Taxation of Estates, Trusts, and Partnerships

H. General Professional Partnership (GPP) and Estate and Trust H.1.
GPP V Ordinary Partnership GENERAL PROFESSIONAL PARTNERSHIPS - partnerships formed by person for the sole purpose of exercising their common profession, no part of the income of which is derived from engaging in any trade or business. Persons engaged in business as partners in a GPP, shall be liable for income tax only in their separate and individual capacities. i. For purposes of computing the distributive share of the partners, the net income of the partnership shall be computed in the same manner as a corporation. Each partner shall report as gross income his distributive share, actually or constructively received, in the net income of the partnership. Income of a GPP is deemed constructively received by the partners. ii. The undistributed shares will still be considered as constructive income already taxable on the part of the individual partners. Now, even if the GPP is not subject to 30% corporate tax rate on the net income, the net income is considered as earned by the partners composing the GPP. And taxable separately on such partners to 5%- 32%. iii. The partners and the GPP are required to file individual ITR. PARTNERSHIP an association of two or more persons where each partner contribute money, property or industry to a common fund with the intention of dividing profits among themselves i. The partners in a partnership are considered as stockholders for tax purposes. The profits distributed to them are considered as dividends. ii. For taxation purposes, business partnerships are taxable irrespective of whether it was orally constituted or in writing and whether or not it is registered with the SEC. Case: Tan V Del Rosario Facts: Petitioners challenge the constitutionality of RA 7496, commonly known as the Simplified Net Income Taxation Scheme (SNIT). Issue and Ruling: 1.W/N the SNIT applies to partners in general professional partnerships. YES. There is no distinction in income tax liability between a person who practices his profession alone or individually and one who does it through a partnership (whether registered or not) with others in the exercise of a common profession. Under the present income tax system, all individuals deriving income from any source whatsoever are treated in almost invariably the same manner and under a common set of rules. Although the general professional partnership is exempt from the payment of taxes (but it still has an obligation to file an income tax return mainly for administration and data), the partners themselves are liable for the payment of income tax in their individual capacity computed on their respective and distributive shares of profits. Case Notes: Differences between general professional partnerships and ordinary business partnership s: a. A general professional partnership, unlike an ordinary business partnership (which is treated as a corporation for income tax purposes and so subject to the corporate income tax), is not itself an income taxpayer. The income tax is imposed not on the professional partnership, which is tax exempt, but on the partners themselves in their individual capacity computed on their distributive shares of partnership profits. b. Ordinary business partnerships, no matter how created or organized, are taxable partnerships. General professional partnerships are exempt partnerships. Under the Tax Code on income taxation, the general professional partnership is deemed to be no more than a mere mechanism or a flowthrough entity in the generation of income by, and the ultimate distribution of such income to, respectively, each of the individual partners H.2. Estate and Trust, Defined ESTATE - The mass of property, rights and obligation left behind by the decedent upon his death. For purposes of income tax, an estate may be one that is under judicial administration or one that is not under judicial administration. TRUST - It is an arrangement whereby the trustor grants the control of certain property in the person of the trustee for the benefit of the beneficiary. Taxation of estates and trusts Income tax imposed upon individuals shall also apply to the income of estates or of any kind of property held in trust. The tax shall be computed upon taxable income of the estate or trust and shall be paid by the fiduciary. What are the income of the estates or trusts which are included for taxation? 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. Blue Sapphires Copy| Taxation 1 Notes for Finals 2013| Atty. Christopher Malaya 1
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. 4. Income which, in the discretion of the fiduciary, may be either distributed to the beneficiaries or accumulated. Exception from taxation of estates or trusts Employees trust which forms part of a pension, stock bonus or profit -sharing plan of an employer for the benefit of some or all of his employees shall be exempt from income tax: 1. If contributions are made to the trust by such employer, or employees, or both, for the purpose of distributing to such employees the earnings and the principal of the fund accumulated by the trust in accordance with such plan; and 2. If 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 used for or diverted to purposes other than for the exclusive benefit of the employees. However, any amount actually distributed to any employee or distributee 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 distributee. Taxable income of estates or trusts 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. However, there shall be allowed as a deduction 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 a guardian of an infant which is to be held or distributed as the court may direct, but the amount so allowed as a deduction shall be included in computing the taxable income of the beneficiaries, whether distributed or not. 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 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 creditedduring 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. The deductions allowed above shall not be allowed in case of a trust administered in a foreign country. Exemption allowed to estates and trusts There shall be allowed an exemption of twenty thousand pesos (P20,000) from the income of the estate or trust. Fiduciary returns Guardians, trustees, executors, administrators, receivers, conservators and all persons or corporations acting in any fiduciary capacity shall render a return of the income of the persons, trust or estate for whom or which they act, and be subject to all the provisions of this Title, which apply to individuals in case such person, estate or trust has a gross income of twenty thousand pesos (P20,000) or over during the taxable year. Such fiduciary or person filing the return for him or it, shall take oath that he has sufficient knowledge of the affairs of such person, trust or estate to enable him to make such return and that the same is, to the best of his knowledge and belief, true and correct, and be subject to all the provisions of this Title which apply to individuals. Fiduciaries indemnified against claims for taxes paid Trustees, executors, administrators and other fiduciaries are indemnified against the claims or demands of every beneficiary for all payments of taxes which they shall be required to make under the provisions of this Title, and they shall have credit for the amount of such payments against the beneficiary or principal in any accounting which they make as such trustees or other fiduciaries. Q: 3 Trusts created by 1 person, could there be a P20,000 personal exemption of each trust? A: No. Consolidate all income of the Trust, only 1 P20,000 for all.
H. 3 Revocable Trust V Irrevocable REVOCABLE TRUST A revocable trust is one where, under the trust treatment, the power to revest in the grantor title to the property transferred to the trust or any part of the corpus of such trust is vested:
Blue Sapphires Copy| Taxation 1 Notes for Finals 2013| Atty. Christopher Malaya
a. in the grantor, either alone or in conjunction with any person not having substantial adverse interest in the disposition of such part of the corpus, or the income therefore; or b. in any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom - in short, it is a trust where the title can revest back to the grantor anytime - not taxable as an entity because the income forms part of the income of the grantor NOTE: An estate is taxable as a separate entity when it is already subject to a judicial proceeding A trust is taxable as a separate entity if the trust is irrevocable. This is because the grantor has absolutely given up the corpus and any incidents thereto. In this case, the grantor has no control over the corpus of the trust. The benefits of the trust will not to go the grantor. The grantor has transferred the income earning property to a beneficiary. He has absolutely given up the incidents of it. If there is a condition that provides that a portion shall be reserved for the grantors medical expenses (for example), this condition does not convert the irrevocable trust to a revocable trust. But that portion is taxable income of the grantor. If it is a revocable trust, then the whole income or he property is taxable on the part of the grantor. An irrevocable trust is where the grantor has unconditionally parted with all the incidents of ownership. If the transfer is revocable, the entire income shall be taxable in the hands of the grantor.
I. Gross Income Section 32. Gross Income. (A) General Definition. - Except when otherwise provided in this Title, gross income means all income derived from whatever source, including (but not limited to) the following items: (1) Compensation for services in whatever form paid, including, but not limited to fees, salaries, wages, commissions, and similar items; (2) Gross income derived from the conduct of trade or business or the exercise of a profession; (3) Gains derived from dealings in property; (4) Interests; (5) Rents; (6) Royalties; (7) Dividends; (8) Annuities; (9) Prizes and winnings; (10) Pensions; and (11) Partner's distributive share from the net income of the general professional partnership. I. 1. Definition - income, gain or profit subject to tax. It includes compensation for personal and professional services, business income, profits, and income derived from any source whatever (whether legal or illegal), unless exempt from tax under the Constitution, tax treaty or statute. In other words, gross income is derived at without deducting expenses. I. 2. Items of Inclusions [Sec. 32 (A)] see codal I.2.1.1 Income from whatever source a. Income from illegal sources gambling, betting, lotteries, extortion, or fraud b. Compensation from damages if it represents payments for loss of expected profits Recovery of damages taxable it represents loss profit/income c. The amount of the debt of a stockholder to a corporation when forgiven if a corporation forgives you debt and you are a stockholder, it may be considered as dividend. d. Bad debts previously charged off but later recovered What then is the rule on bad debts already declared as worthless and uncollectible but subsequently collected or subsequently paid by the debtor? - Shall be recognized as part of the taxable income of the creditor in the year of collection, but only to the extent of the benefit derived from deducting it as an expense in the year of charging-off as bad debt.
- So if no benefit has been derived in the year of charging-off, then subsequent collection cannot result to taxable income on the part of the creditor. e. Taxes paid and subsequently refunded Tax refund taxable if it results in reduction of the taxpayers liability in the preceding year. This means that the tax refunded must be previously claimed as deduction form gross income. Tax benefit rule likewise applies. Taxes previously allowed as deductions, when refunded or credited, shall be included as part of gross income in the year of receipt to the extent of the income tax benefit of such deduction. Sec. 34 (c) f. Tax informers reward Informers reward would apply to all corrections made by the BIR as a result of any information that you have given for a tax evasion case. So if you happen to be reporting to the BIR in a case of a tax evasion and it is actually supported and it will eventually result in the conviction (?) actual collection of taxes, you can receive a maximum of P1M from the government as an informer or 10% of whatever has been collected. But the 10% should in a way be higher than the P1M limit. But that payment that you will get as a reward will also be taxed by the government because the government will not expect it to be part of your gross income. So it will be taxed with finality subject to 10% FWT. I.2.2 Compensation In general, the term compensation means all remuneration for services performed by an employee for his employer under an ER-EE relationship, unless specifically excluded by the Code. I.2.2.1 Nitafan vs CIR Facts: Nitafan and some others seek to prohibit the CIR from making any deduction of withholding taxes from their salaries or compensation for such would tantamount to a diminution of their salary, which is unconstitutional. On June 7 1987, the Court en banc had reaffirmed the directive of the Chief Justice. ISSUE: Whether or not the members of the judiciary are exempt from the payment of income tax.
HELD: What is provided for by the constitution is that salaries of judges may not be decreased during their continuance in office. They have a fix salary which may not be subject to the whims and caprices of congress. But the salaries of the judges shall be subject to the general income tax as well as other members of the judiciary. I.2.2.2 13 Month Pay and Other benefits Gross benefits received by officials and employees of public and private entities are not included from the computation of gross income. Provided however, that the total exclusion shall not exceed P30,000. I.2.2.3 GSIS, SSS, Medicare and Other Contributions These items are not included in the Gross Taxable Compensation Income. contributions refer to the mandatory/compulsory contributions of the concerned employees to the SSS, GSIS, PHIC and HDMF. I.2.2.4 Withholding Tax The income recipient (i.e., EE) is the person liable to pay the tax income, yet to improve the collection of compensation income of EEs, the State requires the ER to withhold the tax upon payment of the compensation income. I.2.2.5 Free living Quarter and Meal If a person receives salary as remuneration for services rendered, and in addition thereto, living quarters or meals are provided, the value to such person of the quarters and meals so furnished shall be added to the remuneration paid for the purpose of determining the amount of compensation subject to withholding. However, if living quarters or meals are furnished to an employee for the convenience of the employer, the value thereof need not be included as part of compensation income. I.2.2.6 Fixed and Variable Transportation, representation and other allowances
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GENERAL RULE: Fixed or variable transportation, representation or other allowances that are received by a public officer or employee of a private entity, in addition to the regular compensation fixed for his position or office is COMPENSATION subject to withholding tax. (Rev. Regs. 2-98) EXCEPTION: any amount paid specifically, either as advances or reimbursements for travelling, representation and other bona fide ordinary and necessary expenses incurred or reasonably expected to be incurred by the employee in the performance of his duties are NOT COMPENSATION provided the following conditions are satisfied: o it is for ordinary and necessary travelling and representation or entertainment expenses paid or incurred by the employee in the pursuit of the employers trade, business or profession; and o The employee is required to account or liquidate for the foregoing expenses. (in accordance with the specific requirements of substantiation for each category of expenses pursuant to sec. 34 of the Tax Code) The excess of actual expenses over advances made shall constitute taxable income if such amount is not returned to the employer.
I.2.2.7 Unused Vacation Leaves Rules in determining whether money received for vacation and sick leave is taxable or not: a. If paid or availed of as salary of an employee who is on vacation or on sick leave notwithstanding his absence from work, it constitutes TAXABLE income. [RR 6-82, 2d] b. Monetized value of unutilized vacation leave credits of ten (10) days or less which were paid to private employees during the year and the monetized value of leave credits paid to government officials and employees are not subject to income tax and to the withholding tax. [RR no. 2-98, Sec 2.78.1(A)(7)] c. Terminal leave or money value of accumulated vacation and sick leave benefits received by heir upon death of employee is not taxable.
I.2.2.8 Fringe Benefit Tax (FBT) I.2.2.8.1 Definition: A final withholding tax imposed on the gross-up monetary value (GMV) of fringe benefits furnished, granted or paid by the employer to the employee, except rank and file employees. (1st par. Sec 2. 33(A), Rev. Regs. No. 3-98) Fringe benefit any good, service, or other benefit furnished or granted by an employer, in cash or in kind, in addition to basic salaries, to an individual employee. It is given instead of an increase in the basic pay because it may be discounted or adjusted downward as the financial condition of the employer dictates. Rationale for granting Fringe Benefits: Incentive to encourage employee productivity and loyalty to employer. I.2.2.8.2 Who is liable? Managerial and Supervisory employees; If the recipient of the fringe benefits is a rank and file employee, and the said benefit is not tax-exempt, then the value of such fringe benefit shall be considered as part of the compensation income of such employee. Where the recipient of the fringe benefit is not a rank and file employee, and the said benefit is not taxexempt, then the same shall not be included in the compensation income of such employee. The fringe benefit is instead levied upon the employer, who is required to pay. **The fringe benefits granted to the employee (other than a rank and file employee) is taxable to the employer unless exempted. The fringe benefits tax shall be treated as a FINAL TAX on the employee which shall be withheld and paid by the employer on a calendar quarterly basis. Notes: Rank and file employeesmeans all employees who are holding neither managerial nor supervisory position. Managerial employees refer to those who are vested with powers or prerogatives to lay down and execute management policies and/or to hire, transfer, suspend, lay-off, recall, discharge, assign or discipline employees. Supervisory employees are those who effectively recommend such managerial actions if the exercise of such authority is not merely routinary or clerical in nature but requires the use of independent judgment.
