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RR 02-40

RR 02-40

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Revenue Regulations 02-40Page
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REVENUE REGULATIONS NO. 02-40
February 10, 1940
INCOME TAX REGULATIONS
SECTION 1.Scope. — In accordance with the provisions of Sections 4 (I) and 338 of Commonwealth Act No. 466, otherwise known as the National Internal Revenue Code, the followingregulations affecting Sections 19 to 84 of the same Code relating to the income tax are herebypromulgated to supersede all circulars, precedents, rulings, and regulations heretofore published onthe same subject, and they shall be known as Revenue Regulations No. 2, or the Income TaxRegulations:(Only the section numbers of the Code are given below as their texts will be found in the same Code.They serve as captions of the pertinent provisions of the Regulations.)(Section 20 of the Code)SECTION 2.Application of title. — Section 20 provides that the provisions of Title II of the NationalInternal Revenue Code shall apply only to income received from January 1, 1939.(Section 21 of the Code)SECTION 3.Persons considered citizens of the Philippines. — The following shall be consideredcitizens of the Philippines:(1)Those who were citizens of the Philippines at the time of the adoption of the Constitution of thePhilippines.(2)Those born in the Philippines of foreign parents who, before the adoption of the Constitution, hadbeen elected to public office in the Philippines.(3)Those whose fathers are citizens of the Philippines.(4)Those whose mothers are citizens of the Philippines and, upon reaching the age of majority,elect Philippine citizenship.(5)Those who are naturalized in accordance with law. (Sec. 1, Article IV, Constitution of thePhilippines.)Philippine citizenship may be lost or reacquired in the manner provided by law. A foreigner who hascome to reside in the Philippines and has filed his petition to acquire Philippine citizenship but has notyet received the requisite naturalization certificate still remains an alien.SECTION 4.Tax on citizens and residents. — Section 21 imposes progressive rates of incometaxes on citizens and residents, starting from 3 per cent upon the amount by which the net incomedoes not exceed P2,000 and rising gradually to 60 per cent upon the amount by which the net incomeexceeds P500,000. (Conforms with amendments by R.A. 2343, effective June 20, 1959.)The following is a table, showing the rates of income tax under Section 21, as amended by Section 1of R.A. No. 2343, applicable to income received from Jan. 1, 1959 and for fiscal periods ending after June 30, 1959:123456ExceedingNotBracketRateTax on EachCumulativeExceedingof TaxBracketAmount of TaxP -P2,0002,0003%P60P602,0004,0002,0006%1201804,0006,0002,0009%1803606,0008,0002,00016%3206808,00010,0002,00020%4001,08010,00020,00010,00024%2,4003,48020,00030,00010,00030%3,0006,48030,00040,00010,00036%3,60010,08040,00050,00010,00040%4,00014,08050,00060,00010,00042%4,20018,28060,00070,00010,00044%4,40022,68070,00080,00010,00046%4,60027,28080,00090,00010,00048%4,80032,08090,000100,00010,00050%5,00037,080100,000120,00020,00052%10,40047,480120,000140,00020,00053%10,60058,080140,000160,00020,00054%10,80068,880160,000200,00040,00055%22,00090,880200,000250,00050,00056%28,000118,880250,000300,00050,00057%28,500147,380300,000400,000100,00058%58,000205,380400,000500,000100,00059%59,000264,380500,000--60%--Note: Taxable income is arrived at after deducting personal and additional exemptions to whichtaxpayer is entitled.(Section 22 of the Code)SECTION 5.Definition. — A "non-resident alien individual" means an individual —(a)Whose residence is not within the Philippines; and(b)Who is not a citizen of the Philippines.An alien actually present in the Philippines who is not a mere transient or sojourner is a resident of thePhilippines for purposes of the income tax. Whether he is a transient or not is determined by hisintentions with regard to the length and nature of his stay. A mere floating intention indefinite as totime, to return to another country is not sufficient to constitute him a transient. If he lives in thePhilippines and has no definite intention as to his stay, he is a resident. One who comes to thePhilippines for a definite purpose which in its nature may be promptly accomplished is a transient. Butif his purpose is of such a nature that an extended stay may be necessary for its accomplishment, andto that end the alien makes his home temporarily in the Philippines, he becomes a resident, though itmay be his intention at all times to return to his domicile abroad when the purpose for which he camehas been consummated or abandoned.SECTION 6.Loss of residence by alien. — An alien who has acquired residence in the Philippinesretains his status as a resident until he abandons the same and actually departs from the Philippines.An intention to change his residence does not change his status as a resident alien to that of anonresident alien. Thus an alien who has acquired a residence in the Philippines is taxable as aresident for the remainder of his stay in the Philippines.SECTION 7.Taxation of aliens in general. — For purposes of income tax, alien individuals aredivided generally into two classes, namely, resident aliens and non-resident aliens. Resident aliensare