receive purely foreign-source income are no longer required to file their Philippine income tax returns, although they must still file an income tax return covering income from sources within the Philippines. 30

31

A married individual who is engaged in trade or business may die during the year. In this case, two income tax returns must be filed by his executor or administrator - (1) the regular income tax return covering his business income from January 1 up to the date he lived, and (2) the regular income tax return to be filed by the estate of the deceased covering business income from the date of death up to December 31. There will also be two personal exemptions allowed - P32,000 (now P50,000), as married, clai ned by the taxpayer in his individual tax return, and P20,000 (now P50,000), claimed by the estate of the deceased in its tax return. 32

RMC 1-2003 (Substituted Filing System) The Bureau of Internal Revenue (BIR), in its mission of providing an efficient and convenient service to its taxpayers, is implementing a "hassle-free" method of filing Individual Income Tax Returns (BIR Form 1700). This method of filing recognizes under certain circumstances, the employer's Annual Information Return (BIR Form No. 1604CF) as the "substitute" income tax return filed by the employee since it contains the same information found in the income tax return ordinarily filed. 33

This Circular aims to provide some basic information and answers to questions frequently asked on substituted filing. 30

Rev. Regs. No. 3-2002, Mar. 27, 2002. The requirement to file returns by non-resident citizens previously required under RMO 30-99 and Rev. Regs. No. 9-99 was deleted by Rev. Regs. No. 5-2001. Sec. 62, NIRC. RMC 1-2003, Dec. 27,2002 clarifies certain provisions of Revenue Regulations No. 3-2002, as amended by Revenue Regulations No. 19-2002, amending Section 2.83 of Revenue Regulations 2-98 in relation to the Substituted Filing of Income Tax Returns of Qualified Pure Compensation Income Earners. 31

32

33


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"Substituted Filing" applies when the employer's annual return (BIR Form 1604CF) may be considered as the "substitute" Income Tax Return (ITR) of employee inasmuch as the information provided in his income tax return (BIR Form 1700) would exactly be the same information contained in the employer's annual return (BIR Form No. 1604-CF). "Substituted Filing" is different from "Non-Filing" in the sense that under "substituted filing," an individual taxpayer, although required under the law to file his income tax return, will no longer have to personally file his own income tax return, but instead the employer's annual information return filed will be considered as the "substitute" income tax return of the employee inasmuch as the information in the employer's return is exactly the same information contained in the employee's return. "Non-filing" is applicable to certain types of individual taxpayers who are not required under the law to file an income tax return. An example is an employee whose pure compensation income does not exceed P60,000, and has only one employer for the taxable year and whose tax withheld is equivalent to his tax due. Substituted filing applies only to individuals who meet all the following conditions: a.

The employee receives purely compensation income (regardless of amount) during the taxable year;

b.

The employee receives the income only from one employer in the Philippines during the taxable year;

c.

The amount of tax due from the employee at the end of the year equals the amount of tax withheld by the employer;

d.

The employee's spouse also complies with all three (3) conditions stated above;

e.

The employer files the annual information return (BIR Form No. 1604-CF);

f.

The employer issues BIR Form 2316 (Oct 2002 ENCS) version to each employee.

The following individuals are not qualified for substituted filing: a.

Individuals deriving compensation income from two or more employees, concurrently or successively at anytime during the taxable year;


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b.

Employees deriving compensation income, regardless of 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 a collectible or refundable return;

c.

Employees whose monthly gross compensation income does not exceed Five Thousand Pesos (P5,000) or the statutory minimum wage, whichever is higher, and opted for nonwithholding of tax on said income;

d.

Individuals deriving other non-business, non-professionrelated income in addition to compensation not otherwise subject to final tax;

e.

Individuals deriving purely compensation income from a single employer, although the income of which has been correctly subjected to withholding tax, but whose spouse is not entitled to substituted filing;

f.

Non-resident aliens engaged in trade or business in the Philippines deriving purely compensation income or compensation income and other business or profession related income;

BIR Form 2316 (Certificate of Compensation Payment I Tax Withheld for Compensation Payment With or Without Tax Withheld) is a statement signed by both the employee and the employer and serves the same purpose as if BIR Form No. 1700 (Annual Income Tax Return for Individuals Earning Compensation Income) had been filed. This, however, is not to be submitted or filed with the BIR if the employee is qualified for substituted filing. The new BIR Form 2316 consists of the following parts: a.

Part I - Employee Information (Items 3 to 12)

This refers to employee's personal information as declared by him in the Certificate of Update of Exemption and Employer's and Employee's Information (BIR Form 2305). The same information should likewise be consistent with the information in the Annual Information Return (BIR Form 1604CF). 6.

Part II - Present Employer Information (Items 13 to

15A) The information herein refers to the present employer.


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c. to24A)

Part III - Previous Employer Information (Items 16

In cases where an employee has previous employer in the same taxable year, the present employer should mention the previous employer's information as contained in the employee's BIR Form 2316 issued by the previous employer. d. Part TV - Details of Compensation Income and Tax withheld from the Present Employer (Items 25 to 50) This part contains the details and summary of all taxable and nontaxable regular and supplementary compensation received by the employee including the summary of taxes withheld from the compensation of the employee. e.

1st Signature Box (Items 51 and 52)

This contains a declaration by the present employer that all the information contained in BIR Form 2316 (Parts I to IV and Summary) was made in good faith, verified, and to the best of their knowledge and belief, is true and correct pursuant to the provisions of the National Internal Revenue Code. f.

2nd (Substituted Filing) Signature Box (Items 53 and

54) This box shall be accomplished under the substituted filing scheme. In general, every employer or other person who is required to deduct and withhold the tax on compensation including fringe benefits given to rank and file employees, shall furnish every employee from whose compensation taxes have been withheld the Certificate of Compensation Payment/Tax Withheld (BIR Form 2316).

Regular Filing of Tax Returns 1. Individual deriving mixed income, or purely business/ professional income, or other income must file his quarterly income tax returns (BIR Form 1700 Q) and annual income tax return (BIR Form 1700) as follows: 34


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Period Q l Return Q2 Return Q3 Return Annual Return

D u e Date for Filing Return

April 15 of same year August 15 of same year November 15 of same year April 15 of the following year

2. A domestic corporation and resident foreign corporation shall file quarterly corporate income tax return (BIR Form 1702Q) and annual corporate income tax return (BIR Form 1702) as follows: 35

Q l Return Q2 Return Q3 Return Annual Return

May 31 of same year August 31 of same year November 30 of same year April 15 of the following year (if on calendar year), or 15th day of the fourth month following the close of the fiscal year (if on fiscal year).

Computation of the quarterly and annual tax returns of individuals (except those receiving purely compensation income) and corporations shall be made on the cumulative basis, i.e., gross income and deductions are consolidated and the income tax liability is computed on the consolidated net income, and the income taxes paid for the preceding quarter(s) are credited against the consolidated income tax due. Section 51(B) [Individual Returns] of the Tax Code provides that except in cases where the Commissioner otherwise permits, the return shall be filed with an authorized agent bank, Revenue District Officer, Collection Agent or duly authorized treasurer of the city or municipality in which such person has his legal residence or principal place of business in the Philippines, or if there be no legal residence or place of business in the Philippines with the Office of the Commissioner. As an offshoot of a dialogue between the professional entertainers and the BIR, and because of findings of rampant/prevalent noncompliance among the members of show business industry, the Commissioner, in his desire to strictly monitor the same and by virtue of the power vested in him under Section 71 (Disposition of Income Tax Returns, Publication of Lists of Taxpayers and Filers), in relation to Section 51(B)(2) of the National Internal Revenue Code, the Commissioner allows all actors and actresses who were not issued 36

Sec. 75, NIRC.


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Letters of Authority to file and/or pay their amended Income Tax Returns at any authorized banks within the jurisdiction of Revenue District No. 39 - South, Quezon City. 36

The filing of tax returns could be done electronically or manually. Electronic filing of tax returns and payment of taxes is now mandatory for large taxpayers that have been identified in writing by the Commissioner of Internal Revenue as such. 37

Electronic Filing and Payment System (EFPS) All large taxpayers identified as such as of to date are hereby called upon to strictly comply with the EFPS Regulations which require for the e-filing of tax returns and e-payment of taxes due thereon. As clearly enunciated in Section 3(a) and (b) of Revenue Regulations No. 9- 2001, as amended by Rev. Regs. No. 02-2002, Rev. Regs. No. 09-2002, Rev. Regs. No. 05-2004, and last amended by Rev. Regs. No. 10-2007: 38

3.1. Large Taxpayers - (a) Beginning the calendar year 2001 and all fiscal years as well as calendar years thereafter, large taxpayers shall e-file their final adjustment income tax returns for the said calendar/fiscal years and e-pay the taxes due thereon through the EFPS on or before the 15th day of the fourth month following the close of the taxable year. Nonetheless, e-payment shall be optional for tax returns that will be filed until July 31, 2002. Thus, until July 31, 2002, if a taxpayer does not opt to pay electronically, payment shall be made manually. (b) Beginning July 1, 2002, Large Taxpayers shall e-file all the tax returns that can be filed electronically through the EFPS but e-payment shall nonetheless remain optional until July 31, 2002. However, unless otherwise notified by the Commissioner of Internal Revenue (CIR), for all returns that will be filed starting August 1, 2002, e-payment of the taxes due thereon thru EFPS shall become mandatory." Thus, based on the above provisions, since July 1, 2002, there has been no instance where large taxpayers would have manually filed their tax returns nor would have paid their taxes manually since August 1, 2002, unless the BIR system has been down during 'RMC 22-2005, May 25, 2005. 'See Rev. Regs. No. 9-2001. 'RMC 89-2007, Dec. 17, 2007.


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the deadline date or the revised form has not been available in EFPS. In the e-payment of taxes, Section 8.1(a) of the said Regulations provides: "8.1 Large Taxpayers. - (a) Large Taxpayers who will e-pay shall enroll with any EFPS AAB authorized to serve them and who is capable to accept e-payments. E-payments shall be made within the day the return is electronically filed following the "pay-as-you-file" principle. "Accreditation of an existing BIR A A B as an EFPS AAB authorized to service taxpayers classified and notified by the BIR as large taxpayers shall be opened to such number of commercial/ universal banks as may be necessary to provide efficient and effective service to all the large taxpayers." It is apparent that with respect to tax payments of large taxpayers, the same must be made only through their authorized EFPS Authorized Agent Banks ( A A B ) and not through Revenue Collection Officers (RCO) of the Bureau as has been recently noted and discovered during the review of the Collection Performance of the Large Taxpayer Service and of the Revenue Regions. As a practice, tax payments coursed through the RCOs of the Bureau who then issue Revenue Official Receipts (ROR) as evidence of their receipt of tax payments are only allowed in instances where there are no AABs within the revenue district office where the taxpayer is registered which circumstance is obviously unavailing in the case of large taxpayers. Thus, all large taxpayers are hereby reminded to refrain from manually paying their taxes through the RCOs and to strictly comply with the Regulations mandating them to e-pay their taxes through their EFPS AABs. Otherwise, the penalty of 25% surcharge for wrong venue as provided for under Section 248(a)(2) of the 1997 Tax Code, as amended, shall be imposed. 39

Pursuant to Revenue Regulations No. 12-2007, amending certain provisions of RR No. 9-98, relative to the payment of Minimum Corporate Income Tax (MCIT) imposed on domestic corporations and resident foreign corporations, the Enhanced BIR Form 1702Q - Quarterly Income Tax Return for Corporations and Partnerships 39

RMC 3-2008, Nov. 20, 2007.


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[October 2007 (ENCS)] is now available in all Revenue District Offices (RDOs) and Large Taxpayers Offices. The said form can also be downloaded through the BIR's official website - www.bir.gov.ph under BIR Forms and Income Tax Return (Individuals, Corporations, Capital Gains) Link. However, the said enhanced BIR Form 1702Q is not yet available in the eFPS. In view thereof, the following are the work-around procedures to be adopted by all eFPS filers until such time that the enhanced BIR Form 1702Q becomes available in the eFPS: 1. eFPS filers who will be paying the normal income tax shall file using the existing BIR Form 1702Q available in the eFPS and proceed to ePayment; 2. If their income tax due is the MCIT, eFPS filers may have the following options: a.

They may electronically file their quarterly income tax return through the eFPS facility using the existing online BIR Form 1702Q by filling-up the Special Rate Column; Once the enhanced 1702Q becomes available for eFPS filing, taxpayer shall be required to file an amended return;

b.

They may also file their return manually by accomplishing BIR Form 1702Q [October 2007 (ENCS)] or the downloadable copy of the BIR form from the BIR's official website. The return must be filed with the corresponding payment to any Authorized Agent Bank (AAB) located within the territorial jurisdiction of the Revenue District Office/Large Taxpayers Office where the taxpayer's principal office is registered. If there is no payment required, the taxpayer shall file the abovementioned return with the Revenue District Office (RDOVLarge Taxpayers Office having jurisdiction over the principal office of the taxpayer;

3. All filers should submit the required Summary Alphalist of Withholding Agents of Income Payments Subjected to Withholding Tax at Source (SAWT) through the BIR's official website - www.bir. gov.ph - by clicking the "eSUBMISSION" icon and fill-up all the necessary or required information such as: a.

Taxpayer Identification Number ( T I N ) ;

b.

Taxpayer's Registered Name;


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c.

Registered Address; and

d.

E-mail Address/es;

4. Submit the attachments but make sure that the naming convention is observed (the accepted file extension: .dat, .csv within a .zip file), then click "SEND"; and 5. Wait for the acknowledgement receipt and a validation report which will be sent to the taxpayer's email address within 24 hours upon e-Submission of the attachments.

Taxpayers' Responsibility for Representations Made in Their Behalf by Their Tax Agents 40

There have been cases where taxpayers whose tax returns (together with the necessary attachments) were prepared, signed and filed in their behalf by their tax agents/accountants are disowning responsibility for any errors discovered in, or audit findings made on, such returns and documents. Such disclaimers are also being used by the concerned taxpayers as a convenient excuse to abscond from their liability for such errors and/or audit findings. Indeed, it is no longer uncommon for some taxpayers to make such disavowals, on the pretext that they were not the ones who personally prepared their tax returns and financial statements. Taxpayers are therefore advised that the contents and representations - as they are reflected in the tax returns and information statements filed with the BIR - made in their behalf by their tax agents, remain their responsibility in their capacity as the principals stated in the aforesaid returns and information statements. In this regard, a taxpayer is under strict obligation to check, verify and validate: •

The authenticity of a tax return and/or information statement made in their behalf; and

•

The correctness and validity of the information contained in such documents.

In this regard, in cases where it is found that the purported tax payments were not actually received by the BIR, the liability to pay said tax payments again shall remain the responsibility of the concerned taxpayers, even if it should be claimed that such tax payments had already been made in their behalf by their tax agents. 'RMC 82-2007, Dec. 4, 2007.

364


Any findings, errors, violations or infractions noted therein as a result of such verification and authentication procedures shall render both the taxpayer and his/its tax agent civilly, administratively and criminally liable, pursuant to existing laws and regulations.

Audited Financial Statements Additional Compliance Requirements of Concerned Taxpayers in the Light of Mandatory Adoption of the Philippine Financial Reporting Standards in Recording and Presenting Business Transactions and Results. - The Philippines has adopted the International Financial Reporting Standards (IFRS) as the Philippine Financial Reporting Standards (PFRS) that should be observed by big corporate taxpayers in the recording of their business transactions and preparation of Financial Statements starting year 2005. Under the IFRS, the recording and the recognition of business transactions for financial accounting purposes, in a majority of situations, differ from the application of tax rules on the same transactions resulting to disparity of reports for financial accounting vis-d-vis tax accounting. Hence, there is a need to reconcile the disparity in a systematic and clear manner to avoid irritants between the taxpayer and the tax enforcer. Accordingly, concerned taxpayers are hereby mandated to maintain books and records that would reflect the reconciling items between Financial Statements figures and/or data with those reflected/presented in the filed Income Tax Return (ITR). The recording and presentation of the reconciling items in such books and records shall be done in such a manner that would facilitate the understanding by the examiners/auditors of the Bureau of Internal Revenue tasked to undertake audit/investigation functions, providing in sufficient detail the computation of the differences and the reasons therefore aimed at bringing into agreement the IFRS and ITR figures. Start of Keeping of Books and Records. - The keeping of books and records for the reconciling items referred to in the preceding Section shall start for taxable year 2007. For this purpose 'taxable year 2007' shall mean calendar year ending December 31, 2007 and all fiscal years ending not later than June 30, 2008. 41

"Rev. Regs. No. 8-2007, July 3, 2007.


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Use of Functional Currency Pursuant to Section 244 (Authority of Secretary of Finance to Promulgate Rules and Regulations), in relation to Section 6(H) [Authority of the Commissioner to Prescribe Additional Procedural or Documentary Requirements] of the Tax Code of 1997, these Regulations are hereby promulgated to prescribe the guidelines and procedures in adopting the use of functional currency other than the Philippine peso in financial statements that will be submitted and books of accounts that will be maintained for internal revenue tax purposes. 42

"Functional Currency" is the currency of the primary economic environment in which the reporting entity operates; that is the currency of the environment in which an entity primarily generates and expends cash. Foreign Currency is a currency which is other than the functional currency of the qualified entity. For purposes of these Regulations, the Philippine peso or other currencies will be considered as foreign currency if it is not the functional currency of the qualified entity. Authority to Use Functional Currency. - A tax-filer, corporate or otherwise, does not have a free choice as to the functional currency to be used. It cannot arbitrarily choose to use a certain currency as its functional currency in its financial statements and books of accounts for tax purposes. The company's determination of its functional currency shall be made in accordance with the guidelines provided below. The use of functional currency other than the Philippine peso for financial recording and reporting purposes does not mean, however, the use of such functional currency for tax return purposes. This holds true even if the use of functional currency other than the Philippine peso becomes a requirement/is permitted under the Philippineadopted Generally Accepted Accounting Principles, or is mandated by the SEC or other competent body. Determination of the Functional Currency. - In determining its functional currency, the tax-filer should consider the following factors: (a) The currency that mainly influences sales prices for goods and services (this will often be the currency in which sales prices for its goods and services are denominated and settled); "Rev. Regs. No. 6-2006, Mar. 16, 2006.

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(b) The currency of the country whose competitive forces and regulations mainly determine the sales price of its goods and services; (c) The currency that mainly influences labor, material and other costs of providing goods or services (this will often be the currency in which such costs are denominated and settled); (d) The currency in which funds from financing activities are generated; (e) The currency in which receipts from operating activities are usually retained. In cases when the above indicators are mixed and the functional currency is not obvious, the reporting entity can use its judgment as to which is the dominant currency to determine the functional currency that most faithfully represents the economic effects of the underlying transactions, events and circumstances. A company's functional currency reflects the underlying transactions, events and circumstances that are relevant to it. Accordingly, once determined, the functional currency should not be changed unless there is a substantial change in those underlying transactions, events and circumstances. The taxpayer may use the currency that qualifies as its functional currency based on the above guidelines. Functional currency shall not be limited to the US Dollar but shall include the Japanese Yen, Euro Dollar and other major foreign currencies, the adoption thereof being subject to SEC notification for corporations and to the procedural requirements for individuals, as mentioned below. Notification Requirements. — A corporate tax-filer electing to use as functional currency for financial reporting purposes a currency other than the Philippine peso must submit to the Revenue District Office (RDO) or Large Taxpayers District Office(LTDO) or Large Taxpayers Service (LTS), whichever is the BIR office that has jurisdiction over the taxpayer, a copy of the duly received notification sent to the SEC (as provided in SEC Memorandum Circular 1, series of 2006) for the use of such functional currency within 30 days from the filing of the notification to the SEC, but may be subject to extension on meritorious grounds. Such copy of the SEC notification duly stamped received by the BIR must also be attached to the income tax return upon filing of said return. In the case of an individual electing to adopt functional currency in financial reporting, an application/notification under oath must be


367


filed with the RDO/LTDO/LTS, whichever is the BIR office that has jurisdiction over the taxpayer, within 30 days after the taxable year in which the use of functional currency takes effect. Such application/ notification shall contain justification that the individual taxpayer has complied with the guidelines above. The information on functional currency shall form part of the taxpayer's registration database. Change in Functional Currency. - In the case of a corporation whose functional currency changes from one currency to another, the taxpayer must submit to the BIR a copy of such SEC duly received notification to change the functional currency (as provided in SEC Memorandum Circular 1, series of 2006) within 30 days from the filing of such notification with the SEC. In the case of an individual, a revised application/notification under oath shall be filed with the RDO/LTDO/LTS within 30 days after the taxable year in which the change of functional currency takes effect. As a rule, a taxpayer shall not be allowed to change its functional currency in the middle of the year, or adopt one for a period less than one year. However, in certain exceptional cases like in the case of business combinations such as mergers or consolidations, change in functional currency to cover a period of less than one full year may be permitted. Currency to be Used for Income Tax Purposes. - The income tax returns (ITR) of taxpayers which have adopted functional currency (other than Philippine peso) in their financial statements and books of accounts shall still be prepared in Philippine pesos. Thus, all entries in the ITR shall be in Philippine pesos. For purposes of translating the functional currency income and expenses to Philippine Pesos, the translation shall be done on a monthly basis using the average exchange rate during the month (under the Philippine Dealing System or PDS). The total translated amounts per month shall be added to arrive at the income and expenses in Philippine pesos for the quarter/year, which shall be the basis in computing the taxpayer's income tax liability. The total figures in the ITR for the year should be reconciled with the total of the equivalent peso figures as converted from the functional currency figures in the subsidiary ledgers maintained to serve as the source of the figures reflected in tax returns other than income

368


tax. The reconciliation of the figures shall be done at the end of the year and the reconciling items shall be reflected in the annual or final adjustment income tax return. Thus, after such reconciliation, the figures in the annual ITR should tally with the total annual figures in the other tax-type tax returns such as the tax returns for VAT, Percentage Tax, Withholding Tax, Documentary Stamp Tax, etc. Tax credits applied against the income tax due (in Philippine pesos), if any, shall be equal to the actual amounts of such credits in Philippine pesos, as shown in the supporting documents (e.g., withholding tax certificates issued by the other party withholding agents, proof of advance payment of the tax and prior year's income tax return). Currency to be Used in the Filing of Tax Returns Other than Income Tax. - All tax returns other than the ITR shall likewise be filed in Philippine peso currency using historical peso amounts or actual conversion/prevailing PDS rate on transaction day, whichever is applicable. Submission of Audited Financial Statements. - Only the audited financial statements in the qualified functional currency shall be submitted to the BIR. For purposes of the annual income tax return, the taxpayer, however, shall submit together with the duly audited financial statements in qualified functional currency, a supplementary schedule showing the quarterly amounts of functional currency income and expenses with translation to Philippine pesos. In determining the quarterly amounts, the rules provided above shall apply. Books of Accounts to be Maintained. - Taxpayers who qualified hereunder should maintain their books in functional currency (if other than the Philippine peso). However, said taxpayers shall also maintain subsidiary ledgers for transactions subject to the other taxes (i.e. aside from income tax), which will be recorded both in functional currency and in Philippine peso using the historical peso amounts or actual conversion/prevailing rate on transaction day, whichever is applicable. Said functional currency books/records must be registered with the BIR in accordance with existing rules on registration of books and may be subject to BIR audit in connection with the audit of tax liabilities.


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Preparing Financial Statements in Functional Currency. - A qualified entity presenting functional currency (other than the Philippine Peso) financial statements should: 1. Restate its prior year financial statements as if the company had been booking its transactions in prior years using such functional currency; 2. Treat the transactions in the Philippine Peso and other currencies as foreign currency transactions for reporting purposes. For purposes of functional currency financial statements, Philippine Peso and currencies other than the functional currency are considered foreign currencies and transactions therein shall be accounted for under prevailing generally accepted accounting principles. Transactions in foreign currencies shall be converted and recorded in the books of accounts in equivalent functional currency amount using the conversion rate on the day of the transaction. The conversion rate used should always be mentioned in the books of accounts. In the transition to functional currency reporting or in the translation of Philippine peso financial statements at the start of the initial year when functional currency is adopted, the qualified entity shall translate its Philippine peso balances to its functional currency financial statements as follows: a. Functional currency amounts (for both balance sheet and income statement items, including capital accounts) should be specifically identified and carried over to the functional currency financial statements in their original functional currency amounts, i.e., not translated amounts. For example, assuming the determined functional currency is the U.S. dollars (USD), all accounts denominated in USD amounts should be carried over to the functional currency financial statement; b. For foreign currency monetary assets and liabilities, translate using the closing spot exchange rate as of the balance sheet date; c. Non-monetary foreign currency items that are measured in terms of historical cost in a foreign currency shall be converted/ translated using the exchange rate at the date of transaction; d. Non-monetary items that are measured at fair value in a foreign currency shall be translated using the exchange rates at the


370

date such fair value was determined. For example, property, plant and equipment denominated in foreign currency and carried at revalued amounts shall be translated into the functional currency using the exchange rate on revaluation date; e. Non-monetary items for which the carrying amount is determined by comparing two or more amounts, such as inventories which are carried at lower of cost or net realizable value, or the carrying amount of an asset for which there is an indication of impairment and is therefore carried at net recoverable amount, the carrying amount is determined by comparing: i.

The cost or carrying amount, as appropriate, translated at the exchange rate at the date that amount was determined (i.e., the rate at the date of the transaction for an item measured in terms of historical cost); and

ii.

The net realizable value or recoverable amount, as appropriate, translated at the exchange rate at the date that value was determined (i.e., the closing rate when the value was determined at the balance sheet date).

f. For foreign currency income and expense items recognized in the reporting period, for each period presented (i.e., including comparatives), translation should be based on exchange rates at the dates of the transactions. For practical reasons, a rate that approximates the actual exchange rates at the dates of the transactions, for example, an average rate for the period, may be used to translate foreign currency income and expense items; g. For capital accounts, the exchange rates on the dates the Philippine Peso contributions were made shall be used to translate into the functional currency financial statements. In cases where capital is allowed to be contributed in currency other than Philippine Peso, such original amount shall be carried over to the functional currency financial statements if the contributions were made in the entity's functional currency. If the contributions were made in currency other than the entity's functional currency, then the exchange rates on the dates contributions were made shall be used to translate such amount into functional currency financial statements; h. Any exchange differences resulting from the first-time presentation of functional currency financial statements shall be charged or credited to retained earnings;


371


i.

Comparative financial statements are required to be filed;

j.

All references to exchange rates refer to the PDS rates.

and

Treatment of Gain or Loss on Sale of Investment under Functional Currency. - An investor which invests in functional currency (other than Philippine peso) securities can compute its gain or loss from the sale of said investment using the functional currency. For example: If Company A invests in a US dollar bond at US$100,000 when the US$:P rate was US$1:40 and sells the same investment at US$102,000 when the US$:P rate was US$1:50, the computation of the capital gain shall be as follows:

Selling price Cost Taxable Gain

USD

Pesos

102,000 100,000 2,000

5,100,000 4,000,000

In the above illustration, the taxable gain that should be reported is only $2,000. Thus, in reporting for tax purposes of the $2,000 gain in equivalent or converted Philippine peso denomination, the equivalent peso denomination is the peso equivalent of $2,000 U.S. dollars using the conversion rate on the date of the consummation of the transaction. The above rule shall also apply to non-resident stockholders of an investee-company where such investee-company in the Philippines uses a functional currency other than the Philippine peso for its financial statements. However, if an investor makes an investment in Philippine peso, then it shall compute the gain or loss from sale of said investment using the Philippine peso cost and Philippine peso selling price. Ai ailment of NOLCO and Excess MCIT. - The Net Operating Loss Carry-Over (NOLCO) and excess Minimum Corporate Income Tax (MCIT) can still be carried forward in the income tax computation of the taxpayer that has switched to a functional currency other than the Philippine peso, subject to the three year life limitation and other rules governing NOLCO and MCIT. However, in all cases, the


372

NOLCO and MCIT that shall be applied in subsequent year/s shall be determined using the historical peso amounts shown in the income tax return/s for the previous year(s) or years where they originate or emanate. Payment of Taxes in Functional Currency. - Taxpayers filing tax returns in the Philippine peso may pay the tax in functional currency computed using the functional currency buying rate of the collecting bank vis-a-vis the Philippine peso at the time of payment. The collecting bank shall, however, report to the BIR said collection in peso as converted/translated. Despite the permission to pay in functional currency, all figures in the tax returns shall always be in peso.

Attachments to Audited Financial Statements 43

These Regulations are hereby promulgated to prescribe the manner of compliance with any documentary and/or procedural requirements in connection with the preparation and submission of financial statements accompanying the tax returns. Contents and format of financial statements. - The Financial Statements with accompanying Auditor's Certificate attached to the Annual Income Tax Return, or Annual Information Return for the Tax exempt persons, as the case may be, to be filed with the Bureau of Internal Revenue, thru its collection agents including Accredited Agent Banks, shall present/state the accounts therein in a very descriptive fashion such that the nature of the specific transactions entered in the accounts are known to the reader. The account titles to be used must be specific and not control accounts which must completely be enumerated in the financial statements and these accounts must conform to the rules and requirements of regulatory agencies that have supervision over them such as the Securities and Exchange Commission (SEC), Bangko Sentral ng Pilipinas (BSP), Insurance Commission (IC), etc. The accounts prescribed in the reports required by the SEC, BSP, IC and other regulatory bodies shall likewise be the accounts to be used by individual taxpayers who are engaged in business or in the exercise of profession, except for accounts that are peculiar to corporations and other juridical persons. 43

Rev. Regs. No. 21-2002, Sept. 18, 2002.


373


The Profit and Loss Statement/Income Statement shall show separately by segment (there should be proper labeling), with breakdown of the specific accounts, the following: I. Sales Revenues II. Cost of Goods Sold (for seller of goods)/Cost of Services (for seller of services); III. Selling and Administrative Expenses; IV.

Financial Expenses, if any;

V. Other Income; and V I . Other Expenses.

44

[ N O T E : Items I, IV, V and VI should be fully explained in the Notes to the Financial Statements; Items II and I I I should be supported by Schedules.] Coverage. - The Financial Statements shall be composed of the following: a)

Balance Sheet;

b)

Income Statement/Profit and Loss Statement;

c)

Statement of Changes in Equity; and

d)

Statement of Cash Flows, together with all notes to the statements.

Starting 2005, except as provided under Section 232 of the NIRC, only financial statements audited by external auditors accredited by the Bureau of Internal Revenue shall be accepted. 45

The submission of the above statements is mandatory even if there is no income, retained earnings, etc. All the financial statements filed with accompanying auditor's certificate as cited above shall show the comparative figures of the current year and the previous year. Thus, Financial Statements with no required Auditors Certificate as enunciated in Section 232 (Keeping of Books of Accounts) of the Tax Code need not be presented in comparative format. "Rev. Regs. No. 7-2007, July 9, 2007. Sec. 2, Rev. Regs. No. 13-2006, Apr. 3, 2006. 46


374

Moreover, it is the responsibility of the taxpayer to reflect in its books of accounts (i.e., general, subsidiary ledgers, and journals) the adopted/accepted year-end adjusting entries made corollary to the preparation and filing of its audited financial statements and annual income tax returns. Correspondingly, all the necessary working papers prepared by the taxpayer pertinent to the year-end adjustments shall, nevertheless, be made available to the investigating officers of the Bureau upon audit and/or verification. 46

Responsibility of External Auditors. - Unless a longer period of retention is required under the Tax Code or other relevant laws (e.g., the Accountancy Law, etc.), the independent CPA who audited the records and certified the financial statements of the taxpayer, equally as the taxpayer, has the responsibility to maintain and preserve copies of the audited and certified financial statements for a period of three (3) years from the due date of filing the annual income tax return or the actual date of filing thereof, whichever comes later. This is in addition to all other responsibilities of the independent CPA under other pertinent provisions of the Tax Code and implementing regulations, including generally accepted auditing standards, and applicable jurisprudence. Submission of documents by taxpayers enjoying income tax holiday. - Section 6 of the Tax Code, as amended, provides that the Commissioner may prescribe the manner of compliance with any documentary or procedural requirements relative to the preparation and submission of financial statements and tax returns. Pursuant thereto, all taxpayers registered with the Board of Investments (BOI), BOI Autonomous Region of Muslim Mindanao (BOI-ARMM) and Philippine Economic Zone Authority (PEZA) availing of fiscal incentives approved by the said agencies are hereby required, upon filing of the Annual Income Tax Return (BIR Form 1701 and 1702) for taxable year 2006 and onwards, to attach thereto the following: a. Photocopy of the Certificate of Entitlement (CE) for Income Tax Holiday (ITH) issued by the BOI/BOI-ARMM stating therein that the concerned entity is a bona fide BOI/BOI-ARMM-registered enterprise entitled to I T H incentives; and b. Photocopy of the Certification issued by the PEZA stating therein that the entity is a bona fide PEZA-registered enterprise entitled to ITH and/or the 5% Gross Income Tax incentive. "Ibid.


375


The above requirement is in keeping with the joint under taking spelled out in separate Memoranda of Agreement (MOA) executed on March 1, 2007 between the BIR and the BOI/BOI-ARMM, and the PEZA. 47

Financial statements to be attached to loans obtained from banks. - Revenue Regulations No. 4-2005 defined "financial statements" to include "the balance sheet, statement of income, statement of changes in equity, and the statement of cash flows, together with all notes to the statements." It further states that "starting 2005 and for taxpayers with total assets of more than P15 Million, only financial statements audited by external auditors accredited by the Securities and Exchange Commissioner (SEC) shall be acceptable." For clarification, the financial statements referred to in MB Circular No. 472, series of 2005, shall be "the balance sheet, statement of income, statement of changes in equity, and the statement of cash flows, together with all notes to the statements" duly prepared and certified correct by an independent external auditor qualified under Revenue Regulations No. 15-99, as amended, which was filed with and duly stamped received by the LTS/LTDO/RDO or offices of the Bureau having jurisdiction over the taxpayer. Therefore, for purposes of Revenue Regulations No. 4-2005, the requirement that the financial statements submitted to the LTS/LTDO/RDO concern must be prepared by an external auditor accredited by the SEC shall not apply to financial statements prepared for periods covering 2004 and earlier. 48

However, in line with coordinating the action of all agencies and instrumentalities of the government, and to minimize the cost of doing business, starting with financial statements for the period covering 2005, for taxpayers with total assets of more than Fifteen Million Pesos, we enjoined all taxpayers to have their financial statements prepared by external auditors who are accredited both with the SEC and the BIR, in the meantime that Revenue Regulations No. 15-99 has not been amended to automatically accredit for BIR purposes, external auditors duly accredited by the SEC.

"RMC 21-2007, Mar. 5, 2007. • T o implement MB Circular No. 472, Rev. Regs. No. 4-2005 was issued. See also RMC 9-2005, Mar. 19, 2005.


376

Capital Gains Tax Returns Shares of stock of a domestic corporation Listed and traded in a local stock exchange: The transaction is exempt from income tax, but subject to the 1/2 of 1% stock transaction tax, which is required to be withheld and deducted by the stockbroker handling the transaction and remitted to the BIR within five (5) working days from the date of sale. Unlisted, or listed but traded outside a local stock exchange: The capital gains tax must be filed within thirty (30) days from the date of sale with the Revenue District Office where the principal place of business of the seller is located. Real Property Located in the Philippines The capital gains tax return shall be filed by the seller within thirty (30) days from the date of sale with the Revenue District Office having jurisdiction over the place where the property being transferred is located. The Certificate Authorizing Registration shall be issued by the RDO where the real property is located. 49

Annotation of CAR in TCT. - The Land Registration Authority, through the concerned Register of Deeds, is hereby directed to annotate in the Transfer Certificates of the Title the serial number of the Certificate Authorizing Registration (CAR) issued by the BIR, the date of its issuance, the Revenue District Office Number of the district office that issued the CAR, the name of the Revenue District Officer who signed the CAR and the taxes paid. This shall be an indispensable requirement prior to the issuance of a Transfer Certificate of Title by the Register of Deeds. 50

The additional annotation requirement shall cover transfers of Original, Condominium, and Transfer Certificates of Title of real properties sought to be registered with the Register of Deeds.