I.2.2.8.3 Tax rate and Tax base: A final tax of 32% of the grossed-up monetary value of fringe benefits furnished or granted to the employee (except rank and file employees) by the employer (unless the fringe benefit is required by the nature of, or necessary to the trade, business or profession of the employee, or when the fringe benefit is for the convenience or advantage of the employer). I.2.2.8.4 Items not subject to FBT a. When the fringe benefit is required by the nature of, or necessary to the trade, business or profession of the employer, or b. when the fringe benefit is for the convenience or advantage of the employer (Employers convenience rule) **Kinds of fringe benefits that are not subject to FBT: a. Fringe benefits which are authorized and exempted from tax under the NIRC of 1997 or special laws; b. Contributions of the employer for the benefit of the employee to retirement, insurance and hospitalization benefit plans; c. Benefits given to the rank and file employees, whether granted under a collective bargaining agreement or not; and d. De minimis benefits as defined in the rules and regulations to be promulgated by the Secretary of Finance upon recommendation of the Commissioner of Internal Revenue. I.2.2.9 De minimis benefits (Facilities and privileges of relatively small value) De minimis benefits benefits which are relatively small in value offered by the employer as a means of promoting goodwill, contentment and efficiency of employees **Question: Are de minimis benefits given to rank and file and non-rank and file employees exempt from tax? Assuming that it is in the range of the minimum allowed by law. Whether or not the recipient is a rank and file or nonrank and file employee, is always exempt from tax provided that it is in the range (minimum) allowed by law. It is not subject to income or any other tax. I.2.2.10 Retirement Pay Retirement benefits, gratuities, pensions, etc. that are excluded from gross income: Retirement benefits received under RA 7641 Retirement received from reasonable private benefit plan after compliance with certain conditions Amounts received for beyond control separation Foreign social security, retirement gratuities, pensions, etc USVA benefits SSS benefits GSIS benefits GR: Retirement pay is subject to tax. Exception: If subject to: SSS GSIS US Veterans Law What are the requirements for a retirement pay under reasonable retirement benefit plan to be exempt? There must be a reasonable retirement benefit plan set up by the company The employee must at least render 10 years of service The private employee or official must be at least 50 years old They must be availed only once. If you take a 2nd job, after retirement, if you work on the government your 2nd retirement will still be exempted but if you work on the private sector your retirement benefit will not be exempted. Reasonable retirement benefit plan must be approved by whom? Must be approved by the BIR. And the employer on his own or together with his employee must give contribution to the retirement benefit plan. I.2.2.10.1 Borromeovs CSC(199 SCRA 911) Blue Sapphires Copy| Taxation 1 Notes for Finals 2013| Atty. Christopher Malaya 6
GR 96032, 31 July 1991 Facts: Jesus N. Borromeo was the Chairman of the Civil Service Commission until his retirement on 1 April 1986. In 1988, he wrote the Commission on Audit requesting an opinion whether the money value of the terminal leave of retired Constitutional Commission members should include the allowances received at the time of retirement. Borromeo requested for the payment of terminal leave differential representing the unpaid Cost of Living Allowance (COLA) and Representation and Transportation Allownace (RATA) amounting toP111,229.04. The Department of Budget and Management denied the request. Issue: Whether the terminal leave pay of the former CSC Chairman should be computed on the basis of the highest monthly salary plus COLA and RATA, or solely on the basis of highest monthly salary without saidallowances. Held: An application for terminal leave is an application for a commutation of leave credits and not a commutation of salary as the officer or employee has already severed his connection with his employer and is no longer working. The cash value of his accumulated leave credits should not be treated as compensation for services rendered at that time. Inasmuch as terminal leave payments are given not only at the same time but also for the same policy considerations governing retirement benefits, the payments therefore should include COLA and RATA. Section 286 of the Revised Administrative Code is not applicable. It cannot be construed as limiting the basis of the computation of terminal leave pay to monthly salary only ** It is axiomatic that retirement laws are liberally construed and administered in favor of the persons intended to be benefited. All doubts as to the intent of the law should be resolved in favor of the retiree to achieve its humanitarian purposes. Although terminal leave pay is not synonymous with, and is not a part of, the five-year lump sum gratuity provided under RA 910 as amended and Administrative Order No. 444, the former may, in a broad sense, partake of the nature of a gratuity rather than actual salary. A gratuity is that paid to the beneficiary for past services rendered purely out of generosity of the giver or grantor. (Peralta v. Auditor General, 100 Phil 1051 [1957]) It is a mere bounty given by the government in consideration or in recognition of meritorious services and springs from the appreciation and graciousness of the government. **Why should he be penalized for faithfully working continuously and not consuming his leave credits until his last working day? Why should the basis for the commutation of leave credits be different just because he chose to avail himself of his leave benefits immediately before and not immediately after retirement? Surely this disparity in consequence could not have been intended by our lawmakers. Rationale of why it is excluded: Retirees are most deserving of compassion and should not be given a strict interpretation under the law. Retirement laws aim to assist retirees in his old age, not to punish him for having survived. **The monetary value of accumulated leave credit/terminal leave given to a retiring government official or employee is not subject to tax. I.2.2.11 Separation Pay Separation pay because of death, sickness or other physical disability or for any cause beyond the control of the employee is excluded from computation of gross income and thus NOT TAXABLE. Note: The phrase causes beyond the control connotes involuntariness on the part of the official or employee. The separation from the service of the official or employee MUST NOT BE ASKED or INITIATED BY HIM. General Rule: Separation pay is not tax exempt Exceptions: Automatic exclusions: a. Illness b. Death c. Physical incapacity or injury Conditional exclusion: a. Causes beyond the control of the employees EXCLUDED (e.g. installation of labor saving devices or bankruptcy) Within employees control INCLUDED
Separation pay: Voluntary: taxable Involuntary: non-taxable
I.2.2.11.1 CIR v CA(GR No. 96016, October 17, 1991) Facts: Efren Castaneda retired from government service as Revenue Attach in the Philippine Embassy in London, England on 10 December 1982 under the provisions of Section 12 (c) of Commonwealth Act 186, as amended. Upon retirement, he received, among other benefits, terminal leave pay from which the Commissioner withheld P12,557.13, allegedly representing income tax thereon. Castaneda claimed for a refund. Issue: Whether terminal leave pay is subject to withholding income tax. Held: Terminal Leave Pay received by a government official or employee is not subject to withholding income tax. In the exercise of sound personnel policy, the Government encourages unused leaves to be accumulated. The Government recognizes that retirement pay for public servants is less than generous, if not meager or scrimpy. Terminal leave payments are given thus not only at the same time but also for the same policy considerations governing retirement benefits. Not being part of the gross salary or income of a government official or employee but a retirement benefit, terminal leave pay is not subject to income tax. I.2.2.12 Minimum Wage Income Earners Income also exempt from tax Minimum Wage - minimum wage determined by the RTWPB (327 in Region VII) Minimum Wage Income Earners employees of private establishments earning P327; below salary grade 5 if in government Not subject to income tax Not subject to withholding tax What if employer pays one peso more than the minimum wage? If wage is P328, what is the taxable amount? P328. It is the entire amount that becomes taxable and not the excess in the statutory minimum wage. Overtime Pay - additional rate paid for work rendered beyond 8 hours Night Shift Differential - additional rate on hours worked from 10Pm-6AM (10%) Hazard Pay - additional compensation for exposure to hazards in the line of employment Holiday Pay - additional compensation for work rendered during holidays Special Holidays Regular Holidays I.2.2.13 Senior Citizens They are exempted from income tax only but not as to other taxes. Deductions from gross income under RA 9257 or the Expanded Senior Citizens Act of 2003: Deduction from gross income of private establishments for the 20% sales discounts granted to senior citizens on the sale of goods and/or services. Additional deduction from gross income of private establishments for compensation paid to senior citizens. ** The 20% discount to qualified senior citizens now deductible from gross income and not as a tax credit. Establishments that may claim the sales discount as a deduction: a. Hotels and similar lodging establishments b. Restaurants c. Recreation centers d. Theaters, cinema houses and concert halls, circuses, carnivals and other similar places of culture, leisure, and amusement e. Drug stores, hospital pharmacies, medical and optical clinics and similar establishments dispensing medicines f. Medical and dental services in private facilities g. Domestic air and sea transportation companies h. Public land transportation facilities i. Funeral parlors and similar establishments **Establishments granting sales discounts are entitled to deduct the said discount from gross income subject to the following conditions:
Only that portion of the gross sales EXCLUSIVELY USED, CONSUMED OR ENJOYED BY THE SENIOR CITIZEN shall be eligible for the deductible sales discount 2. The gross selling price and the sales discount MUST BE SEPARATELY INDICATED IN THE OFFICIAL RECEIPT OR SALES INVOICE issued by the establishment for the sale of goods or services to the S.C. 3. Only the actual amount of the discount granted on a sales discount not exceeding 20% of the gross selling price can be deducted from the gross income, net of VAT and from gross sales or receipts of the business 4. The discount can only be allowed as deduction from gross income for the same taxable year that the discount is granted. 5. The business establishment giving sales discounts to qualified S.C. is required to keep separate and accurate record of sales (name of the S.C., OSCA ID, gross sales/receipts, discount granted, dates of transaction and invoice number of every sale transaction) ** Private establishments employing senior citizens shall be entitled to additional deduction from their gross income equivalent to 15% of the total amount paid as salaries and wages to senior citizens subject to Sec 34 of the Tax Code and its IRR provided the following conditions are met: 1. The employment shall have to continue for a period of at least 6 months 2. The annual taxable income of the senior citizen does not exceed the poverty level as may be determined by the NEDA thru the NSCB. For this purpose, the senior citizen shall submit to his employer a sworn certification that his annual taxable income does not exceed the poverty level. I.2.3 Gains from Profession, Trade or Business 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. Profession is primarily any field or work requiring specialized training in the field of learning, art or science engaged in as a means of livelihood or profit of an individual or group of individuals. Business Income refers to income derived from merchandising, mining, manufacturing, farming, and other similar operations. Business any activity that entails time and effort of an individual or group of individuals for purposes of livelihood or profit. I.2.4 Gains from dealings in property Ordinary assets vs Capital assets Ordinary assets 1. Stock in trade of the taxpayer or other properties of a kind which would properly be included in the inventory (e.g. supplies on hand, merchandise inventory) 2. Property held by the taxpayer primarily for sale to customers in the ordinary course of business (e.g. subdivision lots by a real estate developer) 3. Personal property used in trade or business subject to depreciation (e.g. delivery truck, store and office equipment) 4. Real property used in trade or business (e.g. warehouse, factory, office building) Treatment of ordinary gains and losses 1. Ordinary gains are included in the gross income. 2. Ordinary losses are deductible from gross income. Capital Assets Include all property held by the taxpayer, whether or not connected with his trade or business, but not including those enumerated above as ordinary assets. Treatment of capital gains and losses 1. Capital gains derived from sale of shares of stock of a domestic corporation are subject to capital gains tax. 2. A capital gain derived from sale of real property in the Philippines is subject to capital gains tax but NO loss is recognized because gain is presumed. 3. For other capital assets, the rules on capital gains and losses apply in the determination of the amount to be included in gross income and NOT subject to capital gains tax.
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Real Property
1. If the seller is a real estate dealer, 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 non-resident alien engaged in trade or business, or 25% final tax if a non-resident alien not engaged in trade or business) or to the normal corporate income tax (if a domestic corporation or a resident foreign corporation). Non-resident foreign corporations are taxed on their gross income from sources within the Philippines, including gain from sale of real property. 2. If the seller is not a real estate developer, determine whether the real property sold is a) used in the taxpayers trade, business, or profession or b) treated as fixed asset used in trade, business or profession subject to depreciation. If the answer in either of the two cases is in the affirmative, the real property shall be treated as an ordinary asset, and the gain, if any, subject to graduated income tax rates or normal corporate income tax rate. If the answer is in the negative, the real property shall be treated as capital asset and the gain by a citizen, alien, and domestic corporation shall be subject to final capital gains tax of 6% based on the selling price or fair market value, whichever is higher. It is to be noted that foreign corporations are not entitled to the preferential tax rates. Therefore, real property sold by a RFC shall be subject to NCIT. Shares of Stock 1. If the seller is a dealer in securities, the shares of stock shall be treated as ordinary assets and the ordinary gain shall be subject to the graduated income tax rates (individual) or normal corporate income tax (corporate). 2. If the seller is not a dealer 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. However, it is subject to one-half of one percent stock transaction tax based on the gross selling price. 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 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. In the case of NRA-NETB, capital gain shall be taxed at 25% of gross income.
Gain from forced sale of property The acquisition by the Government of private properties through the exercise of the power of eminent domain is embraced within the meaning of the term sale and the proceeds derived therefrom is subject to income tax as capital gain (since the property is not used in the owners trade or business). Only the fair market value of the property as of the date of acquisit ion should be considered in determining the gain or loss. Buyer of real property classified as capital asset is the government or any of its political subdivisions or agencies, or GOCCs- the taxpayer has the option to treat the capital gain as subject to 6% capital gains tax or to the graduated rates (5-32%) for individuals.
I.2.5. Interest Income Amount of compensation paid for the use of money, goods or credit or forbearance from such use. Interests from bank deposits are included in the gross income if they are derived from sources outside the Philippines (i.e., bank is located outside the Philippines). If they are derived from sources within the Philippines, they are excluded from gross income but subject to final tax of 20%. Interests from LOANS (both local and foreign) are ALWAYS INCLUDED in the gross income. (For rules on interests, review passive income subject to final tax.) I.2.6. Rental Income Amount or compensation paid for the use or enjoyment of a thing or right and implies a fixed sum or property amounting to a fixed sum to be paid at a stated time for the use of the property.
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Scope: All amount or property received from lease contract, whether used in business or not. Rental income includes: 1. Agreed amount per month or per year 2. Obligations of lessor to third parties which the lessee undertakes to pay such as: - real estate taxes - insurance premiums - dividends paid by lessee to stockholders of lessor-corporation in lieu of rent - interest paid by lessee to holder of bonds issued by lessor-corporation in lieu of rent Rental income excludes: 1. Those paid to non-resident owner or lessor of vessels chartered by Philippine nationals- subject to 4.5% of gross rentals. 2. Those paid to non-resident owner or lessor of aircraft, machineries and other equipment- subject to 7.5% of gross rentals. Notes 1. Prepaid or advance rental is taxable income in the year received, if so received under a claim of right and without restriction as to its use. 2. Security deposit applied to the rental of the month must be recognized as income at the time it is applied. 3. If the security deposit is to ensure contract compliance, it is not income to the lessor until the lessee violates any provision of the contract. Income from leasehold improvements When the lessee erected or built permanent improvements in the leased property which will become the property of the lessor upon expiration of the lease, the value of the improvements should be reported as income of the lessor. No income accrues to the lessor if the improvements are subject to removal by the lessee.
