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Revenue Regulations 02-40 Page 1 of 39

REVENUE REGULATIONS NO. 02-40 100,000


120,000
120,000
140,000
20,000
20,000
52%
53%
10,400
10,600
47,480
58,080
February 10, 1940
140,000 160,000 20,000 54% 10,800 68,880
160,000 200,000 40,000 55% 22,000 90,880
INCOME TAX REGULATIONS 200,000 250,000 50,000 56% 28,000 118,880
250,000 300,000 50,000 57% 28,500 147,380
SECTION 1. Scope. — In accordance with the provisions of Sections 4 (I) and 338 of 300,000 400,000 100,000 58% 58,000 205,380
Commonwealth Act No. 466, otherwise known as the National Internal Revenue Code, the following 400,000 500,000 100,000 59% 59,000 264,380
regulations affecting Sections 19 to 84 of the same Code relating to the income tax are hereby 500,000 - - 60% - -
promulgated to supersede all circulars, precedents, rulings, and regulations heretofore published on Note: Taxable income is arrived at after deducting personal and additional exemptions to which
the same subject, and they shall be known as Revenue Regulations No. 2, or the Income Tax taxpayer is entitled.
Regulations: (Section 22 of the Code)

(Only the section numbers of the Code are given below as their texts will be found in the same Code. SECTION 5. Definition. — A "non-resident alien individual" means an individual —
They serve as captions of the pertinent provisions of the Regulations.) (a) Whose residence is not within the Philippines; and
(Section 20 of the Code) (b) Who is not a citizen of the Philippines.

SECTION 2. Application of title. — Section 20 provides that the provisions of Title II of the National An alien actually present in the Philippines who is not a mere transient or sojourner is a resident of the
Internal Revenue Code shall apply only to income received from January 1, 1939. Philippines for purposes of the income tax. Whether he is a transient or not is determined by his
(Section 21 of the Code) intentions with regard to the length and nature of his stay. A mere floating intention indefinite as to
time, to return to another country is not sufficient to constitute him a transient. If he lives in the
SECTION 3. Persons considered citizens of the Philippines. — The following shall be considered Philippines and has no definite intention as to his stay, he is a resident. One who comes to the
citizens of the Philippines: Philippines for a definite purpose which in its nature may be promptly accomplished is a transient. But
(1) Those who were citizens of the Philippines at the time of the adoption of the Constitution of the if his purpose is of such a nature that an extended stay may be necessary for its accomplishment, and
Philippines. to that end the alien makes his home temporarily in the Philippines, he becomes a resident, though it
(2) Those born in the Philippines of foreign parents who, before the adoption of the Constitution, had may be his intention at all times to return to his domicile abroad when the purpose for which he came
been elected to public office in the Philippines. has been consummated or abandoned.
(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, SECTION 6. Loss of residence by alien. — An alien who has acquired residence in the Philippines
elect Philippine citizenship. retains his status as a resident until he abandons the same and actually departs from the Philippines.
(5) Those who are naturalized in accordance with law. (Sec. 1, Article IV, Constitution of the An intention to change his residence does not change his status as a resident alien to that of a
Philippines.) nonresident alien. Thus an alien who has acquired a residence in the Philippines is taxable as a
Philippine citizenship may be lost or reacquired in the manner provided by law. A foreigner who has resident for the remainder of his stay in the Philippines.
come to reside in the Philippines and has filed his petition to acquire Philippine citizenship but has not
yet received the requisite naturalization certificate still remains an alien. SECTION 7. Taxation of aliens in general. — For purposes of income tax, alien individuals are
divided generally into two classes, namely, resident aliens and non-resident aliens. Resident aliens
SECTION 4. Tax on citizens and residents. — Section 21 imposes progressive rates of income are taxable in the same manner as citizens of the Philippines, that is, a resident alien is taxable on
taxes on citizens and residents, starting from 3 per cent upon the amount by which the net income income derived from all sources including sources without the Philippines. Non-resident aliens are
does not exceed P2,000 and rising gradually to 60 per cent upon the amount by which the net income taxable only on income from sources within the Philippines.
exceeds 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 1 SECTION 8. Taxation of non-resident aliens; classification. — Non-resident alien individuals are
of R.A. No. 2343, applicable to income received from Jan. 1, 1959 and for fiscal periods ending after divided into two classes: (1) Those engaged in trade or business within the Philippines, and (2) those
June 30, 1959: not engaged in trade or business within the Philippines. Non-resident aliens falling within the first
class are subject to the graduated rates established in Section 21 with respect to their net income
1 2 3 4 5 6 from sources within the Philippines. Non-resident aliens falling within the second class are subject to
Exceeding Not Bracket Rate Tax on Each Cumulative a flat rate of 20 per cent on their total income from sources within the Philippines, if such total income
Exceeding of Tax Bracket Amount of Tax does not exceed P23,800, otherwise, the graduated rates established in Section 21 will apply to the
P- P2,000 2,000 3% P60 P60 total income if it exceeds P23,800. (Conforms with amendments by R.A. 2343, effective June 20,
2,000 4,000 2,000 6% 120 180 1959.)
4,000 6,000 2,000 9% 180 360
6,000 8,000 2,000 16% 320 680 The phrase "engaged in trade or business within the Philippines" includes the performance of
8,000 10,000 2,000 20% 400 1,080 personal services within the Philippines. Whether a non-resident alien has an "office or place of
10,000 20,000 10,000 24% 2,400 3,480 business," however, implies a place for the regular transaction of business and does not include a
20,000 30,000 10,000 30% 3,000 6,480 place where casual or incidental transactions might be, or are, effected. Neither the beneficiary nor
30,000 40,000 10,000 36% 3,600 10,080 the grantor of a trust, whether revocable or irrevocable, is deemed to be engaged in trade or business
40,000 50,000 10,000 40% 4,000 14,080 in the Philippines or to have an office or place of business therein, merely because the trustee is
50,000 60,000 10,000 42% 4,200 18,280 engaged in trade or business in the Philippines or has an office or place of business therein. (Test of
60,000 70,000 10,000 44% 4,400 22,680 "office or place of business" was deleted by R.A. 2343.)
70,000 80,000 10,000 46% 4,600 27,280 (Section 23 of the Code)
80,000 90,000 10,000 48% 4,800 32,080
90,000 100,000 10,000 50% 5,000 37,080
Revenue Regulations 02-40 Page 2 of 39

SECTION 9. Personal exemption. — Personal exemption is an arbitrary amount allowed for cent on the excess. The term "corporation" includes partnership no matter how created or organized,
personal, living, or family expenses of the taxpayer. It is allowed to citizens of the Philippines, to joint-stock companies, joint-account (cuentas en participacion), association, or insurance companies
resident aliens, and to non-resident aliens in certain cases. The procedure of arriving at the tax due but does not include duly registered general co-partnership (companias colectivas). The tax is upon
after giving effect to the exemptions allowable is set forth in Section 4 of these regulations. EHcaDT net income, which is undetermined by subtracting from the gross income, as defined in the law, the
allowable deductions. (Conforms with amendments by R.A. 2343, effv. June 20, 1959.)
SECTION 10. Personal exemption of single individuals. — A single individual is entitled to a personal
exemption of P1,800. SECTION 16. Corporations liable to tax. — Every corporation, domestic or foreign, not otherwise
exempt from tax under Title II or any other law, is liable to tax. A domestic corporation is taxed on its
SECTION 11. Personal exemption of married persons and heads of family. — A married person is income from sources within and without the Philippines, but a foreign corporation is taxed only on its
entitled to a personal exemption of P3,000. Only one exemption of P3,000 is allowed with respect to income form sources within the Philippines.
the aggregate income of both husband and wife. (Conforms with amendments by R.A. 2343, effective
June 20, 1959.) The tax imposed by law on corporations is not imposed only upon such corporations as are organized
and operated for profit. Any corporation, firm or association, no matter how created or organized, or
A head of family is an individual who actually supports and maintains in one household one or more what the purpose of its organization may be, is subject to the tax, except as provided in Section 27,
individuals, who are closely connected with him by blood relationship, relationship by marriage, or by relative to exemptions from tax on corporations. A corporation is not exempt simply and only because
adoption, and whose right to exercise family control and provide for these dependent individuals is it is primarily not organized and operated for profit.
based 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 the SECTION 17. Dividends received by a corporation from a domestic corporation. — Dividends
statute must depend on the character of the separation. If a father is absent on business, or a child or received by a domestic or resident foreign corporation from a domestic corporation subject to tax are
other dependent is away at school or on a visit, the common home being still maintained, the taxable only to the extent of 25 per cent thereof. All other classes of income (except net capital gains,
additional exemption applies. If, moreover, through force of circumstances a parent is obliged to Section 34) of corporations are taxable in full. Likewise dividends from a foreign corporation, whether
maintain his dependent children with relatives or in a boarding house while he lives elsewhere, the resident or non-resident, are taxable in full. (See Sections 250 to 256 of these regulations relative to
additional exemption may still apply. If, however, without necessity, the dependent continuously taxation of dividends and other distributions.)
makes 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. SECTION 17-A. Tax on life insurance companies. — Every life insurance company organized in or
Chief support means principal or main support. Partial support not amounting to chief support will not existing under the laws of the Philippines, or foreign life insurance company authorized to carry on
entitle the taxpayer to claim exemption as a head of a family. business 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-
Under the law the following persons are entitled to P3,000 exemption: (a) a married man; (b) a 1/2%. However, purely cooperative insurance companies or associations which are conducted by the
married woman; and (c) an unmarried man or woman with one or both parents, or one or more members thereof with the money collected from among themselves and solely for their own protection
brothers or sisters, or one or more legitimate, recognized natural, or adopted children living with and and not for profit are exempt from income tax.
dependent upon him or her for their chief support, where such brothers, sisters, or children are not
more than 23 years of age, unmarried and not gainfully employed or where such children are The total net investment income of domestic life insurance companies means the gross investment
incapable of self-support because mentally or physically defective. (Conforms with amendments by income received during the taxable year from rents, dividends and interest less deductions for real
R.A. 2343, effv. June 20, 1959.) estate expenses, depreciation, interest paid within the taxable year on its indebtedness except on
indebtedness incurred to purchase or carry obligation the interest upon which is wholly exempt from
SECTION 12. Additional exemption for dependents. — The taxpayer is entitled to an additional taxation under existing laws, and such investment expenses paid during the taxable year as are
exemption of P1,000 for each legitimate, recognized natural, or adopted child wholly dependent upon ordinary and necessary in the conduct of its investment. The total net investment income of foreign
and living with such person, if such dependent is not more than 23 years of age, unmarried and not life insurance companies doing business here is that portion of their gross world investment income
gainfully employed or incapable of self-support because mentally or physically defective, provided that which bears the same ratio to such income as their total Philippines reserve (whether kept in the
the person claiming additional exemption is a head of family. The children with respect to whom Philippines or abroad) bears to their total world reserve less that portion of their total world investment
additional exemption is claimed must be wholly dependent upon the taxpayer for support. (Conforms expenses which bears the same ratio to such expenses as their total Philippine investment income
with amendments by R A. 2343, effv. June 20, 1959.) bears to their total world investment income. The following equation simplifies this formula:

SECTION 13. Change of status. — If the status of the taxpayer, insofar as it affects the personal and PGI = PR/WR x WGI
additional exemptions, changes during the taxable year by reason of his death, the amount of the PIE = PGI/WGI x WIE
personal and additional exemptions shall be apportioned, in accordance with the number of months PGI - PIE = PNI
before and after such change. For the purpose of such apportionment, a fractional part of a month
shall be disregarded unless it amounts to more than half a month in which case it shall be considered Legend:
as one month. (Conforms with amendment by R.A. 590, effv. Sept. 22, 1950.) PGI is Philippine Gross Investment Income
PNI is Philippine Net Investment Income
SECTION 14. Personal exemption of non-resident aliens. — A non-resident alien is entitled to a PR is Total Philippine Reserve
personal exemption in an amount equal to the exemptions allowed by the income tax law in the WR is Total World Reserve
country of which he is a citizen or subject to citizens of the Philippines. The exemption allowed to non- WGI is World Gross Investment Income
resident aliens is a reciprocal one; that is, it is only allowed if the country of said non-resident aliens PGI is Philippine Gross Investment Income
allows similar exemptions to Filipinos not residing in such country but deriving income from sources WIE is Total World Investment Expenses
therein. If the country of which the non-resident alien is a citizen or subject does not have any income PIE is Philippine Investment Expense
tax law, such non-resident alien will not be entitled to personal exemption.
(Section 24 of the Code) In both cases, the deductible expenses must be connected with the investment income subjected to
SECTION 15. Income tax on corporations. — The law imposes an annual income tax of 22 per tax. For the proper determination of the income tax liability of resident foreign life insurance
centum upon that portion of the net income of every corporation not in excess of P100,000 and 30 per companies, they should submit the necessary financial statement reflecting the nature of the
Revenue Regulations 02-40 Page 3 of 39

investment income and corresponding expenses. These financial statements must be duly certified by profits. However, if the corporation is a mere holding or investment company, then the law gives
an independent certified public accountant and authenticated by a Philippine consular official. further weight to the presumption of correctness already arising from the Commissioner of Internal
Revenue's determination by expressly providing an additional presumption of the existence of a
Foreign life insurance companies not doing business in the Philippines are subject to the normal purpose to avoid the tax upon shareholders, while if earnings or profits are permitted to accumulate
income tax on their income received from sources within the Philippines. They are subject to tax at beyond the reasonable needs of the business then the law adds still more weight to the
the rate of 30% like any other foreign corporation. Commissioner of Internal Revenue's determination by providing that irrespective of whether or not the
Domestic life insurance companies and foreign life insurance companies doing business in the corporation is a mere holding or investment company, the existence of such an accumulation is
Philippines are not allowed to deduct from their gross income the net additions, if any, required by law determinative of the purpose to avoid the tax upon shareholders unless the taxpayer proves the
to be made within the year to reserve funds and the sums other than dividends paid within the year on contrary by such a clear preponderance of all the evidence that the absence of such a purpose is
policy and annuity contracts. (Proposed by the BIR. If adopted, this will supersede Sec. 124 of unmistakable.
existing regulations.)
(Section 25 of the Code) SECTION 20. Holding and investment companies. — A corporation having practically no activities
except holding property, and collecting the income therefrom or investing therein, shall be considered
SECTION 18. Taxation of corporation formed or utilized for avoidance of tax. — Section 25 imposes a holding company within the meaning of Section 25. If the activities further include, or consist
for each year, in addition to the tax imposed by Section 24 a tax of 25 per cent on the undistributed substantially of, buying and selling stocks, securities, real estate, or other investment property
portion of the profits or surplus of a corporation which is formed or availed of for the purpose of (whether upon an outright or a marginal basis) so that the income is derived not only from the
preventing the imposition of the tax upon its shareholders or members or the shareholders or investment yield but also from profits upon market fluctuations, the corporation shall be considered an
members of any other corporation through the medium of permitting gains or profits to accumulate investment company within the meaning of Section 25.
instead of dividing or distributing them. However, banks, insurance companies, personal holding
companies and foreign personal holding companies as defined in Chapter VIII, are excepted from SECTION 21. Unreasonable accumulation of profits. — An accumulation of earnings or profits
taxation under Section 25. The tax imposed by Section 25 applies whether the avoidance was (including the undistributed earnings or profits of prior years) is unreasonable if it is not required for
accomplished through the formation or use of only one corporation or a chain of corporations. For the purposes of the business, considering all the circumstances of the case. It is not intended,
example, if the capital stock of the M Corporation is held by the N Corporation so that the dividend however, to prevent accumulations of surplus for the reasonable needs of the business if the purpose
distributions of the M Corporation would not be returned as income subject to the tax on individuals is not to prevent the imposition of the tax upon shareholders. No attempt is here made to enumerate
until distributed in turn by the N Corporation to its individual shareholders, nevertheless the tax all the ways in which earnings or profits of a corporation may be accumulated for the reasonable
imposed by Section 25 applies to the M Corporation, if that corporation is formed or availed of for the needs of the business. Undistributed income is properly accumulated if retained for working capital
purpose of preventing the imposition of the tax upon the individual shareholders of the N Corporation. needed by the business; or if invested in additions to plant reasonably required by the business; or if
A foreign corporation, whether resident or non-resident, is subject to the tax provided for under in accordance with contract obligations placed to the credit of a sinking fund for the purpose of retiring
Section 25 in the same manner and under the same circumstances as a domestic corporation. bonds 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, the
SECTION 19. Purpose to avoid tax; evidence; burden of proof; definitions of holding or investment financial condition of the corporation at the close of the taxable year, and the use of the undistributed
company. — The Collector of Internal Revenue's determination that a corporation was formed or earnings or profits will be considered in determining the reasonableness of the accumulations.
availed of for the purpose of avoiding the tax on its shareholders or members is subject to disproof by
competent evidence. The existence or non-existence of the purpose may be indicated by The business of a corporation is not merely that which it has previously carried on, but includes in
circumstances other than the evidence specified in Section 25(b), and whether or not such purpose general any line of business which it may undertake. However, a radical change of business when a
was present depends upon the particular circumstances of each case. In other words, a corporation is considerable surplus has been accumulated may afford evidence of a purpose to avoid the tax. If one
subject to taxation under Section 25 if it is formed or availed of for the purpose of preventing the corporation owns the stock of another corporation in the same or a related line of business and in
imposition of the progressive rates of tax upon shareholders through the medium of permitting effect operates the other corporation, the business of the latter may be considered in substance
earnings or profits to accumulate, even though the corporation is not a mere holding or investment although not in legal form the business of the first corporation. Earnings or profits of the first
company 50 per cent or more of the outstanding stock of which is owned directly or indirectly by one corporation put into the second through the purchase of stock or otherwise may, therefore, if a
person, and does not have an unreasonable accumulation of earnings or profits; and on the other subsidiary relationship is established, constitute employment of the income in its own business.
hand, the fact that a corporation is such a company or has an accumulation is not absolutely Investment by a corporation of its income in stock and securities of another corporation is not of itself
conclusive against it if, by clear and convincing evidence, the taxpayer satisfies the Commissioner of to be regarded as employment of the income in its business. The business of one corporation may not
Internal Revenue that the corporation was neither formed nor availed of for the purpose of avoiding be regarded as including the business of another unless the other corporation is a mere
the tax on individuals. All the other circumstances which might be construed as evidence of the instrumentality of the first; to establish this it is ordinarily essential that the first corporation own all or
purpose to avoid the tax on shareholders cannot be outlined, but among other things the following will substantially all of the stock of the second.
be considered: (1) Dealings between the corporation and its shareholders, such as withdrawal by the
shareholders as personal loans or the expenditure of funds by corporation for the personal benefit of The Commissioner of Internal Revenue may require any corporation to furnish a statement of its
the shareholders, and (2) the investment by the corporation of undistributed earnings in assets having accumulated earnings and profits, the name and address of, and number of share held by each of its
no reasonable connection with the business. The mere fact that the corporation distributed a large shareholders or members, and the amounts that would be payable to each, if the income of the
part of its earnings for the year in question does not necessarily prove that earnings were not corporation were distributed.
permitted to accumulate beyond reasonable needs or that the corporation was not formed or availed (Section 26 of the Code)
of to avoid the tax upon shareholders.
SECTION 22. General co-partnerships. — General co-partnerships, when duly registered, are not
If the Commissioner of Internal Revenue determined that the corporation was formed or availed of for subject to income tax, but are required to file returns of their income on B.I.R. Form No. 17.04 for the
the purpose of avoiding the progressive rates of tax on individuals through the medium of permitting purpose of furnishing information as to the share in the gains or profits which each partner shall
earnings or profits to accumulate, and the taxpayer contests such determination of fact by litigation, include in his individual return. Individuals carrying on business in general co-partnership are,
the burden of proving the determination wrong by a preponderance of evidence, together with the however, taxable upon their distributive shares of the net income of such partnership, whether
corresponding burden of first going forward with evidence, is on the taxpayer under principles distributed or not, and are required to include such distributive shares in their individual returns. The
applicable to income tax cases generally, and this is so even though the corporation is not a mere returns of duly registered general co-partnerships should be rendered on or before April 15 of each
holding or investment company and does not have an unreasonable accumulation of earnings or year or within sixty days after the end of their fiscal year depending on whether their books are kept
Revenue Regulations 02-40 Page 4 of 39

on the calendar or on the fiscal year basis. (Conforms with amendments by R.A. 2343, effv. June 20,
1959.) SECTION 29. Cemetery companies. — A cemetery company may be entitled to exemption, (1) if it is
owned by and operated exclusively for the benefit of its lot owners, or (2) if it is not operated for profit.
SECTION 23. Distributive shares of partners. — The distributive share of the net profit of a general Any cemetery corporation chartered solely for burial purposes and not permitted by its charter to
co-partnership must be included in the individual returns of the partners. But where the result of engage in any business not necessarily incident to that purpose, is exempt from income tax, provided
partnership operation is a loss, the loss will be divisible by the partners in the same proportion as the that no part of its net earnings inures to the benefit of any private shareholder or individual. A
net income would have been divisible (or, if the partnership agreement provides for the division of a cemetery company which fulfills the other requirement of the statute may be exempt, even though it
loss in a manner different from the division of a gain, in the manner so provided) and may be taken by issues preferred stock entitling the holders to dividend at a fixed rate, provided that its articles of
the individual partners in their respective returns of income. incorporation require (a) that the preferred stock shall be retired at par as soon as sufficient funds are
(Section 27 of the Code) realized from sales, and (b) that all funds not required for the payment of dividends upon or for the
retirement of preferred stock shall be used by the company for the care and improvement of the
SECTION 24. Proof of exemption. — In order to establish its exemption, and thus be relieved of the cemetery property.
duty of filing returns of income and paying the tax, it is necessary that every organization claiming
exemption file an affidavit with the Commissioner of Internal Revenue, showing the character of the A cemetery company having a capital stock represented by shares, or which is operated for profit or
organization, the purpose for which it was organized, its actual activities, the sources of its income for the benefit of persons other than its members, does not come within the exempted class.
and its disposition, whether or not any of its income is credited to surplus or inures or may inure to the
benefit of any private shareholder or individual, and in general, all facts relating to its operations which SECTION 30. Religious, charitable, scientific, athletic, cultural, and educational corporations. — A
affect its right to exemption. To such affidavit should be attached a copy of the charter or articles of corporation falling among those enumerated in subsection (e) of Section 27 is exempt from tax on its
incorporation, the by-laws of the organization, and the latest financial statement showing the assets, income (other than income of whatever kind and character from its properties, real or personal) if such
liabilities, receipts, and disbursement of the organization. corporation meets two tests: (a) It must be organized and operated for one or more of the specified
purposes; and (b) no part of its net income must inure to the benefit of private stockholders or
Upon receipt of the affidavit and other papers by the Commissioner of Internal Revenue, the individuals.
organization will be informed whether or not it is exempt. When an organization has established its
right to exemption, it need not thereafter make and file a return of income as required under Section The income of such corporation which is considered as income from their properties, real or personal,
46 of the Tax Code. However, the organization should file on or before April 15 of each year, an generally consists of income from corporate dividends, rentals received from their properties, interests
annual information return under oath, stating its gross income and expenses incurred during the received from such capital loaned to other persons, income from agricultural lands owned by such
preceding year, and a certificate showing that there has not been any substantial change in its By- corporations, profits from the sale of property, real or personal, and other similar income. ASIETa
Laws, Articles of Incorporation, manner of operation and activities as well as sources and disposition
of income. (As amended by Revenue Regulations No. 7-64, approved November 25, 1964.) Income not derived from their properties, real or personal, are exempt. For example, in the case of a
religious corporation, income from the conduct of strictly religious activities, such as fees received for
SECTION 25. Agricultural and horticultural organizations. — The organizations contemplated by administering baptismals, solemnizing marriages, attending burials, holding masses, and other like
subsection (a) of Section 27 of the Code as entitled to exemption from income taxation are those income, is exempt. In the case of an educational corporation, income from the holding of an
which (1) have no net income inuring to the benefit of any member; (2) are educational or instructive educational fair or exhibit is exempt. However, if such exempt income is invested by the corporation,
in character; and (3) have as their objects the betterment of the conditions of those engaged in such the income from such investment, as interests from the capital where the capital has been loaned or
pursuits, the improvement of the grade of their products, and the development of a higher degree of dividends on stock where the capital has been invested in shares of stock, will constitute taxable
efficiency in their respective occupations. Organizations such as provincial fairs and like associations income. Donations and other similar contributions received by such corporation from other persons
of a quasi-public character, which are designed to encourage the development of better agricultural are exempt.
and horticultural products through a system of awards, prizes, or premiums, and whose income
derived from gate receipts, entry fees, donations, etc., is used exclusively to meet the necessary The clause "except income expressly exempt by this Title" appearing in subsection (e) of Section 27
expenses of upkeep and operation, are thus exempt. On the other hand, associations which have for refers to those classes of income which, in accordance with subsection (b) of Section 29, are exempt
their purpose, for example, the holding of periodical race meets, the profits from which may inure to from taxation under Title II.
the benefit of their shareholders, are not exempt. Similarly, corporations engaged in growing
agricultural or horticultural products or raising live stock or similar products for profits are not exempt Charitable corporations include an association for the relief of the families of clergymen, even though
from tax under this paragraph. the latter make a contribution to the fund established for this purpose; or for furnishing the services of
trained nurses to persons unable to pay for them; or for aiding the general body of litigants by
SECTION 26. Mutual savings bank. — In order that a corporation may be entitled to exemption as a improving the efficient administration of justice. Educational corporations may include associations
mutual savings bank, it must appear that it is an organization (1) which has no capital stock whose sole purpose is the instruction of the public. But associations formed to disseminate
represented by shares, and (2) whose earnings less only the expenses of operation, are distributable controversial or partisan propaganda are not educational within the meaning of the law. Scientific
wholly among the depositors. If it appears that the organization has shareholders who participate in corporations include an association for the scientific study of law with a view to improving its
the profits, the organization will not be exempt from income tax. administration.

SECTION 27. Fraternal beneficiary societies. — A fraternal beneficiary society is exempt from tax It does not prevent exemption that private individuals, for whose benefit a charity is organized, receive
only if operated under the "lodge system", or for the exclusive benefit of the members of a society so the income of the corporation or association. The law refers to individuals having a personal and
operating. "Operating under the lodge system" means carrying on its activities under a form of private interest in the activities of the corporation, such as stockholders. If, however, a corporation
organization that comprises local branches, chartered by a parent organization and largely self- issues "voting shares", which entitle the holders upon the dissolution of the corporation to receive the
governing, called lodges, chapters, or the like. In order to be exempt, it is also necessary that the proceeds of its property, including accumulated income, the right to exemption ceases to exist, even
society should have an established system for payment to its members or their dependents of life, though the by-laws provide that the shareholders shall not receive any dividend or other return upon
sick, accident, or other benefits. their shares.

SECTION 28. Building and loan associations. — (Now subject to tax, as amended by Sec. 4, R.A. SECTION 31. Business leagues. — A business league is an association of persons having some
82.) common business interest, which limits its activities to work for such common interest and does not
Revenue Regulations 02-40 Page 5 of 39

engage in a regular business of a kind ordinarily carried on for profit. Its work need not be similar to
that of a chamber of commerce or board of trade. If it engages in a regular business of a kind SECTION 36. Meaning of net income. — The tax imposed by law is upon income. In the computation
ordinarily carried on for profit, the fact that the business is conducted on a cooperative basis or of the tax, various classes of income must be considered: (a) Income, in the broad sense, meaning all
produces only sufficient income to be self-sustaining, is not ground for exemption. An association wealth which flows into the tax-payer other than as a mere return of capital. It includes the forms of
engaged in furnishing information to prospective investors, to enable them to make sound income specifically described as gains and profits, including gains derived from the sale or other
investments, is not exempt, since its members have no common business interest, even though all of disposition of capital assets. Income cannot be determined merely by reckoning cash receipts, for the
its income is devoted to the purpose stated. A clearing house association, not organized for profit, no statute recognizes as income determining factor other items, among which are inventories, accounts
part of the net income of which inures to any private shareholder or individual, is exempt provided its receivable, property exhaustion, and accounts payable for expenses incurred. (b) Gross income,
activities are limited to the exchange of checks, and similar work for the common benefit of its meaning income (in the broad sense) less income which is by statutory provision or otherwise exempt
members. An association of persons who are engaged in the transportation business, whether by land from the tax imposed by law. (c) Net income, meaning gross income less statutory deductions. The
or water, which is designed to promote the legitimate objects of such business, and all of the income statutory deductions are, in general, though not exclusively, expenditures other than capital
of which is derived from membership dues and is expended for office expenses is exempt from tax. expenditures, connected with production of income. (d) In the case of a taxpayer other than a
corporation as defined in Section 84 (b) of the Code, net income means gross income less
SECTION 32. Civic leagues. — Civic leagues entitled to exemption comprise those not organized for exemptions. Ordinarily the net income is to be computed in accordance with the method of accounting
profit but operated exclusively for purposes beneficial to the community as a whole. In general, regularly employed in keeping the books of the taxpayer.
organizations engaged in promoting the welfare of mankind are exempt from tax.
SECTION 37. Computation of net income. — Net income must be computed with respect to a fixed
SECTION 33. Social clubs. — The exemption applies to practically all social and recreation clubs period. That period is twelve months ending December 31st of every year except in the case of a
which are supported by membership fees, dues, and assessments. If a club, by reason of the corporation filing returns on a fiscal year basis in which case net income will be computed on the
comprehensive powers granted in the charter, engages in business or in agriculture or horticulture, for basis of such fiscal year. Items of income and of expenditures, which as gross income and
profit, such club is not organized and operated exclusively for pleasure, recreation, or social deductions, are elements in the computation of net income, need not be in the form of cash. It is
purposes, and any profit realized from such activities is subject to tax. sufficient that such items may be appraised in terms of money. The time as of which any item of gross
income or any deduction is to be accounted for must be determined in the light of the fundamental
SECTION 34. Mutual insurance companies and like organizations. — It is necessary to exemption rule that the computation shall be made in such a manner as would clearly reflect the taxpayer's
that the income of the company be derived solely from assessments, dues, and fees collected from income. If the method of accounting regularly employed by him in keeping his books clearly reflects
members. If income is received from other sources, the corporation is not exempt. Income, however, his income, it is to be followed with respect to the time as of which items of gross income and
from sources other than those specified does not prevent exemption where its receipt is a mere deductions are to be accounted for, otherwise the computation of net income shall be made in such
incident of the business of the company. Thus the receipt of interest upon a working bank balance, or manner as in the opinion of the Commissioner of Internal Revenue would clearly reflect it.
of the proceeds of the sale of badges, office supplies, or equipment, will not defeat the exemption.
The same is true of the receipt of interest upon Government bonds, where they were purchased and SECTION 38. Bases of computation. — Approved standard methods of accounting will be ordinarily
were afterwards sold. Where, however, such bonds are bought as a permanent investment, the regarded as clearly reflecting income. A method of accounting will not, however, be regarded as
receipt of the interest destroys the exemption. The receipt of what is, in substance, an entrance fee, clearly reflecting income unless all items of gross income and all deductions are treated with
charged by a mutual fire insurance company as a condition of membership, does not render the reasonable consistency. All items of gross income shall be included in the gross income for the
company taxable, although this fee is called a premium. If an organization issues policies for taxable year in which they are received by the taxpayer and deductions taken accordingly, unless in
stipulated cash premiums, or if it requires advance deposits to cover the cost of the insurance and order clearly to reflect income such amounts are to be properly accounted for as of a different period.
maintains investments from which income is derived, it is not entitled to exemption. On the other For instance, in any case in which it is necessary to use an inventory, no accounting in regard to
hand, an organization may be entitled to exemption, although it makes advance assessment for the purchases and sales will correctly reflect income except an accrual method. A taxpayer is deemed to
sole purpose of meeting future losses and expenses, provided that the balance of such assessments have received items of gross income which have been credited to or set apart for him without
remaining on hand at the end of the year is retained to meet losses and expenses or is returned to restriction. On the other hand, appreciation in value of property is not even an accrual of income to a
members. An organization of a purely local character is one whose business activities are confined to taxpayer prior to the realization of such appreciation through sale or conversion of the property. (For
a particular community, place, or district, irrespective, however, of political subdivisions. methods of accounting and determination of accounting period, see Sections 166 to 169 of these
regulations.)
SECTION 35. Farmers' cooperative marketing and purchasing association. — Cooperative (Section 29(a) of the Code)
associations, acting as sales agents for farmers or others, in order to come within the exemption must
establish that for their own account they have no net income. Cooperative dairy companies, which are SECTION 39. What gross income includes. — Gross income includes, in general, compensation for
engaged in collecting milk and disposing of it or the products thereof and distributing the proceeds, personal and professional services, business income, profits from sales of and dealings in property,
less necessary operating expenses, among their members upon the basis of the quantity of milk or of interests, rents, dividends, and gains, profits, and income derived from any source whatever, unless
butter fat in the milk furnished by such members are exempt from the tax. If the proceeds of the exempt from tax by law. In general, income is the gain derived from capital, from labor, or from both
business are distributed in any other way than on such a proportionate basis, the company will be combined, provided it be understood to include profit gained through a sale or conversion of capital
subject to tax. A farmers' association is not exempt from taxation where in accounting to farmers assets. Profit of citizens, resident aliens, or domestic corporations derived from sales in foreign
furnishing produce for the proceeds of sales it deducts more than the necessary selling expenses commerce must be included in their gross income. Income may be in the form of cash or of property.
incurred. Cooperative associations acting as purchasing agents are not expressly exempt from tax,
but rebates made to purchasers, whether or not members of the association, in proportion to their For the treatment of dividends for purposes of the tax, see Sections 250 to 256 of these regulations.
purchases may be excluded from gross income in computing the net income subject to tax. Any For the treatment of capital gains, see Sections 132 to 135 of these regulations.
profits made from non-members and distributed to members in the guise of rebates are, of course,
subject to tax. SECTION 40. Compensation for personal services. — Where no determination of compensation is
had until the completion of the services, the amount received is ordinarily income for the taxable year
Cooperative marketing associations duly incorporated under Act No. 3425, known as the Cooperative of its determination, if the return is rendered on the accrual basis; or, for the taxable year in which
Marketing Law are exempt from income tax. (See also R.A. 702 exempting cooperative marketing received, if the return is rendered on a receipts and disbursements basis. Commissions paid
associations.) salesman, compensation for services on the basis of a percentage of profits, commissions on
(Section 28 of the Code) insurance premiums, tips, and pensions or retiring allowances paid by private persons or by the
Revenue Regulations 02-40 Page 6 of 39

Government of the United States or of the Philippines (except pensions exempt by law from tax) are composition of all items appearing upon his balance sheet and used in connection with the method of
income to the recipients; as are also marriage fees, baptismal offerings, sums paid for saying masses accounting formerly employed by him, should accompany his return.
for the dead, and other contributions received by a clergyman, evangelists, or religious worker for SECTION 45. Gross income of farmers. — A farmer reporting on the basis of receipts and
services rendered. However, so-called pensions awarded by one to whom no services have been disbursements (in which no inventory to determine profits is used) shall include in his gross income
rendered are mere gifts or gratuities and are not taxable. for the taxable year (1) the amount of cash or the value of merchandise or other property received
from the sale of live stock and produce which were raised during the taxable year or prior years, (2)
SECTION 41. Compensation paid other than in cash. — Where services are paid for with something the profit from the sale of any live stock or other items which were purchased, and (3) gross income
other than money, the fair market value of the thing taken in payment is the amount to be included as from all other sources. The profit from the sale of live stock or other items which were purchased is to
income. If the services were rendered at a stipulated price, in the absence of evidence to the contrary, be ascertained by deducting the cost from the sales price in the year in which the sale occurs, except
such price will be presumed to be the fair value of the compensation received. Compensation paid an that in the case of the sale of animals purchased as draft or work animals, or solely for breeding or
employee of a corporation in its stock is to be treated as if the corporation sold the stock for its market dairy purposes and not for resale, the profit shall be the amount of any excess of the sales prices over
value and paid the employee in cash. When living quarters are furnished in addition to cash salary, the amount representing the difference between the cost and the depreciation theretofore sustained
the rental value of such quarters should be reported as income. and allowed as a deduction in computing net income.