49

Sec. 3, Rev. Regs. No. 8-98, Aug. 25, 1998. This regulation clarifies that the seller is the one responsible for the filing of the capital gains tax return, but there shall be no expanded withholding tax to be deducted from the gross selling price by the buyer-withholding agent. For large taxpayers, Rev. Regs. No. 4-2008 dated Feb. 19, 2008 required that the CAR/TCL shall be secured from LTS. However, Rev. Regs. No. 5-2009 dated Mar. 16, 2009 reverted back the issuance of CAR/TCL involving sale of real property by large taxpayers to RDOs where the real property is located. ^President's Memo Order No. 233, in relation to P.D. No. 1529 (Property Registration Decree); RMC 3-2007, Jan. 15, 2007


377


Annotation of CAR in Tax Declaration. - The City, Municipal and Provincial Assessors are hereby directed to annotate in all Tax Declarations the serial number of the Certificate Authorizing Registration (CAR) issued by the BIR, the date of its issuance, the Revenue District Office Number of the district office that issued the CAR, the name of the Revenue District Officer who signed the CAR and the taxes paid on each transfer of ownership. This shall be indispensable requirement prior to the issuance of a Tax Declaration by the respective Municipal, City and/or Provincial Assessors. In case of revaluation and/or changes made in the Tax Declaration, all previous information contained in the previous tax declaration must be annotated at the back of the new tax declaration, including the information contained in the previous CAR. The additional annotation requirement shall cover all transfers of registered real properties, as well as, unregistered real properties securing a copy of a new tax declaration. 51

Redemption of real property foreclosed by banks, quasibanks and trust companies. - For purposes of reckoning the oneyear redemption period, in the case of individual mortgagors, or the three-month redemption period for juridical persons/mortgagors, the same shall be reckoned from the date of the confirmation of the auction sale which is the date when the certificate of sale is issued. 52

In case of non-redemption, the capital gains tax on the foreclosed capital asset of the mortgagor shall become due within thirty (30) days following the expiration of the redemption period. Nonetheless, if the property is an ordinary asset of the mortgagor, the creditable expanded withholding tax shall be due and paid within ten (10) days following the end of the month in which the redemption period expires. The classification of the asset as either ordinary asset or capital asset depends upon the nature of the asset in the hands of the mortgagor. The mortgagee-banks, quasi-banks, and trust companies are considered the statutory sellers in the foreclosure sales of the foreclosed real properties and are thus expected to have paid the aforesaid taxes within the period provided therefor, once the redemption period thereon has expired, without need to further "Presidential Administrative Order No. 186, July 31,2007; Memorandum Order No. 233, dated December 11, 2006, issued by the Land Registration Authority; RMC 72-2007, Oct. 9, 2007. "RMC 58-2008, Aug. 15, 2008 clarifies Sec. 47 of R.A. 8791 (The General Banking Law of 2000).


378

wait for another or subsequent buyer before taxes on said foreclosed property shall be paid. Additional Mandatory Documentary Requirements for One-time Transactions Involving Transfers of Real Property.™ - To ensure that all internal revenue taxes due on transfers of real property have been correctly paid and remitted to the government, the following mandatory documentary requirements shall be submitted in addition to the checklist of requirements prescribed under Revenue Memorandum Order No. 15-2003: 1. Photocopy of the official receipts issued by the seller, for purposes of determining whether the sale of real property is on cash basis, a deferred-payment sale (when payments in the year of sale exceed 25% of the selling price) or on installment plan (when payments in the year of sale do not exceed 25% of the selling price). The original copy of the official receipts shall be presented to the Bureau for authentication during the processing of the application for Certificate Authorizing Registration (CAR). However, if the seller is not engaged in business, the acknowledgement receipts issued by the seller to the buyer or any proof of payment shall be presented. While the Contract to Sell and official receipts of payments are among the documents required for installment sales in Revenue Memorandum Order No. 15-2003, the taxpayer presents only the Deed of Absolute Sale which is oftentimes executed upon full payment. The purpose of requiring the submission of a photocopy of the official receipts is for the Revenue District Office to have a means of validating if the transaction is on cash basis, deferred payment or installment plan. 2. Certified true copy of the original CAR (copy of the Registry of Deeds) pertaining to the transfer of property prior to the issuance of Original/Transfer Certificate of Title (OCT/TCT) or Condominium Certificate of Title (CCT) which is the subject of the current sale/ transfer, or certification issued by the Registry of Deeds indicating the serial number of the CAR, date of issuance of CAR, the Revenue District Office Number of the district office that issued the CAR, the name of the Revenue District Officer who signed the CAR, the type of taxes paid and the amount of payment per tax type. The afore-mentioned document shall be submitted for OCT/ TCT/CCT issued starting 2007, in case the Register of Deeds fails to 63

RMC 76-2007, Oct. 25, 2007.


379


annotate the information contained in the CAR as prescribed under Section 5 of Revenue Regulations No. 24-2002 dated November 15, 2002 and Section 1 of Memorandum Order No. 23 dated December 11, 2006 issued by President Gloria Macapagal-Arroyo, as circularized in Revenue Memorandum Circular No. 3-2007.

Passive Investment Income Since the passive investment income is already subject to the final withholding tax, which tax is already withheld and deducted from the income payment and remitted to the BIR by the withholding agent/payor, by filing his/its withholding tax return, no other income tax return is required to be filed by the recipient of income covering such income to the BIR. However, these passive investment incomes subjected to the final withholding taxes at preferential tax rates should be shown as "Adjustments to Net Income" of the taxpayer in its corporate income tax return.

CHAPTER X WITHHOLDING TAXES

Chapter X will cover all matters pertaining to withholding income tax. In particular, the following provisions will be discussed: Section 57 - Withholding tax at source; Section 58 - Returns and payment of taxes withheld at source; Section 78 - Definitions; Section 79 - Income tax collected at source; Section 80 - Liability for tax; Section 81 - Filing of return and payment of taxes withheld; Section 82 - Return and payment in cases of government employees; Section 83 - Statements and returns. Importance of withholding taxes The withholding of income tax on compensation income, on certain income payments made to resident taxpayers, and on income payments made to non-resident taxpayers is very important for all taxpayers, because the obligation to withhold and remit the tax is mandatory. The duty to withhold is different from the duty to pay income tax. Indeed, the revenue officers usually disallow the expenses claimed as deductions from gross income, if no withholding tax or an amount lower than the figure required by law or the regulations was withheld and remitted to the BIR within the prescribed dates. In addition, the amount of withholding tax that should have been withheld by the withholding agent and remitted to the BIR as well as the penalties for non-, late-, or erroneous-payment of the withholding tax, such as surcharges and deficiency interests, are assessed by the B I R against the withholding agent. The 380

expenses claimed as deductions from gross income may, however, be allowed as deductions, provided that the corresponding deficiency withholding taxes and penalties are paid by the withholding agent not later than the reinvestigation or reconsideration of the assessment. Withholding Tax-at-Source Since the withholding taxes are deducted by the withholding agents (who have control, custody, or receipt of the funds) when the income payments are paid or payable, they are described as "withholding taxes-at-source." In other words, the income tax of the recipient of income is withheld and deducted at the source and at the time of accrual or payment of the expense by the withholding agent-payor of income. The withholding of income tax is particularly significant where the payee is a non-resident alien individual or a nonresident foreign corporation over whom the Philippine government has no jurisdiction and cannot, therefore, enforce collection of deficiency tax assessments. Moreover, it has been observed by tax authorities that collection of the taxes at the level of the payors of income (or withholding agents) who are not so many and have good accounting records is more efficient and expeditious than collecting the same amounts and kinds of taxes from the recipients of income who are numerous and located in different areas in the country. The withholding of the tax is also an effective way of collecting income tax on interest on bank deposits of taxpayers who enjoy confidentiality of their deposits under R.A. No. 1405 (Bank Secrecy Law).

A.

Final Withholding Tax There are two (2) types of final withholding taxes. The first type refers to income payments to resident taxpayers, and the second type relates to income payments to non-resident taxpayers. Under the final withholding tax system, the amount of income tax withheld by the withholding agent is constituted as a full and final payment of the income tax due from the payee on said income. The liability for payment of the income tax rests primarily on the payor of income as a withholding agent. Thus, in case of the withholding agent's failure to withhold the tax or in case of under-withholding, the deficiency tax shall be collected from him. The payee-recipient of income is not required to file an income tax return for the particular income, nor is he


382

1

liable for the payment of the tax. The recipient of income (or income payee) does not report such income subjected to final withholding tax in his tax return for the period, but he/it is not allowed to claim any tax credit for the amount withheld from his income. In fact, no certificate of tax withheld shall be issued by the withholding agent to the income recipient because the amount withheld is a final tax. The finality of the withholding tax is limited only to the payee's income tax liability on the particular income. It does not extend to the payee's other tax liability on said income, such as when the said income is further subject to a percentage tax, such as gross receipts tax in the case of a bank. Income payments to resident and non-resident taxpayers are listed in Section 57(A) [Withholding Tax At Source] of the Tax Code and discussed in details in Section 2.57-1, Revenue Regulations No. 2-98, as amended by numerous subsequent regulations on the matter. The specific transactions are presented below: 1.

Due to resident taxpayers a.

Sale or Disposition of Real Property Classified as Capital Asset 2

Pursuant to the provisions of Section 244, in relation to Sections 24(A), 24(D)(1), 25, 27(A), 27(D) (5), 34(K), 57(A), 57(B), 58,151,173,196 and 245, all of the National Internal Revenue Code, as amended, these regulations are hereby promulgated to further amend portions of Revenue Regulations Nos. 2-98 and 13-99, as amended, providing for additional income payments subject to creditable withholding tax; clarifying existing provisions on income payments subject to creditable/expanded withholding tax and the requirements for deductibility of certain payments; providing for withholding as the mode of remitting final capital gains tax on the sale of real property classified as capital asset, and for other purposes. 'Sec. 2.57, Rev. Regs. No. 2-98. Rev. Regs. No. 17-2003, March 31, 2003 amended Rev. Regs. Nos. 8-98, 13-99, and 14-2000 2

WITHHOLDING TAXES

383

Income Payments Subject to FWT. - Section 2.57.1 of Revenue Regulations No. 2-98, as amended, is hereby further amended to read as follows: "Sec. 2.57.1. Income Payments Subject to Final Withholding Tax. - The following forms of income shall be subject to final withholding tax at the rates herein specified: ( A ) Income payments to a citizen or to a resident alien individual. xxx

xxx

xxx

(6) On capital gains presumed to have been realized from the 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 based on the gross selling price or fair market value as determined in accordance with Section 6(E) of the Code (i.e., the authority of the Commissioner to prescribe real property values), whichever is higher Six percent (6%). In case of sale on installment of real property classified as capital asset, the procedures stated under Section 2.57.2( J) hereof on the sale of real property classified as ordinary asset shall apply with the exception that the withholding tax on the former shall be final whereas that on the latter shall be creditable. In case of dispositions of real property classified as capital asset by individuals to the government or any of its political subdivisions or agencies or to government-owned or controlled corporations, the tax to be imposed shall be determined either under Section 24(A) of the Code for the normal rate of income tax for individual citizens or residents or under Section 24(D)(1) of the Code for the final tax on the presumed capital gains from sale of property at six percent (6%), at the option of the taxpayer-seller.

384


In case of sale/transfer of principal residence, the Buyer/Transferee shall withhold from the seller and shall deduct from the agreed selling price/consideration the 6% capital gains tax which shall be deposited in cash or manager's check in interest-bearing account with an Authorized Agent Bank (AAB) under an Escrow Agreement between the concerned Revenue District Officer, the Seller and the Transferee , and the AAB to the effect that the amount so deposited, including its interest yield, shall only be released to such Transferor upon certification by the said RDO that the proceeds of the sale/disposition thereof has, in fact, been utilized in the acquisition or construction of the Seller/Transferor's new principal residence within eighteen (18) calendar months from date of the said sale or disposition. The date of sale or disposition of a property refers to the date of notarization of the document evidencing the transfer of said property. In general, the term "Escrow" means 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. After depositing the amount representing the six percent ( 6 % ) capital gains tax as mentioned above, the Buyer/Transferee and the Seller, shall jointly file within thirty (30) days from the date of the sale or disposition of the principal residence, with the Revenue District Office having jurisdiction over the property, in duplicate, the Final Capital Gains Tax Return ( B I R Form No. 1706, or any form number assigned by the B I R ) , covering the property bought with no computed tax due stating that the supposed-tax due/amount so withheld by the buyer is maintained in an escrow account, which amount will be used to satisfy future tax liability, if any, on the subject transaction. For

WITHHOLDING TAXES

385

purposes of the capital gains tax otherwise due on the sale, exchange or disposition of the said Principal Residence, the execution of the Escrow Agreement referred to in the immediately preceding paragraph shall be considered sufficient. The tax return so filed in pursuance hereof shall bear the addresses of both the seller and the buyer. If within thirty (30) days after the lapse of the aforesaid 18-month period, the Seller/ Transferor fails to submit documentary evidence showing that he has utilized the proceeds of sale or disposition of his old principal residence to acquire/construct his new principal residence, he shall be treated as deficient in the payment of his capital gains tax on the sale or disposition of his aforesaid Principal Residence, and shall be accordingly assessed for deficiency capital gains tax, inclusive of penalties and the 20% interest per annum computed from the 31st day after the date of sale/disposition of the said principal residence, pursuant to the provisions of Section 228 (Protesting of Assessment) of the Code, as implemented by Revenue Regulations No. 12-99, in relation to Section 249 (Interest) of the said Code. In the issuance of assessments, the Seller shall receive all the required notices following existing procedures. Upon the time that the said deficiency tax assessment has become final and executory, the deposit in escrow, inclusive of its interest earnings, shall be forfeited and applied against the deficiency capital gains tax liability. If the same is insufficient to cover the entire amount assessed, the Seller/Transferor shall remain liable for the remaining balance of the assessment. On the other hand, the excess of the deposit in escrow, if any, shall forthwith be returned to the Seller, by the Bank upon written authorization from the Commissioner or his duly authorized representative.


386

(G) Income Payment to a Domestic Corporation - The following items of income shall be subject to a final withholding tax, based on the gross amount thereof and at the rate of tax prescribed therefor: xxx

xxx

xxx

(5) On capital gains presumed to have been realized from the sale, exchange or other disposition of land and building located in the Philippines classified as capital assets, based on the gross selling price or fair market value as determined in accordance with Section 6(E) of the Code, whichever is higher - Six percent (6%). In case of sale on installment of real property classified as capital asset, the procedures stated under Section 2.57.2(J) hereof on the sale of real property classified as ordinary asset shall apply with the exception that the withholding tax on the former shall be final whereas that on the latter shall be creditable. Real Property Transactions

3

Pursuant to the provisions of Section 244, in relation to Sections 57(A)2 and (B)3 of the Tax Code, these regulations are hereby promulgated to further amend portions of Revenue Regulations Nos. 2-98, as last amended by Revenue Regulations No. 17-2003 and 8-1998, providing for withholding as a mode of remitting final capital gains tax on the sale of real property classified as capital assets by non-resident aliens, increasing the withholding tax rates on certain income payments, inclusion of non-food products in the coverage of expanded withholding tax, providing sanctions to payees who refuse the withholding of tax on their income/receipts, and for other purposes. "Sec. 2.57.1 of Revenue Regulations No. 2-98, as amended, is hereby further amended to read as follows: "Sec. 2.57.1. Income Payments Subject to Final a

Rev. Regs. No. 30-2003, Dec. 12, 2003.

WITHHOLDING TAXES

387

Withholding Tax. - The following forms of income shall be subject to final withholding tax at the rates herein specified. ( A ) Income payments to a citizen or to a resident alien individual. xxx

xxx

xxx

(B) Income Payment to Non-resident Aliens Engaged in Trade or Business in the Philippines. - The following forms of income derived from sources within the Philippines shall be subject to final withholding tax in the hands of a non-resident alien individual engaged in trade or business within the Philippines, based on the gross amount thereof and at the rates prescribed therefor: xxx

xxx

xxx

(3) On capital gains presumed to have been realized from the sale exchange or other disposition of real property located in t i e Philippines, classified as capital assets, includingpacto de retro sales and other forms of conditional sales based on the gross selling price or fair market value as determined in accordance with Section 6(E) of the Code (i.e. the authority of the Commissioner to prescribe zonal values), whichever is higher - Six percent (6%). In case of sale on installment of real property classified as capital asset, the procedures stated under Section 2.57.2(J) hereof on the sale of real property classified as ordinary asset shall apply with the exception that the withholding tax on the former shall be final whereas that on the latter shall be creditable. In case of dispositions of real property classified as capital asset by individuals to the government or any of its political subdivisions or agencies or to government-owned or controlled corporations, the tax to be imposed shall be determined either under Section 24(A) of the Code for the normal rate of income tax for individual citizens or residents or under Section 24(D)(1) of the Code for the final tax on the presumed capital gains from sale of property at six percent (6%) at the option of the taxpayer-seller.


388

(C)

Income Derived from All Sources Within the Philippines by a Non-resident Alien Individual Not Engaged in Trade or Business Within the Philippines. - The following forms of income derived from all sources within the Philippines shall be subject to a final withholding tax in the hands of a non-resident alien individual not engaged in trade or business within the Philippines based on the following amounts and at the rates prescribed therefor: xxx

xxx

xxx

(2) On capital gains presumed to have been realized from the 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 based on the gross selling price or fair market value as determined in accordance with Section 6(E) of the Code (i.e. the authority of the Commissioner to prescribe the real property values), whichever is higher - Six percent (6%) In case of sale on installment of real property classified as capital asset, the procedures stated under Section 2.57.2(J) hereof on the sale of real property classified as ordinary asset shall apply with the exception that the withholding tax on the former shall be final whereas that on the latter shall be creditable. In case of dispositions of real property classified as capital asset by individuals to the government or any of its political subdivisions or agencies or to government-owned or controlled corporations, the tax to be imposed shall be determined either under Section 24(A) of the Code for the normal rate of income tax for individual citizens or residents or under Section 24(D)(1) of the Code for the final tax on the presumed capital gains from sale of property at six percent (6%) at the option of the taxpayer-seller. Other types of income, gain or profit subject to final withholding taxes, payable to resident taxpayers, are discussed in Chapter IV (Gross Income) and Chapter V I I (Tax Bases and Rates) of this book.

WITHHOLDING TAXES

2.

389

Due to non-resident taxpayers

Gross income payable to non-resident aliens and nonresident foreign corporations are subject to the final withholding taxes under various provisions of Title II of the Tax Code. For details, you may refer to Chapter IV (Gross Income) and Chapter V I I (Tax Bases and Rates) of this book and Revenue Regulations No. 2-98, as amended.

B.

Creditable Withholding Taxes Under the creditable withholding tax system, taxes withheld on certain income payments are intended to equal or at least approximate the tax due of the payee on said income. The income recipient is still required to file quarterly and annual income tax return to report the income and/or to pay the difference between the tax withheld and the tax due on the income. Taxes withheld on income payments covered by the expanded withholding tax and compensation income are creditable in nature against the income tax liability for the year, provided that the same is evidenced by the appropriate withholding tax certificate (BIR Form 2317) that is attached to the income tax return filed with the Bureau of Internal Revenue. 4

There are three (3) types of creditable withholding taxes, namely: (1) expanded withholding tax on certain income payments made by private persons to resident taxpayers; (2) withholding tax on compensation income for services done in the Philippines; and (3) withholding tax on money payments made by the government. 1.

Expanded Withholding Tax The summary of creditable withholding tax bases and rates applied on income payments liable to income tax are shown below:

4

Other documentary evidence such as the Journal Voucher, showing the gross income and the corresponding EWT thereto, and the check issued by the payor as well as the EWT return filed by the payor may be used as substitutes for BIR Form 2307 - Certificate of Tax Withheld.


390

1.

Professional fees for services rendered by individuals; and professional entertainers and athletes, and directors: 5

If gross income for current year exceeds P720,000 If gross income for current year does not P720,000 2.

5

- 10% - 15%

Rental income Real properties Personal properties of P10,000 per payment; P10.000 shall not apply when accumulated rental to same lessor exceeds or is reasonably expected to exceed P10,000 within a year Poles, satellites and transmission facilities Billboards

4.

- 15%

If recipient of professional fees, talent fees, etc. is a juridical person: If gross income for current year exceeds P720,000 If gross income for current year does not P720,000

3.

- 10%

Gross payments to resident individuals and corporate cinematographic film owners, lessors, or distributors 6

- 5%

- 5% - 5% - 5%

- 5%

5.

Gross payments to contractors

- 2%

6.

Income distribution to beneficiaries

- 15%

7.

Income payments to certain brokers and agents

- 10%

See Rev. Regs. Nos. 30-2003, 2-2004, Jan 14, 2004. E W T applies not only to fees but also to per diems, allowances and any other form of income payment made to a director (RMC 34-2008, Apr. 15, 2008). RMC 26-2009 revoked BIR RR7 Ruling No. 003-876 dated Sept. 13, 2006. Basis of 2% E W T is gross income and not gross receipts. 6

WITHHOLDING TAXES

8.

9.

391

Income payments to partners of general professional partnerships: If gross income for current year exceeds P720,000

.15%

If otherwise

. 10%

Professional fees paid to medical practitioners 7

10.

If gross income for current year exceeds P720,000

-15%

If otherwise

- 10%

Gross additional payments to government personnel from importers, shipping and airline companies, or their agents

-15%

11. One-half of gross amounts paid by any credit card company in the Philippines 12.

Income payments made by any Top 20,000 Corporation 8

9

Supplier of goods Supplier of services 13.

14.

-1%

-1% - 2%

Income payments made by government to its local/resident supplier of goods and services other than those covered by other rates of withholding taxes Supplier of goods

- 1%

Supplier of services

- 2%

Commissions of independent and exclusive distributors, and marketing agents of companies

- 10%

15. Tolling fees paid to refineries

- 5%

'Rev. Regs. No. 1-2004, Jan 14, 2004. "Rev. Regs. No. 14-2008, Nov. 26, 2008. "It includes a private corporation which has been determined and notified as such by the BIR that satisfies any of the criteria prescribed by CIR (Rev. Regs. No. 17-2003).


392

16. Payments made by pre-need companies to funeral parlor 17. Payments made to embalmers 18. Income payments made to suppliers of agricultural products 19.

20.

21.

Income payments on purchases of minerals, mineral products and quarry resources MERALCO refund to customers With active contracts

- 1% -1% -1%

10%

10

11

-25%

With terminated contracts

-32%

Political contributions to candidates

- 5%

12

Essential Requisites for E W T An income payment is subject to the expanded withholding tax, if the following conditions concur: a.

An expense is paid or payable by the taxpayer, which is income to the recipient thereof subject to income tax;

b.

The income is fixed or determinable at the time of payment;

c.

The income is one of the income payments listed in the regulations that is subject to withholding tax;

d.

The income recipient is a resident of the Philippines liable to income tax; and

e.

The pay or-withholding agent is also a resident of the Philippines.

An expense is paid or payable by the taxpayer, which is income to the recipient thereof subject to income tax The payment must represent income to the recipient thereof and it is subject to income tax. The term "income, gain or profit" was fully explained in Chapter IV of this Book. Unless l

T h e EWT rate of 1% prescribed in Rev. Regs. No. 17-2003 was increased to 10% under Rev. Regs. No. 7-2008, Mar. 25, 2008. "See Rev. Regs. No. 8-2005, Feb. 23, 2005. See Rev. Regs. No. 8-2009, October 2009. 12

WITHHOLDING TAXES

393

such income, gain or profit is expressly exempt under the Tax Code or special law, it is presumed to be taxable. The withholding of creditable withholding tax shall not apply to income payments made to the following: 1. National government and its instrumentalities, including provincial, city or municipal governments and barangays, except government-owned or controlled corporations; 2. Persons enjoying exemption from payment of income taxes pursuant to the provisions of any law, general or special, such as but not limited to the following: a.

Sales of real property by a corporation which is registered with and certified by HLURB or HUDCC as engaged in socialized housing project where the selling price of the house and lot or only the lot does not exceed P400,000 in Metro Manila and other highly urbanized areas and P150,000 in other areas;

b.

Corporations registered with the BOI, PEZA, and SBMA and other freeport zone authorities enjoying exemption from income tax under E.O. No. 226, R.A. No. 7916, and R.A. No. 7227; Corporations which are exempt from income tax under Section 30 of the Tax Code, such as GSIS, SSS, PHIC, and PCSO as well as AFP RSBS;

c.

General professional partnerships;

d.

Joint ventures or consortium formed for the purpose of undertaking construction projects or engaging in petroleum, coal, geothermal and other energy operations pursuant to an operating or consortium agreement under a service contract with the government; and

e.

Revenues derived from carriage of persons, cargo or mail originating from the Philippines up to final destination, paid to international shipping line or through its shipping agent in the Philippines, subject to the 2.5% final tax on Gross Philippine Billings. 13

13

Sec. 28(A)(3)(b), NIRC. The 2.5% tax on GPB is reduced to 1.5% where the international shipping line is a resident of a country that has an effective tax treaty with the Philippines; see BIR Ruling No. DA 204-2006 & 321-2008, Dec. 12, 2008.


394

The income is fixed or determinable at the time of payment Income is "fixed" when it is to be paid in amounts definitely pre-determined. It is "determinable," whenever there is a basis for calculation by which the amount to be paid may be ascertained. An income is described as "annual or periodical," when it is paid from time to time, whether or not at regular intervals. The income need not be paid annually, if it is paid periodically. 14

The income payment is listed in the regulations as subject to withholding tax Revenue Regulations No. 2-98, as amended, enumerates the different income payments subject to the expanded withholding tax. If the income payment is not one of those listed in the regulations, then it is not subject to withholding tax. However, in case the payor of income is one of the top 20,000 Corporations, the income payment, although not listed as subject to EWT under the regulations, is subject to the creditable withholding tax of one (1) percent, if it insolves purchase of goods, or 2%, if it isolves purchase of services. The recipient of income is a resident of the Philippines The provisions of the expanded withholding tax regulations apply only where the recipient of income subject to tax is a resident of the Philippines. This is so because if the recipient of the income is a non-resident taxpayer, the tax on such income cannot be enforced beyond the territorial jurisdiction of the Philippine government; hence, for practical reasons, the income payment to the non-resident taxpayer shall be subject to the final withholding tax, not to the creditable withholding tax. The pay or-withholding agent is resident of the Philippines The power of the government to require the withholding of tax extends only to taxpayers who are residing or doing business within the territorial jurisdiction of the Philippines. Thus, non-resident foreign corporations and embassies of foreign governments in the Philippines may not be constituted N


WITHHOLDING TAXES

395

nor be compelled to act as withholding agents of the Philippine government, because in case of non-compliance with their obligations to withhold, the Philippine government may not anyway enforce its tax laws beyond its territorial jurisdictions. Withholding Agent The withholding agent is a person who has control, receipt, custody, disposal, or payment of income to the person entitled to it, that is designated by law or regulations to act as agent of the government in the collection of taxes. Although it/he is not compensated by the government for doing the withholding and remittance of taxes in behalf of the recipient of income, he may become liable to the tax required to be withheld under the law or regulations plus the penalties attendant to the non-withholding or under-withholding of such tax. Indeed, the withholding agent holds the amount withheld from the income of another person in trust for the government until paid. 15

The following persons are constituted as withholding agents: 16

1.

In general, any juridical person (e.g., corporation, partnership, joint venture estate or trust), including non-stock, non-profit associations, whether or not engaged in trade or business;

2.

An individual, with respect to payments made in connection with his trade or business. However, insofar as taxable sale, exchange or transfer of real property is concerned, individual buyers who are not engaged in trade or business are also constituted as withholding agents;

3.

All government offices, including government-owned or controlled corporations, as well as provincial, city, and municipal governments and barangays.

Agents, employees or any person purchasing goods or services/paying for and in behalf of the aforesaid withholding agents shall likewise withhold in their behalf, Provided, That the official receipts of payment/sales invoice shall be issued in the name of the person whom the former represents and the 16 16

Sec. 58, NIRC. Rev. Regs. No. 2-98, as amended.


396

corresponding certificate of taxes withheld (BIR Form No. 2307) shall immediately be issued upon withholding of the tax. All income payments which are required to be subjected to withholding tax shall be subject to the corresponding withholding tax rate to be withheld by the person having control over the payment and who, at the same time, claims the expenses [e.g., payments to utility companies which are required to be subjected to withholding tax shall likewise be subjected to withholding tax even if the meter or billing statement (e.g., electric or water meter or the telephone bill) is not in the name of the payor, as long as valid proof that payment of a particular expense is being shouldered by the aforementioned payor (i.e., contract between the registered user of the meter and the payor); payments made by persons who are sharing portion of the bill which is in the name of another person as long as he is a duly constituted withholding agent and shall only withhold on the portion of the expense being shouldered by him]. Income payments made thru brokers or agents or other person authorized to collect/receive payments for and on behalf of the payee, whether for consideration or otherwise, shall likewise be subject to the corresponding withholding tax rates to be withheld by the payor/person having control over the payment with the corresponding issuance of certificate of taxes withheld in the name of the payee whom the agent represents. The obligation to withhold is imposed upon the buyer-payor of income although the burden of tax is really upon the sellerincome earner hence, unjustifiable refusal of the latter to be subjected to withholding shall be a ground for the mandatory audit of his income tax liabilities (including withholding tax) upon verified complaint of the buyer-payor. 17

The provisions of Section 57(B) of the Tax Code is broad and all-embracing as it covers the receipt, control, or custody of funds by any person, natural or juridical, for a resident taxpayer, natural or juridical, or foreign corporation not doing business in the Philippines, of practically all forms of income as long as they are fixed or determinable and are received with regularity. The obligation to withhold is compulsory, as it makes such withholding agent personally liable for payment of 17

Rev. Regs. No. 1-2004, Jan 14, 2004.

the tax. - Reinsurance premiums ceded by domestic entities to non-resident foreign corporations are determinable subject to withholding (British Traders Insurance Co., Ltd. vs. Commissioner, G.R. L-20501, Apr. 30,1965). Where the local authorized agent of a foreign insurance corporation had filed an income tax return and had paid the corresponding tax for its non-resident principal, such filing and payment did not become final in the absence of proof that such return included reinsurance premiums subject to withholding tax, ceded to such foreign corporation by the local insurance company, and did not relieve the latter of its legal duty to withhold such tax (Commissioner vs. Malayan Insurance Company, G.R. No. L-21913, Nov. 18, 1967). The withholding agent is the agent both of the government and of the taxpayer, and that the withholding agent is not an ordinary government agent. - With respect to the collection and/or withholding of the tax, he is the Government's agent. In regard to the filing of the necessary income tax return and the payment of the tax to the Government, he is the agent of the taxpayer. The law sets no condition for the personal liability of the withholding agent to attach. The reason is to compel the withholding agent to withhold the tax under all circumstances. In effect, the responsibility for the collection of the tax as well as the payment thereof is concentrated upon the person over whom the Government has jurisdiction (Commissioner vs. Procter & Gamble PMC and CTA, G.R. No. 66838, Dec. 2, 1991). The liability of the withholding agent is direct and independent from the liability of the income recipient. In the operation of the withholding tax system, the withholding agent is the payor, a separate entity acting no more than an agent of the government for the collection of the tax in order to ensure its payments; the payer is the taxpayer - he is the person subject to tax imposed by law; and the payee is the taxing authority. Under the withholding system, however, the agentpayor becomes a payee by fiction of law. His (agent) liability is direct and independent from the taxpayer, because the income tax is still imposed on and due from the latter. The agent is not liable for the tax as no wealth flowed into him - he earned no income. The Tax Code only makes the agent personally liable for the tax arising from the breach of its legal duty to withhold as distinguished from its duty to pay tax, since the government's cause of action against the withholding agent

398


is not for the collection of income tax, but for the enforcement of the withholding provision of Section 53 (now Section 57) of the Tax Code, compliance with which is imposed on the withholding agent and not upon the taxpayer. Codal provisions on withholding tax are mandatory and must be complied with by the withholding agent (Commissioner vs. A. Soriano Corporation, et al., supra). Where a person, acting as attorney-in-fact of a taxpayer, receives an amount from a corporation in payment of the percentages earned by the taxpayer, he and the corporation, must be deemed to be a withholding agent within the purview of Section 53(b) [now Section 57] of the Tax Code, with the duty of deducting the corresponding income tax due thereon before remitting the amount to the taxpayer. Where the CTA dismissed the Government's claim for withholding tax against the withholding agent on the ground that the authorized representative of the non-resident foreign corporation was the one who paid the income tax - an indirect way of saying that the demand, if at all, should be made on the latter - such dismissal must be reversed because the Government's cause of action against the withholding agent is not for the collection of income tax, but for the enforcement of the withholding provision of Section 53 of the Tax Code, compliance with which is imposed on the withholding agent and not upon the taxpayer. In other words, the duty to withhold tax is different from the duty to pay income tax (Republic vs. Jose Razon and Jai-Alai Corporation, G.R. No. L-17462, May 29,1967). A taxpayer, resident or non-resident, who contributes to the withholding tax system, does not really deposit an amount to the Commissioner, but, in truth, to perform and extinguish his tax obligation for the year concerned (Gibbs vs. Commissioner, 15 SCRA 318, Nov. 29, 1965). They are installments on the annual tax which may be due at the end of the taxable year (Commissioner vs. TMX Sales, Inc., supra; ACCRA Investments Corp vs. Commissioner, supra). Installment Sales The term "habitually engaged in real estate business" for purposes of the expanded withholding tax is not limited or restricted only to persons duly registered with the Housing and Land Use Regulatory Board ( H L U R B ) or Housing and

Urban Development Coordinating Council (HUDCC). This proviso simply means that any person duly accredited by the said government agencies shall be deemed habitually engaged in the real estate business. However, even in the absence of registration therewith, a person may also be treated habitually engaged in the real estate business upon a showing that he is in fact actually engaged in the said business. For example, a lessor of real properties may not be registered with the HLURB or HUDCC. Nevertheless, such person is engaged in business as a lessor of real properties; hence, embraced by the proviso "habitually engaged in the real estate business." When a person has six (6) or more real estate sales transactions during the year, he will be considered as engaged in real estate business, even if he does not register as such with HLURB. 18

19

Revenue Regulations No. 1-90 covers all types of sale - cash sale, sale on installment basis, and sale on a deferred payment basis. 20

1.

Sales on the installment plan

Since the installment payment which will be paid by the buyer to the seller will not exceed 25% of the entire consideration, the seller is qualified to report the gains on installment basis, in which case, the amount which may be reported during the taxable year is only that proportion of the installment payments actually received during the year which the gross profit realized or to be realized when payment is completed bears to the contract price. Therefore, the buyer which is engaged in trade or business is required to deduct and withhold the tax on every installment and not on the entire consideration. 21

2.

Sales on d e f e r r e d payment basis, not on the installment plan

Gross selling price or total amount of consideration or its equivalent The term "down payment" is not equal to the gross selling price or the total amount of consideration or its equivalent paid 19

BIR Ruling No. 059-99, Apr. 30, 1999. Rev. Regs. No. 7-2003, Dec. 27, 2002. BIR Ruling No. 078-94, Mar. 18, 1994. BIR Ruling DA-248-04-23-99, citing Sec. 49(B), Tax Code; BIR Ruling No. 161-84, Sept. 26, 1984. 19

20

21


400

to the seller/owner since it is actually a portion of the whole (i.e., of the gross selling price or the total amount of the consideration or its equivalent). The alternative use of the terms "gross selling price" or "total consideration or its equivalent paid to the seller/ owner" is necessary to comprehend the payment other than money made by the buyer which, in all intents, forms part of the consideration or selling price and for which the equivalent value thereof shall be considered in computing the creditable withholding tax. The use of the phrase "or the total amount of consideration or its equivalent paid to the seller" implies a situation wherein the consideration (which could also be the contract or selling price) could be both in money and in kind such as property, labor, etc., in which case, the fair market value of the same shall be considered and added together to arrive at the gross selling price or total consideration received. There is nothing inconsistent between BIR Ruling Nos. 078-94 and 19-96 and Revenue Regulations. No. 1-90 insofar as the basis of the expanded withholding tax is concerned. 22

Medical Practitioners

23

(I) Professional fees paid to medical practitioners. - Any amount collected for and paid to medical practitioners (includes doctors of medicine, doctors of veterinary science and dentists) by hospitals and clinics, or paid directly to the medical practitioners by patients who were 'admitted and confined' to such Hospitals or Clinics, or paid directly to such medical practitioners by health maintenance organizations (HMOs) and/ or similar establishments which is likewise covered by Section 2.57.2(A)(1) - Fifteen percent (15%), if the income payments to the medical practitioner for the current year exceeds P720.000; and Ten percent (10%), if otherwise. a) It shall be the duty and responsibility of the hospital, clinic or HMO to remit taxes withheld from the following:

!

1.

Professional fees paid by H M O s to medical practitioners;

2.

Professional fees paid by patients to medical practitioners thru the hospitals or clinics;

BIR Ruling No. 011-99, Jan. 22, 1999. 'Rev. Regs. No. 1-2004, Jan. 14, 2004.

3.

Professional fees paid by patients directly to medical practitioners where the 10% or 15% expanded withholding tax, whichever is applicable, shall in turn be given by medical practitioners directly to the Accounting Office of the hospitals or clinics; c)

xxx

xxx

xxx

(ii) Medical practitioners whose professional fee was paid to them directly by the patients and the 10% or 15% withholding tax, whichever is applicable, was given by such practitioners to the Accounting Office of the hospital or clinic; (iii) Medical practitioners whose professional fee was paid to them directly by the patients but the 10% or 15% withholding tax, whichever is applicable, was not given by such practitioners to the Accounting Office of the hospital or clinic. (e) Hospitals and clinics shall be responsible for the accurate computation of taxes to be withheld on professional fees paid by patients thru the hospitals and clinics, in the same way that HMOs shall be responsible for the computation of taxes to be withheld from the professional fees paid by them to the medical practitioners, and timely remittance of the 10% or 15% expanded withholding tax, whichever is applicable. The list of all income recipients-payees in this Subsection shall be included in the Alphalist of Payees Subject to Expanded Withholding Tax, attached to BIR Form No. 1604-E (Annual Information Return of Creditable Income Taxes Withheld (Expanded)/Income Payments Exempt from Withholding Tax). Likewise, the hospitals, clinics or HMOs shall issue a Certificate of Creditable Tax Withheld at Source (BIR Form No. 2307) to medical practitioners who are subjected to withholding, every 20th day following the close of the taxable quarter or upon request of the payee. Top 20,000 Private Corporations "Top twenty thousand (20,000) private corporations" shall include a corporate taxpayer who has been determined and notified by the Bureau of Internal Revenue (BIR) as having satisfied any of the following criteria:


402

a.