I.2.7. Royalties It is the payment for the use and exhaustion of property such as earnings from copyrights, patents, trademarks, and natural resources under lease. Royalties are included in the gross income subject to graduated rates if derived from sources outside the Philippines; otherwise, it is subject to final withholding tax. If the recipient of the royalty paid by a DC is either a NRA-NETB or NRFC, a lower tax rate may be allowed under an existing treaty.
I.2.8. Dividends Only dividends issued by a foreign corporation to an individual taxpayer is included in the computation of gross income since those issued by a domestic corporation are subject to final tax. Taxpayer Paid by a DC Paid by a FC RC 10% 5-32% NRC 10% Sources within- 5-32% RA Sources without- exempt NRA-ETB 20% Sources within- 5-32% Sources without- exempt NRA-NETB 25% Sources within- 5-32% Sources without- exempt DC exempt 30% RFC exempt Sources within- 30% Sources without- exempt NRFC 15%- w/ tax sparing Sources within- 30% 30%- w/o tax sparing Sources without- exempt
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I.2.9. Annuities Periodic instalment payments of income or pension by insurance companies during the life of a person or for a guaranteed fixed period of time. The portion representing return of premium is not taxable while that portion that represents interest is taxable. Example Mr. A purchased a life annuity for P500,000 which will pay him P120,000 a year. Life expectancy of Mr. A is 5 years. Mr. A will receive a total of P600,000. The P500,000 shall be excluded from gross income as it represents return of premiums while the excess P100,000 shall be taxable.
I.2.10. Prizes and Winnings Amount of money in cash or in kind received by chance or through luck are generally taxable except if specifically mentioned under the exclusions. Includes: a. Prizes derived from sources within and amounting to P10,000 or less. Prizes in excess of P10,000 is subject to 20% final tax. Winnings derived from within are not included in the gross income because it is subject to final tax regardless of amount. b. Prizes and winnings derived from sources outside the Philippines, regardless of amount. Exclusion from gross income: Prizes and awards made primarily in 1. recognition of charitable, artistic, religious, civic achievement, educational, literary or scientific 2. recipient was selected without any action of his part 3. recipient is not required to render substantial future services. Prizes and awards granted to athletes in sports competitions locally or abroad and sanctioned by their national sports association National Sports Associations- those duly accredited by the Philippine Olympic Committee Tax implications: a. The prizes and awards shall be exempt from income tax b. The prizes and awards shall be deductible from gross income of the donor. c. The donors of such prizes and awards shall be exempt from donors tax.
I.2.10 Pension Amount of money received in lump sum or on staggered basis in consideration of services rendered given after an individual reaches the age of retirement. Pensions to be included in the gross income are those received from a pension plan which is NOT BIR APPROVED. Otherwise, they are excluded.
I.3. Items of Exclusions A. Proceeds of Life Insurance Conditions for exclusion- It must be paid to the heirs or beneficiaries upon the death of the insured, whether in a single sum or otherwise.
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Payments for reasons other than death are subject to tax to the extent of the excess of the premiums paid. If there are any policy loans, these are to be considered as advances deductible from the life insurance proceeds received upon death. When the insured outlives the policy, the proceeds less the total amount of premiums should be included in gross income since death is an essential element for the exclusion. Instances when life insurance proceeds are not excluded: 1. When the life insurance policy is used to secure a money obligation 2. When the life insurance policy was transferred for a valuable consideration 3. The recipient of the insurance proceeds is a business partner of the deceased and the insurance is to compensate the partner-beneficiary for any loss in income 4. The recipient of the insurance proceeds is a partnership in which the insured is a partner and the insurance was taken to compensate the partnership for any loss in income 5. The recipient of the life insurance proceeds is a corporation in which the insured was an employee or officer.
B. Return of insurance premium Conditions for exclusion: The amounts must be received as a return of premiums paid by him under life insurance, endowment, and annuity contracts. If the total premium returns exceed the aggregate premiums paid, the excess shall be included in the gross income. C. Gift, bequest, devise or descent The consideration is based on pure liberality and is already subject to donors (gift) or estate tax (bequest or devise). Only donated property is excluded from gross income. Donations of income are included as part of gross income. Income from property received as gift is subject to income tax. If the amount received is on account of services rendered, the receipt is income. Gift tax test 1. If there is NO legally demandable obligation to give the gift- not taxable. 2. If there is a legally demandable obligation to give, there is income- taxable.
D. Compensation for injuries or sickness Rationale: This is just an indemnification for injuries or damages suffered. Excluded from gross income: 1. Amounts received through Accident or Health Insurance or Workmens Compensation Act as compensation for personal injuries or sickness. 2. Amounts of any damages received whether by suit or agreement on account of such injuries or sickness. Compensation for unearned income (lost profits) Not excluded from gross income. Such damages are merely replacement of income which would have been subjected to tax if earned.
E. Retirement benefits, pension, gratuities 1. Retirement benefits under RA 4917; Retirement benefits under RA 7641 a. Retiree employed for at least 10 years b. Retiree at least 50 years old c. Retiree avails of the benefit only once d. BIR approved private benefit plan
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It does not matter whether the retirement is voluntary or not, as long as the requirements are met, the retirement proceeds are excluded from gross income. However, if the retirement is compulsory, there is no need to comply with the above requirements because the same would be excluded as separation pay beyond the control of the employee. Reasonable private benefit plan- pension, gratuity, stock bonus or profit-sharing plan maintained by an employer for the benefit of employees wherein contributions are made by such employer for the employees or both. Can be availed of only once- applies only to retirement benefit from subsequent private employer. It does not apply to subsequent public employer as the benefits are exempt under the GSIS Act. 2. Terminal leave- monetized value of retirees accumulated vacation leave and sick leave For compulsory retirement- exempt For optional retirement- SL is taxable, VL up to 10 days is exempt, excess is taxable. Rationale: Terminal leave pay is applied for by an employee who is no longer working. It is no longer compensation for services rendered. 3. Separation pay because of death, sickness or other physical disability or for any cause beyond the control of the employee Phrase beyond control connotes involuntariness on the part of the employee. Separation from service of the employee must not be asked for or initiated by him. 4. Social security benefits, retirement gratuities, and other similar benefits received by citizens and aliens who come to reside permanently here from foreign government agencies and other institutions, private or public. 5. Benefits due to residents under the laws of the US administered by the US Veterans Administration 6. SSS benefits 7. GSIS benefits F. Income exempt under treaty G. Miscellaneous items 1. Passive income derived by: a. Foreign governments b. Financing institutions owned, controlled or enjoying refinancing from foreign government c. International and regional institutions established by foreign governments 2. Income derived by the Phil government from: a. any public utility b. the exercise of any essential governmental function 3. Prizes and awards made primarily in a. recognition of charitable, artistic, religious, civic achievement, educational, literary or scientific b. recipient was selected without any action of his part c. recipient is not required to render substantial future services. 4. Prizes and awards granted to athletes in sports competitions locally or abroad and sanctioned by their national sports association National Sports Associations- those duly accredited by the Philippine Olympic Committee Tax implications: a. The prizes and awards shall be exempt from income tax b. The prizes and awards shall be deductible from gross income of the donor. c. The donors of such prizes and awards shall be exempt from donors tax. 5. 13 month pay and other benefits up to P30,000
th
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6. GSIS, SSS, Philhealth and Pag-ibig contributions and union dues of individuals 7. Gains from bonds or other certificates of indebtedness with a maturity of more than 5 years. 8. Gains from redemption of shares in Mutual Fund.
SEC. 34. Deductions from Gross Income. - Except for taxpayers earning compensation income arising from personal services rendered under an employer-employee relationship where no deductions shall be allowed under this Section other than under subsection (M) hereof, in computing taxable income subject to income tax under Sections 24 (A); 25 (A); 26; 27 (A), (B) and (C); and 28 (A) (1), there shall be allowed the following deductions from gross income; (A) Expenses. (1) Ordinary and Necessary Trade, Business or Professional Expenses.(a) In General. - There shall be allowed as deduction from gross income all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on or which are directly attributable to, the development, management, operation and/or conduct of the trade, business or exercise of a profession, including: (i) A reasonable allowance for salaries, wages, and other forms of compensation for personal services actually rendered, including the grossed-up monetary value of fringe benefit furnished or granted by the employer to the employee: Provided, That the final tax imposed under Section 33 hereof has been paid; (ii) A reasonable allowance for travel expenses, here and abroad, while away from home in the pursuit of trade, business or profession; (iii) A reasonable allowance for rentals and/or other payments which are required as a condition for the continued use or possession, for purposes of the trade, business or profession, of property to which the taxpayer has not taken or is not taking title or in which he has no equity other than that of a lessee, user or possessor; (iv) A reasonable allowance for entertainment, amusement and recreation expenses during the taxable year, 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 or its trade, business or exercise of a profession not to exceed such ceilings as the Secretary of Finance may, by rules and regulations prescribe, upon recommendation of the Commissioner, taking into account the needs as well as the special circumstances, nature and character of the industry, trade, business, or profession of the taxpayer: Provided, That any expense 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.
(b) Substantiation Requirements. - No deduction from gross income shall be allowed under Subsection (A) hereof unless the taxpayer shall substantiate with sufficient evidence, such as official receipts or other adequate records: (i) the amount of the expense being deducted, and (ii) the direct connection or relation of the expense being deducted to the development, management, operation and/or conduct of the trade, business or profession of the taxpayer. (c) Bribes, Kickbacks and Other Similar Payments. - No deduction from gross income shall be allowed under Subsection (A) hereof for any payment made, directly or indirectly, to an official or employee of the national government, or to an official or employee of any local government unit, or to an official or employee of a government-owned or -controlled corporation, or to an official or employee or representative of a foreign government, or to a private corporation, general professional partnership, or a similar entity, if the payment constitutes a bribe or kickback.
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(2) Expenses Allowable to Private Educational Institutions. - In addition to the expenses allowable as deductions under this Chapter, a private educational institution, referred to under Section 27 (B) of this Code, may at its option elect either: (a) to deduct expenditures otherwise considered as capital outlays of depreciable assets incurred during the taxable year for the expansion of school facilities or (b) to deduct allowance for depreciation thereof under Subsection (F) hereof.
(B) Interest.(1) In General. - The amount of interest paid or incurred within a taxable year on indebtedness in connection with the taxpayer's profession, trade or business shall be allowed as deduction from gross income: Provided, however, That the taxpayer's otherwise allowable deduction for interest expense shall be reduced by an amount equal to the following percentages of the interest income subjected to final tax: Forty-one Thirty-nine Thirty-eight percent percent percent (41%) (39%) (38%) beginning January beginning January 1, beginning January 1, 1999; 1, 1998; and 2000;
(2) Exceptions. - No deduction shall be allowed in respect of interest under the succeeding subparagraphs: (a) 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: Provided, That such interest shall be allowed a a deduction in the year the indebtedness is paid: Provided, further, That if the indebtedness is payable in periodic amortizations, 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; (b)If both the taxpayer and the person to whom the payment has been made or is to be made are persons specified under Section 36 (B); or (c)If the indebtedness is incurred to finance petroleum exploration.
(3) Optional Treatment of Interest Expense. - At the option of the taxpayer, interest incurred to acquire property used in trade business or exercise of a profession may be allowed as a deduction or treated as a capital expenditure.
(C) Taxes.(1) In General. - Taxes paid or incurred within the taxable year in connection with the taxpayer's profession, trade or business, shall be allowed as deduction, except (a) The income tax provided for under this Title; (b) Income taxes imposed by authority of any foreign country; but this deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of paragraph (3) of this subsection (relating to credits for taxes of foreign countries); (c) Estate and donor's taxes; and (d) Taxes assessed against local benefits of a kind tending to increase the value of the property assessed. Provided, That taxes allowed under this Subsection, when refunded or credited, shall be included as part of gross income in the year of receipt to the extent of the income tax benefit of said deduction.
(2) Limitations on Deductions. - In the case of a nonresident alien individual engaged in trade or business in the Philippines and a resident foreign corporation, the deductions for taxes provided in paragraph (1) of this Subsection (C) shall be allowed only if and to the extent that they are connected with income from sources within the Philippines. Blue Sapphires Copy| Taxation 1 Notes for Finals 2013| Atty. Christopher Malaya 16
(3) Credit Against Tax for Taxes of Foreign Countries . - If the taxpayer signifies in his return his desire to have the benefits of this paragraph, the tax imposed by this Title shall be credited with:
(a) Citizen and Domestic Corporation. - In the case of a citizen of the Philippines and of a domestic corporation, the amount of income taxes paid or incurred during the taxable year to any foreign country; and (b) Partnerships and Estates. - In the case of any such individual who is a member of a general professional partnership or a beneficiary of an estate or trust, his proportionate share of such taxes of the general professional partnership or the estate or trust paid or incurred 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 this Title. An alien individual and a foreign corporation shall not be allowed the credits against the tax for the taxes of foreign countries allowed under this paragraph.
(4) Limitations on Credit. - The amount of the credit taken under this Section shall be subject to each of the following limitations: (a) The amount of the credit in respect to the tax paid or incurred to any country shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer's taxable income from sources within such country under this Title bears to his entire taxable income for the same taxable year; and (b) 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 taxable income from sources without the Philippines taxable under this Title bears to his entire taxable income for the same taxable year.
(5) Adjustments on Payment of Incurred Taxes. - If accrued taxes when paid differ from the amounts claimed as credits by the taxpayer, or if any tax paid is refunded in whole or in part, the taxpayer shall notify the Commissioner; who shall redetermine the amount of the tax for the year or years affected, and the amount of tax due upon such redetermination, if any, shall be paid by the taxpayer upon notice and demand by the Commissioner, or the amount of tax overpaid, if any, shall be credited or refunded to the taxpayer. In the case of such a tax incurred but not paid, the Commissioner as a condition precedent to the allowance of this credit may require the taxpayer to give a bond with sureties satisfactory to and to be approved by the Commissioner in such sum as he may require, conditioned upon the payment by the taxpayer of any amount of tax found due upon any such redetermination. The bond herein prescribed shall contain such further conditions as the Commissioner may require. (6) Year in Which Credit Taken. - The credits provided for in Subsection (C)(3) of this Section may, at the option of the taxpayer and irrespective of the method of accounting employed in keeping his books, be taken in the year which the taxes of the foreign country were incurred, subject, however, to the conditions prescribed in Subsection (C)(5) of this Section. If the taxpayer elects to take such credits in the year in which the taxes of the foreign country accrued, the credits for all subsequent years shall be taken upon the same basis and no portion of any such taxes shall be allowed as a deduction in the same or any succeeding year. (7)Proof of Credits. - The credits provided in Subsection (C)(3) hereof shall be allowed only if the taxpayer establishes to the satisfaction of the Commissioner the following:
(a) The total amount of income derived from sources without the Philippines; (b) The amount of income derived from each country, the tax paid or incurred to which is claimed as a credit under said paragraph, such amount to be determined under rules and regulations prescribed by the Secretary of Finance; and Blue Sapphires Copy| Taxation 1 Notes for Finals 2013| Atty. Christopher Malaya 17
(c) All other information necessary for the verification and computation of such credits.
(D) Losses. (1) In General.- Losses actually sustained during the taxable year and not compensated for by insurance or other forms of indemnity shall be allowed as deductions: (a) If incurred in trade, profession or business; (b) Of property connected with the trade, business or profession, if the loss arises from fires, storms, shipwreck, or other casualties, or from robbery, theft or embezzlement. The Secretary of Finance, upon recommendation of the Commissioner, is hereby authorized to promulgate rules and regulations prescribing, among other things, the time and manner by which the taxpayer shall submit a declaration of loss sustained from casualty or from robbery, theft or embezzlement during the taxable year: Provided, however, That the time limit to be so prescribed in the rules and regulations shall not be less than thirty (30) days nor more than ninety (90) days from the date of discovery of the casualty or robbery, theft or embezzlement giving rise to the loss. (c) No loss shall be allowed as a deduction under this Subsection if at the time of the filing of the return, such loss has been claimed as a deduction for estate tax purposes in the estate tax return.
(2) Proof of Loss. - In the case of a nonresident alien individual or foreign corporation, the losses deductible shall be those actually sustained during the year incurred in business, trade or exercise of a profession conducted within the Philippines, when such losses are not compensated for by insurance or other forms of indemnity. The secretary of Finance, upon recommendation of the Commissioner, is hereby authorized to promulgate rules and regulations prescribing, among other things, the time and manner by which the taxpayer shall submit a declaration of loss sustained from casualty or from robbery, theft or embezzlement during the taxable year: Provided, That the time to be so prescribed in the rules and regulations shall not be less than thirty (30) days nor more than ninety (90) days from the date of discovery of the casualty or robbery, theft or embezzlement giving rise to the loss; and (3) Net Operating Loss Carry-Over. - 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: Provided, however, That 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: Provided, further, That a 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-five percent (75%) in nominal value of outstanding issued shares., if the business is in the name of a corporation, is held by or on behalf of the same persons; or (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 'not operating loss' shall mean the excess of allowable deduction over gross income of the business in a taxable year. Provided, That 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 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
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form
the
taxable
income
of
the
next
remaining
four
(4)
years.
(4)
Capital
Losses.
(a) Limitation. - Loss from sales or Exchanges of capital assets shall be allowed only to the extent provided in Section 39. (b) Securities Becoming worthless. - If securities as defined in Section 22 (T) become worthless during the taxable year and are capital assets, the loss resulting therefrom shall, for purposes of this Title, be considered as a loss from the sale or exchange, on the last day of such taxable year, of capital assets.
(5) Losses From Wash Sales of Stock or Securities. - Losses from 'wash sales' of stock or securities as provided in Section 38. (6) Wagering Losses. - Losses from wagering transactions shall b allowed only to the extent of the gains from such transactions. (7) Abandonment Losses. -
(a) In the event a contract area where petroleum operations are undertaken is partially or wholly abandoned, all accumulated exploration and development expenditures pertaining thereto shall be allowed as a deduction: Provided, That accumulated expenditures incurred in that area prior to January 1, 1979 shall be allowed as a deduction only from any income derived from the same contract area. In all cases, notices of abandonment shall be filed with the Commissioner. (b) In case a producing well is subsequently abandoned, the unamortized costs thereof, as well as the undepreciated costs of equipment directly used therein , shall be allowed as a deduction in the year such well, equipment or facility is abandoned by the contractor: Provided, That if such abandoned well is reentered and production is resumed, or if such equipment or facility is restored into service, the said costs shall be included as part of gross income in the year of resumption or restoration and shall be amortized or depreciated, as the case may be.
(E) Bad Debts. (1) In General. - Debts due to the taxpayer actually ascertained to be worthless and charged off within the taxable year except those not connected with profession, trade or business and those sustained in a transaction entered into between parties mentioned under Section 36 (B) of this Code: Provided, That recovery of bad debts previously allowed as deduction in the preceding years shall be included as part of the gross income in the year of recovery to the extent of the income tax benefit of said deduction. (2) Securities Becoming Worthless. - If securities, as defined in Section 22 (T), are ascertained to be worthless and charged off within the taxable year and are capital assets, the loss resulting therefrom shall, in the case of a taxpayer other than a bank or trust company incorporated under the laws of the Philippines a substantial part of whose business is the receipt of deposits, for the purpose of this Title, be considered as a loss from the sale or exchange, on the last day of such taxable year, of capital assets. (F) Depreciation. (1) General Rule. - There shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including reasonable allowance for obsolescence) of property used in the trade or business. In the case of property held by one person for life with remainder to another person, the deduction shall be computed as if the life tenant were the absolute owner of the property and shall be allowed to the life tenant. In the case of property held in trust, the allowable deduction shall be apportioned between the income beneficiaries and the trustees in
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accordance with the pertinent provisions of the instrument creating the trust, or in the absence of such provisions, on the basis of the trust income allowable to each. (2) Use of Certain Methods and Rates. - The term 'reasonable allowance' as used in the preceding paragraph shall include, but not limited to, an allowance computed in accordance with rules and regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner, under any of the following methods:
(a) The straight-line method; (b) Declining-balance method, using a rate not exceeding twice the rate which would have been used had the annual allowance been computed under the method described in Subsection (F) (1); (c) The sum-of-the-years-digit method; and (d) any other method which may be prescribed by the Secretary of Finance upon recommendation of the Commissioner. (3) Agreement as to Useful Life on Which Depreciation Rate is Based. - Where under rules and regulations prescribed by the Secretary of Finance upon recommendation of the Commissioner, the taxpayer and the Commissioner have entered into an agreement in writing specifically dealing with the useful life and rate of depreciation of any property, the rate so agreed upon shall be binding on both the taxpayer and the national Government in the absence of facts and circumstances not taken into consideration during the adoption of such agreement. The responsibility of establishing the existence of such facts and circumstances shall rest with the party initiating the modification. Any change in the agreed rate and useful life of the depreciable property as specified in the agreement shall not be effective for taxable years prior to the taxable year in which notice in writing by certified mail or registered mail is served by the party initiating such change to the other party to the agreement: Provided, however, that where the taxpayer has adopted such useful life and depreciation rate for any depreciable and claimed the depreciation expenses as deduction from his gross income, without any written objection on the part of the Commissioner or his duly authorized representatives, the aforesaid useful life and depreciation rate so adopted by the taxpayer for the aforesaid depreciable asset shall be considered binding for purposes of this Subsection. (4) Depreciation of Properties Used in Petroleum Operations . - An allowance for depreciation in respect of all properties directly related to production of petroleum initially placed in service in a taxable year shall be allowed under the straight-line or declining-balance method of depreciation at the option of the service contractor. However, if the service contractor initially elects the declining-balance method, it may at any subsequent date, shift to the straight-line method. The useful life of properties used in or related to production of petroleum shall be ten (10) years of such shorter life as may be permitted by the Commissioner. Properties not used directly in the production of petroleum shall be depreciated under the straight-line method on the basis of an estimated useful life of five (5) years. (5) Depreciation of Properties Used in Mining Operations. - an allowance for depreciation in respect of all properties used in mining operations other than petroleum operations, shall be computed as follows:
(a) At the normal rate of depreciation if the expected life is ten (10) years or less; or (b) Depreciated over any number of years between five (5) years and the expected life if the latter is more than ten (10) years, and the depreciation thereon allowed as deduction from taxable income: Provided, That the contractor notifies the Commissioner at the beginning of the depreciation period which depreciation rate allowed by this Section will be used.
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(6) Depreciation Deductible by Nonresident Aliens Engaged in Trade or Business or Resident Foreign Corporations . In the case of a nonresident alien individual engaged in trade or business or resident foreign corporation, a reasonable allowance for the deterioration of Property arising out of its use or employment or its non-use in the business trade or profession shall be permitted only when such property is located in the Philippines. (G) Depletion of Oil and Gas Wells and Mines. (1) In General. - In the case of oil and gas wells or mines, a reasonable allowance for depletion or amortization computed in accordance with the cost-depletion method shall be granted under rules and regulations to be prescribed by the Secretary of finance, upon recommendation of the Commissioner. Provided, That when the allowance for depletion shall equal the capital invested no further allowance shall be granted: Provided, further, That after production in commercial quantities has commenced, certain intangible exploration and development drilling costs: (a) shall be deductible in the year incurred if such expenditures are incurred for non-producing wells and/or mines, or (b) shall be deductible in full in the year paid or incurred or at the election of the taxpayer, may be capitalized and amortized if such expenditures incurred are for producing wells and/or mines in the same contract area. 'Intangible costs in petroleum operations' refers to any cost incurred in petroleum operations which in itself has no salvage value and which is incidental to and necessary for the drilling of wells and preparation of wells for the production of petroleum: Provided, That said costs shall not pertain to the acquisition or improvement of property of a character subject to the allowance for depreciation except that the allowances for depreciation on such property shall be deductible under this Subsection. Any intangible exploration, drilling and development expenses allowed as a deduction in computing taxable income during the year shall not be taken into consideration in computing the adjusted cost basis for the purpose of computing allowable cost depletion. (2) Election to Deduct Exploration and Development Expenditures. - In computing taxable income from mining operations, the taxpayer may at his option, deduct exploration and development expenditures accumulated as cost or adjusted basis for cost depletion as of date of prospecting, as well as exploration and development expenditures paid or incurred during the taxable year: Provided, That the amount deductible for exploration and development expenditures shall not exceed twenty-five percent (25%) of the net income from mining operations computed without the benefit of any tax incentives under existing laws. The actual exploration and development expenditures minus twenty-five percent (25%) of the net income from mining shall be carried forward to the succeeding years until fully deducted. The election by the taxpayer to deduct the exploration and development expenditures is irrevocable and shall be binding in succeeding taxable years. 'Net income from mining operations', as used in this Subsection, shall mean gross income from operations less 'allowable deductions' which are necessary or related to mining operations. 'Allowable deductions' shall include mining, milling and marketing expenses, and depreciation of properties directly used in the mining operations. This paragraph shall not apply to expenditures for the acquisition or improvement of property of a character which is subject to the allowance for depreciation. In no case shall this paragraph apply with respect to amounts paid or incurred for the exploration and development of oil and gas. The term 'exploration expenditures' means expenditures paid or incurred for the purpose of ascertaining the existence, location, extent or quality of any deposit of ore or other mineral, and paid or incurred before the beginning of the development stage of the mine or deposit. The term 'development expenditures' means expenditures paid or incurred during the development stage of the mine or other natural deposits. The development stage of a mine or other natural deposit shall begin at the time when deposits of ore or other minerals are shown to exist in sufficient commercial quantity and quality and shall end upon commencement of actual commercial extraction.
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(3) Depletion of Oil and Gas Wells and Mines Deductible by a Nonresident Alien individual or Foreign Corporation . In the case of a nonresident alien individual engaged in trade or business in the Philippines or a resident foreign corporation, allowance for depletion of oil and gas wells or mines under paragraph (1) of this Subsection shall be authorized only in respect to oil and gas wells or mines located within the Philippines.
(H) Charitable and Other Contributions. (1) In General. - Contributions or gifts actually paid or made within the taxable year to, or for the use of the Government of the Philippines or any of its agencies or any political subdivision thereof exclusively for public purposes, or to accredited domestic corporation or associations organized and operated exclusively for religious, charitable, scientific, youth and sports development, cultural or educational purposes or for the rehabilitation of veterans, or to social welfare institutions, or to non-government organizations, in accordance with rules and regulations promulgated by the Secretary of finance, upon recommendation of the Commissioner, no part of the net income of which inures to the benefit of any private stockholder or individual in an amount not in excess of ten percent (10%) in the case of an individual, and five percent (%) in the case of a corporation, of the taxpayer's taxable income derived from trade, business or profession as computed without the benefit of this and the following subparagraphs. (2) Contributions Deductible in Full. - Notwithstanding the provisions of the preceding subparagraph, donations to the following institutions or entities shall be deductible in full;
(a) Donations to the Government. - Donations to the Government of the Philippines or to any of its agencies or political subdivisions, including fully-owned government corporations, exclusively to finance, to provide for, or to be used in undertaking priority activities in education, health, youth and sports development, human settlements, science and culture, and in economic development according to a National Priority Plan determined by the National Economic and Development Authority (NEDA), In consultation with appropriate government agencies, including its regional development councils and private philantrophic persons and institutions: Provided, That any donation which is made to the Government or to any of its agencies or political subdivisions not in accordance with the said annual priority plan shall be subject to the limitations prescribed in paragraph (1) of this Subsection; (b) Donations to Certain Foreign Institutions or International Organizations. - donations to foreign institutions or international organizations which are fully deductible in pursuance of or in compliance with agreements, treaties, or commitments entered into by the Government of the Philippines and the foreign institutions or international organizations or in pursuance of special laws; (c) Donations to Accredited Nongovernment Organizations. - the term 'nongovernment organization' means a non profit domestic corporation:
(1) Organized and operated exclusively for scientific, research, educational, character-building and youth and sports development, health, social welfare, cultural or charitable purposes, or a combination thereof, no part of the net income of which inures to the benefit of any private individual; (2) Which, not later than the 15 day of the third month after the close of the accredited nongovernment organizations 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 in accordance with the rules and regulations to be promulgated, upon recommendation of the Commissioner; (3) The level of administrative expense of which shall, on an annual basis, conform with the rules and regulations to be prescribed by the Secretary of Finance, upon recommendation of the Commissioner, but in no case to exceed thirty percent (30%) of the total expenses; and