SECTION 42. Compensation paid in promissory notes. — Promissory notes or other evidence of In the case of a farmer reporting on the accrual basis (in which an inventory is used to determine
indebtedness received in payment for services, and not merely as security for such payment, profits), his gross profits are ascertained by adding to the inventory value of live stock and products
constitute income to the amount of their fair market value. A taxpayer receiving as compensation a on hand at the end of the year the amount received from the sale of live stock products, and
note regarded as good for its face value at maturity, but not bearing interest, shall treat as income as miscellaneous receipts for hire of teams, machinery, and the like, during the year, and deducting from
of the time of receipt the fair discounted value of the note at that time. Thus, if it appears that such a this sum the inventory value of live stock and products on hand at the beginning of the year and the
note is or could be discounted on a 6 per cent basis, the recipient shall include such note in his gross cost of live stock and products purchased during the year. In such cases all live stock raised or
income to the amount of its face value less discount computed at the prevailing rate for such purchased for sale shall be included in the inventory at their proper valuation determined in
transactions. accordance with the method authorized and adopted for the purpose. Also, live stock acquired for
drafts, breeding, or dairy purposes and not for sale may be included in the inventory, instead of being
If the payment due on a note so accounted for are met as they become due, there should be included treated as capital assets subject to depreciation, provided such practice is followed consistently by the
as income in respect of each such payment so much thereof as represents recovery for the discount taxpayer. In case of the sale of any live stock included in an inventory their cost must not be taken as
originally deducted. an additional deduction in the return of income, as such deduction will be reflected in the inventory.

SECTION 43. Gross income from business. — In the case of a manufacturing, merchandising, or In every case of the sale of machinery, farm equipment, or other capital assets (which are not to be
mining business, "gross income" means the total sales, less the cost of goods sold, plus any income included in an inventory if one is used to determine profits) any excess over the cost thereof less the
from investments and from incidental or outside operations or sources. In determining the gross amount of depreciation theretofore sustained and allowed as a deduction in computing net income,
income, subtractions should not be made for depreciation, depletion, selling expenses or losses, or shall be included as gross income. Where farm produce is exchanged for merchandise, groceries, or
for items not ordinarily used in computing the cost of goods sold. the like, the market value of the article received in exchange is to be included in gross income. Rents
received in crop shares shall be returned as of the year in which the crop shares are reduced to
SECTION 44. Long term contracts. — Income from long-term contracts is taxable for the period in money or a money equivalent. Proceeds of insurance, such as fire and typhoon insurance on growing
which the income is determined, such determination depending upon the nature and terms of the crops, should be included in gross income to the amount received in cash or its equivalent for the
particular contract. As used herein the term "long-term" contracts means building, installation, or crop injured or destroyed. If a farmer is engaged in producing crops which take more than a year from
construction contracts covering a period in excess of one year. Persons whose income is derived in the time of planting to the time of gathering and disposing, the income therefrom may be computed
whole or in par from such contracts may, as to such income, prepare their returns upon the following upon the crop basis; but in any such cases the entire cost of producing the crop must be taken as a
bases: deduction in the year in which the gross income from the crop is realized. EaICAD

(a) Gross income derived from such contracts may be reported upon the basis of percentage of As herein used the term "farm" embrace the farm in the ordinarily accepted sense, and includes
completion. In such case there should accompany the return certificate of architects, or engineers stock, dairy, poultry, fruit, and truck farms, also plantations, ranches, and all land used for farming
showing the percentage of completion during the taxable year of the entire work performed under operations. All individuals, partnerships, or corporations that cultivate, operate, or manage farms for
contract. There should be deducted from such gross income all expenditures made during the taxable gain or profit either as owners, or tenants, are designated farmers. A person cultivating or operating a
year on account of the contract, account being taken of the material and supplies on hand at the farm for recreation or pleasure, the result of which is a continual loss from year to year, is not
beginning and end of the taxable period for use in connection with the work under the contract but not regarded as a farmer.
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 of Internal SECTION 46. Sale of patents and copyrights. — A taxpayer disposing of patents or copyrights by
Revenue may permit or require an amended return. sale should determine the profit or loss arising therefrom by computing the difference between the
selling price and the cost. The taxable income in the case of patents or copyrights acquired prior to
(b) Gross income may be reported in the taxable year in which the contract is finally completed and March 1, 1913, should be ascertained in accordance with the provisions of section 136 of these
accepted if the taxpayer elects as a consistent practice to so treat such income, provided such regulations. The profit or loss thus ascertained should be increased or decreased, as the case may
method clearly reflects the net income. If this method is adopted there should be deducted from gross be, by the amounts deducted on account of depreciation of such patent or copyrights since March 1,
income all expenditures during the life of the contract which are properly allocated thereto, taking into 1913, or since the date of acquisition if subsequent thereto.
consideration any material and supplies charged to the work under the contract but remaining on
hand at the time of the completion. SECTION 47. Sale of goodwill. — Gain or loss from a sale of goodwill results only when the
business, or a part of it, to which the goodwill attaches is sold, in which case the gain or loss will be
Where a taxpayer has filed his return in accordance with the method of accounting regularly determined by comparing the sale price with the cost or other basis of the assets, including goodwill.
employed by him in keeping his books and such method clearly reflects the income, he will not be If specific payment was not made for goodwill acquired after March 1, 1913, there can be no
required to change to either of the methods above set forth. If a taxpayer desires to change his deductible loss with respect thereto, but gain may be realized from the sale of goodwill built up
method of accounting in accordance with paragraphs (a) and (b) above, a statement showing the through expenditures which have been currently deducted. It is immaterial that goodwill may never
Revenue Regulations 02-40 Page 7 of 39

have been carried on the books as an asset but the burden of proof is on the taxpayer to establish the SECTION 52. Income constructively received. — Income which is credited to the account of or set
cost or fair market value on March 1, 1913, of the goodwill sold. apart for a taxpayer and which may be drawn upon by him at any time is subject to tax for the year
during which so credited or set apart, although not then actually reduced to possession. To constitute
SECTION 48. Annuities and insurance policies. — Annuities paid by religious, charitable, and receipt in such a case the income must be credited to the taxpayer without any substantial limitation
educational corporations under an annuity contract are subject to tax to the extent that the aggregate or restriction as to the time or manner of payment or condition upon which payment is to be made. A
amount of the payments to the annuitant exceeds the amounts paid by him as consideration for the book entry, if made, should indicate an absolute transfer from one account to another. If the income is
contract. An annuity charged upon devised land is taxable to a donee-annuitant, whether paid by the not credited, but is set apart, such income must be unqualifiedly subject to the demand of the
devisee out of the rents of the land or from other sources. The devisee is not required to return as taxpayer. Where a corporation contingently credits its employees with bonus stock, but the stock is
gross income the amount of rent paid to the annuitant, and he is not entitled to deduct from his gross not available to such employees until some future date, the mere crediting on the books of the
income any sums paid to the annuitant. Amounts received by an insured as a return of premiums paid corporation does not constitute receipt.
by him under life insurance, endowment, or annuity contracts, such as the so-called "dividends" of a
mutual insurance company, which may be credited against the current premium, are not subject to SECTION 53. Examples of constructive receipt. — When interest coupons have matured and are
tax. Distributions on paid-up policies which are made out of earnings of the insurance company payable, but have not been cashed, such interest payment though not collected when due and
subject to tax are in the nature of corporate dividends and should be included in the taxable income of payable, is nevertheless available to the taxpayer and should therefore be included in his gross
the individual, without any credit for the amount of tax paid by the corporation at source. income for the year during which the coupons matured. This is true if the coupons are exchanged for
other property instead of eventually being cashed. Defaulted coupons are income for the year in
SECTION 49. Improvements by lessees. — When buildings are erected or improvements made by a which paid. The distributive share of the profits of a partner in a general co-partnership duly registered
lessee in pursuance of an agreement with the lessor, and such buildings or improvements are not is regarded as received by him, although not distributed. Interest credited on savings bank deposits,
subject to removal by the lessee, the lessor may at his option report the income therefrom upon either even though the bank nominally has a rule, seldom or never enforced, that it may require so many
of the following bases; days' notice in advance of cashing depositors' checks, is income to the depositor when credited. An
amount credited to shareholders of a building and loan association, when such credit passes without
(a) The lessor may report as income at the time when such buildings or improvements are restriction to the shareholder, has taxable status as income for the year of the credit. When the
completed the fair market value of such buildings or improvements subject to the lease. amount of such accumulations has not become available to the shareholder until the maturity of a
(b) The lessor may spread over the life of the lease the estimated depreciated value of such share, the amount of any share in excess of the aggregate amount paid in by the shareholder is
buildings or improvements at the termination of the lease and report as income for each year of income for the year of maturity of the share.
the lease an aliquot part thereof.
SECTION 54. Creation of corporate sinking fund. — If a corporation in order solely to secure
If for any other reason than a bona fide purchase from the lessee by the lessor the lease is payment of its bonds or other indebtedness, places property in trust, or sets aside certain amounts in
terminated, so that the lessor comes into possession or control of the property prior to the time a sinking fund under the control of a trustee who may be authorized to invest and reinvest such sums
originally fixed for the termination of the lease, the lessor receives additional income for the year in from time to time, the property or fund thus set aside by the corporation and held by the trustee is an
which the lease is so terminated to the extent that the value of such buildings or improvements when asset of the corporation, and any gain arising therefrom is income of the corporation and shall be
he became entitled to such possession exceeds the amount already reported as income on account included as such in its annual return.
of the erection of such buildings or improvements. No appreciation in value due to causes other than
the premature termination of the lease shall be included. Conversely, if the building or improvements SECTION 55. Acquisition or disposition by a corporation of its own capital stock. — Whether the
are destroyed prior to the expiration of the lease, the lessor is entitled to deduct as a loss for the year acquisition or disposition by a corporation of share of its own capital stock gives rise to taxable gain or
when such destruction takes place the amount previously reported as income because of the erection deductible loss depends upon the real nature of the transaction, which is to be ascertained from all its
of such buildings or improvements, less any salvage value subject to the lease to the extent that such facts and circumstances. The receipt by a corporation of the subscription price of shares of its capital
loss was not compensated for by insurance. If the buildings or improvements destroyed were stock upon their original issuance gives rise to neither taxable gain nor deductible loss, whether the
acquired prior to March 1, 1913, the deduction shall be based on the cost or the value subject to the subscription or issue price be in excess of, or less than, the par or stated value of such stock.
lease to the extent that such loss was not compensated for by insurance. HSaCcE
But if a corporation deals in its own shares as it might in the shares of another corporation, the
SECTION 50. Forgiveness of indebtedness. — The cancellation and forgiveness of indebtedness resulting gain or loss is to be computed in the same manner as though the corporation were dealing in
may amount to a payment of income, to a gift, or to a capital transaction, dependent upon the the shares of another. So also if the corporation receives its own stock as consideration upon the sale
circumstances. If, for example, an individual performs services for a creditor, who, in consideration of property by it, or in satisfaction of indebtedness to it, the gain or loss resulting is to be computed in
thereof cancels the debt, income to that amount is realized by the debtor as compensation for his the same manner as though the payment had been made in any other property. Any gain derived from
services. If, however, a creditor merely desires to benefit a debtor and without any consideration such transaction is subject to tax, and any loss sustained is allowable as deduction where permitted
therefor cancels the debt, the amount of the debt is a gift from the creditor to the debtor and need not by the provisions of Title II.
be included in the latter's gross income. If a corporation to which a stockholder is indebted forgives
the debt, the transaction has the effect of the payment of a dividend. SECTION 56. Contributions by shareholders. — Where a corporation requires additional funds for
conducting its business and obtains such needed money through voluntary pro rata payments by its
SECTION 51. When income is to be reported. — Gains, profits, and income are to be included in the shareholders, the amounts so received being credited to its surplus account or to a special capital
gross income for the taxable year in which they are received by the taxpayer, unless they are included account, will not be considered income, although there is no increase in the outstanding shares of
when they accrue to him in accordance with the approved method of accounting followed by him. If a stock of the corporation. The payments in such circumstances are in the nature of voluntary
person sues in one year on a pecuniary claim or for property, and money or property is recovered on assessments upon, and represent an additional price paid for, in shares of stock held by the individual
a judgment therefore in a later year, income is realized in that year, assuming that the money or shareholders, and will be treated as an addition to and as a part of the operating capital of the
property would have been income in the earlier year if then received. This is true of a recovery for company.
patent infringement. Bad debts or accounts charged off subsequent to March 1, 1913, because of the
fact that they were determined to be worthless, which are subsequently recovered, whether or not by SECTION 57. Sale and retirement of corporate bonds. — (1) (a) If bonds are issued by a corporation
suit, constitute income for the year in which recovered, regardless of the date when amounts were at their face value, the corporation realizes no gain or loss. (b) If thereafter the corporation purchases
charged off. and retires any of such bonds at a price in excess of the issuing price or face value, the excess of the
purchase price over the issuing price or face value is a deductible expense for the taxable year. (c) If,
Revenue Regulations 02-40 Page 8 of 39

however, the corporation purchases and retires any of such bonds at a price less than the issuing
price or face value, the excess of the issuing price or face value over the purchase price is gain or SECTION 62. Proceeds of insurance. — The proceeds of life-insurance policies, paid by reason of
income for the taxable year. the death of an insured to his estate or to any beneficiary (individual, partnership, or corporation, but
not a transferee for a valuable consideration), directly or in trust, are excluded from the gross income
(2) (a) If bonds are issued by a corporation at a premium, the net amount of such premium is gain or of the beneficiary. It is immaterial whether the proceeds are received in a single sum or in
income which should be prorated or amortized over the life of the bond. (b) If thereafter the installments. If, however, such proceeds are held by the insurer under an agreement to pay interest
corporation purchases and retires any of such bonds at a price in excess of the issuing price minus thereon, the interest payments must be included in gross income. Amounts received (other than
any amount of premium already returned as income, the excess of the purchase price over the amounts paid by reason of the death of the insured and interest payments on such amounts) under a
issuing price minus any amount of premium already returned as income (or over the face value plus life insurance, endowment, or annuity contract are excluded from gross income but, if such amounts
any amount of premiums not yet returned as income) is a deductible expenses for the taxable year. (when added to amounts received before the taxable year under such contract) exceed the aggregate
(c) If, however, the corporation purchases and retires any of such bonds at a price less than the premiums or consideration paid (whether or not paid during the taxable year) then the excess shall be
issuing price minus any amount of premium already returned as income, the excess of the issuing included in gross income. However, in the case of a transfer for a valuable consideration, by
price minus any amount of premium already returned as income (or of the face value plus any amount assignment or otherwise, of a life insurance, endowment, or annuity contract, or any interest therein,
of premium not yet returned as income) over the purchase price is gain or income for the taxable year. only the actual value of such consideration and the amount of the premiums and other sums
subsequently paid by the transferee are exempt from taxation.
(3) (a) If bonds are issued by a corporation at a discount, the net amount of such discount is
deductible and should be prorated or amortized over the life of the bonds. (b) If thereafter the SECTION 63. Amounts received as compensation for injuries or sickness. — The amounts received
corporation purchases and retires any of such bonds at a price in excess of the issuing price plus any by an insured or his estate or beneficiaries through accident or health insurance or under workmen's
amount of discount already deducted, the excess of the purchase price over the issuing price plus any compensation acts as compensation for personal injuries or sickness are excluded from the gross
amount of discount already deducted (or over the face value minus any amount of discount not yet income of the insured, his estate, and other beneficiaries. Any damages recovered by suit or
deducted), is a deductible expense for the taxable year. (c) If, however, the corporation purchases agreement on account of such injuries or sickness are similarly excluded from the gross income of the
and retires any of such bonds at a price less than the issuing price plus any amount of discount individual injured or sick, if living, or of his estate or other beneficiaries entitled to receive such
already deducted, the excess of the issuing price plus any amount of discount already deducted (or of damages, if dead.
the face value minus any amount of discount not yet deducted) over the purchase price is gain or
income for the taxable year. SECTION 64. Gifts and bequests. — Property received as a gift or received under a will or testament
or through legal succession, is exempt from the income tax, although the income therefrom or income
SECTION 58. Income of corporation from leased property. — Where a corporation has leased its derived from its investment, sale, or otherwise is not. An amount of principal paid under a marriage
property in consideration that the lessee shall pay in lieu of other rental an amount equivalent to a settlement is a gift. Neither alimony nor an allowance based on a separation agreement is taxable
certain rate of dividend on the lessor's capital stock or the interest on the lessor's outstanding income.
indebtedness, together with taxes, insurance or other fixed charges, such payments shall be (Section 30(a) of the Code)
considered rental payments and shall be returned by the lessor corporation as income,
notwithstanding the fact that the dividends and interest are paid by the lessee directly to the SECTION 65. Business expenses. — Business expenses deductible from gross income include the
shareholders and bondholders of the lessor. The fact that a corporation has conveyed or let its ordinary and necessary expenditures directly connected with or pertaining to the taxpayer's trade or
property and has parted with its management and control, or has ceased to engage in the business business. The cost of goods purchased for resale, with proper adjustment for opening and closing
for which it was originally organized, will not relieve it from liability to the tax. While the payments inventories, is deducted from gross sales is computing gross income. Among the items included in
made by the lessee directly to the bondholders or shareholders of the lessor are rentals as to both the business expenses are management expenses, commissions, labor, supplies, incidental repairs,
lessee and lessor (rentals paid in one case and rentals received in the other), to the bondholders and operating expenses of transportation, equipment used in the trade or business, traveling expenses
the shareholders, such amounts are interest and dividend payments received as from the lessor and while away from home solely in the pursuit of a trade or business, advertising and other selling
as such shall be accounted for in their returns. expenses, together with insurance premiums against fire, storm, theft, accident, or other similar
losses in the case of a business, and rental for the use of business property. A taxpayer is entitled to
SECTION 59. Gross income of a corporation in liquidation. — When a corporation is dissolved, its deduct the necessary expenses paid in carrying on his business from his gross income from whatever
affairs are usually wound up by a receiver or trustee in dissolution. The corporate existence is source.
continued for the purpose of liquidating the assets and paying the debts, and such receiver or trustee
stands in the stead of the corporation for such purposes. Any sales of property by them are to be SECTION 66. Traveling expenses. — Traveling expenses as ordinarily understood, include
treated as if made by the corporation for the purpose of ascertaining the gain or loss. transportation expenses and meals and lodging. If the trip is undertaken for other than business
purposes, the transportation expenses are personal expenses, and the meals and lodging are living
SECTION 60. Gross income of foreign corporations. — The gross income of a foreign corporation expenses, and therefore, not deductible. If the trip is solely on business, the reasonable and
subject to tax consists of its gross income from sources within the Philippines. Gross income from necessary traveling expenses, including transportation expenses, meals and lodging, become
sources within the Philippines, as applied to foreign corporations, shall include interest received on business instead of personal expenses.
bonds, notes, or other interest-bearing obligations issued by residents, corporate or otherwise, as well
as income derived from dividends on the capital stock or from the net earnings of domestic or resident (a) If, then, an individual, whose business requires him to travel receives a salary as full
foreign corporations, joint stock companies, associations, or insurance companies, dividends from compensation for his services, without reimbursement for traveling expenses, or is employed on
other foreign corporations to the extent provided in Section 37 of the Code, and likewise income from a commission basis with no expense allowance, his traveling expenses, including the entire
rentals and royalties from all sources within the Philippines. amount expended far meals and lodging, are deductible from gross income.
(Section 29(b) of the Code) (b) If an individual receives a salary and is also repaid his actual traveling expenses, he shall
include in gross income, the amount so repaid and may deduct such expenses. aDcHIC
SECTION 61. Exclusions from gross income. — The term "gross income" as used in the Act does not (c) If an individual receives a salary and also an allowance for meals and lodging, as for example, a
include those items of income exempted by statute or by fundamental law. Such tax-free income per diem allowance in lieu of subsistence, the amount of the allowance should be included in
should not be included in the income tax return unless information regarding it is specifically called for. gross income and the cost of such meals and lodging may be deducted therefrom.
The exclusion of such income should not be confused with the reduction of gross income by the
application of allowable deductions.
Revenue Regulations 02-40 Page 9 of 39

A payment for the use of a sample room at a hotel for the display of goods is a business basis different from that applying to compensation at a flat rate. Generally speaking, if contingent
expense. Only such expenses as are reasonable and necessary in the conduct of the business and compensation is paid pursuant to a free bargain between the employer and the individual made
directly attributable to it may be deducted. A taxpayer claiming the benefit of the deductions referred before the services are rendered, not influenced by any consideration on the part of the
to herein must attach to his return a statement showing (1) the nature of the business in which he is employer other than that of securing on fair and advantageous terms the services of the
engaged; (2) the number of days away from home during the taxable year on account of business; (3) individual, it should be allowed as a deduction even though in the actual working out of the
the total amount of expenses incident to meals and lodging while absent from home and business contract it may prove to be greater than the amount which would ordinarily be paid.
during the taxable year; (4) the total amount of other expenses incident to travel and claimed as a (3) In any event the allowance for compensation paid may not exceed what is reasonable in all the
deduction. circumstances. It is in general just to assume that reasonable and true compensation is only
such amount as would ordinarily be paid for like services by like enterprises in like
Claim for the deductions referred to herein must be substantiated, when required by the circumstances. The circumstances to be taken into consideration are those existing at the date
Commissioner of Internal Revenue by record showing in detail the amount and nature of the when the contract for services was made, not those existing at the date when the contract is
expenses incurred. questioned.

SECTION 67. Cost of materials. — Taxpayers carrying materials and supplies on hand should SECTION 71. Treatment of excessive compensation. — The income tax liability of the recipient in
include in expenses the charges for materials and supplies only to the amount that they are actually respect of an amount ostensibly paid to him as compensation, but not allowed to be deducted as such
consumed and used in operation during the year for which the return is made, provided that the cost by the payer, will depend upon the circumstances of each case. Thus, in the case of excessive
of such materials and supplies has not been deducted in determining the net income for any previous payments by corporations, if such payments correspond or bear a close relationship to stockholdings,
year. If a taxpayer carries incidental materials or supplies on hand for which no record of consumption and are found to be distribution of earnings or profits, the excessive payments will be treated as
is kept or of which physical inventories at the beginning and end of the year are not taken, it will be dividend. If such payments constitute payment for property, they should be treated by the payer as a
permissible for the taxpayer to include in his expenses and deduct from gross income the total cost of capital expenditure and by the recipient as part of the purchase price. HSCcTD
such supplies and materials as were purchased during the year for which the return is made, provided
the net income is clearly reflected by this method. SECTION 72. Bonuses to employees. — Bonuses to employees will constitute allowable deductions
from gross income when such payments are made in good faith and as additional compensation for
SECTION 68. Repairs. — The cost of incidental repairs which neither materially add to the value of the services actually rendered by the employees, provided such payment, when added to the
the property nor appreciably prolong its life, but keep it in an ordinarily efficient operating condition, stipulated salaries, do not exceed a reasonable compensation for the service rendered. It is
may be deducted as expense, provided the plant or property account is not increased by the amount immaterial whether such bonuses are paid in cash or in kind or partly in cash and partly in kind.
of such expenditure. Repairs in the nature of replacement, to the extent that they arrest deterioration Donations made to employees and others, which do not have in them the element of compensation or
and appreciably prolong the life of the property should be charged against the depreciation reserves if are in excess of reasonable compensation for services, are not deductible from gross income.
such account is kept.
SECTION 73. Pensions, compensation for injuries. — Amounts paid for pensions to retired
SECTION 69. Professional expenses. — A professional may claim as deductions the cost of supplies employees or to their families or others dependent upon them, or on account of injuries received by
used by him in the practice of his profession, expenses paid in the operation and repair of employees, and lump-sum amounts paid or accrued as compensation for injuries, are proper
transportation equipment used in making professional calls, dues to professional societies and deductions as ordinary and necessary expenses. Such deductions are limited to the amount not
subscriptions to professional journals, the rent paid for office rooms, the expenses of the fuel, light, compensated for by insurance or otherwise. When the amount of the salary of an officer or employee
water, telephone, etc.; used in such offices, and the hire of office assistants. Amounts currently is paid for a limited period after his death to his widow or heirs, in recognition of the services rendered
expended for books, furnitures, and professional instruments and equipment, the useful life of which by the individual, such payments may be deducted. Salaries paid by employers to employees who are
is short, may be deducted. But amounts expended for books, furniture, and professional instruments absent in the military, naval or other service of the Government, but who intend to return at the
and equipment of a permanent character are not allowable as deductions. SEHTIc conclusion of such service, are allowable deductions. (See Section 118 of these regulations, relative
to pension trust.)
SECTION 70. Compensation for personal services. — Among the ordinary and necessary expenses
paid or incurred in carrying on any trade or business may be included a reasonable allowance for SECTION 74. Rentals. — Where a leasehold is acquired for business purposes for a specified sum,
salaries or other compensation for personal services actually rendered. The test of deductibility in the the purchaser may take as a deduction in his return an aliquot part of such sum each year, based on
case of compensation payments is whether they are reasonable and are, in fact, payments purely for the number of years the lease has to run. Taxes paid by a tenant to or for a landlord for business
service. This test and its practical application may be further stated and illustrated as follows: property are additional rent and constitute a deductible item to the tenant and taxable income to the
landlord, the amount of the tax being deductible by the latter. The cost borne by a lessee in erecting
(1) Any amount paid in the form of compensation, but not in fact as the purchase price of buildings or making permanent improvements on ground of which he is lessee is held to be a capital
services, is not deductible. (a) An ostensible salary paid by a corporation may be a investment and not deductible as a business expense. In order to return to such taxpayer his
distribution of dividend on stock. This is likely to occur in the case of a corporation having investment of capital, an annual deduction may be made from gross income of an amount equal to
few shareholders, practically all of whom draw salaries. If in such a case the salaries are in the cost of such improvements divided by the number of years remaining of the term of lease, and
excess of those ordinarily paid for similar services, and the excessive payment correspond such deduction shall be in lieu of a deduction for depreciation. If the remainder of the term of lease is
or bear a close relationship to the stockholdings of the officers or employees, it would seem greater than the probable life of the buildings erected, or of the improvements made, this deduction
likely that the salaries are not paid wholly for services rendered, but that the excessive shall take the form of an allowance for depreciation.
payments are a distribution of earnings upon the stock. (b) An ostensible salary may be in
part payment for property. This may occur, for example, where a partnership sells out to a SECTION 75. Expenses of farmers. — A farmer who operates a farm for profit is entitled to deduct
corporation, the former partners agreeing to continue in the service of the corporation. In from gross income as necessary expenses all amounts actually expended in the carrying on of the
such a case it may be found that the salaries of the former partners are not merely for business of farming. The cost of ordinary tools of short life or small cost, such as hand tools, including
services, but in part constitute payment for the transfers of their business. shovels, rakes, etc., may be included. The cost of feeding and raising livestock may be treated as an
(2) expense deduction, in so far as such cost represents actual outlay, but not including the value of farm
(2) The form or method of fixing compensation is not decisive as to deductibility. While any form of produce grown upon the farm or the labor of the taxpayer. Where a farmer is engaged in producing
contingent compensation invites scrutiny as a possible distribution of earnings of the enterprise, crops which take more than a year from the time of planting to the process of gathering and disposal,
it does not follow that payments on a contingent basis are to be treated fundamentally on any expenses deducted may be determined upon the crop basis, and such deductions must be taken in
Revenue Regulations 02-40 Page 10 of 39

the year in which the gross income from the crop has been realized. The cost of farm machinery, moneys received for investment and secured by interest-bearing certificates of indebted issued by
equipment, and farm buildings represents a capital investment and is not an allowable deduction as such hank or loan or trust company may be deducted from gross income.
an item of expense. Amounts expended in the development of farms, orchards, and ranches, prior to
the time when the productive state is reached may be regarded as investments of capital. Amounts SECTION 79. Interest on capital. — Interest calculated for cost-keeping or other purposes on
expended in purchasing work, breeding or dairy animals are regarded as investments of capital, and account of capital or surplus invested in the business, which does not represent a charge arising
may be depreciated unless such animals are included in an inventory in accordance with Section 149 under an interest-bearing obligation, is not allowable deduction from gross income.
of these regulations. The purchase price of transportation equipment even when wholly used in (Section 30(c) of the Code)
carrying on farm operations, is not deductible but is regarded as an investment of capital. The cost of
gasoline or fuel, repairs, and upkeep of the transportation equipment if used wholly in the business of SECTION 80. Taxes in general. — As a general rule, taxes are deductible with the exception of those
farming is deductible as an expense; if used partly for business purposes and partly for the pleasure with respect to which the law does not permit deduction. However, in the case of a non-resident alien
or convenience of the taxpayer or his family, such cost may be apportioned according to the extent of individual and a foreign corporation, deduction is allowed only if and to the extent that the taxes for
the use for purposes of business and pleasure or convenience, and only the proportion of such cost which deduction is claimed are connected with income from sources within the Philippines.
justly attributable to business purposes is deductible as a necessary expense. If a farm is operated for
recreation or pleasure and not on a commercial basis, and if the expenses incurred in connection with Import duties paid to the proper customs officers, and business, occupation, license, privilege, excise
the farm are in excess of the receipt therefrom, the entire receipts from the sale of products may be and stamp taxes and any other taxes of every name or nature paid directly to the Government of the
ignored in rendering a return of income, and the expenses incurred, being regarded as personal Philippines or to any political subdivision thereof, are deductible. The word "taxes" means taxes
expenses, will not constitute allowable deduction. proper and no deductions should be allowed for amounts representing interest, surcharge, or
penalties incident to delinquency. Postage is not a tax. Automobile registration fees are considered
SECTION 76. When charges are deductible. — Each year's return, so far as practicable, both as to taxes. Taxes are deductible as such only by the person upon whom they are imposed. Thus the
gross income and deductions therefrom, should be complete in itself, and taxpayers are expected to merchants' sales tax imposed by law upon sales is not deductible by the individual purchaser even
make every reasonable effort to ascertain the facts necessary to make a correct return. The though the tax may be billed to him as a separate item.
expenses, liabilities, or deficit of one year cannot be used to reduce the income of a subsequent year.
A taxpayer has the right to deduct all authorized allowances and it follows that if he does not within In computing the net income of an individual no deduction is allowed for the taxes imposed upon his
any year deduct certain of his expenses, losses, interests, taxes, or other charges, he can not deduct interest as shareholder of a bank or other corporation, which are paid by the corporation without
them from the income of the next or any succeeding year. If it is recognized, however, that particularly reimbursement from the taxpayer. The amount so paid should not be included in the income of the
in a going business of any magnitude there are certain overlapping items both of income and shareholder.
deduction, and so long as these overlapping items do not materially distort the income, they may be
included in the year in which the taxpayer, pursuant to a consistent policy, takes them into his In the case of corporate bonds or other obligations containing a tax-free covenant clause the
accounts. Judgments or other binding judicial adjudication, on account of damages for patent corporation paying a tax or any part of it, for someone else pursuant to its agreement is not entitled to
infringement, personal injuries, or other cause, are deductible from gross income when the claim is so deduct such payment from gross income on any ground.
adjudicated or paid, unless taken under other methods of accounting which clearly reflect the correct
deduction, less any amount of such damages as may have been compensated for by insurance or SECTION 81. Income tax imposed by the Government of the Philippines. — The law does not permit
otherwise: If subsequent to its occurrence, however, a taxpayer first ascertains the amount of a loss the deduction of the income tax paid to or accrued in favor of the Government of the Philippines, and
sustained during a prior taxable year which has not been deducted from gross income, he may render in no case may the taxpayer avail of such deduction.
an amended return for such preceding taxable year including such amount of loss in the deduction
from gross income and may in proper cases file a claim for refund of the excess tax paid by reason of SECTION 82. Income, war-profits, and excess-profits taxes imposed by the authority of a foreign
the failure to deduct such loss in the original return. A loss from theft or embezzlement occurring in country. — Income, war-profits, and excess-profits taxes imposed by the authority of a foreign country
one year and discovered in another is ordinarily deductible for the year in which sustained. (including the United States and possessions thereof) are allowed as deductions only if the taxpayer
does not signify in his return his desire to have to any extent the benefits of the provisions of law
SECTION 77. Expenses allowable to non-resident aliens and foreign corporations. — The expenses allowing credits against the tax for taxes of foreign countries. In the case of a citizen of a foreign
allowable to a non-resident alien or a foreign corporation consist of only such expenses as are country residing in the Philippines whose income from sources within such foreign country is not
incurred in carrying on any business or trade conducted within the Philippines exclusively. subject to income tax, only that portion of the taxes paid to such foreign country which corresponds to
(Section 30(b) of the Code) his net income subject to the Philippine income tax shall be allowed as deduction.