Classified and duly notified by the CIR as a large taxpayer under Rev. Regs. No. 1-1998, as amended, or belonging to the top five thousand (5,000) private corporations under Rev. Regs. No. 12-1994, or to the top ten thousand (10,000) private corporations under Rev. Regs. No. 17-2003, unless previously de-classified as such or had already ceased business operations; 24

b.

Any taxpayer with net V A T paid or payable for the preceding year of at least P100,000;

c.

Any taxpayer with annual income tax paid or payable for the preceding year of at least P200.000;

d.

Any taxpayer with percentage taxes for the preceding year of at least P100,000;

e.

Any taxpayer whose gross sales for the preceding year is over P10,000,000; and

f.

Any taxpayer whose gross purchases for the preceding year is over P5,000,000. 25

Non-large taxpayers belonging to the top 20,000 private corporations duly identified under Rev. Regs. No. 14-2008 and notified by the Commissioner as such shall make use of the EFPS in filing their returns and in paying their taxes due thereon. Returns of said non-large taxpayers shall include those of their branches, provided that they are located in the computerized revenue district offices. The provisions hereof shall apply to returns to be filed starting April 1, 2009. 26

The term "goods" pertains to tangible personal property. It does not include intangible personal property as well as real property. The term "local/resident supplier of goods" pertains to a supplier from whom any of the top ten thousand (10,000) [now 20,000] private corporations, as determined by the Commissioner, regularly makes its purchases of goods. As a general rule, this term does not include a casual purchase of goods, that is, purchases made from non-regular suppliers 24

See RMC 45-2007, July 6, 2007. Rev. Regs. No. 14-2008, Nov. 26, 2008. ^Sec. 2, Rev. Regs. No. 3-2009, Feb. 9, 2009. 26

and oftentimes involving single purchases. However, a single purchase which involves ten thousand pesos (P10,000.00) or more shall be subject to a withholding tax. The term "regular suppliers" refers to suppliers who are engaged in business or exercise of profession/calling with whom the taxpayer-buyer has transacted at least six (6) transactions, regardless of amount per transaction, either in the previous year or current year. The same rules apply to local/resident supplier of services other than those covered by separate rates of withholding tax. A corporation shall not be considered a withholding agent for purposes of this Section, unless such corporation has been determined and duly notified, in writing, by the Commissioner. Any corporation which has been duly classified and notified as large taxpayer by the Commissioner pursuant to Rev. Regs. No. 1-98, as amended, shall be automatically considered one of the top ten thousand (10,000) [now 20,000] private corporations; Provided, however, That its authority as a withholding agent shall be effective only upon receipt of written notice from the Commissioner that it has been classified as a large taxpayer, as well as one of the top ten thousand (10,000) private corporations, for purposes of these regulations. Any corporation shall remain a withholding agent for purposes of these regulations, unless the Commissioner notifies it in writing that it shall cease to be one. The following, however, are some of the reasons that a taxpayer shall automatically cease to be a withholding agent, and therefore no prior written notice, for purposes of these Regulations, is required, to wit: a)

Closure/cessation of business/dissolution (for taxpayer with notice of dissolution given to the BIR);

b)

Merger/consolidation (for dissolved or absorbed corporation); or

c)

Any other form of business combination wherein by operation of law a corporate taxpayer loses its juridical personality.

The withholding agent shall submit on a semestral basis a list of regular suppliers of goods and/or services to the Large Taxpayers Assistance Division/Large Taxpayers District Office in the case of large taxpayers duly notified as such pursuant to Rev. Regs. No. 1-98, as amended, or Revenue District Office

404


having jurisdiction over the withholding agent's principal place of business on or before July 31 or January 31 of each year. A government-owned or controlled corporation previously classified as one of the top five (5,000) [now 20,000] corporations under Rev. Regs. No. 14-94, as amended, shall cease to be a withholding agent or included in the top ten thousand (10,000) private corporations for purposes of these regulations but rather shall be treated as one under the succeeding sub-section (N) since it is already withholding two percent (2%) of the amount paid for the purchase of goods/services from local/resident suppliers. The Commissioner of Internal Revenue may recommend to the Secretary of Finance the amendment/modification to any or all of the criteria in the determination and selection of taxpayers forming part of the top ten thousand (10,000) [now 20,000] private corporations after considering such factors as inflation, volume of business, and similar factors. Provided, however, That the Commissioner is empowered to conduct periodic review as to the number of taxpayers who ceased to qualify under the category of top ten thousand private corporations for purposes of delisting them or excluding them from the list and to identify taxpayers to be added to the list of top 10,000 private corporations. The top ten thousand (10,000) private corporations will be announced through the issuance of a Revenue Memorandum Circular to be issued for this purpose. All taxpayers previously included in the list of Top 5,000 Corporations under Rev. Regs. No. 12-94, as amended, shall continue to withhold the one percent (1%) withholding tax (which shall become 1% for supplier of goods and 2% for supplier of services upon the effectivity of these Regulations) unless any of the following situations occur: (a) the Commissioner communicates in writing that they have ceased to qualify as taxpayers includible in the list of top ten thousand private corporations; or (b) those officially identified to have ceased business operations, or undergone any of the business combinations wherein by operation of law the juridical personality of said taxpayers ceased. Time to Withhold Tax Withholding tax shall be deducted and withheld by the withholding agent when the income payment is paid or payable

27

or accrued, or the income payment is accrued or recorded as an expense or asset, whichever is applicable, in the payor's books, whichever comes first. The term "payable" refers to the date the obligation becomes due, demandable or legally enforceable. Where the income is not yet paid or payable but the same has been recorded as an expense, the obligation to withhold shall arise in the last month of the return period in which the same is claimed as an expense or amortized for tax purposes. Revenue Regulations No. 8-98 provides that a "creditable withholding tax based on the gross selling price/total amount of consideration or the fair market value ... paid to the seller/ owner for the sale, transfer or exchange of real property, other than capital asset, shall be imposed upon the withholding agent/buyer..." In relation to this, Section 2.57.4 of Revenue Regulations No. 2-98 provides that the obligation of the payor to deduct and withhold the tax arises at the time an income is paid or payable, whichever comes first. Pursuant to the above regulations, if, under the Purchase and Sale Agreement, the release of the first installment pay.nent comprising 25% of the consideration is made dependent on the annotation of the Agreement on the title pursuant to Section 54 of P.D. No. 1259, the buyer is not required to deduct and withhold the creditable withholding tax, since no income has yet been realized by the seller when such annotation at the back of the title was not made during the year due to the failure to secure the required Certificate Authorizing Registration or Certificate of Tax Clearance from the appropriate Revenue District Officer, as required by the Register of Deeds. As expressly provided by the regulations, the obligation of the buyer to deduct and withhold the tax on the transaction arises on payment by the buyer of the first installment of the agreed purchase price. 28

Bases and Rates of Withholding Taxes General Rule The gross amount of income payment, which is used as basis in computing the expanded withholding tax, will depend on the status of the recipient of income. Thus: 29

27

Rev. Regs. No. 2-98, as amended (Annex "A"). ^BIR Ruling DA-248-04-23-99, Burgundy Realty Corporation. RMC 72-2004, Nov. 16, 2004. 29


406

1. Income payment to non-VAT registered seller of services (e.g., contractor) shall be computed on the gross amount: Gross Billing on Services Less: 2% EWT x PIOO.OOO.OO Net amount due the payee 30

PIOO.OOO.OO 2,000.00 P 98.000.00

2. Income payment to VAT-registered seller of services (e.g., contractor) shall be computed on the gross amount paid, exclusive or net of VAT: Gross amount paid Less: 2% EWT ( P I 10,000.00 x 10/11 x 2%) Amount due the payee

P110,000.00 2, 000.00 P108.000.00

31

3. Income payment for purchases of goods and services by the Top 20,000 Private Corporations and Government Office (GOVLarge Taxpayer ( L T ) , where the purchases of goods and services are not billed separately: In cases where purchases of goods are separately billed from purchases of service, the applicable rate of 1% on goods and 2% on services shall be applied, respectively. However, in case of failure to separately bill goods and services, the higher rate of 2% shall apply to the gross amount paid. Exceptions Some exceptions to the general rule (i.e., EWT shall be based on the gross income payment), where the basis of the withholding tax is not just the income but may include return of capital which is not subject to income tax, are shown hereunder: A creditable withholding tax based on the gross selling price/total amount of consideration or the fair market value, T h e r e are different EWT rates applicable to sellers of services, depending on the nature of services they provide to clients. An independent contractor is subject to 2% EWT. If the Seller is one who sells goods and the buyer is one of the Top 20,000 Corporations, the applicable EWT rate is 1%. To determine the 12% V A T component in a V A T sales invoice or receipt, the total invoice amount is divided by 1.12, and the difference between the total invoice amount aii& the amount of gross sales or gross receipts arrived at is the 12% VAT comporient. 31

WITHHOLDING TAXES

407

whichever is higher, paid to the seller/owner for the sale, transfer or exchange of real property, other than capital asset, shall be imposed upon the withholding agent/buyer, in accordance with the following schedule: a. b.

c.

Where the seller/transferor is exempt from creditable withholding tax

- Exempt

Upon the following values of real property, where the seller/transferor is habitually engaged in the real estate business as per proof of registration with the HLURB or HUDCC: With a selling price of five hundred thousand pesos (P500,000) or less

1.5%

With a selling price of more than five hundred thousand pesos (P500,000) but not more than two million pesos (P2,000,000)

3.0%

With a selling price of more than two million Pesos (P2,000,000)

5.0%

Where the seller/transferor is not habitually engaged in the real estate business

6.0%

Sale by a corporation which is habitually engaged in real estate business, certified as such by the Chamber of Real Estate and Builders Association, Inc. (CREBA) and who is registered with HUDCC shall be subject to a creditable withholding tax of 2.5% based on the gross selling price or total amount of consideration or its equivalent paid to the seller/owner. Certificate Authorizing Registration (CAR) Upon presentation of the capital gains tax return or creditable withholding tax return with a bank validation evidencing full payment of the capital gains tax or the creditable withholding tax due on the sale, transfer, barter, exchange or other disposition of real property classified as capital or ordinary asset, as the case may be, the RDO of the revenue district where the property being transferred is located shall issue the corresponding Tax Clearance Letter (TCL) or Certificate


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Authorizing Registration (CAR) for the registration of the real property in favor of the transferee. 32

Signatory ofCARs. - The RDO, being the Head of the ONETT Team, shall sign/approve CAR and Tax Clearance (TCL) for computerized districts. In the absence, the ARDO may sign the CAR and TCL. However, if the ARDO is designated as the Head, ONETT Team, the RDO shall sign in his absence. 33

EWT Rules on Certain Special Cases A. On Income Payments to M E R A L C O , Telecom and Other Utility Companies 34

Q l . Are payments to Meralco and telecommunications companies like PLDT, SMART, etc. considered payment for services and as such, subject to the 2% EWT if the payor is a Top Ten Thousand Corporation/Government Office/ Large Taxpayer (TTC/GO/LT)? A l . Payments to Meralco and telecommunications companies are considered payments for services and therefore subject to the 2% EWT, if the payor is a TTC/GO/LT pursuant to Sections 2.57.2 ( M ) and ( N ) of Revenue Regulations No. 2-98, as amended. Q2. For payments made to Meralco by TTC/GO/LT, what will be the tax base in the computation of the 2% EWT? A2.

It shall be the current amount due appearing in the Meralco billing statement. 35

Q3. Is the installation and removal cost of service application for temporary service, reimbursements made by the payor to Meralco for charges for relocation of poles and other 32

Rev. Regs. No. 8-98, Aug 25, 1998. RMC 68-2007, Nov. 5, 2007; See RMO 15-2003. Rev. Regs. No. 8-2005, Feb. 23, 2005. This provision creates many problems for the taxpayers. For example, Meralco will not agree with the client-payor that the 2% EWT based on the gross amount shown in the billing statement shall be deducted by the payor, and if the client-payor insists on the 2% EWT, its/his supply of electricity might be cut or stopped because the amount in the bill is not paid in full. On the part of Meralco, withholding the 2% EWT on the gross amount shown in the billing statement would result in unfairness, because only the distribution income belongs to Meralco and the bigger part of the billing statement, which refers to generation charges and transmission charges, belongs to the generation companies and the transmission company, respectively. 33

34

35

electrical facilities, use of rubber hose for safety precaution and testing of meters considered as non-revenues subject to the 2% EWT? A3. The payment made by the TTC/GO/LT to Meralco on installation and removal cost of service application for temporary service is subject to the 2% EWT. On the other hand, all amounts reimbursed by the payor to Meralco for relocation of poles and other electrical facilities are not subject to 2% EWT. Q4. Is the payment to telecommunications companies by the TTC/GO/LT on overseas dispatch, message or conversation originating in the Philippines subject to the 2% EWT? What shall be the tax base? A4. Yes. The tax base shall be the amount paid less the overseas communication tax. Q5. Is the TTC/GO/LT-lessee required to withhold the 2% EWT on its payments to Meralco, PLDT and other utility companies which are coursed through the lessor, the electric meter being in the name of the lessor? A5. Yes, the TTC/GO/LT-lessee shall withhold the 2% EWT whether or not the electric meter is in its name, provided that valid proof that payment of a particular expense is being shouldered by the payor claiming the expense. The lessee shall present the contract of lease together with the photocopy of the notice from the BIR designating the corporation as one of the Top 10,000 (now 20,000) Private Corporations to Meralco, PLDT and other utility companies through the lessor and shall likewise issue the corresponding BIR Form No. 2307 in the name of the utility companies. Q6. TTC/GO/LT failed to withhold tax on payments to Meralco, telecommunications companies, service providers, purchase of supplies or goods etc. as enumerated under Rev Regs No. 17-2003 from June, 2003 to present. May the TTC/ GO/LT deduct the tax from the current billing of the said companies? Will the TTC/GO/LT be penalized for its failure to withhold for the months of June and July, 2003? A6. No, withholding of the EWT shall be in the current month and may only be deducted in the billings for the

410


current month. Penalties for failure to withhold the 2% EWT from prior periods shall be imposed on the payorwithholding agent but it may request for abatement of penalties under Rev Regs No. 13-2001 dated September 27, 2001. Q7. On rentals of personal property in excess of P10,000.00 per year under Section 2.57.2(C)(2) of Rev Regs No. 2-98, as amended by Rev Regs No. 17-2003, what will be the basis of the 5% EWT, considering the following payments for taxable year 2003 and on what month will the payor withhold the tax? 36

June July August September TOTAL

P

3,000.00 3,000.00 3,000.00 5,000.00 P 14.000.00

A7. The basis of the 5% EWT shall be the total amount of P14, 000.00, which is to be deducted from the September payment, since it is the period when it exceeded the threshold of P10,000.00 per annum. However, if the withholding agent reasonably expects that the annual rental will exceed P10,000.00, then it may start withholding on the first month in the above example (June). "Reasonably expects" is determined when it clearly shows in the documents like lease contract/agreement the amount to be received within a given period. The basis of withholding as applied above shall also be applicable to other income payments with applicable threshold amount of income payments. Q8. Could we consider a seller of goods or services as regular supplier if the amount per transaction is only P500.00 but has more than six (6) transactions in a taxable year? A8. The term "regular suppliers" is defined as suppliers who are engaged in business or exercise of profession/calling with whom the taxpayer-buyer has transacted at least six (6) transactions, regardless of amount per transaction, either in the previous year or current year. The threshold 'RMC 72-2004, Nov. 16, 2004.

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amount of less than P10,000.00 applies only to a "single purchase." On Income Payments to Professionals/Talents, etc. Q l . What are the prevailing withholding tax rates applicable to income payments made to professionals, talent, etc.? Al.

On gross professional, promotional and talent fees or any other form of remuneration for the services of professionals, talents, etc., the withholding tax shall be 15%, if the gross income for the current year exceeds P720,000, and 10%, if otherwise. The income tax withheld is creditable against the income tax due computed at the end of the quarter or taxable year.

Q2. How will the withholding agent determine the applicable rate considering that he/it may not have knowledge of the gross earning of the payee from all sources? A2. In order to determine the applicable rate of 10% or 15% to be applied by the withholding agent, every payee (professional/talent/corporate director/juridical person) shall periodically disclose his/its gross income for the current year to the BIR by submitting a NOTARIZED SWORN DECLARATION in three (3) copies {2copies for BIR and 1 copy for the taxpayer} to the Collection Division of the Regional Office/LTAD/LTDO where the income earner is registered. The disclosure should be filed on June 30 of each year or within 15 days after the end of the month the payee's income reaches P720,000, whichever comes earlier. In case the total gross income is less than P720,000 as of June 30, he shall submit a second disclosure within 15 days after the end of the month when his gross income exceeded P720,000. Copies of the sworn declaration stamped "RECEIVED" by the BIR shall be furnished to each concerned withholding agent/payor. Thus, for the period Januaryl to June 30, unless the payee has informed the payor/withholding agent through the sworn declaration that his gross income has exceeded P720.000, the applicable withholding tax rate is 10%. Starting July 1, if the payee fails to execute a sworn declaration or furnish a copy to the payor if one has been executed, the withholding tax shall be 15%.


412

In case the withholding agent has made accumulated payments within the year exceeding P720,000 to a particular payee, then subsequent payments by the payee shall be subjected to 15%, even without the sworn declaration. Q3. Are honoraria paid to instructors of cooking lessons, martial arts and various sports and health activities subject to EWT? A3. Yes, they are considered talent fees subject to the 10% EWT, if current annual income of the instructor is P720,000.00 and below, and 15%, if otherwise. Other Clarifications Q l . Are payments for life and non-life insurance premium by the TTC/GO/LT to domestic/resident foreign insurance companies considered payment for services subject to the 2% EWT? A l . Yes. Q2. What will be the basis of the 2% EWT to be deducted on the premium for the insurance coverage of the vehicle sold to the customer of a TTC-automotive dealer to the Insurance Company considering the information on the insurance policy as follows: Premium (CTPL, OD, TPPD, etc.) VAT Doc. Stamp Tax Local Tax Total amount per policy

P 26,000.00 2,600.00 3,250.00 130.00 P 31.980.00

A2. The 2% EWT shall be computed based on the amount of premium paid, exclusive of the V A T and other taxes. Thus, P26,000. 00 x 2% = P520.00. Q3. Are insurance premiums paid through brokers/agents subject to the 2% EWT? A3. Yes, premium payments to insurance companies through brokers or agents or any other person authorized to receive/ collect payment on behalf of the insurance company shall be subject to the 2% EWT to be withheld by the payor or person having control over the payment. However, the

payor is required to issue the corresponding certificate of taxes withheld (BIR Form No. 2307) in the name of the insurance company, not in the name of the insurance broker. Q4. Is payment of interest on bank loans by the TTC/GO/LT and other fees paid to the bank subject to the 2% EWT? A4. Yes. However, payment of interest to OBUs/FCDUs shall be subject to final withholding tax of 10%. Q5. Is the payment of the principal and interest on loans, service fees and other charges considered as income extended by local banks, quasi-banks and other financial institutions to the TTC/GO/LT subject to the 2% EWT? A5. Only the interest payments on loans, service fees and other charges considered as income are considered payment for services rendered, hence, subject to 2% EWT. Payment corresponding to the principal amount is not subject to EWT. Q6. If the payment for the purchase of goods or services to their regular suppliers by the TTC/GO/LT is through credit card or through company issued credit card to officers/ employees for purposes of reimbursements, will the TTC/ GO/LT be required to withhold the tax when it presents the credit card to the supplier? A6.

The TTC/GO/LT is not required to withhold the tax upon presentation of the credit card to the supplier. The TTC/ GO/LT, however, is required to withhold the 2% expanded withholding tax corresponding to the interest payment and/or service fee and other charges imposed by the credit card company. The credit card company, on the other hand, shall withhold 1% of 50% of the gross amount paid to any business entity pursuant to Section 2.57.2(L) of Rev Regs No. 2-98, as amended.

Q7. Is the payment by the TTC/GO/LT to their regular suppliers through employees/ agents or any persons purchasing for or in its behalf representing reimbursable expenses by the payee subject to the EWT? A7. Yes, the reimbursable expenses are subject to the EWT of 1% on goods or 2% on services, provided that the sales

414


invoice/official receipt shall be in the name of the persons whom the former represents and the corresponding certificate of taxes withheld at source (BIR Form No. 2307) is issued. It is reiterated that BIR Form No. 2307 shall only be issued by duly authorized representative of the employer-withholding agent. Q8. Is the payment made by the TTC/GO/LT to a customs broker for arrastre, customs duties, wharfage, documentation, handling fee and forwarders subject to the 2% EWT? A8. Yes, it is subject to the 2% EWT. However, advance payment by the customs brokers for expenses such as arrastre, wharfage, documentation fee, etc. should not form part of the gross receipts, if invoiced directly in the name of the broker's client and if reimbursement to the broker is not invoiced with the broker's V A T invoice/official receipt. Q9. Is the payment for membership dues of the TTC/GO/LT to country clubs and/or sports club and the like considered service subject to the 2% EWT under RR 17-2003? A9. Yes, membership fees are considered services subjected to the 2% E W T . However, when the payee-club or organization is a non-stock, non-profit organization not subject to income tax, hence, payment is not subject to EWT upon presentation of proof of exemption issued by the BIR. Q10. What will be the basis of the 2% EWT if the charges of hotel, motel, resort and similar establishments to TTC/ GO/LT include room accommodation, food and beverage, laundry, business center charges, etc. including service charges? A10. The basis shall be the gross billing exclusive or net of the VAT for VAT registered payees and gross billing for NONVAT registered payees. Q l l . Are payments made by TTC/GO/LT for the purchase of movie and/or concert tickets subject to the 2% EWT? A l l . Yes, payment for movie/concert tickets are considered payment for services and therefore subject to 2% EWT. Q12. Are the corporations previously belonging to the Top 5000 (now Top 20,000) Corporations still required to file the

list of regular suppliers of goods? How about suppliers of services? A12. Yes, former Top 20,000 corporations are still required to submit the list of their regular suppliers of goods and services, unless they have been informed by the BIR that they ceased to be included in the Top 20,000 corporations. They are required to submit their 1st semester list on July 31 and 2nd semester on January 31 of the following year. They shall continue to withhold 1% EWT for the purchase of goods and 2% for services, unless informed otherwise. Q13. Are services rendered by private hospitals and entities considered as government owned or controlled corporations (GOCC) subject to the 2% EWT, if the payor is a TTC/GO/ LT? A13. Yes, since they are also engaged in the supply of services. Only GSIS, SSS, Philhealth & PCSO and AFP RSBS are exempted from income tax, and consequently from EWT. Q14. Is payment by T T C / G O / L T for magazine/newspaper subscription subject to 1% EWT? A14. Yes, it shall be considered purchase of goods subject to 1% EWT. Q15. Is the amount paid to TV or radio stations by the TTC/GO/ LT for airing commercials and payment made directly to newspaper publishers for print advertisements subject to the 2% EWT? A15. Yes, they are considered suppliers of service and therefore subject to 2% EWT. Q16. Is the payment made by an advertising agency for the print advertisement of TTC/GO/LT to newspaper publishers (Manila Bulletin, Manila Times, etc.) subject to EWT? A16. The payment made by the advertising agency for the print advertisement of TTC/GO/LT to the newspaper publisher is subject to the 2% EWT, provided that the advertising agency is a TTC/LT. Q17. Is the payment made to Health Maintenance Organizations (HMOs) by TTC/GO/LT subject to EWT?


416

A17. Yes, the payment is subject to 2% EWT. Q18. Are payments made by TTC/GO/LT to cooperatives for the purchase of goods and/or services subject to EWT? A18. Yes, except when they can show proof of exemption from income tax issued by the BIR. Q19. Are payments made to companies registered with PEZA/ BOI for the purchase of goods or services subject to EWT? A19. Yes. However, payments to P E Z A / B O I registered companies which are exempt from income tax shall not be subjected to EWT pursuant to Section 2.57.5 of RR 2-98, as amended, upon presentation of proof of exemption issued by the BIR. Q20. Are payments made to embassies for visa fees/services subject to EWT? A20. No. Q21. Is the payment by a TTC-bank to the Car or Automotive Dealer representing a certain percentage of the cost of the vehicle bought by a customer through financing subject to EWT? What is the rate? A21. The payment shall be considered purchase of goods (vehicle) and shall be subject to 1% EWT. Q22. Is the amount paid by a TTC/GO/LT to the automotive dealer representing the entire amount of a car availed of by an employee through a company car plan subject to EWT if the car will be registered with Land Transportation Office (LTO) under the name of the employee? A22. Yes, the amount paid by the TTC/GO/LT to the automotive dealer is subject to 1% EWT. Q23. For those availing of EFPS, what shall be the deadlines for filing of returns and remittance of taxes withheld? A23. The date of filing of withholding tax returns shall be in accordance with the deadlines set in RR 26-20024 while the remittance of taxes withheld shall be five (5) days later than the deadlines set for taxpayer/withholding agents not availing of the EFPS.

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D. Taxability of Agricultural Suppliers 1.

Prior to Rev Regs No. 3-2004

Pursuant to the provisions of Section 244, in relation to Section 57(B)2 of the Tax Code of 1997, these regulations are hereby promulgated to suspend the implementation of Section 2.57.2 (S) of Revenue Regulations No. 2-98, as amended by Revenue Regulations Nos. 17-2003, 30-2003, and 1-2004, which provides as follow: "(S) Income payments made to suppliers of agricultural products. - Income payments made to agricultural suppliers such as those, but not limited to, payments made by hotels, restaurants, resorts, caterers, food processors, canneries, supermarkets, livestock, poultry, fish and marine products dealers, hardwares, factories, furniture shops and all other establishments, except for income payments to marginal income earners which, as defined in Revenue Regulations 11-2000 dated December 12, 2000, refer to individuals not otherwise deriving compensation as an employee under an employee-employer relationship, but who are self-employed and deriving gross sales/receipts not exceeding P100,000.00 during any 12-month period - one percent (1%)." 31

The term "agricultural suppliers" refers to suppliers/ sellers of agricultural, forest and marine food and non-food products, livestock and poultry of a kind generally used as, or yielding or producing foods for human consumption; and breeding stock and genetic materials therefore. "Livestock" shall include cows, bulls and calves, pigs, sheep, goats and other animals similar thereto. "Poultry" shall include fowls, ducks, geese, turkey and others similar thereto. "Marine products" shall include fish and crustaceans, such as but not limited to, eels, trout, lobsters, shrimps, prawns, oysters, mussels and clams, shells and other aquatic products. Meat, fruits, fish, vegetables and other agricultural and marine food products, even if they have undergone the simple processes of preparation or preservation for the market, such as freezing, drying, salting, smoking or stripping, including those using advanced technological means of packaging, such 37

Rev. Regs. No. 3-2004, March 1, 2004 suspended the implementation of Rev. Regs. Nos. 17-2003 and 1-2004.

418


as shrink wrapping in plastics, vacuum packing, tetra-pak and other similar packaging method, shall still be covered by this subsection. Polished and/or husked rice, corn grits, locally produced raw cane sugar and ordinary salt shall be considered as agricultural food products. In 2003, certain amendatory provisions were introduced by Revenue Regulations 17-2003 on Revenue Regulations No. 2-98, which impacted the taxability of agricultural suppliers for withholding tax purposes. These amendatory provisions were as follows: (1) Section 2.57.2(M) which imposed withholding tax at rates of 1% (for goods) and 2% (for services) on income payments made by the top ten thousand (10,000) private corporations to their local/resident suppliers of goods and local/resident supplier of services other than those covered by other rates of withholding tax; (2) Section 2.57.2(N) (as subsequently amended by RR 30-2003) which imposed withholding tax at rates of 1% (for goods) and 2% (for services) on income payments made by the government to its local/resident supplier of goods and local/ resident supplier of services other than those covered by other rates of withholding tax; and (3) Section 2.57.2(S) (as subsequently amended by RR 1-2004) which imposed withholding tax at rate of 1% on income payments made to agricultural suppliers by hotels, restaurants, resorts, caterers, food processors, canneries, supermarkets, livestock, poultry, fish and marine products dealers, hardwares, factories, furniture shops and all other establishments. Consequently, in 2004, RR 3-2004 was issued suspending the implementation of the provision under Section 2.57.2(S) which is the general proviso relating to the imposition of withholding tax on income payments made to agricultural suppliers. Apparently, on the ground of such suspension made, agricultural suppliers desisted from being withheld tax even if their income payments are derived from payors, who happen to be covered by Section 2.57.2(M) and ( N ) respectively, citing the suspension made by RR3-2004 as their ground for exemption.

38

Thus, this Circular is being issued in order to clarify the position of the BIR on this issue. 1. On income payments made by top 10,000private corporations under Section 2.57.2(M) of RR 2-98, as amended. - Income payments received by agricultural suppliers from these taxpayers are subject to withholding tax but only at the rate provided for by Section 2.57.2(S) which is 1%. The withholding tax rates under Section 2.57.2(M) shall only apply if there is no other tax rates provided in the Regulations which is not the case for agricultural suppliers. 2. On income payments made by government under Section 2.57 J2(N) ofRR 2-98, as amended. - Income payments received by agricultural suppliers from these taxpayers are subject to withholding tax but only at the rate of 1% for the same reason above cited. 3. On income payments made by hotels, restaurants, resorts, caterers, food processors, canneries, supermarkets, livestock, poultry, fish and marine products dealers, hardwares, factories, furniture shops and all other establishments under Section 2.57 2(S) ofRR 2-98, as amended by RR 1-2004 but suspended by RR 3-2004. - Income payments received by agricultural suppliers from the aforementioned payors not otherwise covered by the other provisions of the withholding tax regulations are subject to withholding tax at the rate of 1%. Example: Mr. Rebullido is a supplier of agricultural products to the following: (a) X Supermarket which is included in the top 10,000 private corporations; (b)

City Government of Quezon City; and

(c) Y Mini-Grocery Store which is not included in the top 10,000 private corporations. Income payments received by Mr. Rebullido from the above clients are subject to withholding tax but only at the rate of 1%. 2. Upon the Effectivity of Rev. Regs. No. 3-2004 1. On income payments made by top 10,000private corporations under Section 2.57.2(M) of RR 2-98, as 3fl

RMC 44-2007, July 6, 2007.


420

amended. - Income payments received by agricultural suppliers from these taxpayers are subject to withholding tax at the rate of 1% as supplier of goods. 2. On income payments made by government under Section 2.572(N) ofRR 2-98, as amended. - Income payments received by agricultural suppliers from these taxpayers are subject to withholding tax but only at the rate of 1% for supplier of goods. 3. On income payments made by hotels, restaurants, resorts, caterers, food processors, canneries, supermarkets, livestock, poultry, fish and marine products dealers, hardwares, factories, furniture shops and all other establishments under Section 2.57 MS) ofRR 2-98, as amended by RR 1-2004 but suspended by RR 3-2004. - Income payments received by agricultural suppliers from the aforementioned payors not otherwise covered by the other provisions of the withholding tax regulations (i.e., RR 2-98, as amended) are deemed not subject to withholding tax by virtue of the suspension of the imposition of Sec.2.57.2(S) under RR 2-98, as amended by RR 3-2004. Example: Mr. Rebullido is a supplier of agricultural products to the following: a. X Supermarket, which is included in the top 10,000 private corporations; b.

City Government of Quezon City; and

c. Y Mini-Grocery Store, which is not included in the top 10,000 private corporations. The only income payments subject to withholding tax are those received by Mr. Rebullido from X Supermarket and that from the City Government of Quezon City. Income payment from Y Mini-Grocery is the item of income payment effectively suspended by RR 3-2004 for withholding tax purposes. In the light of the above clarification, there is no ground by which agricultural suppliers can claim that they are exempt from the imposition of withholding tax on their sales to top 10,000 private corporations and/or to the government by virtue of the suspension granted by RR 3-2004. In fine, RR 3-2004 did not in any way affect the taxability of agricultural suppliers for withholding tax purposes, insofar as their dealings with the top

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10,000 private corporations and/or with the government are concerned. E.

On Income Payments to Security Agencies

39

For income tax purposes, all sellers of services as well as sellers of goods or properties may adopt either the cash basis or accrual basis as their accounting method for reporting income. This means that the timing of the imposition of the tax depends on the accounting method employed by the taxpayer. However, for V A T purposes, sellers of services, including Security Agencies, have to be taxed solely on the cash basis - that is upon actual or constructive receipt of the income because the V A T on sale of services is specifically imposed by law on the taxpayer's gross receipts. But in order that an amount received will form part of gross receipts, the same must constitute the gross income of the taxpayer when received or earned. Hence, if something is received by a taxpayer but the amount received does not or will not form part of its gross income (i.e., receipt of money constituting a loan or liability), the same cannot be part of its gross receipts subject to VAT. The issue that comes into fore is whether or not the security guard's salaries, which form part of the Contract Price of the security services rendered by the Security Agency, can be treated as gross income of the Security Agency, which will constitute as part of the taxable gross receipts subject to VAT, whether actually or constructively received. In several rulings issued by the Bureau, it has been consistently maintained that salaries of the security guards form part of the taxable gross receipts of a security agency. As cited in BIR Ruling Nos. 69-02, 049-85 and 271-81, the reason for this is "that the salaries of the security guards are actually the liability of the agency and that the guards are considered their employees; hence, for percentage tax purposes, the salaries of the security guards are includible in its gross receipts." However, technically speaking, the salaries of the security guards are being paid for by the principals or clients of the Security Agency. Under Section 6 of Republic Act No. 6727 (The Wage Rationalization Act), amending Presidential Decree No. 3

»RMC 39-07, Jan. 22, 2007.

422


442, otherwise known as "The Labor Code of the Philippines", the liability of the security agencies for the prescribed increases in the wage rates of workers are explicitly required to be borne by the principals or clients of the service contractors (e.g., Security Agency), with the latter being made jointly and severally liable for the same, but only in the event that the principal or client fails to pay the prescribed wage rates, to wit: "Section 6. In the case of contractors for construction projects and for security, janitorial, and similar services, the prescribed increase in the wage rates of the workers shall be borne by the principals or clients of the construction/service contractors and the contract shall be deemed amended accordingly. In the event, however, that the principal or client fails to pay the prescribed wage rates, the construction/service contractor shall be jointly and severally liable with its principal or client" Furthermore, under Section 1, Rule XTV of the 1994 Revised Rules and Regulations implementing Republic Act No. 5487, as amended, which governs the "Organization and Operation of Private Security Agencies and Company Security Forces throughout the Philippines," it is so provided that: "Section 1. Compensation. - No watchman, security guard or private detective shall be paid a salary or compensation less than prescribed by existing laws, rules and regulations including those that may be promulgated relative thereto. The amount prescribed therein shall be earmarked and set aside for the purpose aforestated; thus the same shall thereafter be segregated from the monies received by the agency from its clients as an amount reserved for the remuneration of the guard or detective." Clearly, the Security Agency has no control or dominion over that portion of the payment received from its Client which is intended or earmarked as salaries of the security guards. The Security Agency does not own the funds such that it cannot use it for any other purpose like payment of rentals, utilities, taxes and other expenses. It is now well settled that only receipts which is subject to a taxpayer's unfettered command and which he is free to enjoy at his own option is taxed to him as his income whether he sees fit to enjoy it or not (Corliss v. Bowers, 281 U.S. 376). In view of the clear language of the law and its implementing

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regulations placing the primary obligation on the Client to pay the salaries of the security guards coupled with the requirement that the monies received by the Security Agency representing salaries shall be earmarked and segregated for the said guards, the amount paid by the Client representing the salaries of the security guards will not form part of the Security Agency's gross income, and neither will it form part of its taxable gross receipts when actually or constructively received. This peculiarity obviously places the Security Agency on a tax situation different from other service providers, such as employment agencies and janitorial agencies. Income Tax Treatment of Payments Made to the Security Agency 1.