taxable in the same manner as citizens of the Philippines, that is, a resident alien is taxable onincome derived from all sources including sources without the Philippines. Non-resident aliens aretaxable only on income from sources within the Philippines.SECTION 8.Taxation of non-resident aliens; classification. — Non-resident alien individuals aredivided into two classes: (1) Those engaged in trade or business within the Philippines, and (2) thosenot engaged in trade or business within the Philippines. Non-resident aliens falling within the firstclass are subject to the graduated rates established in Section 21 with respect to their net incomefrom sources within the Philippines. Non-resident aliens falling within the second class are subject toa flat rate of 20 per cent on their total income from sources within the Philippines, if such total incomedoes not exceed P23,800, otherwise, the graduated rates established in Section 21 will apply to thetotal income if it exceeds P23,800. (Conforms with amendments by R.A. 2343, effective June 20,1959.)The phrase "engaged in trade or business within the Philippines" includes the performance of personal services within the Philippines. Whether a non-resident alien has an "office or place of business," however, implies a place for the regular transaction of business and does not include aplace where casual or incidental transactions might be, or are, effected. Neither the beneficiary nor the grantor of a trust, whether revocable or irrevocable, is deemed to be engaged in trade or businessin the Philippines or to have an office or place of business therein, merely because the trustee isengaged in trade or business in the Philippines or has an office or place of business therein. (Test of "office or place of business" was deleted by R.A. 2343.)(Section 23 of the Code)
 
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SECTION 9.Personal exemption. — Personal exemption is an arbitrary amount allowed for personal, living, or family expenses of the taxpayer. It is allowed to citizens of the Philippines, toresident aliens, and to non-resident aliens in certain cases. The procedure of arriving at the tax dueafter giving effect to the exemptions allowable is set forth in Section 4 of these regulations. EHcaDTSECTION 10.Personal exemption of single individuals. — A single individual is entitled to a personalexemption of P1,800.SECTION 11.Personal exemption of married persons and heads of family. — A married person isentitled to a personal exemption of P3,000. Only one exemption of P3,000 is allowed with respect tothe aggregate income of both husband and wife. (Conforms with amendments by R.A. 2343, effectiveJune 20, 1959.)A head of family is an individual who actually supports and maintains in one household one or moreindividuals, who are closely connected with him by blood relationship, relationship by marriage, or byadoption, and whose right to exercise family control and provide for these dependent individuals isbased upon some moral or legal obligation. In the absence of continuous actual residence together,whether or not a person with dependent relatives is a head of a family within the meaning of thestatute must depend on the character of the separation. If a father is absent on business, or a child or other dependent is away at school or on a visit, the common home being still maintained, theadditional exemption applies. If, moreover, through force of circumstances a parent is obliged tomaintain his dependent children with relatives or in a boarding house while he lives elsewhere, theadditional exemption may still apply. If, however, without necessity, the dependent continuouslymakes his home elsewhere, his benefactor is not the head of a family, irrespective of the question of support. A resident alien with children abroad is not thereby entitled to credit as the head of a family.Chief support means principal or main support. Partial support not amounting to chief support will notentitle the taxpayer to claim exemption as a head of a family.Under the law the following persons are entitled to P3,000 exemption: (a) a married man; (b) amarried woman; and (c) an unmarried man or woman with one or both parents, or one or morebrothers or sisters, or one or more legitimate, recognized natural, or adopted children living with anddependent upon him or her for their chief support, where such brothers, sisters, or children are notmore than 23 years of age, unmarried and not gainfully employed or where such children areincapable of self-support because mentally or physically defective. (Conforms with amendments byR.A. 2343, effv. June 20, 1959.)SECTION 12.Additional exemption for dependents. — The taxpayer is entitled to an additionalexemption of P1,000 for each legitimate, recognized natural, or adopted child wholly dependent uponand living with such person, if such dependent is not more than 23 years of age, unmarried and notgainfully employed or incapable of self-support because mentally or physically defective, provided thatthe person claiming additional exemption is a head of family. The children with respect to whomadditional exemption is claimed must be wholly dependent upon the taxpayer for support. (Conformswith amendments by R A. 2343, effv. June 20, 1959.)SECTION 13.Change of status. — If the status of the taxpayer, insofar as it