SECTION 78. Interest. — Interest paid or accrued within the taxable year on indebtedness may be SECTION 83. Estate, inheritance, and gift taxes: taxes assessed against local benefits. — Estate,
deducted from gross income, except that interest on indebtedness incurred or continued to purchase inheritance, and gift taxes are not deductible.
bonds and other securities, the interest upon which is exempt from tax, is not deductible. Interest paid
by the taxpayer on a mortgage upon real estate of which he is the legal or equitable owner, even So-called taxes, more properly assessments, paid for local benefits, such as street, sidewalk, and
though the taxpayer is not directly liable upon the bond or not secured by such mortgage, may be other like improvements, imposed because of and measured by some benefit inuring directly to the
deducted as interest on his indebtedness. property against which the assessment is levied, do not constitute an allowable deduction from gross
income. A tax is considered assessed against local benefits when the property subject to the tax is
In the case of a non-resident alien individual or foreign corporation, the allowable deduction will be the limited to the property benefited. Special assessments are not deductible, even though an incidental
proportion of such interest which the amount of gross income from sources within the Philippines benefit may inure to the public welfare. The taxes deductible are those levied for the general public
bears to the amount of gross income from all sources within and without this country; however, to welfare, by the proper taxing authorities at a like rate against all property in the territory over which
avail of this deduction, such non-resident alien individual or foreign corporation shall include in the such authorities have jurisdiction. When assessments are made for the purpose of maintenance or
return all the information necessary for its calculation. repair of local benefits, the taxpayer may deduct assessments paid as an expense incurred in
business, if the payment of such assessments is necessary to the conduct of his business. When the
Interest paid by a corporation on scrip dividends is an allowable deduction. So-called interest on assessments are made for the purpose of constructing local benefits, the payments by the taxpayer
preferred stock, which is in reality a dividend thereon, can not be deducted in computing net income. are in the nature of capital expenditures and are not deductible. Where assessments are made for the
In the case of banks and loan or trust companies, interest paid within the year on deposits or on purpose of both construction and maintenance or repairs, the burden is on the taxpayer to show the
Revenue Regulations 02-40 Page 11 of 39

allocation of the amounts assessed to the different purposes. If the allocation can not be made, none If it is the desire of the taxpayer to claim as a credit and not as a deduction accrued income, war-
of the amounts so paid is deductible. profits, and excess profits taxes imposed by the authority of any foreign country or possession of the
United States but at the time the return is made it is impossible to estimate the amount of such taxes
SECTION 84. Analysis of credit for taxes: — If the taxpayer signifies in his return his desire to claim a that may have accrued for the period for which the return is made, the form required under this
credit for taxes, the basis of such credit, in the case of a citizen of the Philippines, whether resident or section may be filed at a later date but a credit cannot be allowed for such taxes unless the taxpayer
non-resident, and in the case of a domestic corporation, is as follows: (a) The amount of any income, signifies in his return his desire to have to any extent the benefits of Section 30(c) (3) to (9).
war-profits, and excess-profits taxes paid or accrued during the taxable year to any foreign country;
and (b) an individual's proportionate share of any such taxes of which he is a partner or of an estate SECTION 87. Redetermination of tax when credit proves incorrect. — In case credit has been given
or trust of which he is a beneficiary paid or accrued during the taxable year to a foreign country if his for taxes accrued, or a proportionate share thereof, and the amount that is actually paid on account of
distributive share of the income of such partnership or trust is reported for taxation under Title II of the such taxes, or a proportionate share thereof, is not the same as the amount of such credit, or in case
Code. any tax payment credited is refunded in whole or in part, the taxpayer shall immediately notify the
Commissioner of Internal Revenue. The Commissioner of Internal Revenue will thereupon
In the case of an alien resident of the Philippines who signifies in his return his desire to claim a credit redetermine the amount of the tax of such taxpayer for the year or years for which such incorrect
for such taxes the basis of the credit is as follows: (a) The amount of any such taxes paid or accrued credit was granted. The amount of tax, if any, due upon such redetermination shall be paid by the
during the taxable year to any foreign country if the foreign country of which such alien resident is a taxpayer upon notice and demand by the Commissioner of Internal Revenue. The amount of tax, if
citizen or subject, in imposing such taxes, allows a similar credit to citizens of the Philippines residing any, shown by such redetermination to have been overpaid shall be credited or refunded to the
in such country; and (b) his proportionate share of any such taxes of a partnership of which he is a taxpayer in accordance with the provisions of Section 309 of the Code.
partner or an estate or trust of which he is a beneficiary paid or accrued during the taxable year to any
foreign country if his distributive share of the net income of such partnership or trust is reported for SECTION 88. Countries which do or do not satisfy the similar credit requirements. — A country
taxation under Title II of the Code, and if the foreign country of which such alien resident is a citizen or satisfies the similar credit requirement of Section 30(c)(3)(B), as to income tax paid to such country,
subject, in imposing such taxes, allows a similar credit to citizens of the Philippines residing in such either by allowing to citizens of the Philippines residing in such country a credit for the amount of
country. income taxes paid to the Philippines. A country does not satisfy the similar credit requirement of
Section (30)(c)(3)(B) if it does not allow any credit to citizens of the Philippines residing in such
If a taxpayer signifies in his return his desire to claim credit for taxes, such action will be considered to country for the amount of income taxes paid to the Philippines, or if such country does not impose any
apply to income, war-profits, and excess-profits taxes paid to all foreign countries (including the income taxes. If the country of which a resident alien is a citizen or subject does not allow to a Filipino
United States and possessions thereof), and no portion of any such taxes shall be allowed as a citizen residing in such country a credit for taxes paid by such citizen to another foreign country, no
deduction from gross income. credit is allowed to such resident alien for taxes paid by him to such foreign country.

SECTION 85. Meaning of terms. — The "amount of any income, war-profits, and excess-profits taxes SECTION 89. When credit for taxes may be taken. — The credit for taxes provided by Section (30)
paid or accrued during the taxable year" means taxes proper (no credit being given for amounts (c)(3) to (9) may ordinarily be taken either in the return for the year in which the taxes accrued or in
representing interest or penalties) paid or accrued during the taxable year on behalf of the taxpayer which the taxes were paid, dependent upon whether the accounts of the taxpayer are kept and his
claiming credit. "Foreign country" means any foreign state or political subdivision thereof, or any returns filed upon the accrual basis or upon the cash receipts and disbursements basis. Section 30(c)
foreign political entity, which levies and collects income, war-profits, or excess-profits taxes, and (6) allows the taxpayer, at his option and irrespective of the method of accounting employed in
includes the United States or any political subdivision thereof. keeping his books, to take such credit for taxes as may be allowable in the return for the year in which
the taxes accrued. An election thus made must be followed in returns for all subsequent years, and no
SECTION 86. Conditions of allowance of credits. — If the taxpayer signifies in his return his desire to portion of any such taxes will be allowed as a deduction from gross income.
claim credit for income, war-profits, or excess-profits taxes paid other than to the Philippines, the
income tax return must be accompanied by the appropriate form prescribed by the Commissioner of SECTION 90. Domestic corporation owning a majority of the stock of foreign corporation. — In the
Internal Revenue. The form must be carefully filled in with all the information there called for and with case of a domestic corporation which owns a majority of the voting stock of a foreign corporation from
the calculations of credits there indicated, and must be duly signed and sworn to or affirmed. If credit which it receives dividends in any taxable rear, the credit for foreign taxes includes not only the
is sought for taxes already paid the form must have attached to it the receipt for each such tax income, war profits and excess-profits taxes paid or accrued during the taxable year to any foreign
payment. If credit is sought for taxes accrued, the form must have attached to it the return on which country by such domestic corporation, but also income, war-profits and excess-profits taxes deemed
each such accrued tax was based. This receipt or return so attached must be either the original, a to have been paid determined by taking the same proportion of any income, war-profits, and excess-
duplicate original, a duly certified or authenticated copy, or a sworn copy. In case only a sworn copy of profits taxes paid or accrued by such controlled foreign corporation to any foreign country upon or
a receipt or return is attached, there must be kept readily available for comparison on request the with respect to the accumulated profits of such foreign corporation from which such dividends were
original, a duplicate original, or a duly certified or authenticated copy. If the receipt of the return is in a paid, which the amount of any such dividends received bears to the amount of such accumulated
foreign language, a certified translation thereof must be furnished by the taxpayer. Any additional profits. The amount of taxes deemed to have been paid is limited, however, to an amount of the tax
information necessary for the determination of the amount of income derived from sources without the against which the credit for foreign taxes is taken, which the amount of such dividends bears to the
Philippines and from each foreign country shall, upon the request of the Commissioner of Internal amount of the entire net income of the domestic corporation in which such dividends are included. If
Revenue, be furnished by the taxpayer. dividends are received from more than one controlled foreign corporation, the limitation is to be
computed separately for the dividends received from each controlled foreign corporation. If the credit
In the case of a credit sought for a tax accrued but not paid, the Commissioner of Internal Revenue for foreign taxes includes taxes deemed to have been paid, the taxpayer must furnish the same
may in addition require as a condition precedent to the allowance of credit a bond from the taxpayer. It information with respect to the taxes deemed to have been paid as it is required to furnish with
shall be in such sum as the Commissioner of Internal Revenue may prescribe, and shall be respect to the taxes actually paid or accrued by it. Taxes paid or accrued by a controlled foreign
conditioned for the payment by the taxpayer of any amount of tax found due upon any corporation are deemed to have been paid by the domestic corporation for purposes of credit only.
redetermination of the tax made necessary by such credit proving incorrect, with such further cSTHAC
conditions as the Commissioner of Internal Revenue may require. This bond shall be executed by the
taxpayer, or the agent or representative of the taxpayer, as principal, and by sureties satisfactory to SECTION 91. Non-resident aliens and foreign corporations not allowed credits against the tax. —
and approved by the Commissioner of Internal Revenue. Non-resident aliens and foreign corporations may not claim credits against the tax from taxes of
foreign countries.
Revenue Regulations 02-40 Page 12 of 39

SECTION 92. Limitation on credit for foreign taxes. — The amount of credit for foreign taxes shall be use, and to machinery only when its use as such is permanently abandoned. Any loss to be
subject to the following limitations: deductible under this exception must be charged off in the books and fully explained in returns of
(a) The amount of the credit in respect to the tax paid or accrued to any country shall not exceed the income.
same proportion of the tax against which such credit is taken, which the taxpayer's net income
from sources within such country taxable under Title II bears to his entire net income for the SECTION 99. Shrinkage in value of stocks. — A person possessing stock of a corporation can not
same taxable year; and deduct from gross income any amount claimed as a loss merely on account of shrinkage in value of
(b) The total amount of the credit shall not exceed the same proportion of the tax against which such such stock through fluctuation of the market or otherwise. The loss allowable in such case is that
credit is taken, which the taxpayer's net income from sources without the Philippines taxable under actually suffered when the stock is disposed of. If stock of a corporation becomes worthless, its cost
Title II bears to his entire net income for the same taxable year. or other basis determined in accordance with these regulations may be deducted by the owner in the
(Section 30(d) of the Code) taxable year in which the stock became worthless, provided a satisfactory showing of its
worthlessness be made, as in the case of bad debts.
SECTION 93. Losses by individuals. — Losses sustained by individuals during the year not
compensated for by insurance or otherwise are fully deductible (except by non-resident aliens) — SECTION 100.Losses of farmers. — Losses incurred in the operation of farms as business
(a) If incurred in a taxpayer's trade; or enterprises are deductible from gross income. If farm products are held for favorable markets, no
(b) If incurred in any transaction entered into for profits; or deduction on account of shrinkage in weight or physical value or by deterioration in storage shall be
(c) Of property not connected with the trade or business if arising from fires, storm, shipwreck, or allowed, except as such shrinkage may be reflected in an inventory if used to determine profits. The
other casualty, or from robbery, theft or embezzlement. No loss shall, however, be allowed as a total loss by storm, flood, or fire of a prospective crop is not a deductible loss in computing net
deduction if at the time of filing of the return, such loss has been claimed as deduction for estate income. A farmer engaged in raising and selling stock, cattle, sheep, horses, etc., is not entitled to
or inheritance tax purposes in the estate or inheritance tax return. claim as a loss the value of animals that perish from among those animals that were raised on the
farm, except as such loss is reflected in an inventory if used. If livestock has been purchased after
SECTION 94. Losses by corporations. — Domestic corporations may deduct losses actually March 1, 1913, for any purpose, and afterwards dies from disease, exposure, or injury, or is killed by
sustained and charged off within the year and not compensated for by insurance or otherwise. order of the authorities, the actual purchase price of such stock, less any depreciation allowable as a
deduction in computing net income, with respect to such perished, livestock, and also any insurance
SECTION 95. Losses by non-resident alien and foreign corporation. — Non-resident aliens and or indemnity recovered, may be deducted as a loss. The actual cost of other property (with proper
foreign corporations are allowed only losses sustained in business or trade conducted within the adjustment for depreciation), which is destroyed by order of the authorities, may in like manner be
Philippines, losses of property within the Philippines arising from fires, storms, shipwreck, or other claimed as a loss; but if reimbursement is made in whole or in part on account of stock killed or
casualty and from robbery, theft, or embezzlement, and losses actually sustained in transactions property destroyed, the amount received shall be reported as income for the year in which
entered into for profit in the Philippines, although not connected with their trade or business, not reimbursement is made. The cost of any feed, pasturage, or care which has been deducted as an
compensated by insurance or otherwise. expense of operation shall not be included as part of the cost of the stock for the purpose of
ascertaining the amount of a deductible loss. If gross income is ascertained by inventories, no
SECTION 96. Losses generally. — Losses must usually be evidenced by closed and completed deduction can be made for livestock or products lost during the year, whether purchased for resale,
transactions. Proper adjustment must be made in each case for expenditures or items of loss properly produced on the farm, as such losses will be reflected in the inventory by reducing the amount of
chargeable to capital account, and for depreciation, obsolescence, amortization, or depletion. livestock or products on hand at the close of the year. If an individual owns and operates a farm, in
Moreover, the amount of the loss must be reduced by the amount of any insurance or other addition to being engaged in another trade, business or calling, and sustains a loss from such
compensation received, and by the salvage value, if any, of the property. A loss on the sale of operation of the farm, then the amount of loss sustained may be deducted from gross income
residential property is not deductible unless the property was purchased or constructed by the received from all sources, provided the farm is not operated for recreation or pleasure. IEaCDH
taxpayer with a view to its subsequent sale for pecuniary profit. No loss is sustained by the transfer of
property by gift or death. Losses sustained in illegal transactions are not deductible. EAISDH SECTION 101.Capital losses; losses on wash sales of stock or securities. — Losses on sales or
exchanges of capital assets are allowed to the extent provided in section 34 of the Code. If any
SECTION 97. Voluntary removal of buildings. — Loss due to the voluntary removal or demolition of securities which are capital assets become worthless during the taxable year, the loss resulting
old buildings, the scrapping of old machinery, equipment, etc., incident to renewals and replacements therefrom shall be considered as a loss from the sale or exchange, on the last day of such taxable
will be deductible from gross income. When a taxpayer buys real estate upon which is located a year, of capital assets. Losses on "wash sales" of stock or securities are treated in section 33 of the
building, which he proceeds to raze with a view to erecting thereon another building, it will be Code.
considered that the taxpayer has sustained no deductible expense on account of the cost of such (Section 30 (e) of the Code)
removal, the value of the real estate, exclusive of old improvements, being presumably equal to the
purchase price of the land and building plus the cost of removing the useless building. SECTION 102.Bad debts. — Where all the surrounding circumstances indicate that a debt is
worthless, and the debt is charged off on the books of the taxpayer within the year, the same may be
SECTION 98. Loss of useful value. — When through some change in business conditions, the allowed as a deduction in computing net income. There should accompany the return a statement
usefulness in the business of some or all of the capital assets is suddenly terminated, so that the showing the propriety of any deduction claimed for bad debts. Before a taxpayer may charge off and
taxpayer discontinues the business or discards such assets permanently from use of such business, deduct a debt, he must ascertain and be able to demonstrate, with a reasonable degree of certainty,
he may claim as deduction the actual loss sustained. In determinating the amount of the loss, the uncollectibility of the debt. Any amount subsequently received on account of a bad debt previously
adjustment must be made, however, for improvements, depreciation and the salvage value of the charged off and allowed as a deduction for income tax purposes, must he included in gross income
property. This exception to the rule requiring a sale or other disposition of property in order to for the taxable year in which received. In determining whether a debt is worthless the Commissioner
establish a loss requires proof of some unforeseen cause by reason of which the property has been of Internal Revenue will consider all pertinent evidence, including the value of the collateral, if any,
prematurely discarded, as, for example, where an increase in the cost or change in the manufacture securing the debt and the financial condition of the debtor.
of any product makes it necessary to abandon such manufacture, to which special machinery is
exclusively devoted, or where new legislation directly or indirectly makes the continued profitable use Where the surrounding circumstances indicate that a debt is worthless and uncollectible and that legal
of the property impossible. This exception does not extend to a case where the useful life of property action to enforce payment would in all pro-ability not result in the satisfaction of execution on a
terminates solely as a result of those gradual processes for which depreciation allowance are judgment, a showing of those facts will be sufficient evidence of the worthlessness of the debt for the
authorized. It does not apply to inventories or to other than capital assets. The exception applies to purpose of deduction. Bankruptcy is generally an indication of the worthlessness of at least a part of
buildings only when they are permanently abandoned or permanently devoted to a radically different an unsecured and unpreferred debt. Actual determination of worthlessness in bankruptcy is
Revenue Regulations 02-40 Page 13 of 39

sometimes possible before and at other times only when a settlement in bankruptcy shall have been limited, will not usually be a proper subject of such an allowance. If however, an intangible asset
had. Where a taxpayer ascertained a debt to be worthless and charged it off in one year, the mere acquired through capital outlay is known from experience to be of value in the business for only a
fact that bankruptcy proceedings instituted against the debtor are terminated in a later year, limited period, the length of which can be estimated from experience with reasonable certainty, such
confirming the conclusion that the debt is worthless, will not authorize shifting the deduction to such intangible asset may be the subject of a depreciation allowance, provided the facts are fully shown in
later year. If a taxpayer computes his income upon the basis of valuing his notes or accounts the return or prior thereto to the satisfaction of the Commissioner of Internal Revenue.
receivable at their fair market value when received, which may be less than their face value, the
amount deductible for bad debts in any case is limited to such original valuation. SECTION 108.Capital sum recoverable through depreciation allowances. — The capital sum to be
replaced by depreciation allowances is the cost or other basis of the property in respect of which the
SECTION 103.Examples of bad debts. — Worthless debts arising from unpaid wages, salaries, rents, allowance is made. To this amount should be added from time to time the cost of improvements,
and similar items of taxable income will not be allowed as a deduction unless the income such items additions, and betterment and from it should be deducted from time to time the amount of any definite
represent has been included in the return of income for the year in which the deduction as a bad debt loss or damage sustained by the property through casualty, as distinguished from the gradual
is sought to be made or in a previous year. Only the difference between the amount received in exhaustion of its utility which is the basis of the depreciation allowance. Where the lessee of real
distribution of the assets of a bankrupt and the amount of the claim may be deducted as a bad debt. property erects buildings, or makes permanent improvements which become part of the realty and
The difference between the amount received by a creditor of a decedent in distribution of the assets income has been returned by the lessor as a result thereof, as provided in Section 49 of these
of the decedent's estate and the amount of his claim may be considered a worthless debt. A regulations, the capital sum to be replaced by depreciation allowance is the same as though no such
purchaser of accounts receivable which can not be collected and are consequently charged off the buildings had been erected or such improvements made. No depreciation deduction will be allowed in
hooks as bad debt is entitled to deduct them, the amount of deduction to be based upon the price he the case of property which has been amortized to its scrap value and is no longer in use. AaSCTD
paid for them and not upon their face value.
SECTION 109.Method of computing depreciation allowance. — The capital sum to be replaced
Where under foreclosure of a mortgage, the mortgagee buys the mortgaged property and credits the should be charged off over the useful life of the property, either in equal annual installments or in
indebtedness with the purchase price, the difference between the purchase price and the accordance with any other recognized trade practice, such as an apportionment of the capital sum
indebtedness will not be allowable as a deduction for a bad debt, for the property which was security over units of production. Whatever plan or method of apportionment is adopted must be reasonable
for the debt stands in the place of the debt. The determination of loss in such case is deferred until the and must have due regard to operating conditions during the taxable period. While the burden of proof
disposal of the property. must rest upon the taxpayer to sustain the deductions taken by him, such deductions must not be
disallowed unless shown by clear and convincing evidence to be unreasonable. The reasonableness
SECTION 104.Securities becoming worthless. — If any securities which are capital assets are of any claim for depreciation shall be determined upon the conditions known to exist at the end of the
ascertained to be worthless and charged off within the taxable year, the loss resulting therefrom shall, period for which the return is made. If it develops that the useful life of the property will be longer or
except in the case of a bank or trust company incorporated under the laws of the Philippines or of the shorter than the useful life as originally estimated under all the then known facts, the portion of the
United States a substantial part of whose business is the receipt of deposits, be considered as a loss cost or other basis of the property not already provided for through depreciation allowances should be
from the sale or exchange, on the last day of such taxable year, of capital assets. spread over the remaining useful life of the property as reestimated in the light of the subsequent
(Section 30(f) of the Code) facts, and depreciation deductions taken accordingly.

SECTION 105.Depreciation. — A reasonable allowance for the exhaustion, wear and tear, and SECTION 110. Obsolescence. — With respect to physical property the whole or any portion of which
obsolescence of property used in the trade or business may be deducted from gross income. For is clearly shown by the taxpayer as being affected by economic conditions that will result in its being
convenience such an allowance will usually be referred to as depreciation, excluding from the term abandoned at a future date prior to the end of its normal useful life, so that depreciation deductions
any idea of a mere reduction in market value not resulting from exhaustion, wear and tear, or alone are insufficient to return the cost (or other basis) at the end of its economic term of usefulness,
obsolescence. The proper allowance for such depreciation of any property used in the trade or a reasonable deduction for obsolescence, in addition to depreciation, may be allowed in accordance
business is that amount which should be set aside for the taxable year in accordance with a with the facts obtaining with respect to each item of property concerning which a claim for
reasonable consistent plan whereby the aggregate of the amount so set aside, plus the salvage obsolescence is made. No deductions for obsolescence will be permitted merely because, in the
value, will, at the end of the useful life of the property in business, equal the basis of the property. Due opinion of a taxpayer, the property may become obsolete at some later date. This allowance will be
regard must also be given to expenditures for current upkeep. confined to such portion of the property on which obsolescence is definitely shown to be sustained
and can not be held applicable to an entire property unless all portions thereof are affected by the
SECTION 106.Depreciable property. — The necessity for a depreciation allowance arises from the conditions to which obsolescence is found to be due.
fact that certain property used in the business gradually approaches a point where its usefulness is
exhausted. The allowances should be confined to property of this nature. In the case of tangible SECTION 111. Depreciation of patent or copyright. — In computing depreciation allowance in the
property, it applies to that which is subject to wear and tear, to decay or decline from natural causes, case of a patent or copyright, the capital sum to be replaced is the cost or other basis of the patent or
to exhaustion and to obsolescence due to the normal progress of the art, as where machinery or other copyright. The allowance should be computed by an apportionment of the cost or other basis of the
property must be replaced by a new invention, or due to the inadequacy of the property to the growing patent or copyright over the life of the patent or copyright since its grant, or since its acquisition by the
needs of the business. It does not apply to inventories or to stock in trade, nor to land apart from the taxpayer, or since March 1, 1913, as the case may be. If the patent or copyright was acquired from
improvements or physical development added to it. It does not apply to bodies of minerals which the Government, its cost consists of the various Government fees, cost of drawings, experimental
through the process of removal suffer depletion. Property kept in repair may, nevertheless, be the models, attorney's fees, development or experimental expenses, etc., actually paid. Depreciation of a
subject of a depreciation allowance. The deduction of an allowance for depreciation is limited to patent can be taken on the basis of the fair market value as of March 1, 1913, only when affirmative
property used in the taxpayer's trade or business. No such allowance may be made in respect to and satisfactory evidence of such value is offered. Such evidence should whenever practicable be
automobiles or other transportation equipment used solely for the pleasure, a building used by the submitted with the return. If the patent becomes obsolete prior to its expiration, such proportion of the
taxpayer solely as his residence, nor in respect of furniture or furnishings therein, personal effects, or amount on which its depreciation may be based as the number of years of its remaining life bears to
clothing; but properties and costumes used exclusively in a business, such as theatrical business, the whole number of years intervening between the basic date when it legally expires may be
may be the subject of a depreciation allowance. deducted, if permission to do so is specifically secured from the Commissioner of Internal Revenue.
Owing to the difficulty of allocating to a particular year the obsolescence of a patent, such permission
SECTION 107.Depreciation of intangible property. — Intangibles, the use of which in the trade or will be granted only if affirmative and satisfactory evidence that the patent became obsolete in the
business is definitely limited in duration, may be the subject of a depreciation allowance. Examples year for which the return is made is submitted to the Commissioner of Internal Revenue. The fact that
are patents, copyrights, and franchises. Intangibles, the use of which in the business or trade is not so
Revenue Regulations 02-40 Page 14 of 39

depreciation has not been taken in prior years does not entitle the taxpayer to deduct in any taxable Gross income after deducting rents and royalties P100.00 P100.00
year a greater amount for depreciation than would otherwise be allowable. AcDHCS 27 1/2% thereof 27.50 27.50
Net income or net profit 50.00 70.00
SECTION 112. Depreciation of drawings and models. — Where a taxpayer has incurred expenditures 50°/ of net income or net profit 25.00 35.00
in his business for designs, drawings, patterns, models, or work of an experimental nature calculated Allowance depletion 25.00 27.50
to result in improvement of his facilities or his product, if the period of usefulness of any such asset
may be estimated from experience with reasonable accuracy, it may be the subject of depreciation Under column (1) P25.00 is the allowance depletion because the allowable percentage cannot
allowances spread over such estimated period of usefulness. The facts must be fully shown in the exceed 50% of the net profit or net income. Under column (2), the allowable depletion is P27.50
return or prior thereto to the satisfaction of the Commissioner of Internal Revenue. Except for such because it does not exceed 50% of either the net income or net profit.
depreciation allowances no deduction shall be made by the taxpayer against any sum so set up as an
asset except on the sale or other disposition of such asset at a loss or on proof of a total loss thereof. SECTION 115-A-3. Definition of terms. — For purposes of the depletion allowance for oil and gas
wells and mines, the following terms and phrases shall have the meaning indicated:
SECTION 113. Charging off depreciation. — A depreciation allowance, in order to constitute an (a) Gross income. — Gross income means the "gross income from the property". The gross income
allowable deduction from gross income, must be charged off. The particular manner in which it shall in the case of gas and oil wells is the amount for which the taxpayer sells the oil and gas in the
be charged off is not material, except that the amount measuring a reasonable allowance for immediate vicinity of the well. If the oil and gas are not sold on the property but are manufactured or
depreciation must be either deducted directly from the book value of the assets or preferably credited converted into a refined product prior to sale, the gross income from the property shall be assumed to
to a depreciation reserve account, which must be reflected in the annual balance sheet. The be equivalent to the representative market or field price (as of the date of sale) of the oil and gas
allowances should be computed and charged off with express reference to specific items, units, or before conversion or transportation.
groups of property, each item or unit being considered separately or specifically included in a group "Gross income from the property" means, in the case of mines, the gross income from mining. The
with others to which the same factors apply. The taxpayer should keep such records to each item or gross income from mining consists of the proceeds from the sales of ores or minerals extracted from
unit of depreciable property as will permit the ready verification of the factors used in computing the the mining property. Where ores are sent abroad where the ordinary treatment processes are applied
allowance for each year for each item, unit, or group. or where they are refined and where they are sold, the actual cost of ocean freight as well as
insurance, should be deducted from the actual selling price for gross income purposes. Also where
SECTION 114. Depreciation in the case of farmers. — A reasonable allowance for depreciation may minerals or mineral products are sold or consigned abroad by the lessee or owner of the mine under
be claimed on farm buildings (other than a dwelling occupied by the owner), farm machinery, and C.I.F. terms, the actual cost of ocean freight and insurance should be deducted. ECDHIc
other physical property. A reasonable allowance for depreciation may also be claimed on live stock
acquired for work, breeding, or dairy purposes, unless they are included in an inventory used to (b) Mining. — The term "mining" includes not merely the extraction of the ores or minerals from the
determine profits in accordance with these regulations. Such depreciation should be based on the ground but also the ordinary treatment process normally applied by mine owners or operators in order
cost or other basis and the estimated life of the live stock. If such live stock be included in an to obtain the commercially marketable mineral product or products, and so much of the transportation
inventory no depreciation thereof will be allowed, as the corresponding reduction in their value will be of ores or minerals (whether or not by common carrier) from the point of extraction from the ground to
reflected in the inventory. the plants or mills in which the ordinary treatment processes are applied thereto as is not in excess of
50 miles unless the Commissioner of Internal Revenue finds that the physical and other requirements
SECTION 115. Statement to be attached to return. — To each return in which depreciation charges are such that the ore or mineral must be transported a greater distance to such plants or mills.
are claimed, there should be attached a statement showing the item, unit, or group of depreciable
property, the cost price or its market value as of March 1, 1913, if acquired prior to that date, the rate (c) Extraction of the ores or minerals from the ground. — The term "extraction of the ores or
of charge, amount previously deducted, and the amount claimed in the return. These data must agree minerals from the ground" includes the extraction by mine owners or operators of ores or minerals
with those appearing in the books of the taxpayer. from the waste or residue of prior mining. Thus income derived from the working over of tailings, piles
(Section 30(g) of the Code) or culm banks is included in determining "gross income from the property". The length of time
between the prior mining and extraction of ores or minerals from the waste or residue of such mining
SECTION 115-A-1. General Circular V-332, January 6, 1961 — Who is entitled to deduct depletion. is immaterial. Whether the waste or residue results from the application of ordinary treatment
— In order to be entitled to percentage depletion allowance, the taxpayer must have an economic processes or from the process of removal from the ground, income derived therefrom is within the
interest in the property. To acquire an economic interest, the taxpayer must have a capital investment term "gross income from the property". To be included in "gross income from the property", income
in the property and not a mere economic advantage. The taxpayer must have acquired at least, by derived from the extraction of ores or minerals from the waste or residue of prior mining must come
investment, any interest in oil or gas or mineral in place, and secures, by any form of legal from such extraction by the mine owner or operator himself.
relationship, income derived from the extraction of the oil, gas or mineral, to which he must look for a
return of his capital. Thus the parties entitled to share in oil or mineral extracted, or the gross (d) Ordinary treatment processes. — The term "ordinary treatment processes" includes the
proceeds therefrom (including the parties to a lease providing for royalty payments of stated amounts following:
per unit mined) have economic interests in the oil or minerals in place. That is, they, as owners of the (1) In the case of coal-cleaning, breaking, sizing, dust-allaying, treating to prevent freezing, and
rights in oil or other mineral in place, share the income from production, and the depletion allowances loading for shipment;
thereon are regarded as designed to permit tax-free recovery of at least their capital investments in (2) In the case of sulfur recovered by the Frasch process — pumping to vats, cooling, breaking, and
such property rights. loading for shipment;
(3) In the case of iron ore, bauxite, ball and sagger clay, rock asphalt, and minerals which are
SECTION 115-A-2. Basis for depletion. — On oil or gas wells the percentage depletion allowance is customarily sold in the form of a crude mineral product — sorting, concentrating; and sintering
fixed at 27 1/2% of gross income while on mines, the percentage depletion allowance varies in to bring to shipping grade and form, and loading for shipment;
accordance with the class of minerals. The gross income basis is the amount remaining after (4) In the case of lead, zinc, copper, gold, silver, or fluorspar ores, potash, and ores which are not
deducting therefrom rents or royalties paid or incurred by the taxpayer in respect to the property. In customarily sold in the form of the crude mineral product-crushing, grinding, and beneficiation by
both cases, the total percentage depletion allowance shall in no case exceed 50% of the net income concentration (gravity, flotation, amalgamation, electrostatic, or magnetic) cyanidation, leaching,
or profit. crystallization, precipitation (but not including as an ordinary treatment process electrolytic
deposition, roasting, thermal or electric smelting, or refining), or by substantially equivalent
Illustration processes, or extraction of the product or products from the ore, including the furnacing of
Subject: Oil and gas wells (1) (2) quicksilver ores; and
Revenue Regulations 02-40 Page 15 of 39