th
22
(4) The assets of which, in the even of dissolution, would be distributed to another nonprofit domestic corporation organized for similar purpose or purposes, or to the state for public purpose, or would be distributed by a court to another organization 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. Subject to such terms and conditions as may be prescribed by the Secretary of Finance, the term 'utilization' means: (i) Any amount in cash or in kind (including administrative expenses) paid or utilized to accomplish one or more purposes for which the accredited nongovernment organization was created or organized. (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 nongovernment organization was created or organized. An amount set aside for a specific project which comes within one or more purposes of the accredited nongovernment organization may be treated as a utilization, but only if at the time such amount is set aside, the accredited nongovernment organization has established to the satisfaction of the Commissioner that the amount will be paid for the specific project within a period to be prescribed in rules and regulations to be promulgated by the Secretary of Finance, upon recommendation of the Commissioner, but not to exceed five (5) years, and the project is one which can be better accomplished by setting aside such amount than by immediate payment of funds. (3) Valuation. - The amount of any charitable contribution of property other than money shall be based on the acquisition cost of said property. (4) Proof of Deductions. - Contributions or gifts shall be allowable as deductions only if verified under the rules and regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner.
(I) Research and Development.(1) In General. - a taxpayer may treat research or development expenditures which are paid or incurred by him during the taxable year in connection with his trade, business or profession as ordinary and necessary expenses which are not chargeable to capital account. The expenditures so treated shall be allowed as deduction during the taxable year when paid or incurred. (2) Amortization of Certain Research and Development Expenditures . - At the election of the taxpayer and in accordance with the rules and regulations to be prescribed by the Secretary of Finance, upon recommendation of the Commissioner, the following research and development expenditures may be treated as deferred expenses:
(a) Paid or incurred by the taxpayer in connection with his trade, business or profession; (b) Not treated as expenses under paragraph 91) hereof; and (c) Chargeable to capital account but not chargeable to property of a character which is subject to depreciation or depletion. In computing taxable income, such deferred expenses shall be allowed as deduction ratably distributed over a period of not less than sixty (60) months as may be elected by the taxpayer (beginning with the month in which the taxpayer first realizes benefits from such expenditures). The election provided by paragraph (2) hereof may be made for any taxable year beginning after the effectivity of this Code, but only if made not later than the time prescribed by law for filing the return for such taxable year. The method so elected, and the period selected by the taxpayer, shall be adhered to in Blue Sapphires Copy| Taxation 1 Notes for Finals 2013| Atty. Christopher Malaya 23
computing taxable income for the taxable year for which the election is made and for all subsequent taxable years unless with the approval of the Commissioner, a change to a different method is authorized with respect to a part or all of such expenditures. The election shall not apply to any expenditure paid or incurred during any taxable year for which the taxpayer makes the election.
(3)
Limitations
on
deduction.
This
Subsection
shall
not
apply
to:
(a) Any expenditure for the acquisition or improvement of land, or for the improvement of property to be used in connection with research and development of a character which is subject to depreciation and depletion; and (b) Any expenditure paid or incurred for the purpose of ascertaining the existence, location, extent, or quality of any deposit of ore or other mineral, including oil or gas.
(J) Pension Trusts. - An employer establishing or maintaining a pension trust to provide for the payment of reasonable pensions to his employees shall be allowed as a deduction (in addition to the contributions to such trust during the taxable year to cover the pension liability accruing during the year, allowed as a deduction under Subsection (A) (1) of this Section ) a reasonable amount transferred or paid into such trust during the taxable year in excess of such contributions, but only if such amount (1)has not theretofore been allowed as a deduction, and (2) is apportioned in equal parts over a period of ten (10) consecutive years beginning with the year in which the transfer or payment is made.
(K) Additional Requirements for Deductibility of Certain Payments . - Any amount paid or payable which is otherwise deductible from, or taken into account in computing gross income or for which depreciation or amortization may be allowed under this Section, shall be allowed as a deduction only if it is shown that the tax required to be deducted and withheld therefrom has been paid to the Bureau of Internal Revenue in accordance with this Section 58 and 81 of this Code.
(L) Optional Standard Deduction. - In lieu of the deductions allowed under the preceding Subsections, an individual subject to tax under Section 24, other than a nonresident alien, may elect a standard deduction in an amount not exceeding ten percent (10%) of his gross income. Unless the taxpayer signifies in his return his intention to elect the optional standard deduction, he shall be considered as having availed himself of the deductions allowed in the preceding Subsections. Such election when made in the return shall be irrevocable for the taxable year for which the return is made: Provided, That an individual who is entitled to and claimed for the optional standard deduction shall not be required to submit with his tax return such financial statements otherwise required under this Code: Provided, further, That except when the Commissioner otherwise permits, the said individual shall keep such records pertaining to his gross income during the taxable year, as may be required by the rules and regulations promulgated by the Secretary of Finance, upon recommendation of the Commissioner.
(M) Premium Payments on Health and/or Hospitalization Insurance of an Individual Taxpayer . - the amount of premiums not to exceed Two thousand four hundred pesos (P2,400) per family or Two hundred pesos (P200) a month paid during the taxable year for health and/or hospitalization insurance taken by the taxpayer for himself, including his family, shall be allowed as a deduction from his gross income: Provided, That said family has a gross income of not more than Two hundred fifty thousand pesos (P250,000) for the taxable year: Provided, finally, That in the case of married taxpayers, only the spouse claiming the additional exemption for dependents shall be entitled to this deduction. Notwithstanding the provision of the preceding Subsections, The Secretary of Finance, upon recommendation of the Commissioner, after a public hearing shall have been held for this purpose, may prescribe by rules and regulations, limitations or ceilings for any of the itemized deductions under Subsections (A) to (J) of this Section: Provided, That for purposes of determining such ceilings or limitations, the Secretary of Finance shall consider the following factors: (1) adequacy of the prescribed limits on the actual expenditure requirements of each particular industry; and (2)effects of inflation on expenditure levels: Provided, further, That no ceilings shall further be imposed on items of expense already subject to ceilings under present law.
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ITEMIZED DEDUCTIONS/ ALLOWABLE DEDUCTIONS SEC. 34 (BELT DID CRP) (a) Bad Debts (b) Expenses (c) Losses (d) Taxes (e) Depreciation (f) Interest (g) Depletion of oil & gas wells & mines (h) Charitable & other contributions (i) Research & Development (j) Pension trusts EXCLUSIONS (Sec. 32(b)) 1. Refer to the flow of wealth which are not treated as part of gross income because either exempted by the constitution or statute or do not come within the definition of income. 2. Pertain to the computation of gross income. DEDUCTIONS Sec. 34 1. Refer to the amounts which the law allows to be deducted from gross income in order to arrive at net income
2.
Pertain to the computation of net income (part of allowable deductions). Something spent or paid in earning of gross income.
3.
Something earned or received by the taxpayer which does not form part of gross income.
3.
1. EXPENSES (SEC 34A) 1) Ordinary & necessary trade, business or professional expenses only REQUISITIES FOR DEDUCTIBILITY (SPOD RYN): 1. It must be ORDINARY AND NECESSARY. Ordinary - expense which is normal in relation to the taxpayers business and the surrounding circumstances. The expense need not be recurring. *Expenses that usually increase the profit. i.e. advertisement Necessary where the expenditure is appropriate or helpful in the development of the taxpayers business or that the same is proper for the purpose of realizing a profit or minimizing a loss. The TWO CONDITIONS MUST CONCUR. A court may decide on when an expense is, or is not, ordinary, but as much as possible, it will refuse to substitute its judgment for that of the taxpayer on the necessity of an expense. 2. It must be paid or incurred during the taxable YEAR 3. It must be paid or incurred in carrying on or which are DIRECTLY attributable to, the development, management, operation and/or conduct of the trade, business or exercise of a profession. 4. The amount must be REASONABLE. 5. It must be SUBSTANTIATED with sufficient evidence, such as official receipts or other adequate records, showing: i. the amount of the expense being deducted; and ii. the direct connection or relation of the expense being deducted to the development, management, operation and/or conduct of the trade, business or profession of the taxpayer. 6. It is NOT CONTRARY to law, public policy or morals. 7. The tax required to be withheld on the amount paid or payable must have been PAID to the BIR by the taxpayer, who is constituted as a withholding agent of the government (for instance, withholding tax on compensation income paid to employees, fringe benefit tax on fringe benefits given to managerial and supervisory employees, etc.). (Sec. 2.58.5, RR 298 as amended by Sec. 6, RR 14-2002)
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EXAMPLES: (CERT) 1. Salaries, wages, and other forms of compensation for personal services actually rendered, including the grossed-up monetary value (GMV) of fringe benefit furnished by the employer to the employee 2. Travel expenses, here and abroad, while away from home in the pursuit of trade, business or profession 3. Rentals and/or other payments which are required as a condition for the continued use or possession, for purposes of the trade, business or profession, of property to which the taxpayer has not taken or is not taking title or in which he has no equity other than that of a lessee, user or possessor 4. 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 or its trade, business or exercise of a profession Representation Expenses [Sec. 2, RR 10-2002] incurred by a taxpayer in connection with the conduct of his trade, business or exercise of profession, in entertaining, providing amusement and recreation to, or meeting with, a guest or guests at a dining place, place of amusement, country club, theater, concert, play, sporting event, and similar events or places. Ceiling [Sec. 5, RR 10-2002] The amount of actual entertainment, amusement and recreation expense paid or incurred within the taxable year by the taxpayer, but in no case shall such deduction exceed: For taxpayers engaged in sale of goods or properties: 0.5% of net sales (i.e., gross sales less sales returns/allowances and sales discounts) For taxpayers engaged in sale of services, including exercise of profession and use or lease of properties: 1.0% of net revenue (i.e., gross revenue less discounts)
2) Substantiation Requirements: sufficient evidence (i.e. official receipts, financial statements or other adequate records) to substantiate: (a) amt. of expense deducted (b) direct connection/relation of the expense to the development, management operation &/or conduct of the trade, business or profession of the taxpayer 3) Bribes, Kickbacks & Other Similar Payments: NOT deductible While illegal income will form part of the income of the taxpayer, expenses which constitute bribe, kickback, and other similar payment, being against law and public policy are not deductible from gross income (Sec. 34A1c). Business expense expenditure related to the business that is deductible in the year incurred, in the same taxable year. Capital expense expenditure that improves or adds to the value of your property or equipment. Not immediately deductible. It is deductible over time, such as in the form of depreciation. Expenses allowable to private educational institutions: In addition to the expenses allowable as deductions, a private educational institution has the option to elect either: (a) to deduct as expense those otherwise considered as capital outlays of depreciable assets for the expansion of school facilities (b) to capitalize asset & deduct allowance for depreciation
Paper Industries Corporation of the Philippines vs. CA Facts: PICOP received from the Commissioner of Internal Revenue ("CIR") a letter of assessment and demand for deficiency income tax. The CIR alleged that PICOP should not be allowed to claim as deductible expenses the net operating losses of another corporation (i.e., Rustan Pulp and Paper Mills, Inc Issue: WON PICOP should be allowed to claim as allowable deductions the net operating loss of another corporation (Rustan) that it merged with. Held:
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Picop entered into a merger agreement with the Rustan Pulp and Paper Mills, Inc. ("RPPM") and Rustan Manufacturing Corporation ("RMC"). Under this agreement, the rights, properties, privileges, powers and franchises of RPPM and RMC were to be transferred, assigned and conveyed to Picop as the surviving corporation. Immediately before merger effective date, RPPM had accumulated losses over the preceding years. In its Income Tax Return, Picop claimed P44,196,106.00 of RPPM's accumulated losses as a deduction against Picop's gross income. The SC ruled that PICOP should not be allowed to claim as deductions RPPMs accumulated losses. In the instant case, to allow the deduction claimed by Picop would be to permit one corporation or enterprise, Picop, to benefit from the operating losses accumulated by another corporation or enterprise, RPPM. To grant Picop's claimed deduction would be to permit Picop to shelter its otherwise taxable income (an objective which Picop had from the very beginning) which had not been earned by the registered enterprise which had suffered the accumulated losses. In effect, to grant Picop's claimed deduction would be to permit Picop to purchase a tax deduction and RPPM to peddle its accumulated operating losses. Under the CTA and Court of Appeals decisions, Picop would benefit by immunizing P44,196,106.00 of its income from taxation thereof although Picop had not run the risks and incurred the losses which had been encountered and suffered by RPPM. Conversely, the income that would be shielded from taxation is not income that was, after much effort, eventually generated by the same registered operations which earlier had sustained losses. The CTA and the CA allowed the deductions, basically because towards the end of the taxable year, upon the arrival of the effective date of merger, only one (1) corporation, Picop, remained. The losses suffered by RPPM's registered operations and the gross income generated by Picop's own registered operations now came under one and the same corporate roof. We consider that this circumstance relates much more to form than to substance. We do not believe that that single purely technical factor is enough to authorize and justify the deduction claimed by Picop. CIR vs. Isabela Cultural Corporation Facts: ICC received from the BIR an Assessment Notice for deficiency income tax in the amount of P333,196.86, for the taxable year 1986. The deficiency income tax of P333,196.86, arose from: (1) The BIRs disallowance of ICCs claimed expense deductions for professional and security services billed to and paid by ICC in 1986, to wit: (a) Expenses for the auditing services for the year 1985; (b) Expenses for the legal services for the years 1984 and 1985. (c) Expense for security services of April and May 1986. The CTA rendered a decision canceling and setting aside the assessment notice issued against ICC. It held that the claimed deductions for professional and security services were properly claimed by ICC in 1986 because it was only in the said year when the bills demanding payment were sent to ICC. Hence, even if some of these professional services were rendered to ICC in 1984 or 1985, it could not declare the same as deduction for the said years as the amount thereof could not be determined at that time. Petitioner filed the instant petition contending that since ICC is using the accrual method of accounting, the expenses for the professional services that accrued in 1984 and 1985, should have been declared as deductions from income during the said years and the failure of ICC to do so bars it from claiming said expenses as deduction for the taxable year 1986. Issue: WON ICC can claim as deductions the expenses for auditing(1985), legal services(1984 and 1985) and for security services(April and May 1986). Held: The requisites for the deductibility of ordinary and necessary trade, business, or professional expenses, like expenses paid for legal and auditing services, are: (a) the expense must be ordinary and necessary; (b) it must have been paid or incurred during the taxable year; (c) it must have been paid or incurred in carrying on the trade or business of the taxpayer; and (d) it must be supported by receipts, records or other pertinent papers. The requisite that it must have been paid or incurred during the taxable year is further qualified by Section 45 of the National Internal Revenue Code (NIRC) which states that: "[t]he deduction provided for in this Title shall be taken for the taxable year in which paid or accrued or paid or incurred, dependent upon the method of accounting upon the basis of which the net income is computed x x x". In the instant case, the accounting method used by ICC is the accrual method.