On the Part of the Security Agency:

The Security Agency must record as part of its gross income the Agency Fee portion of the payment, net of the VAT thereon. Since the security guards' salaries are tacked in as part of the service fees, the Security Agency mast always recognize that portion of the fees as a liability. For this purpose, the Contract for Security Services entered into by and between the Security Agency and its Client must provide for a breakdown of the amount of security services into two components: (1) the Agency Fee; and (2) the Security Guards' Salaries. If the Contract does not provide for a breakdown of the amount payable to the Security Agency, the entire amount representing the Contract Price will be taxed as income to the Agency, which must form part of its gross receipts, whether actually or constructively received. For illustrative purposes, assume that Vigilant Security Agency, Inc. was contracted by Tanzo Jewelry Corp. to provide security services in the latter's store. The contract price on a monthly basis is Eighteen Thousand Pesos (P18,000.00) broken down into: Security Guards' Salaries of P14,179.08 and Agency Fee of P3,820.92 (inclusive of the V A T ) . The entry to record the transaction should be as follows: Cash P 17,931.77 Prepaid Income Tax (2% EWT on agency fee) 68.23 Service Income (agency fee) P 3,411.54 Output Tax (on agency fee) 409.38 Due to Security Guards 4,179.08

424


The Security Agency who is the trustee of the funds segregated and earmarked as salaries of the security guards is the withholding agent for purposes of the withholding tax on compensation income. Upon payment of the security guards' salaries, the Security Agency shall record the same as follows: Due to Security Guards Cash Withholding Tax Payable

P 14,179.08 P 12,637.11 1,541.97*

* Withholding tax on the security guard's salaries was computed based on the assumption that the security guard employed is single and included in his taxable income were the basic pay, overtime, holiday premiums, night differential and ECOLA.

2. On the Part of the Client or User of Security Services: The Client who is engaged in business can claim as a deduction from gross income the total amount paid to the Security Agency, net of the V A T on the Agency Fee. It is allowed to recognize an input tax based on the Agency Fee, if the transaction is covered by a V A T Official Receipt issued by the Security Agency. It is also required to withhold and remit the Expanded Withholding Tax (EWT) on the Agency Fee. The portion of the expense pertaining to the security guards Salaries will be covered by a Non-VAT acknowledgment Receipt issued by the Security Agency. When the expense (Security Services) is paid, the Client must record the transaction as follows: Security Services - Agency Fee Security Services - Security Guards Salaries Input Tax (only on Agency fee) Cash Withholding Tax Payable (2% EWT on Agency Fee)

P 3,411.54 P 14,179.08 409.38 P 17,931.77 68.23

Withholding Tax Compliance As a general rule, "all income payments which are required to be subjected to withholding of income tax shall be subject to the corresponding withholding tax rate to be withheld by the

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person having control over the payment and who, at the same time, claims the expenses" (Rev. Regs. No. 2-98, as amended byRev. Regs. No. 30-03). Insofar as the Agency Fee is concerned, the Client is constituted as the withholding agent of the EWT following the rule above-mentioned. However, with respect to the portion of the Contract Price representing the amount segregated and earmarked as salaries of the security guards, the Security Agency shall be the one responsible for the withholding of the tax on compensation income. This is so because while it is the Client who claims the payment as an expense, it is the Security Agency who physically controls the payment to the salaries of the Security Guards. However, in order to comply with the requirement for deductibility under Section 34(K), in relation to Section 58 and 81, all of the National Internal Revenue Code, as amended, the Security Agency must furnish its Client, on or before January 31 of the year following the year of withholding, a Notarized Certification, indicating the names of the guards employed by the Client, their respective TINs, the amount of their salaries and the amount of tax withheld from each. This certification together with the covering Non-VAT Acknowledgment Receipt must be kept on file by the Client as substantiation for the claim of the expense. The above requirement is without prejudice to the provisions of Revenue Regulations No. 2-2006, requiring the mandatory filing and submission of the Monthly Alphalist of Payees ( M A P ) and Summary Alphalist of Withholding Agents (SAWT). F.

On Income Payments by Freight F o r w a r d e r s

4 0

The business of Freight Forwarders is to ensure the delivery of goods or cargoes from a certain pick-up point to their final destination. As a service provider, the value-added refers to the compensation for the services rendered by them to their client/shipper. Their services may cover a cross-border movement (i.e., from the Philippines to a foreign port or viceversa) or a local movement (i.e., within the Philippines) of cargoes.

"RMC 35-2006, June 21, 2006.

426


For cross-border movement of cargoes, the forwarders act only as integrator of various services (i.e., sorting, trucking [for pick-up/delivery], documentation, air/sea carriage etc.), which services are traditionally separated from each other by different companies. As a matter of fact, the actual shipment of the goods from the Philippines to a foreign country or vice versa is not performed by them for want of facility to do the same. While the forwarders bill and collect the entire shipping cost from their clients, comprised of the cost of services to be rendered by thirdparty service providers and their service fee and/or commission for their integration services, what is retained by them is only the compensation for the services actually rendered by them. Out of the total funds collected for a particular shipment, the forwarders pay for the services of the third-party service providers. In fine, the forwarders act merely as an intermediary between the client/ shipper and the different service providers wherein the client/ shipper deals with just one entity, the forwarder, who makes the necessary arrangements for the provision of all the needed services to complete the movement, i.e., delivery of the cargoes up to their final destination. The forwarder has no control over the goods once laden on board because it is the carrier who takes responsibility for any loss or damage on the cargoes. For value-added tax purposes, the gross receipts (valueadded) of the forwarder, is merely limited to the compensation for the services it performs, just like any service provider. In the shipment of goods from one place to another, it is not actually the forwarder which renders all the said services but some of which are rendered by third-party service providers; hence, the payments received by the forwarder from its clients which are intended for third-party service providers can not be considered as forming part of its gross receipts for tax purposes. Accordingly, the forwarders may only be subject to tax on their commissions and/or service fees they charge to their clients for the said integration and/or for the services they actually render in the Philippines. In so far as local movement of cargoes is concerned, the forwarders, as a matter of business practice, take full responsibility and control in bringing said cargoes to their final destination. Once the forwarders issue their V A T official receipt for the entire services, it is presumed that the entire payment made by the shipper is intended to indemnify the forwarders

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for their services of bringing the cargoes from one point in the Philippines to another point in the Philippines. E W T Treatment

For EWT purposes, the forwarders shall not be considered as commercial forwarders or agents subject to ten percent (10%) withholding tax. Instead, the forwarders shall be treated as other contractors (Operator of forwarding establishment) pursuant to Section 2.57.2(E)(4)(d) of Rev. Regs. No. 2-98, as amended by Rev. Regs. No. 6-2001; hence, subject to two percent (2%) withholding tax. 1.

On Cross-Borders Transactions

In so far as cross-border shipment of goods is concerned, the 2% EWT to be withheld and remitted by the client/shipper shall be based only on the gross commissions received, plus the local origin/destination charges and CAF computed as follows: a.

For services subject to regular V A T rate: E

b.

WT yATamount_ Rate of VAT =

x 2 %

For services subject to zero-rate: EWT = Total compensation for zero-rated services x 2%

where the total compensation (on cross-border shipment) refers to the gross commissions received on the freight paid to airline or shipping companies plus the local origin/ destination charges and CAF. For this purpose, the gross commissions deemed to have been received by the forwarders is 5% of the freight paid to the airline or shipping companies. The payments to third-party service providers are likewise subject to the expanded withholding tax. The forwarder shall withhold and remit the 2% EWT (in behalf of various shippers) since it is the party which has control over the disbursement of the funds. In addition, the forwarder shall prepare a listing/ summary of the shippers/clients indicating therein the amounts charged as freight and accessorial charges (net of commission) which shall be attached to the EWT return filed by the forwarder with the BIR. Further, as a duly constituted withholding agent, it shall be the duty of the freight forwarder to issue in behalf of the


428

various shippers, the Certificate of Creditable Taxes Withheld (BIR Form No. 2307) to the third party service provider. 2.

On Local Transactions

The withholding of the 2% EWT will always fall on the Shipper who claims the entire expense for income tax purposes. If the forwarder issues its V A T Official Receipt on the entire amount, the entire amount received (exclusive of the V A T ) will be reported as its income. As a rule, "all income payments which are required to be subjected to withholding of income tax shall be subject to the corresponding withholding tax rate to be withheld by the person having control over the payment and who, at the same time, claims the expenses" (Sec. 5, Rev. Regs. No. 30-2003). However, in case where a portion of the amount received by the forwarder is booked as advances or reimbursable expenses because they are earmarked for payments to third-party service providers, not only the amount covered by the forwarder's V A T Official Receipts (which amount constitute its gross income) shall be subject to EWT by the Shipper, but also the amount covered by the Non-VAT acknowledgment receipt. It is observed, in such a case, that while the forwarders, as agents of the Shippers (importers/exporters), have control over payment of the reimbursable expenses and/or advanced payments, they do not claim the same as their own expenses. Thus, considering the peculiarity of the said situation, the Shippers who are ultimately claiming the same as their own expenses shall be the one primarily responsible for remitting the withholding taxes due thereon although the issuance of the corresponding Certificates of Taxes Withheld (BIR Form No. 2307) shall be the responsibility of the forwarders who should issue the same, on behalf of the Shippers, as payors, in the name of or to the Third-party Service Providers as payees upon payment by the forwarders to the said third-party service providers of the reimbursable expenses, net of the Expanded Withholding Tax. In other words, upon making the payments to the third-party service providers (the persons to whom the advance payments have been made by the forwarders), the forwarders shall pay or advance the prescribed amount net of the required expanded withholding tax (EWT), which net amount is the amount that should be requested for reimbursement from the Shippers while the retained amount pertaining to the Expanded Withholding

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Tax shall be remitted to the BIR by the said Shippers. The Certificate of Tax Withheld (BIR Form No. 2307) shall reflect the name of the Shipper as the payor of the billed income payment, the name of the forwarders as the agent of the real payor who is the Shipper, and the name of the third party service provider as the payee of the billed income payment. To ensure, however, that the proper taxes are deducted and withheld from such payments to third-party service providers, the following conditions/procedures must be complied with, to wit: 1. It shall be the responsibility of the forwarders to instruct the third-party service providers to issue the official receipts directly in the name of Shippers of the forwarders; 2. Upon making the payments to the third-party service providers, the forwarders shall compute and deduct the EWT due on the said payments. At the same time, the forwarder shall issue the Certificate of Tax Withheld (BIR Form No. 2307) for the deducted amount of EWT, which Certificate shall reflect the name of the third-party service provider as the payee of the income payment, the name of the Shipper as the real payor of the income payment with parenthetical mention of the name of the forwarder as agent of the Shipper, the amount of income payment, the covered period and such other information as required under existing rules and regulations. At this point in time, the third-party service provider shall forward to the forwarder the third-party service provider's official receipt issued to the Shipper reflecting therein the name of the third party service provider as the issuer of the official receipt, the name of the Shipper as the buyer of the service, the nature and description of the transaction, the volume of the transaction, the price of the transaction, the VAT passed on and billed separately, if any, the EWT deducted by the agent of the payor, the net amount paid and such other information as are required under existing rules and regulations; 3. In the subsequent claim for reimbursement of the said payments, the forwarder shall demand from the Shippers only the amount actually paid to the third-party service providers (which is already net of the EWT) with instructions to said Shippers to remit to the BIR the amount of EWT on the said payments;


4. The forwarders shall attach to their NON-VAT Official Acknowledgement Receipts (reflecting the amount being reimbursed) the original copy of the official receipts issued by the third-party service providers in the name of the Shippers of the forwarders; and 5. The time for withholding of the taxes due on said payments to third-party providers shall be governed by the provisions of the prevailing law and regulations on withholding of the tax on income payments reckoned from the time the reimbursement is claimed from the Shippers by the forwarders. With respect to the reimbursement to the forwarders by their Shippers of the reimbursable expenses and/or advanced payments of the formers in favor of the latter following the prescribed procedures, the same shall no longer be subject to EWT since these payments do not form part of the gross receipts of the forwarders. They merely collect what they have advanced on behalf of their Shippers and hence, they do not derive any income from collecting such advances. However, for reimbursable expenses and/or advanced payments of expenses redounding to the benefit of the forwarder, and all other reimbursable expenses covered by V A T official receipts of the forwarders, the same shall, upon reimbursement by the Shippers, form part of the forwarders' gross receipts and shall therefore be subject to EWT notwithstanding that such reimbursement are for payments of reimbursable expenses and/ or advanced payments made by the forwarders on behalf of their Shippers. On Income Payments to Brokers and Others Similarly Situated 41

It has been a common business practice in the brokerage industry to incur reimbursable expenses and/or to advance payments, on behalf of customers (hereinafter referred to as "Customers"), to answer for certain expenses such as arrastre, wharfage, documentation, trucking, handling charges, storage fees, duties and taxes, etc. Accordingly, in billing Customers for their services, the brokers include in the said billing the foregoing reimbursable expenses and/or the advance payments " R M C 9-2006, Jan. 25, 2006.

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made relative thereto, previously recorded as "Receivable for Cash advances on Behalf of Customers." However, treatment for tax purposes by the payor (broker) of the aforementioned advanced payments or reimbursable expenses on behalf of a customer may differ depending upon the procedures in receipting or issuing Receipt on said advanced payments/reimbursable expenses by both the third-party service provider and the broker. Transactions and Amounts Subject to EWT As a rule, "all income payments which are required to be subjected to withholding of income tax shall be subject to the corresponding withholding tax rate to be withheld by the person having control over the payment and who, at the same time, claims the expenses" (Sec. 5, Rev. Regs. No. 30-03). However, it has been observed that while the brokers, as agents of their Customers (importers/exporters), have control over payment of the reimbursable expenses and/or advanced payments, they do not claim the same as their own expenses. Thus, considering the peculiarity of the said situation, the Customers who are ultimately claiming the same as their own expenses shall be the ones primarily responsible for remitting the withholding taxes due thereon although the issuance of the corresponding Certificates of Taxes Withheld (BIR Form No. 2307) shall be the responsibility of the brokers who should issue the same, on behalf of the Customers as payors, in the name of or to the Third-party Service Providers as payees upon payment by the brokers to the said third-party service providers of the reimbursable expenses, net of the Expanded Withholding Tax. In other words, upon making the payments to the third-party service providers (the persons to whom the advance payments have been made by the brokers), the brokers shall pay or advance the prescribed amount net of the required expanded withholding tax (EWT), which net amount is the amount that should be requested for reimbursement from the Customers while the retained amount pertaining to the Expanded Withholding Tax shall be remitted to the BIR by the said Customers. The Certificate of Tax Withheld (BIR Form No. 2307) shall reflect the name of the Customer as the payor of the billed income payment, the name of the broker as the agent of the real payor who is the Customer, and the name of the third-party service

432


provider as the payee of the billed income payment. To ensure, however, that the proper taxes are deducted and withheld from such payments to third-party service providers, the following conditions/procedures must be complied with, to wit: 1. It shall be the responsibility of the brokers to instruct the third-party service providers to issue the official receipts directly in the name of Customers of the brokers; 2. Upon making the payments to the third-party service providers, the brokers shall compute and deduct the EWT due on the said payments. At the same time, the broker shall issue the Certificate of Tax Withheld (BIR Form No. 2307) for the deducted amount of EWT, which Certificate shall reflect the name of the third-party service provider as the payee of the income payment, the name of the Customer as the real payor of the income payment with parenthetical mention of the name of the broker as agent of the Customer, the amount of income payment, the amount of EWT, the nature and description of the income payment, the covered period and such other information as required under existing rules and regulations. At this point in time, the third-party service provider shall forward to the broker the third-party service provider's official receipt issued to the Customer reflecting therein the name of the third party service provider as the issuer of the official receipt, the name of the Customer as the buyer of the service, the nature and description of the transaction, the volume of the transaction, the price of the transaction, the V A T passed on and billed separately, if any, the EWT deducted by the agent of the payor, the net amount paid and such other information as are required under existing rules and regulations; 3. In the subsequent claim for reimbursement of the said payments, the broker shall demand from the Customers only the amount actually paid to the third-party service providers (which is already net of the E W T ) with instructions to said Customers to remit to the BIR the amount of EWT on the said payments; 4. The brokers shall attach to their NON-VAT Official Acknowledgement Receipts (reflecting the amount being reimbursed) the original copy of the official receipts issued by the third-party service providers in the name of the Customers of the brokers; and

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5. The time for withholding of the taxes due on said payments to third-party service providers shall be governed by the provisions of the prevailing law and regulations on withholding of the tax on income payments reckoned from the time the reimbursement is claimed from the customers by the brokers. With respect to the reimbursement to the brokers by their Customers of the reimbursable expenses and/or advanced payments of the formers in favor of the latter following the prescribed procedures, the same shall no longer be subject to EWT since these payments do not form part of the gross receipts of the brokers. They merely collect what they have advanced on behalf of their Customers and hence, they do not derive any income from collecting such advances. However, for reimbursable expenses and/or advanced payments of expenses redounding to the benefit of the brokers, and all other reimbursable expenses covered by VAT official receipts of the brokers, the same shall, upon reimbursement by the customers, form part of the brokers' gross receipts and shall therefore be subject to EWT notwithstanding that such reimbursements are for payments of reimbursable expenses and/or advanced payments made by the brokers on behalf of their Customers. Venue for filing withholding tax returns and time for payment of tax Creditable withholding taxes deducted and withheld by the withholding agent/buyer on the sale, transfer or exchange of real property classified as ordinary asset, shall be paid by the withholding agent/buyer upon filing of the return with the authorized agent bank located within the RDO having jurisdiction over the place where the property being transferred is located within ten (10) days following the end of the month in which the transaction occurred. However, taxes withheld in December shall be filed on or before January 25 of the following year. 42

43

42

Sec. 78, NIRC provides that the FWT shall be filed and the payment made within 25 days from te close of each taxable quarter, while the return for CWT shall be filed and the payment made not later than the last day of the month following the close of the quarter during which the withholding was made. The CIR, subject to the approval of DOF Secretary, may change the deadline set in the law. "Sec. 14-2008, Nov. 26, 2008 amended Rev. Regs. No. 8-98, Aug. 25, 1998.


434

The obligation of the payor to withhold the tax under Section 2.57 of the regulations arises at the time an income payment is paid or payable, or the income payment is accrued or recorded as an expense or asset, whichever is applicable, in the payor's books, whichever comes first. The term "payable" refers to the date the obligation becomes due, demandable or legally enforceable. Where the income is not yet paid or payable but the same has been recorded as an expense or asset, whichever is applicable, in the payor's books, the obligation to withhold shall arise in the last month of the return period in which the same is claimed as an expense or amortized for tax purposes. 44

SAWT and M A P Attached to the Tax Returns

45

Summary Alphalist of Withholding Agents/Payors of Income Payments subjected to Creditable Withholding Tax at Source (SAWT) is a consolidated alphalist of withholding agents from whom income was earned or received and subjected to withholding tax to be submitted by the payee-recipient of income as attachment to its duly filed return for a given period. It contains a summary of information showing, among others, total amounts of income/gross sales/gross receipts and claimed tax credits taken from all Certificates of Creditable Withholding Tax at Source (BIR Form No. 2307) issued by the payors of income payment. Monthly Alphalist of Payees ( M A P ) is a consolidated alphalist of income earners from whom taxes have been withheld by the payor of income for a given return period and in whose behalf, the taxes were remitted. It contains a summary of information on taxes withheld and remitted through the monthly remittance returns (BIR Form Nos. 1601-E, 1601-F, and 1600), showing among others total amounts of income/gross sales/gross receipts and taxes withheld and remitted. Persons required to submit SAWT: 1. A l l persons claiming refund or applying their creditable tax withheld at source against the tax due with not "Sec. 4, Rev. Regs. No. 12-2001, Sept. 7, 2001. "Rev. Regs. No. 2-2006, Dec. 1, 2005.

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more than ten (10) withholding agents-payor of income payment per return period are strictly required to submit SAWT in hard copy as attachment to the required tax return; 2. All persons claiming for refund or applying their creditable tax withheld at source against the tax due with more than ten (10) withholding agents-payor of income payment per return period are strictly required to submit SAWT electronically in a 3.5 inch floppy diskette following the format to be prescribed by the BIR; 3. A l l taxpayers required to file thru the EFPS, regardless of the number of withholding agents/payor of income, are strictly required to attach the electronic copy of the SAWT to the electronic return. Persons required to submit M A P : 1. All withholding agents enumerated under Sections 2.57, 4.11, 5.11 of Revenue Regulations No. 2-98, as amended, who are required to withhold anci remit taxes withheld and have not more than ten income payees-income recipient per return period are strictly required to submit M A P in hard copy as attachment to the required return; 2. All withholding agents enumerated under Sections 2.57, 4.11, 5.11 of Revenue Regulations No. 2-98, as amended, who are required to withhold and remit taxes withheld and have more than ten (10) income payees-income recipient per return period are strictly required to submit MAP in electronic copy in a 3.5 inch floppy diskette following the format to be prescribed by the BIR; 3. All taxpayers remitting taxes withheld thru the EFPS, regardless of the number of income payees/income recipient, are strictly required to attach an electronic copy of the MAP to the electronic return. Returns required to be filed with SAWT and Certificate of Creditable Tax Withheld at Source. 1.

BIR Form No. 1701Q

2. 3.

BIR Form No. 1701 BIR Form No. 1700

Individual Quarterly Income Tax Return Individual Annual Income Tax Return Individual Annual Income Tax Return for Compensation income Earners (for those required to file an ITR)


436

4.

BIR Form No. 1702Q

5. 6. 7. 8. 9.

BIR Form No. 1702 BIR Form No. 2550Q BIR Form No. 2550M BIR Form No. 2551M BIR Form No. 2553

Corporate Quarterly Income Tax Return Corporate Annual Income Tax Return Quarterly VAT Return Monthly VAT Declaration Monthly Percentage Tax Return Percentage Tax Return under Special Laws

The validation of e-filed returns shall ensure that the total amounts claimed as creditable tax withheld in the return must have the corresponding attached SAWT reflecting total amounts which is equal to the total amounts claimed as credits. Returns required to be filed with MAP: 1.

BIR Form No. 1601-E

2

BIR Form No. 1601-F

3.

BIR Form No. 1600

Monthly Remittance Return of Creditable Income Taxes Withheld (Expanded Withholding tax) Monthly Remittance Return of Final Taxes Withheld Monthly Remittance Return of Value Added Tax and Other Percentage Taxes (Under RAs 1051, 4649, 8241 and 8424)

A withholding agent/payor may file a consolidated withholding tax return for the head office and all the branches or may file withholding tax returns separately for its head office and each branch and facility. For such decentralized way of filing tax return for the head office, branch or facility, one withholding tax return per tax type per return period shall be filed for each office. For purposes of such filing, a T I N with branch code shall be issued to the branch of the withholding agent/ payor, which branch code must be indicated in the return so that remittance shall be posted accordingly. Such policy shall also apply to government agencies and instrumentalities, political subdivisions (provincial, city, municipal, barangay), governmentowned or controlled corporations for their respective branches, regional, provincial, district offices and implementing units where such reporting entity is using decentralized accounting. For the centralized way of filing withholding tax returns, the head office of withholding agents/payors using centralized accounting (e.g., Large Taxpayers, etc.) shall file a consolidated withholding tax return per tax type per return period; Provided, however, That a withholding agent/payor enrolled under EFPS shall e-file the electronic copy of the M A P together with the return. The validation of such e-filed returns shall ensure that

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the total amount of taxes withheld and remitted must correspond to that reflected in the MAP. C.

Withholding Tax on Compensation Income For withholding taxes on compensation income taxable under R.A. No. 8424, which were received from January 1, 1998 to June 30, 2008, the withholding tax tables in Section 2.78, Revenue Regulations No. 2-98 shall be applied. However, the revised withholding tax tables prescribed in Revenue Regulations No. 10-2008, which was issued to implement the provisions of R.A. No. 9504, shall be applied for compensation income received from July 6, 2008 and onward.

D.

Withholding Tax on Money Payments by the Government Representation Allowance and Transportation Allowance (RATA) The recent implementation of the provisions of Republic Act No. 9337, as amended, and implemented by Revenue Regulations No. 16-2005, as amended, has created confusion on the treatment of reimbursable expenses made by personnel/ officials of the government or any of its political subdivisions, instrumentalities or agencies including government-owned or controlled corporations (GOCC). This circular is being issued to clarify certain issues and concern as to the treatment of these types of expenses, vis-a-vis the required withholding of 5% Final VAT fro m government money payments. These reimbursable expenses are considered as Representation and Transportation Allowance (RATA) or allowances given to public officers and employees, which essentially constitute reimbursement for expenses incurred in the performance of government personnel's official duties. These are expenses made by such government officials/ employees in their personal capacity even if reimbursed by the government agency. As such, these expenses are not considered as government money payments and are therefore, not subject to the withholding of 5% Final VAT. 46

46

RMC 13-2007, Feb. 5, 2007.


438

Guidelines in Remittance of Taxes Withheld by N G A s

47

For the purpose of this Circular, the following terms shall be construed to mean: 1. Taxes Withheld - refer to all taxes deducted by the NGAs from the payments due to payees (employees, suppliers and contractors) as required by law and regulations. 2. S u m m a r y of Taxes Withheld (STW) - refers to the document which summarizes the type and amount of taxes withheld based on the withholding tax returns. The STW shall be certified by the Chief Accountant and approved by Head of the NGA or his duly authorized representative. 3. TRA - refers to the accountable document to be issued by the concerned DBM Office which shall be the basis for the NGAs to record the remittance of all taxes withheld to the BIR. The same document shall be the basis for the BIR and BTR to record the collection and deposit in their respective books of account. General Guidelines 1. The use of the MDS check and ADA by NGAs in the remittance of all taxes withheld to the BIR shall be discontinued. Instead, the NGAs shall use the T R A in the remittance of all current and prior years' taxes withheld to the BIR. However, existing procedures shall still apply for those transactions of government agencies funded from the Working/Imprest Fund and Revolving Fund; 2. The account to be used in the remittance of all taxes withheld through the T R A shall be Cash - Treasury/Agency Account Current - Tax Remittance Advice (8-70-710) and the existing account of Cash - Treasury/Agency Account Current Non-Cash Deposit (8-70-702) shall be used for the deposit of collections through T R A . The description and use of these accounts are discussed in Section 5.0 of this Joint Circular; 3. NGAs shall review and analyze the accounts used in recording taxes withheld and due the BIR and ensure that said amounts are recorded under the accounts, Trust, Liabilities47

RMC 3-2000, Mar. 15, 2000, DOF-DBM-COA Joint Circular No. 1-2000, Jan. 3, 2000.

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NGA, Taxes Withheld Covered by TRA (8-84-120) and Trust Liabilities-NGA, Taxes Withheld Not Covered by TRA (8-84130). The description and use of this accounts are discussed in Section 5.0 of this Joint Circular; 4. All NGAs shall submit their letters of request duly supported by the STW on or before the 25th day of each month at the concerned DBM Office. The amount of request shall be equal to the unremitted current and prior years' taxes withheld as reflected under the credit balance of account 8-84-120; Upon submission of its request, the N G A shall, likewise, file with the concerned Revenue District Office (RDO) a copy of the request and STW duly received by the DBM together with the required tax returns for all taxes withheld for compensation, expanded, final and government money payments (BIR Form 1601-C, 1601-E, 1601-F. and 1600 respectively); 5. Submission of all the requirements as cited under 3.4 and 3.4.1 shall be construed to be sufficient compliance by the N G A in the payment and filing requirements of the BIR, pursuant to Section 81 of the National Internal Revenue Code, subject to BIR audit. Incomplete submission of requirements shall be subject to the usual interest and other penalties for late payment and filing if said requirements are not completed on the 25th of each month. The interest and other penalties resulting from the non-submission or late submission to the DBM of the request duly supported by the STW shall be the personal liability of the heads of agencies and the respective chief accountants in accordance with Section 272 (Violation of Withholding Tax Provision) of the NIRC as implemented by Revenue Regulation (RR) 10-97; 6. All adjustments (over or under-remittances) of taxes withheld by the NGAs shall be considered in the following month's request; 7. The concerned DBM Office shall issue the TRA within ten (10) working days upon receipt of the request duly supported by the STW from the concerned NGA, copy furnished the BIR and the BTR. All requests not duly supported by the STW shall be returned within five (5) working days upon receipt thereof;

440


8.

The concerned N G A shall record TRAs received from

the concerned DBM Office as remittances to the B I R for taxes withheld in its books of accounts; 9. The BIR Office shall record TRAs received from the concerned DBM Office as tax collection in the Journal of tax remittances By Government Agencies (JTRGA) as prescribed in Annex"C-l"; 10. The BTR Office shall record the amount of TRAs received from the concerned DBM Office as deposit for the remittances of all taxes withheld by the N G A s in the Journal of Tax Deposits by Government Agencies ( J T D G A ) as prescribed in Annex "C-2"; and

11. All heads of agencies and the respective chief accountants shall ensure that the taxes withheld are in accordance with the law and existing rules and regulations.

CHAPTER

XI

TAX ON FRINGE BENEFITS,

MINIMUM

C O R P O R A T E I N C O M E TAX, IMPROPERLY A C C U M U L A T E D E A R N I N G S TAX, A N D TAX ON

ENTERPRISES

REGISTERED WITH

SPECIAL ECONOMIC AND

FREEPORT ZONE

AUTHORITIES

Chapter XI covers special types of income taxes that are imposed on certain incomes of taxpayers, particularly those covered under Section 29 - Imposition of improperly accumulated earnings tax, and Section 33 - Special treatment of fringe benefits, as well as those covered by special laws relating to special economic zones and freeport zones.

A.

FRINGE BENEFITS TAX (FBT) As a general rule, the income recipient is the person liable to pay the income tax. In order to improve the collection of income on the compensation income of employees, the State requires the employer to withhold the tax upon payment of the compensation income, such that at the end of the calendar year, the employee needs only to file a tax return and no tax is paid, because his total withholding tax during the year is equal to his income tax liability. It had been observed by government, however, that many of the fringe benefits paid by the employer to his employees are not being subjected to income tax and withholding tax on compensation. To plug this loophole, R.A. No. 8424, which imposes a fringe benefits tax on the fringe benefits received by supervisory and managerial 1

2

'Beginning calendar year 2002, qualified employees need not file their income tax returns and the employer may file a substituted return for the employees. FBT imposed in R.A. No. 8424 was implemented by Rev. Regs. No. 3-98. 2

441


442

employees, was enacted in 1997 to take effect on the first day of the following year. The law mandates that the employer shall assume the fringe benefits tax imposed on the taxable fringe benefits of the managerial or supervisory employee, but allows the employer to deduct such fringe benefit tax as a business expense from its gross income. However, the fringe benefits of rank-and-file employees are treated as part of his compensation income subject to income tax and withholding tax on compensation income, which must be withheld and deducted by his employer from the compensation income of the employee. Due to the different tax treatment of fringe benefits received by supervisory and managerial employees, on one hand, and those received by rank-and-file employees, on the other hand, some say that the law is anti-poor and contravenes the fundamental principle that the income tax shall be imposed based on the taxpayer's ability to pay. This is also the reason why supervisory and managerial employees want to treat the amounts paid to them by their employers as fringe benefits, while the employer wants to consider the payments as compensation income. Fringe benefits received by employees, except rank-andfile employees, in special economic zones and freeport zones are subject to the 32% normal fringe benefits tax (effective January 1, 2000), or 25% on the fringe benefits received by non-resident aliens not engaged in trade or business in the Philippines, or 15% imposed on the fringe benefits received by an alien individual employed by a regional or area headquarters, regional operating headquarters, offshore banking units, or foreign petroleum service contractors or sub-contractors, or any of their Filipino individual employees who are employed and occupying same positions as those held by the alien employees. 3

Housing assistance granted by a PEZA-registered corporation to its expatriate employees who are directors or managers are considered as fringe benefits subject to the fringe benefits tax. The amount of rent subsidized by the company in behalf of its expatriate employee shall be treated as fringe benefit subject to the fringe benefits tax. However, where the amount of the lease is higher than the fringe benefit allowable, 4

3

4

BIR Ruling No. 04-2000, Jan. 5, 2000. BIR Ruling No. 208-99, Dec. 28, 1999.

the excess shall be treated as income subject to income tax and withholding tax. 5

The fringe benefits tax is imposed on 50% of the grossedup monetary value of the leased motor vehicle. Thus, only 10% (50% less 40%) of the monthly car rental is subject to the fringe benefits tax of the firm engaged in the lease of cars and other vehicles for use of its salesmen, executives and other employees, since the 40% share of said personnel on the monthly rental has already been taxed as compensation income. 6

Fringe benefits of P18.000, which Philippine Long Distance Telephone Company granted per rank-and-file employee of the company labor union in the form of education assistance in its recently concluded Collective Bargaining Agreement, is exempt from the fringe benefits tax on the part of the recipients. 7

Overtime meal allowance furnished by a domestic corporation to its rank-and-file and supervisory, professional and technical employees pursuant Lo its Collective Bargaining Agreement is not subject to fringe benefits tax. 8

De minimis Benefits There are certain fringe benefits denominated as "de minimis benefits" that are exempt from income tax and withholding tax, even if received by rank-and-file employees and supervisory or managerial employees. These include: 9

a.

Monetized unused vacation leave credits of private employees not exceeding ten (10) days during the year and the monetized value of leave credits paid to government officials and employees; 10

11

b.

5

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

BIR Ruling No. 025-2001, June 13, 2001. BIR Ruling No. 009-2000, Jan 4, 2000. BIR Ruling No. 057-98, May 21, 1998. BIR Ruling No. 061-99, May 5, 1999. 'See Sec. 1, Rev. Regs. No. 10-2008, July 8, 2008. "See Rev. Regs. No. 8-2000. "See Rev. Regs. No. 10-2000, Dec. 14, 2000.

6

7

8


444

c.

Rice subsidy of P I ,500.00 or one (1) sack of 50-kg rice per month amounting to not more than Pl,500.00; 12

d.

Uniforms and clothing allowance not exceeding P4,000.00 per annum; 13

e.

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

f.

Laundry allowance not exceeding P300.00 per month;

g.

Employees achievement awards {e.g., for length of service or safety achievement, which must be in the form of a 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;

h.

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

i.

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

j.

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

The amount of "de minimis" benefits conforming to the ceiling herein prescribed shall not be considered in determining the P30,000.00 ceiling of "other benefits" excluded from gross income under Section 32(b)(7)(e) [Exclusions] of the Tax Code. However, if the employer pays more than the ceiling prescribed by these regulations, the excess shall be taxable to the employee receiving the benefits only if such excess is beyond the P30,000.00 ceiling. Any amount given by the employer as benefits to its employees, whether classified as de minimis benefits or fringe benefits, shall constitute as deductible expense upon such employer. MWEs receiving 'other benefits' exceeding 12

The rice subsidy of P1.000 per month was increased to Pl,500 per month under Rev. Regs. No. 5-2008 dated Apr. 17, 2008. "Uniform and clothing allowance of P3,000 per year was increased to P4.000 per year under RR 5-2008.

T A X O N F B T , M C I T , I A E T AND S E Z A

445

the P30.000 limit shall be taxable on the excess benefits, as well as on his salaries, wages and allowances, just like an employee receiving compensation income beyond the SMW. 14

Where compensation is paid in property other than money, the employer shall make necessary arrangements to ensure that the amount of the tax required to be withheld is available for payment to the BIR. The prevailing judicial opinion is to the effect that generally, the value to the employee of living quarters and meals furnished in addition to salary constitutes income subject to tax. However, where the quarters and meals are furnished for the convenience of the employer, the ratable value of the same need not be added to the salary or cash compensation of the employee for income tax purposes (Henderson vs. Collector, 1 SCRA 649, June 28, 1957). The value of the meals is not taxable to the employee, if the meals are provided by the employer for a substantial non-compensatory business purpose (generally when employee is required to be on duty during the meal period). Lodging is excluded only if the employee must accept the lodging on the employer's business premises as a condition of his employment. 15

16

B.

MINIMUM CORPORATE INCOME TAX (MCIT) Gross Receipts and Cost of Services Per Industry

17

For purposes of applying the MCIT, the 'gross receipts' and 'cost of services' of taxpayers engaged in the following types of services, or any other kind but of a similar nature, shall be determined as follows: (i) Banks and non-bank financial intermediaries performing quasi-banking activities pursuant to Sec. 22(V), (W), and (X) of the NIRC of1997. - Their gross receipts shall mean actual or constructive receipts from interests, commissions, and discounts from lending activities, and all other items treated as gross income under Section 32 of the NIRC of 1997 that are not subject to final withholding income tax. Their cost of services shall refer to those incurred directly and exclusively for the following activities: "Sec. 1, Rev. Regs. No. 10-2008, July 8, 2008. Sec. 119-l(a), U.S. IRC. Sec. 119, U.S. IRC. "RMC 4-2003, Dec. 21, 2002. 16

16


446

01. Lending/investment of funds; 02. Obtaining of funds from the public through the receipt of deposits; and, 03. Trading of foreign exchange and other financial instruments. and shall be limited to the following: 01.

Salaries, wages and other employee benefits of personnel directly engaged in any of the said activities;

02.

Interest expense except interest charged by or paid to the head office on funds considered/classified as assigned capital of the branch;

03.

PDIC premium payments; and,

04

BSP supervision fee.

(ii) Insurance and pension funding companies. - Insurance and pension funding companies refer to those engaged in life and non-life insurance business as defined under the Insurance Code and pre-need companies, including health maintenance organizations. Their gross receipts shall mean actual or constructive receipts representing: net retained premiums (gross premiums net of returns, cancellations, and premiums ceded)/gross premium or collection from planholders; membership fees (in the case of HMOs); miscellaneous income; investment income not subject to final tax; released reserve and, in the case of pre-need companies, gross withdrawals from the trust funds set up independently as mandated by the Securities and Exchange Commission (SEC); and, all other items treated as gross income under Section 32 of the Tax Code. Their costs of services shall refer to those incurred directly and exclusively in the insurance and pre-need business, including the generation of investment income not subject to final taxes, and shall be limited to the following: 01.