(5) The pulverization of talc, the burning of magnesite, and the sintering and modulizing of (Section 30(j) of the Code)
phosphate rock.
SECTION 118. Payments to employees' pension trusts. — An employer who adopts or has adopted a
(e) Net income or net profit. — "Net income" or "net profit" means the taxpayer's taxable income reasonable pension plan, actuarially sound, and who establishes, or has established, and maintains a
from the property. Net income or net profit (computed without allowance for depletion) means the pension trust for the payment of reasonable pensions to his employees shall be allowed to deduct
"gross income from the property" less the allowable deductions attributable to the mineral property from gross income reasonable amounts paid to such trust, in accordance with the pension plan
upon which the depletion is claimed and the allowable deductions attributable to the treatment (including any reasonable amendment thereof), as follows:
processes insofar as they relate to the product of such property, including overhead and operating
expenses, development costs properly charged to expense, depreciation, taxes, losses sustained, (a) If the plan contemplates the payment to the trust, in advance of the time when pensions are
etc. Deductions not directly attributable to particular properties or processes shall be fairly allocated. granted, of amounts to provide for future pensions payments, then (1) reasonable amounts paid to the
trust during the taxable year representing the pension liability applicable to such year, determined in
(f) Property. — For the purpose of computing the depletion allowance in the case of mines and accordance with the plan, shall be allowed as a deduction for such year as an ordinary and necessary
wells, the term "property" means each separate interest owned by the taxpayer in each mineral business expense, and in addition (2) one-tenth of a reasonable amount transferred or paid to the
deposit in each separate tract or parcel of land. trust during the taxable year to cover in whole or in part the pension liability applicable to the years
prior to the taxable year, or so transferred or paid to place the trust on a sound financial basis, shall
If a taxpayer owns two or more separate operating mineral interests which constitute part or all of an be allowed as a deduction for the taxable year and for each of the nine succeeding taxable years.
operating unit, he may elect to form (a) one aggregation of, and to treat as one property, any two or
more of such interests and (b) to treat as a separate property each such interest which he does not (b) If the plan does not contemplate the payment to the trust, in advance of the time when pensions
elect to include within the aggregation referred to in (a). Separate operating mineral interests which are granted, of amounts to provide for future pension payments, then (1) reasonable amounts paid to
constitute part or all of an operating unit may be aggregated whether or not they are included in the trust during the taxable year representing the present value of the expected future payments in
contiguous tracts or parcels. A taxpayer may not elect to form more than one aggregation of operating respect of pensions granted to employees retired during the taxable year shall be allowed as
mineral interests within any one operating unit. Such election may be made by the taxpayer by the deduction for such year as an ordinary and necessary business expense, and in addition (2) one tenth
giving of notice of such election to the Commissioner of Internal Revenue not later than the time of a reasonable amount transferred or paid to the trust during the taxable year to cover in whole or in
prescribed for filing of the return and any such election so made shall be binding upon the taxpayer part the present value of the expected future payments in respect of pensions granted to employees
for all subsequent taxable years, except that the Commissioner of Internal Revenue may consent to a retired prior to the taxable year, or so transferred or paid to place the trust on a sound financial basis,
different treatment of the interest with respect to which the election has been made. shall be allowed as a deduction for the taxable year and for each of the nine succeeding taxable
years.
SECTION 115-A-4. Depletion deductible by non-resident aliens or foreign corporations. — A non- (Section 30(k) of the Code)
resident alien individual or a foreign corporation is entitled to an allowance for depletion of oil and gas
wells or mines located in the Philippines. (Gen. Cir. V-332 implements Sec. 30(g), Tax Code, as SECTION 118-A. Optional standard deduction. — In lieu of the deductions allowed under this
amended by R.A. 2698) section an individual, other than a non-resident alien, may elect a standard deduction. Such optional
(Section 30(h) of the Code) standard deduction shall be in the amount of one thousand pesos or in an amount equal to ten per
centum of his gross income, whichever is the lesser. Unless the taxpayer signifies in his return his
SECTION 116. When contributions or gifts may be deducted. — Contributions or gifts within the intention to elect the optional standard deduction he shall be considered as having availed himself of
taxable year are deductible to an aggregate amount not in excess of 6 per centum, in the case of an the deductions allowed in the preceding subsection. The Secretary of Finance shall prescribe the
individual, and 3 per centum, in the case of a corporation, of the taxpayer's taxable net income, if manner of the election. Such election when made in the return shall be irrevocable for the taxable
actually paid or made to or for the use of the Government of the Philippines or any political year for which the return is made.
subdivision thereof for exclusively public purposes or to domestic corporations or associations (Section 31 of the Code)
organized and operated exclusively for religious, charitable, scientific, athletic, cultural or educational
purposes, or to societies for the prevention of cruelty to children or animals, provided that no part of SECTION 119. Personal, living, and family expenses. — Personal, living, and family expenses are not
the net income of which inures to the benefit of any private stockholders or individual. deductible. Insurance paid on a dwelling owned and occupied by a taxpayer is a personal expense
and not deductible. Premiums paid for life insurance by the insured are not deductible. In the case of
In connection with claims for deductions, there shall be stated on returns of income the name and a professional man who rents a property for residential purposes, but incidentally receives his clients,
address of each organization to which a gift was made and the approximate date and the amount of patients, or callers in connection with his professional work (his place of business being elsewhere),
the gift in each case. Where the gift is other than money, the basis for calculation of the amount no part of the rent is deductible as a business expense. If however, he uses part of the house for his
thereof shall be the fair market value of the property at the time of the gift. Contributions or gifts paid office, such portion of the rent as is properly attributable to such office is deductible. Where the father
or made to corporations or associations specified in the law will only be allowed as deduction when is legally entitled to the services of his minor children, any allowances which he gives them, whether
the taxpayer attaches to his return the receipt duly signed by the responsible officer of the said to be in consideration of services or otherwise, are not allowable deductions in his return of
corporations or associations to which the contributions or gifts has been paid or made. If desired, said income. Alimony, and an allowance paid under a separation agreement are not deductible from gross
receipt will be returned to the taxpayer after they have served their purpose. income.
(Section 30(i) of the Code)
SECTION 120.Capital expenditures. — No deduction from gross income may be made for any
SECTION 117. Allowance of deductions and credits. — Unless a non-resident alien individual shall file amounts paid out for new buildings or for permanent improvements or betterments made to increase
or cause to be filed with the Commissioner of Internal Revenue, a true and accurate return of income the value of the taxpayer's property, or for any amount expended in restoring property or in making
from all sources, corporate, or otherwise, within the Philippines, regardless of amount, the tax shall be good the exhaustion thereof for which an allowance for depreciation or depletion or other allowance is
collected on the basis of the gross income (not the net income) from sources within the Philippines. In or has been made. Amounts expended for securing a copyright and plates, which remain the property
case of failure to file such return, the Commissioner of Internal Revenue will cause a return of income of the person making the payments, are investments of capital. The cost of defending or perfecting
to be made and include therein the income of such non-resident alien from all source concerning title to property constitutes a part of the cost of the property and is not a deductible expense. The
which he has information, and he will assess the tax and collect it from one or more of the sources of amount expended for architect's services is part of the cost of the building. Commissions paid in
income of such non-resident alien within the Philippines, without allowance for deductions or credit. purchasing securities are a part of the cost of such securities. Commissions paid in selling securities
(Cf. effect of Sec. 22(b) as amended by R.A. 2343.) are an offset against the selling price. Expenses of the administration of an estate, such as court
Revenue Regulations 02-40 Page 16 of 39

costs, attorney's fees, and executor's commissions, are chargeable against the "corpus" of the estate deferred dividend period, the amount so ascertained, apportioned, or credited lapses. (c) "Treated as
and are not allowable deductions. Amounts to be assessed and paid under an agreement between an abatement of premium" means of the premium for the taxable year. Where the dividend paid back
bondholders or shareholders of a corporation, to be used in a reorganization of the corporation, are is in excess of the premium received from the policyholder within the taxable year there may be
investments of capital and not deductible for any purpose in return of income. DaACIH excluded from gross income only the amount of such premium received, and where no premium is
received from the policyholder within the taxable year the company is not entitled to exclude from its
In the case of a corporation, expenses for organization, such as incorporation fees, attorney's fees premiums received from other policyholders an amount in respect to such dividend payment. (See
and accountants' charges, are ordinarily capital expenditures; but where such expenditures are changes in Sec. 24(b), Tax Code.)
limited to purely incidental expenses, a taxpayer may charge such items against income in the year in
which they are incurred. A holding company which guarantees dividends at a specified rate on the SECTION 125.Gross income of mutual insurance companies. — The gross income of mutual
stock of a subsidiary corporation for the purpose of securing new capital for the subsidiary and insurance companies (other than life) consists of their total revenue from the operation of the
increasing the value of its stockholdings in the subsidiary may not deduct amounts paid in carrying out business and of their income from all other sources within the taxable year, except as otherwise
this guaranty in computing its net income, but such payments may be added to the cost of its stock in provided by the statute. Premiums received by mutual marine insurance companies which are paid
the subsidiary. out for reinsurance should be eliminated from gross income and the payments for reinsurance, from
disbursement. Deposit premiums on perpetual risks received and returned by mutual fire insurance
SECTION 121.Premiums on life insurance of employees. — Any amounts paid for premiums on any companies should be treated in the same manner, as no reserve will be recognized covering liability
life insurance policy covering the life of an officer or employee or of any person financially interested for such deposits. The earnings on such deposits, including such portion, if any, of the premium
in the business of the taxpayer when the taxpayer is directly or indirectly a beneficiary under such deposits as are not returned to the policyholders upon cancellation of the policies, must be included in
policy are not deductible. the gross income.

SECTION 122.Losses from sales or exchanges of property. — No deduction is allowed in respect of SECTION 126.Deductions allowed insurance companies. — Insurance companies are entitled to the
losses from sales or exchanges of property, directly or indirectly — same deductions from gross income as other corporations, and also to the deduction of the net
addition required by law to be made within the taxable year to reserve funds and of the sums other
(a) Between members of a family. As used in Section 31, the family of an individual shall include than dividends paid with the taxable year on policy and annuity contracts. "Paid" includes "accrued" or
only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal "incurred" (construed according to the method of accounting upon the basis of which the net income
descendants; is computed) during the taxable year, but does not include any estimate for losses incurred but not
(b) Except in the case of distributions in liquidation, between an individual and a corporation more reported during the taxable year. As payments on policies there should be reported all death, disability
than fifty per centum in value of the outstanding stock of which is owned, directly or indirectly, by or for and other policy claims (other than dividends as above specified) paid within the year, including fire,
such individual; accident and liability losses, matured endowments, annuities, payments on installment policies and
(c) Except in the case of distributions in liquidation, between two corporations more than 50 per cent surrender values actually paid.
in value of the outstanding stock of each of which is owned, directly or indirectly, by or for the same
individual, if either one of such corporations with respect to the taxable year of the corporation SECTION 127.Special deductions allowed mutual insurance companies. — Mutual insurance
preceding the date of the sale or exchange was, under the law applicable to such taxable year, a companies (other than mutual life and mutual marine insurance companies), which require their
personal holding company or a foreign personal holding company; members to make premium deposits to provide for losses and expenses, are allowed to deduct from
(d) Between a grantor and a fiduciary of any trust; gross income the aggregate amount of premium deposits returned to their policyholders or retained
(e) Between the fiduciary of a trust and the fiduciary of another trust, if the same person is a grantor for the payment of losses, expenses, and reinsurance reserves. In determining the amount of
with respect to each trust; or premium deposits retained by a mutual fire or mutual casualty insurance company for the payment of
(f) Between a fiduciary of a trust and a beneficiary of such trust. losses, expenses, and reinsurance reserves, it will be presumed that losses and expenses have been
(Section 32 of the Code) paid out of earnings and profits other than premiums to the extent of such earnings and profits. If,
however, any portion of such amount is applied during. the taxable year to the payment of losses,
SECTION 123.Gross income of insurance companies. — In general, the gross income of insurance expenses, or reinsurance reserves, or which a separate allowance is taken, then such portion is not
companies consists of their total revenue from the operation of the business and of their income from deductible; and if any portion of such amount for which an allowance is taken is subsequently applied
all other sources within the taxable year, except as otherwise provided by the statute. Gross income to the payment of expenses, losses, or reinsurance reserves, then such payment can not be
includes net premiums (that is, gross premium less returned premiums on policies not taken), separately deducted. The amount of premium deposits retained for the payment of expenses and
investment income, profits from the sale of assets, and all gains, profits, and income reported to the losses and the amount of such expenses and losses, may not both be deducted. A company which
Insurance Commissioner, except income specifically exempt from tax. A net decrease in reserve invests part of the premium deposits so retained by it in interest-bearing securities may, nevertheless,
funds required by law within the taxable year must be included in the gross income to the extent that deduct such part, but not the interest received on such securities. A mutual fire insurance company
such funds are released to the general uses of the company and increase its free assets. Any net which has a guaranty capital is taxed like other mutual fire insurance companies. A stock fire
decrease in reserves shall be added to the gross income, unless the company shall show that such insurance company operated on the mutual plan to the extent of paying dividends to certain classes
decrease resulted from the application of reserves to the purposes for which they were established. of policyholders, may make a return on the same basis as a mutual fire insurance company with
respect to its business conducted on the mutual plan.
SECTION 124.Gross income of life insurance companies. — A life insurance company shall not
include in gross income such portion of any actual premiums received from any individual policyholder SECTION 128.Special deductions allowed mutual marine insurance companies. — Mutual marine
as is paid back or credited to or treated as an abatement of premium of such policyholder within the insurance companies should include in gross income the gross premiums collected and received by
taxable year. (a) "Paid back" means paid in cash. (b) "Credited to" means held to the credit of, them less amounts paid for reinsurance. They may deduct from gross income amounts repaid to
including dividends applied to pay renewal premiums, to purchase additional paid-up insurance or policyholders on account of premiums previously paid by them together with the interest actually paid
annuities, or to shorten the endowment or premium-paying period. It does not include dividends upon such amounts between the date of ascertainment and the date of payment thereof. The
provisionally ascertained and apportioned upon deferred dividends policies. Dividends provisionally remainder of the premiums accordingly forms part of the net income of the company, except to the
ascertained, apportioned, or credited on deferred dividends policies can not be excluded or deducted extent that it is subject to then deductions allowed such insurance companies and other corporations.
from gross income for the reason that the assured has no vested or enforceable right in them and can
not at the time of the ascertainment, apportionment, or credit, not until the maturity of the policy, avail SECTION 129.Net addition to reserve funds. — All policy premiums on which net addition to reserve
himself of such dividends; and in the event of the death of the assured prior to the expiration of the is computed, must be included in gross income. Insurance companies may deduct from gross income
Revenue Regulations 02-40 Page 17 of 39

the net addition required by law to be made within the taxable year to reserve funds. When the EXAMPLE (1): A, whose taxable year is the calendar year, on December 1, 1939, purchased 100
reserve at the end of the year is less than at the beginning of the year there is a "released reserve", shares of common stock in the M Company for P10,000 and on December 15, 1939, purchased 100
and the amount so released must be included in gross income. In the case of assessment insurance additional shares for P9,000. On January 2, 1940, he sold the 100 shares purchased on December 1,
companies, whether domestic or foreign, the actual deposit of sums with the officers of the 1939, for P9,000. Because of the provisions of Section 33 no loss from the sale is allowable as a
Government of the Philippines, pursuant to law, as addition to guaranty or reserve funds shall be deduction.
treated as being payments required by law to reserve funds. In the case of life insurance companies,
the net addition to the "reinsurance reserve" and the "reserve for supplementary contracts", and in the EXAMPLE (2): A, whose taxable year is the calendar year, on September 21, 1939, purchased 100
case of fire, marine, accident, liability, and other insurance companies, the net addition to the shares of the common stock of the M Company for P5,000. On December 21, 1939, he purchased 50
"unearned premium reserves", and only such other reserves as are specifically required by the statute shares of substantially identical stock for P2,750, and on December 26, 1939, he purchased 25
will be allowed as deductions. ADEacC additional shares of such stock for P1,125. On January 2, 1940, he sold for P4,000 the 100 shares
purchased on September 21, 1939. There is an indicated loss of P1,000 on the sale of the 100
SECTION 130.Copy of report to Insurance Commissioner to be furnished the Commissioner of shares. Since within the sixty-one-day period A purchased 75 shares of substantially identical stock,
Internal Revenue. — To facilitate the auditing of income tax returns, insurance companies shall submit the loss on the sale of 75 of the shares (P3,750 less P3,000, or P750) is not allowable as a deduction
to the Commissioner of Internal Revenue together with returns of income, wherever possible a copy because of the provisions of Section 33. The loss on the sale of the remaining 25 shares (P1,250 less
of their annual report to the Insurance Commissioner. P1,000, or P250) is deductible subject to the limitations provided in Sections 31(b) and 34. The basis
(Section 33 of the Code) of the 50 shares purchased December 21, 1939, the acquisition of which resulted in the non-
deductibility of the loss (P500) sustained on 50 of the 100 shares sold on January 2, 1940, is P2,500
SECTION 131.Losses from wash sales of stock or securities. — (a) A taxpayer cannot deduct any (the cost of 50 of the shares sold on January 2, 1940), plus P750 [the difference between the
loss claimed to have been sustained from the sale or other disposition of stock or securities, if, within purchase price of the 50 shares acquired on December 21, 1939, (P2,750) and the selling price of 50
a period beginning thirty days before the date of such sale or disposition and ending thirty days after of the shares sold on January 2, 1940 (P2,000)], or P3,250. Similarly the basis of the 25 shares
such date (referred to in this section as the sixty-one-day period), he has acquired (by purchase or by purchased on December 26, 1939, the acquisition of which resulted in the nondeductibility of the loss
an exchange upon which the entire amount of gain or loss was recognized by law), or has entered (P250) sustained on 25 of the shares sold on January 2, 1940, is P1,250 plus P125, or P1,375. (See
into a contract or option so to acquire, substantially identical stock or securities. However, this Section 143 of these regulations.)
prohibition does not apply in the case of a dealer in stock or securities if the sale or other disposition
of stock or securities is made in the ordinary course of its business as such dealer. EXAMPLE (3): A, whose taxable year is the calendar year, on September 15, 1938, purchased 100
shares of the stock of the M Company for P5,000. He sold these shares on February 1, 1940, for
(b) Where more than one loss is claimed to have been sustained within the taxable year from the P4,000. On each of the four days from February 15, 1940, to February 18, 1940, he purchased 50
sale or other disposition of stock or securities, the provisions of this section shall be applied to the shares of substantially identical stock for P2,000. There is an indicated loss of P1,000 from the sale of
losses in the order in which the stock or securities the disposition of which resulted in the respective the 100 shares on February 1, 1940, but since within the sixty-one-day period A purchased not less
losses were disposed of (beginning with the earliest disposition). If the order of disposition of stock or than 100 shares of substantially identical stock, the loss is not deductible. The particular shares of
securities disposed of at a loss on the same day cannot be determined, the stock or securities will be stock the purchase of which resulted in the nondeductibility of the loss are the first 100 shares
considered to have been disposed of in the order in which they were originally acquired (beginning purchased within such period, that is, the 50 shares purchased on February 15, 1940, and the 50
with earliest acquisition). shares purchased on February 16, 1940.
(Section 34 of the Code)
(c) Where the amount of stock or securities acquired within the sixty-one day period is less than the
amount of stock or securities sold or otherwise disposed of, then the particular shares of stock or SECTION 132.Definition of "capital assets." — The law provides that the term "capital assets" shall
securities the loss from the sale or other disposition of which is not deductible shall be those with be held to mean property held by the taxpayer (whether or not connected with his trade or business),
which the stock or securities acquired are matched in accordance with the following rule: but does not include stock in trade of the taxpayer or other property of a kind which would properly be
included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by
The stock or securities acquired will be matched in accordance with the order of their acquisition the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or
(beginning with the earliest acquisition) with an equal number of the shares of stock or securities sold property, used in the trade or business, of a character which is subject to the allowance for
or otherwise disposed of. depreciation provided in subsection (f) of Section 30 of the Code. The term "capital asset" includes all
classes of property not specifically excluded by Section 30(a).
(d) Where the amount of stock or securities acquired within the sixty- one-day period is not less than
the amount of stock or securities sold or otherwise disposed of, then the particular shares of stock or The exclusion from the term "capital assets" of property used in the trade or business of a taxpayer of
securities the acquisition of which resulted in the nondeductibility of the loss shall be those with which a character which is subject to the allowance for depreciation provided in Section 30(f) of the Code is
the stock or securities disposed of are matched in accordance with the following rule: limited to property used by the taxpayer in the trade or business at the time of the sale or exchange. It
has no application to gains or losses arising from the sale of real property used in the trade or
The stock or securities sold or otherwise disposed of will be matched with an equal number of the business to the extent that such gain or loss is allocable to the land, as distinguished from depreciable
shares of stock or securities acquired in accordance with the order of acquisition (beginning with the improvements upon the land. To such gain or loss allocable to the land, the limitations of Section
earliest acquisition) of the stock or securities acquired. 34(b) and (c) apply (such limitation may be inapplicable to a dealer in real estate, but, if so, it is
because he holds the land primarily for sale to customers in the ordinary course of his trade or
(e) The acquisition of any security which results in the non-deductibility of a loss under the business, not because land is subject to a depreciation allowance). Gains or losses from the sale or
provisions of this section shall be disregarded in determining the deductibility of any other loss. exchange of property used in the trade or business of the taxpayer of a character which is subject to
the allowance for depreciation provided in Section 30(f) of the Code, will not be subject to the
(f) The word "acquired" as used in this section means acquired by purchase or by an exchange percentage provisions of Section 34(b) and losses from such transactions will not be subject to the
upon which the entire amount of gain or loss was recognized by law, and comprehends cases where limitation of losses provided in Section 30(c). (Real property used in taxpayer's trade or business is no
the taxpayer has entered into a contract or option within the sixty-one-day period to acquire by longer capital asset per Am. R.A. 82.)
purchase or by such an exchange.
SECTION 133.Percentage taken into account. — In computing net income, only 50 per cent of the
gain or loss recognized upon the sale or exchange for a capital asset shall be taken into account.
Revenue Regulations 02-40 Page 18 of 39

Thus, in the case of a merchandising concern which has an "ordinary net income" (net income ———
exclusive of net gains from the sale or exchange of capital assets) of P10,000 and a net capital gain One-half P2,500
of P5,000, the net income subject to tax will be P10,000 plus P2,500 (50 % of P5,000), of P12,500. ———
Less-Capital loss carried over (#) 2,250
SECTION 134.Limitation on capital losses. — Losses from sales or exchanges of capital assets are Net capital gain 250
allowed only to the extent of the gains from such sales or exchanges. If the dealings of the taxpayer in ———
capital assets during the year result in a net capital loss, such loss cannot be deducted from his Net income subject to tax P2,450
ordinary income, inasmuch as capital losses are allowable only to the extent of capital gains. In the ======
case, for example, of a taxpayer, engaged in buying and selling goods, having an ordinary net income # The net capital loss of P5,000 sustained in 1946 and carried over in 1947 is reduced to P2,250 for
of P20,000, capital gains of P5,000 and capital losses of P3,000 the taxable net income is computed the reason that the net income from business and other sources (not including capital gain), for the
as follows: year 1946 is only P2,250.

Ordinary net income P20,000 If a bank or trust company incorporated under the laws of the Philippines or of the United States, a
substantial part of whose business is the receipt of deposits, sells any bond, debenture, note, or
Gains from sales of capital assets certificate or other evidence of indebtedness issued by any corporation (including one issued by a
(as stocks or securities) P5,000 government or political subdivision thereof), with interest coupons or in registered form, any loss
50% of such gains P2,500 resulting from such sale shall not be subject to the limitation contained in Section 34(c) and shall not
Losses from sales of capital assets P3,000 be included in determining the applicability of such limitation to other losses.
50% of such losses P1,500
Net taxable capital gains 1,000 SECTION 135.Gains and losses from short sales. — For income tax purposes, a short sale is not
———— deemed to be consummated until the delivery of property to cover the short sale. If the short sale is
Taxable net income P21,000 made through a broker and the broker borrows property to make delivery, the short sale is not
======= deemed to be consummated until the obligation of the seller created by the short sale is finally
If such taxpayer had an ordinary net income of P20,000, capital gains of P2,000 and capital losses of discharged by delivery of property to the brokers to replace the property borrowed by such broker.
P7,000, the taxable net income would be computed as follows: (Section 35 of the Code)
Ordinary net income P20,000
Losses from sales of capital assets SECTION 136.Basis for determining gain or loss from sale of property. — For the purpose of
(as stocks or securities) P7,000 ascertaining the gain or loss from the sale or exchange of property, the basis is the cost of such
50% of such losses P3,500 property, or in the case of property which should be included in the inventory, its latest inventory
Gains from sales of capital assets 2,000 value. But in the case of property acquired before March 1, 1913, when its fair market value as of that
50% of such gains 1,000 date is in excess of its cost, the gain to be included in gross income is the excess of the amount
——— realized therefor over such fair market value. (See illustration I, Section 137 of these regulations).
Net capital losses P2,500 Also in the case of property acquired before March 1, 1913, when its fair market value as of that date
Taxable net income P20,000 is lower than its cost the deductible loss is the excess of such fair market value over the amount
====== realized therefor. (See Illustration II, Id.). No gain or loss is recognized in the case of property sold or
(The net capital loss of P2,500 is not deductible in arriving at the taxable net income inasmuch as exchanged (a) at more than cost but less than its fair market value as of March 1, 1913 (See
capital losses are allowed only to the extent of capital gains.) Illustration III, Id.), or (b) at less than cost but at more than its fair market value as of March 1, 1913.
(See Illustration IV, Id., Id., Id.) In any case proper adjustment must be made in computing gain or
SECTION 134-A. Capital loss carry-over-Illustration. — A, an individual has the following incomes loss from the exchange or sale of property for any depreciation or depletion sustained and allowable
and losses: as deduction in computing net income; the amount of depreciation previously charged off by the
1946 — Net income from business 1,000 taxpayer shall be deemed to be true depreciation sustained unless shown by clear and convincing
Dividends received 750 evidence to be incorrect. What the fair market value of property was as of March 1, 1913, is a
Interest earned500 question of fact to be established by evidence which will reasonably and adequately make it appear.
Capital gains — on capital assets held for 8 months 5,000 The nature and extent of the sales and the circumstances under which they were made should be
Capital losses — on capital assets held for 9 months 10,000 considered. Prices received at forced sales or for small lots of property may be and often are no real
1947 — Net income from business 2,000 indication of the value of the amount of property in question. For instance, sales from time to time of a
Interest earned 200 small number of shares of stock is little indication of the value of a large or controlling interest in the
Capital gains — on capital assets held for 15 months 5,000 corporation. If the taxpayer can not determine the cost of securities purchased prior to March 1, 1913,
In 1946, his taxable income is computed as follows: because of the loss, destruction, or failure to keep records, the value of the securities at the date of
Income from business, dividends and interest P2,250 approximate date of acquisition may be used in determining the cost basis for purposes of computing
Capital gains and losses: the gain or loss from the sale of the securities. When the date or approximate date of acquisition is
Capital gains P5,000 unknown, no general rule can be stated for determining the cost value of such securities. Each case
Less-Capital losses 10,000 must be considered separately upon its own facts.
———
Net loss carried over to 1947 (P5,000) SECTION 137.Illustrations of the computation of gain or loss from the sale or exchange of property
——— acquired prior to March 1, 1913. — To avoid complexity no adjustment has been made in these
Net income subject to tax P2,250 examples for depreciation or depletion.
In 1947, his taxable income is computed as follows:
Income from business and interest P2,200 In the case of property acquired before March 1, 1913, when its fair market value as of that date is in
Capital gains and losses: excess of its cost, the taxable gain is the excess of the amount realized therefor over such fair market
Capital gains P5,000 value.
Revenue Regulations 02-40 Page 19 of 39

Where the fair market value as of March 1, 1913, is equal to or greater than the cost and the selling
ILLUSTRATION I price is less than the cost, the deductible loss is the amount by which the cost exceeds the selling
Fair Market price.
Cost Value Sale Price Taxable gain
Mar. 1, 1913 ILLUSTRATION VI
P20,000 P30,000 P40,000 P10,000 Fair Market
Excess of amount realized over fair Cost Value Sale Price Taxable gain
market value as of March 1, 1913. Mar. 1, 1913
Gain attributed to the period prior P20,000 P30,000 P10,000 P10,000
to March 1, 1913 not taxable. Reason: Loss on whole transaction, all
In the case of property acquired before March 1, 1913, when its fair market value as of that date is of which is attributable to period
lower than its cost, the deductible loss is the excess of such fair market value over the amount subsequent to March 1, 1913. Only
realized therefor. actual loss sustained deductible.

ILLUSTRATION II SECTION 138.Sale of property acquired by gift. — In computing the gain or loss from the sale or
Fair Market other disposition of property acquired by gift, the basis shall be the selling price and the fair market
Cost Value Sale Price Taxable gain value of the property at the time the gift was made, or its fair market value as of March 1, 1913, if
Mar. 1, 1913 acquired prior thereto, determined in accordance with the next two preceding sections. In the case of
P20,000 P10,000 P6,000 P4,000 gifts made on or after July 1, 1939, the value taken as a basis for gift tax purposes shall be
Excess of fair market value over considered as the fair market value in computing gain or loss from the sale or other disposition of the
amount realized. Loss attributable to property.
the period prior to March 1, 1913, not
deductible. SECTION 139.Sale of property acquired by devise, bequests, or inheritance. — In computing the gain
No gain or loss is recognized in the case of property acquired before March 1, 1913, and sold or or loss from the sale or other disposition of property acquired by devise, bequest, or inheritance, the
disposed of at more than cost but at less than its fair market value as of that date. basis shall be the fair market price or value of such property at the time of the death of the decedent.
The term "property acquired by bequest, devise, or inheritance" as used herein includes (a) such
ILLUSTRATION III property interests as the taxpayer has received as the result of a transfer, or creation of a trust, in
Fair Market contemplation of or intended to take effect in possession or enjoyment at or after death, and (b) such
Cost Value Sale Price Taxable gain property interest as the taxpayer has received as the result of the exercise by a person of a general
Mar. 1, 1913 power of appointment (1) by will, or (2) by deed executed in contemplation of or intended to take
P20,000 P60,000 P40,000 No taxable gain or deductible effect in possession or enjoyment at or after death. In the case of property acquired by gift, bequest,
loss. devise, or inheritance, prior to March 1, 1913, the taxable gain or deductible loss from the sale or
Reason: A gain on whole transaction, other disposition thereof shall be computed in accordance with sections 136 and 137 of these
which gain is attributed to period prior regulations. In the case of property acquired by bequest, devise or inheritance, its value as appraised
to March 1,1913. for the purpose of the inheritance tax shall be deemed to be its fair market value when acquired.
No gain or loss is recognized in the case of property acquired before March 1, 1913, and sold or
disposed of at less than cost but at more than its fair market value as of that date. SECTION 140.Exchange of property. — Gain or loss arising from the acquisition and subsequent
disposition of property is realized only when as the result of a transaction between the owner and
ILLUSTRATION IV another person the property is converted into other property (a) that is essentially different from the
Fair Market property disposed of, and (b) that has a market value. The requirement that the property received in
Cost Value Sale Price Taxable gain exchange must be "essentially different from the property disposed of" implies that there must be a
Mar. 1, 1913 change in substance and not merely a change in form. By way of illustration, if a taxpayer owning ten
P20,000 P6,000 P10,000 No taxable gain or deductible shares of stock exchanges his stock certificate for a voting trust certificate, no income is realized. The
loss. term "market value" means the fair value of the property in money as between one who wishes to
Reason: A loss on whole transaction, purchase and one who wishes to sell. It is not, however, what can be obtained for the property when
which loss is attributable to period the owner is under peculiar compulsion to sell or the purchaser to buy; nor is it a purely speculative
prior to March 1, 1913. value which an owner could not reasonably expect to obtain for the property although he might
Where the cost is equal to or greater than the fair market value as of March 1, 1913, and the selling possibly be fortunate enough to do so. "Market value" is the price at which a seller willing to sell at a
price exceeds the cost, the gain to be included in gross income is the excess of the selling price over fair price and a buyer willing to buy at a fair price, both having reasonable knowledge of the facts, will
the cost. trade. Evidence as to the assets and liabilities of a corporation and as to its earnings may furnish
definite indications of the market value of its stock.
ILLUSTRATION V
Fair Market SECTION 141.Determination of gain or loss from the exchange of property. — The amount of income
Cost Value Sale Price Taxable gain derived or loss sustained from an exchange of property is the difference between the market value at
Mar. 1, 1913 the time of the exchange of the property received in exchange and the original cost, or other basis, of
P20,000 P10,000 P40,000 P20,000 the property exchange. If the property exchanged was acquired prior to March 1, 1913, see Sections
Reason: Gain on whole transaction, 136 and 137 of these regulations.
all of which is attributable to period
subsequent to March 1, 1913. SECTION 142.Readjustment of interest in a registered copartnership. — When a partner retires from
a duly registered copartnership, or the partnership is dissolved, he realizes a gain or loss measured
by the difference between the price received for his interest and the cost to him of his interest in the
Revenue Regulations 02-40 Page 20 of 39

partnership including in such cost the amount of his share in any undistributed partnership net income (b) By a shareholder: A shareholder who exchanges his stock in a corporation which is a party to the
earned since he became a partner on which the income tax has been paid. However, if such interest merger or consolidation solely for stock of another corporation, also a party to the merger or
in the partnership was acquired prior to March 1, 1913, both the cost as hereinbefore provided and consolidation.
the amount of such interest as of date, plus the amount of the shares in any undistributed partnership (c) By a security holder: A security holder of a corporation which is a party to the merger or
net income earned since March 1, 1913, on which the income tax has been paid, shall be ascertained consolidation, who exchanges his securities in such corporation solely for stock or securities in
and the taxable gain derived or the deductible loss sustained shall be computed as provided in another corporation, a party to the merger or consolidation.
Sections 136 and 137 of these regulations. If the partnership distributes its assets in kind and not in
cash, the partner realizes gain or suffers loss according to the market value of the property received 3. Recognition of gain in part but not loss, where exchanges are not solely in kind.
in liquidation. Whenever a new partner is admitted, to a partnership, or any existing partnership is (a) By a shareholder or security holder. — If in connection with an exchange made by a shareholder
reorganized, the facts as to such change or reorganization should be fully set forth in the next return or security holder described in the above exceptions, he receives not only stock or securities,
of income, in order that the Commissioner of Internal Revenue may determine whether any gain or permitted to be received without recognition of loss or gain, but also money and/or other property,
loss has been realized by any partner. then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of
money and the fair market value of such other property. The loss, if any, to the shareholder or security
SECTION 143.Basis of stock or securities acquired in "wash sales". — In the sale or other disposition holder from such an exchange is not to be recognized to any extent. However, if the distribution of
of stocks or securities the acquisition of which (or the contract or option to acquire which) resulted in such other property and/or money to a shareholder in the course of a merger or consolidation has the
the non deductibility of the loss from the sale or other disposition of substantially identical stock or effect of the distribution of a taxable dividend, there shall be taxed to the distributee as a taxable
securities the basis shall be the basis of the substantially identical stock so sold or disposed of, dividend such an amount of the gain recognized on the exchange as is not in excess of the
increased or decreased, as the case may be, by the difference, if any, between the price at which the distributee's ratable share of the undistributed earnings and profits of the corporation, and as a capital
stock or securities was acquired and the price at which such substantially identical stock or securities gain, the remainder, if any, of the gain so recognized.
were sold or otherwise disposed of. The application of this rule may be illustrated by the following Example: A, in connection with a merger or consolidation in 1957 exchanges a share of stock in
examples: the X Corporation (a party to the merger or consolidation) purchased in 1939 at a cost of P100 for a
share of stock of the Y Corporation (also a party to the merger or consolidation), which has a fair
EXAMPLE (1): A purchased a share of common stock of the X Corporation for P100 in 1936, which he market value of P90, plus P20 in cash. The gain from the transaction is P10 and is recognized and
sold January 15, 1940, for P80.00. On February 1, 1940, he purchased a share of common stock of taxed as a gain from the exchange of property. However, if the share of stock received had a fair
the same corporation for P90.00. No loss from the sale is recognized under Section 33 of the Code. market value of P70, the loss from the transaction of P10 would not be recognized.
The basis of the new share is P110; that is, the basis of the old share (P100) increased by P10,
excess of the price at which the new share was acquired (P90) over the price at which the old share (b) By a corporation. — If, in pursuance of a plan of merger or consolidation above described, the
was sold (P80). transferor corporation receives not only stock permitted to be received without the recognition of gain
or loss, but also money and/or other property, then, if such money and/or other property received by
EXAMPLE (2): A purchased a share of common stock of the X corporation for P100 in 1936, which he the corporation is distributed by it pursuant to the plan of merger or consolidation, no gain to the said
sold January 15, 1940, for P80. On January 1, 1940, he purchased a share of common stock of the corporation will be recognized. If the other property and/or money received by the corporation is not
same corporation for P70. No loss from the sale is recognized under Section 33 of the Code. The distributed by it pursuant to the plan of merger and consolidation, the gain, if any, to the corporation
basis of the new share is P90; that is, the basis of the old share (P100) decreased by P10, the excess from the exchange will be recognized in an amount not in excess of the sum of money and the fair
of the price at which the old share was sold (P80) over the price at which the new share was acquired market value of the other property so received which is not distributed. In either case no loss from the
(P70). (See Section 131 of these regulations). exchange will be recognized.