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Under the accrual method of accounting, expenses not being claimed as deductions by a taxpayer in the current year when they are incurred cannot be claimed as deduction from income for the succeeding year. Thus, a taxpayer who is authorized to deduct certain expenses and other allowable deductions for the current year but failed to do so cannot deduct the same for the next year. The accrual method relies upon the taxpayers right to receive amounts or its obligation to pay them, in opposition to actual receipt or payment, which characterizes the cash method of accounting. Amounts of income accrue where the right to receive them become fixed, where there is created an enforceable liability. Similarly, liabilities are accrued when fixed and determinable in amount, without regard to indeterminacy merely of time of payment. For a taxpayer using the accrual method, the determinative question is, when do the facts present themselves in such a manner that the taxpayer must recognize income or expense? The accrual of income and expense is permitted when the all-events test has been met. This test requires: (1) fixing of a right to income or liability to pay; and (2) the availability of the reasonable accurate determination of such income or liability. The all-events test requires the right to income or liability be fixed, and the amount of such income or liability be determined with reasonable accuracy. However, the test does not demand that the amount of income or liability be known absolutely, only that a taxpayer has at his disposal the information necessary to compute the amount with reasonable accuracy. The amount of liability does not have to be determined exactly; it must be determined with "reasonable accuracy." Accordingly, the term "reasonable accuracy" implies something less than an exact or completely accurate amount. The propriety of an accrual must be judged by the facts that a taxpayer knew, or could reasonably be expected to have known, at the closing of its books for the taxable year. Accrual method of accounting presents largely a question of fact; such that the taxpayer bears the burden of proof of establishing the accrual of an item of income or deduction. In the instant case, the expenses for professional fees consist of expenses for legal and auditing services. The expenses for legal services pertain to the 1984 and 1985 legal and retainer fees of the law firm Bengzon Zarraga Narciso Cudala Pecson Azcuna & Bengson, and for reimbursement of the expenses of said firm in connection with ICCs tax problems for the year 1984. As testified by the Treasurer of ICC, the firm has been its counsel since the 1960s. From the nature of the claimed deductions and the span of time during which the firm was retained, ICC can be expected to have reasonably known the retainer fees charged by the firm as well as the compensation for its legal services. The failure to determine the exact amount of the expense during the taxable year when they could have been claimed as deductions cannot thus be attributed solely to the delayed billing of these liabilities by the firm. For one, ICC, in the exercise of due diligence could have inquired into the amount of their obligation to the firm, especially so that it is using the accrual method of accounting. For another, it could have reasonably determined the amount of legal and retainer fees owing to its familiarity with the rates charged by their long time legal consultant. In the same vein, the professional fees of SGV & Co. for auditing the financial statements of ICC for the year 1985 cannot be validly claimed as expense deductions in 1986. This is so because ICC failed to present evidence showing that even with only "reasonable accuracy," as the standard to ascertain its liability to SGV & Co. in the year 1985, it cannot determine the professional fees which said company would charge for its services. ICC thus failed to discharge the burden of proving that the claimed expense deductions for the professional services were allowable deductions for the taxable year 1986. As to the expenses for security services, the records show that these expenses were incurred by ICC in 1986 and could therefore be properly claimed as deductions for the said year.
2. INTEREST Requisites for deductibility: 1. there must be an indebtedness 2. there should be an interest expense paid or incurred upon such indebtedness 3. indebtedness must be that of the taxpayer 4. indebtedness must be connected with the taxpayers trade, business or exercise of profession 5. interest expense must have been paid or incurred during the taxable year 6. interest must have been stipulated in writing 7. interest must be legally due 8. interest payment arrangement must not be between related taxpayers 9. interest must not be incurred to finance petroleum operations 10. in case of interest incurred to acquire property used in trade, business or exercise of profession, the same was not treated as a capital expenditure 11. the interest is not expressly disallowed by law to be deducted from gross income of the taxpayer.
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LIMITATION ON DEDUCTION Interest expense shall be reduced by an amt. equal to the ff. % of interest income subjected to 33%: Example: Int. exp. = P2,000 Int. income subjected to FT = P1,500 Deduct as int. exp.: P2,000 - (P1,500 x 33%) = P1,505 The objective of the limitation is to discourage tax arbitrage on back to back loans, the proceeds of which are invested in income earning interest that is subject to 20% final tax. Tax arbitrage- is a method of borrowing without entering into a debtor/creditor relationship, often to resolve financing and exchange control problems. In tax cases, back-to-back loan is used to take advantage of the lower rate of tax on interest income and a higher rate of tax on interest expense deduction. DEDUCTIBLE INTEREST EXPENSE: 1. interest on taxes, such as those paid for deficiency or delinquency, since taxes are considered indebtedness (provided that the tax is a deductible tax, except in the case of income tax). However, fines, penalties, and surcharges on account of taxes are not deductible. The interest on unpaid business tax shall not be subjected to the limitation on deduction. 2. Interest paid by a corporation on scrip dividends. 3. Interest on deposits paid by authorized banks of the BSP to depositors, if it is shown that the tax on such interest was withheld. 4. Interest paid by a corporate taxpayer who is liable on a mortgage upon real property of which the said corporation is the legal or equitable owner, even though it is not directly liable for the indebtedness. NON-DEDUCTIBLE INTEREST (a) interest paid in advance through discount or otherwise(in case of cash basis taxpayer) allowed as deduction in the year the debt is paid if indebtedness is payable in periodic amortizations, int. is deducted in proportion of the amt. of the principal paid. (b) payments made: 1. between members of a family (include only brothers & sisters, spouse, ancestors, & lineal descendants) 2. between an individual & a corp. more than 50% in value of outstanding stock is owned by such individual (except in case of distributions in liquidation) 3. between 2 corps. more than 50% in value of outstanding stock owned by same individual, if either one is a personal holding co. or a foreign holding co. during the taxable yr. preceding the date of sale/exchange 4. between grantor & fiduciary of any trust 5. between Fiduciary of a trust & the fiduciary of another if same person is a grantor to each trust 6. between Fiduciary & a beneficiary of a trust 7. indebtedness is incurred by a service contractor to finance petroleum corp. 8. interest on preferred stock which in reality is dividend 9. interest on unpaid salaries and bonuses 10. interest calculated for cost keeping on account of capital or surplus invested in business which does not represent charges arising under interest-bearing obligation 11. interest paid when there is no stipulation for the payment thereof OPTIONAL TREATMENT OF INTEREST EXPENSE - at the option of taxpayer, interest incurred to acquire property used in trade or business may be allowed as: (a) as expense (deduction) (b) as capital expenditure 3. TAXES The term taxes refers to national and local taxes, and means TAXES PROPER, hence, no deductions are allowed for: Interests surcharges penalties or fines incident to delinquency (sec. 80, Rev. Reg. 2)
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DEDUCTIBLE TAXES - All taxes, national, or local, paid or incurred during the taxable year in connection with the taxpayers profession, trade or business, are deductible from gross income. REQUISITES FOR DEDUCTIBILITY (TEDY): a. it must be paid or incurred within the taxable Year b. it must be paid or incurred in connection with the taxpayers Trade, profession or business c. it must be imposed Directly on the taxpayer d. it must not be specifically Excluded by law from being deducted from the taxpayers gross income NON-DEDUCTIBLE TAXES (a) Philippine income tax (but FBT can be deducted from gross income RR 8-98)) (b) income tax imposed by authority of any foreign country (except when the taxpayer signifies his desire to avail of the tax credit for taxes of foreign countries) (c) estate & donors taxes (d) taxes assessed against local benefits of a kind tending to increase the value of the property assessed (e) final taxes, being in the nature of income tax (f) special assessments Taxes, when refunded or credited, shall be included as part of GI in the year of receipt to the extent of income tax benefit of said deduction. (Tax Benefit Rule) For NRAETB and RFC, taxes paid or incurred are allowed as deductions only if and to the extent that they are connected from income within the Philippines.
Tax Credit: a right of an income taxpayer to deduct from income tax payable the foreign income tax he has paid to his foreign country subject to limitation. Tax credit is given to a taxpayer in order to provide relief from too onerous a burden of taxation where the same income is subject to both foreign income tax and the Philippine income tax. In determining the tax credit that may be allowed a taxpayer, the foreign income tax should be understood to mean tax proper only; no credit shall be taken for any amount paid or incurred to the foreign country which represents interest, surcharge or penalty incident WHO CAN CLAIM? 1. Citizen 2. Domestic Corp 3. Member of GPP 4. Beneficiary of an estate or trust WHO CANNOT CLAIM? 1. Alien individual (except resident aliens deriving income from within & without the Philippines, if there is reciprocity) 2. Foreign Corp. Substantiation requirements: The tax credits shall be allowed only if the taxpayer establishes to the satisfaction of the Commissioner the following: 1. The total amount of income derived from sources without the Philippines; 2. The amount of income derived from each country, the tax paid or incurred to which is claimed as a credit under said paragraph, such amount to be determined under rules and regulations prescribed by the Secretary of Finance; and 3. All other information necessary for the verification and computation of such credits. What amount may be taken as tax credit: The amount of tax credit allowed is equivalent to the tax paid or incurred to a foreign country during the taxable year but NOT TO EXCEED THE FOLLOWING LIMITS: Per Country Limitation Amount of credit to tax paid/incurred to any country shall not exceed same proportion of the tax against which such credit is taken.
Income from OUTSIDE the Phils. (Per Country) Income WITHIN the Philippines
Total Income from ALL SOURCES = Limitation Per Country
30
Income from outside the Phils (per country)
>
Income from foreign country
Global Limitation Total amount of credit shall not exceed same proportion of tax which such credit is taken.
Income from OUTSIDE the Phils (Per Country) Total income from ALL SOURCES
Income from WITHIN the Phils. = Global Limitation
Income from outside the Phils (per country)
>
Income from foreign country
WHEN CREDIT FOR TAXES MAY BE TAKEN: - The credit for taxes provided by Section 34(C)(3) to (7) 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 cash receipts and disbursements.
Optional Standard Deductions 1. No need to substantiate (i.e., no need to keep invoices and receipts) 2. Less complicated
Itemized Deductions 1. There is a need to substantiate 2. More complicated
Taxpayers usually choose itemized deductions because it will give them less taxable income. Optional Standard Deductions (OSD) in lieu of a to j (Itemized deductions/allowable deductions) Rate: 40% Who can avail of OSD? Individual Taxpayers: 1. Resident Citizen 2. Non-Resident Citizen 3. Resident Alien Tax Base: Gross Sales/Receipts Gross Sales [Tax base for individual taxpayers] Less: Cost of Sales Gross Income [Tax base for corporate taxpayers] Taxpayer (enumerated above) has option to select. However, once chosen, it is irrevocable for the taxable year.
Corporate Taxpayers: 1. Domestic Corporation 2. Resident Foreign Corporation Tax Base: Gross Income
I.4.4 Losses Loss vs. Net Operating Loss Lossthing is totally extinguished and owner is deprived of his possession unintentionally Net Operating Loss Gross Sales Less: Cost of Salecost of raw materials (not part of allowable deduction) _______________________ Gross Profit (in taxation its Gross Income from business) Less: allowable deductions Ordinary and necessary expenses (e.g. rental, wage, utility) Income Subject to Taxwhen gross income is higher than allowable deductions Net Operating Loss Blue Sapphires Copy| Taxation 1 Notes for Finals 2013| Atty. Christopher Malaya 31
when allowable deductions is higher than gross income can be carried over to the next three years cannot be used to reduce your compensation income because compensation earners are allowed only Basic Personal Exemption and Additional Exemption Net Operating Loss Carry-Over (NOLCO) o requires that stockholders of the party to whom the net operating loss is attributable, gains or retains 75% or more interest after a change of ownership i.e. no substantial change in ownership o cannot be deferred for whatever reason when a company opts to avail of an Optional Standard Deduction (instead of itemized deduction you will deduct 40% of the amount of gross income in lieu of itemized deduction); there is no loss/ no NOLCO i.e., three-year reglementary period on the carry-over of NOLCO shall continue to run, it will not extend the three year period, three year period shall continue to run notwithstanding the fact that corporation paid its income tax under the Minimum Corporate Income Tax computation instead of normal income tax
I.4.4.1 Requisites for deductibility 1. loss claimed as deduction must be that of a taxpayer If for example, there are three business segments what if one segment is losing (gross income is less than allowable deductions) can expense be shifted to the other two segments? Can the excess loss be absorbed by the other two segments to form part of the other two segments allowable deductions? No, it cannot be shifted, following the first requisite, it must be personal and not transferrable. 2. loss incurred in connection with trade, business or profession those involving the properties of the business excludes personal properties 3. loss must have been sustained during the taxable year A loss of 100K due to embezzlement was discovered the following year in January. The loss however, occurred in December. When can you deduct? From the time of the discovery. 4. submit a declaration of loss sustained during the taxable year BIR regulation: within 45 days of discovery NIRC: in not less than 30 days nor more than 90 days from the date of discovery of such loss 5. no loss shall be allowed as deduction if at the time of filing of the return, such loss has been claimed as a deduction for estate tax estate tax returndeductions from gross estate includes expenses/ losses/ interest taxes taxpayer has the option to either make the loss part of estate tax OR to deduct it as part of income tax return (choose only one) 6. loss evidenced by a closed and completed transaction 7. loss not compensated by insurance or other form of indemnity I4.4.2 Wagering losses tax rule: deductible only to the extent of gain or winning gross income in form of business income of 500K and wagering/gambling gain 100K, wagering loss of 150K : the excess of 50K is not an allowable deduction; only 100K is deductible o NOT deductible: excess of loss over the gain if the wagering loss is 100K and wagering gain is 150K, the income subject to tax is 550K composed of 500K business income, deduct wagering loss from wagering gain: 150K-100K=50K is taxable o TAXABLE: the excess of the gain over loss losses incurred from an investment in a wagering transaction can be allowed as deduction only up to the extent of gains realized NOT deductible (Dimaampao): Blue Sapphires Copy| Taxation 1 Notes for Finals 2013| Atty. Christopher Malaya 32
o o
losses from sweepstakes winnings because it is EXEMPT from taxation losses from an illegal transaction (neither can it be offset against gains from a legal transaction)
I.4.4.3 Losses on wash sales of stocks (61-day sale) Requisites: 1. taxpayer must have bought or sold stocks or securities; 2. substantially identical stock or securities are acquired within a period beginning 30 days before the date of sale and ending 30 days after such date; o 2% preferred share of stock of San Miguel Corporation, what is the substantially identical share? Substantially identical share is also 2% preferred share of stock of San Miguel Corporation. o 30 days prior or 30 days after a purchase or sale is made o If for example, stock bought for P100, 30 days after you sell it for P90, can you deduct the P10 as a loss? Yes, it is deductible; it is a close and completed transaction that cannot be recovered. o Purchased share for P100 30 days prior, sold it for P90, then purchased another share at P100 before the end of the 30-day period, will you deduct the loss incurred that day? No, it is a temporary loss that cannot be deducted. The loss of P10 is not permanent (the taxpayer is trying to play in the market in order not to lose so much), there is an intention to sell because within that 30 days after the sale there was a purchase of substantially the same share of stock. That P10 loss will not be deductible and instead capitalized as part of the subsequent purchase. The amount is P100 but the cost is P110 because of the short time, the loss here is considered temporary. 3. there must have been sale or disposition of stocks or securities; 4. not limited to situations where the replacement is acquired by purchase. It also applies to acquisition through a taxable exchange and the making of an option contract; 5. the seller is not a dealer in securities o holds the share for his own consumption Reasons for non-deductibility of loss from wash sale: o prevent deduction of losses on sales of stock or securities that were replaced by substantially identical stocks or securities. o loss is added to the cost of the subsequently acquired securities/stock. Hence a mere artificial loss. Losses due to voluntary removal of building incident to renewal or replacement If you buy a house and lot and the purpose was to construct a building on it and you have to demolish the old residential house on that land, will you consider the value of the old residential house as a loss? It is not a loss, instead it is an investment which should be included as part of the value of the land. (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.) Casualty loss Requisites: 1. loss arising from fire, storms, robbery, theft or embezzlement 2. sworn declaration of loss must be filed with the BIR within 45 days after the date of the occurrence 3. loss incurred for properties actually used in the business enterprise 4. loss not compensated by insurance or other form of indemnity I.4.4.4 Loss in shrinkage in value of stock Prices of stock fluctuate, changing everyday, if for example, you purchased one share for P100, and the next day when you opened the newspaper, it jumped to P99, theres a loss of P1, is that a deductible loss? Should that form part of the allowable deduction? Generally no, it cannot be deducted because it is only a loss that is temporary in nature unless it becomes permanent or a close and completed transaction. It becomes an actual and permanent loss that can be deductible when there is: o actual sale or disposal