Salaries, wages and other employee benefits of personnel directly engaged in said activities: a.

underwriting;

b.

claims and benefits;

c.

actuary;

d.

policy owner services, such as but limited to policy changes and amendments; policy endorsements/assignments; policy benefits and features; changes in forfeiture options; and policy reinstatements.

02.

Commissions on direct writings/reinsurance;

03.

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

04.

Inspection and medical fees;

05.

Claims, losses, maturities and benefits, net of reinsurance recoveries; and,

06. Additions required by law to reserve fund; and 07.

Reinsurance ceded.

18

It should be noted that re-issuance fees, reinstatement fees, renewal fees as well as penalties paid to the life insurance company are likewise considered as income of the life insurance company for services rendered to customers. (iii) Finance companies and other financial intermediaries not performing quasi-banking activities. - Finance companies and other financial intermediaries not performing quasi-banking activities refer to those engaged in the business of extending credit facilities to consumers and to industrial, commercial, or agricultural enterprises, including lending investors. Their gross receipts shall mean actual or constructive receipts representing interests, discounts, and all other items treated as gross income under Section 32 of the NIRC of 1997 that are not subject to final withholding income tax. Their costs of services shall refer to those incurred directly and exclusively in their lending, financing and generating of investment income not subject to final taxes, and shall be limited to the following: 01. Salaries, wages and other employee benefits of personnel directly doing such functions; and, 02. Interest expense. 18

RMC 30-2008, Apr. 1, 2008, as amended by RMC 59-2008, Aug. 23, 2008.


448

(iv) Brokers of securities (excluding banks). - Their gross receipts shall mean actual or constructive receipts for engaging in the business of effecting transactions in securities for the account of others. Their costs of services shall refer to those incurred directly and exclusively for such activity, and shall be limited to the following: 01. Salaries, wages and other employee benefits of personnel directly engaged in said activities; 02. Philippine Stock Exchange (PSE) terminal fees; 03. Communication charges related to trading/sales of securities; 04.

Research fees such as access to Bloomberg and Reuters stock data;

05.

Commissions paid to its agents who are not employees of the brokerage firm; and,

06.

Settlement/processing costs of trades, commonly known as "exchange dues."

(v) Customs, insurance, real estate, immigration and commercial brokers. - Their gross receipts shall mean actual or constructive receipts in the form of brokerage fees, commissions and remuneration as such broker. Their costs of services shall refer to those incurred directly and exclusively for brokering activities, and shall be limited to the following: 01. Salaries, wages and other employee benefits of personnel directly engaged in brokering activities; and, 02.

Commissions paid to its agents who are not employees of the brokerage firm.

(vi) General engineering and/or building contractors. - General engineering and/or building contractors refer to those engaged in contracting business in connection with fixed works requiring specialized engineering knowledge and skill (e.g., reclamation works, railroads, highways, streets roads, tunnels, airports), or with any structure built, for the support, shelter and enclosure of persons, animals, chattels, or movable property of any kind, requiring in its construction the use of more than two unrelated building trades or crafts, or to do or superintend the

TAX O N F B T , M C I T , I A E T AND S E Z A

449

whole or any part thereto (e.g., sewers and sewerage, disposal plants and systems, parks, playgrounds, refineries). Their gross receipts shall mean actual or constructive receipts representing the contract price, including the amount charged for materials supplied with the services. Their costs of services shall refer to those incurred directly and exclusively for such activities, and shall be limited to the following: 01.

Cost of materials used in construction;

02.

Salaries, wages and other employee benefits of site laborers and supervisors;

03.

Health insurance, workers compensation and general liability insurance of site laborers and supervisors;

04.

Fees and costs paid to sub-contractors;

05.

Costs of performance bonds on the particular contract;

06.

Depreciation/amortization, rentals, repairs and maintenance of equipment directly used in the said activities;

07.

Costs of moving equipment and materials to and from the contract site;

08.

Costs of design and technical assistance; and,

09.

Supplies and tools directly used in the said activities.

(vii) Common carriers or transportation contractors. Their gross receipts shall mean actual or constructive receipts for engaging in the business of carrying or transporting passengers or goods or both, by land, water, or air, for compensation, offering their services to the public, including transportation contracting (e.g., operation of public utility buses, jeepneys, taxi-cabs and cars-for-rent). Their costs of services shall refer to those incurred directly and exclusively for such activities, and shall be limited to the following: 01. Salaries, wages and other employee benefits of personnel directly engaged in the operation of the transportation equipment; 02. Toll fees (representing rental for the use of road); 03. Parking fees (for aircraft, sea craft and motor vehicles);


450

04. Franchise fees (representing rental for the use of road network); 05. Depreciation/amortization, rentals, repairs and maintenance of: -

Transportation equipment, and

-

Properties, building and improvements exclusively used as parking for aircrafts, sea crafts or motor vehicles;

06. Fuel and lubricants of motor vehicles, aircraft or sea craft directly used in transporting passengers and/or goods/cargoes; 07. Meals provided to passengers; 08. Cost of safety paraphernalia and other supplies for use by passengers (e.g., life jacket, mask, etc.); and, 09. Annual transportation equipment registration fee. (viii) Hotel, motel, rest/pension/lodging house and resort operators. - Their gross receipts shall mean actual or constructive receipts derived from the operation of such hotel, motel, rest/pension/lodging house, resort and other similar places. Their costs of services shall refer to those incurred directly and exclusively for providing rooms and other related facilities (e.g., hotel premises, kitchen, restaurants, recreational facilities, other spaces used by customers, but should not include office premises of administrative staff) for the enjoyment of customers, and shall be limited to the following: 01. Salaries, wages and other employee benefits of housekeeping staff, concierge personnel and other hotel/house/resort attendants; 02. Depreciation/amortization, rentals, repairs and maintenance of building, properties and facilities, and equipment directly used in the said activities; 03.

Commissions paid to travel agents for bookings of guests for such establishments;

04.

In case the operator also serves food and beverage, its direct costs shall include those allowed to food service establishments; and


451

05. Supplies (e.g. hotel room/housekeeping, kitchen and laundry). (ix) Food service establishments. — Their gross receipts shall mean actual or constructive receipts derived from the operation of such restaurant, bars, cafes, clubs, caterers, other eating/drinking-places, as well as take-out counters. Their costs of services shall refer to those incurred directly and exclusively in the preparation and serving/selling of foods and drinks and other requirements of the customers, and shall be limited to the following: 01.

Cost of raw/cooked foods and drinks prepared and served/sold;

02.

Salaries, wages and other employee benefits of personnel directly engaged in the said activities;

03.

Depreciation/amortization, rentals, repairs and maintenance of properties, buildings, furniture and fixtures, and equipment directly used in the performance of said activities;

04.

Cost of cooking oil, condiments and other ingredients used in cooking the food; and

05.

Royalties paid by franchisee.

(x) Lessors of property. - Those engaged in the business of leasing out properties, such as real properties, equipment, and other movable properties. Their gross receipts shall mean actual or constructive receipts derived from such lease of properties. Their costs of services shall refer to those incurred directly and exclusively for the property leased, and shall be limited to the depreciation/amortization, rentals, real property taxes/charges, and repairs and maintenance, of the properties being leased, as well as salaries of employees and fees of contractors hired to provide maintenance (repairs, cleaning/maintenance of leased properties) and collection services. (xi) Telephone and telegraph, electric, gas, and water utilities. - Their gross receipts shall mean actual or constructive receipts derived from the operation of such systems/ utilities covered by the law granting the franchise. Their costs of services shall refer to those incurred directly and exclusively for the production and delivery of such systems/utilities, and shall be limited to the following:


452

01. Salaries, wages and other employee benefits of personnel directly engaged in the said activities; 02. Depreciation/amortization, rentals, repairs and maintenance of properties and equipment directly used in the said activities (i.e., water pipes, electric poles, antennas, etc.); 03. Interconnection fee and/or share of foreign telecommunications administration (FA) for the services they perform; 04.

Fuel and lubricants on vehicles or equipment directly utilized in the said activities;

05. Amortization of franchise or development fees; 06.

Franchise fees; and

07.

Royalties.

(xii) Radio and/or television broadcasting. - Their gross receipts shall mean actual or constructive receipts derived from the operation of such radio/television broadcasting covered by the law granting the franchise. Their costs of services shall refer to those incurred directly and exclusively for such production and broadcasting, and shall be limited to the following: 01. Fees of talents hired for production/broadcasting; 02. Salaries, wages and other employee benefits of production and broadcasting personnel; 03. Tapes and other production materials & supplies; 04.

Satellite charges & wire services;

05. Film rights royalties & dubbing expenses; 06.

Set requirements;

07.

Rentals for production equipment & facilities;

08. Rentals for locations used exclusively for production/ broadcasting; 09.

Costumes, props & prizes; and

10.

Depreciation on production and broadcasting equipment.

The term 'salaries, wages and other employee benefits' as used herein shall include the following employee benefits: bonuses, Pag-ibig, SSS, Medicare, and HDMF Contributions. If a cost or expenditure is incurred both directly to provide a service required by a client, and indirectly for administration, operation, or sales-promotion purposes, the taxpayer shall be allowed a ratable portion of such cost or expenditure to form part of the "Cost of Services."

A minimum corporate income tax (MCIT) of two percent (2%) of the gross income as of the end of the taxable year (whether calendar or fiscal year, depending on the accounting period employed) is hereby imposed upon any domestic corporation begirining on the fourth (4th) taxable year immediately following the taxable year in which such corporation commenced its business operations. The MCIT shall be imposed whenever such corporation has zero or negative taxable income or whenever the amount of minimum corporate income tax is greater than the normal income tax due from such corporation. 19

Notwithstanding the above provision, the computation and the payment of MCIT, shall likewise apply at the time of filing the quarterly corporate income tax as prescribed under Section 75 (Declaration of Quarterly Corporate Income Tax) and Section 77 (Place and Time of Filing and Payment of Quarterly Corporate Income Tax) of the Tax Code, as amended. 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 at the time of filing the quarterly corporate income tax return shall be the MCIT which is two percent ( 2 % ) of the gross income as of the end of the taxable quarter. In the payment of said quarterly MCIT, excess MCIT from the previous taxable year/s shall not be allowed to be credited. Expanded withholding tax, quarterly corporate income tax payments under the normal income tax, and the MCIT paid in the previous taxable quarters) are allowed to be applied against the quarterly M C I T due.

20

Quarterly MCIT paid on the Quarterly Income Tax Return shall be credited against the normal income tax at year end, if "Sec. 27(E), NIRC. "Rev. Regs. No. 9-98, as amended by Rev. Regs. No. 12-97, Oct. 10, 2007.

454


in the preparation and filing of the annual income tax return and in the final computation of the annual income tax due, it appears that the normal income tax due is higher than the computed annual MCIT. Moreover, in addition to the quarterly MCIT paid and quarterly normal income tax payments in the taxable quarters of the same taxable year, excess MCIT in the prior year/s (subject to the prescriptive period allowed for its creditability), expanded withholding taxes in the current year and excess expanded withholding taxes in the prior year shall be allowed to be credited against the annual income tax computed under the normal income tax rules. However, if in the computation of the annual income tax due, the computed annual MCIT due appears to be higher than the annual normal income tax due, what may be credited against the annual MCIT due shall only be the quarterly MCIT payments of the current taxable quarters, the quarterly normal income tax payments in the quarters of the current taxable year, the expanded withholding taxes in the current year and excess expanded withholding taxes in the prior year. Excess MCIT from the previous taxable year/s shall not be allowed to be credited therefrom as the same can only be applied against normal income tax. 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. 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 returns whether this be MCIT or normal income tax. Thus, under the example, the taxpayer should have paid the MCIT of P75.000.00 since this amount is greater than the normal income tax of P50.000.00 in 1998. In the case of a domestic corporation 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, if a BOI-registered enterprise has a "registered" and an "unregistered" activity, the MCIT shall apply to the unregistered activity.


455

Carry forward of excess minimum corporate income taxAny excess of the minimum corporate income tax (MCIT) over the normal income tax as computed under Section 27(A) of the Code shall be carried forward on an annual basis and credited against the normal income tax for the three (3) immediately succeeding taxable years. Illustration on how to carry forward excess minimum corporate income tax Normal Income Year 1998 1998 amount of tax payable 1999 1999 amount of tax payable

Tax P 50,000 P 75,000 P 60,000 P100.000

2000

P100,000

Excess of MCIT Over the Normal MCIT Income Tax P 75,000 P25.000 PI00,000

P40,000

P 60,000

Computation of Net Amount of Tax Payable in 2000: Amount of tax payable Less: 1998 excess MCIT 1999 excess MCIT Net amount of tax payable

P100.000 (25,000) (40,000)

P65,000 P35.000

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) of the Code. The comparison between the normal income tax payable by the corporation and the MCIT shall be made at the end of the taxable year. Thus, under the example, the taxpayer will pay the MCIT of P75,000.00 since this amount is greater than the normal income tax of P50,000.00 in 1998. In 1999, the firm will also pay the MCIT since the MCIT of PIOO.OOO.OO is greater than the normal income tax of P60,000.00. In the year 2000, where the normal or regular corporate income tax of PIOO.OOO.OO is greater than the M C I T of P60,000.00, the firm will pay the normal income tax. The corporation can credit the excess of its MCIT over the normal income tax for 1998 (i.e. P25,000) and 1999 (i.e. P40.000), or a total amount of P65.000 from the amount of normal income

456


tax which is payable by the firm in the year 2000. Thus, the amount of income tax payable by the firm is P35.000 after deducting P65,000 from P100,000. The excess MCIT is creditable against the normal income tax within the next three (3) years from payment thereof. Thus, in the illustration above where the corporation had an excess MCIT of P25,000 over its normal income tax in 1998, the P25,000 can be claimed as a tax credit against the normal income tax up to the year 2001 and only when the normal income tax is greater than the MCIT. The excess MCIT cannot be claimed as a credit against the MCIT itself or against any other losses. (xiii) Relief from the Minimum Corporate Income Tax under Certain Conditions - The Secretary of Finance, upon recommendation of the Commissioner, may suspend imposition of the M C I T upon submission of proof by the applicantcorporation, duly verified by the Commissioner's authorized representative, that the corporation sustained substantial losses on account of a prolonged labor dispute or because of "force majeure" or because of legitimate business reverses. (xiv) Definition of Terms — (a) "Gross Income" defined - For purposes of the minimum corporate income tax prescribed under this Subsection, the term "gross income" means gross sales less sales returns, discounts and allowances and cost of goods sold. "Gross sales" shall include only sales contributory to income taxable under Section 27(A) of the Code. "Cost of goods sold" shall include all business expenses directly incurred to produce the merchandise to bring them to their present location and use. Passive incomes which have been subject to a final tax at source shall not form part of gross income for purposes of the minimum corporate income tax. For a trading or merchandising concern, "cost of goods sold" means the invoice cost of the 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


457

raw materials used, direct labor and manufacturing overhead, ' f r e i g h t cost, insurance premiums and other costs incurred to bring the raw materials to the factory or warehouse. In the case of sales of services, the term "gross income" means gross receipts less sales returns, allowances, discounts and cost of services. "Cost of services" means all direct costs and expenses necessarily incurred to provide the services required by the customers and clients including (a) salaries and employee benefits of personnel, consultants and specialists directly rendering the service, and (b) cost of facilities directly utilized in providing the service such as depreciation or rental of equipment used and cost of supplies: Provided, however, That "cost of services" shall not include interest expense except in the case of banks and other financial institutions. The term "gross receipts" as used herein means amounts actually or constructively received during the taxable year; Provided, That for taxpayers employing the accrual basis of accounting, the term "gross receipts" shall mean amounts earned as gross income. The term "direct costs and expenses" shall only pertain to those costs exclusively and directly incurred in relation to the revenue realized by the sellers of services. In fine, these refer to costs which are considered indispensable to the earning of the revenue such that without such costs, no revenue can be generated. Thus, expenses and other costs dispensed outside the ambit of what has been defined herein as "direct costs and expenses" are not items allowed for inclusion to "cost of services", for purposes of computing the gross income subject to the 2% MCIT. 21

(b) The term "substantial losses from a prolonged labor dispute" means losses arising from a strike staged by the employees which lasted for more than six (6) months within a taxable period and which has caused the temporary shutdown of business operations. (c) The term "force majeure" means a cause due to an irresistible force as by "Act of God" like lightning, earthquake, storm, flood and the like. This term shall also include armed conflicts like war or insurgency. "RMC 24-2008, Mar. 18, 2008.

458


(d) The term "legitimate business reverses" shall include substantial losses sustained due to fire, robbery, theft or embezzlement, or for other economic reason as determined by the Secretary of Finance. (xv) Specific Rules for Determining the Period When a Corporation Becomes Subject to the MCIT - For purposes of the MCIT, the taxable year in which business operations commenced shall be the year in which the domestic corporation registered with the Bureau of Internal Revenue (BIR). Firms which were registered with BIR in 1994 and earlier years shall be covered by the MCIT beginning January 1, 1998. Firms which were registered with BIR in any month in 1998 shall be covered by the MCIT three calendar years thereafter (i.e. after the lapse of three calendar years from 1998). For example, a firm which was registered in May 1998 shall be covered by the MCIT in 2002. The reckoning point for firms using the fiscal year shall also be 1998. For example, a firm which registered with the BIR on July 1, 1998 shall be subject to an MCIT on his gross income earned for the entire fiscal year ending in the year 2002. Transitory Rule for determining the MCIT for 1998 on firms which are taxable on a fiscal year basis. - For firms using the fiscal year basis and whose first taxable period under the minimum corporate income tax covers month/months in 1997 (i.e., prior to the imposition of MCIT under R.A. No. 8424), the MCIT which is due for 1998 shall be computed using an apportionment formula. The ratio to be applied is the number of months in 1998 to twelve (12) months (i.e., the total number of months in a fiscal year). Illustration: Firm A registered with the BIR in July 1994. It becomes subject to the MCIT in 1998. Since it is using a fiscal year as basis of its taxable period, a part of the tax base for the MCIT was earned by the corporation in 1997 prior to the imposition of the MCIT (i.e. gross income from July to December 1997). The MCIT which is due from the firm is computed using the gross income of the firm for 1998 (January to June) which is computed on an apportionment basis as follows:

Gross income of the firm for the entire fiscal year Multiply: 0.50 (i.e. ratio of 6 months in 1998 to 12 months covering FY 97-98) Equals: Tax base of the MCIT for 1998 Multiply: 2% (i.e. MCIT tax rate) Equals: MCIT for 1998. (xvi) Manner of filing and payment - The minimum corporate income tax ( M C I T ) shall be paid on a taxable year basis. It shall be covered by a tax return designed for the purpose which will be submitted together with the corporation's annual final adjustment income tax return. Domestic corporations shall not be required to pay the minimum corporate income tax on a quarterly basis, the provisions of Section 75 (Declaration of Quarterly Income Tax Return) of the Code notwithstanding. (xvii) Accounting treatment of the excess minimum corporate income tax paid - Any amount paid as excess minimum corporate income tax shall be recorded in the corporation's books as an asset under account title "deferred charges-minimum corporate income tax". This asset account shall be carried forward and may be credited against the normal income tax due for a period not exceeding three (3) taxable years immediately succeeding the taxable year/s in which the same has been paid. Any amount of the excess minimum corporate income tax which has not or cannot be so credited against the normal income taxes due for the 3-year reglementary period shall lose its creditability. Such amount shall be removed and deducted from "deferred charges-minimum corporate income tax" account by a debit entry to "retained earnings" account and a credit entry to "deferred charges-minimum corporate income tax" account since this tax is not allowable as deduction from gross income it being an income tax. Illustration on the accounting treatment of the excess minimum corporate income tax paid Assume that ABC Corporation commenced business operations in calendar year 1991. It is already more than four (4) years in operation as of calendar year 1998 hence, subject to the minimum corporate income tax beginning taxable year 1998. Assume, further, that its income taxes during the years from 1998 to year 2005 are as follows:

460


YEAR

NORMAL INCOME TAX

MCIT

EXCESS OF MCIT OVER NORMAL INCOME TAX

1998

P25.000

P100,000

P75.000

1999

130,000

150,000

20,000

2000

200,000

190,000

2001

-

300,000

300,000

2002

10,000

50,000

40,000

2003

15,000

60,000

45,000

2004

8,000

40,000

32,000

2005

1,000

50,000

49,000

In this case, ABC Corporation shall not be allowed to carry forward and credit the 1998 excess MCIT against the income tax liability for 1999 since the 1999 MCIT is greater than the normal income tax for said year. However, for year 2000, where the normal income tax is greater than the computed MCIT, ABC Corporation shall be allowed to apply the excess MCIT of 1998 and 1999 amounting to P95,000 (P75,000 plus P20,000) against the normal income tax liability of P200,000. The excess MCIT for the year 2001 (P300,000) may only be credited against normal income tax liabilities for the succeeding three years from 2002 to 2004. However, since the normal income tax liabilities for these succeeding years are lesser than the respective MCITs, the excess MCIT for the year 2001 of P300,000 loses its creditability by the year 2005 hence, must be removed and deducted from "Deferred charges-MCIT" account and charged to "Retained Earnings" account. Illustrative accounting entries to record excess MCIT — (a) For taxable year 1998 when MCIT is greater than the normal income tax liability of the company 1998 (1)

Debit: Provision for income tax P25,000 Credit: Income tax payable

P25,000

To record income tax liability using the normal income tax rate (2)

Debit: Deferred Charges-MCIT P75,000 Credit: Income Tax Payable

P75,000

To record excess MCIT (P100,000 - P25,000)

(3)

Debit: Income Tax Payable PIOO.OOO Credit: Cash in bank P100,000 To record payment of income tax due for 1998

(b) For taxable year 2000 when excess MCIT (1998 and 1999) is applied against normal income tax liability 2000 (1)

Debit: Provision for income tax P200,000 Credit: Income Tax Payable P200,000 To record income tax liability using the normal income tax rate

(2)

Debit: Income tax payable P95,000 Credit: Deferred Charges-MCIT (P75,000 plus P20,000)

P95,000

To record application of excess MCIT against normal income tax liability for taxable year 2000 (3)

Debit: Income Tax Payable Credit: Cash in Bank

P105.000 P105,000

To record payment of income tax due (P200.000 less P95,000) (c) For taxable year 2005 when the expired portion of excess MCIT (P300.000) for taxable year 2001 is closed to the retained earnings account due to its non-application. 2005 Debit: Retained Earnings P300,000 Credit: Deferred Charges-MCIT P300,000 To record the expired portion of Deferred Charges-MCIT (xviii) Exceptions — The minimum corporate income tax (MCIT) shall apply only to domestic corporations subject to the normal corporate income tax prescribed under these Regulations. Accordingly, the minimum corporate income tax shall not be imposed upon any of the following: (a) Domestic corporations operating as proprietary educational institutions subject to tax at ten percent (10%) on their taxable income; or

462


(b) Domestic corporations engaged in hospital operations which are nonprofit subject to tax at ten percent (10%) on their taxable income; and (c) Domestic corporations engaged in business as depository banks under the expanded foreign currency deposit system, otherwise known as Foreign Currency Deposit Units (FCDUs), on their income from foreign currency transactions with local commercial banks, including branches of foreign banks, authorized by the Bangko Sentral ng Pilipinas (BSP) to transact business with foreign currency deposit system units and other depository banks under the foreign currency deposit system, including their interest income from foreign currency loans granted to residents of the Philippines under the expanded foreign currency deposit system, subject to final income tax at ten percent (10%) of such income. (d) Firms that are taxed under a special income tax regime such as those in accordance with R.A. Nos. 7916 and 7227 (the PEZA law and the Bases Conversion Development Act, respectively). Section 2.28(A)(2) Minimum Corporate Income Tax (MCIT) on Resident Foreign Corporation - A minimum corporate income tax of two percent (2%) of the gross income from sources within the Philippines is hereby imposed upon any resident foreign corporation, beginning on the fourth (4th) taxable year (whether calendar or fiscal year, depending on the accounting period employed) immediately following the taxable year in which the corporation commenced its business operations, whenever the amount of the minimum corporate income tax is greater than the normal income tax due for such year. In computing for the minimum corporate income tax due from a resident foreign corporation, the rules prescribed under Section 2.27(E) of these Regulations shall apply: Provided, however, That only the gross income from sources within the Philippines shall be considered for such purposes. Exceptions. - The minimum corporate income tax shall only apply to resident foreign corporations which are subject to normal income tax. Accordingly, the minimum corporate income tax shall not apply to the following resident foreign corporations:

(a) Resident foreign corporations engaged in business as "international carrier" subject to tax at two and one-half percent (2-1/2%) of their "Gross Philippine Billings"; (b) Resident foreign corporations engaged in business as Offshore Banking Units (OBUs) on their income from foreign currency transactions with local commercial banks, including branches of foreign banks, authorized by the Bangko Sentral ng Pilipinas (BSP) to transact business with Offshore Banking Units (OBUs), including interest income from foreign currency loans granted to residents of the Philippines, subject to a final income tax at ten percent (10%) of such income; and (c) Resident foreign corporations engaged in business as regional operating headquarters subject to tax at ten percent (10%) of their taxable income. Firms that are taxed under a special income tax regime such as those in accordance with R.A. Nos. 7916 and 7227 (the PEZA law and the Bases Conversion Development Act, respectively).

C.

IMPROPERLY ACCUMULATED EARNINGS TAX (IAET) In addition to other income taxes imposed under Title II (Income Tax), an improperly accumulated earnings tax equal to ten percent (10%) of the improperly accumulated taxable income for each taxable year shall be imposed. 22

Concept of I m p r o p e r l y Accumulated Earnings Tax (IAET) 23

A tax equal to 10% of the improperly accumulated taxable income of corporations formed or availed of for the purpose of avoiding the income tax with respect to its shareholders or the shareholders of any other corporation, by permitting the earnings and profits of the corporation to accumulate instead of dividing them among or distributing them to the shareholders is imposed. The rationale is that 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 22

Sec. 29, NIRC. "Rev. Regs. No. 2-2001, Feb. 12, 2001.

464


would incur no tax in respect to the undistributed earnings and profits of the corporation. 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 upon shareholders who are supposed to pay dividends tax on the earnings distributed to them by the corporation. The touchstone of the liability is the purpose behind the accumulation of the 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, the 10% improperly accumulated earnings tax shall be imposed. Determination of Reasonable Needs of the Business An accumulation of earnings or profits (including undistributed earnings or profits of prior years) is unreasonable if it is not necessary for the purpose of the business, considering all the circumstances of the case. To determine the "reasonable needs" of the business in order to justify an accumulation of earnings, these Regulations hereby adhere to the so-called "Immediacy Test" under American jurisprudence as adopted in this jurisdiction. Accordingly, the term "reasonable needs of the business" are hereby construed to mean the immediate needs of the business, including reasonably anticipated needs. In either case, the corporation should be able to prove an immediate need for the accumulation of the earnings and profits, or the direct correlation of anticipated needs to such accumulation of profits. Otherwise, such accumulation would be deemed to be not for the reasonable needs of the business, and the penalty tax would apply. For purposes of these Regulations, the following 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;


465

b)

Earnings reserved for definite corporate expansion projects or programs requiring considerable capital expenditure as approved by the Board of Directors or equivalent body;

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.

The 10% Improperly Accumulated Earnings Tax (IAET) is imposed on improperly accumulated taxable income earned starting January 1, 1998 by domestic corporations as denned under the Tax Code and which are classified as closely-held corporations. However, Improperly Accumulated Earnings Tax shall not apply to the following corporations: a)

Banks and other non-bank financial intermediaries;

b)

Insurance companies;

c)

Publicly-held corporations;

d)

Taxable partnerships;

e)

General professional partnerships;

f)

Non- taxable joint ventures; and

g)

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, as well as other enterprises duly registered under special economic zones declared by

466


law which enjoy payment of special tax rate on their registered operations or activities in lieu of other taxes, national or local. For purposes of these Regulations, 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 or for not more than twenty (20) individuals. Domestic corporations not falling under the aforesaid definition are, therefore, publicly-held corporations. For purposes of determining whether the corporation is closely held corporation, insofar as such determination is based on stock ownership, the following rules shall be applied: (1) Stock Not Owned by Individuals. — Stock owned directly or indirectly by or for a corporation, partnership, estate or trust shall be considered as being owned proportionately by its shareholders, partners or beneficiaries. (2) Family and Partnership Ownership. — An individual shall be considered as owning the stock owned, directly or indirectly, by or for his family, or by for his partner. For purposes of this paragraph, the family of an individual includes his brothers or sisters (whether by whole or half-blood), spouse, ancestors and lineal descendants. (3) Option to Acquire Stocks. — If any person has an option to acquire stock, such stock shall be considered as owned by such person. For purposes of this paragraph, an option to acquire such an option and each one of a series of option shall be considered as an option to acquire such stock. (4) Constructive Ownership as Actual Ownership. — Stock constructively owned by reason of the application of paragraph (1) or (3) hereof shall, for purposes of applying paragraph (1) or (2), be treated as actually owned by such person; but stock constructively owned by the individual by reason of the application of paragraph (2) hereof shall not be treated as owned by him for purposes of again applying such paragraph in order to make another the constructive owner of such stock. However, a branch of a foreign corporation is not covered by these Regulations, the same being a resident foreign corporation.


467

Tax base of improperly accumulated earnings tax For corporations found subject to the tax, the "Improperly Accumulated Taxable Income" for a particular year is first determined by adding to that year's taxable income the following: (a)

Income exempt from tax;

(b)

Income excluded from gross income;

(c)

Income subject to final tax; and

(d) The amount of net operating loss carry-over (NOLCO) deducted. The taxable income as thus determined shall be reduced by the sum of: (a)

Income tax paid/payable for the taxable year;

(b)

Dividends actually or constructively paid/issued from the applicable year's taxable income;

(c)

Amount reserved for the reasonable needs of the business as defined in these Regulations emanating from the covered year's taxable income.

The resulting "Improperly Accumulated Taxable Income" is thereby multiplied by 10% to get the Improperly Accumulated Earnings Tax (IAET). Once the profit has been subjected to IAET, the same shall no longer be subjected to IAET in later years even if not declared as dividend. Notwithstanding the imposition of the IAET, profits which have been subjected to IAET, when finally declared as dividends, shall nevertheless be subject to tax on dividends imposed under the Tax Code of 1997, except in those instances where the recipient is not subject thereto. For purposes of determining the source of earnings or profits declared or distributed from accumulated income for each taxable year, the dividends shall be deemed to have been paid out of the most recently accumulated profits or surplus and shall constitute a part of the annual income of the distributee for the year in which received pursuant to Section 73(C) [Distribution of Dividends or Assets by Corporations] of the Code. Provided, however, That where the dividends or portion of the said dividends declared forms part of the accumulated earnings


468

as of December 31, 1997, or emanates from the accumulated income of a particular year and, therefore, is an exception to the proceeding statement, such fact must be supported by a duly executed Board Resolution to that effect. Period for Payment of Dividend/Payment of IAET The dividends must be declared and paid or issued not later than one year following the close of the taxable year, otherwise, the IAET, if any, should be paid within fifteen (15) days thereafter. Determination of Purpose to Avoid Income Tax The fact that a corporation is a mere holding company or investment company shall be prima facie evidence of a purpose to avoid the tax upon its shareholders or members. Likewise, the fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid the tax upon its shareholders or members. In both instances, the corporation may, by clear preponderance of evidence in its favor, prove the contrary. For purposes of these Regulations, the term "holding or investment company" shall refer to a corporation having practically no activities except holding property, and collecting the income therefrom or investing the same. The following are prima facie instances of accumulation of profits beyond the reasonable needs of a business and indicative of purpose to avoid income tax upon shareholders: (a)

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

(b)

Investment in bonds and other long-term securities;

(c)

Accumulation of earnings in excess of 100% of paidup capital, not otherwise intended for the reasonable needs of the business as defined in these Regulations.

In order to determine whether profits are accumulated for the reasonable needs of the business as to avoid the imposition of the improperly accumulated earnings tax, the controlling intention of the taxpayer is that which is manifested at the


469

time of accumulation, not subsequently declared intentions which are merely the product of afterthought. A speculative and indefinite purpose will not suffice. The mere recognition of a future problem or the discussion of possible and alternative solutions is not sufficient. Definiteness of plan/s coupled with action/s taken towards its consummation are essential. The I A E T shall not apply on improperly accumulated income as of December 31,1997 in the case of corporations using the calendar year basis. In the case of corporations adopting the fiscal year accounting period, the IAET shall not apply on improperly accumulated taxable income as of the end of the month comprising the twelve-month period of fiscal year 19971998. Taxable income improperly accumulated prior to the effectivity of these regulations if declared as dividend and paid/ issued within one month from the effectivity hereof will not be subjected to the 10% Improperly Accumulated Earnings Tax. The corporation did not involve itself in the development of subdivisions but merely subdivided its own lots and sold them for bigger profits. It derived its income mostly from interest, dividends and rental realized from the sale of realty. Ninetynine (99%) per cent in value of the outstanding stock of the corporation is owned by Antonio Tuason himself. Out of the P3.2 million retained earnings, the corporation has invested only P773.720. These circumstances support the BIR findings that the corporation accumulated its profits for the purpose of avoiding the imposition of progressive tax on its shareholders. Indeed, the surtax was aimed at corporations so that they would declare dividends to their shareholders, by removing the tax shelter available to taxpayers through accumulation of profits. The law placed upon the corporation the burden of good faith to prove that the fact of accumulation was not beyond the reasonable needs of the business. The touchstone of liability is the purpose behind the accumulation of the income and not the consequences of the accumulation (Commissioner vs. Antonio Tuason, Inc. & CTA, G.R. No. 85749, May 15, 1989). To justify an accumulation of earnings and profits for the reasonably anticipated future needs, the accumulation must have been used within a reasonable time after the close of the taxable year. In Manila Wine Merchants, Inc. vs. Commissioner (L-26145, Feb. 25,1984), the court ruled that there was improper accumulation due to the investment in U.S. Treasury Bonds,

470


which was not in any way related to the taxpayer's business of importing wines and liquors. Under the "immediacy test," the term "unreasonable needs of the business" meant the immediate needs of the business, so that if the corporation did not prove an immediate need for accumulation of earnings, the accumulation was not for reasonable needs of the business, and the surtax would apply. Moreover, the company never had occasion to use the bonds for financing its importation. Its claim that the same would be used for buying a lot and constructing a building was not sufficient to justify the accumulation since they were future contingencies. The controlling intention of the taxpayer, for purposes of determining whether profits were accumulated for the reasonable needs of the business, is that which was manifested at the time of the accumulation, not subsequently declared intentions which are merely the products of after-thought. In determining whether accumulations of earnings or profits in a particular year are within the reasonable needs of a corporation, it is necessary to take into account prior accumulations, since accumulations prior to the year involved may have been sufficient to cover the business needs and additional accumulation during the year involved would not reasonably be necessary (Basilan Estate, Inc. vs. Commissioner, 21 SCRA 17).

D.

FINAL TAX ON ENTERPRISES REGISTERED WITH SPECIAL ECONOMIC ZONE AND FREEPORT ZONE AUTHORITIES I. Subic Bay Metropolitan Authority ( S B M A ) Gross Income Earned 24

For purposes of implementing the tax incentive provision under paragraph (c) of Section 12 of Republic Act No. 7227, otherwise known as "The Bases Conversion Development Act of 1992," Section 3(o) of Revenue Regulations No. 1-95, as amended by Revenue Regulations No. 16-99, shall read as follows: "(o) Gross income earned - shall refer to gross sales or gross revenues derived from business activity within the "R.A. No. 7227 (The Bases Conversion Development Act of 1992), as implemented by Rev. Regs. No. 13-2005, Apr. 25, 2005, which revoked Sec. 7 and suspended Sees. 3, 4, ana 6 of Rev. Regs. No. 2-2005


471

Zone, net of sales discounts, sales returns and allowances and minus costs of sales or direct costs but before any deduction is made for administrative, marketing, selling and/or operating expenses or incidental losses during a given taxable period. For financial enterprises, gross income shall include interest income, gains from sales, and other income, net of costs of funds. For purposes of computing the total five percent (5%) tax rate imposed, the following deductions shall be allowable for the calculation of gross income earned for specific types of enterprises: 1.

Trading Enterprises: -

2.

3.

Cost of Sales (Cost of Sales which is equal to inventory, beginning plus purchases minus inventory of goods, ending)

Manufacturing Enterprises: -

Direct salaries, wages or labor expenses;

-

Production supervision salaries;

-

Raw materials used in the manufacture of products;

-

Decrease in Goods in Process Account (Intermediate goods);

-

Decrease in Finished Goods Account;

-

Supplies and fuels used in production;

-

Depreciation of machinery and equipment used in production, and of that portion of the building owned or constructed by the registered enterprise that is used exclusively in the production of goods;

-

Rent and utility charges associated with building, equipment and warehouses used in production; and

-

Financing charges associated with fixed assets used in production the amount of which were not previously capitalized;

Service Enterprises: -

Direct salaries, wages or labor expense;


472

4.