SECTION 143-A. Excerpts from B.I.R. General Circular No. V-253 publishing Republic Act No. 1921 4. Assumption of liability. — Where upon an exchange described in the foregoing exceptions, a
amending Section 35 of the Code, particularly subsection (c) thereof: taxpayer receives stock or securities which would be permitted to be received without the recognition
of gain if it were the sole consideration, and as part of the consideration, another party to the
Features of the Amendment exchange assumes a liability of the taxpayer, or acquires from the taxpayer property subject to a
1. Before and after the amendment. — Under the provisions of subsection (c) of Section 35 of the liability, such assumption or acquisition shall not be considered as money and/or other property, and
National Internal Revenue Code, before its amendment by Republic Act No. 1921, when shall not prevent the exchange from being within the exceptions. Accordingly, the assumption of the
property is exchanged for another property, the property received in exchange shall, for the aforesaid liabilities is not to be treated as other property or money for the purpose of determining the
purpose of determining gain or loss, be treated as the equivalent of cash to the amount of its fair amount of realized gain.
market value.
5. Basis of stock or securities for the purpose of determining gain or loss upon subsequent sale.
Paragraph 1 of subsection (c) of section 35 of the Tax Code after the amendment states the general
rule that upon the sale or exchange of property, the entire amount of gain or loss as the case may be, (a) By the transferor corporation, or its shareholder or security holder. — The basis of the stock or
is recognized, while paragraphs 2 and 3 give the exceptions where gain or loss is not recognized, or securities received by the transferor corporation or its shareholder or security holder upon the
gain is recognized only in part. exchange specified in the above exceptions shall be the same as the basis of the property, stock or
securities exchanged decreased by the money received and the fair market value of the other
2. Exceptions to the rule recognizing gain or loss in exchanges of property solely in kind. — Under property received, and increased by the amount treated as dividend of the shareholder and the
paragraph 2 of subsection (c) of Section 35 of the Tax Code after its amendment by Republic Act amount of any gain that was recognized on the exchange. The other property or "boot" received in
No. 1921, no gain or loss shall be recognized in the following cases of exchanges made in exchange shall have as basis its fair market value.
pursuance of a plan of merger or consolidation:
Examples:
(a) By a corporation: If a corporation, a party to a merger or consolidation, in pursuance of such plan 1. A purchased a share of stock in the X Corporation in 1939 for P100. Pursuant to a plan of merger
of merger or consolidation, exchanges property solely for stock in another corporation, a party to the or consolidation, A in 1957 exchanged his share for one share in the Y Corporation, worth P90 and
merger or consolidation. P30 in cash. A realized a gain of P20 upon the exchange. The basis of the share of stock in the Y
Corporation is P90, that is, the basis of the share in the X Corporation (P100) less the amount of
money received by A (P30) plus the amount of the gain recognized on the exchange (P20).
Revenue Regulations 02-40 Page 21 of 39

2. A purchased a share of stock in the X Corporation in 1939 for P100. Upon a merger or possession, but should not include goods ordered for future delivery transfer of title to which has not
consolidation of the X Corporation in 1957, A received in place of his stock in the X Corporation a yet been effected.
share of stock in the Y Corporation worth P60, a Treasury Bond worth P50, and in addition P20 in
cash. A realized a gain of P30 upon the exchange. The basis of the property received in exchange is SECTION 145.Valuation of inventories. — The law provides two tests to which each inventory must
the basis of the old stock decreased in the amount of money received (P20) and increased in the conform. — (1) It must conform as nearly as possible to the best accounting practice in the trade or
amount of gain that was recognized (P30), which results in a basis for the property received of P110. business, and (2) it must clearly reflect the income. It follows, therefore, that inventory rules can not
This basis of P110 is apportioned between the Treasury Bond and the share of stock, the basis of the be uniform but must give effect to trade customs which come within the scope of the best accounting
Treasury Bond being its fair market value at the date of the exchange, P50, and of the share of stock, practice in the particular trade or business. In order to clearly reflect income, the inventory practice of
the remainder, P60. a taxpayer should be consistent from year to year, and greater weight is to be given to consistency
than to any particular method of inventory or basis of valuation, as long as the method or basis used
(b) By the transferee. — The basis of the property transferred in the hands of the transferee shall be is substantially in accord with these regulations. An inventory that can be used under the best
the same as it would be in the hands of the transferor, increased by the amount of the gain accounting practice in a balance sheet showing the financial position of the taxpayer is, as a general
recognized to the transferor on the transfer. rule, regarded as clearly reflecting his income.

(c) If corporation shareholder or security holder received several kinds of stock or securities. — The bases of valuation most commonly used by business concerns and which meet the requirements
When securities of a single class were exchanged for new securities of different classes where no of the Income Tax Law are (a) cost price or (b) cost or market price, whichever is the lower. Any goods
gain or loss was recognized, the proper method of apportionment is to allocate to each class of new in an inventory which are unsalable at normal prices or unusable in the normal way because of
securities that proportion of the original basis which the market value of the particular class bears to damage, imperfections, shop wear, changes of style, odd or broken lots, or other similar causes,
the market value of all securities received on the date of the exchange, for purposes of determining including second hand goods taken in exchange, should be valued at "bona fide" selling prices
the gain or loss on the subsequent sale of any of the new securities. For example, if 100 shares of whether basis (a) or (b) is used, or if such goods consist of raw materials or partly finished goods held
common stock par value P100, are exchanged for 50 shares of preferred and 50 shares of common for use or consumption, they should be valued upon a reasonable basis, taking into consideration the
each of P100 par value, and the cost of the old stock was P250 per share, or P25,000, but the market usability and the condition of the goods, but in no case shall such value be less than the scrap value.
value of the preferred stock on the date of the exchange was P110 per share, or P5,500 for the 50 "Bona fide" selling price means actual offerings of goods during a period ending not later than thirty
shares, and the market value of the common was P440 per share or P22,000 for the 50 shares of days after inventory date. The burden of proof will rest upon the taxpayer to show that such
common, one-fifth of the original cost, or P5,000, would be regarded as the cost of the preferred and exceptional goods as are valued upon such selling bases come within the classifications indicated
four-fifths, or P20,000 as the cost of the common. above, and he shall maintain such records of the disposition of the goods as will enable a verification
of the inventory to be made.
As previously shown cash "boot" operates in the first instance to reduce basis. Then to this result
must be added the gain recognized. The remainder is to be allocated between the several types of In respect to normal goods, whichever basis (a) or (b) is adopted must be applied with reasonable
stock and securities permitted to be received without the recognition of gain or loss. To illustrate: The consistency to the entire inventory. Taxpayers were given the option to adopt either basis (a) or (b) for
taxpayer in a nontaxable exchange trades A stock which cost P100 for one share of common stock their 1921 inventories, and the basis adopted for that year is controlling and a change can now be
and one share of preferred stock of B corporation, together worth P100 (P100 each), and P50 cash. made after permission is secured from the Commissioner of Internal Revenue. Goods taken in the
The basis for the share of B common stock will therefore be P50 (1/2 of P100) and the B preferred inventory which have been so intermingled that they can not be identified with specific invoices will be
stock will likewise take a P50 basis. deemed to be either (a) the goods most recently purchased or produced and the cost thereof will be
the actual cost of the goods purchased or produced during the period in which the quantity of goods in
6. Definitions: the inventory has been acquired, or (b) where the taxpayer maintains book inventories in accordance
(a) The term "securities" means bonds and debentures but not "notes" of whatever class or duration. with a sound accounting system in which the respective inventory accounts are charged with the
(b) The term "merger" or "consolidation" shall be understood to mean the ordinary merger or actual cost of the goods purchased or produced and credited with the value of the goods used,
consolidation, or the acquisition by one corporation of all or substantially all the properties of another transferred, or sold, calculated upon the basis of the actual cost of the goods acquired during the
corporation solely for stock. In order that a transaction may be regarded as a merger or consolidation taxable year (including the inventory at the beginning of the year) the net value as shown by such
within the purview of the amendment, it must be undertaken for a bona fide business purpose and not inventory accounts will be deemed to be the cost of the goods on hand. The balances shown by such
solely for the purpose of escaping the burden on taxation. In determining whether a bona fide inventories should be verified by physical inventories at reasonable intervals and adjusted to conform
business purpose exists, each and every step of the transaction shall be considered and the whole therewith.
transaction or series of transactions shall be treated as a single unit. The term "property" shall be
taken to include the cash assets of the transferor for purpose of determining whether the property Inventories should be recorded in a legible manner, properly computed and summarized, and should
transferred constitutes a substantial portion of the property of the transferor. "Substantially all" as be preserved as a part of the accounting record of the taxpayer. The inventories of taxpayers on
used under this amendment means the acquisition by one corporation of at least 80% of the assets, whatever basis taken will be subject to investigation by the Commissioner of Internal Revenue and
including cash, of another corporation, which has the element of permanence and not merely the taxpayer must satisfy the Commissioner of Internal Revenue of the correctness of the price
momentary holding. adopted.
(Section 36 of the Code)
The following methods, among others, that are sometimes used in taking or valuing inventories, are
SECTION 144.Need of inventories. — In order to reflect the net income correctly, inventories at the not in accord with these regulations and therefore their use for income tax purposes is prohibited, viz.:
beginning and end of each year are necessary in every case in which the production, purchase or (1) Deducting from the inventory a reserve for price changes, or an estimated depreciation in the
sale of merchandise is an income producing factor. The inventory should include raw materials and value thereof.
supplies on hand that have been acquired for sale, consumption, or use in productive processes (2) Taking work in process, or other parts of the inventory, at a nominal price or at less than its
together with all finished or partly finished goods. Only merchandise title to which is vested in the proper value.
taxpayer should be included in his inventory. Accordingly the seller should include in his inventory (3) Omitting portions of the stock on hand.
goods under contract for sale but not yet segregated and applied to the contract and goods out upon (4) Using a constant price or nominal value for a so called normal quantity of materials or goods in
consignment, but should exclude from inventory goods sold, title to which has passed to the stock.
purchaser. A purchaser should include in inventory merchandise purchased, title to which has passed (5) Including stock in transit, either shipped to or from the taxpayer, the title to which is not vested in
to him although such merchandise is in transit or for other reasons has not been reduced to physical the taxpayer.
Revenue Regulations 02-40 Page 22 of 39

their individual capacities buy and sell securities, are not dealers in securities within the meaning of
SECTION 146.Inventories at cost price. — Cost means: this rule.
(1) In the case of merchandise on hand at the beginning of the taxable year, the inventory price of
such goods. SECTION 149.Inventories of livestock raisers and other farmers. —
(2) In the case of merchandise purchased since the beginning of the taxable year, the invoice price
less trade or other discounts, except strictly cash discounts, approximating a fair interest rate, which (1) Farmers may change the basis of their returns from that of receipts and disbursements to that of
may be deducted or not at the option of the taxpayer, provided a consistent course is followed. To this an inventory basis, which necessitates the use of opening and closing inventories for the year in
net invoice price should be added transportation or other necessary charges incurred in acquiring which the change is made. There should be included in the opening inventory all farm products
possession of the goods. (including livestock) purchased or raised which were on hand at the date of the inventory, but
(3) In the case of merchandise produced by the taxpayer since the beginning of the taxable year, (a) inventories must not include real estate, buildings, permanent improvements, or any other fixed
the cost of raw materials and supplies entering into or consumed in connection with the products; (b) assets.
expenditures for direct labor; (c) indirect expenses incident to and necessary for the production of the
particular article, including therein a reasonable proportion of management expenses, but not (2) Because of the difficulty of ascertaining actual cost of livestock and other farm products, farmers
including any cost of selling or return on capital whether by way of interest or profit. who render their returns upon an inventory basis may at their option value their inventories for the
(4) In any industry in which the usual rules for computation of cost of production are inapplicable, current taxable year according to the "farm-price method" which provides for the valuation of
costs may be approximated upon such basis as may be reasonable and in conformity with inventories at market price less cost of marketing. If the use of the "farm-price method" of valuing
established trade practice in the particular industry. Among such cases are: (a) Farmers and raisers of inventories for any taxable year involves a change in method of pricing inventories from that
1ivestock; (b) miners and manufacturers who by a single process or uniform series of processes employed in prior years, the opening inventory for the taxable year in which the change is made
derive a product of two or more kinds, size or grade, the unit cost of which is substantially alike; and should be brought in at the same value as the closing inventory for the preceding taxable year. If such
(c) retail merchants who use what is known as the "retail method" in ascertaining approximate cost. valuation of the opening inventory for the taxable year in which the change is made results in an
cCaSHA abnormally large income for that year, there may be submitted with the return for such taxable year an
adjustment statement for the preceding year based on the "farm-price method" of valuing inventories;
SECTION 147.Inventories at market price. — Under ordinary circumstances, and for normal goods in upon the amount of which adjustments the tax, if any be due, shall be assessed and paid at the rate
an inventory "market price" means the current bid price prevailing at the date of the inventory for the of tax in effect for such preceding year.
particular merchandise in the volume in which usually purchased by the taxpayer and is applicable in
the cases (a) of goods purchased and on hand, and (b) of basic elements of cost (materials, labor, (3) Where returns have been made in which the taxable net income has been computed upon
and burden) in goods in process of manufacture and in finished goods on hand; exclusive, however, incomplete inventories, the abnormality should be corrected by submitting with the return for the
of goods on hand or in process of manufacture for delivery upon firm sales contracts (i.e., those not current taxable year a statement for the preceding year in which such adjustments shall be made as
legally subject to cancellation by either party) at fixed prices entered into before the date of the are necessary to bring the closing inventory for the preceding year into agreement with opening
inventory, which goods must be inventoried at cost. Where no open market exists or where quotations complete inventory for the current taxable year.
are nominal due to stagnant market condition, the taxpayer must use such evidence of a fair market
price at the date or dates nearest the inventory as may be available, such as specific purchase or SECTION 150.Inventories of miners and manufacturers. — A taxpayer engaged in mining or
sales by the taxpayer or others in reasonable volume and made in good faith, or compensation paid manufacturing who by a single process or uniform series of processes derives a product of two or
for cancellation of contracts for purchase commitments. Where the taxpayer in the regular course of more kinds, sizes or grades, the unit cost of which is substantially alike, and who in conformity to a
business has offered for sale such merchandise at prices lower than the current price as above recognized trade practice allocates an amount of cost to each kind, size, or grade of product which in
defined, the inventory may be value at such prices and the correctness of prices will be determined by the aggregate will absorb the total cost of production, may use such allocated cost a the basis for
reference to the actual sales of the taxpayer for a reasonable period before and after the date of the pricing inventories, provided such allocation bears a reasonable relation to the respective selling
inventory. Prices which vary materially from the actual prices so ascertained will not be accepted as values of the different kinds of products.
reflecting the market price.
SECTION 151.Inventories of retail merchants. — Retail merchants who employ what is known as the
SECTION 148.Inventories by dealers in securities. — A dealer in securities who in his books of "retail method" of pricing inventories may make their returns upon that basis, provided that the use of
account regularly inventories unsold securities on hand either — such method, is designated upon the returns, that accurate accounts are kept and that such method
(a) At cost; is consistently adhered to unless a change is authorized by the Commissioner of Internal Revenue.
(b) At, cost or market, whichever is lower; or Under this method the goods in the inventory are ordinarily priced at the selling prices and the total
(c) At market value. retail value of the goods in each department or of each class of goods is reduced to approximate cost
may make his return upon the basis upon which his accounts are kept; provided that a description of by deducting the percentage which represents the difference between the retail selling value and the
the method employed shall be included in or attached to the return, that all the securities must be purchase price. This percentage is determined by departments of a store or by classes of goods, and
inventoried by the same method, and that such method must be adhered to in subsequent years, should represent as accurately as may be the amounts added to the cost prices of the goods to cover
unless another method be authorized by the Commissioner of Internal Revenue. A dealer in securities selling and other expenses of doing business and for the margin of profit. In computing the
in whose books of accounts separate computations of the gain or loss from the sale of the various lots percentage above mentioned, proper adjustment should be made for all mark-ups and mark-downs.
of securities sold are made on the basis of the cost of each lot shall be regarded, for the purposes of
this section, as regularly inventorying his securities at cost. For the purposes of this rule a dealer in A taxpayer maintaining more than one department in his store or dealing in classes of goods carrying
securities is a merchant of securities, whether an individual, partnership; or corporation, with an different percentages of gross profit should not use a percentage of profit based upon an average of
established place of business, regularly engaged in the purchase of securities and their resale to his entire business but should compute and use in valuing his inventory the proper percentages for
customers; that is, one who as a merchant buys securities and sells them to customers with a view to the respective departments or classes of goods.
the gains and profits that may be derived therefrom. If such business is simply a branch of the (Section 37 of the Code)
activities carried on by such person, the securities inventoried as here provided may include only
those held for purposes of resale and not for investment. Taxpayers who buy and sell or hold SECTION 152.Income from sources within the Philippines. — The law divides the income of
securities for investment or speculation, irrespective of whether such buying or selling constitutes the taxpayers into three classes:
carrying on of a trade or business, and officers of corporations and members of partnerships who in (1) Income which is derived in full from sources within the Philippines;
(2) Income which is derived in full from sources without the Philippines; and
Revenue Regulations 02-40 Page 23 of 39

(3) Income which is derived partly from sources within and partly from sources without the (2) Dividends other than those derived from sources within the Philippines as provided in Section
Philippines. 37(a)(2);
(3) Compensation for labor or personal services performed without the Philippines;
Non-resident alien individuals and foreign corporations are taxable only upon income from sources (4) Rentals or royalties derived from property without the Philippines or from any interest in such
within the Philippines. Citizens and residents of the Philippines and domestic corporations are taxable property, including rentals or royalties for the use of or for the privilege of using without the
upon income derived from sources both within and without the Philippines. EAcTDH Philippines, patents, copyrights, secret processes and formulas, goodwill, trade-marks, trade
The taxable income from sources within the Philippines includes that derived in full from sources brands, franchises, and other like property; and
within the Philippines and that portion of the income which is derived partly from sources within and (5) Gain derived from the sale of real property located without the Philippines. AEIDTc
partly from sources without the Philippines which is allocated or apportioned to sources within the
Philippines. SECTION 159.Sale of personal property. — Income derived from the purchase and sale of personal
property shall be treated as derived entirely from the country in which sold. The world "sold" includes
SECTION 153.Interest. — Interest on bonds or notes or other interest bearing obligations of "exchanged". The "country in which sold" ordinarily means the place where the property is marketed.
residents, corporate or otherwise, constitutes income from sources within the Philippines. This section does not apply to income from the sale of personal property produced (in whole or in
part) by the taxpayer within and sold without the Philippines or produced (in whole or in part) by the
SECTION 154.Dividends. — Gross income from sources within the Philippines includes dividends, as taxpayer without and sold within the Philippines. (See Section 162 of these regulations.)
defined by Section 83 of the Code:
(a) From a domestic corporation; and SECTION 160.Apportionment of deductions. — From the items specified in Section 37(a) as being
(b) From a foreign corporation unless less than 50 per cent of its gross income for the three-year derived specifically from sources within the Philippines there shall be deducted the expenses, losses,
period ending with the close of its taxable year preceding the declaration of such dividends, or for and other deductions properly apportioned or allocated thereto and a ratable part of any other
such part of such period as it has been in existence, was derived from sources within the Philippines; expenses, losses or deductions which can not definitely be allocated to some item or class of gross
but only in an amount which bears the same ratio to such dividends as the gross income of the income. The remainder shall be included in full as net income from sources within the Philippines. The
corporation for such period derived from sources within the Philippines bears to its gross income from ratable part is based upon the ratio of gross income from sources within the Philippines to the total
all sources. gross income.

Dividends will be treated as an income from sources within the Philippines unless the taxpayer EXAMPLE: A non-resident alien individual whose taxable year is the calendar year, derived gross
submits sufficient data to establish to the satisfaction of the Commissioner of Internal Revenue that income from all sources for 1939 of P180,000, including therein:
they should be excluded from gross income under Section 37(a)(2)(B). Interest on bonds of a domestic corporation P9,000
Dividends on stock of domestic corporation 4,000
SECTION 155.Compensation for labor or personal services. — Gross income from sources within the Royalty for the use of patents within the Philippines 12,000
Philippines includes compensation for labor or personal services performed within the Philippines Gain from sale of real property located within the Philippines 11,000
regardless of the residence of the payor, of the place in which the contract for service was made, or of ————
the place of payment. If a specific amount is paid for labor or personal services performed in the Total P36,000
Philippines, such amount shall be included in the gross income. If no accurate allocation or
segregation of compensation for labor or personal services performed in the Philippines can be made, that is, one-fifth of the total gross income was from sources within the Philippines. The remainder of
or when such labor or service is performed partly within and partly without the Philippines, the amount the gross income was from sources without the Philippines, determined under Section 37(c).
to be included in the gross income shall be determined by an apportionment of the time basis, i.e.,
there shall be included in the gross income an amount which bears the same relation to the total The expenses of the taxpayer for the year amounted to P78,000. Of these expenses the amount of
compensation as the number of days of performance of the labor or services within the Philippines P8,000 is properly allocated to income from sources within the Philippines and the amount of P40,000
bears to the total number of days performance of labor or services for which the payment is made. is properly allocated to income from sources without the Philippines.
Wages received for services rendered inside the territorial limits of the Philippines and wages of an
alien seaman earned on a coastwise vessel are to be regarded as from sources within the The remainder of the expense, P30,000, cannot be definitely allocated to any class of income. A
Philippines. ratable part thereof, based upon the relation of gross income from sources within the Philippines to
the total gross income, shall be deducted in computing net income from sources within the
SECTION 156.Rentals and royalties. — Gross income from sources within the Philippines includes Philippines. Thus, there are deducted from the P36,000 of gross income from sources within the
rentals or royalties from property located within the Philippines or from any interest in such property, Philippines expenses amounting to P14,000 (representing P8,000 properly apportioned to the income
including rentals or royalties for the use of or the privilege of using in the Philippines, patents, from sources within the Philippines and P6,000, a ratable part (one-fifth) of the expenses which could
copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises, and other not be allocated to any item or class of gross income). The remainder, P22,000, is the net income
like property. The income arising from the rental of property whether tangible or intangible located from sources within the Philippines.
within the Philippines, or from the use of property, whether tangible or intangible, located within the
Philippines, is from sources within the Philippines. SECTION 161.Other income from sources within the Philippines. — Items of gross income other than
those specified in Section 37(a) and (c) shall be allocated or apportioned to sources within or without
SECTION 157.Sale of real property. — Gross income from sources within the Philippines includes the Philippines, as provided in Section (37)(e).
gain, computed under the provisions of Section 35, derived from the sale or other disposition of real
property located in the Philippines. For the treatment of capital gains and losses, see Sections 132 to The income derived from the ownership or operation of any farm, mine, oil or gas well, other natural
135 of these regulations. deposit, or timber, located within the Philippines, and from the sale by the producer of the products
thereof within or without the Philippines, shall ordinarily be included in gross income from sources
SECTION 158.Income from sources without the Philippines. — Gross income from sources without within the Philippines. If, however, it is shown to the satisfaction of the Commissioner of Internal
the Philippines includes: Revenue that due to the peculiar conditions of productions and sale in a specific case or for other
(1) Interest other than that specified in Section 37(a)(1), as being derived from sources within the reasons all of such gross income should not be allocated to sources within the Philippines and to
Philippines; sources without the Philippines shall be made as provided in Section 162 of these regulations.
Revenue Regulations 02-40 Page 24 of 39

Where items of gross income are separately allocated to sources within the Philippines, there shall be affirmative evidence showing such value to be greater or less than the actual value. The average
deducted therefrom, in computing net income, the expenses, losses, and other deductions properly value during the taxable year or period shall be employed. The average value of property as above
apportioned or allocated thereto and a ratable part of other expenses, losses, or other deductions prescribed at the beginning and end of the taxable year or period ordinarily may be used, unless by
which cannot definitely be allocated to some item or class of gross income. reason of material changes during the taxable year or period such average does not fairly represent
the average for such year or period, in which event the average shall be determined upon a monthly
SECTION 162.Income from the sale of personal property derived from sources partly within and or daily basis. Bills and accounts receivable shall (unless satisfactory reason for a different treatment
partly without the Philippines. — Items of gross income not allocated by Sections 152 to 159 or 161 of is shown) be assigned or allocated to the Philippines when the debtor resides in the Philippines.
these regulations to sources from within or without the Philippines shall (unless unmistakably from a HCIaDT
source within or a source without the Philippines) be treated as derived from sources partly within and
partly without the Philippines. CASE 3. Applications for permission to base the return upon the taxpayer's books of account will be
considered by the Commissioner of Internal Revenue in the case of any taxpayer who, in good faith
The portion of such income derived from sources partly within the Philippines and partly within a and unaffected by considerations of tax liability, regularly employs in his books of account a detailed
foreign country which is attributable to sources within the Philippines shall be determined according to allocation of receipts and expenditures which reflects more clearly than the processes or formulas
the following rules and cases: herein prescribed, the income derived from sources within the Philippines.