affects the personal andadditional exemptions, changes during the taxable year by reason of his death, the amount of thepersonal and additional exemptions shall be apportioned, in accordance with the number of monthsbefore and after such change. For the purpose of such apportionment, a fractional part of a monthshall be disregarded unless it amounts to more than half a month in which case it shall be consideredas one month. (Conforms with amendment by R.A. 590, effv. Sept. 22, 1950.)SECTION 14.Personal exemption of non-resident aliens. — A non-resident alien is entitled to apersonal exemption in an amount equal to the exemptions allowed by the income tax law in thecountry of which he is a citizen or subject to citizens of the Philippines. The exemption allowed to non-resident aliens is a reciprocal one; that is, it is only allowed if the country of said non-resident aliensallows similar exemptions to Filipinos not residing in such country but deriving income from sourcestherein. If the country of which the non-resident alien is a citizen or subject does not have any incometax law, such non-resident alien will not be entitled to personal exemption.(Section 24 of the Code)SECTION 15.Income tax on corporations. — The law imposes an annual income tax of 22 per centum upon that portion of the net income of every corporation not in excess of P100,000 and 30 per cent on the excess. The term "corporation" includes partnership no matter how created or organized, joint-stock companies, joint-account (cuentas en participacion), association, or insurance companiesbut does not include duly registered general co-partnership (companias colectivas). The tax is uponnet income, which is undetermined by subtracting from the gross income, as defined in the law, theallowable deductions. (Conforms with amendments by R.A. 2343, effv. June 20, 1959.)SECTION 16.Corporations liable to tax. — Every corporation, domestic or foreign, not otherwiseexempt from tax under Title II or any other law, is liable to tax. A domestic corporation is taxed on itsincome from sources within and without the Philippines, but a foreign corporation is taxed only on itsincome form sources within the Philippines.The tax imposed by law on corporations is not imposed only upon such corporations as are organizedand operated for profit. Any corporation, firm or association, no matter how created or organized, or what the purpose of its organization may be, is subject to the tax, except as provided in Section 27,relative to exemptions from tax on corporations. A corporation is not exempt simply and only becauseit is primarily not organized and operated for profit.SECTION 17.Dividends received by a corporation from a domestic corporation. — Dividendsreceived by a domestic or resident foreign corporation from a domestic corporation subject to tax aretaxable only to the extent of 25 per cent thereof. All other classes of income (except net capital gains,Section 34) of corporations are taxable in full. Likewise dividends from a foreign corporation, whether resident or non-resident, are taxable in full. (See Sections 250 to 256 of these regulations relative totaxation of dividends and other distributions.)SECTION 17-A.Tax on life insurance companies. — Every life insurance company organized in or existing under the laws of the Philippines, or foreign life insurance company authorized to carry onbusiness in the Philippines are taxable on their total net investment income derived from interest,dividends and rents from all sources whether within or without the Philippines, to the flat rate of 6-1/2%. However, purely cooperative insurance companies or associations which are conducted by themembers thereof with the money collected from among themselves and solely for their own protectionand not for profit are exempt from income tax.The total net investment income of domestic life insurance companies means the gross investmentincome received during the taxable year from rents, dividends and interest less deductions for realestate expenses, depreciation, interest paid within the taxable year on its indebtedness except onindebtedness incurred to purchase or carry obligation the interest upon which is wholly exempt fromtaxation under existing laws, and such investment expenses paid during the taxable year as areordinary and necessary in the conduct of its investment. The total net investment income of foreignlife insurance companies doing business here is that portion of their gross world investment incomewhich bears the same ratio to such income as their total Philippines reserve (whether kept in thePhilippines or abroad) bears to their total world reserve less that portion of their total world investmentexpenses which bears the same ratio to such expenses as their total Philippine investment incomebears to their total world investment income. The following equation simplifies this formula:PGI = PR/WR x WGIPIE = PGI/WGI x WIEPGI - PIE = PNI
Legend:PGI is Philippine Gross Investment IncomePNI is Philippine Net Investment IncomePR is Total Philippine ReserveWR is Total World ReserveWGI is World Gross Investment IncomePGI is Philippine Gross Investment IncomeWIE is Total World Investment ExpensesPIE is Philippine Investment Expense