-

Service supervision salaries;

-

Direct materials, supplies used;

-

Depreciation of machineries and equipment used in the rendition of registered services, and of that portion of the building owned or constructed that is used exclusively in the rendition of the registered service;

-

Rent and utility charges for buildings and capital equipment used in the rendition of registered services; and

-

Financing charges associated with fixed assets used in the registered service business the amount of which were not previously capitalized.

Financial Institutions: -

None.

Importations of registered businesses and enterprises or locators within the Subic Special Economic Zone in excess of the requirements of their registered business or authorized business activity consisting of raw materials, capital goods and equipment shall be deemed brought into or sold within the customs territory and, therefore, subject to the payment of taxes and customs duties in accordance with existing customs and tax laws. 25

R . A No. 9400 - An Act Amending R A . N o . 7227, otherwise known as The Bases Conversion and Development Act of 1992 26

Sec. 1. Section 12 of Republic Act No. 7227, as amended, otherwise known as the Bases Conversion and Development Act of 1992, is hereby amended to read as follows: "SEC. 12. Subic Special Economic Zone, — x x x "(a) x x x "(b) The Subic Special Economic Zone shall be operated and managed as a separate customs territory 5 6

Exec Order No. 660 as circularized by RMC 20-2008, Feb. 9, 2008. RMC 27-2007.


473

ensuring free flow or movement of goods and capital within, into and exported out of the Subic Special Economic Zone, as well as provide incentives such as tax and duty-free importations of raw materials, capital and equipment. However, exportation or removal of goods from the territory of the Subic Special Economic Zone to the other parts of the Philippine territory shall be subject to customs duties and taxes under the Tariff and Customs Code of the Philippines, as amended, the National Internal Revenue Code of 1997, as amended, and other relevant tax laws of the Philippines; "(c) The provision of existing laws, rules and regulations to the contrary notwithstanding, no national and local taxes shall be imposed within the Subic Special Economic Zone. "In lieu of said taxes, a five percent (5%) tax on gross income earned shall be paid by all business enterprises within the Subic Special Economic Zone and shall be remitted as follows: three percent (3%) to the National Government, and two (2%) percent to the Subic Bay Metropolitan Authority (SBMA) for distribution to the local government units affected by the declaration of and contiguous to the zone, namely: the City of Olongapo and the municipalities of Subic, San Antonio, San Marcelino and Castillejos of the Province of Zambales; and the municipalities of Morong, Hermosa and Dinalupihan of the Province of Bataan, on the basis of population (50%), land area (25%), and equal sharing (25%). Sec. 2. Section 15 of the Republic Act No. 7227, as amended, is hereby amended to read as follows: "SEC. 15. Clark Special Economic Zone (CSEZ) and Clark Freeport Zone (CFZ). - Subject to the concurrence by resolution of the local government units directly affected, the President is hereby authorized to create by executive proclamation a Special Economic Zone covering the lands occupied by the Clark military reservations and its contiguous extensions as embraced, covered and defined by the 1947 Military Bases Agreement between the Philippines and the United States of America, as amended, located within the territorial jurisdiction of Angeles City, municipalities of Mabalacat and Porac,

474


Province of Pampanga, and the municipalities of Capas and Bamban, Province of Tarlac, in accordance with the provision as herein provided insofar as applied to the Clark military reservations. The Clark Air Base proper with an area of not more than four thousand four hundred hectares (4,400 has.), with the exception of the twenty-two-hectare commercial area situated near the main gate and the Bayanihan Park consisting of seven and a half hectares (7.5 has.) located outside the main gate of the Clark Special Economic Zone, is hereby declared a Freeport zone. "The CFZ shall be operated and managed as a separate customs territory ensuring free flow or movement of goods and capital equipment within, into and exported out of the CFZ, as well as provide incentives such as tax and duty-free importation of raw materials and capital equipment. However, exportation or removal of goods from the territory of the CFZ to the other parts of the Philippine territory shall be subject to customs duties and taxes under the Tariff and Customs Code of the Philippines, as amended, the National Internal Revenue Code of 1997, as amended, and other relevant tax laws of the Philippines. "The provisions of existing laws, rules and regulations to the contrary notwithstanding, no national and local taxes shall be imposed on registered business enterprises within the CFZ. In lieu of said taxes, a five percent (5%) tax on gross income earned shall be paid by all registered business enterprises within the CFZ and shall be directly remitted as follows: three percent (3%) to the National Government, and two percent (2%) to the treasurer's office of the municipality or city where they are located. "The governing body of the Clark Special Economic Zone shall likewise be established by executive proclamation with such powers and functions exercised by the Export Processing Zone Authority pursuant to Presidential Decree No. 66, as amended: Provided, That it shall have no regulatory authority over public utilities, which authority pertains to the regulatory agencies created by law for the purpose, such as the Energy Regulatory Commission created under Republic Act No. 9136 and the National Telecommunications Commission created under Republic Act No. 7925.


475

"Subject to the concurrence by resolution of the local government units directly affected and upon recommendation of the Philippine Economic Zone Authority (PEZA), the President is hereby authorized to create by executive proclamation Special Economic Zones covering the City of Balanga and the municipalities of Limay, Mariveles, Morong, Hermosa, and Dinalupihan, Province of Bataan. "Subject to the concurrence by resolution of the local government units directly affected and upon recommendation of the PEZA, the President is hereby authorized to create by executive proclamation Special Economic Zones covering the municipalities of Castillejos, San Marcelino, and San Antonio, Province of Zambales. "Duly registered business enterprises that will operate in the Special Economic Zones to be created shall be entitled to the same tax and duty incentives as provided for under Republic Act No. 7916, as amended: Provided, That for the purpose of administering these incentives, the PEZA shall register, regulate, and supervise all registered enterprises within the Special Economic Zones." Sec. 3. A new Section 15-A is hereby inserted, amending Republic Act No. 7227, as amended, to read as follows: "SEC. 15-A. Poro Point Freeport Zone (PPFZ). - The two hundred thirty-six and a half-hectare (236.5 has.) secured area in the Poro Point Special Economic and Freeport Zone created under Proclamation No. 216, series of 1993, shall be operated and managed as a freeport and separate customs territory ensuring free flow or movement of goods and capital equipment within, into and exported out of the PPFZ. The PPFZ shall also provide incentives such as tax and duty-free importation of raw materials and capital equipment. However, exportation or removal of goods from the territory of the PPFZ to the other parts of the Philippine territory shall be subject to customs duties and taxes under the Tariff and Customs Code of the Philippines, as amended, the National Internal Revenue Code of 1997, as amended, and other relevant tax laws of the Philippines. "The provisions of existing laws, rules and regulations to the contrary notwithstanding, no national and local

476


taxes shall be imposed on registered business enterprises within the PPFZ. In lieu of said taxes, a five percent (5%) tax on gross income earned shall be paid by all registered business enterprises within the PPFZ and shall be directly remitted as follows: three percent (3%) to the National Government, and two percent (2%) to the treasurer's office of the municipality or city where they are located. "The governing body of the PPFZ shall have no regulatory authority over public utilities, which authority pertains to the regulatory agencies created by law for the purpose, such as the Energy Regulatory Commission created under Republic Act No. 9136 and the National Telecommunications Commission created under Republic Act No. 7925." Sec. 4. A new Section 15-B is hereby inserted, amending Republic Act No. 7227, as amended, to read as follows: "SEC. 15-B. Morong Special Economic Zone (MSEZ). - Duly registered business enterprises operating within the MSEZ created under Proclamation No. 984, series of 1997, shall be entitled to tax and duty-free importation of raw materials and capital equipment. In lieu of all national and local taxes except real property tax on land, a five percent (5%) tax on gross income earned shall be paid by all registered business enterprises which shall be directly remitted as follows: three percent (3%) to the National Government, and two percent (2%) to the treasurer's office of the municipality or city where they are located." Sec. 5. A new Section 15-C is hereby inserted, amending Republic Act No. 7227, as amended, to read as follows: "Sec. 15-C. John Hay Special Economic Zone (JHSEZ). — Registered business enterprises which will operate after the effectivity of this Act, within the JHSEZ created under Proclamation No. 420, series of 1994, shall be entitled to the same tax and duty incentives as provided for under Republic Act No. 7916, as amended: Provided, That for the purpose of administering these incentives, the PEZA shall register, regulate, and supervise all registered enterprises within the JHSEZ: Provided, further, That the Conversion Authority and the John Hay Management


477

Corporation ( J H M C ) shall only engage in acquiring, owning, holding, administering or leasing real properties^ and in other activities incidental thereto." Sec. 6. In case of conflict between national and local laws with respect to the tax exemption privileges in the CFZ, PPFZ JHSEZ and MSEZ, the same shall be resolved in favor of the aforementioned zones: Provided, That the CFZ and PPFZ shall be subject to the provisions of paragraphs (d), (e), (f), (g), (h), and (i) of Section 12 of Republic Act No. 7227, as amended. Sec. 7. Business enterprises presently registered and granted with tax and duty incentives by the Clark Development Corporation ( C D C ) , Poro Point Management Corporation (PPMC), JHMC, and Bataan Technological Park Incorporated (BTPI), including such governing bodies, shall be entitled to the same incentives until the expiration of their contracts entered into prior to the effectivity of this Act. II.

Philippine Economic Zone Authority (PEZA)

A. R A . 7903 (Zamboanga City Special Economic Zone Act of 1995) and R . A 7922 (Cagayan Special Economic Zone Act of 1995) 27

"Gross Income." - For purposes of implementing the tax incentive provision under Paragraph (c) of Section 4 of Republic Act No. 7922 otherwise known as "Cagayan Special Economic Zone Act of 1995" and Paragraph (f) of Section 4 of Republic Act No. 7903, otherwise known as "Zamboanga City Special Economic Zone Act of 1995," the term "gross income" shall refer to gross sales or gross revenues derived from business activity within the Zone, net of sales discounts, sales returns and allowances and minus costs of sales or direct costs but before any deduction is made for administrative, marketing, selling and/or operating expenses or incidental losses during a given taxable period. For purposes of computing the total five percent (5%) tax rate imposed, the following deductions shall be allowed for calculating gross income for the following specific types of enterprises: "Rev. Regs. No. 12-2005, Apr. 25, 2005 revoked Sec. 7 of Rev. Regs. No. 2-2005; see MOA between BIR and PEZA under RMC 15-2007, Mar. 5, 2007.


Trading Enterprises: -

Cost of Sales (Cost of Sales which is equal to inventory, beginning plus purchases minus inventory of goods, ending)

Manufacturing Enterprises: -

Direct salaries, wages or labor expenses;

-

Production supervision salaries;

-

Raw materials used in the manufacture of products;

-

Decrease in Goods in Process Account (Intermediate goods);

-

Decrease in Finished Goods Account;

-

Supplies and fuels used in production;

-

Depreciation of machinery and equipment used in production, and of that portion of the building owned or constructed by the registered enterprise that is used exclusively in the production of goods;

-

Rent and utility charges associated with building, equipment and warehouses used in production; and

-

Financing charges associated with fixed assets used in production the amount of which were not previously capitalized.

Service Enterprises: -

Direct salaries, wages or labor expense;

-

Service supervision salaries;

-

Direct materials, supplies used;

-

Depreciation of machineries and equipment used in the rendition of registered services, and of that portion of the building owned or constructed that is used exclusively in the rendition of the registered service;

-

Rent and utility charges for buildings and capital equipment used in the rendition of registered services; and


479

Financing charges associated with fixed assets used in the registered service business the amount of which were not previously capitalized. Sec. 1. Scope. - Pursuant to the provisions of Sections 244 and 245 of the National Internal Revenue Code of 1997 as amended, these regulations are hereby promulgated to implement: 28

1. Sections 12(b) and 12(c) of Republic Act No. 7227 governing businesses and enterprises within the Subic Special Economic and Freeport Zone (SUBIC-ECOZONE); 2. Sections 23, 24, 26, 50 and 51 of Republic Act No. 7916 governing businesses and enterprises within the Special Economic Zones (ECOZONE); 3. Sections 4(e) and 4(f) of Republic Act No. 7903 governing businesses and enterprises within the Zamboanga City Special Economic Zone (ZAMBO-ECOZONE); and 4. Sections 4(b) and 4(c) of Republic Act No. 7922 governing businesses and enterprises within the Cagayan Special Economic Zone and Free Port (CAGAYAN-ECOZONE) Sec. 2. Definitions. - For purposes of these Regulations the terms used herein shall be construed to have the following meanings: a. SUBIC-ECOZONE - refers to the Subic Special Economic and Freeport Zone, created under Section 12 of RA No. 7227. b. SUBIC-ECOZONE Registered Enterprise - refers to any business entity or concern located within the SUBICECOZONE and duly registered with and/or licensed by the SBMA to operate any lawful economic activity within the SUBICECOZONE. c. SUBIC-ECOZONE Facilities Operator - refers to a SUBICECOZONE Enterprise which operates facilities or services within the SUBIC-ECOZONE, including the subleasing of land or other property to other SUBIC-ECOZONE Enterprise ^Rev. Regs. No. 2-2005, Feb. 8, 2005.

480


d. SBMA — refers to the Subic Bay Metropolitan Authority, established and created pursuant to Section 13 of the Republic Act No. 7227 e. ECOZONES or "Special Economic Zones" - shall refer to selected areas with highly developed or which have the potential to be developed into agro-industrial, industrial, tourist, recreational, commercial, banking, investment and financial centers established in accordance with Sees. 5 and 6 of Republic Act No. 7916. f. ECOZONE Registered Enterprise - refers to any business entity or concern within the ECOZONE duly registered with and/or licensed by the PEZA to operate any lawful economic activity within the ECOZONE. An ECOZONE Registered Enterprise may be classified as follows: f.l "ECOZONE Export Enterprise" - refers to an individual, association, partnership, corporation or other form of business organization which has been registered with the PEZA to engage in manufacturing, assembling or processing activity falling within the purview of the Act and resulting in the exportation of 100% of its production, unless a lower percentage of its production for exportation is prescribed by the PEZA Board subject to such terms and conditions as the latter may determine. f.2 "ECOZONE Domestic Market Enterprise" - refers to an individual, association, partnership, corporation or other form of business organization which has been registered with the PEZA to engage in manufacturing, assembling or processing activity falling within the purview of the Act resulting in the sale of its finished products in the customs territory or in the non-restricted or authorized areas within the ECOZONE in its entirety or if exporting a portion of its production output, it continually fails to export at least fifty percent (50%) thereof for a period of three (3) years without any justifiable reason in case at least 60% of its working capital is owned by Philippine nationals or in case more than 40% of its working capital is owned by foreign nationals, it continually fails to export at least seventy percent (70%) of its production output for a period of three (3) years without any justifiable reason. f.3 "ECOZONE Pioneer Enterprise" - shall mean an ECOZONE enterprise (1) engaged in the manufacture,


481

processing or production and not merely in the assembly or packaging of goods, products, commodities or raw materials that have not been or are not being produced in the Philippines on a commercial scale or (2) which uses a design, formula, scheme, method, process or system of production or transformation of any element, substance or raw materials into another raw material or finished goods which is new and untried in the Philippines or (3) which produces non-conventional fuels or manufactures equipment which utilizes non-conventional sources of energy or uses or converts to coal or other non-conventional fuels or sources of energy in its production, manufacturing or processing operations: or (4) engaged in the pursuit of agri-export processing zone development or (5) given such status under the Investment Priorities Plan: Provided, That the final product in any of the foregoing instances involves or will involve substantial use and processing of domestic raw materials, whenever available, taking into account the risk and magnitude of investment. f.4 "ECOZONE Free Trade Enterprise" - refers to an individual, association, partnership, corporation or other form of business organization which has been registered with the PEZA to engage in the importation of goods or merchandise within the restricted or free trade area in the ECOZONE tax and duty-free for immediate transshipment or for storage, repacking, sorting, mixing or manipulation and subsequent exportation, unless the Board allows the sale thereof in the customs territory subject to the payment of customs duties and internal revenue taxes and to such other terms and conditions as it may determine. f.5 "ECOZONE Utilities Enterprise" — shall refer to a business entity or concern within the ECOZONE duly registered with and/or franchised/licensed by the PEZA with or without the incentives provided under Republic Act No. 6957, (the Build-Operate-Transfer Law), as amended, and/or with or without financial exposure on the part of the PEZA, such as contractors/operators of light and power systems, water supply and distribution systems, communications and transportation systems within the ECOZONE and other similar or ancillary activities as may be determined by the PEZA Board. f.6 "ECOZONE Facilities Enterprise" - shall refer to a business entity or concern within the ECOZONE duly registered with and/or franchised/licensed by the PEZA with or without incentives provided under Republic Act No. 6957 (the Build-

482


Operate-Transfer Law), as amended, and/or with or without financial exposure on the part of the PEZA such as contractors/ operators of buildings, structures, warehouses, site development and road network, ports, sewerage and drainage system and other facilities for the development, operation and maintenance of the ECOZONE and other similar or ancillary activities as may be determined by the PEZA Board. f.7 "ECOZONE Developer/Operator" - refers to a business entity or concern duly registered with and/or licensed by the PEZA to develop, operate and maintain an ECOZONE or any or all of the component IE, EPZ, Free Trade Zone or Tourist/ Recreational Center and the required infrastructure facilities and utilities such as light and power system, water supply and distribution system, sewerage and drainage system, pollution control devices, communication facilities, paved road network, administration building and other facilities as may be required by the PEZA. The term shall include the PEZA and/or the Local Government Unit when by themselves or in joint venture with a qualified private entity, shall act as the Developer/Operator of the ECOZONES. As such, they shall be entitled to the same incentives under Rule XTV of these Rules in accordance with the pertinent provisions of Republic Act No.7916 and the Omnibus Investments Code. f.8 "ECOZONE Service Enterprise" - shall refer to a business entity or concern within the ECOZONE such as but not limited to those engaged in customs brokerage, trucking/ forwarding services, parcel services, janitorial services, security services, insurance, and/or banking services, consultancy services, restaurants or such other services within the ECOZONE as may be determined by the Board, duly registered and/or licensed by the PEZA whose income derived within the ECOZONE shall be subject to taxes under the National Internal Revenue Code pursuant to Section 25 of the Republic Act No. 7916, as amended by Republic Act No. 8748. f.9 "ECOZONE Tourism Enterprise" - shall refer to an individual, association, partnership, corporation or other business organization duly registered with the PEZA proposing to engage in the establishment and operation of tourist-oriented accommodations, restaurants operated as an integral part of a tourism facility (e.g. hotels, resorts, recreational centers), sports and recreational facilities within the ECOZONE.


483

g. Restricted Area - shall mean a specific area within the ECOZONE, which has been classified and/or fenced-in as export processing zone, free trade zone or such other similar areas as may be declared by governing Board. h. PEZA - shall refer to the Philippine Economic Zone Authority i. ZAMBO-ECOZONE - refers to the Zamboanga City Special Economic Zone and Freeport created pursuant to Sec. 3 of the Republic Act No. 7903. j. Z A M B O - E C O Z O N E Enterprise - refers to any business entity or concern within the ZAMBO-ECOZONE, duly registered with and/or licensed by the ZAMBO-ECOZONE Authority to operate any lawful economic activity within the ZAMBO-ECOZONE. k. Z A M B O - E C O Z O N E Authority - refers to the Zamboanga City Special Economic Zone Authority created under Sec. 5 of Republic Act No. 7903. 1. C A G A Y A N - E C O Z O N E - refers to the Cagayan Special Economic Zone and Freeport created pursuant to Sec. 3 of the Republic Act No. 7922. m. CAGAYAN-ECOZONE Enterprise - refers to any business entity or concern within the CAGAYAN-ECOZONE, duly registered with and/or licensed by the CEZA to operate any lawful economic activity within the CAGAYAN-ECOZONE. n. CEZA - refers to Cagayan Economic Zone Authority created under Sec. 5 of Republic Act No. 7922. o. Zone - refers to the SUBIC-ECOZONE, ECOZONES, ZAMBO-ECOZONE or CAGAYAN-ECOZONE, as the context may require. p. Resident — refers to any individual who is registered and authorized by the SBMA, PEZA, ZAMBO-ECOZONE Authority or CEZA to establish and maintain a personal residence in the Zone where they are registered. q. Certificate of Registration — refers to the certificate issued by the SBMA, PEZA, ZAMBO-ECOZONE Authority or CEZA evidencing the registration of the business entity as an Enterprise in the applicable Zone where registered.

PHILIPPINE INCOME TAX

484

r. Certificate of Residency — refers to the certificate issued by the SBMA, PEZA, ZAMBO-ECOZONE Authority or CEZA evidencing the registration of an individual as a Resident of the applicable Zone where registered. s. Date of Registration - shall refer to the date appearing in the Certificate of Registration or Certificate of Residency t.

Customs — means the Philippine Bureau of Cus-

toms u. Customs Territory — refers to the portion of the Republic of the Philippines outside of SUBIC-ECOZONE, ECOZONE, ZAMBO-ECOZONE or the CAGAYAN-ECOZONE, as the case maybe. v. Articles — refers to any goods, wares, merchandise and in general, any thing which under the Tariff and Customs Code of the Philippines or other laws may be made or is the subject of importation or exportation. w. Domestic Articles — refers to articles which are the growth, produce, or manufacture of the Philippines on which all national internal revenue taxes have been paid, if subject thereto, and upon which no drawback or bounty has been allowed; and articles of foreign origin on which all duties and taxes have been paid and upon which no drawback or bounty has been allowed, or which have previously been entered into Customs Territory free of duties or taxes. x. Foreign Articles — refers to articles of foreign origin on which duties and taxes have not been paid, or if paid, upon which drawback or a bounty has been allowed, or which have not previously been entered into Customs Territory; or articles which are the growth, produce, or manufacture of the Philippines on which not all national internal revenue taxes have been paid, if subject thereto, or if paid, upon which drawback or a bounty has been allowed. y. Transshipment — refers to transshipment of articles discharged at ports or airports of entry located in Customs territory destined for delivery and actually delivered to the Zone, and articles coming from the latter intended for export and actually exported thru a Philippine Customs port/airport of entry which may be transported under bond, upon examination, and consigned to the Collector at the port of destination/export


485

who will allow the consignor or consignee, as the case may be, to make entry exportation. z. Retail Sale — refers to the sale of articles in the Zone, in small quantities to any person, natural or juridical, for his/ her/its own personal use and account and not for resale. aa. Foreign Exchange — shall mean any currency other than the Philippine Peso acceptable for international reserve or authorized for international transaction by the Central Bank of the Philippines. Sec. 3. National Tax Exemption and Incentives to Zone Registered Enterprises — All ECOZONE-registered enterprises, CAGAYAN-ECOZONE registered enterprises and ZAMBO-ECOZONE registered enterprises who are covered by the special tax regime of 5%, including all SUBIC-ECOZONE registered enterprises doing business within the Zone shall enjoy the following: a. Exemption from national internal revenue taxes on importations of raw materials for manufacture and actually manufactured into finished products, and capital goods and equipment needed for their business operation, within the Zone. Removal of raw materials, capital goods, equipment and consumer items out of the Zone for sale to non-Zone registered enterprises shall be subject to the usual taxes and duties provided for in Republic Act No. 7227 for SUBIC-ECOZONE. b. Exemption from the national internal revenue taxes, such as gross receipts tax, VAT, ad valorem and excise taxes on their sales of goods and services for which they shall otherwise have been directly liable, except for local sales as discussed in sub-section (f) of this Section and unless provided for in other laws to the contrary. c. Exemption from franchise, common carrier or value added taxes and other percentage taxes on public and service utilities and enterprises within the Zone for services rendered within Zone. d. Preferential tax treatment on income earned/derived from business operations within the Zone or from foreign sources. However, in the case of telecommunications service, the income of the enterprise within the Zone shall be net of the share of the foreign telecommunications company, and in the case of common

486


carriers by land, air or water, only that portion of the income and expenses for the transport of cargoes and passengers within the Zone shall be covered by the preferential income tax treatment and what is not covered shall be subject to the regular corporate income tax. e. Purchases from enterprises in the Customs Territory of raw materials forming part of finished goods exported by the Zone registered enterprises shall be considered effectively zero-rated or exempt for V A T purposes depending on the fiscal incentives availed of by the Zone registered enterprise. The application of this rule on V A T will however be covered by a separate Revenue Regulations discussing in particular the V A T implications of transaction within, into and outside the Zone. f. Zone registered enterprises may generate income from sources within the Customs Territory of but up to Thirty Percent (30%) of its total income from all sources only. All of the income of Zone registered enterprises generated from sources within the Customs Territory shall be subject to the internal revenue laws of the Customs Territory and the regular internal revenue taxes and rate imposed for enterprises in the Customs Territory. Provided, however, That in the event SUBIC-ZONE registered enterprises shall generate income from sources within the Customs Territory in excess of thirty percent (30%) of its total income from all sources, all of its income shall be subject to the regular internal revenue tax rate imposed for enterprise in the Customs Territory. Business enterprises operating within the Zone, but which are not registered by or accredited with SBMA, PEZA, ZAMBO-ECOZONE Authority or CEZA shall not be entitled to the preferential tax treatment provided for in Section 12(c) of the Republic Act No. 7227; Section 24 of Republic Act No. 7916; Section 4(f) of Republic Act No. 7903; and Section 4(c) of Republic Act No. 7922. Sec. 4. Tax and Fiscal Obligation — Pursuant to Section 12(c) of the Republic Act No. 7227; Section 24 of Republic Act No. 7916; Section 4(f) of Republic Act No. 7903; and Section 4(c) of Republic Act No. 7922:

a. Zone registered enterprises doing business within the Zone shall, in lieu of local and national taxes, be liable to the pay 5% of gross income earned, broken down as follows: RA No. 7227 - Subic-Ecozone (1)

3% to the National Government;

(2)

1% to the Local Government units affected by the declaration of the Zone; and

(3)

1% to the Special Development Fund to be utilized for the development of municipalities outside the City of Olongapo and the Municipality of Subic and other municipalities contiguous to the base area.

RA No. 7916 - Ecozones (1)


(2)

2% which shall be directly remitted by the business establishments to the treasurer's office of the municipality o c city where the enterprise is located.

RA No. 7903 - Zambo-Ecozone (1)


(2)

2% to the City of Zamboanga; and

(3)

1% to the barangay special development fund, which is hereby created, for the development and improvement of the barangays within the City of Zamboanga.

RA No. 7922 - Cagayan-Ecozone (1)

2% to the national government;

(2)

1% to the Province of Cagayan;

(3)

1/2% to be shared by municipalities affected by the declaration of the Zone in proportion to their income from business activities within the Zone; and

(4)

1 1/2% to the CEZA.

b. A zone registered enterprise operating within the Zone shall be constituted as withholding agent for the government (1)

488


if it acts as an employer and its employees receive compensation income subject to the withholding tax under Section 72(a), Chapter X, Title II of the NIRC as implemented by Revenue Regulations No. 12-86 as amended, or (ii) if it makes income payments to individuals or corporations subject to the expanded withholding tax pursuant to Section 50(b) of the NIRC, as amended, and as implemented by Revenue Regulations No. 6-85 as amended; or (iii) if it makes payment/remittance of certain income subject to the final withholding tax under Sec. 50(a) in relation to Section 51 of the NIRC. c. Interest from any Philippine currency bank deposits and yield or any other monetary benefit from deposit substitutes, and from trust fund and similar arrangements received by a zone registered enterprise engaged in business within the Zone shall be subject to the internal revenue taxes under the National Internal Revenue Code as amended. Sec. 5. Removal or Withdrawal from the Zone to Customs Territory. - Notwithstanding the above-mentioned tax and duty exemptions, foreign articles removed, withdrawn or otherwise disposed to the customs territory, shall be subject to the payment of customs duties and internal revenue taxes as ordinary importations in accordance with the provisions of the Tariff and Customs Code of the Philippines, as amended and National Internal Revenue Code and other applicable laws. Articles removed customs territory will be presumed to be foreign unless there is sufficient evidence presented to satisfy Customs officials that they are domestic articles, as defined in these regulations. Sec. 6. Service Establishments. — On income derived service establishments within the Zone, the following rules shall apply: a) On income derived within ECOZONES: All income derived by persons and by all service establishments rendering their services within the ECOZONES, whether registered or not with PEZA, which may qualify as ECOZONE Service Enterprise as defined herein shall be subject to all internal revenue taxes under the National Internal Revenue Code, as amended. However, all service establishments registered with the PEZA as ECOZONE locators which export their services or are rendering their services abroad through the use of information

technologies shall remain to enjoy the five percent (5%) preferential tax rate under these revenue regulations, provided that such services are paid in foreign currency inwardly remitted through the Banko Sentral ng Pilipinas. b) On income derived within S U B I C - E C O Z O N E , ZAMBO-ECOZONE and CAGAYAN-ECOZONE: all income derived by persons shall be subject to withholding taxes under existing tax laws, rules and regulations. All income derived by service establishments within SUBIC-ECOZONE, ZAMBOECOZONE and C A G A Y A N ECOZONE shall be subject to the five percent (5%) preferential tax rate, provided that such services are paid in foreign currency inwardly remitted through the Banko Sentral ng Pilipinas. II.

A U R O R A SPECIAL E C O N O M I C Z O N E

29

Sec. 5. Incentives to Registered Enterprises. — The Aurora Special Economic Zone Authority (ASEZA) may administer the following incentives to the registered enterprises located therein to the extent of the activity/project: ( A ) Income Tax Holiday ( I T H ) . — Registered enterprises shall be entitled to an income tax holiday from the start of their commercial operations to the extent of their activity under the following categories: Category A - Registered domestic enterprise located in highly developed areas, as determined by the Board of Investments (BOI), shall be entitled to a four - year income tax holiday. Category B - Registered domestic enterprise on the following shall be entitled to a six- year income tax holiday: (1) Located in less developed areas as denned by the BOI; or (2) Producing/rendering new products/services or having strong backward or forward linkages. Category C - Registered export enterprise shall be entitled to a six-year income tax holiday: Provided, however, That if the export enterprise complies with 29

R.A. No. 9490, June 29, 2007, as circularized by RMC 23-2008, Feb. 5, 2008.

490


the following: (1) large capital investments or sizeable employment generation; or (2) use high level of technology; or (3) located outside Metro Manila, it shall be entitled to an eight-year income tax holiday. Registered enterprises embarking on new investments that are listed in the current Investment Priorities Plan (IPP) shall be entitled to incentives provided herein pertaining to the new investments and subject to such terms and conditions as the BOI may determine. For this purpose, a registered enterprise shall be defined as any person, natural or juridical, licensed to do business in the Philippines and registered with the Aurora Special Economic Zone Authority (ASEZA) to transact business within the Aurora Special Economic Zone. A registered export enterprise shall be defined as any registered enterprise engaged directly or indirectly in the production, manufacture or trade of products or services which earns at least seventy percent (70%) of its normal operating revenues from the sale of its products or services abroad for foreign currency. A registered domestic enterprise, meanwhile, shall be defined as any registered enterprise not falling under the definition of a registered export enterprise. Additional investments in the project shall be entitled to the income tax holidays corresponding to such investments as may be determined by the BOI. Additional income tax holiday may be granted for as long as the investment is made on the same project: Provided, That the project is listed in the IPP at the same time the additional investment in the project is made: Provided, further, That the entitlement period for additional investments shall not exceed three times the period provided under this subsection: Provided, however, That the total I T H period for an export enterprise availing of an eight- year ITH shall not exceed twenty (20) years. Any unused incentives shall therefore be deemed forfeited if not used during the incentive period. Enterprises registered with the ASEZA are required to share in the special development fund of the BOI for investment promotion projects of the government equivalent to one percent (1%) of the I T H granted for every application. The Bureau of Internal Revenue (BIR) shall require a registered enterprise availing of ITH or Net Operating Loss


491

Carryover (NOLCO) to secure a certificate of eligibility from the ASEZA before submitting its income tax return (ITR) with the ASEZA for validation. Failure to secure certification and/or to file the I T H or NOLCO availment for validation by the ASEZA within forty-five (45) days from the last day of each statutory filing date for ITR shall cause the forfeiture of the availment for the taxable period. (B) Net Operating Loss Carryover (NOLCO). - Net operating loss of the business or enterprise during the first three years from the start of commercial operations which have not been previously offset as deduction from gross income shall be carried over as a deduction from gross income for the next five consecutive years immediately following the year of such loss: Provided, however, That operating loss resulting from availment of incentives provided in this Act shall not be entitled to NOLCO. Registered enterprises availing of the I T H as herein provided shall not be entitled to avail of the NOLCO. (C) Imposition of a tax rate of five percent (5%) on Gross Income Earned (GIE) - Except for real property tax on land, no local and national taxes as prescribed under Republic Act No. 8424, also known as "The National Internal Revenue Code of 1997, as Amended" such as income tax, excise tax and franchise taxes, shall be imposed on registered enterprises operating within the Aurora Ecozone. In lieu thereof, five percent (5%) of the gross income earned shall be paid as follows: (a)

Three percent (3%) to the national government;

and (b) Two percent (2%) shall be remitted by the business establishments to the treasurer's office of the municipality or city where the enterprise is located. All persons and service establishments in the Aurora Ecozone shall be subject to national and local taxes under the National Internal Revenue Code of 1997, as amended, and the Local Government Code. (D) Accelerated Depreciation. Accelerated depreciation of plant, machinery and equipment that are reasonably needed and actually used for the production and transport of goods and services may be allowed using a rate not


492

exceeding twice the rate which would have been used had the annual allowance been computed in accordance with the rules and regulations prescribed by the Secretary of Finance and the provisions of the National Internal Revenue Code of 1997, as amended. (E) Capital Equipment Incentives. - (1) Importations of capital equipment, spare parts, tools and dye, or those required for pollution abatement and control, cleaner production and waste reduction including consignment thereof by registered enterprises upon the effectivity of this law, shall be exempted to the extent of one hundred percent (100%) of the taxes and customs duties: Provided, That the imported items thereof shall be used exclusively by the registered enterprises in its registered activity: Provided, further, That the importation of machinery and equipment and accompanying parts shall comply with the following conditions: (i)

They are not manufactured domestically in sufficient quantity, of comparable quality and at reasonable prices;

(ii) They are reasonably needed and will be used exclusively by the registered enterprise in the manufacture of its products, unless prior approval of the ASEZA is secured for the part time utilization of said equipment in a non-registered activity to maximize usage thereof or the proportionate taxes and duties are paid on a specific equipment and machinery being permanently used for non-registered activities; and (iii) Approval of the ASEZA was obtained by the registered enterprise for the importation of such machinery, equipment and spare parts. Approval of the ASEZA must be secured before any sale, transfer or disposition of the imported capital equipment, machinery or spare parts is made: Provided, That if such sale, transfer or disposition is made within the first five years from date of importation, any of the following conditions must be present: (1)

The same is made to another enterprise enjoying tax and duty exemption on imported capital equipment;


493

(2) The same is made to another enterprise, upon the payment of any taxes and duties on the net book value of the capital equipment to be sold; (3)

The exportation of the capital equipment, machinery, spare parts or source documents or those required for pollution abatement and control; or

(4)

Proven technical obsolescence of the said equipment, machinery or spare parts.

When the aforementioned sale, transfer or disposition is made under any of the conditions provided for in the foregoing paragraphs other than paragraph (2) herein, the registered firm shall not pay the taxes and duties waived on such items: Provided, further, That if the registered enterprises sell, transfer or dispose the aforementioned imported items without prior approval within five years from the date of importation, the registered enterprise and the vendee, transferee or assignee shall be solidarily liable to pay twice the amount of the tax and duty exemption given it: Provided, finally, That even if the sale, transfer or disposition of the capital equipment, machinery or spare parts is approved after five years from the date of importation, the registered enterprises are still liable to pay the taxes and duties based on the net book value of the capital equipment, machinery or spare parts if any of the registration terms and conditions has been violated. Otherwise, they shall no longer be subject to the payment of the taxes and duties waived thereon. (2) The purchase of machinery, capital equipment, raw materials, supplies, parts and semi-finished products to be used in the fabrication of machinery and capital equipment by a registered export-oriented enterprise from a domestic manufacturer shall be subject to zero percent (0%) value-added tax. The registered export-oriented enterprise shall be granted a tax credit equivalent to the amount of duties that would have been waived on the machinery, capital equipment, raw materials, supplies, parts and semi-finished products used in the fabrication of machinery and capital equipment, had these items been imported, upon its submission to the Department of Finance (DOF) of the bill of materials evidencing the transaction value of such and other pertinent documents, for verification and proper endorsement.