PERSONAL PROPERTY PRODUCED AND SOLD: — Gross income derived from the sale of SECTION 163.Foreign steamship companies. — The returns of foreign steamship companies whose
personal property produced (in whole or in part) by the taxpayer within the Philippines and sold within vessels touch ports of the Philippines should include as gross income, the total receipts of all out-
a foreign country, or produced (in whole or in part) by the taxpayer within a foreign country and sold going business whether freight or passengers. With the gross income thus ascertained, the ratio
within the Philippines shall be treated as derived partly from sources within the Philippines and partly existing between it and the gross income from all parts, both within and without the Philippines of all
from sources within a foreign country under one of the cases below. As used herein the word vessels, whether touching ports of the Philippines or not, should be determined as the basis upon
"produced" includes created, fabricated, manufactured, extracted, processed, cured, or aged. which allowable deductions may be computed, the principle being that allowable deductions shall be
computed upon a basis which recognizes that the income arising and accruing from business done if
CASE 1. Where the manufacturer or producer regularly sells a part of his output to wholly any from this country shall bear its share, and no more, of expense, incident to the earning or creation
independent distributors or other selling concerns in such a way as to establish fairly an independent of such income, in the ratio that the gross income arising in and from this country bears to the entire
factory or production price — or shows to the satisfaction of the Commissioner of Internal Revenue gross income arising from business done both within and without this country. In other words, the net
that such an independent factory or production price has been otherwise established — unaffected by income of a foreign steamship company doing business in or from this country is ascertained for the
considerations of tax liability, and the selling or distributing branch or department of the business is purpose of the income tax, by deducting from the gross receipts from outgoing business such a
located in a different country from that in which the factory is located or the production carried on, the portion of the aggregate expenses, losses, etc., as such receipts bear to the aggregate receipts from
net income attributable to sources within the Philippines shall be computed by an accounting which all ports of all vessels, including in each case incoming of a nonshipping character but incidental, to
treats the products as sold by the factory or productive department of the business to the distributing the shipping business such as dividends from investments, interests on deposits, etc. For example —
or selling department at the independent factory price as established. In all such cases the basis of
the accounting shall be fully explained in a statement attached to the return. Given
(a) Gross receipts from outgoing freights and passengers
CASE 2. Where an independent factory or production price has not been established as provided from P.I. ports P20,000
under Case 1, the net income shall first be computed by deducting from the gross income derived (b) Gross receipts from outgoing freights and passengers
from the sale of personal property produced (in whole or in part) by the taxpayer within the Philippines from all ports other than those of P. I 200,000
and sold within a foreign country or produced (in whole or in part) by the taxpayer within a foreign (c) Interests and other nonshipping income received by P.I.
country and sold within the Philippines, the expenses, losses, or other deductions properly office 5,000
apportioned or allocated thereto and a ratable part of any expenses, losses, or other deductions (d) Interests, dividends, and other nonshipping income received
which can not definitely be allocated to some item or class of gross income. Of the amount of net by all offices other than those in P.I. 50,000
income so determined, one-half shall be apportioned in accordance with the value of the taxpayer's (e) Total expenses and deductions of the company as a whole,
property within the Philippines and within the foreign country, the portion attributable to sources within including those incurred by P.I. office 150,000
the Philippines being determined by multiplying such one half by a fraction the numerator of which Computation of P.I. Net Income
consists of the value of the taxpayer's property within the Philippines, and the denominator of which (f) P.I. Gross Income:
consists of the value of the taxpayer's property both within the Philippines and within the foreign Freights and passengersP20,000
country. The remaining one-half of such net income shall be apportioned in accordance with the gross Interest and other income 5,000
sales of the taxpayer within the Philippines and within the foreign country, the portion attributable to ———
sources within the Philippines being determined by multiplying such one-half by a fraction the Total 25,000
numerator of which consists of the taxpayer's gross sales for the taxable year or period within the (g) P.I. expenses:
Philippines, and the denominator of which consists of the taxpayer's gross sales for the taxable year, P.I. gross income
or period both within the Philippines and within the foreign country. The "gross sales of the taxpayer —————————— x World's expenses, or
within the Philippines" means the gross sales made during the taxable year which were principally World's gross income
secured, negotiated, or effected by employees, agents, offices, or branches of the taxpayer's 20,000 plus 5,000
business resident or located in the Philippines. The term "gross sales" as used in this paragraph —————————————————— x 150,000, or
refers only to the sales of personal property produced (in whole or in part) by the taxpayer within the 200,000 plus 20,000 plus 50,000 plus 5,000
Philippines and sold within a foreign country or produced (in whole or in part) by the taxpayer within a 25,000
foreign country and sold within the Philippines, and the term "property" includes only the property held —————x 150,000 = 13,636
or used to produce income which is derived from such sales. Such property should be taken at its 275,000
actual value, which in the case of property valued or appraised for purposes of inventory, (h) P.I. net income:
depreciation, depletion, or other purposes of taxation shall be the highest amount at which so valued P.I. gross income less P.I. expenses, or
or appraised, and which in other cases shall be deemed to be its book value in the absence of P25,000 less P13,636 = P11,364
Revenue Regulations 02-40 Page 25 of 39

changed, the taxpayer shall attach to his return a separate statement setting forth for the taxable year
SECTION 164.Telegraph and cable service. — A foreign corporation carrying on the business of and for the preceding year the classes of items differently treated under the two systems, specifying in
transmission of telegraph or cable messages between points in the Philippines and points outside the particular all amounts duplicated or entirely omitted as the result of such change.
Philippines derives income partly from sources within and partly from sources without the Philippines.
A taxpayer who changes the method of accounting employed in keeping his book shall, before
(1) GROSS INCOME. — The gross income from sources within the Philippines derived from such computing his income upon such new method for purposes of taxation, secure the consent of the
services shall be determined by adding (a) its gross revenues derived from messages originating in Commissioner of Internal Revenue. For the purposes of this action, a change in the method of
the Philippines and (b) amounts collected abroad on collect messages originating in the Philippines accounting employed in keeping books means any change in the accounting treatment of items of
and deducting from such sum amounts paid or accrued for transmission of messages beyond the income or deductions, such as a change from cash receipts and disbursements method to the accrual
company's own circuit. Amounts received by the company in the Philippines with respect to collect method, or vice versa; a change involving the basis of valuation employed in the computation of
messages originating without the Philippines shall be excluded from gross income. inventories (see Sections 144 to 151 of these regulations); a change from the cash or accrual method
to the long-term contract method, or vice versa; a change in the long-term contract method from the
(2) NET INCOME. — In computing net income from sources within the Philippines there shall be percentage of completion basis to the completed contract basis or vice versa (see Section 44 of these
allowed as deductions from gross income determined in accordance with paragraph (1): (a) all regulations); or a change involving the adoption of, or a change in the use of, any other specialized
expenses incurred in the Philippines (not including any general overhead expenses), incident to the basis of computing net income such as the crop basis. Application for permission to change the
carrying on of the business in the Philippines; (b) all direct expenses incurred abroad in the method of accounting employed and the basis upon which the return is made shall be filed within 90
transmission of messages originating in the Philippines (not including any general overhead expenses days after the beginning of the taxable year to be covered by the return. The application shall be
or maintenance, repairs, and depreciation of cable and not including any amount already deducted in accompanied by a statement specifying all amounts which would be duplicated or entirely omitted as
computing gross income); (c) depreciation of property (other than cables) located in the Philippines a result of the proposed change. Permission to change the method of accounting will not be granted
and used in the trade or business therein; and (d) a proportionate part of the general overhead unless the taxpayer and the Commissioner of Internal Revenue agree to the terms and conditions
expenses [not including any items incurred abroad corresponding to those enumerated in (a), (b), and under which the change will be effected.
(c)], and of maintenance, repairs, and depreciation of cables of the entire cable system of the
enterprise based on the ratio which the number of words originating in the Philippines bears to the SECTION 169.Accounting period. — Income tax returns, whether for individuals or for corporations,
total words transmitted by the enterprise. associations, or partnerships, are required to be made and their income computed for each calendar
year ending on December 31st of every year. However, corporations, associations, or partnerships
SECTION 165.Computation of income. — If a taxpayer has gross income from sources within or may with the approval of the Commissioner of Internal Revenue first secured, file their returns and
without the Philippines as defined by Section 37 (a) or (c) together with gross income derived partly compute their income on the basis of a fiscal year which means an accounting period of twelve
from sources within and partly from sources without the Philippines, the amounts thereof, together months ending on the last day of any month other than December. But in no instance shall individual
with the expenses and investment applicable thereto, shall be segregated, and the net income from taxpayers be authorized to establish a fiscal year as basis for filing their returns and computing their
sources within the Philippines shall be separately computed therefrom. income. (For authority to file on fiscal year basis see Section 172 of these regulations.)
(Section 38 of the Code) (Section 39 of the Code)

SECTION 166.General rule. — The method of accounting regularly employed by the taxpayer in SECTION 170.When included in gross income. — Except as otherwise provided in Section 39 in the
keeping his books, if such method clearly reflects his income is to be followed with respect to the time case of the death of a taxpayer, gains, profits, and income are to be included in the gross income for
as of which items of gross income and deductions are to be accounted for. If the taxpayer does not the taxable year in which they are received by the taxpayer, unless they are included as of a different
regularly employ a method of accounting which clearly reflects his income, the computation shall be period in accordance with the approved method of accounting followed by him. If a taxpayer has died
made in such manner as in the opinion of the Commissioner of Internal Revenue clearly reflects it. there shall also be included in computing net income for the taxable period in which he died amounts
(See Section 137 of these regulations for computation of net income, and Section 38 for bases of accrued up to the date of his death if not otherwise properly includible in respect of such period or a
computation. For the use of inventories, see Sections 144 to 151 of these regulations.) prior period, regardless of the fact that the decedent may have kept his books and made his returns
on the basis of cash receipts and disbursements.
SECTION 167.Methods of accounting. — It is recognized that no uniform method of accounting can
be prescribed for all taxpayers, and the law contemplates that each taxpayer shall adopt such forms (For income not reduced to possession but considered as constructively received and for examples of
and systems of accounting as are in his judgment best suited to his purpose. Each taxpayer is constructive receipt, see Sections 52 and 53 of these regulations. For the treatment of income from
required by law to make a return of his true income. He must, therefore, maintain such accounting long-term contracts, see Section 44 of these regulations.)
records as will enable him to do so. Any approved standard method of accounting which reflects (Section 40 of the Code)
taxpayer's income may be adopted. Among the essentials are the following:
(1) In all cases in which the production, purchase, or sale of merchandise of any kind is an income SECTION 171."Paid or incurred" and "paid or accrued". — (a) The terms "paid or incurred" and "paid
producing factor, inventories of the merchandise on hand (including finished goods, work in process, or accrued" will be construed according to the method of accounting upon the basis of which the net
raw materials, and supplies) should be taken at the beginning and end of the year and used in income is computed by the taxpayer. The deductions and credits must be taken for the taxable year in
computing the net income of the year in accordance with Sections 144 to 151 of these regulations; which "paid or accrued" or "paid or incurred", unless in order clearly to reflect the income such
(2) Expenditures made during the year should be properly classified as between capital and income; deductions or credits should be taken as of a different period. If a taxpayer desires to claim a
that is to say, expenditures for items of plant, equipment, etc., which have a useful life extending deduction or a credit as of a period other than the period in which it was "paid or accrued" or "paid or
substantially beyond the year should be charged to a capital account and not to an expense account; incurred", he shall attach to his return a statement setting forth his request for consideration of the
and case by the Commissioner of Internal Revenue together with a complete statement of the facts upon
(3) In any case in which the cost of capital assets is being recovered through deductions for wear which he relies. However, in his income tax return he shall take the deduction or credit only for the
and tear, depletion, or obsolescence, any expenditure (other than ordinary repairs) made to restore taxable period in which it was actually "paid or incurred", or "paid or accrued", as the case may be.
the property or prolong its useful life should be added to the property account or charged against the Upon the audit of the return, the Commissioner of Internal Revenue will decide whether the case is
appropriate reserve and not to current expenses. within the exception provided by the law, and the taxpayer will be advised as to the period for which
the deduction or credit is properly allowable.
SECTION 168.Changes in accounting methods. — The true income, computed under the law shall in
all cases be entered in the return. If for any reason the basis of reporting income subject to tax is
Revenue Regulations 02-40 Page 26 of 39

(b) The provisions of paragraph (a) of this section in general are not applicable with respect to the The income from a casual sale or other casual disposition of personal property (other than property of
taxable period during which the taxpayer dies. In such case there shall also be allowed as deductions a kind which should properly be included in inventory) may be reported on the installment basis only if
and credits for such taxable period amounts accrued up to the date of his death if not otherwise (1) the sale price exceeds P1,000 and (2) the initial payments do not exceed 25 per cent of the selling
allowable with respect to such period or a prior period, regardless of the fact that the decedent was price.
required to keep his books and make his returns on the basis of cash receipts and disbursements.
(See also Section 76 of these regulations.) If for any reason the purchaser defaults in any of his payments, and the vendor returning income on
(Section 41 of the Code) the installment basis repossesses the property sold whether title thereto had been retained by the
vendor or transferred to the purchaser, gain or loss for the year in which the repossession occurs is to
SECTION 172.Change of accounting period. — If a corporation, including a duly registered general be computed upon any installment obligations of the purchaser which are satisfied or discharged
co-partnership, desires to change its accounting period from fiscal year to calendar year or from upon the repossession or are applied by the vendor to the purchase or bid price of the property. Such
calendar year to fiscal year, or from one fiscal year to another, it shall at any time not less than thirty gain or loss is to be measured by the difference between the fair market value of the property
days prior to the date fixed in Section 46(b) of the Code for the filing of its return on the basis of its repossessed and the basis in the hands of the vendor of the obligations of the purchaser which are so
original accounting period submit a written application to the Commissioner of Internal Revenue satisfied, discharged, or applied, with proper adjustment for any other amounts realized or costs
designating the proposed date for the closing of its new taxable year, together with a statement of the incurred in connection with the repossession. The basis in the hands of the vendor of the obligations
date on which the books of account were opened and closed each year for the past three years, the of the purchaser satisfied, discharged, or applied upon the repossession of the property shall be the
date on which the taxable year began and ended as shown on the returns filed for the past three excess of the face value of such obligations over an amount equal to the income which would be
years, and the reasons why the change in accounting period is desired. (See also Section 46(d) of the returnable were the obligations paid in full. No deduction for a bad debt shall in any case be taken on
Code.) account of any portion of the obligations of the purchaser which are treated by the vendor as not
(Section 42 of the Code) having been satisfied, discharged, or applied upon the repossession, unless it is clearly shown that
SECTION 173.Returns for periods of less than twelve months. — No return can be made for a period after the property was repossessed the purchaser remained liable for such portion; and in no event
of more than twelve months. A separate return for a fractional part of a year is therefore required shall the amount of the deduction exceed the basis in the hands of the vendor of the portion of the
whenever there is a change, with the approval of the Commissioner of Internal Revenue, in the basis obligations with respect to which the purchaser remained liable after the repossession. If the property
of computing net income from one taxable year to another taxable year. The periods to be covered by repossessed is bid in by the vendor at a lawful public auction or judicial sale, the fair market value of
such separate returns in the several cases are stated in Section 42(a). The requirements with respect the property shall be presumed to be the purchase or bid price thereof in the absence of clear and
to the filing of a separate return and the payment of tax for a part of a year are the same as for the convincing proof to the contrary. The property repossessed shall be carried on the books of the
filing of a return and the payment of tax for a full taxable year closing at the same time. DAETcC vendor at its fair market value at the time of the repossession.
(Section 43 of the Code) If the vendor chooses as a matter of consistent practice to return the income from installment sales on
the straight accrual or cash receipts and disbursement basis, such a course is permissible.
SECTION 174.Sale of personal property on installment plan. — Dealers in personal property
ordinarily sell either for cash or on the personal credit of the purchaser or on the installment plan. SECTION 175.Sale of real property involving deferred payments. — Under Section 43 deferred-
Dealers who sell on the installment plan usually adopt one of four ways of protecting themselves in payment sales of real property include (a) agreements to purchase and sale which contemplate that a
case of default — conveyance is not to be made at the outset, but only after all or a substantial portion of the selling
(a) By an agreement that title is to remain in the vendor until the purchaser has completely price has been paid, and (b) sales in which there is an immediate transfer of title, the vendor being
performed his part of the transaction; protected by a mortgage or other lien as to deferred payments. Such sales either under (a) or (b), fall
(b) By a form of contract in which title is conveyed to the purchaser immediately, but subject to a lien into two classes when considered with respect to the terms of sale, as follows:
for the unpaid portion of the selling price; (1) Sales of property on the installment plan, that is, sales in which the payments received in cash or
(c) By a present transfer of title to the purchaser, who at the same time executes a reconveyance in property other than evidences of indebtedness of the purchaser during the taxable year in which the
the form of a chattel mortgage to the vendor; or sale is made do not exceed 25 per cent of the selling price.
(d) By conveyance to a trustee pending performance of the contract and subject to its provisions. (2) Deferred-payment sales not on the installment plan, that is sales in which the payments received
The general purpose and effect being the same in all of these cases, the same rule is uniformly in cash or property other than evidences of indebtedness of the purchaser during the taxable year in
applicable. The general rule prescribed is that a person who regularly sells or otherwise disposes of which the sale is made exceed 25 per cent of the selling price.
personal property on the installment plan, whether or not title remains in the vendor until the property
is fully paid for, may return as income therefrom in any taxable year that proportion of the installment In the sale of mortgaged property the amount of the mortgage, whether the property is merely taken
payments actually received in that year which the total or gross profit (that is, sales less cost of goods subject to the mortgage or whether the mortgage is assumed by the purchaser, shall be included as a
sold) realized or to be realized when the property is paid for, bears to the total contract price. Thus the part of the "selling price" but the amount of the mortgage, to the extent that it does not exceed the
income of a dealer in personal property on the installment plan may be ascertained by taking as basis to the vendor of the property sold, shall not be considered as a part of the "initial payments" or
income that proportion of the total payments received in the taxable year from installment sales (such of the "total contract price", as those terms are used in Section 43 of the Code, in Sections 174 and
payments being allocated to the year against the sales of which they apply) which the total or gross 176 of these regulations, and in this section. The term "initial payments" does not include amounts
profit realized or to be realized on the total installment sales made during each year bears to the total received by the vendor in the year of sale from the disposition to a third person of notes given by the
contract price of all such sales made during that respective year. No payments received in the taxable vendee as part of the purchase price which are due and payable in subsequent years. Commissions
year shall be excluded in computing the amount of income to be returned on the ground that they and other selling expenses paid or incurred by the vendor are not to be deducted or taken into
were received under a sale the total profit from which was returned as income during a taxable year account in determining the amount of the "initial payments," the "total contract price", or "the selling
or years prior to the change by the taxpayer to the installment basis of returning income. Deductible price". The term "initial payments" contemplates at least one other payment in addition to the initial
items are not to be allocated to the years in which the profits from the sales of a particular year are to payment. If the entire purchase price is to be paid in a lump sum in a later year, there being no
be returned as income, but must be deducted for the taxable year in which the items are "paid or payment during the first year, the income may not be returned on the installment basis. Income may
incurred" or "paid or accrued", as provided by Section 40 and 84(q) of the Code. A dealer who desires not be returned on the installment basis where no payment in cash or property, other than evidences
to compute his income on the installment basis shall maintain books of account in such a manner as of indebtedness of the purchaser, is received during the first year, the purchaser having promised to
to enable an accurate computation to be made on such basis in accordance with the provisions of this make two or more payments, in later years.
section.
SECTION 176.Sale of real property on installment plan. — In transactions included in class (1) in the
preceding section the vendor may return as income from such transactions in any taxable year that
Revenue Regulations 02-40 Page 27 of 39

proportion of the installment payments actually received in that year which the total profit realized or parcels and made a matter of record on the books of the taxpayer, to the end that any gain derived
to be realized when the property is paid for bears to the total contract price. from the sale of any such lots or parcels may be returned as income for the year in which the sale
was made. This rule contemplates that there will be a measure of gain or loss on every lot or parcel
If the purchaser defaults in any of his payments, and the vendor returning income on the installment sold, and not that the capital invested in the entire tract shall be extinguished before any taxable
basis reacquires the property sold, whether title thereto had been retained by the vendor or income shall be returned. The sale of each lot or parcel will be treated as a separate transaction and
transferred to the purchaser, gain or loss for the year in which the reacquisition occurs is to be the gain or loss will be accounted for accordingly.
computed upon any installment obligations of the purchaser which are satisfied or discharged upon
the reacquisition or are applied by the vendor to the purchase or bid price of the property. Such gain SECTION 178(a). In all cases where a taxpayer sells during the year real or personal property on
or loss is to be measured by the difference between the fair market value of the property acquired the installment basis, there should be attached to the income tax return a statement of each sale
(including the fair market value of any fixed improvements placed on the property by the purchaser) made during the year containing the following information:
and the basis in the hands of the vendor of the obligations of the purchaser which are so satisfied, (a) Name of buyer
discharged, or applied, with proper adjustment for any other amounts realized or costs incurred in (b) Address of buyer
connection with the reacquisition. The basis in the hands of the vendor of the obligations of the (c) Date of sale
purchaser satisfied, discharged, or applied upon the reacquisition of the property will be the excess of (d) Selling price
the face value of such obligations over an amount equal to the income which would be returnable (e) Payments received during the year corresponding to each sale.
were the obligations paid in full. No deduction for a bad debt shall in any case be taken on account of (This new section has been inserted in Revenue Regulations No. 2 by Revenue Regulations No. 8-65
any portion of the obligations of the purchaser which are treated by the vendor as not having been dated June 1, 1965. Took effect upon their promulgation in the Official Gazette on September 27,
satisfied, discharged, or applied upon the reacquisition of the property, unless it is clearly shown that 1965).
after the property was reacquired the purchaser remained liable for such portion; and in no event shall (Section 44 of the Code)
the amount of the deduction exceed the basis in the hands of the vendor of the portion of the
obligations with respect to which the purchaser remained liable after the acquisition. If the property SECTION 179.Determination of the taxable net income of a controlled taxpayer. — (A) DEFINITIONS.
reacquired is bid in by the vendor at a foreclosure sale, the fair market value of the property shall be — When used in this section —
presumed to be the purchase or bid price thereof in the absence of clear and convincing proof to the (1) The term "organization" includes any organization of any kind, whether it be a sole
contrary. If the property reacquired is subsequently sold, the basis for determining gain or loss is the proprietorship, a partnership, a trust, an estate, or a corporation or association, irrespective of the
fair market value of the property at the date of reacquisition (including the fair market value of any place where organized, where operated, or where its trade or business is conducted, and regardless
fixed improvements placed on the property by the purchaser). of whether domestic or foreign, whether exempt or taxable, or whether affiliated or not.
If the vendor chooses as a matter of consistent practice to turn the income from installment sales on (2) The terms "trade" or "business" include any trade or business activity of any kind, regardless of
the straight accrual or cash receipts and disbursements basis, such a course is permissible, and the whether or where organized, whether owned individually or otherwise, and regardless of the place
sales will be treated as deferred-payment sales not on the installment plan. where carried on.
(3) The term "controlled" includes any kind of control, direct or indirect, whether legally enforceable,
SECTION 177.Deferred-payment sale of real property not on installment plan. — In transactions and however exercisable or exercised. It is the reality of the control which is decisive, not its form or
included in class (2) in Section 175 of these regulations, the obligations of the purchaser received by the mode of its exercise. A presumption of control arises if income or deductions have been arbitrarily
the vendor are to be considered as the equivalent of cash. shifted.
(4) The term "controlled taxpayer" means any one of two or more organizations, trades, or
If the vendor has retained title to the property and the purchaser defaults in any of his payments, and businesses owned or controlled directly or indirectly by the same interests. aCHDST
the vendor repossesses the property, the difference between (1) the entire amount of the payments (5) The terms "group" and "group of controlled taxpayers" mean the organizations, trades, or
actually received on the contract and retained by the vendor plus the fair-market value at the time of businesses owned or controlled by the same interests.
repossession of fixed improvements placed on the property by the purchaser and (2) the sum of the (6) The term "true net income" means, in the case of a controlled taxpayer, the net income (or, as
profits previously returned as income in connection therewith and an amount representing what would the case may be, any item or element affecting net income) which would have resulted to the
have been a proper adjustment for exhaustion, wear and tear, obsolescence, amortization, and controlled taxpayer, had it in the conduct of its affairs (or, as the case may be, in the particular
depletion of the property during the period the property was in the hands of the purchaser had the contract, transaction, arrangement, or other act) dealt with the other member or members of the group
sale not been made will constitute gain or loss, as the case may be to the vendor for the year in which at arm's length. It does not mean the income, the deductions, or the item or element of either,
the property is repossessed, and the basis of the property in the hands of the vendor will be the resulting to the controlled taxpayer by reason of the particular contract, transaction, or arrangement,
original basis at the time of the sale plus the fair market value at the time of repossession, of fixed the controlled taxpayer, or the interests controlling it, chose to make (even though such contract,
improvements placed on the property by the purchaser. If the vendor has previously transferred title to transaction, or arrangement be legally binding upon the parties thereto).
the purchaser, and the purchaser defaults in any of his payments and the vendor reacquired the
property, such reacquisition shall be regarded as a transfer by the vendor, in exchange for the (b) SCOPE AND PURPOSE. — The purpose of Section 44 is to place a controlled taxpayer on a tax
property for such of the purchaser's obligations as are applied by the vendor to the purchase or bid parity with an uncontrolled taxpayer, by determining, according to the standard of an uncontrolled
price of the property. Such an exchange will be regarded as having resulted in the realization by the taxpayer, the true net income from the property and business of a controlled taxpayer. The interests
vendor of gain or loss, as the case may be for the year of reacquisition, measured by the difference controlling a group of controlled taxpayers are assumed to have complete power to cause each
between the fair market value of the property including fixed improvements placed by the purchaser controlled taxpayer so to conduct its affairs that its transactions and accounting record truly reflect the
on the property, and the amount of the obligations of the purchaser which were applied by the vendor net income from the property and business of each of the controlled taxpayers. If, however, this has
to the purchase or bid price of the property. The fair market value of the property reacquired shall be not been done, and the taxable net incomes are thereby understated, the statute contemplates that
presumed to be the amount for which it is bid in by the vendor in the absence of clear and convincing the Commissioner of Internal Revenue shall intervene, and, by making such distributions,
proof to the contrary. If the property reacquired is subsequently sold the basis for determining gain or apportionments, or allocations as he may deem necessary of gross income or deductions, or of any
loss is the fair market value of the property at the date of reacquisition including the fair market value item or element affecting net income, between/or among the controlled taxpayers constituting the
of the fixed improvements placed on the property by the purchaser. group, shall determine the true net income of each controlled taxpayer dealing at arm's length with
another uncontrolled taxpayer. The standard to be applied in every case is that of an uncontrolled
SECTION 178.Sale of real estate in lots. — Where a tract of land is purchased with a view to dividing taxpayer. Section 44 grants no right to a controlled taxpayer to apply its provisions at will, nor does it
it into lots or parcels of ground to be sold as such, the entire fair market value as of March 1, 1913, or grant any right to compel the Commissioner of Internal Revenue to apply such provisions.
the cost, if acquired subsequently to that date, shall be equitably apportioned to the several lots or
Revenue Regulations 02-40 Page 28 of 39

(c) APPLICATION. — Transactions between the controlled taxpayer and another will be subjected to Commissioner of Internal Revenue or to the provincial treasurers, or their deputies in ample time to
special scrutiny to ascertain whether the common control is being used to reduce, avoid, or escape have their returns prepared, verified, and filed with the proper official on or before the due date. Each
taxes. In determining the true net income of a controlled taxpayer, the Commissioner of Internal taxpayer should carefully prepare his return so as to fully and clearly set forth the data therein called
Revenue is not restricted to the case of improper accounting, to the case of a fraudulent, colorable, or for. Imperfect or incorrect returns will not be accepted as meeting the requirements of the statute.
sham transaction, or to the case of a device designed to reduce or avoid tax by shifting or distorting (There are now BIR Provincial Revenue Officers.)
income or deductions. The authority to determine true net income extends to any case in which either (Section 46 of the Code)
by inadvertence or design the taxable net income in whole or in part, of a controlled taxpayer, is other
than it would have been had the taxpayer in the conduct of his affairs been an uncontrolled taxpayer SECTION 184.Corporation returns. — Corporations are required to make returns of income in
dealing at arm's length with another uncontrolled taxpayer. duplicate, regardless of the amount of their net income.
(Section 45 of the Code)
A corporation claiming exemption from tax and from the filing of returns must establish its right to
SECTION 180.Individual returns. — Returns, in duplicate, are required of: (a) Every citizen or resident exemption in accordance with the procedure set forth in Section 24 of these regulations, otherwise it
alien having a gross income of P1,800 or more for the taxable year; (b) every non-resident alien will be amenable to the penalties for failure to file returns.
having income from sources within the Philippines irrespective of amount; and (c) guardians, trustees,
executors, administrators, receivers, conservators, and all others acting in any fiduciary capacity, In the case of ordinary corporations, partnerships, and joint accounts (cuentas en participacion), the
when, for the taxable year, the gross income of the person, trust, or estate for whom or which they act return shall be on the form prescribed for corporations (B.I.R Form No. 17.02), and the returns of
reaches P1,800. (See Section 214 of these regulations.) insurance companies, on the prescribed form (B.I.R. Form No. 17.03). A corporation having an
For each calendar year, every person whether married or single, having a gross income from all existence during any portion of a taxable year is required to make a return. A corporation which has
sources of P1,800 or over, including dividends, excepting stock dividends, must make a return of received a charter, but has never perfected its organization, and which has transacted no business
income although the tax has been paid at source and the return shows no tax liability. Whether or not and had no income from any source, may upon presentation of the facts to the Commissioner of
an individual is the head of a family or has dependents is immaterial in determining his liability to Internal Revenue be relieved from the necessity of making a return so long as it remains in an
render a return. The husband shall include in his return the income derived not only from his services, unorganized condition. In the absence of a proper showing to the Commissioner of Internal Revenue
labor, or industry or the income derived from the conjugal partnership but also the income of the wife such corporation must file the necessary return.
derived from her industry or labor as well as that derived from her separate, data, or paraphernal
property. Where, however, the filing of one consolidated return is impracticable, married persons may A corporation desiring to change its accounting period from calendar year to fiscal year must comply
file separate returns but the incomes declared in such returns will be consolidated and the tax with the procedure set forth in Section 172 of these regulations relative to the change in accounting
computed on such consolidated income. period of corporations.

The law requires that the income of unmarried minors derived from property received from a living SECTION 185.Returns of insurance companies. — Insurance companies transacting business in the
parent shall be included in the return of the parent, except (1) when the gift tax imposed under Philippines or deriving income from sources therein are required to file returns of income. The return
Chapter II of Title III of the Code has been paid on such property, or (2) where the transfer of such shall be made on the prescribed form (B.I.R. Form No. 17.03).
property is exempt from the gift tax.
A signature affixed to a return is presumed to be genuine. SECTION 186.Returns of foreign corporations. — Every foreign corporation having income from
sources within the Philippines must make a return of income on the form prescribed for corporation
SECTION 181.When and where to file individual returns. — The return must be filed with the (B.I.R. Form No. 17.02). If such a corporation has no office or place of business in this country, but
Commissioner of Internal Revenue, provincial revenue agent, or treasurer of the province, city or has a resident agent therein, the latter shall make the return. Although the foreign corporation is not
municipality in which the taxpayer has his legal residence or principal place of business, on or before engaged in business in this country and has no office, branch, or agency in the Philippines, it is
April 15th of the year following that for which the return is filed. required to make a return if it has received income from sources within the Philippines.

When the last due date for filing return falls on Sunday or a legal holiday, the last due date will be held SECTION 187.Time and place for filing corporate returns. — Returns of corporations, associations, or
to be the day following such Sunday or legal holiday, or if placed on the mails, it should be posted in partnerships must be filed on or before the fifteenth day of April in each year or on or before the 15th
ample time to reach the Commissioner of Internal Revenue, provincial revenue agent or treasurer of day of the fourth month following the close of a duly designated fiscal year. The return, if placed in the
the province, city, or municipality in which the taxpayer has his legal residence or principal place of mails, should be posted in ample time to reach the Commissioner of Internal Revenue, provincial,
business, under ordinary handling of mail, on or before the date on which the return is required to be revenue agent, or treasurer of the province, city or municipality in which is located the principal office
filed. When question is raised as to whether or not the return was posted in ample time to reach the of the corporation where its books of account and other data are kept, on or before the last due date
proper official, the envelope in which the return was transmitted and the return should be submitted to for the filing of the return. When the last due date falls on Sunday or a legal holiday, the returns may
the Commissioner of Internal Revenue with such comment and recommendation as the receiving be filed without penalty on the next succeeding business day. (Conforms with Am. by R.A. 2343.)
officer may consider proper to make. (Section 47 of the Code)

SECTION 182.Persons under disability. — If the taxpayer is unable to make his own return, on SECTION 188.Extension of time for filing returns. — The Commissioner of Internal Revenue may, in
account of minority, illness, absence or non-residence, the return may be made by his duly authorized meritorious cases, grant a reasonable extension of time for filing returns of income. Requests for such
agent or representative or by the guardian or other person charged with the care of his person or extension of time must be submitted before the last day of the period for filing returns. Absence or
property, the principal and his representative or guardian assuming the responsibility of making the sickness is considered as reasonable cause, whereas, inability to close the books or to gather
return and incurring penalties provided for erroneous, false, or fraudulent returns. information required due to various circumstances will be subject to careful investigations before the
request for extension is favorably considered.
SECTION 183.Form of return. — Individual returns shall be prepared on B.I.R. Form No. 17.01. The (Section 48 of the Code)
forms may be had from the office of the Commissioner of Internal Revenue in Manila, or in the office
of the provincial treasurers or their deputies. SECTION 189.Returns by receiver. — Receivers, trustees in dissolution, trustees in bankruptcy, and
assignees, operating the property or business of corporations, partnerships, or associations must
A taxpayer will not be excused from making a return by the fact that no return form has been make returns of income for such corporations, partnerships or associations covering each year or part
furnished him. Taxpayers not supplied with the proper forms should make application therefor to the of the year during which they are in control. Notwithstanding that the powers and functions of a
Revenue Regulations 02-40 Page 29 of 39

corporation are suspended and that the property and business are for the time being in the custody of same became due until paid, shall be added to the amount of such tax. (See Sec. 51(b) to (e) as
the receiver, trustee, or assignee, subject to the order of the court, such receiver, trustee, or assignee amended by R.A. 2343, effv. June 20, 1959.)
stands in the place of the corporate officers and is required to perform all the duties and assume all (Section 52 of the Code)
the liabilities which would devolve upon the officers of the corporation were they in control. A receiver
in charge of only part of the property of a corporation, however, as a receiver in mortgage foreclosure SECTION 197.Receipts for income tax payments. — It shall be the duty of the collecting officer to
proceedings involving merely a small portion of its property, need not make a return of income. acknowledge the receipt of the payment of income tax due from each taxpayer by issuing the
(Section 49 of the Code) requisite Revenue Official Receipt (B.I.R. Form No. 25.24).
(Section 53 of the Code)
SECTION 190.Returns of duly registered general co-partnerships. — Duly registered general
copartnerships are required to render, in duplicate, a return of their earnings, profits and income, SECTION 198.Withholding tax at source. — Withholding is required (a) of a tax of 20 per centum in
setting forth the items of the gross income and the deductions allowable, and the names and the case of fixed or determinable annual or periodical income, including dividends or net gains or net
addresses of the individuals who would be entitled to the net earnings, profits, and income, if profits received from corporations, partnerships or associations, payable to non-resident alien
distributed. (See sections 22 and 23 of these regulations.) individuals not engaged in trade or business and not having an office or place of business in the
(Section 50 of the Code) Philippines; and (b) of a tax of 20 per centum in the case of interest upon bonds, obligations or
securities issued by domestic or resident foreign corporations, containing a so-called tax-free
SECTION 191.Verification of returns. — All income tax returns must be verified by the oath or covenant clause, payable either to citizens or aliens, residents or non-residents, where the owner of
affirmation of the person rendering them. Oath may be taken before any officer authorized to such interest income does not file with the withholding agent a signed notice on B.I.R. Form No. 17.13
administer oaths or if desired, before the Commissioner of Internal Revenue or any internal-revenue claiming the benefit of personal exemption. Subject to the exception just mentioned, withholding taxes
officer especially deputized by him or authorized by law to administer oaths, free of charge. takes place in all cases of payments of interest upon tax-free covenant bonds or other securities
regardless of the place where such bonds or securities are issued or marketed and the interest
SECTION 192.Discovery of understatement of income. — If the amount of income declared in a thereupon paid. Bonds issued under a trust deed containing a tax-free covenant are treated as if they
return has been found to be understated, the Commissioner of Internal Revenue or any internal- contain such a covenant.
revenue officer shall notify the taxpayer of such fact, and the taxpayer may, if he so desires, under a
sworn statement, present testimony to the contrary and disprove the findings made. SECTION 199.Fixed or determinable annual or periodical income. — Only fixed or determinable
(Section 51 of the Code) annual or periodical income is subject to withholding. The statute specifically includes in such income,
interests, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, and
SECTION 193.Assessment of tax. — All income tax returns filed with the provincial revenue agents or emoluments, but other kinds of income may be included, as for instance, royalties.
with the treasurers of provinces, cities, or municipalities must be stamped with the date of their receipt Income is fixed when it is to be paid in amounts definitely pre-determined. On the other hand, it is
and immediately forwarded to the Commissioner of Internal Revenue. All assessments of income tax determinable whenever there is a basis of calculation by which the amount to be paid may be
shall be made by the Commissioner of Internal Revenue and all taxpayers shall be notified of the ascertained.
amount for which they are respectively liable on or before the first day of May of each successive
year. In the case of a corporation filing returns on the basis of a fiscal year, it shall be notified of the The income need not be paid annually if it is paid periodically; that is to say, from time to time,
amount for which it is liable on or before the first day of the fifth month following the close of its fiscal whether or not at regular intervals. That the length of time during which the payments are to be made
year. (See changes made by R.A. 2343, effv. June 20, 1959, introducing here self assessment.) may be increased or diminished in accordance with some one's will or with the happening of an event
does not make the payments any the less determinable or periodical. A salesman working by the
SECTION 194.Payment of tax. — The total amount of tax assessed shall be paid on or before the month for a commission on sales which is paid or credited monthly receives determinable periodical
fifteenth day of April following the close of the calendar year by the person subject to tax, and in the income. The income derived from the sale in the Philippines of property whether real or personal, is
case of a corporation, by the president, vice-president, or other responsible officer thereof. In the case not fixed or determinable annual or periodical income.
of corporations filing returns on the basis of a fiscal year, the total amount of tax shall be paid on or
before the fifteenth day of the fourth month following the close of the fiscal year. (Conforms with Dividends from every domestic corporation are subject to the withholding provisions of the law.
amendments by R.A. 2343, effv. June 20, 1959.) Dividends from a foreign corporation are subject to withholding if (1) such foreign corporation is
engaged in trade or business within the Philippines or has an office or place of business therein, and
Where the tax assessed against the taxpayer is in excess of P500, the taxpayer may elect to pay the (2) more than 85 per cent of its gross income for the three-year period ending with the close of its
tax in two equal installments. The first installment shall be paid on or before the date prescribed in taxable year preceding the declaration of such dividends (or for such part of such period as the
section 51 (a) and the second installment on or before the fifteenth day of July following the close of corporation has been in existence) was derived from sources within the Philippines. In case the
the calendar year or on or before the fifteenth day of the seventh month following the close of the owners of any securities are not known to the withholding agent, the latter should deduct and withhold
fiscal year, as the case may be. Upon failure to pay any installment on the date fixed for its payment, a tax of 20 per cent on the interest on such securities.
the whole amount of the tax unpaid becomes due and payable, together with the delinquency
penalties. (Conforms with amendments by R.A. 2343, effv. June 20, 1959.) SECTION 200.Payments to non-resident alien individuals. — The law requires withholding of the tax
on income payable to a non-resident alien individual not engaged in trade or business in the
SECTION 195.Commissioner's authority to make returns. — In cases wherein taxpayers have Philippines and not having an office or place of business therein. A non-resident alien individual is
neglected or refused to make return, and in cases wherein returns are found, upon examination or presumed not to be engaged in trade or business in the Philippines and not to have an office or place
otherwise, to be erroneous, false, or fraudulent, the Commissioner of Internal Revenue shall upon of business therein, unless the withholding agent has definite knowledge that such resident is
discovery thereof, make a return upon the best evidence obtainable, and the tax so discovered to be engaged in trade or business in the Philippines and of the name and address of his resident agent in
due, together with the penalties prescribed, shall be assessed and the amount thereof shall be paid this country, or unless the withholding agent definitely knows that such non-resident has an office or
immediately upon notice and demand. place of business in the Philippines and of the location of such office or place of business. An
individual whose address is without the Philippines is presumed to be a non-resident alien, unless the
SECTION 196.Surcharge and interest in case of delinquency. — Upon failure to pay any tax or withholding agent has definite knowledge that such person is either a citizen or a resident of the
installment thereof, of any deficiency tax, when the same is due, a penalty of 5 per cent of the amount Philippines. An individual whose address is within the Philippines, may be presumed to be a resident
of tax unpaid, and interest at the rate of 1 per cent per month upon the said tax from the time the of the Philippines, unless the withholding agent has reason to believe that such individual, not being a
citizen of the Philippines, has not established residence in this country.
Revenue Regulations 02-40 Page 30 of 39