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the status of the business is already closed e.g. you are a stockholder of Atlas mining owning 100 shares of stock, here you suffer a permanent loss which is a deductible loss even though there was no disposal
I.4.5 Bad Debts I.4.5.1 Requisites for deductibility 1. existence of a valid debt and subsisting debt (legal and factual). 2. debts must be actually ascertained to be worthless. before a debt can be ascertained to be worthless, the taxpayer must also show that it is indeed uncollectible in the future Collection case in court is not always necessary as long creditor could show that during the years he attempted to collect the debt. Factors affecting worthlessness o bankruptcy or insolvency of the debtor; o insufficiency of the collateral o statute of limitation o death of the debtor leaving no assets o injury of the debtor making it impossible for him to earn a living o meager amount involved o improbability of success of judicial collection o destruction by fire of original invoices evidencing the indebtedness 3. debt must be charged off within the year of worthlessness 4. debt arises from business or trade. 5. does not arise from transactions between related taxpayers Related Parties under Sec. 36 (B) Losses from Sales or Exchanges of Property. - In computing net income, no deductions 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 descendants; or (2) Except in the case of distributions in liquidation, between an individual and 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 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 of exchange was under the law applicable to such taxable year, a personal holding company or a foreign personal holding company; (4) Between the grantor and a fiduciary of any trust; or (5) Between the fiduciary of and the 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 beneficiary of such trust. I.4.5.2 Philippine Refining Company v CA 256 SCRA 667 FACTS: Philippine Refining Company (PRC) has a claim for deduction as bad debts of several accounts in the total sum of P395,324,27 PRC protested the tax assessment on the ground that it was based on the erroneous disallowances of "bad debts" and "interest expense" although the same are both allowable and legal deductions. The CA ruled that PRC did not satisfy the requirements of "worthlessness of a debt" as to the thirteen (13) accounts disallowed as deductions. ISSUE: Whether or not PRCs claim for deduction as bad debts should be allowed. HELD: No, PRC was unable to show proof of its efforts to collect the debts, even by a single demand letter therefor. While it is not required to file suit, it is at least expected by the law to produce reasonable proof that the debts are uncollectible although diligent efforts were exerted to collect the same.
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Collector vs. Goodrich International Rubber Co., which established the rule in determining the "worthlessness of a debt." In said case, we held that for debts to be considered as "worthless," and thereby qualify as "bad debts" making them deductible, the taxpayer should show that (1) there is a valid and subsisting debt; (2) the debt must be actually ascertained to be worthless and uncollectible during the taxable year; (3) the debt must be charged off during the taxable year; and (4) the debt must arise from the business or trade of the taxpayer. Additionally, before a debt can be considered worthless, the taxpayer must also show that it is indeed uncollectible even in the future. Furthermore, there are steps outlined to be undertaken by the taxpayer to prove that he exerted diligent efforts to collect the debts, viz: (1) sending of statement of accounts; (2) sending of collection letters; (3) giving the account to a lawyer for collection; and (4) filing a collection case in court. Depreciation Depreciable assets Depletion Natural resources
I.4.6 Depreciation method on how to apportion the total loss overtime arising from normal wear and tear, exhaustion and obsolescence of property used in the trade or business Methods of Depreciation o straight-line method o declining balance o sum-of-the-years-digit method e.g. building will stay in good condition for not more than 40 years, if constructed for 2M that should be charged over 40yrs I.4.7 Depletion Wasting assets which are physically consumable and irreplaceable allocation of the cost or other basis of wasting asset over the period the natural resource is extracted or produced it enables the taxpayer to recover the capital interest-free from income tax, at its cost or some other basis e.g. mineral ore found in a property bought for 40M that ore will be worth 40M determine the number of units that can be recovered in the property I.4.8 Charitable and Other Contributions donation for charitable purposes 2 types o full deductibilityhow much you contributed will be part of the deduction donations to the government (charity projects) donations to international organizations donations to NGOs 1. will not inure to the benefit of a private individual, and is exclusively for a. scientific b. research c. character building d. youth and sports development e. health f. social welfare g. cultural h. charitable i. any combination thereof th rd 2. utilized not later than 15 day of the 3 month following the close of its taxable year 3. administrative expense must not exceed 30% of total expenses 4. upon dissolution, assets must be distributed to another non-profit domestic corporation or to the state o partial deductibilityonly portion of amount contributed can be deducted (5% for corporate donor or 10% for an individual donor of Net Income before Charitable Contribution) donations to the Philippine Government or to any of its agencies or political subdivision exclusively for public purposes donations to accredited domestic corporations or associations organized and operated exclusively for religious, charitable, scientific, youth and sports development, cultural or educational purposes, or for the rehabilitation of veterans , or to social welfare institutions, or to NGOs Blue Sapphires Copy| Taxation 1 Notes for Finals 2013| Atty. Christopher Malaya 35
not in accordance with priority plan conditions are not complied with If taxpayer donates money to the church it falls under partial deductibility Requisites for deductibility 1. contribution or gift must be actually paid during the taxable year 2. must be given to the organization specified by Tax Code or special law 3. the net income of the institution must not inure to the benefit of any member or individual 4. it must not be in excess of 10% for an individual donor and 5% for a corporate donors income before the deduction for charitable contributions 5. taxpayer engaged in trade, business or profession engaged in trade and business (does not have to be related to trade and business or in furtherance thereof) e.g. if youre a furniture business and donate money to the church, then that is still considered a deductible contribution I.4.9 Research and Development costs specifically related to research and development like the research activities attributed to the creation of a new product defer expenses through time total amount accumulated is deductible as: o ordinary and necessary expense (outright, for the taxable year) OR o capitalized and apportioned over five years I.4.10 Pension Trust Contribution employer establishing or maintaining a pension trust for his employees reasonable amount transferred or paid into such trust during the taxable year in excess of such contributions if: o amount has not been allowed as a deduction and o is apportioned in equal parts over a period of ten consecutive years beginning with the year in which the transfer or payment is made companys own retirement plan for its employees amount contributed will be deducted on a yearly basis in a scenario wherein a company is already operating before establishment of the retirement plan, in an accounting to come up with the proper matching of revenue and expenses, compute the retirement cost for the employees already working with the company before establishment of retirement plan, that pension cost called past pension th cost will have to be deducted not as an outright expense but over 10 yrs. On the 10 year past pension cost is 10M, will have to be amortized for 10 years i.e., 2M per year. I.4.11 Optional Standard Deductions instead of itemized deduction you will deduct 40% of the amount of gross income in lieu of itemized deduction I.4.12 Non-deductible Expenses (Sec 36, NIRC) SEC. 36. Items Not Deductible.(A) General Rule. - In computing net income, no deduction shall in any case be allowed in respect to (1) Personal, living or family expenses; o in lieu of such there is BPE of 50K/month (2) Any amount paid out for new buildings or for permanent improvements, or betterments made to increase the value of any property or estate o not deducted outright as ordinary and necessary expenses BUT capitalized and deductible as depreciation 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 o not deducted outright as ordinary and necessary expenses BUT capitalized and deductible as depreciation (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. o Company insured the life of the CEO and the beneficiary is the Company, is that a deductible expense? Not deductible. o The Company insures the CEO, the beneficiaries are his spouse and children. Is that deductible expense? Yes, deductible because the beneficiary is OTHER than the Company. (5) (NOT under NIRC) losses from sales or exchanges of property between related taxpayers
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J.
Accounting Methods and Periods, and Filing of Income Tax Returns J.1. Accounting Methods
Accounting method method of accounting of income and expenses of the taxpayer
1. A.
Principal methods Cash method Recognition of income and expense dependent on inflow or outflow of cash. Accrual method Method under which income, gains and profits are included in gross income when earned whether received or not, and expenses are allowed as deductions when incurred: although not yet paid. It is the right to receive and not the actual receipt that determines the inclusion of the amount in gross income Examples: 1. interest or rent income earned but not yet received 2. rent expense accrued but not yet paid 3. wages due to workers but remaining unpaid
B.
C. Hybrid method method of accounting under which the taxpayer reports his income and expenses by employing combination of cash and accrual methods. Its use is impliedly authorized by the provision of the Tax Code which gives the taxpayer the option to adopt such form or system of accounting as in his judgment is best suited for his purpose subject to the limitation that it clearly reflects his true income.
Other methods of accounting in the tax code: 1. 2. 3. Installment method theres possibility of uncollectability Percentage of completion method used for building, installation or construction contracts; either based on architects/engineers estimate of completion (in the tax code) or the total cost Crop year basis expenses are deducted in the year in which the gross income from the crop has been realized
-common to the 3: it takes more than one year to complete one cycle, or to earn revenues Section 48. Accounting for Long-term Contracts. - Income from long-term contracts shall be reported for tax purposes in the manner as provided in this Section. As used herein, the term 'long-term contracts' means building, installation or construction contracts covering a period in excess of one (1) year. Persons whose gross income is derived in whole or in part from such contracts shall report such income upon the basis of percentage of completion. The return should be accompanied by a return certificate of architects or engineers showing the percentage of completion during the taxable year of the entire work performed under 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 material and supplies on hand at the beginning and end of the taxable period for use in connection with the work under the contract but not yet so applied. If upon completion of a contract, it is found that the taxable net income arising thereunder has not been clearly reflected for any year or years, the Commissioner may permit or require an amended return. -percentage of completion method Gross profit rate = income/contract cost J.2. Accounting Periods
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Accounting period is the taxable year. It is a fixed period of time, consisting of 12 months, upon the basis of which the taxable income is computed and the income tax imposed. 2 kinds of accounting period: Calendar year a period of 12 months beginning January 1 and ending December 31 of every year Fiscal year a period of 12 months ending on the last day of any month other than December Short-term period:
Sec. 6(D) Authority to Terminate Taxable Period. _ When it shall come to the knowledge of the Commissioner that a taxpayer is retiring from business subject to tax, or is intending to leave the Philippines or to remove his property therefrom or to hide or conceal his property, or is performing any act tending to obstruct the proceedings for the collection of the tax for the past or current quarter or year or to render the same totally or partly ineffective unless such proceedings are begun immediately, the Commissioner shall declare the tax period of such taxpayer terminated at any time and shall send the taxpayer a notice of such decision, together with a request for the immediate payment of the tax for the period so declared terminated and the tax for the preceding year or quarter, or such portion thereof as may be unpaid, and said taxes shall be due and payable immediately and shall be subject to all the penalties hereafter prescribed, unless paid within the time fixed in the demand made by the Commissioner. - 5 instances in the Tax Code (in yellow highlight) Other instances: Newly organized and commenced operations A corporation changes its accounting period A corporation is dissolved Final return of decedent Individuals, estates or trusts, and GPPs are required to compute their taxable income on the basis of the calendar year only. A corporation may employ either calendar year or fiscal year as a basis for filing its annual income tax return. It shall not change the accounting period employed w/o prior approval of the Commissioner.
Individual taxpayer, estates or trusts, GPP only calendar year basis Corporate taxpayer can choose between fiscal year or calendar year; if it doesnt choose the presumption is calendar year You cannot change the accounting period without prior approval of the Commissioner
J.3. Sec. 51.
Individuals not required to file ITRs
The following individuals shall not be required to file an income tax return;
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(a) An individual whose gross income does not exceed his total personal and additional exemptions for dependents under Section 35: Provided, That a citizen of the Philippines and any alien individual engaged in business or practice of profession within the Philippine shall file an income tax return, regardless of the amount of gross income; (b) An individual with respect to pure compensation income, as defined in Section 32(A)(1), derived from such sources within the Philippines, the income tax on which has been correctly withheld under the provisions of Section 79 of this Code: Provided, That an individual deriving compensation concurrently from two or more employers at any time during the taxable year shall file an income tax return; (c) An individual whose sole income has been subjected to final withholding tax pursuant to Section 57(A) of this Code; and (d) A minimum wage earner as defined in Section 22(HH) of this Code or an individual who is exempt from income tax pursuant to the provisions of this Code and other laws, general or special. J.4.
SUBSTITUTED FILING
Substituted filing of Income Tax Returns
is when the employers annual return may be considered as the substitute Income Tax Return (ITR) of employee inasmuch as the information provided in his income tax return would exactly be the same information contained in the employers annual return. HOW IS SUBSTITUTED FILING DIFFERENT FROM NON-FILING? 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 employers annual information return filed is the considered substitute income tax return of the employee inasmuch as the information in the employers return is exactly the same information contained in the employees return. Non-filing applicable to certain types of individual taxpayers who are not required under the law to file an income tax return. Example: 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 OF INCOME TAX RETURNS BY EMPLOYEES RECEIVING PURELY COMPENSATION INCOME. [SECTION 4, RR 3-2002; RMC 01-03] Requisites: 1. The employee receives purely compensation income (regardless of amount) during the taxable year. 2. The employee receives the income only from one employer during the taxable year. 3. The amount of tax due from the employee at the end of the year equals the amount of tax withheld by the employer. 4. The employee's spouse also complies with all three (3) conditions stated above. 5. The employer files the annual information return (BIR Form No. 1604-CF) 6. The employer issues BIR Form 2316 (Oct 2002 ENCS) version to each employee INDIVIDUALS NOT QUALIFIED FOR SUBSTITUTED FILING (STILL REQUIRED TO FILE) 1. 2. Individuals deriving compensation from two or more employers concurrently or successively during the taxable year. Employees deriving compensation income, regardless of the amount, whether from a single or several employers during the calendar year, the income tax of which has not been withheld correctly (i.e. tax due is not equal to the tax withheld) resulting to collectible or refundable return. Individuals deriving other non-business, non-profession-related income in addition to compensation income not otherwise subject to final tax. Individuals receiving purely compensation income from a single employer although the income tax of which has been correctly withheld, but whose spouse falls under 1 to 3 above. Non-resident aliens engaged in trade or business in the Philippines deriving purely compensation income, or compensation income and other non-business, non-profession-related income.