In both cases, the deductible expenses must be connected with the investment income subjected totax. For the proper determination of the income tax liability of resident foreign life insurancecompanies, they should submit the necessary financial statement reflecting the nature of the
 
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investment income and corresponding expenses. These financial statements must be duly certified byan independent certified public accountant and authenticated by a Philippine consular official.Foreign life insurance companies not doing business in the Philippines are subject to the normalincome tax on their income received from sources within the Philippines. They are subject to tax atthe rate of 30% like any other foreign corporation.Domestic life insurance companies and foreign life insurance companies doing business in thePhilippines are not allowed to deduct from their gross income the net additions, if any, required by lawto be made within the year to reserve funds and the sums other than dividends paid within the year onpolicy and annuity contracts. (Proposed by the BIR. If adopted, this will supersede Sec. 124 of existing regulations.)(Section 25 of the Code)SECTION 18.Taxation of corporation formed or utilized for avoidance of tax. — Section 25 imposesfor each year, in addition to the tax imposed by Section 24 a tax of 25 per cent on the undistributedportion of the profits or surplus of a corporation which is formed or availed of for the purpose of preventing the imposition of the tax upon its shareholders or members or the shareholders or members of any other corporation through the medium of permitting gains or profits to accumulateinstead of dividing or distributing them. However, banks, insurance companies, personal holdingcompanies and foreign personal holding companies as defined in Chapter VIII, are excepted fromtaxation under Section 25. The tax imposed by Section 25 applies whether the avoidance wasaccomplished through the formation or use of only one corporation or a chain of corporations. For example, if the capital stock of the M Corporation is held by the N Corporation so that the dividenddistributions of the M Corporation would not be returned as income subject to the tax on individualsuntil distributed in turn by the N Corporation to its individual shareholders, nevertheless the taximposed by Section 25 applies to the M Corporation, if that corporation is formed or availed of for thepurpose of preventing the imposition of the tax upon the individual shareholders of the N Corporation.A foreign corporation, whether resident or non-resident, is subject to the tax provided for under Section 25 in the same manner and under the same circumstances as a domestic corporation.SECTION 19.Purpose to avoid tax; evidence; burden of proof; definitions of holding or investmentcompany. — The Collector of Internal Revenue's determination that a corporation was formed or availed of for the purpose of avoiding the tax on its shareholders or members is subject to disproof bycompetent evidence. The existence or non-existence of the purpose may be indicated bycircumstances other than the evidence specified in Section 25(b), and whether or not such purposewas present depends upon the particular circumstances of each case. In other words, a corporation issubject to taxation under Section 25 if it is formed or availed of for the purpose of preventing theimposition of the progressive rates of tax upon shareholders through the medium of permittingearnings or profits to accumulate, even though the corporation is not a mere holding or investmentcompany 50 per cent or more of the outstanding stock of which is owned directly or indirectly by oneperson, and does not have an unreasonable accumulation of earnings or profits; and on the other hand, the fact that a corporation is such a company or has an accumulation is not absolutelyconclusive against it if, by clear and convincing evidence, the taxpayer satisfies the Commissioner of Internal Revenue that the corporation was neither formed nor availed of for the purpose of avoidingthe tax on individuals. All the other circumstances which might be construed as evidence of thepurpose to avoid the tax on shareholders cannot be outlined, but among other things the following willbe considered: (1) Dealings between the corporation and its shareholders, such as withdrawal by theshareholders as personal loans or the expenditure of funds by corporation for the personal benefit of the shareholders, and (2) the investment by the corporation of undistributed earnings in assets havingno reasonable connection with the business. The mere fact that the corporation distributed a largepart of its earnings for the year in question does not necessarily prove that earnings were notpermitted to accumulate beyond reasonable needs or that the corporation was not formed or availedof to avoid the tax upon shareholders.If the Commissioner of Internal Revenue determined that the corporation was formed or availed of for the purpose of avoiding the progressive rates of tax on individuals through the medium of permittingearnings or profits to accumulate, and the taxpayer contests such determination of fact by litigation,the burden of proving the determination wrong by a preponderance of evidence, together with thecorresponding burden of first going forward with evidence, is on the taxpayer under principlesapplicable to income tax cases