required to withhold a tax of 30 per cent thereon, file the requisite withholding return on the prescribed
In case of doubt, a withholding agent may always protect himself by withholding the tax due, and form (B.I.R. Form No. 17.43), and pay the tax withheld, in accordance with the provisions of sections
promptly causing a query to be addressed to the Commissioner of Internal Revenue for the 198 to 204 of these regulations. The withholding provisions of the law are likewise applicable to the
determination of whether or not the income paid to an individual is not subject to withholding. In case income derived from interest upon bonds, mortgages, or deeds of trust, or other interest-bearing
the Commissioner of Internal Revenue decides that the income paid to an individual is not subject to obligations of a domestic or resident foreign corporation, firm or association, whether or not the bonds
withholding the withholding agent may thereupon remit the amount of tax withheld. and other such obligations, or securities contain the so-called tax-free covenant clause, and
regardless of the place where such bonds, obligations, or securities are issued, negotiated, or
SECTION 201.Exception from withholding. — Withholding of a tax on interests upon bonds or other marketed and the interest thereon paid, in case where such interest-income is received or obtained
obligations containing a tax-free covenant clause shall not be required in the case of a citizen or by, or paid to, a non-resident alien firm, corporation, association, trust company, or trustee, not
resident alien individual if he files with the withholding agent when presenting interest coupons for engaged in business or trade within the Philippines and not having an office or place of business
payment, not later than February 1 following the taxable year, an ownership and exemption certificate therein. (Conforms with amendments by R.A. 2343, effv. June 20, 1959.)
on the requisite form (B.I.R. Form No. 17.13) claiming a personal exemption or credits for
dependents. The withholding agent shall forward such certificate to the Commissioner of Internal A foreign corporation is presumed not to be engaged in trade or business within the Philippines and
Revenue with a letter of transmittal. The income of domestic and resident foreign corporations is free not to have office or place of business therein, unless the withholding agent has definite knowledge
from withholding. that such foreign corporation is in fact engaged in trade or business in the Philippines and of the
name and address of its resident agent, or unless the withholding agent has definite knowledge that
SECTION 202.Ownership certificates for interest coupons. — The owners, except domestic and such foreign corporation has a branch office or business in this country and of the location of such
resident foreign corporations, of bonds or other obligations containing a tax-free covenants clause, branch office or place of business.
issued by a domestic or resident foreign corporation, when presenting interest coupons for payment, (Section 55 of the Code)
shall file a certificate of ownership on B.I.R. Form No. 17.13, for each issue of bonds, showing the
name and address of the debtor corporation, the name and address of the owner of the bonds, the SECTION 206.Income tax not otherwise collectible from taxpayer chargeable to his representative. —
nature of the obligations, the amount of interest and its due date, and the amount of any tax withheld. It is the intent and purpose of the law to charge and collect income tax imposed under Title II of the
In the case of corporate bonds or similar obligations not containing a tax-free covenant clause, no Code on all gains, profits, and income of a taxable class, and the tax is required to be paid by the
ownership certificates are required. But ownership certificates are required in the case of such bonds owner of such gains, profits. and income or by the proper representative having the receipt, custody,
if the owner is unknown to the withholding agent. Ownership certificates need not be filed in the case control, or disposal of the same. Thus, where a non-resident has charged a resident, under a power
of interest payments on bond or similar obligations of the United States or of the Government of the of attorney, to sell in his behalf property, real or personal in the Philippines, the proper tax due may be
Philippines or of any political subdivision thereof. collected from the owner of the gains or profits or from the representative who had the receipt,
custody, control or disposal of such gains, profits, or income, as the personal liability of such
Where in connection with the sale of its property payment of the bonds or other obligations of a representative.
corporation is assumed by the assignee, such assignee, whether an individual, partnership, (Sections 56 to 60 of the Code)
corporation, province, city or municipality, must deduct and withhold such taxes as would have been
required to be withheld by the assignor had not such sales and transfer been made. SECTION 207.Estates and trusts. — "Fiduciary" is a term which applies to all persons or corporations
that occupy positions of peculiar confidence towards others, such as trustees, executors, or
SECTION 203.Return and payment of tax withheld. — (a) Every withholding agent shall make an administrators; and a fiduciary, for income tax purposes, is any person or corporation that holds in
annual return in duplicate, on B.I.R. Form No. 17.43 of the tax withheld from interest on corporate trust an estate of another person or persons. In order that a fiduciary relationship may exist, it is
bonds or other obligations on or before the 15th day of April of each year for the preceding calendar necessary that a legal trust be created.
year. (b) Every person required to deduct and withhold any tax from income other than such bond
interest shall make an annual return thereon, in duplicate, on B.I.R. Form No. 17.43 on or before April In general, the income of a trust for the taxable year which is to be distributed to the beneficiaries
15 of each year for each non-resident alien individual not engaged in trade or business within the must be returned by and will be taxed to the respective beneficiaries, but the income of a trust which
Philippines and not having any office or place of business therein, to whom income other than bond is to be accumulated or held for future distribution, whether consisting of ordinary income or gain from
interest was paid during the previous taxable year. The entire amount of the income from which the the sale of assets included in the corpus of the trust, must be returned by and will be taxed to the
tax was withheld shall be included in gross income without deduction for such payment of the tax. trustee. Three exceptions to this general rule are found in the law: (1) in the case of revocable trust
(Conforms with amendments by R.A. 2343, effv. June 20, 1959.) (Section 59); (2) in the case of a trust the income of which, in whole or in part, may be held or
distributed for the benefit of the grantor (Section 60); and (3) in the case of a trust administered in a
The tax due on withholding income tax returns are payable at the same time and in the same manner foreign country [Section 57(c)]. In the first case, the income from such part of the trust estate title to
as taxes due on individual returns. which may be revested in the grantor should be included in the grantor's return. In the second case,
part of the income of the trust, which may be held or distributed for the benefit of the grantor, should
SECTION 204.Income of recipient. — Income upon which the tax is required to be withheld at source be included in the grantor's return. In the third case, the trustee is not entitled to the deductions
shall nevertheless be included in the return of the recipient of such income. However, the amount of mentioned in subsections (a) and (b) of Section 57 and the net income of the trust undiminished by
tax withheld shall be credited against the amount of income tax due on such return, and the amount, if any amounts distributed, paid or credited to beneficiaries will be taxed to the trustees; however, the
any, by which the tax withheld at source exceeds the tax due on the return shall be refunded in income included in the return of the trustees is not to be included in computing the income of the
accordance with the provisions of Section 309 of the Code. beneficiaries.
(Section 54 of the Code)
SECTION 208.Consolidation of incomes of two or more trusts. — Section 56(b)(2) expressly requires
SECTION 205.Withholding of tax on income of nonresident foreign corporations, firms, etc. — All the consolidation of the income of two or more trusts where the creator of the trust in each instance is
persons, corporations, partnerships, and associations, having the control, receipt, custody, disposal, the same person and the beneficiary in each instance is the same. The tax due on the consolidated
or payment of interest, dividends, rents, salaries, wages, premiums, annuities, compensations, income will be collected from the trustees in proportion to the net income of the of the respective
remunerations, emoluments, or other fixed or determinable annual or periodical gains, profits, and trusts. (See Section 215 of these regulations.)
income received or obtained from sources within the Philippines by a non-resident alien firm,
copartnership, corporation, association, trust company, trustee, and insurance company, not engaged SECTION 209.Estates and trusts taxed to fiduciary. — In the case of a decedent's estate the
in business or trade within the Philippines and not having an office or place of business therein, are settlement of which is the object of testamentary or intestate proceedings, the fiduciary, executor, or
Revenue Regulations 02-40 Page 31 of 39

administrator is required to file an annual return for the estate up to the final settlement thereof. In the himself makes a return or cause it to be made. The parent is held to be the natural guardian of a
same manner, the fiduciary is required to file a yearly return covering the income of a trust, whether minor child.
created by will or deed, for accumulation of income, whether for unascertained persons or persons
with contingent interests or otherwise. In both cases the income of the estate or trust is taxed to the SECTION 215.Returns in case of two or more trusts. — Where, in the case of more than one trust,
fiduciary. Where under the terms of a will or deed, the trustee, may in his discretion, distribute the the creator of the trust in each instance is the same person and the trustee in each instance is the
income or accumulate it, the income is taxed to the trustee, irrespective of the exercise of his same but the beneficiaries are different, the trustee should make a separate return for each of the
discretion. The imposition of the tax is not affected by the fact that an ultimate beneficiary may be a trusts in his hands. When a trustee holds trust created by different persons for the benefit of the same
person exempt from tax. beneficiary, he should also make a return for each trust separately. But where a person creates two or
more trusts in favor of the same beneficiary [Section 56(b) (2)] appointing two or more trustees, the
SECTION 210.Estate and trust taxed to beneficiaries. — In the case of (a) a trust the income of which latter should each make a separate return for each trust but in such case the Commissioner of
is to be distributed annually or regularly; (b) an estate of a decedent the settlement of which is not the Internal Revenue will consolidate the net incomes of the different trusts and compute the tax on such
object of judicial testamentary or intestate proceedings; and (c) properties held under a co-ownership consolidated income, allowing only one absolute exemption of 1,800.
or tenancy in common, the income is taxable directly to the beneficiary or beneficiaries. Each
beneficiary must include in his return his distributive share of the net income of the trust, estate, or co- SECTION 216.Return by receiver. — A receiver who stands in the place of an individual or
ownership. In the case of trusts which are in whole or in part subject to revocation by the grantor, or corporation must render a return of income and pay the tax for his trust, but a receiver of only part of
which are for the benefit of the grantor, the income of the trust is to be included in computing the net the property of an individual or corporation need not. If the receiver acts for an individual the return
income of the grantor. shall be on B.I.R. Form No. 17.01. When acting for a corporation a receiver is not treated as a
fiduciary, and in such case the return shall be made, as if by the corporation itself, on B.I.R. Form No.
SECTION 211. Decedent's estate administration. — The "period of administration or settlement of the 17.02.
estate" is the period required by the executor or administrator to perform the ordinary duties (Section 62 of the Code)
pertaining to administration, in particular, the collection of assets and the payment of debts and
legacies. Estates during the period of administration have but one beneficiary and that beneficiary is SECTION 217.Fiduciaries indemnified against claims for taxes paid. — Fiduciaries are indemnified
the estate. against the claims or demands of every beneficiary for all payments of taxes which they shall be
required to make and they shall have credit for such payments in any accounting which they make as
No taxable income is realized from the passage of property to the executor or administrator on the such fiduciaries.
death of the decedent, even though it may have appreciated in value since the decedent acquired it. (Section 63 of the Code)
In the event of delivery of property in kind to a legatee or distributee, no income is realized. Where,
however, prior to the settlement of the estate, the executor or administrator sells property of a SECTION 218.Tax on personal holding companies. — Section 63 imposes for such taxable year
decedent's estate for more than the appraised value placed upon it at the death of the decedent, the beginning after December 31, 1938 (in addition to the tax imposed by Section 24 of the Code), a tax
excess is income, taxable to the estate. Where property is sold after the settlement of the estate by upon corporations classified as personal holding companies. Corporations so classified are exempt
the devisee, legatee or heir at a price greater than the appraised value placed upon it at the time he from the additional tax on corporation improperly accumulating surplus imposed by Section 25, but
inherited the property from the decedent, he is taxable individually on any profit derived. An allowance are not exempt from the other taxes imposed by Title II of the Code. Unlike the tax imposed by
paid a widow or heir out of the corpus of the estate is not deductible from gross income. Section 25, the tax imposed by Section 63 applies to all personal holding companies defined as such
in Section 64, regardless of whether or not they were formed or availed of to accumulate earnings or
SECTION 212.Liability for tax on estate or trusts. — Liability for payment of the tax attaches to the profits for the purpose of avoiding the tax upon shareholders. The tax imposed by Section 63 is 45 per
person of an executor or administrator up to and after his discharge, where prior to distribution and cent of the amount of the undistributed net income.
discharge he had notice of his tax obligations or failed to exercise due diligence in determining
whether or not such obligations existed. Liability for the tax also follows the estate itself, and when the A foreign corporation, whether resident or non-resident, which is classified as a personal holding
estate has been distributed, the heirs, devisees, legatees, and distributors may be required to company under Section 64 (not including a foreign personal holding company as defined in Section
discharge the amount of the tax due and unpaid, to the extent of and in proportion to any share 67) is subject to the tax imposed by Section 63 with respect to its income from sources within the
received. The same consideration apply to other trusts. Where the tax has been paid on the net Philippines. The term "personal holding company" as used in Chapter VIII of Title II of the Code does
income of an estate or trust by the fiduciary, the net income on which the tax is paid is free from tax not include a foreign corporation if (1) its gross income from sources within the Philippines for the
when distributed to the beneficiaries. period specified in Section 37(a) (2) (B) is less than 50 per cent of its total gross income from all
sources and (2) all of its stock outstanding during the last half of the taxable year is owned by
SECTION 213.Exemption allowed to estate or trusts. — An estate or a trust is allowed a personal nonresident alien individuals, whether directly or indirectly through other foreign corporations.
exemption of P1,800. Each beneficiary is entitled to but one personal exemption, no matter from how (Section 64 of the Code)
many trusts he may receive income.
(Section 61 of the Code) SECTION 219.Definition of personal holding company. — A personal holding company is any
corporation (other than a corporation specified in section 64(b) which for the taxable year meets (a)
SECTION 214.Fiduciary returns. — Fiduciaries are required to make returns of income on B.I.R. the gross income requirement specified in Section 220 of these regulations, and (b) the stock
Form No. 17.01, in duplicate, when the gross income of the person, trust, or estate for whom or which ownership requirement specified in Section 221 of these regulations. Both requirements must be
they act amounts to P1,800 or more and will be subject to all the provisions of law which apply to satisfied and both must be met with respect to each taxable year.
individuals. A fiduciary making return shall make oath that he has sufficient knowledge of the affairs of
the person trust, or estate for whom or which he acts to enable him to make such return, and that the SECTION 220.Gross income requirement. — To meet the gross income requirement, it is necessary
same is, to the best of his knowledge and belief, true and correct. A return by one of two or more joint that either of the following percentages of gross income of the corporation for the taxable year be
fiduciaries in the form prescribed filed in the municipality or city in which such fiduciary resides shall personal holding company income as defined in Section 65:
be sufficient compliance with the requirement for fiduciary returns. (a) Eighty per cent or more; or
(b) Seventy per cent or more if the corporation has been classified as a personal holding company
A fiduciary acting as the guardian of a minor or other incapacitated person must make a return for for any taxable year beginning after December 31, 1938, unless —
such minor or incapacitated person and pay the tax, unless such minor or incapacitated person
Revenue Regulations 02-40 Page 32 of 39

(1) A taxable year has intervened since the last taxable year for which it was so classified, stock company, insurance, company association, or other organization classified as a corporation
during no part of the last half of which the stock ownership requirement specified in Section under Title II) certificates of interest or participation in mineral royalty, or leave, collateral trust
64(a) (2) exists; or certificates, voting trust certificates, stock rights or warrants, bonds, debentures, certificates of
(2) Three consecutive years have intervened since the last taxable year for which it was so indebtedness, notes, car trusts certificates, bills of exchange, obligations issued by or on behalf of a
classified, during each of which its personal holding company income was less than 70 per Government, State, Territory, or political subdivision thereof. In the case of "regular dealers in stock or
cent of its gross income. securities" the term does not include gains derived from the sale or exchange of stock or securities
made in the normal course of business. The term "regular dealer in stock or securities" means
In determining whether the personal holding company income is equal to the required percentage of corporations with an established place of business regularly engaged in the purchases of stock or
the total gross income, the determination must not be made upon the basis of gross receipts, since securities and their resale to customers, but such corporations are not dealers with respect to stock or
gross income is not synonymous with gross receipts. For a further discussion of what constitutes securities held for speculation or investment.
"gross income", see Section 29 of the Code and the regulations prescribed under that section. (6) GAINS FROM FUTURES TRANSACTIONS IN COMMODITIES. — Gains from futures
transactions in commodities include gains from futures transactions in any commodity on or subject to
SECTION 221.Stock ownership requirements. — To meet the stock ownership requirement, it is the rules of a board of trade or commodity exchange, but do not include gains from cash transactions
necessary that at some time during the last half of the taxable year more than 50 per cent it value of or gains by a producer, processor, merchant, or handler of the commodity, which arise out of bonafide
the outstanding stock of the corporation be owned, directly or indirectly, by or for not more than five hedging transactions reasonably necessary to the conduct of its business in the manner in which such
individuals: For such purpose, the ownership of the stock must be determined as provided in Section business is customarily and usually conducted by others. In general, personal holding company
66. income includes gains on futures contracts which are speculative. Futures contracts representing true
hedges against price fluctuations in spot goods are not speculative transactions, though not
In the event of any change in the stock outstanding during the last half of the taxable year, whether in concurrent with spot transactions. Futures contracts which are not hedges against spot transactions
the number of shares or classes of stock, or whether in the ownership thereof, the conditions existing are speculative unless they are hedges against concurrent futures or forward sales or purchases.
immediately prior .and subsequent to each change must be taken into consideration. (7) INCOME FROM ESTATES AND TRUSTS. — The income from estates and trusts which is to be
included in personal holding company income consists of the income from estates and trusts which is
In determining whether the statutory conditions with respect to stock ownership are present at any required to be included in the gross income of the corporation under Section 29 in relation to Section
time during the last half of the taxable year, the phrase "in value" shall, in the light of all the 56 of the Code, together with the gains derived by the corporation from the sale or other disposition of
circumstances, be deemed the value of the corporate stock outstanding at such time (not including any interest in an estate or trust.
treasury stock). This value may be determined upon the basis of the company's net worth, earning (8) AMOUNTS RECEIVED UNDER PERSONAL SERVICE CONTRACTS. — Amounts includible in
and dividend paying capacity, appreciation of assets, together with such other factors as have a personal holding company income as amount received under personal service contracts consist of
bearing upon the value of the stock. If the value of the stock is greatly at variance with that reflected amounts received pursuant to a contract under which the corporation is to furnish personal services,
by the corporate books the evidence of such value should be filed with the return. In any case where and amounts received from a sale or other disposition of such a contract, if —
there are two or more classes of stock outstanding, the total value of the stock should be allocated (a) Some person other than the corporation has the right to designate (by name or by description)
among the different classes according to the relative value of each class therein. the individual who is to perform the services or if the individual who is to perform the services is
designated (by name or by description) in the contract; and
The rules stated in the last two preceding paragraphs are equally applicable in determining the stock (b) At some time during the taxable year 25 per cent or more in value of the outstanding stock of the
ownership requirement specified in Section 65(e); relating to personal service contracts and Section corporation is owned, directly or indirectly, by or for the individual who has performed, is to perform, or
65(f), relating to the use of corporation property by a shareholder. The stock ownership requirement may be designated (by name or by description), as the one to perform such services. For this purpose
specified in these sections relates, however, to the stock outstanding at anytime during the entire the stock ownership must be determined as provided in Section 66 of the Code.
taxable year and not merely during the last half thereof. The application of Section 65(e) may be illustrated by the following examples:
(Section 65 of the Code) Example (1): A, whose profession is that of an actor, owns all of the outstanding capital stock of the M
Corporation. The Corporation entered into a contract with A under which A was to perform personal
SECTION 222.Personal holding company income. — The term "personal holding company income" services for the person or persons whom the M Corporation might designate, in consideration of
means the portion of the gross income which consists of the following: which A was to receive P10,000 a year from the M Corporation. The M Corporation entered into a
(1) DIVIDENDS. — The term "dividends" includes dividends as defined in Section 83 (a), and contract with the O Corporation in which A was designated to perform personal services for the O
amounts required to be included in gross income under Section 69 (b) of this Code. It does not Corporation in consideration of which the O Corporation was to pay the M Corporation P500,000 a
include stock dividends (to the extent that they do not constitute income to the shareholders with the year. The P500,000 received by the M Corporation from the O Corporation constitutes a personal
meaning of Section 83(b) of the Code) and liquidating dividends. holding company income.
(2) INTEREST (other than interest constituting rent). — The term "interest" means any amount, Example (2): The N Corporation, the entire outstanding capital stock of which is owned by four
includible in gross income, received for the use of money loaned except that it does not include individuals, is engaged in engineering. The N Corporation entered into a contract with the O
interest constituting rent [see subparagraph (1)]. Corporation to perform engineering services for the O Corporation, in consideration of which the O
(3) ROYALTIES (other than mineral, oil, or gas royalties). — The term "royalties" include amounts Corporation was to pay the N Corporation P50,000. The individual who was to perform the services
received for the privilege of using patents, copyrights, secret processes and formulas, good will, trade was not designated (by name or by description) in the contract and no one but the N Corporation had
marks, trade brands, franchises, and other like property. It does not include rents, or overriding the right to designate (by name or by description) such individual. The P50,000 received by the N
royalties received by an operating company. As used in this paragraph the term "overriding royalties" Corporation from the O Corporation does not constitute personal holding company income. HTaIAC
means amounts received from the sublease by the operating company which originally leased and (9) COMPENSATION FOR USE OF PROPERTY. — The compensation for the use of, or the right to
developed the natural resources property in respect of which such overriding royalties are paid. use, the property of the corporation which is to be included in personal holding company income
(4) ANNUITIES. — The term "annuities" includes annuities only to the extent includible in the consists of amounts received as compensation (however designated and from whomsoever received)
computation of gross income. [See Section 29(b) (2)]. for the use of, or the right to use, property of the corporation in any case in which, at any time during
(5) GAINS FROM THE SALE OR EXCHANGE OF STOCK OR SECURITIES. — The term "gains the taxable year 25 per cent or more in value of the outstanding stock of the corporation is owned,
from the sale or exchange of stock or securities" as used in Section 65(b) applies to all gains directly or indirectly, by or for an individual entitled to the use of the property, whether such right is
(including gains from liquidation dividends and other distributions from capital) from the sale or obtained directly from the corporation or by means of a sublease or other arrangement. The property
exchange of stock or securities includible in gross income. The term "stock or securities" as used in may consist of a yacht, a city residence, a country house, or any other kind of property.
Section 65(b) includes shares or certificates of stock, or interest in any corporation (including any joint
Revenue Regulations 02-40 Page 33 of 39

(10) RENTS (including interest constituting rent). — The rents which are to be included in personal former marriage
holding company income consist of compensation, however, designated including charter fees, etc., (son's half sister) ASHS 10 BSHS 40 CSHS 40 DSHS 40 ESHS
for the use of, or the right to use, real property, or any other kind of property and the interest on debts 40
bowed to the corporation, to the extent such debts represent the price for which real property held His brother's wife ABW 10 BBW 10 CBW 10 DBW 160 EBW
primarily for sale to customers in the ordinary course of its trade or business was sold or exchanged 10
by the corporation, but do not include amounts constituting personal holding company income under His wife's father AWF10 BWF 10 CWF 110 DWF 10 EWF
Section 65(f) and paragraph (9) of this section. However, rents do not constitute personal holding 10
company income if constituting 50 per cent or more of the gross income of the corporation. His wife's brother AWB10 BWB 10 CWB 10 DWB 10 EWB
(II) MINERAL, OIL, OR GAS ROYALTIES. — The income from mineral, oil, or gas royalties is to be 10
included as personal holding company income, unless (A) the aggregate amount of such royalties His wife's brother's
constitutes 50 percent or more of the gross income of the corporation for the taxable year and (B) the wife AWBW 10 BWBW 10 CWBW 10 DWBW 10 EWBW
aggregate amount of deductions allowable for expenses under Section 30 (a) of the Code (other than 110
compensation for personal services rendered by the shareholders of the corporation) equals 15 per Individual's partner AP 10 - - - - - - - -
cent or more of the gross income of the corporation for the taxable year.
The term "mineral, oil, or gas royalties" means all royalties, except "overriding royalties", received By applying the statutory rule provided in Section 66(a) five individuals own more than 50 per cent of
from any interest in mineral, oil, or gas royalties. As used in this paragraph the term "overriding the outstanding stock as follows:
royalties" means amounts received from the sublease by the operating company which originally A (including AF, AW, AB, AS, ASHS, AP) 160
leased and developed the natural resources property in respect of which such overriding royalties are B (including BF, BW, BB, BS, BSHS) 160
bid. CW (including C, CS, CWF, CWB) 220
(Section 66 of the Code) DB (including D, DF, DBW) 200
EWB (including EW, EWF, EWBW) 170
SECTION 223.Stock ownership. — For the purpose of determining whether — ——
(a) A corporation is a personal holding company in so far as such determination is based on the Total, or more than 30 per cent 910
stock ownership requirement specified in Section 64(a) (2), or
(b) Amounts received under a personal service contract or from the sale of such a contract Individual A represents the obvious case where the head of the family owns the bulk of the family
constitute personal holding company income in so far as such determination is based on the stock stock and naturally is the head of the group. A's partner owns to shares of the stock. Individual B
ownership requirement specified in Section 65 (e), or represents the case where he is still head of the group because of the ownership of stock by his
(c) Compensation for the use of property constitutes personal holding company income in so far as immediate family. Individuals C and D represent cases where the individuals fall in groups headed in
such determination is based on the stock owner-ship requirement specified in Section 65(f), stock C's case by his wife and in D's case by his brother because of the preponderance of holdings on the
owned by an individual includes stock constructively owned by him as provided in Section 66. All part of relatives by marriage. Individual E represents the case where the preponderant holding of
forms and classes of stock, however denominated, which represent the interests of shareholders, others eliminate that individual from the group.
members, or beneficiaries in the corporation shall be taken into consideration.
The method of applying the family and partnership rule as illustrated in the foregoing example also
SECTION 224.Stock not owned by individual. — In determining the ownership of stock for any of the applies in determining the ownership of stock for the purposes stated in (b) and (c) of Section 223 of
purposes set forth in the preceding section, stock owned, directly or indirectly, by or for a corporation, these regulations.
partnership, estate, or trust shall be considered as being owned proportionately by its shareholders,
partners, or beneficiaries. For example, if A and B, two individuals, are the exclusive and equal SECTION 226.Options. — In determining the ownership of stock for any of the purposes set forth in
beneficiaries of a trust or estate, and if such trust or estate owns the entire capital stock of the M Section 223 of these regulations if any person has an option to acquire stock, such stock may be
Corporation, and if the M Corporation in turn owns the entire capital stock of the N Corporation, then considered as owned by person. The term "option" as used in this section includes an option to
the stock of both the M Corporation and the N Corporation shall be considered as being owned acquire such an option and each one of a series of such options, so that the person who has an
equally by A and B as the individuals owning the beneficial interest therein. option on an option to acquire stock may be considered as the owner of the stock.
(Section 67 of the Code)
SECTION 225.Family and partnership ownership. — In determining the ownership of stock for any of
the purposes set forth in Section 223 of these regulations, an individual shall be considered as owning SECTION 227.Definition of foreign personal holding company. — A foreign personal holding company
the stock owned, directly or indirectly, by or for his family or by or for his partner. For the purposes of is any foreign corporation (other than a corporation exempt from taxation under Section 27 of the
such determination the family of an individual includes only his brothers and sisters (whether by the Code) which for the taxable year meets (a) the gross income requirements specified in Section 67 (a)
whole or half blood), spouse, ancestors, and lineal descendants. (1), and (b) the stock ownership requirement specified in Section 67(a) (2). Both requirements must
be satisfied and both must be met with respect to each taxable year.
The application of the family and partnership rule in determining the ownership of stock for the A foreign corporation which comes within the classification of a foreign personal holding company for
purpose set forth in (a) of Section 223 of these regulations is illustrated by the following example: any taxable year beginning after December 31, 1938, is not subject to taxation for such taxable year
under Section 25 of the Code but may be subject to taxation under that section for other taxable
Example: The M Corporation at some time during the last half of the taxable year had 1,800 shares of years. The fact that a foreign corporation is a foreign personal holding company does not relieve the
outstanding stock, 450 of which were held by various individuals having no relationship to one another corporation from liability for the tax imposed generally under Section 24 upon foreign corporations,
and none of whom were partners, and the remaining 1,350 were held by 51 shareholders as follows: since such tax applies regardless of the classification of the foreign corporation as a-foreign personal
Relationship Shares Shares Shares Shares Shares holding company.
An individual A 100 B 20 C 20 D 20 E 20
His father AF 10 BF 10 CF 10 DF 10 EF 10 SECTION 228.Gross income requirement. — To meet the gross income requirement, it is necessary
His wife AW 10 BW 40 CW 40 DW 40 EW 40 that either of the following percentages of gross income of the corporation for the taxable year be
His brother AB 10 BB 10 CB 10 DB 10 EB 10 foreign personal holding company income in accordance with Section 68 in relation to Section 65 of
His son AS 10 BS 40 CS 40 DS 40 ES 40 the Code:
His daughter by (a) Sixty per cent of more; or
Revenue Regulations 02-40 Page 34 of 39