3. 4. 5.
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Substituted filing filing by employer instead of employee Forms used: 1601C (quarterly), 1604CF (annually), 2316 (withholding tax)
Requisites of substituted filing (Sir Malayas version): 1. 2. 3. 4. Working with only one employer Earning purely compensation Salaries is less than basic personal and additional exemptions, or minimum wage Withholding tax equals to tax payable
If two or more employers because of graduated tax rates, withholding tax will not equal to tax payable, so you still have a liability to the government
J.5.
Filing of ITR by spouses
Married individuals, whether citizens, resident or nonresident aliens, who do not derive income purely from compensation, shall file a return for the taxable year to include the income of both spouses. It if is impracticable for the spouses to file one return, each spouse may file separate return of income which shall be consolidated by the BIR for verification. For spouses taxes computed separately but in a joint return Husband is the one who claims the additional exemptions unless there is a waiver, or he is not earning, or is outside the country J.6. Corporation Every corporation subject to tax except foreign corporations not engaged in trade or business in the Philippines shall file a true and accurate quarterly income tax return and final or adjustment return. The return shall be filed by the president, v-president, or other principal officer, and shall be sworn to by such officer and by the treasurer or assistant treasurer. The attachments shall include, among others, the Certificate of the Independent CPA in case the gross sales, earnings, receipts or output of the corporation exceed P150,000. GPPs Every GPP shall file a return of its income except income exempted by law, showing the items of gross income and of deductions allowed; and the names, TIN, addresses and shares of each of the partners. GPPs as such are not subject to income tax. It is the partners who are liable for income tax in their separate and individual capacities. The partner shall report as gross income his distributive share, actually and constructively received from the net income of the partnership. GPP required to file a return (1702q and 1702 but under exempt transaction) but only for information purposes; so match the income earned by the GPP with the shares of each partner in their individual returns Section 54. Returns of Receivers, Trustees in Bankruptcy or Assignees. - In cases wherein receivers, trustees in bankruptcy or assignees are operating the property or business of a corporation, subject to the tax imposed by this Title, such receivers, trustees or assignees shall make returns of net income as and for such corporation, in the same manner and form as such Blue Sapphires Copy| Taxation 1 Notes for Finals 2013| Atty. Christopher Malaya 40 Required to file ITRs other than Individuals
organization is hereinbefore required to make returns, and any tax due on the income as returned by receivers, trustees or assignees shall be assessed and collected in the same manner as if assessed directly against the organizations of whose businesses or properties they have custody or control. J. 7. When to File
Sec. 51. (C) When to File. (1) The return of any individual specified above shall be filed on or before the fifteenth (15th) day of April of each year covering income for the preceding taxable year. Individuals Pure compensation earner: only an annual return (only one return) - on or before April 15 of the next taxable year Purpose of filing by employee: to make adjustments in case employer made a mistake and to pay the adjustments Business income, or mixed income Quarterly return On the 15 day of the 2 month following the close of each of the first 3 quarters of the taxable year except for the 1 quarter. First quarter (Jan-Mar) on or before april 15 Second quarter (Apr-Jun) on or before August 15 Third quarter (Jul-Sept) on or before Nov. 15 Annual return on or before April 15 of the next taxable year Business income earner: quarterly payments 1 -3 quarters 1701Q 4 quarter 1701 3-yr and 5-yr prescriptive periods will be based on 1701 and other annual returns because this is the final and correct return and not anymore an estimate Corporations A. Calendar year
th st rd th nd st
Quarterly return
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Within 60 days following the close of each of the first 3 quarters of the taxable year. First quarter May 30 Second quarter Aug 29 Third quarter Nov 29 Annual return on or before April 15 of the next taxable year B. Fiscal year
Quarterly return Within 60 days following the close of each of the first 3 quarters of the taxable year. Annual return on or before the 15 day of the 4 month following the close of the fiscal year. Corporations: 1 -3 quarters 1702Q 4 quarter 1702 But dates for quarterly returns will not be fixed if u use the fiscal year 60 days after the end of each quarter; for the annual th return, you have until 15 days after the 4 month If year ends jan 31 you have until may 15 J. 8. When to Pay pay as you file system you pay the tax when you file your return Exception: Installment payment (discussed in J.10.) J.9. Where to File The return shall be filed w/: 1. 2. 3. 4. Authorized agent bank Revenue district officer Collection agent OR Duly authorized treasurer
th st rd th th
of the city or municipality in which such person has his legal residence or place of business in the Phils. 5. Office of the commissioner if there be no legal residence or place of business in the Phils.
Consequences of filing:
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1. 2. 3.
Pay balance Ask for tax refund or tax credit, or Carry over to the next taxable year
Electronic filing and payment system: 1. 2. Top 20 corporations Government agencies and institutions
-needs software -same deadline as manual filing Payment thru banks: 1. 2. 3. Bank transfer to BIRs account Bank debit memo (fill up the form) Government agencies tax remittance advice
-It is now real time; no time gap
J.
10. Installment Payments
Section 56. Payment and Assessment of Income Tax for Individuals and Corporation . (A) Payment of Tax. (2) Installment of Payment. - When the tax due is in excess of Two thousand pesos (P2,000), the taxpayer other than a corporation may elect to pay the tax in two (2) equal installments in which case, the first installment shall be paid at the time the return is filed and the second installment, on or before July 15 following the close of the calendar year. If any installment is not paid on or before the date fixed for its payment, the whole amount of the tax unpaid becomes due and payable, together with the delinquency penalties.
Installment payment of more than P2,000 tax. The tax may be paid in 2 equal installments so as to relieve the taxpayer from the burden of paying the whole amount of tax at once. The first shall be paid at the time the return is filed and the second, on or before July 15 following the close of the calendar year. J.11. Payment of Capital Gains Tax
Sec. 51. (2) Individuals subject to tax on capital gains; (a) From the sale or exchange of shares of stock not traded thru a local stock exchange as prescribed under Section 24(c) shall file a return within thirty (30) days after each
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transaction and a final consolidated return on or before April 15 of each year covering all stock transactions of the preceding taxable year; and (b) From the sale or disposition of real property under Section 24(D) shall file a return within thirty (30) days following each sale or other disposition. Section 52. Corporation Returns. (D) Return on Capital Gains Realized from Sale of Shares of Stock not Traded in the Local Stock Exchange . Every corporation deriving capital gains from the sale or exchange of shares of stock not traded thru a local stock exchange as prescribed under Sections 24 (c), 25 (A)(3), 27 (E)(2), 28(A)(8)(c) and 28 (B)(5)(c), shall file a return within thirty (30) days after each transactions and a final consolidated return of all transactions during the taxable year on or before the fifteenth (15th) day of the fourth (4th) month following the close of the taxable year. Capital gains tax payment from sale of real property 30 days from sale (when sale is notarized) Capital gains from sale of shares of stock not traded in SE 30 days from each sale but needs to be consolidated not later than april 15 in the next taxable year because of the graduated rates J. Installment method applies to: Personal property selling price exceeds 1,000 Real property no limit 25% or less total payment installment method More than 25% - deferred sale method deferred sale method - the BIR will treat the entire selling price as earned even if you have only received a part of it Total payment = downpayment of 240k + monthly payment of 40k = 280k/selling price of 1.2M = 23% = installment method But if downpayment is 300k = 28% = deferred sale method Tax implications: Installment pay tax on installment also Deferred pay tax in full as if transaction is already completed K. Withholding Taxes 12. Installment Method vs. Deferred Sales Basis
Withholding taxes, just like foreign income tax paid or accrued, are tax credits. Thus, withholding taxes on income are being deducted from the income tax due and not from gross income.
Withholding tax is not a tax but is simply a mechanism of collecting income tax in advance Parties involved: Blue Sapphires Copy| Taxation 1 Notes for Finals 2013| Atty. Christopher Malaya 44
1. 2.
Payee Withholding agent or payor
K.1. Importance of withholding taxes
The Philippine government does not have jurisdiction over some taxpayers like non-resident foreign corporations, hence, the government cannot expect them to declare their income at the end of the year or on a quarterly basis. What it expects is that, any payor of the income, meaning the persons to whom these persons is transacting with has the obligation of a withholding agent. As a withholding agent, he will be liable for non-withholding. K.2. Final withholding tax 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 the said income. The liability for payment of the tax rests primarily on the payor as a withholding agent. Thus, in case of his failure to withhold the tax or in case of underwithholding, the deficiency tax shall be collected from the payor/withholding agent. The payee is not required to file an income tax return for the particular income. K.3. Expanded withholding tax Expanded Withholding Tax is a kind of withholding tax which is prescribed on certain income payments and is creditable against the income tax due of the payee for the taxable quarter/year in which the particular income was earned. K.4. Creditable withholding tax Under the creditable 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 an income tax return to report the income and/or 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. K.5. Withholding Tax on Compensation Income Withholding Tax on Compensation is the tax withheld from income payments to individuals arising from an employeremployee relationship. The withholding of tax on compensation income is a method of collecting the income tax at source upon receipt of the income. It applies to all employed individuals whether citizens or aliens deriving income from compensation for services rendered in the Phils. The employer is constituted as the withholding agent. Based on Sir Malayas problem: Salaries and wages (net of withholding taxes of 8,500) 61,500 add 61,500 to 8,500 to get the gross salaries and wages EXPENSE BY EMPLOYER DO NOT DEDUCT WITHHOLDING TAXES OF 8,500 FROM THE INCOME TAX PAYABLE BECAUSE THAT TAX WAS PAID BY THE EMPLOYEE AND NOT THE EMPLOYER On the part of the employee: income is 70,000 but withholding tax can be deducted in the tax credit portion (or more precisely, tax withheld per BIR form no. 2316)
K.6. Withholding Tax on Money Payments to the Government
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Withholding Tax on Government Money Payments (GMP) - Percentage Taxes - is the tax withheld by National Government Agencies (NGAs) and instrumentalities, including government-owned and controlled corporations (GOCCs) and local government units (LGUs), before making any payments to non-VAT registered taxpayers/suppliers/payees Withholding Tax on GMP - Value Added Taxes (GVAT) - is the tax withheld by National Government Agencies (NGAs) and instrumentalities, including government-owned and controlled corporations (GOCCs) and local government units (LGUs), before making any payments to VAT registered taxpayers/suppliers/payees on account of their purchases of goods and services. K. 7. Venue for filing withholding tax returns and time for payment of tax
Section 58. Returns and Payment of Taxes Withheld at Source. (A) Quarterly Returns and Payments of Taxes Withheld. - Taxes deducted and withheld under Section 57 by withholding agents shall be covered by a return and paid to, except in cases where the Commissioner otherwise permits, an authorized Treasurer of the city or municipality where the withholding agent has his legal residence or principal place of business, or where the withholding agent is a corporation, where the principal office is located. The taxes deducted and withheld by the withholding agent shall be held as a special fund in trust for the government until paid to the collecting officers. The return for final withholding tax shall be filed and the payment made within twenty-five (25) days from the close of each calendar quarter, while the return for creditable withholding taxes shall be filed and the payment made not later than the last day of the month following the close of the quarter during which withholding was made: Provided, That the Commissioner, with the approval of the a Secretary of Finance, may require these withholding agents to pay or deposit the taxes deducted or withheld more frequent intervals when necessary to protect the interest of the government.
The return shall be filed w/: 1. 2. 3. 4. Authorized agent bank Revenue district officer Collection agent OR Duly authorized treasurer
of the city or municipality in which such withholding agent has his legal residence or place of business in the Phils. 5. Office of the commissioner if there be no legal residence or place of business in the Phils.
TIME TO WITHHOLD TAX AT SOURCE - arises at the time an income is paid or payable, whichever comes first. The term payable refers to the date the obligation becomes due, demandable or legally enforceable. (Sec. 2.54.4 Rev. Regs. 2.98) Additional notes from the last session: Withholding tax is not a tax but is simply a mechanism of collecting income tax in advance Parties involved:
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3. 4.
Payee burden to pay the tax; usually the employee Withholding agent or payor statutorily liable to pay the tax; source of income; usually the employer
Who are required to withhold: 1. 2. 3. Individual engaged in trade or business Juridical entities All govt offices including GOCCs well as LGUs
With respect to salaries of employees
Individual not engaged in trade or business can be a withholding agent if he is a buyer in the sale or exchange of real property as capital asset; 6% final withholding tax Burden of seller to pay but buyer will remit to BIR
Normal instance (law on sales): burden will be on the seller Not required to withhold (not required to be creditable withholding tax agent): 1. 2. 3. National government and its instrumentalities you cannot tax the taxing authority Exempt organizations not subject to tax Those under PEZA zones not governed by NIRC
Final vs. creditable withholding tax 1. As to nature:
Final full and final Creditable equal or approximate, not final 2. As to liability:
final based on payor as withholding agent creditable based on the payee 3. Effect of failure:
Final failure to withhold, deficiency will be collected from payor Creditable deficiency collected from payee 4. Requirement of filing income tax return:
Final payee not required to file an income tax return Creditable payee required to file an income tax return to report the income and/or pay the difference between the tax withheld and the tax due on the income
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Expanded withholding tax creditable tax Examples of withholding tax rates: 15% if the gross income exceeds P720,000; 10% if it does not Payments made by government offices on local purchase of goods 1% Payments made by govt offices on local services 2% Rentals of real property 5% Residential house and lot and seller is not habitually engaged in real estate business 6% (capital gains tax); final withholding tax to be paid by buyer Condo unit and seller habitually engaged in real estate business: not over P500k 1.5%, over P500k to P2M 3%, over P2M 5%; creditable withholding tax by seller and paid by seller Where to file: based on residence of withholding agent
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Taxation of Estates, Trusts, and Partnerships

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Taxation of Estates, Trusts, and Partnerships

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H. General Professional Partnership (GPP) and Estate and Trust H.1.

Separation pay: Voluntary: taxable Involuntary: non-taxable

Total Income from ALL SOURCES = Limitation Per Country

Income from outside the Phils (per country)

Income from foreign country

Income from WITHIN the Phils. = Global Limitation

Income from outside the Phils (per country)

Income from foreign country

Itemized Deductions 1. There is a need to substantiate 2. More complicated

Accounting method method of accounting of income and expenses of the taxpayer

J.3. Sec. 51.

Individuals not required to file ITRs

Substituted filing of Income Tax Returns

Filing of ITR by spouses

-It is now real time; no time gap

10. Installment Payments

Payee Withholding agent or payor

K.1. Importance of withholding taxes

K.6. Withholding Tax on Money Payments to the Government

With respect to salaries of employees

Final vs. creditable withholding tax 1. As to nature:

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