494


The availment by a registered export enterprise of the incentive stated under the immediately preceding two paragraphs shall be subject to the following conditions: (a) that said capital equipment, machinery and spare parts will be used exclusively by the registered enterprise in its registered activity; (b) that the capital equipment or machinery where the raw materials, supplies, parts and semi-finished products were used would have qualified for tax and duty- free importation; and (c) that the approval of the ASEZA is obtained by the registered enterprise. If the registered enterprise sells, transfers or disposes of these machineries, capital equipment and spare parts, the provision in the preceding paragraphs for such disposition shall apply. This incentive shall be deemed waived if application for tax credit under this subsection was not filed within one year from the date of delivery. (F) The importation of source documents by information technology-registered enterprises shall be eligible for tax and duty free importation. (G) Raw Materials Incentives. - Every registered export-oriented enterprise shall enjoy a tax credit equivalent to the internal revenue taxes and customs duties paid on the supplies, raw materials and semi-manufactured products provided the same are not sufficient in quantity, quality or are not competitively priced in the Philippines and which are used in the manufacture, processing or production of its export products forming part thereof, exported directly and indirectly by the registered export-oriented enterprise, based on the actual taxes and duties paid for such materials/supplies/semi-manufactured products by the registered enterprise. This incentive shall be deemed waived if application for tax credit under this subsection was not filed within one year from the date of exportation of the final product. (H) Incentives on Breeding Stocks and Genetic Materials. - Importation of breeding stocks and genetic materials within ten (10) years from the date of registration of commercial operation of the enterprise shall be exempt from all taxes and duties: Provided, That such breeding stocks and genetic materials are reasonably needed in the registered activity, and approved by the ASEZA.

The availment of the incentives by the registered enterprise shall be subject to the following: (a) that said breeding stocks and genetic materials would have been qualified for tax and duty-free importation under the preceding paragraph; (b) that the breeding stocks and genetic materials are reasonably needed in the registered activity; (c) that approval of the ASEZA has been obtained by the registered enterprise; and (d) that the purchase is made within ten (10) years from the date of registration of commercial operation of the registered enterprise. This incentive shall be deemed waived if application for tax credit under this subsection is not filed within one year from the date of delivery. (I) Exemption from Wharfage Dues. - The provisions of law to the contrary notwithstanding, exports by a registered enterprise shall be exempted from wharfage dues. (J) Deferred Imposition of the Minimum Corporate Income Tax. - The Minimum Corporate Income Tax (MCIT) of two percent (2%) of the gross income as of the end of the taxable year shall be imposed when the MCIT is greater than the income tax computed under the NIRC of 1997, as amended, for the taxable year: Provided, however, That said MCIT shall be imposed only after the enterprise's entitlement period to the income tax-based incentives has expired. ( K ) Tax Treatment of Merchandise in the Aurora Ecozone. - (a) Domestic merchandise sent from the Aurora Ecozone to areas outside the said ecozone shall, whether or not combined with or made part of other articles likewise of local origin or manufactured in the Philippines while in the export processing zone, be subject to internal revenue laws of the Philippines as domestic goods sold, transferred or disposed of for local consumption. (b) Merchandise sent from the Aurora Ecozone to areas outside the said ecozone shall, whether or not combined with or made part of other articles while in the zone, be subject to rules and regulations governing imported merchandise. The duties and taxes shall be based on the value of said imported materials (except when the final product is exempt). (c) Articles produced or manufactured in the Aurora Ecozone and exported therefrom shall, on subsequent importation into the customs territory, be subject to the import

496


laws applicable to like articles manufactured in a foreign country. (d) Unless the contrary is shown, merchandise taken out of the Aurora Ecozone shall be considered for tax purposes to have been sent to customs territory. ( L ) Tax Treatment of Raw Materials and Capital Equipment in the Aurora Ecozone. — Importations of raw materials and capital equipment shall be treated as in the Omnibus Investments Code. ( M ) Importations of raw materials and capital equipment shall be treated as in the Omnibus Investments Code. - Registered export-oriented enterprise shall have access to the utilization of the bonded warehousing system in accordance with the rules and regulations of the Bureau of Customs.

TABLE OF CASES

GENERAL PRINCIPLES IN TAXATION 3M Philippines, Inc. vs. Commissioner, (G.R. No. 82833, Sept. 26, 1988), 193

-AA . M . Johnson, (32 B.T.A. 156), 302 AB Capital and Investment Corporation vs. Commissioner, (CTA Case No. 5233), 166 ACCRA Investments Corp vs. Commissioner, (supra), 398 Adams, (18 BTA 391), 276 AFISCO Insurance Corp., et al. vs. Commissioner, (G.R. No. 112675, Jan. 25, 1999), 49 Aguinaldo Industries Corporation vs. Collector, (CTA Case 1636, June 29, 1968), 188 Alexander Howden & Co. vs. Collector, (CTA Case 22848, Nov. 24, 1961), 75 Alexander Howden & Co. vs. Collector, (G.R. L-19392, Apr. 14,1965), 72, 74 Algue, Inc. vs. Commissioner, (CTA Case 1620, Jan. 16, 1968), 187 Alhambra Cigar & Cigarette Mfg. Co. vs. Collector, (CTA Case 143, July 31, 1956), 220, 274 Alhambra Cigar & Cigarette Mfg. Co. vs. Commissioner, (21 SCRA 1111), 187 Anderson vs. Posadas, (66 Phil. 205), 75 Antonio Porta Ferrer vs. Collector, (G.R. No. L-16021, Aug. 31,1962, 5 SCRA 1022), 314 Araneta vs. Collector, (CTA Case No. 1699, Nov. 6, 1970), 347 Arguelles vs. Meer, (92 Phil. 14), 88 Asia Transmission Corp. vs. Commissioner, (CTA Case No. 3380, July 27, 1988), 167 497

498


Associated Sugar, Inc. vs. Collector, (CTA Case 1405, Apr. 7, 1966), 188 Atlas Consolidated Mining & Development Co. vs. Commissioner, (CTA Case 1312, Oct. 25, 1966), 199 Atlas Consolidated Mining Co. vs. Commissioner, (L-20911, Jan. 27, 1981, 102 SCRA 246), 275

-BBaier-Nickel vs. Commissioner, (G.R. No. 156305, Feb. 17, 2003), 64 Bank of America N.T. and S.A. vs. Court of Appeals, et al., (G.R. No. L-103092, July 21, 1994, 234 SCRA 302), 53 Bank of the Phil Islands vs. Trinidad, (45 Phil 384), 181 Basilan Estates, Inc. vs. Collector, (21 SCRA 17), 245, 470 Bias Gutierrez and Maria Morales vs. CTA and Collector, (G.R. Nos. L-9738 & 9771, May 31, 1957), 92 Board of Assessment Appeals, Province of Laguna vs. CA and National Waterworks and Sewerage Authority, (8 Phil. 227), 104 British Overseas Airways Corporation (BOAC) vs. Commissioner (G.R. L-65773, Apr. 30, 1987, 149 SCRA 395), 52, 87 British Traders Insurance Co., Ltd. vs. Commissioner, (G.R. L-20501, Apr. 30, 1965), 397 Brixton Investment Corp., et al. vs. Tabios, (CTA Case No. 1681, Apr. 18, 1967), 110, 187 Butuan Sawmill, Inc. vs. CTA, et al, (G.R. No. L-20601, Feb. 28, 1966), 71

-CC. Soriano, Inc. vs. Collector, (CTA Case No. 1550, Dec. 19,1966), 198 C M . Hoskins & Co., Inc. vs. Commissioner, (L-24059, Nov. 28,1969) Calasanz vs. Commissioner, (144 SCRA 664, 669-670), 306 Calasanz. vs. Commissioner, (G.R. L-26284, Oct. 9, 1986), 314 Castro vs. Collector, (G.R. No. 12174, Dec. 28,1962,6 SCRA 886), 209 Cebu Portland Cement Co. vs. Collector (25 SCRA 789), 211 Collector vs. Batangas Transportation Co., (L-9692, Jan. 6, 1958, 102 Phil. 822), 48 Collector vs. Calsado and CTA, (G.R. No. L-10293, Feb. 27,1959), 269

General Principles in Taxation

Collector vs. Douglas Fisher, et al.,(l SCRA 93), 210 Collector vs. Goodrich International Rubber Co., (21 SCRA 1336) 198, 201, 236 Collector vs. Magalona, et al., (L-15802, Sept. 30, 1960), 202 Collector vs. Philippine Education Co., Inc., (99 Phil. 319), 194 Collector vs. Prieto, (G.R. No. L-13912, Sept. 30, 1960), 202, 203 Collector vs. Soriano y Cia & CTA, (G.R. L-24893, Mar. 26,1971), 275 Collector vs. St. Paul Hospital in Iloilo, (L-12127, May 25,1958), 176 Commissioner of Customs vs. Philippine Acetylene Co., (39 SCRA 70), 181 Commissioner vs. Air India, (157 SCRA 648), 53, 67 Commissioner vs. American Airlines, (180 SCRA 264), 53, 67 Commissioner vs. American Rubber Co. (18 SCRA 82), 211 Commissioner vs. Antonio Tuason, Inc. & CTA, (G.R. No. 85749, May 15, 1989), 469 Commissioner vs. Arnoldus Carpentry Shop, (L-71122, Mar. 25, 1988), 181 Commissioner vs. Baier-Nickel, (G.R. No. 153793, Aug. 29, 2006), 65 Commissioner vs. BOAC, (GR L-65773-74, Apr. 30, 1987), 61 Commissioner vs. British Overseas Airways Corp., et al., (G.R. L-65773-74, Apr 30, 1987, 149 SCRA 395 [1987]), 67 Commissioner vs. CA & Castaneda, (G.R. No. 96016, Oct. 17, 1991, 203 SCRA 72), 166 Commissioner vs. CA and GCL Retirement Plan, (207 SCRA 487), 163 Commissioner vs. CA, CTA and A. Soriano Corp., (G.R. No. 108576, Jan. 20, 1999), 125 Commissioner vs. Court of Appeals and YMCA of the Phils., (G.R. No. 124043, Oct. 14, 1998), 173 Commissioner vs. General Foods Phil., (G.R. No. 143672, Apr. 24, 2003), 190 Commissioner vs. Isabela Cultural Corp. (G.R. No. 172231, Feb. 12, 2007), 12, 185 Commissioner vs. Itogon-Suyoc Mines, Inc., (G.R. No. 25399, July 29, 1969), 209 Commissioner vs. Javier, (G.R. No. 71479, July 31, 1991, 199 SCRA 824), 80

500


Commissioner vs. Lednicky, (L-18169, July 31, 1964), 215 Commissioner vs. Malayan Insurance Company, (G.R. No. L-21913, Nov. 18, 1967), 397 Commissioner vs. Marubeni Corp., (G.R. No. 137377, Dec. 18, 2001), 162 Commissioner vs. Marubeni Corporation, (G.R. No. 137377, Dec. 18, 2001), 65 Commissioner vs. Mitsubishi Metal Corp., et al., (G.R. No. 54908 and G.R. No. 80041, Jan. 22, 1990), 108, 168 Commissioner vs. Mitsubishi, (181 SCRA 214), 150 Commissioner vs. Palanca, (L-16626, Oct 29,1966,18 SCRA 496), 202 Commissioner vs. Phoenix Assurance Co., (1965), 200 Commissioner vs. Priscila Estate, Inc., (L-18282, May 29,1964), 249 Commissioner vs. Procter & Gamble PMC (G.R. No. L-66838, Apr. 15, 1988, 160 SCRA 560),114 Commissioner vs. Procter & Gamble PMC, (Dec. 2, 1991, 204 SCRA 378), 22, 115 397 Commissioner vs. Royal Inter-ocean Lines and CTA, (G.R. No. L-26806, July 30, 1970), 72 Commissioner vs. Rufino, (G.R. No. L-33665-68, Feb. 27, 1987, 148 SCRA 42), 321 Commissioner vs. S.C. Johnson and Son, Inc. and CTA, (G.R. No. 127105, June 25, 1999), 135 Commissioner vs. Smith Kline & French Overseas Co. [Phil. Branch], (G.R. No. L-54108, Jan. 17, 1984), 194 Commissioner vs. Smith, (324 US 177), 81, 86, 142 Commissioner vs. Tire & Rubber Corp. ( C A . GR 42300, Apr. 11, 1997), 135 Commissioner vs. TMX Sales, Inc., (supra), 398 Commissioner vs. Tours Specialist, (183 SCRA 402), 76 Commissioner vs. Tours Specialists, Inc. and CTA, (G.R. No. 66416, Mar. 21, 1990), 7 Commissioner vs. Visayan Electric Co., (23 SCRA 715), 32 Commissioner vs. Visayan Electric Company and CTA, (G.R. L-22611, May 27, 1968), 164 Commissioner vs. Wander Philippines, Inc., (160 SCRA 573 [1988]), 120

T A B L E OF C A S E S

501


Commissioner vs. Wilcox, (286 U.S. 417, 424), 79 Congregacion de la Mission de San Vicente de Paul vs. Collector (CTA Case No. 1468, Oct. 14, 1968), 176 Connell Bros Co [Phil.] vs. Collector, (CTA Case 411, supra), 241 Consolidated Mines vs. CTA and Commissioner, (G.R. No. L-18843 Aug. 29, 1974), 339 Consolidated Mines, Inc. vs. Collector, ( CTA Case 565, May 6,1961), 219 Conwi vs. Court of Tax Appeals and Commissioner, (G.R. No. 48532, Aug. 31, 1992, 213 SCRA 83), 11, 75, 77 Cook vs. Tait, (265 U.S. 47, 68 L. Ed. 895, 44), 26 Corliss v. Bowers, (281 U.S. 376), 422 Crown Cork International Corp., (4 T.C. 19, affirmed 194 F[2d] 968), 277 Cu Unjieng Sons, Inc. vs. Collector, (1956), 221

-D De Leon vs. Commissioner, (CTA Case No. 728, Sept. 11, 1961), 34 De Vera vs. Collector, (CTA Case 167, Mar 23, 1959), 248 Dolpher Trades Corporation vs. Intermediate Appellate Court, (157 SCRA 349 [1988]), 322

-EEisner vs. Macomber, (252 U.S. 189), 77, 79 El Oriente Fabrica de Tabacos vs. Posadas, (G.R. No. 34774, Sept. 21, 1931, 56 Phil. 147), 158 El Porvenir Rubber Products vs. Vera, (CTA Case 1702, July 26, 1969), 198, 200, 241 Escareal vs. Court of Tax Appeals, et al., (CA-GR SP No. 41989, Sept. 30, 1998), 85 Esso Standard Eastern Inc. vs. Collector, (CTA Case 1530, Nov. 11, 1968), 242 Esso Standard Eastern vs. Commissioner, (G.R. No. 28508, July 7, 1989), 275 Estate of Jacob S. Hoffman, (36 BTA 972), 217 Evangelista, et al. vs. Collector, (102 Phil. 140), 38, 49

502


-FFelix Montenegro, Inc. vs. Commissioner, (CTA Case 695, Apr. 30, 1969), 194 Fernandez Hermanos, Inc. vs. Collector, (G.R. No. L-21551, Sept. 30, 1969, 29 SCRA 552), 76, 243, 253 Fernandez Hermanos, Inc. vs. Commissioner, (CTA Case 787, June 10, 1963), 142, 221 Filinvest Credit Corporation vs Philippine Acetylene Co., (G.R. No. L-50449 Jan. 30, 1982), 303 Filipinas Life Assurance Co vs. Court of Tax Appeals, (21 SCRA 622, Oct 31, 1967), 295 Filipinas Life Assurance Co. vs. CTA and Commissioner, (G.R. No. L-21258, Oct. 31, 1967), 113 Fisher vs. Trinidad, (43 Phil 973) 79 123 Fisher vs Trinidad, (43 Phil. 981), 1, 75 Fort Bonifacio Development Corporation vs. Commissioner, (G.R. No. 158885, Apr 2, 2009), 3 Frederick Fisher vs. Collector, (G.R. No. 17518, Oct. 30,1922), 111

-G Gancayco vs. Collector, (1 SCRA 980), 200 Gatchalian vs. Collector, (67 Phil. 666), 48 General Electric [P.I.], Inc. vs. Collector, (CTA Case 1117, July 14, 1963), 184 George Engineering Co., (21 BTA 532), 240 Gibbons vs. Mahon, (136 U.S. 549), 77 Gibbs vs. Commissioner, (15 SCRA 318, Nov. 29, 1965), 398 Gold Green Mining Corp. vs. Tabios, (CTA Case 1497, Apr 29,1967), 194 Goodrich International Rubber Co. vs. Collector, (CTA Case 468, June 8, 1965), 191 Greenfeld vs. Meer, (77 Phil. 394), 3 Guagua Electric Company vs. Collector, (19 SCRA 796), 2 Gutierrez vs. Collector, (14 SCRA 33), 193, 210 Gutierrez vs. Collector, (CTA Case No. 65, Aug. 31, 1965), 81, 142 Gutierrez vs. Collector, (L-19537, May 20, 1965), 245

T A B L E OF CASES

503


Gutierrez vs. CTA and Collector, (G.R. No. L-9738, May 31,1957), 76

-H Helvering vs. Chester N. Weaver Co., (305 U.S. 293), 302 Helvering vs. Hammel, (311 U.S. 504), 302 Helvering vs. Horst, (311 U.S. 112-122), 79 Henderson vs. Collector, (1 SCRA 649, June 28, 1957), 445 Hicks vs. Collector, (CTA Case 38, Oct. 19, 1955), 184 Hilado vs. Collector, (100 Phil. 288), 2, 3 Home Products Intl, Ltd vs. Collector, (CTA Case 725, Feb. 26,1962) 200 Hopewell Power [Phils.] Corp. vs. Commissioner, (CTA Case No. 5321, Oct. 7, 1998), 275 Hospital de San Juan de Dios vs. Commissioner, (G.R. No. 31305, May 10, 1990, 185 SCRA 273), 193 Hyatt vs. Alen, (56 NY 553), 123

-I Imperial vs. Collector, 97 Phil. 992, 1002, 87 INGBank [Manila Branch] vs. Commissioner, (CTA Case No. 6017, Mar. 11, 2002), 54 International Freighting Corporation vs. Commissioner, (135 F. 2d 310 [2d Circ. 1943]), 75 Ishwar Jethmal Ramnani, et al. vs. Commissioner, (CTA Case No. 5108, Sept. 13, 1996), 78

-J J. L. Manning, et al. vs. Commissioner, (CTA Case No. 1626, Oct. 30, 1967), 125 James vs. U.S., (366 U.S. 213), 75 Jamir vs. Collector, (4 SCRA 718), 193 Jamir vs. Collector, (CTA Case 443, Nov. 28, 1959), 246 Japan Air Lines vs. Commissioner, (G.R. No. L-30041, Feb. 3, 1969), 53, 67 Jesus Sacred Heart College vs. Collector, (95 Phil. 16), 176

504


-KKieselback vs. Commissioner, (317 U.S. 399, 87 L. ed. 358, 63 S. Ct. 303), 302 Kuenzle & Streiff, Inc. vs. Commissioner, (106 Phil. 355), 208 Kuenzle & Streiff, Inc. vs. Commissioner, (G.R. No. L-18840, May 29, 1969), 189 -L-

Lee Live Stock Commission Co., (7 BTA 532), 242 Lepanto Consolidated Mining Co. vs. Commissioner, (L-21601, Dec. 18, 1968, 26 SCRA 540), 125 Liddell & Co., Inc. vs. Collector, (2 SCRA 632), 322 Limpan Investment Corp. vs. Collector, (CTA Case 1397, Dec. 11, 1967), 202 Limpan Investment Corp. vs. Commissioner, (17 SCRA 703), 95, 249 Limpan Investment Corp. vs. Commissioner, (G.R. No. L-21570, July 26, 1966), 11 Limpan Investment Corporation vs. Collector, (CTA Case 1358, Sept. 20, 1967), 197 Llewellyn vs. Pittsburgh B. & L.E.R. Co., (CCA. Pa. 22 F. 177,185), 88 Lorenzo vs. Posadas, (64 Phil. 353), 2

-M Ma-ao Sugar Central Co. vs. Commissioner, (CTA Case 1434, Sept. 21, 1967), 218, 249 Madrigal vs. Rafferty, (38 Phil. 414), 75, 79, 81, 268 Madrigal vs. Rafferty, (G.R. No. 12287, Aug. 8, 1918), 8 Manila Electric Company vs. Yatco, (69 Phil. 89 [1939]), 73 Manila Mandarin Hotels, Inc. vs. Commissioner of Internal Revenue, (CTA Case No. 5046, Mar. 24, 1997), 348 Manila Wine Merchants, Inc. vs. Commissioner (L-26145, Feb. 25, 1984), 469 Marcelo Steel Corporation vs. Collector, (L-13401, Oct 31, 1960, 109 Phil. 921), 218 Marcial Eleuterio Resaba, et al. vs. Republic, (G.R. No. L-6294, June 28, 1954), 270

T A B L E OF CASES

505


Marinduque Mining and Industrial Corp. vs. Commissioner cited in Paper Industries Corporation of the Philippines vs. Commissioner, (G.R. No. 106949, Dec. 1, 1995), 10 Marubeni Corporation vs. Commissioner, (G.R. L-76573, Sept 14 1989, 177 SCRA 500), 53, 120, 121 Mason Machine Works Co.,( 3 BTA 745), 240 Mathews vs. Squire, (59 F. Supp. 827), 277 Merrimac Hat Corp., (29 BTA 690), 276 Mindanao Bus Co. vs. Collector, (L-14078, Feb. 24, 1961, 1 SCRA 538), 2 Moore vs. Commissioner, (24 F[2d] 991), 62

-NNational Development Company vs. Commissioner, (G.R. No. L-53961, June 30, 1987), 160 Nava vs. Collector, (CTA Case No. 568, Sept. 25, 1961), 193, 261 Nielsen & Co., Inc. vs. Lepanto Consolidated Mining Co., (L-21601, Dec. 28, 1968), 123 Nippon Life Insurance Company vs. Commissioner, (CTA Case No. 6142, Feb. 4, 2002), 170 North American Oil Consolidated vs. Burnett, (286 U.S. 417), 80

-OObillos vs. Commissioner, (L-68118, Oct. 29,1985,139 SCRA 436), 35 Ona vs. Commissioner, (L-19342, May 25, 1972), 34

-PPacific Banking Corp. vs. Commissioner, (CTA Case 1667, Oct. 29, 1970) Paper Industries Corp. of the Philippines vs. CA, CTA and Commissioner, (G.R. No. 106949, Dec. 1, 1995, 250 SCRA 434), 208, 234 Pascual vs. Commissioner, (166 SCRA 560, Oct. 18, 1988), 35 Perfecto vs. Meer and Endencia vs. David, 86 Phil Trust Co. vs. Collector, (CTA Case 367, Jan. 30, 1961), 208 Phil. Fiber Processing Co. vs Commissioner, (CTA Case 1407, Dec. 29, 1966), 143, 244

506

P H I U P P I N E INCOME T A X

Phil. National Bank vs. Blaquera, (CTA Case 250, May 20,1960), 244 Phil. Refining Co. vs. CA, et al., (G.R. No. 118794, May 8, 1996, 256 SCRA 667), 243 Phil. Sugar Estate vs. Collector, (60 Phil. 565), 221 Phil. Telephone & Telegraph Co. vs. Collector, (58 Phil 639), 122 Phil. Trust Co. vs. Collector, (CTA Case 367, Jan. 30,1961), 218, 242 Philex Mining Corp. vs. Commissioner, (G.R. No. 148187, Apr. 16, 2008), 50 Philex Mining Corporation vs. Commissioner, (CTA Case No. 5200, Aug. 21, 1998), 276 Philippine American Life Insurance Co., et al. vs. Commissioner and CTA, (CA-GR SP No. 31283, Apr. 25, 1995), 139 Philippine Guaranty Co., Inc. vs. Commissioner and CTA, (G.R. No. L-22074, Apr. 30, 1965), 74 PICOP vs. Commissioner, (G.R. No. 106949-50, Dec. 1, 1995), 276 Pirovano vs. Commissioner, (14 SCRA 832), 159 Plaridel Surety & Insurance Co. vs. Collector, ( 21 SCRA 1187), 219 PLDT Co. vs. Commissioner, (CTA Case No. 4375, Jan. 7,1992), 167 Polo vs. Commissioner, (G.R. No. 78780, July 23,1987), 86 Priscilla Estate, Inc. vs. CTA & Commissioner, (L-18282, May 29, 1964), 222 -Q-

Querol vs. Collector, (CTA Case 320, Oct. 7, 1959), 242

-RRattan Art and Decorations, Inc. vs. Collector, et al., (13 SCRA 626), 71 Republic vs. Gancayco, (115 SCRA 380), 2 Republic vs. Jose Razon and Jai-Alai Corporation, (G.R. No. L-17462, May 29, 1967), 398 Republic vs. Lim Tian Teng Sons & Co., (G.R. No. L-21731, Mar. 31, 1966, 16 SCRA 584), 349 Reyes vs. Collector, (CTA Case 42, July 26, 1956), 252 Reyes vs. Commissioner, (24 SCRA 198), 49 Rizal Theatrical Co., Inc. and Ayala Corp. vs. Commissioner, (CTA Case No. 3463, Apr. 24,1989), 38

507

Roxas vs. CTA and Commissioner, (G.R. No. L-25043, Apr. 26 1968) 315 Roxas vs. CTA, (23 SCRA 276), 193, 262 Rufno Tan, et al. vs. Commissioner, (G.R. No. 109289, Oct. 3,1994), 36

-SSambrano vs. CTA, G.R. No. (L-8652, Mar. 30, 1957, 53 O.G. 4839 Aug. 1957), 202 th

Scholl vs. Commissioner, (174 F2d 893, CCA 5 ) , 86 Semple vs. Guenther, (96 N . W . 895, 896), 88 Shangkuan vs. Collector, (CTA Case 19, Mar. 23, 1955), 244 Sison vs. Ancheta (G.R. No. 59431, July 25, 1984), 4 Southeast Asian Regional Center for Graduate Study and Research in Agriculture [SEARCA] vs. Commissioner, (CTA Case No. 4982, Oct. 6, 1995), 177 -TTalisay-Silay Co., Inc. vs. Collector, (CTA Case 1399, Dec. 29,1965), 219,240 Tan Tiong Bio, et al. vs. Collector, (4 SCRA 986), 146 Tan vs. Del Rosario, (237 SCRA 324, 334), 8 Teodorica R. Viuda de Jose vs. Julio Barrueco, (G.R. No. 45955, Apr. 5, 1939), 93 The City Lumber, Inc. vs. Domingo, (L-18611, Jan. 30, 1964), 220 th

Thomas vs. Commissioner, (135 F2d 378, CCA 5 ), 86 Tourist Trade and Travel Corp. vs. Commissioner, (CTA Case No. 4806, Jan. 19, 1996), 78 Tuazon vs. Lingad, (G.R. No. L-24248, July 31, 1974, 58 SCRA 170), 313

-U U.S. Industrial Alcohol Co. vs. Helvering, (137 F. [2d] 511), 302 University of San Agustin vs. Commissioner, (L-12222, May 28, 1958), 177 UST Hospital Employees vs. Santo Tomas Hospital, (G.R. No. L-6988, Oct. 29, 1955), 176

508


-VValerio vs. Secretary of Agriculture and Natural Resources, (L-18587, Apr. 23, 1963), 2 Visayan Transportation Co., Inc. vs. Domingo, (CTA Case 1119, Sept. 30, 1964), 196 VisayanCebu Terminal Co. vs. Collector, (CTA Case 128, June 29, 1957), 184 Vito vs. Collector, (CTA Case 1186, Apr. 30, 1966), 197, 200

-WW.C. Ogan and Bohol Land Transportation Co vs. Meer, (G.R. No. 49102, May 30, 1949), 320 Walker vs. Commissioner, (88 F[2d] 170 [CCA 5th 1943]), 143 Waring vs. City of Savannah ([1878] 60 Ga., 93), 79 Western Minolco Corp. vs. Commissioner, et al., (124 SCRA 212), 10, 181 Western Pacific Corp. vs. Collector, (CTA Case 720), 241 William Redfield, (34 BTA 967), 240 Winston Bros. Co. vs. Commissioner, (76 F [2d] 381), 302 Wise & Co. vs. Meer, (78 Phil. 655), 3 Wise & Co., Inc. vs. Meer, (G.R. No. 48231, June 30, 1947), 146

-XXavier School, Inc. vs. Commissioner, (CTA Case 1682, Oct. 8,1969), 175

-YYek Hua Trading Corp. vs. Collector, (CTA Case 580, Jan. 25,1963), 219 Yulo vs. Araneta, (CTA Case No. 84, July 8, 1958), 219

-ZZamora vs. Collector, (5 SCRA 163), 193 Zamora vs. Collector, (8 SCRA 163), 195, 246 Zapata Marine Services Ltd vs. CTA, et al, (G.R. No. 80046, Apr. 18, 1988), 298

INDEX 180-Day Rule, 29

-AAbility-to-Pay Principle, 7 Accounting Methods, 335 prohibition to use "hybrid" method of accounting, 339 rules regarding change in method of accounting employed, 340 Accrediting Entity, 255-256 designated entities under E.O. No. 761, 256 Accrual Method, 335 Actual Income or Gain, 281 Adjusted Basis, 280 Adoption valid adoption, 269 purpose, 269 Agricultural Suppliers, 417 taxability of income payments made to suppliers, 417 Aliens classification, 15 subjected to preferential income tax rates, 30 All Events Test, 184 Allowable Deductions defined, under NOLCO regulations, 227 Applied Research, 257 Areas for Priority Development (APD) exemption from tax, 154 Arm's Length Price, 57 Articles, 484 Asset natures, ordinary and capital assets, 281 significance of knowing the nature of asset sold or exchanged, 301 Aurora Special Economic Zone Authority (ASEZA) incentives to registered enterprises, 489 categories of registered enterprises, 489 registered enterprise, 490 509

510


registered export enterprise, 490 registered export enterprise, 490 tax rate of gross income earned, 491 incentives, 492-495 tax treatment of merchandise, 495 Awards (see Prizes) -BBad Debt Theory, 219 Bad Debts, 234 conditions for deductibility from gross income, 235-236 exceptions, 236 determination of debt worthlessness, 236-237 distinguished from loss, 237 examples, 239-243 Banks, 17 regular banking unit (RBU) and foreign currency deposit unit (FCDU), 39 distinguishing FCDU transactions from RBU's, 39 requirements of filing two income tax returns to banks with FCDU, 39 Basic Research, 257 Benefactor entitled to additional exemptions, 270 BIR Form 2316, 357 parts, 357-358 BIR Form No. 1700, 357 BIR Form No. 2307, 428, 429 Bona fide Debt, 275 Bona fide Selling Price, 342 Bonus (to Employees) deductibility from gross income, 188 factors determining reasonableness of bonus as compensation, 189 deductibility of Christmas bonus, 189 Boot, 323 Branch Profit Remittance Tax, 53-54 Building Contractors, 448 gross receipts and costs of services, 449 Bulletin "F", 246 Bureau of Internal Revenue (BIR), 9 rulings, 2

INDEX

511

substituted filing system, 355 Business Expenses conditions from deductibility of expenses from gross income 182183 of rent expenses, 195 of entertainment, amusement recreation and representation expenses, 196-198 Business Income, 86 incomes from business subject to tax, 87-93 Business Process Re-Engineering Program, 165 Business, 16 change in ownership of business, 231-232 determining reasonable needs of business, 464 earning constituting accumulation of earning for reasonable needs, 464-465 By or on Behalf of the Same Persons, 228-229

-CCAGAYAN-ECOZONE, 483 enterprise, 483 entitled benefits, 485 tax liabilities, 487 Capital Asset, 281, 303, 305 types, 97 income tax on other capital assets, 106 determining gain or loss from sale of property, 280 exclusions to the scope of the term, 303 distinctions from sale of ordinary assets, 304-307 guidelines to determine whether property is capital, 308-316 usable factors in justifying real property as capital asset, 315 Capital Expenditures, 273-275 Capital Gains long-term and short-term, 106 imposition of tax on presumed gain, 316 filing of tax returns, 376 Capital, 78 differences from an income, 78-79 return of capital from items excluded in gross income, 150, 178 determining amount of return of capital, 180 Carrying on Business, 88 Cash Dividend, 122

512


distinctions with stock dividend, 122 tax rates, 285 Cash Method, 335 Character Building and Youth and Sports Development Purposes, 258 Charitable Activity, 257 Charitable Contributions conditions for deductibility from gross income, 253 Citizen (Filipino Citizen), 24 taxable incomes, 8, 25 importance of knowing residence of the citizen, 24-25 kinds, 25 subjected to preferential income tax rates, 30 exemption from interest income tax from long-term deposit, 170 Clark Special Economic and Freeport Zone, 473-474 governing body, 474 Closely-Held Corporations, 466 Cohan Rule, 200 Combination, 228 Commercial Brokers gross receipts and costs of services, 448 Common Carrier's Tax, 67 Common Carriers gross receipts and costs of services, 449 Community Mortgage Program (CMP), 328 exemption to national taxes for real properties sold under the program, 153 tax treatment of sale of real properties under the program, 329 Compensation (for Personal Services) test of deductibility of compensation payments, 185-186 forms of payment, 186 additional compensation in form of percentage of profits, 188 factors determining reasonableness of bonus as compensation, 189 deductibility of compensation for retired employees and employee injuries, 190 Compensation Income, 83 withholding tax, 437 Compensation, 83 Congress on Global Tax System, 3 on reduction of the deductible amount of interest expense, 205 Consolidation, 228

INDEX

513

Constructive Receipt Doctrine, 347 Corporation, 14, 38 classifications, 14-15, 37 law of incorporation test, to determine residence of corporations 37 scope of the term under Tax Code and for income tax purposes 38 reasons for excluding construction activity in the definition of the term (P.D. No. 929), 38 deductible losses by corporations, 218 regular corporate income tax, 288 minimum corporate income tax, 290 filing of tax return for a period less than 12 months, 349 rules to determine if corporation is closely-held, 466 Cost of Goods Manufactured and Sold, 290, 456 Cost of Goods Sold, 290, 456 Cost of Services, 290, 445, 457 determination for purposes of MCIT, 445 Cost, 343 Court of Tax Appeals, 2 Crop Year Method, 337 Cultural Activity, 258 Customs Brokers gross receipts and costs of services, 448 Customs Territory, 484

-DDacion en pago, 302 De minimis Benefits, 443-444 Debtor-Creditor Relationship test of existence, 276 Dependent, 270 Deposit Substitutes, 17 Depreciation, 245 conditions for deductibility from gross income, 244 of tangible property, 245-246 of intangibles, 247 person, who may take depreciation deduction, 248 period of deducting depreciation, 248 of patents and copyrights, 250 of drawings and models, 251 requirement of charging off to constitute allowable deduction, 251

514


Direct Costs and Expenses, 457 Dividend Exclusion, 113, 294 Dividend Income, 111 distinguished from interest income, 109-110 applicable rules on taxation, 112-114 taxation rules in case dividend is paid by a foreign or domestic corporation, 121-122 Dividend, 110, 111, 122 Doing Business, 88 Domestic Articles, 484 Domestic Corporation, 14, 37 tax liability, 37 income from sale of shares of stocks tax, 72 rules on sale or exchange of shares of stocks, 98 deductibility of regional managements fees from gross income, 195 subjected to preferential tax rates, 292-294 incomes subjected to preferential rates, 298-299 Down Payment, 399

-E Educational Activity, 258 methods, 258-259 Educational Institutions, 173 exemption from internal revenue taxes, non-stock and non-profit institutions, 173-174 exemption of private educational institutions to value-added tax, 174 Electronic Filing and Payment System (EFPS), 360-363 Employee Trust, 32, 163 requirements for tax exemption, 32, 163 tax exemption, 163 Employees, Rank-and-File, 18 Engage in Trade or Business, 87-88 Engage, 87 Escrow, 384 Estate, 31 taxable income and exemption, 31 exceptions in the computation of taxable income, 32-33 Expenses ordinary and necessary, 184 non-deductible expenses, 273

INDEX

515

-FFarmers items to include in his gross income, 89-90 deductibility of farmer's expenses from gross income, 191-192 deductibility of farmer's losses from gross income, 223 claiming allowance for depreciation, 252 Fiduciary, 15 Finance Companies not performing quasi-banking activities, 447 gross receipts, 447 costs of services, 447 Financial Statements, 375 contents and format, 372-374 responsibility of external auditors to a financial statement, 374 Fiscal Year, 16 defined, under NOLCO regulations, 228 Food Service Establishments gross receipts and costs of services, 451 For Any Cause Beyond The Control Of The Said Official Or Employee, Phrase, 165 Force Majeure, 457 Foreign Articles, 484 Foreign Corporation, 14, 37 types, 51 allowable business expenses, 200 Foreign Country, 213 Foreign Currency Deposits Unit (FCDU), 39 distinguishing FCDU transactions from regular banking units, 39 Foreign Exchange Transaction, 77 Foreign Exchange, 485 Formal Method of Educational Instruction, 258 Freight Forwarders, 425 tax treatment to income payments, 426-427 expanded withholding tax treatment, 427 on cross-borders transactions, 427 on local transactions, 428 procedures to comply to ensure proper deduction of taxes, 429-430 Fringe Benefits Tax, 441-443 Functional Currency, 365 factors considered in determining currency, 365 requirements in case of changes in currency, 367

516


for income tax purposes, 367 essentials in presenting functional currency financial statements, 369-371 computation of gain/loss from sale of investments using currency, 371