(b) Fifty per cent or more if the foreign corporation has been classified as a foreign personal holding taxable year on which the Philippine groups existed with respect to the company. Such Philippine
company for the taxable year ending after December 31, 1938, unless — shareholders, accordingly, are determined by the stock holdings as of such specified time. This
(1) A taxable year has intervened since the last taxable year for which it was so classified, applies to every Philippine shareholder who was a shareholder in the company at the specified time
during no part of which the stock ownership requirement specified in Section 67 (a) (z) exist; or regardless of whether the Philippine shareholder is included with the Philippine group.
(2) Three consecutive years have intervened since the last taxable year for which it was so
classified, during each of which its foreign personal holding company income was less than 50 The Philippine shareholders must include in their gross income their distributive shares of that
per cent of its gross income. proportion of the undistributed net income for the taxable-year of the company which is equal in ratio
to that which the portion of the taxable year up to and including the last day on which the Philippine
In determining whether the foreign personal holding company income is equal to the required group with respect to the company existed bears to the entire taxable year. Thus if the last day in the
percentage of the total gauss income, the determination must not be made on the basis of gross taxable year on which the required Philippine group existed was also the end of the taxable year, the
receipts since gross income is not synonymous with gross receipts. For a further discussion on what portion of the taxable year up to and including such last day would be equal to 100 per cent and in
constitutes "gross income," see Section 29(n) and the regulations prescribed under that section. such case, the Philippine shareholders would be required to return their distributive shares in the
entire undistributed net income. But if the last day on which the required Philippine group existed was
SECTION 229.Stock ownership requirement. — To meet the stock ownership requirement it is September 30, and the taxable year was a calendar year, the portion of the taxable year up to and
necessary that at some time in the taxable year more than 50 per cent in value of the outstanding including such last day would be equal to nine-twelfths of the undistributed net income.
stock of the foreign corporation be owned, directly or indirectly, by or for not more than five individuals
who are citizens or residents of the Philippines. The amount which each Philippine shareholder must return is that amount which he would have
received as a dividend if the above specified portion of the undistributed net income had in fact been
In the event of any change in the stock outstanding during the taxable year, whether in the number of distributed by the foreign personal holding company as a dividend on the last day of its taxable year
shares or classes of stock, or whether in the ownership thereof, the conditions existing immediately on which the required Philippine group existed. Such amount is determined, therefore, by the interest
prior and subsequent to each change must be taken into consideration, since a corporation comes of the Philippine shareholder in the foreign personal holding company, that is, by the number of
within the classification if the statutory conditions with respect to stock ownership are present at any shares of stock owned by the Philippine shareholder and the relative rights of his class of stock, if
time during the taxable year. there are several classes of stock outstanding. Thus, if a foreign personal holding company has both
common and preferred stock outstanding and the preferred shareholders are entitled to a specific
In determining whether the statutory conditions with respect to stock ownership are present at any dividend before any distribution may be made to the common shareholders, then the assumed
time during the taxable year, the phrase "in value" shall, in the light of all the circumstances, be distribution of the stated portion of the undistributed net income must first be treated as a payment of
deemed the value of the corporate stock outstanding at such time (not including treasury stock). This the specified dividend on the preferred stock before any part may be allocated as a dividend on the
value may be determined upon the basis of the company's net worth, earning and dividend paying common stock.
capacity, appreciation of assets, together with such other factors as have a bearing upon the value of
the stock. If the value of the stock which is used is greatly at variance with that reflected by the The assumed distribution of the required portion of the undistributed net income must be returned as
corporate books, the evidence of such value should be filed with the return. In any case where there dividend income by the Philippine shareholders for their respective taxable years in which or with
are two or more classes of stock outstanding, the total value of all the stock should be allocated which the taxable year of the foreign personal holding company ends. In applying this rule, the date
among the different classes according to the relative value of each lass therein. DIcSHE as of which the Philippine group last existed with respect to the company is immaterial. CTDHSE
(Section 68 of the Code) (Section 70 of the Code)

SECTION 230.Gross income and stock ownership requirements of foreign personal holding SECTION 232.Information returns by officers and directors of certain foreign corporations. — (a)
companies. — For the purpose of determining whether a foreign corporation satisfies the gross REQUIREMENT FOR FILING RETURNS. — (1) General. — Under Section 70 (a), on the 15th day of
income requirement prescribed under Section 67(a)(1), the same items of income classified under each month which begins after July 1, 1939, each individual who on such 15th day is an officer or, a
Section 65 as personal holding company income shall, if received by a foreign corporation, be director of a foreign corporation which, with respect to its taxable year preceding the taxable year in
considered as foreign personal holding company income. In determining whether a foreign which such month occurs, was a foreign personal holding company, is required to file with the
corporation satisfies the stock ownership requirement prescribed under Section 67(a) (2) the rules Commissioner of Internal Revenue a monthly information return as provided in Section 70(a). The
established in Section 66 shall apply. Commissioner of Internal Revenue may authorize the filing of returns covering periods longer than a
(Section 69 of the Code) month.
(2) RETURNS JOINTLY MADE. — If two or more officers or directors of a foreign corporation are
SECTION 231.Income of foreign personal holding companies taxed to Philippine shareholders. — (a) required to file information returns for any period under Section 70(a), any two or more of such
General rule. — Section 69 does not impose a tax on. foreign personal holding companies. The officers or directors may, in lieu of filing separate returns for such period, jointly execute and file one
undistributed net income (from all sources), of such companies, however, must be included in the return.
manner and to the extent set forth in this section, in the gross income of their "Philippine (b) FORM OF RETURN. — The return under Section 70(x). of the Code and this section shall be
shareholders", that is, the shareholders who are individual citizens or residents of the Philippines. made on the form prescribed by the Commissioner of Internal Revenue. Each officer or director
(b) AMOUNT INCLUDIBLE IN GROSS INCOME. — Each Philippine shareholder, who was a should carefully prepare his return so as to set forth fully and clearly the information called for therein
shareholder on the day in the taxable year of the, foreign personal holding company which was the and by the applicable regulations. Returns which have not been so prepared will not be considered as
last day on which the stockholders satisfying the stock ownership requirement of Section 67(a)(2), meeting the requirements of the law.
hereinafter referred to as the "Philippines group", existed with respect to the company, shall include in (c) CONTENTS OF RETURN. — The return shall, in accordance with provisions of this section and
his gross income a dividend, for the taxable year in which or with which the taxable year of the the instructions on the form, set forth with respect to the preceding period the following information:
company ends, the amount he would have received as a dividend if on such last day there has been (1) Name and address of corporation;
distributed by the company and received by the shareholders an amount which bears the same ratio (2) Kind of business in which the corporation is engaged;
to the net income of the company for the taxable year as the portion of such taxable year up to and (3) Date of incorporation;
including such last day bears to the entire taxable year. (4) The country under the laws of which the corporation is incorporated;
(5) Number of shares and par value of common stock of the corporation outstanding as of the
The undistributed net income of the foreign personal holding company is includible only in the gross beginning and end of the period;
income of the Philippine shareholders who were shareholders in the company on the last day of its
Revenue Regulations 02-40 Page 35 of 39

(6) Number of shares and par value of preferred stock of the corporation outstanding as of the (2) Duplicate returns. — If a shareholder in a foreign corporation files, as an officer or director in
beginning and end of the period, the rate of dividend on such stock and whether such dividend is such corporation, the returns required by Section 70(b), such returns shall be considered as
cumulative or noncumulative; returns filed under Section 71(a).
(7) A description of the convertible securities issued by the corporation, including a statement of the (b) FORM OF RETURN. — The return under Section 71(a) shall be made on the form prescribed by
face value of, and rate of interest on, such securities: the Commissioner of Internal Revenue. Each shareholder should carefully prepare his return so as to
(8) The name and address of each shareholder, the class and number of shares held by each, set forth fully and clearly the information called for therein and by the applicable regulations. Returns
together with any changes in stock holdings during such period; which have not been so prepared will not be considered as meeting the requirements of the law.
(9) The name and address of each holder of securities convertible into stock of the corporation, the (c) CONTENTS OF RETURN. — The return shall, in accordance with the provisions of this section
class, number and face value of the securities held by each, together with any changes in the holding and the instructions on the form, set forth with respect to the preceding period the same information
of such securities during the period; as required, to be shown on that form by Section 70(a) and paragraph (c) of Section 232 of these
(10) A certified copy of any resolution or plan, and any amendments thereof or supplements thereto, regulations.
for or in respect of the dissolution of the corporation of the liquidation of the whole or any part of its If a person is required to file a return under Section 71(a) of the Code and this section with respect to
capital stock; and more than one foreign corporation, a separate return must he filed with respect to each foreign
(11) Such other information as may be required by the return form. corporation.
If a person is required to file a return under Section 70(a) of the Code and this section with (d) VERIFICATION OF RETURNS. — All returns required by Section 71(a) of the Code and this
respect to more than one foreign corporation, a separate return must be filed with respect to each section shall be verified under oath or affirmation of the parties rendering the same.
foreign corporation.
(d) VERIFICATION OF RETURNS. — All returns required by Section 70(a) and this section shall be SECTION 235.Annual information returns by shareholders of certain foreign corporations. —
verified under oath or affirmation of the parties rendering the same. (a) REQUIREMENT FOR FILING RETURNS.
(1) General. — Under Section 71(b) of the Code, on the sixtieth day after the close of the taxable
SECTION 233.Annual information returns by officers and directors of certain foreign corporations. — year of a foreign personal holding company, each Philippine shareholder, by or for whom on such
(a) Requirement for filing returns. sixtieth day 50 per cent or more in value of the outstanding stock of the company is owned, directly or
(1) GENERAL. — Under Section 70(b), on the sixtieth day after the close of the taxable year of a indirectly [including the case of an individual stock owned by members of his family as defined in
foreign personal holding company each individual who on such sixtieth day is an officer or director of Section 66(b)], shall file with the Commissioner of Internal Revenue an information returns as
the corporation shall file with the Commissioner of Internal Revenue an annual information return as provided in that section and this section.
provided in that section of the Code and this section. (2) Duplicate returns. — If a shareholder in a foreign corporation files as an officer or director in such
(2) RETURNS JOINTLY MADE. — If two or more officers or directors of a foreign corporation are corporation, the return required by Section 70(b), such returns shall be considered as returns filed
required to file annual information returns under Section 70(b) for any taxable year of the corporation under Section 71(b).
any two or more of such officers or directors may in lieu of filing separate annual returns for such (b) FORM OF RETURN. — The return under Section 71(b) shall be made on the form prescribed by
taxable year, jointly execute and file one annual return. the Commissioner of Internal Revenue. Each shareholder should carefully prepare his return so as to
(b) FORM OF RETURN. — The return under Section 70(b) and this section shall be made on the set forth fully and clearly the information called for therein and by the applicable regulations. Returns
form prescribed by the Commissioner of Internal Revenue. Each officer or director should carefully which have not been so prepared will not be considered as meeting the requirements of the law.
prepare his returns so as to set forth fully and clearly the information called for therein and by the (c) CONTENTS OF RETURN. — The return shall, in accordance with the provisions of this section
applicable regulations. Returns which have not been so prepared will not he considered as meeting and the instructions on the form, set forth with respect to the taxable year of the foreign personal
the requirements of the law. holding company the same information which is required under Section 71(a), paragraph (c) of
(c) CONTENTS OF RETURN. — The return shall, in accordance with the provisions of this section Section 232 of these regulations and paragraph (c) of the preceding section, except that if all the
and the instructions on the form, set forth with respect to the taxable year of the foreign personal required returns with respect to such year have been filed under Section 71(a), no return under
holding company the following information: Section 71(b) is required.
(1) The gross income, deductions and credits, net income, and undistributed net income of the If a person is required to file an annual return under Section 71(b) with respect to more than one
foreign personal holding company for such taxable year, in complete detail; foreign personal holding company, a separate return must be filed with respect to each foreign
(2) The same information with respect to such taxable year which is required by Section 70(a) and personal holding company.
paragraph (c) of the preceding section, except that if all the required returns with respect to such year (d) VERIFICATION OF RETURNS. — All returns required by Section 71(b) and this section shall be
have been filed under Section 70(a) and the preceding section, no information under Section 70(b) (2) verified under oath or affirmation of the parties rendering the same.
and this paragraph need be set forth in such annual return; and (Section 72 of the Code)
(3) Such other information as may be required by the return form.
(d) VERIFICATION OF RETURNS. — All returns required by Section 70(b) and this section shall be SECTION 236.Ad valorem penalty for failure to file return. — In case of a failure to make and file a
verified under oath or affirmation of the parties rendering the same. return or list within the time prescribed by law, not due to willful neglect, where such return or list is
(Section 71 of the Code) voluntarily filed by the taxpayer without notice from the Commissioner of Internal Revenue or other
officer and it is shown that the failure to file it in due time was due to a reasonable cause, no
SECTION 234.Information returns by shareholders of certain foreign corporations. — surcharge will be added to the amount of tax due on the return. In such cases, in order to avoid the
(a) REQUIREMENT FOR FILING RETURNS. imposition of the surcharge, the taxpayer must make a statement showing all the facts alleged as a
(1) General. — On the 15th day of each month which begins after July 1, 1939 each Philippine reasonable cause for failure to file the return on time in the form of an affidavit which should be
shareholder, by or for whom 50 per cent or more in value of the outstanding stock of a foreign attached to the return. If the Commissioner of Internal Revenue is satisfied that the delinquency was
corporation is owned, directly or indirectly [including, in the case of an individual, stock owned by due to a reasonable cause, no surcharge will be added to the tax due on the return. Whether or not
members of his family as defined in Section 66(b)], if such foreign corporation with respect to its reasonable cause exists will depend upon the circumstances of each case. As a general rule, if the
taxable year preceding the taxable year in which such month occurs was a foreign personal taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the
holding company, shall file with the Commissioner of Internal Revenue an information, return as return within the prescribed time, the delay will be considered as being due to a reasonable cause.
provided in Section 71(a). The Commissioner of Internal Revenue may authorize the filing of
returns covering period longer than a month. In case of a failure to make and file a return or list within the time prescribed by law, not due to willful
neglect, where the taxpayer voluntarily files the return without notice from the Commissioner of
Internal Revenue or other officer and attaches to such return the affidavit mentioned in the preceding
Revenue Regulations 02-40 Page 36 of 39

paragraph but where the Commissioner of Internal Revenue is not satisfied as to the reasonableness securities (not payable in the Philippines) by means of coupons, checks, or bills of exchange shall,
of the cause of the delinquency, a surcharge of 25 per cent will be added to the amount of tax due on upon application, obtain a license therefor from the Commissioner of Internal Revenue. The
the return. application shall show the name, address, occupation, and status (as to citizenship or nationality and
residence) of the applicant.
In case the failure to make and file a return or list within the time prescribed by law is due to willful (Section 77 of the Code)
neglect a surcharge of 50 per cent will be added to the amount of tax due on the return. There is
willful neglect in the case of a taxpayer who, being liable to file a return, knowingly delays the filing of SECTION 243.Return of information as to payments of P1,800 or more. — All persons, corporations,
such return. Where the filing of the return has been delayed for a considerable length of time, the partnerships, and associations, making payment to another person of fixed or determinable income of
delinquency will be presumed to be due to willful neglect. P1,800 or more in a taxable year must render a return thereof to the Commissioner of Internal
Revenue within the time fixed for the filing of the annual returns of said person, corporations,
The amount of surcharge so added to the tax due on the return shall be collected at the same time partnerships, and associations. The name and address of the recipient of the income should be
and in the same manner and as part of the tax unless the tax has been paid before the discovery of stated, if possible. Although to make necessary a return of information the income must be fixed or
the cause giving rise to the imposition of the surcharge, in which case the amount so added shall be determinable, it need not be annual or periodical.
collected in the same manner as the tax.
The names of all employees to whom payments of P1,800 or over a year are made, whether such
SECTION 237.Ad valorem penalty for false or fraudulent return. — In case a false or fraudulent return total sum is made up of wages, salaries, commissions, or compensation in any other form, must be
or list is made, the Commissioner of Internal Revenue shall add to the tax ascertained to be due on reported. Compensations in kind, such as living quarters, meals, and lodging, are taxable income to
the true net income of the taxpayer a surcharged of 50 per cent of the amount of such tax. If payment the recipient and, as such, should be reported if the sum total of the same and the other
has been made on the basis of such false or fraudulent return before the discovery of the falsity or compensation in cash received shall amount to P1,500 or more during the year.
fraud, the basis of the surcharge of 50 per cent will be the amount of the tax due on the true net
income less the amount so paid. In the case of payments of annual or periodical income to nonresident alien individual or to foreign
(Section 73 of the Code) corporations or firm not engaging in trade or business within the Philippines and not having any office
or place of business therein, the return by withholding agents shall constitute and be treated as return
SECTION 238.Penalty for failure to file return or to pay tax. — Any person liable to pay the tax, to of information.
make a return or to supply information required under Title II of the Code, who refuses or neglects to
pay such tax, to make such return or to supply such information at the time or times specified in each SECTION 243.Return of information as to payments of P1,800 or more. — All persons, corporations,
case shall be punished by a fine of not more than P2,000 or by imprisonment for not more than six partnerships and associations making payments to another of fixed or determinable income of P1,800
months, or both. In case of a corporation failing to file its, return or pay the tax, the penalty prescribed or more in a taxable .year must render a return thereof in duplicate on the form prescribed therefor
under the first paragraph of Section 73 will be imposed upon the president, vice-resident, or other (BIR Form No. 17.01-B). These forms should be attached to and filed together with the annual income
responsible officer required to file the return of the corporation or pay the tax due from the same, in tax returns of said persons, corporations, partnerships and associations as payers, within the time
accordance with the provisions of Section 46(a) and 51(b) of the Code. In the case of a duly fixed by law for the filing of income tax returns. The payments referred to herein do not include the
registered general copartnership, failing to file the return required under Section 49 of the Code, the following:
penalty prescribed under the first paragraph of Section 73 will be imposed upon the managing partner
or other responsible officer of such partnership. (1) Dividend payments mentioned under Section 75 of the National Internal Revenue Code.
(2) Salaries, wages, bonuses, and other compensations in kind, such as living quarters, meals, and
SECTION 239.Penalty imposed upon person causing a false or fraudulent corporate return to be lodging which are subject to withholding tax and reported in W-2 forms as provided for under
filed. — If a false or fraudulent return is filed for a corporation or duly registered general Republic Act 590.
copartnership, the individual or any officer thereof causing such return to be filed shall be punished by (3) Payments subject to withholding tax at source enumerated under Section 53 of the National
a fine not exceeding P4,000 or by imprisonment for not more than one year, or both. Internal Revenue Code.
(Section 74 of the Code)
Examples of income covered by these regulations and to be declared in BIR Form 17.01-B are
SECTION 240.Penalty on corporation refusing or neglecting to make return. — A corporation or duly interests, rents, commissions, royalties, advertisements, professional fees, and the like, arising
registered general copartnership, refusing or neglecting to make a return required under Title II of the generally from payments between payers and recipients who have no employer-employee
Code, or, rendering a false or fraudulent return, will be liable to a fine of not exceeding P20,000. The relationship.
fine imposed under Section 74 will be paid by the corporation or duly registered general copartnership (Revenue Regulations No. 9-65 amending and superseding section 243 appearing on page 723. As of
as an entity, and is in addition to the penalty which may be imposed under Section 73 of the Code October 20, 1965, these Regulations, dated June 30, 1965, have not yet been published in the Official
upon the president, vice-president, or other responsible officer of a corporation or duly registered Gazette).
general copartnership. (Section 78 of the Code)
(Section 75 of the Code)
SECTION 244.Return of corporation contemplating dissolution or retiring from business. — All
SECTION 241.Return of information as to payments of dividends. — Every domestic resident foreign corporations, partnership, joint accounts and associations, contemplating dissolution or retiring from
corporation is hereby required to render a return, in duplicate, on the form prescribed for corporations business without formal dissolution shall, within 30 days after the approval of such resolution
(B.I.R. Form No. 17.02) of its payments of profits or dividends to stock holders for the taxable year or authorizing their dissolution, and within the same period after their retirement from business, file their
period covered by the return, stating the name and address of each stockholder, the number and income tax returns covering the profit earned or business done by them from the beginning of the
class of shares owned by him, the date and amount of such dividend paid him, and when the surplus year up to the date of such dissolution or retirement and pay the corresponding income tax due
out of which it was paid was accumulated. Such return should be verified by the oath or affirmation of thereon upon demand by the Commissioner of Internal Revenue to addition to the income tax return
the person rendering the same. required to be filed they shall also submit within the same period the following:
(Section 76 of the Code) (a) Copy of the resolution authorizing such dissolution;
(b) Balance sheet at the date of dissolution or retirement and a profit and loss statement covering
SECTION 242.Application for and issuance of license for collecting foreign items. — Every individual the period from the beginning of the taxable year to the date of dissolution or retirement;
or organization undertaking, for profit or otherwise, the collection of dividends or interest on foreign
Revenue Regulations 02-40 Page 37 of 39

(c) In the case of a corporation, the names end addresses of the shareholders and the number and (d) CONTENTS OF RETURNS. — The return shall set forth the following information to the full
par value of the shares held by each; and in the case of a partnership, joint-account or extent such information is within the knowledge or possession or under the control of the person
association, the name of the partners or members and the capital contributed by each; required to file the return.
(d) The value and a description of, the assets received in liquidation by each shareholder;
(e) The name and address of each individual or corporation, other than shareholders, if any, (1) The name and address of the person (or persons) to whom and the person (or persons) for
receiving assets at the time of dissolution together with a description and the value of the assets whom or on whose behalf the aid, assistance, counsel, or advice was given;
received by such individuals or corporations; and the consideration, if any, paid by each of them (2) A complete statement of the aid, assistance, counsel, or advice given;
for the assets received. (3) Name and address of the foreign corporation and the country under the laws of which it was
(Section 79 of the Code) formed, organized, or reorganized;
(4) The months and year when the foreign corporation was formed, organized, or reorganized;
SECTION 245.Return of information by brokers. — When required by the Commissioner of Internal (5) A statement of how the formation, organization, or reorganization of the foreign corporation was
Revenue, each person doing business as a broker shall render a return or statement showing the effected;
names and addresses of customers to whom or for whom payments were made or from whom (6) A complete statement of the reasons for, and the purposes sought to be accomplished, by, the
business was transacted during the calendar year or other specified period, and giving all other formation, organization, or reorganization of the foreign corporation;
particulars which may be needed by the Commissioner of Internal Revenue. (7) A statement showing the classes and kinds of assets transferred to the foreign corporation in
(Section 80 of the Code) connection with formation, organization, or reorganization, including a detailed list of any stock or
securities included in such assets, and a statement showing the names and addresses of the persons
SECTION 246.Information returns as to formation, etc., of foreign corporation. — (a) IN GENERAL. who were the owners of such assets immediately prior to the transfer;
— Any attorney, accountant, fiduciary, bank, trust company, financial institution, or other person, who, (8) The names and addresses of the shareholders of the foreign corporation at the time of the
after July 5, 1939, aids, assists, counsels, or advises in, or with respect to, the formation, completion of its formation, organization, or reorganization, showing the classes of stock and number
organization, or reorganization of any foreign corporation (including a foreign association or of shares held by each;
partnership) shall file with the Commissioner of Internal Revenue, within thirty days after giving such (9) The name and address of the person (or persons) having custody of the books of account and
aid, assistance, counsel or advise, an information return; as provided in Section 80 and this section. records of the foreign corporation;
The return must be filed in every such case (1) regardless of the nature of the counsel or advice (10) Such other information as may be required by the return form; and
given, whether for or against the formation, organization, or reorganization of the foreign corporation, (11) Where any of the information required to be furnished is withheld because its character is
or the nature of the aid or assistance rendered and (2) regardless of the action taken upon the advice claimed to be privileged as a communication between attorney and client within the meaning of
or counsel, that is, whether the foreign corporation is actually formed, organized, or reorganized. Section 80, the return must so state and must contain a complete statement of the nature and the
If, in a particular case, the aid, assistance, counsel or advice given by any person extends over a circumstances of the communication on which a decision as to the propriety of the claim of privilege
period of more than one day and not for more than thirty days, such persons, to avoid the multiple may be reached.
filing of returns, may file a single return for the entire period. In such case, the return shall be filed
within thirty days from the first day of such period: If, in a particular case, the aid, assistance, counsel, If a person aids, assists, counsels, or advises in or with respect to, the formation, organization, or
or advice given by any person extends over a period of more than thirty days, such person may file a reorganization of more than one foreign corporation, a separate return must be filed with respect to
return at the end of each thirty days included within such period and at the end of the fractional part of each foreign corporation.
a thirty day period, if any, extending beyond the last full thirty days. In each such case, the return must
disclose all the required information which was not reported on a prior return. (e) VERIFICATION OF RETURN. — All returns required by Section 80 and this section shall be
verified under oath or affirmation.
(b) SPECIAL PROVISIONS. — (1) Employers. — In the case of aid, assistance, counsel, or advice (Section 81 of the Code)
in, or with respect to, the formation, organization, or reorganization of a foreign corporation given by a
person in whole or in part through the medium of subordinates or employees (including in the case of SECTION 247.Disposition of income tax returns. — All income tax returns filed with the
a corporation the officers thereof), the return of the employer must set forth to the full extent all Commissioner of Internal Revenue constitute public records which shall be open to inspection under
information prescribed by these regulations, including that which, as an incident to such employment, rules and regulations prescribed by the Secretary of Finance with the approval of the President of the
is within the possession or knowledge or under the control of such subordinates or employees. Philippines. The circumstances under which income tax returns may be inspected by interested
parties are dealt with under separate regulations.
(2) EMPLOYEES. — The obligation of a subordinate or employee (including in the case of a
corporation the officers thereof) to file a return with respect to any aid, assistance, counsel, or advice SECTION 248.Publication of list of persons filing returns and paying taxes. — The second paragraph
in, or with respect to, the formation, organization, or reorganization of a foreign corporation, given as of Section 81 expressly authorizes the Commissioner of Internal Revenue, with the approval of the
an incident to his employment, will be satisfied if a complete and adequate return as prescribed by Secretary of Finance, to cause to be prepared and published in any newspaper or made available to
these regulations is duly filed by the employer setting forth all of the information within the possession public inspection through other means, lists containing the names and addresses of persons who
or knowledge or under the control of such subordinate or employee. have filed income tax returns, or lists of those who paid income taxes, or both such kinds of lists.
(Section 82 of the Code)
Clerks, stenographers, and other subordinates or employees, rendering aid or assistance solely of a
clerical or mechanical character in, or with respect to, the formation, organization or reorganization of SECTION 249.Recovery of tax. — A suit or proceeding may be maintained for the recovery of any
a foreign corporation are not required to file returns by reason of such services. internal-revenue tax alleged to have been erroneously or illegally assessed and collected, in
accordance with Section 306 of the Code. However, where the Commissioner of Internal Revenue
(3) RETURNS JOINTLY MADE. — If two or more persons aid, assist, counsel, or advise in, or with believes that a return is false or fraudulent or contains any understatement or undervaluation and
respect to, the formation, organization, or reorganization of a particular foreign corporation, any two or proceeds to assess and collect the tax due, no portion of the tax so collected shall be recovered by
more of such persons may, in lieu of filing several returns jointly execute and file one return. any suit unless it is proved that the return was not in fact false or fraudulent and did not contain any
understatement or undervaluation, except with respect to return is made in good faith regarding
(c) PENALTIES. — For criminal penalties for failure to file the return required by Section 80, see annual depreciation of oil or gas wells and mines.
Section 73 of the Code. (Section 83 of the Code)
Revenue Regulations 02-40 Page 38 of 39

SECTION 250.Dividends. — Dividends, for the purpose of the law, comprise any distribution whether (a) Where the stock issued as dividend is all or substantially the same character or preference as
in cash or other property, in the ordinary course of business, even though extraordinary in amount, the stock upon which the stock dividend is paid, the cost of each share (or when acquired prior
made by a domestic or resident foreign corporation, joint-stock company, partnership, joint account to March 1, 1913, the fair market value as of such date) will be the quotient of the cost (or such
(cuentas en participacion), association, or insurance company to the shareholders or members out of fair market value) of the old shares of stock divided by the total number of the old and new
its earnings or profits accumulated since March 1, 1913. shares.
(b) Where the stock issued as a dividend is in whole or in part of a character or preference
Although interest on certain Government bonds and other similar obligations is not taxable when materially different from the stock upon which the stock dividend is paid, the cost (and when
received by a corporation, upon amalgamation with the other funds of the corporation, such income acquired prior to March 1, 1913, the fair market value as of such date) of the old shares of stock
loses its identity and when distributed to shareholders, is taxable to the same extent as other shall be divided between such old stock and the new stock, in proportion, as nearly as may be,
dividend. to the respective value of each class of stock, old and new, at the time the new shares of stock
are issued, and the cost (or when acquired prior to March 1, 1913, the fair market value as of
A taxable distribution made by a corporation to individual stockholders or members shall be included such date) of each share of stock will be the quotient of the cost (or such fair market value as of
is the gross income of the distributees when the cash of other property is unqualifiedly made subject March 1, 1913) of the class to which such share belongs divided by the number of shares in that
to their demand. Dividends, in cash or other property received by an individual, are subject to tax in class.
his hands in the same manner another income. (c) Where the stock with respect to which a stock dividend is issued was purchased at different
times and at different prices and the identity of the lots can. not be determined, any sale of the
Dividends, whether in cash or other property, received by a domestic or resident foreign corporation original stock, will be charged to the earliest purchases of such stock, and any sale of dividend
from a domestic corporation are taxable only to the extent of 25 per cent thereof in accordance with stock issued with respect to such stock will be presumed to have been made from the stock
Section 24 of the Code. Dividends received by a domestic corporation from a foreign corporation, issued with respect to the earliest purchased stock, to the amount of the dividend chargeable to
whether resident or nonresident, are taxable to the extent that they constitute income from sources such stock.
within the Philippines, as provided in Section 37 (a) (2) (b) of the Code. Dividends paid by the (d) Where the stock with respect to which a stock dividend is declared was purchased at different
domestic corporation to a nonresident foreign corporation are taxable in full. (For definition of the times and at different prices, and the dividend stock issued with respect to such stock can not be
different classes of corporations, see Section 84 of the Code). identified as having been issued with respect to any particular lot of such stock, then any sale of
such dividend stock will be presumed to have been made from the stock issued with respect to
SECTION 251.Dividends paid in property. — Dividends paid in securities or other property (other than the earliest purchased stock, to the amount of the stock dividend chargeable to such stock.
its own stock), in which the earnings of a corporation have been invested, are income to the recipients
to the amount of the full market value of such property when receivable by individual stockholders. SECTION 254.Declaration and subsequent redemption of a stock dividend. — A true stock dividend is
When receivable by corporations, the amount of such dividends includible for purposes of the tax on not subject to tax on its receipt in the hands of the recipient. Nevertheless, if a corporation, after the
corporations are specified in Section 24 of the Code. (See also Section 250 of these regulations). A distribution of a stock dividend, proceeds to cancel or redeem its stock at such time and in such
dividend paid in stock of another corporation is not a stock dividend, even though the stock distributed manner as to make the distribution and cancellation or redemption essentially equivalent to the
was acquired through the transfer by the corporation declaring the dividends of property to the distribution of a taxable dividend, the amount received in redemption or cancellation of the stocks
corporation the stock of which is distributed as a dividend. Where a corporation declares a dividend shall be treated as a taxable dividend to the extent of the earnings or profits accumulated by such
payable in a stock of another corporation, setting aside the stock to be so distributed and notifying the corporation since March 1, 1913.
stockholders of its action, the income arising to the recipients of such stock is its market value at the
time the dividend becomes payable. Scrip dividends are subject to tax in the year in which the SECTION 255.Sources of distribution. — For the purpose of income taxation every distribution made
warrants are issued. by a corporation is made out of earnings or profits to the extent thereof and from the most recently
accumulated earnings or profits. In determining the source of a distribution, consideration should be
SECTION 252.Stock dividends. — A stock dividend which represents the transfer of surplus to capital given first, to the earnings or profits of the taxable year; second, to the earnings or profits
account is not subject to income tax. However a dividend in stock may constitute taxable income to accumulated since February 28, 1913, only in the case where, and to the extent that, the distribution
the recipients thereof notwithstanding the fact that the officers or directors of the corporation (as made during the taxable year are not regarded as out of the earnings or profits of the taxable year
defined in Section 84) choose to call such distribution as a stock dividend. The distinction between a and all the earnings or profits accumulated since February 28, 1913, have been distributed; and,
stock dividend which does not, and one which does, constitute income taxable to the shareholder is fourth, to sources other than earnings or profits only after the earnings or profits have been
the distinction between a stock dividend which works no change in the corporate entity, the same distributed.
interest in the same corporation being represented after the distribution by more shares of precisely
the same character, and a stock dividend where there either has been a change of corporate identity SECTION 256.Distribution in liquidation. — In all cases where a corporation (as defined in Section
or a change in the nature of the shares issued as dividends whereby the proportional interest of the 84) distributes all of its property or assets in complete liquidation or dissolution, the gain realized from
shareholders after the distribution is essentially different from his former interests. A stock dividend the transaction by the stockholder, whether individual or corporate, is taxable to the extent recognized
constitutes income if it gives the shareholder an interest different from that which his former stock in Section 34(b) of the Code. For this purpose, the term "complete liquidation" includes any one of a
holdings represented. A stock dividend does not constitute income if the new shares confer no series of distributions made by a corporation in complete cancellation or redemption of all of its stock
different rights or interests than did the old — the new certificates plus the old representing the same in accordance with a bona fide plan of liquidation under which the transfer of all the assets under
proportionate interest in the net assets of the corporation as did the old. liquidation is to be complete within a reasonable time from the date of the first distribution, usually not
to exceed one year from the time of such first distribution. If the amount received by the stockholder in
SECTION 253.Sale of stock received as dividends. — Stock issued by a corporation, as a dividend, liquidation is less than the cost or other basis of the stock, the loss in the transaction is deductible to
does not constitute taxable income to a stockholder in such corporation, but gain may be derived or the extent allowed in Section 34(c) of the Code.
loss sustained by the stockholder, whether individual or corporate, from the sale of such stock, which (Section 84 of the Code)
gain or loss will be treated as arising from the sale or exchange of a capital asset. (See Section 34 of
the Code.) The amount of gain derived or loss sustained from the sale of such stock, or from the sale SECTION 257.Income and deductions of American citizens residing in the Philippines. — Under
of the stack with respect to which it is issued, shall be determined in accordance with the following subsection (u) of Section 84, a citizen of the United States residing in the Philippines, is taxable on
rules: income from sources both within and without the Philippines, except income from sources within the
United States. Accordingly, items of deductions allocable to income of such taxpayer from sources
Revenue Regulations 02-40 Page 39 of 39

within the United States are not deductible from his income subject to Philippine income tax. (Deemed
repealed since our independence).

SECTION 258. Effective date. — These regulations shall take effect upon their promulgation in the
Official Gazette.

(Promulgated February 11, 1941, XXXIX Off. Gaz., No. 18, page 325)

Recommended by:

BIBIANO L. MEER
Collector of Internal Revenue

MANUEL ROXAS
Secretary of Finance