generally, and this is so even though the corporation is not a mereholding or investment company and does not have an unreasonable accumulation of earnings or profits. However, if the corporation is a mere holding or investment company, then the law givesfurther weight to the presumption of correctness already arising from the Commissioner of InternalRevenue's determination by expressly providing an additional presumption of the existence of apurpose to avoid the tax upon shareholders, while if earnings or profits are permitted to accumulatebeyond the reasonable needs of the business then the law adds still more weight to theCommissioner of Internal Revenue's determination by providing that irrespective of whether or not thecorporation is a mere holding or investment company, the existence of such an accumulation isdeterminative of the purpose to avoid the tax upon shareholders unless the taxpayer proves thecontrary by such a clear preponderance of all the evidence that the absence of such a purpose isunmistakable.SECTION 20.Holding and investment companies. — A corporation having practically no activitiesexcept holding property, and collecting the income therefrom or investing therein, shall be considereda holding company within the meaning of Section 25. If the activities further include, or consistsubstantially of, buying and selling stocks, securities, real estate, or other investment property(whether upon an outright or a marginal basis) so that the income is derived not only from theinvestment yield but also from profits upon market fluctuations, the corporation shall be considered aninvestment company within the meaning of Section 25.SECTION 21.Unreasonable accumulation of profits. — An accumulation of earnings or profits(including the undistributed earnings or profits of prior years) is unreasonable if it is not required for the purposes of the business, considering all the circumstances of the case. It is not intended,however, to prevent accumulations of surplus for the reasonable needs of the business if the purposeis not to prevent the imposition of the tax upon shareholders. No attempt is here made to enumerateall the ways in which earnings or profits of a corporation may be accumulated for the reasonableneeds of the business. Undistributed income is properly accumulated if retained for working capitalneeded by the business; or if invested in additions to plant reasonably required by the business; or if in accordance with contract obligations placed to the credit of a sinking fund for the purpose of retiringbonds issued by the corporation. The nature of the investment of earnings or profits is immaterial if they are not in fact needed in the business. Among other things, the nature of the business, thefinancial condition of the corporation at the close of the taxable year, and the use of the undistributedearnings or profits will be considered in determining the reasonableness of the accumulations.The business of a corporation is not merely that which it has previously carried on, but includes ingeneral any line of business which it may undertake. However, a radical change of business when aconsiderable surplus has been accumulated may afford evidence of a purpose to avoid the tax. If onecorporation owns the stock of another corporation in the same or a related line of business and ineffect operates the other corporation, the business of the latter may be considered in substancealthough not in legal form the business of the first corporation. Earnings or profits of the firstcorporation put into the second through the purchase of stock or otherwise may, therefore, if asubsidiary relationship is established, constitute employment of the income in its own business.Investment by a corporation of its income in stock and securities of another corporation is not of itself to be regarded as employment of the income in its business. The business of one corporation may notbe regarded as including the business of another unless the other corporation is a mereinstrumentality of the first; to establish this it is ordinarily essential that the first corporation own all or substantially all of the stock of the second.The Commissioner of Internal Revenue may require any corporation to furnish a statement of itsaccumulated earnings and profits, the name and address of, and number of share held by each of itsshareholders or members, and the amounts that would be payable to each, if the income of thecorporation were distributed.(Section 26 of the Code)SECTION 22.General co-partnerships. — General co-partnerships, when duly registered, are notsubject to income tax, but are required to file returns of their income on B.I.R. Form No. 17.04 for thepurpose of furnishing information as to the share in the gains or profits which each partner shallinclude in his individual return. Individuals carrying on business in general co-partnership are,however, taxable upon their distributive shares of the net income of such partnership, whether distributed or not, and are required to include such distributive shares in their individual returns. Thereturns of duly registered general co-partnerships should be rendered on or before April 15 of eachyear or within sixty days after the end of their fiscal year depending on whether their books are kept

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