-G Gain, see Income General Engineering, 448 gross receipts and costs of services, 449 General Professional Partnership, 14, 36 tax liability and exemption, 36 Gift essential elements of a gift, 159 Global Tax System, 3-4 Goods, 402 Goodwill as income subjected to tax, 75 Gross Income, 60-61 from business, defined, 88 of insurance companies, defined, 88 defined, under NOLCO regulations, 226 defined, for purposes of applying MCIT, 290 defined, in case of engagement in the sale of service, 290 of farmers, 89-80 exclusions/deductions from gross income, 150-170 items of exclusion under special laws, 151-157 excluded items under Tax Code, 157-167 miscellaneous items excluded, 167 requirement of adequate proof, 200 deductible taxes, in general, and exceptions, 210-211 types of deductions, 181 personal exemptions, 268 Gross Philippine Billings defined, under international air carriers case, 68 defined, in the case of international shipping lines, 68 Gross Selling Price rules in determining price, 100

-H Habitually Engaged in Real Estate Business, 399

INDEX

Hazard Pay, 84 Head of the Family, 269 Health Purposes, 260 Holding or Investment Company, 468 Hotel, Motel, Rest House, Resort Operators gross receipts and costs of services, 450

-I Immediacy Test, 470 Immigration Brokers gross receipts and costs of services, 448 Improperly Accumulated Earning Tax ( I A E T ) , 463-464 rationale, 463 subjected and exempted corporations, 465 tax base, 467 inapplicability on improperly accumulated income, 469 Incidental Repairs deductibility of repair costs to gross income, 195-196 Including and Includes, 16 Income (Ordinary Income), Gain or Profit, 11, 18, 74-75 taxable incomes under Tax Code, 8 conditions before subjecting income to tax, 11 exemption from tax, 12 effectively connected income, 56 gross income, see Gross Income person, to whom income is taxable, 61 sources of income within Philippines, forms, 62-63 sources of income, definition in general, 73 activities considered and not considered income , 75-78 distinguished from a capital, 78-79 tests to determine income, 79-81 reasons, why determining type or character of income is important, 82 categories of income, 83 compensation income, 83 business income, 86 "income from any source whatever", 142 gain distinguished from interest, 169-170 non-deductible items in computing net income, 271-275 actual income or gain from sale of property classified as ordinary asset, 281 presumed income or gain, 281-282

517

518


subject to final withholding tax, 383-388 conditions income payment can be subjected to expanded withholding taxes, 392 "fixed", "determinable" and "annual or periodical" income, 394 Income Tax, 1 income tax law, see Philippine Income Tax Law income tax systems, types, 3-7 natures of income tax under Philippine Income Tax Law, 7 types under Tax Code, 9-10 conditions of income tax, 11 special laws granting income tax exemption, 151-157 organizations exempted from paying tax, 171-172 limitations on credit for foreign income taxes, 216 regular corporate income tax (RCIT), 288 minimum corporate income tax (MCIT), 290 normal income tax, defined for purposes of MCIT regulations, 291 determination of purpose to avoid tax, 468 Indebtedness, 202 Installment Method, 336 Insurance and Pension Funding Companies, 446 gross receipts, 446 cost of services, 446 Insurance Companies related provisions regarding income and deductions, 264-265 minimum corporate income tax, 291 Interest Expense deductibility of expense from gross income requisites, 202 rules, 203-204 objective of the reduction of deductible expense, 205 other cases, expense cannot be deducted from gross income, 206-20 Interest Income interest, defined, 106 rules on interest income, 106-109 distinguished from dividend income, 109-110 distinguished from gain, 169-170 scope of "interest", 170 exempted citizens from tax, 170 "interest on preferred stock", 209

INDEX

519

International Carriers tax rule to determine source of income, 66 International Financial Reporting Standards (IFRS), 364 Inventory of goods and/or merchandise, 340-341 tests inventories must conform, 341 manner of recording, 342 prohibitions, 343 Itemized Deductions (from Gross Income), 182

-JJohn Hay Special Economic Zone, 476 Joint Venture (Consortium), 42 essential factors to constitute venture, 41 exempt joint venture, denned, 42 subjected to income tax as separate joint venture or consortium, 42 elements, venture may not be considered having a separate taxable entity, 42 ventures not subjected to income tax, 42 right to maintain or not to maintain books of accounts and records, 43 examples of unincorporated joint venture, 43-46 common rulings involving ventures and consortia, 46-47 taxable venture or consortium, 47-48 -L-

Law of Incorporation Test, 37 Legitimate Businesses Reverses, 458 Lessor prescribed tax liabilities, 93-94 bases of income report from erected buildings or improvements made by lessee, 94-95 gross receipts, 451 costs of services, 451 Liquidating Dividend, 111, 145 distinctions with a distribution in liquidation, 145 Liquidation principle of taxation of distribution in liquidation, 145 Livestock, 417 Loan,110

520


Local Water Districts tax liabilities, 41 Local/Resident Supplier of Goods, 402 Long-Term Contracts, 89 Long-Term Deposit or Investment Certificate, 19 Loss, 18 classifications, 216 conditions for deductibility from gross income, 217 when loss deduction will be denied, rule, 219 net operating loss, 224 distinguished from bad debt, 237 prohibition to deduct in respect to losses from sales/exchange of property, 272, 276-277

-MManufactured Dividends or Benefits, 62 Marginal Income Earners, 417 Marine Products, 417 Market Price, 344 Market Value, 322 Medical Practitioners tax treatment, 400-401 Merger, 228 determining bona fide business purpose of merger, 321 Minimum Corporate Income Tax (MCIT), 290 MCIT for insurance companies, 291 exempted institutions/corporations, 291, 461 exempted resident foreign corporations, 292, 462 determination of gross receipts and cost of services, 445 gross receipts, 446, 456 manner of filing and payment, 459 Minimum Wage Earner, 19 Monthly Alphalist of Payees ( M A P ) , 434 persons required to submit SAWT, 434 returns required to be filed with SAWT, 436 Morong Special Economic Zone, 476 Mutual Fund Company, 19

-N National Housing Authority national internal revenue taxes the agency is exempted from paying, 152

INDEX

521

Net Income, 61 Net Operating Loss Carry Over (NOLCO), 224 principles and policies, 225-226 entitled taxpayers to deduct NOLCO from gross income, exceptions, 229-230 Net Operating Loss, 224, 227 Nominal Value of Outstanding Issued Shares, 227 Non-Bank Financial Intermediary, 17 Non-Filing (of Tax Returns), 356 Non-Formal Method of Educational Instruction, 259 Non-Government Organization (NGO), 254 entitled benefits to donations to NGOs, 260-261 conditions of full deductibility benefit, 260-261 Non-Resident Alien, 15, 28 classification, 28 rule, ascertaining whether alien engaged business in the Philippines or not, 29 subjected tax and rates, 28 exemption from interest income tax from long-term deposits, 170 allowable business expenses, 200 rate of final tax on passive incomes for aliens engaged, and not, in business, 285 Non-Resident Citizen, 14-15, 25-26 subjected tax, 26 Non-Resident Foreign Corporation, 15, 58 subjected income tax, 58 allowable sustained losses in business, 234 incomes subjected to preferential and final withholding taxes, 299 Non-Stock, Non-Profit Corporation/Organization, 253 benefits entitled to donations to accredited organizations, 260-261

-oOffline International Air Carrier, 52 Optional Standard Deduction guidelines, 263-264 Ordinary Asset, 281 distinguished from a sale of capital asset, 304-307 computing gain or loss from sale, 307 guidelines to determine property as ordinary asset, 308-316

522

P H I U P P I N E INCOME TAX

-PPaid or Incurred and Pair or Accrued, 16 Paid-up Capital of the Corporation, 227 Partnership, 38 tax liability same as a corporation, 41 Passive Income, 284 exceptions to subjected preferential tax rate, 284 Pension Trusts deduction by employer from gross income, 262-263 Percentage of Completion Method, 336 Person, 14 liable to tax, 22 to whom income is taxable, 61 self-employed, 87 who may take depreciation deduction, 248 basic exemptions to income tax, 268 additional exemptions, 270 "financially interested", 276 constituted as withholding agents, 395 Philippine Council for NGO Certification Inc. (PCNC), 256 Philippine Economic Zone Authority (PEZA), 477, 483 gross income, 477 allowable deductions for calculating gross income, 477 scope of the law, 479 Philippine Export Zone Authority (PEZA) administered law, 9 Philippine Income Tax Law, 1-2 amendments to the law, 2 other sources of income tax law, 2 features of the law, 7 criteria in imposing tax, 8 Philippine National Bank ( P N B ) Provident Fund, 164 Poro Point Freeport Zone, 475 Poultry, 417 Premiums (Insurance), 74 Presumed Income of Gain, 281-282 Principal Residence, 326 Private Sector taxes private sector participating in socialized housing is exempted from paying, 153 Prizes (Awards) subjected to final withholding tax, 140

INDEX

523

Professional Expenses deductibility from gross income, 184, 192 Professional Income, 87 importance of determining existence of employer-employee relation, 87 Profit, see Income Property (Real Property) applying rules on the sale or exchange of properties, 102-103 exemption from tax of properties sold under CMP, 153 prohibition to deduct in respect to losses from sales/exchange of property, 272, 276-277 determining gain or loss from sale of property, 280 property sold classified as ordinary asset, 281 actual income or gain from sale of property classified as ordinary asset, 281 property as capital asset, 281 tax liability on involved transactions, 286 exemption from capital gains tax in case property is principal residence, 287 when there is indeed sale or exchange of property, 302 seller of property, 304 importance of determining tax status of seller, 308 guidelines to determine whether property is capital or ordinary asset, 308 classified with respect to taxpayers engaged in real estate business, 309 rules in the classification of property in the hands of the buyer/ transferee, 311-312 factors to justify property as capital asset, 315 recognition of amount of gain/loss upon sale/exchange of property, exceptions. 319 original basis of property to be transferred, 324 requirements of parties to a tax-free exchange of property for shares, 325 deferred payment sales under installment basis, 352-353 documentary requirements involving transaction on transfer of property, 378 Property Dividend, 111 tax rates, 285 -Q-

Qualified Jewelry Enterprises

524


incentives, 154-155 Quasi-Banking Activities, 17

-RRadio Broadcasting gross receipts and costs of services, 451 Real Estate Brokers gross receipts and costs of services, 448 Real Estate Dealer, 102, 308 Realization Principle recognition of revenue, 348 Regional Operating Headquarters (of Multinational Companies), 19 Regional or Area Headquarters (of Multinational Companies), 19,295 Regular Banking Unit (RBU), 39 tax liability, 39 Regular Corporate Income Tax (RCIT), 288 Regular Suppliers, 403 Rehabilitation of Veterans, 259 Religious Purpose, 257 Rental Income, 93 tax treatment, 139 Representation Expenses, 198 requirements of deductibility from gross income, 198 Representative Office (of Multinational Companies), 295 Residence, 25 Resident Alien, 15, 26 exemption from interest income tax from long-term deposits, 170 Resident Citizen right to engage in business and trade, 25 importance of determining whether citizen is engaged in a trade or business, 25 Resident Foreign Corporation, 15, 51 general types, 51 subjected tax liabilities and rates, 51-52 in general, 295 tax imposed to local branch of foreign corporations, 53-54 basis of taxation, 57 corporation's local branch compared to a subsidiary, 55-58 subjected administrative requirements to local branch, 58 exempted corporations to minimum corporate income tax, 292 exemption from Philippine income tax, 295 corporations subjected to preferential tax rates, 295-298

INDEX

incomes subjected to preferential rates, 298-299 Retail Sale, 485 Revenue Laws purpose, 79 Revenue Regulations, 1 Royalties, 126 rules of royalty taxation, 133-136 "paid under similar circumstances" phrase, 134 subjected tax rates, royalty paid by foreign or domestic corporation, 137 Royalty Income guidelines in tax treatment, 126

-s Salary deductibility from gross income, 187 Schedular Tax System (B.P. Big. 135), 4-6 constitutionality of system, 4 ways of imposing final income tax on certain incomes, 5-6 Scientific and Research Purpose, 257 Scientific Research, 258 Securities Lending and Borrowing (SLB) tax treatment of, 99 Securities, 16, 236 dealer in securities, defined, 17, 98 substituted basis on exchange, 323-324 broker of securities' gross receipts and costs of services, 448 Security Agency tax treatment to income payments made to agency, 421-423 Self-Employment, 87 self-employment income, 87 Semi-Schedular or Semi-Global Tax System, 6, 81 Senior Citizen, 269 Shareholder, 16 Shares of Stocks, 15 income of domestic corporation from sales of shares, 72 rules on sale/exchange of stocks of a domestic corporation, 98 applying rules in determining gross selling price of SBL covered stocks, 100-101 Social Welfare Purposes, 259 Socialized Housing, 328 Software, 126

525

526


categories of involved transactions, 126 character of transactions involving transfer of software, 127-130 results of transfer classified as transfer of copyright, 127 site, enterprise and network license arrangements, 129 modes of acquisition and tax treatments involving transfer of software, 130Special Economic Zones (ECOZONE), 480 registered enterprise, 480 export enterprise, 480 domestic market enterprise, 480 pioneer enterprise, 480 free trade enterprise, 481 utilities enterprise, 481 facilities enterprise, 481 developer or operator, 482 service enterprise, 482 applicable rules, 488 tourism enterprise, 482 restricted area, 483 residents, 483 certificate of registration, 483 certificate of residency, 484 tax liabilities, 487 Status-at-the-end-of-the-year Rule, 271 Statutory Minimum Wage, 19, 84 exemption from income and withholding tax, 84 Stock Dividend, 77, 111, 121 distinctions with cash dividend, 122 general exemption from income tax, 123 when dividend constitutes income, 123 Subic Bay Metropolitan Authority (SBMA), 480 gross income earned, 470 allowable deductions, 471 gross income, 471 SUBIC-ECOZONE, 479 registered enterprise, 479 facilities operator, 479 entitled benefits, 485 tax liabilities, 487 Subsidiary, 56 in comparison to a local branch of a foreign corporation, 55-58 basis of income taxation, 57

INDEX

527

subjected administrative requirements, 58 Substantial Change in the Ownership of the Business or Enterprise, 228 Substantial Losses from a Prolonged Labor, 457 Substituted Filing System (of Tax Returns), 355-356 conditions, 356 unqualified individuals, 356-357 Summary Alphalist of Withholding Agents/Payors of Income Payments (SAWT), 434 persons required to submit SAWT, 434 returns required to be filed with SAWT, 435 Summary of Taxes Withheld (STW), 438 Supreme Court on constitutionality of B.P. Big. 135 (Schedular Tax System), 4 on single corporate entity, 120 on hybrid method of accounting, 339

-TTax Benefit Rule, 243 Tax Code, 2 nature, 2 items excluded from gross income, 157-170 exempted organizations from paying income tax, 171-172 Tax Treaties, 96 purpose, 140 Taxable Income, 131, 279, 282 defined, under the NOLCO regulations, 227 graduated rates on taxable income, 283 exceptions, incomes not subjected to graduated rates, 284 Taxable Year, 16 defined, under the NOLCO regulations, 227 Taxes Withheld, 438 guidelines in remittance of taxes by NGAs, 438-440 Taxes, 210 Taxpayer (Income Taxpayer), 16, 22 kinds of income taxpayers, 21 situations, kind of taxpayer is not important to be ascertained, 22 importance of tax status of a taxpayer, 22-23 claiming credit for taxes, 212 credit for income, war-profits or excess-profits taxes, 213 not entitled to tax credit, 215

528


period for taking credit for taxes, 215 entitled payers to deduct NOLCO from gross income, exceptions, 229-230 basic personal exemptions, 268 additional exemptions, 270 engaged in real estate business, 309 accounting methods may be used, 335 requirement of law to make return of true income, essentials to the requirement, 338 period and due dates for filing return, 358-359 responsibility for representations made in their behalf by their agents, 363 reasons taxpayer shall automatically cease to be a withholding agent, 403 Telecommunication Companies, 68 added items to determine gross income, 69 items deducted to determine net income, 69 Telephone, Electric, Gas and Water Utilities gross receipts and costs of services, 451 Television Broadcasting gross receipts and costs of services, 451 Top 20,000 Private Corporations, 401 criteria, 402 TRA, 438 Trade, 16 Training Expenses deductibility from gross income, 199 Transportation Contractors gross receipts and costs of services, 449 Transportation Ticket, 67 Transshipment, 484 Traveling Expense deductibility from gross income, 199 Treasury Shares, 125 Trust, 31 taxable income and exemption, 31 exceptions in the computation of taxable income, 32-33 revocable trust instrument, 31 employee trust, 32 requirements for tax exemption, 32

INDEX

529

-uUtilization (by an Accredited NGO), 254-255 -VVoluntary Separation Program, 165

-wWithholding Agent, 15, 395 as agent of both government and the taxpayer, 397 direct and independent liability from liability of income recipient, 397 Withholding Taxes importance, 380 withholding tax-at-source, 381 types of final withholding tax, 381 on sale/disposition of real property classified as capital asset, 382 income subjected to tax, 383-388 creditable withholding tax, types, 389 expanded withholding tax, tax bases and applied rates, 390-392 required conditions, 392 inapplicable income payments, 393 applicable rates, 406 rules on certain special cases, 408-416 venue for filing tax, 433 time to withhold tax, 404-405 tax base and rates, 406 tax on compensation income, 437

-ZZAMBO-ECOZONE, 483 enterprise, 483 authority, 483 entitled benefits, 485 tax liabilities, 487 Zonal Valuation, 286 Zone, 483

PHIUPPINE

By

V I C T O R I N O C. M A M A L A T E O L L . M . ( H A R V A R D ) , L L . B . ( M L Q U ) , M B A (UE), BBA-CPA (UM) Author: Reviewer on Taxation (2008) Value Added Tax (2008) Tax Rights and Remedies (2007) Bar Examiner on Taxation (2008) Bar Reviewer: University of the Philippines (2009); Ateneo (University (1995) San Sebastian Cdllege-Kecoletos (2003-2009); Professor of Law: University of the Philippines (1989-2009) De La Salle University/St. Berilde-CREBA (2002-2009); Assistant Commissioner (Assessment): Bureau of Internal Revenue (1993-1994) Managing Head, Tax Division-Punongbayan & Araulo (1994-2001) Managing Partner, V.C. Mamalateo & Associates (2005-2009).

•

."J

www.wijwWiaWn
Philippine Copyright, 2010

VICTORINO C. MAMALATEO ISBN 978-971-23-5540-0 No portion of this book may be copied or reproduced in books, pamphlets, outlines or notes, whether printed, mimeographed, typewritten, copied in different electronic devices or in any other form, for distribution or sale, without the written permission of the author. Any copy of this book without the corresponding number and the signature of the author on this page either proceeds from an illegitimate source or is in possession of one who has no authority to dispose of the same.

a l l rights reserved

no. 0934 ISBN 978-971-23-5540-0

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Printed by REX pRJNTilNCj COMpANV, INC. TypoqRAphy & creai'ive lirhoqiupliy 84 P. Florentino St., Quezon City Tel. Nos. 712-41-01 • 712-41-08

UNIVERSITY OF THE PHILIPPINES COLLEGE OF LAW

Raul C. Pangalangan Dean

Foreword We are fortunate that a leading practitioner and scholar has once again brought his thoughts together in a book. Professor Victorino C. Mamalateo has lived his career as a tax lawyer, and has seen tax practice in his various roles in government, private practice and in academia, respectively, as Assistant Commissioner in the Bureau of Internal Revenue, Tax Partner in Punongbayan andAraullo, and as a professor of Taxation at the U.P. College of Law. I first met Professor Mamalateo when we were both students at the Harvard Law School. Vic received his L L . M . and was part of the Law School's International Tax Program. He returned to the Philippines and has since written several books on Taxation. He has served as president of the Tax Management Association of the Philippines and Committee Chair on Taxation, Philippine Institution of Certified Public Accountants and Integrated Bar of the Philippines. Only a specialist like Professor Mamalateo, who has immersed himself fully in the study and in practice of his discipline, can do justice to a highly technical subject like Taxation. He alone can go deep into the nuances of legal doctrine without losing sight of the big picture. Fully adept at pushing legal analysis to its limit, he can best advise students and clients when pure logic must yield to intuition and seasoned judgment. Philippine Income Taxation is highly technical yet reader-friendly. It is a useful guide to both the specialist and the lay reader, the lawyer and the student. Finally, I am aware that Vic has dedicated valued time and energy to complete this work, as part of his commitment to the subject of Taxation Law, and his solicitude for his students, and for law students all over the country. Vic had often lamented that he could not find an appropriate textbook for his law students at U.P., iii

and typical of Vic, he immediately worked to provide the solution by writing one himself. The U.P. College of Law is proud that the books published by its faculty will help teach law students far beyond the walls of Malcolm Hall, and help shape the hearts and minds of the next generation of Filipino lawyers. I congratulate Professor Mamalateo, and thank him in behalf of his students, on his latest work in Taxation Law.

Raul C. Pangalangan Dean, U.P. College of Law

PREFACE Taxation is truly dynamic, particularly in the field of Income Taxation! The recent enactment by Congress of new tax laws in 2007-2009, the promulgation by tax authorities of the implementing regulations of these new tax laws as well as the issuance of amendatory regulations and other administrative issuances for existing laws in order to plug loopholes in these laws and to make tax administration more efficient, and the promulgation by the judiciary of leading decisions on tax matters since the first edition of this book came out in 2004, made the updating of this book extremely necessary. This updated book is intended as a textbook for students of law and as a useful guide and reference material for tax practitioners and the taxpaying public, in general. Toward this end and to better understand the different principles presented in various sections of the income tax law, the discussions of the topics generally follow the formula for computing income tax. Thus, after introducing the general principles, gross income and exclusions are first explained, and these are immediately followed by discussions on deductions and personal exemptions. Upon determination of the tax base, the appropriate tax rate on each type of income is expounded. Taxation of capital assets and passive investment incomes has also been given due importance in the light of the semi-global tax system adopted by the Philippines. Noting that withholding tax is almost always included in the deficiency tax assessment of revenue officers, and to make the book more useful for businessmen and professionals alike, the discussions on withholding taxes have been expanded, and a separate Chapter on special types of income taxes, like the minimum corporate income tax, fringe benefits tax, tax on improperly accumulated earnings, and on special laws granting income tax holidays and preferential tax rates to certain locators and investors, has been added. To supplement readings on fundamental principles on income taxation or for advance studies on income tax, involving the application of principles found in the various tax treaties concluded by the Philippines with other countries, my book on "Philippine Tax Treaties," which will be off the press in the early part of 2010, is highly recommended. V

The many favorable and constructive comments the author received from professors and students of law, the tax practitioners, and tax officials who use the book inspired me to undertake this humble work of updating the book. And for their valuable comments and observations, the author wishes to thank his friends in the Tax Management Association of the Philippines, Integrated Bar of the Philippines, Philippine Institute of Certified Public Accountants, University of the Philippines College of Law, Bureau of Internal Revenue, and partners in the law firm, V.C. Mamalateo & Associates. I want to thank also my beloved wife, Sally and children: Victor, Michael, Henry, and Mary Joy who just passed the bar examinations in New York City, and their respective spouses, for their understanding and support for this project, and my new grandchildren - Enrico G. Mamalateo, Veronica G. Mamalateo, and Jaden Matthew M. Jusay - for serving as my inspiration to continue writing this book. Most of all, I thank the Lord for giving me the talent, energy and patience to write this book and I pray that it may serve as an instrument to bring about greater enlightenment, fairness and justice in the study and administration of tax laws.

ACKNOWLEDGMENT I would like to dedicate this book to my wife, Sally, and my children Victor, Michael, Henry and only daughter, Mary Joy, who serve as my inspiration. I also dedicate this book to my daughters-in-law, Michelle and Mia, and my grandchildren Miggy, Chino, Yella, Vincent and Manito. I would like to extend my heartfelt gratitude to Bureau of Internal Revenue Deputy Commissioner Estelita C. Aguirre and Assistant Regional Director Delia Sarmiento; Atty. Carmen P. Victorino, Atty. Pat Bisda, Atty. Mary Ann Lucille Sering, and the following partners and managers of Punongbayan & Araullo: Ms. Marivic C. Espafio, Atty. Benedicta D. Baladad, Atty. Romeo H. Duran, Atty. Melea Solis-Cruz, Miss Lina Figueroa, and Atty. Ernie M. Guevara, for taking time reading the draft of the book and giving their valuable comments and suggestions on my work. Grateful acknowledgement is likewise due to my daughter, Mary Joy, as well as my daughter-in-law, Michelle, who both assisted me in the arduous preparations of this book.

vii

TABLE OF CONTENTS C H A P T E R I: OVERVIEW OF INCOME TAXATION Income Tax Income Tax Law Income Tax Systems Global Tax System Schedular Tax System Semi-Schedular or Semi-Global Tax System Features of the Philippine Income Tax Law Direct Tax Progressive Tax Comprehensive System of Income Tax Semi-schedular or semi-global tax system American Origin Criteria in Imposing Philippine Income Tax Citizenship principle Residence principle Source of Income principle Types of Philippine Income Tax When is Income Taxable? Existence of Income, Gain or Profit Realization or Receipt of Income Income, Gain or Profit is Not Exempt from Tax Provisions of Tax Code Prevail Accounting Principles Effects of the Application of Tax Treaties

1 1 3 3 4 6 7 7 7 7 7 8 8 8 8 8 9 11 11 11 12 12 12

C H A P T E R II: DEFINITION OF TERMS Person Corporation Domestic Corporation Foreign Corporation Non-resident citizen Resident Alien Non-resident Alien Resident Foreign Corporation Non-resident Foreign Corporation ix

14 14 14 14 14 1^ 1^ i 5

15

Fiduciary Withholding Agent Shares of Stocks Shareholder Taxpayer Including and includes Taxable year Fiscal year Paid incurred or paid accrued Trade or business Securities Dealer in securities Bank Non-bank financial intermediary Quasi-banking activities Deposit substitutes Ordinary Income Rank and file employees Mutual fund community Trade, business or profession Regional or area headquarters Regional operating headquarters Long-term deposit or investment certificate Statutory minimum wage Minimum wage earner

1 0 1 5 1 5 1 6 1 6

16 16 16 16 16 16 17 I 17 17 17 18 18 19 19 19 19 19 19 19 7

CHAPTER III: KINDS OF INCOME TAXPAYERS In General Importance of Tax Status of Taxpayer Individual Taxpayers Citizens Residence of Citizens Resident Citizens Non-Resident Citizens Aliens Residence of Aliens Resident Aliens Non-Resident Aliens 180-Day Rule Estates and Trusts Co-ownership General Professional Partnership X

22 22 23 24 24 25 25 27 27 27 28 29 31 33 35

Corporations Test in Determining Residence of Corporations Domestic Corporation Definition of "Corporation" Bank with RBU and FCDU Local Water Districts Partnership Taxable as a Corporation Joint Venture and Consortium Exempt Joint Venture or Consortium Examples of Unincorporated Joint Venture Common Rulings Involving Joint Ventures and Consortia Taxable Joint Ventures and Consortium Foreign Corporations Resident Foreign Corporation Types of Resident Foreign Corporation Offline International Foreign Air Carrier Philippine Branch is merely an Extension of the Foreign Head Office Branch Profit Remittance Tax Subsidiary and branch of a Foreign Corporation Compared Tax base and rate on dividend or profit remittance Existence of retained earnings and formality required Source of dividend or profit Retained earnings before 1998 Legal personality and attribution of income Allocation of overhead expenses Creation of permanent establishment Entitlement to income tax holiday Stockholder's extent of liability Cash or security deposit with SEC Administrative requirements and filing of audited financial statements Non-Resident Foreign Corporation

37 37 37 38 38 40 41 41 42 43 46 47 51 51 51 52 53 53 55 55 55 55 56 56 56 57 57 57 58 58 58

CHAPTER IV: GROSS INCOME A. B.

Gross Income To whom Income, Gain, or Profit is Taxable Sources of Income 1. Interests xi

^ 61 62 6 3

C.

2. Dividends 3. Services 4. Rentals and royalties 5. Sale of real property 6. Sale of personal property Types of Income, Gain or Profit Income Not considered as income Distinctions between Capital and Income Tests in Determining Income 1. Severance or realization test 2. Doctrine of command or control of income 3. Claim of right doctrine 4. Income from whatever source 5. Equivalent of cash doctrine Significance of knowing the type or character of income Kinds of Income Compensation Income Business Income A. National Internal Revenue Code Professional Income Engaged in Trade or Business Lease of Real Property B. Tax Treaties Capital Gains Shares of Stocks of a Domestic Corporation... Real Property Passive Investment Income A. Interest Income Distinctions Between Interest Income and Dividend Income Dividend vs. Loan B. Dividend Income Rules on Taxation of Dividends 1. Dividend is paid by a domestic corporation 2. Dividend is paid by a foreign corporation Recipient is a resident citizen or a domestic corporation Recipient is a non-resident or an alien, or a foreign corporation xii

63 63 70 70 70 74 74 76 78 79 79 79 79 80 81 81 83 83 86 86 87 87 93 96 97 97 102 106 106 109 110 Ill 112 112 121 121

122

Cash dividend vs. Stock dividend.. Stock dividends are generally exempt from tax Treasury Shares C. Royalty Income Characterization of Transactions Modes of Acquiring Software and the Relevant Tax Treatment Thereof A. Acquisition of ownership over a copyright B. Acquisition of copyright rights In General Royalty paid by a domestic corporation Royalty paid by a foreign corporation Distinction between Royalty Income and Service Income Rental Income Prizes and Awards Other Income Income from any source whatever Forgiveness of Indebtedness Gain from Sale of Treasury Stocks Income of a Corporation in Liquidation vs. Liquidating Dividend Interest Coupons and other Income Constructively Received Creation of Corporate Sinking Funds Acquisition or Disposition by a corporation of its own capital stock Contributions by Shareholders Receipt of Tax Credit or Refund

122 123 125 126 127 130 130 131 133 133 137 138 139 140 141 141 142 143 145 146 147 147 148 148

CHAPTER V: EXCLUSION FROM GROSS INCOME AND EXEMPT CORPORATIONS A. B.

Exclusions from Gross Income Exempt Corporations Non-stock, non-profit corporations Non-stock, non-profit educational institutions

150 170 172 173

CHAPTER VI: COSTS AND DEDUCTIONS FROM GROSS INCOME, NON-DEDUCTIBLE ITEMS, AND PERSONAL EXEMPTIONS A.

Return of Capital

1 xiii

7 8

B. C.

D. E. F. G.

Deductions from Gross Income Itemized Deductions 1. Business Expenses Ordinary and necessary expenses 2. Interest Expense 3. Taxes 4. Losses Conditions for Deductibility 5. Bad Debts Conditions for Deductibility of Bad Debts 6. Depreciation 7. Depletion 8. Charitable and other Contributions 9. Research and Development 10. Pension Trusts Optional Standard Deduction Special Additional Deductions Personal and Additional Exemptions Items Not Deductible

181 182 182 184 201 21° 216 217 234 235 244 252 253 262 262 263 264 268 271

CHAPTER VII: TAXABLE BASES A N D TAX RATES Taxable Bases Gain from Sale of Property Nature of Asset or Property a. Ordinary asset b. Capital asset Passive Investment Incomes Tax Rates Graduated Income Tax Rates on Taxable Income of Individuals Capital Gains from Sale of Shares of Stocks of a Domestic Corporation Passive Income of an Individual Subject to Preferential Tax Interests, Royalties, Prizes and Winnings Cash and Property Dividends Sale of Real Property Classified as Capital Asset by an Individual Zone Value of Fair Market Value of Real Property Formula in Determining Fair Market Value of Improvements Sale of Principal Residence xiv

278 279 280 281 281 282 282 282 283 284 284 285 286 286 287 287

Regular Corporate Income Tax Minimum Corporate Income Tax Domestic Corporations Subject to Preferential Tax Rates Inter-corporate Dividends Resident Foreign Corporations Resident Foreign Corporations Exempt from Philippine Income Tax Resident Foreign Corporations Subject to Preferential Tax Rates Income of a Domestic Corporation or Resident Foreign Corporation Subject to Preferential Tax Rates Income of a Non-Resident Foreign Corporation Subject to Preferential Tax Rates

288 290 292 294 295 295 295 298 299

C H A P T E R VIII: ORDINARY ASSETS AND CAPITAL ASSETS A N D TAX-FREE EXCHANGE Sale or Exchange Capital Assets Material Distinctions Between Sale of Capital Asset and Ordinary Asset Significance of Status of Taxpayer as Dealer of Real Property Guidelines in determining whether Real Property is Capital Asset or Ordinary Asset A. Taxpayer is engaged in Real Estate Business B. Taxpayer is Not Engaged in Real Estate Business C. Taxpayer Changing Business from Real Estate Business to Non-Real Estate Business D. Treatment of Abandoned and Idle Real Properties E. Treatment of Real Properties that have been Transferred to a Buyer/Transferee, whether the Transfer is Through Sale, Barter or Exchange, Inheritance, Donation or Declaration of Property Dividends F. Treatment of Real Property Subject of Involuntary Transfer Six Percent (6%) Capital Gains Tax on Presumed Gain Foreclosure Sales of Real Property Redemption Period XV

302 303 304 308 308 309 310 311 311

311 312 316 317 3

1

9

Tax-Free Exchanges Merger or Consolidation Exchange of Property for Shares of Stock Other Tax-Exempt Transactions Sale of Principal Residence Community Mortgage Program Deeds of Trusts Transfers by Mistakes Transfers of Rights Rescinded Contracts Equitable Mortgages Condominium Corporations Miscellaneous Exempt Transactions

d

l

9

320 322 326 326 328 330 331 331 331 332 332 332

C H A P T E R IX: ACCOUNTING METHODS AND PERIODS, A N D FILING OF INCOME TAX RETURNS Accounting Methods Cash Method Accrual Method Installment Method Percentage of Completion Method Changes in Accounting Methods Inventory of Goods or Merchandise Valuation of Inventories Inventories at cost price Inventories at market price Inventories of miners and manufacturers Accounting Period When income is to be reported When included in income Income constructively received Paid or Incurred and Paid or Accrued Installment Sales Sale of personal property on installment plan Sale of real property on installment plan Sale of real property involving deferred payments Fixing of Tax Returns and Payment of Taxes Income Tax Returns Covering Income, Profits and Gains Regular Filing of Tax Returns Electronic Filing and Payment System xvi

335 335 335 336 336 339 340 341 343 344 345 345 345 346 347 347 350 350 351 352 354 354 358 360

Taxpayers' Responsibility for Representations Made in Their Behalf by Their Tax Agents Audited Financial Statements Use of Functional Currency Attachments to Audited Financial Statements Capital Gains Tax Returns Shares of Stock of a Domestic Corporation Real Property Located in the Philippines Passive Investment Income

363 364 365 372 376 376 376 379

C H A P T E R X: WITHHOLDING TAXES Importance of Withholding Taxes Withholding Tax-at-Source A. Final Withholding Tax 1. Due to Resident Taxpayers Real Property Transactions 2. Due to Non-resident Taxpayers B. Creditable Withholding Taxes 1. Expanded Withholding Tax The income is fixed or determinable at the time of payment The income payment is listed in the regulations as subject to withholding tax The recipient of income is a resident of the Philippines The payor-withholding agent is resident of the Philippines Withholding Agent Installment Sales Medical Practitioners Top 20,000 Private Corporations Time to Withhold Tax Bases and Rates of Withholding Taxes Certificate Authorizing Registration EWT Rules on Certain Special Cases A. On Income Payments to MERALCO, Telecom and Other Utility Companies... B. On Income Payments to Professionals/ Talents, etc C. Other Clarifications D. Taxability of Agricultural Suppliers xvii

380 381 381 382 386 389 389 389 394

394 394 394 395 398 400 401 404 405 407 408 408 411 412 417

E.

C. D.

On Income Payments to Security Agencies F. On Income Payments by Freight Forwarders G. On Income Payments to Brokers and Others Similarly Situated Withholding Tax on Compensation Income Withholding Tax on Money Payments by the Government

421 425 430 437 437

C H A P T E R X I : TAX ON FRINGE BENEFITS, MINIMUM CORPORATE INCOME TAX, IMPROPERLY ACCUMULATED EARNINGS TAX, AND TAX ON ENTERPRISES REGISTERED WITH SPECIAL ECONOMIC A N D FREEPORT ZONE AUTHORITIES A. B. C.

D.

Fringe Benefits Tax De minimis Benefits Minimum Corporate Income Tax Gross Receipts and Cost of Services Per Industry Improperly Accumulated Earnings Tax Concept of Improperly Accumulated Earnings Tax Determination of Reasonable Needs of the Business Tax Base of Improperly Accumulated Earning Tax Period for Payment of Dividend/Payment of IAET Determination of Purpose to Avoid Income Tax Final Tax on Enterprises Registered with Special Economic Zone and Free Port Zone Authorities I. Subic Bay Metropolitan Authority II. Philippine Economic Zone Authority A. R.A No. 7903 (Zamboanga City Special Economic Zone) and R.A. No. 7922 (Cagayan Special Economic Zone Act of 1995) B. Aurora Special Economic Zone

Table of Cases Index

441 443 445 445 463 463 464 467 468 468 470 470 477

477 489

497 509

xviii

Income-Taxation Mamalateo OCR

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