1. Definition of Gross Income What is income?

A) Definition under the NIRC: all income derived from whatever source, including (but not limited) to the following items: 1) compensation for services in whatever form paid, including but not limited to fees, salaries, wages, commissions and similar items 2) gross income derived from the conduct of trade or business or the exercise of a profession 3) gains derived from dealings in property 4) interests 5) rents 6) royalties 7) dividends 8) annuities 9) prizes and winnings 10) pensions 11) partner's distributive share from the net income of the general professional partnership NOTE: Everything which falls under this definition is part of gross income. BUT, that does not necessarily mean that it is taxable B) Haig-Simmons Definition Personal income may be defined as the algebraic sum of 1) the market value of rights exercised in consumption; and 2) the change in value of the store or property rights between the beginning and the end of the period in question The problem with the definition given: 1) what are property devaluation (e.g. car value depreciation) - who decides the value of one's property rights 2) liquidity - without a sale of one's property, an individual may not have available cash to pay for tax on the property, even though the assessed value has increased. C) Eisner v. Macomber definition The gain derived from capital, from labor, or from both combined (this is very restrictive) Net income should include dividends and also gains or profits and income derived from any source whatever, but this does NOT include stock dividends D) Commissioner v. Glenshaw 3 part test to determine the income (this expanded the Eisner definition of income)

1) an accession to wealth (is A richer?) 2) clearly realized (has some event happened such that A received money?) 3) compete dominion over the money Sec 32 of the NIRC follows the Glenshaw definition 2. Exclusions from Gross Income 1) life insurance proceeds (benefits) 2) amount received by insured as return of premium 3) value of property acquired as gifts, bequests, and devises (but its doesn't include income from such property) 4) compensation for injuries or sickness plus damages received 5) income exempt under treaty obligations 6) retirement benefits, pensions, gratuities 7) amount received as a consequence of separation 8) miscellaneous items a) income derived from foreign governments social security benefits, retirement gratuities, pensions and other similar benefits b) benefits due under the laws of the US administered by the US Veterans Administration c) income from investment in the Philippines in loans, bonds or other domestic securities, or from deposits in banks in the Philippines d) income derived by the government or its political subdivisions public utility e) prizes and awards i. the recipient was selected without any action on his part ii. recipient not required to render service as a condition f) prizes and awards in sport competition g) 13th month pay and other benefits h) GSIS, SSS, Medicare and other contributions i) Gains from the sale of bonds, debentures or other certificates of indebtedness j) Gains from redemption of shares in mutual fund

ITEMS OF GROSS INCOME SEC. 32. Gross Income. (A) General Definition. Except when otherwise provided in this Title, gross income means all income derived from whatever source, including (but not limited to) the following items: (1) Compensation for services in whatever form paid, including, but not limited to fees, salaries, wages, commissions, and similar items;

(2) Gross income derived from the conduct of trade or business or the exercise of a profession; (3) Gains derived from dealings in property; (4) Interests; (5) Rents; (6) Royalties; (7) Dividends; (8) Annuities; (9) Prizes and winnings; (10) Pensions; and (11) Partner's distributive share from the net income of the general professional partnership. (B) Exclusions from Gross Income. The following items shall not be included in gross income and shall be exempt from taxation under this Title: (1) Life Insurance. The proceeds of life insurance policies paid to the heirs or beneficiaries upon the death of the insured, whether in a single sum or otherwise, but if such amounts are held by the insurer under an agreement to pay interest thereon, the interest payments shall be included in gross income. (2) Amount Received by Insured as Return of Premium. The amount received by the insured, as a return of premiums paid by him under life insurance, endowment, or annuity contracts, either during the term or at the maturity of the term mentioned in the contract or upon surrender of the contract. (3) Gifts, Bequests, and Devises. The value of property acquired by gift, bequest, devise, or descent: Provided, however, That income from such property, as well as gift, bequest, devise, or descent of income from any property, in cases of transfers of divided interest, shall be included in gross income. (4) Compensation for Injuries or Sickness. Amounts received, through Accident or Health Insurance or under Workmen's Compensation Acts, as compensation for personal injuries or sickness, plus the amounts of any damages received, whether by suit or agreement, on account of such injuries or sickness. (5) Income Exempt under Treaty. Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines. (6) Retirement Benefits, Pensions, Gratuities, etc. (a) Retirement benefits received under Republic Act No. 7641 and those received by officials and employees of private firms, whether individual or corporate, in accordance with a reasonable private benefit plan maintained by the employer: Provided, That the retiring official or employee has been in the service of the same employer for at least ten (10) years and is not less than fifty (50) years of age at the time of his retirement: Provided, further, That the benefits granted under this subparagraph shall be availed of by an official or employee only once. For purposes of this Subsection, the term 'reasonable private benefit plan' means a pension, gratuity, stock bonus or

profit-sharing plan maintained by an employer for the benefit of some or all of his officials or employees, wherein contributions are made by such employer for the officials or employees, or both, for the purpose of distributing to such officials and employees the earnings and principal of the fund thus accumulated, and wherein it is provided in said plan that at no time shall any part of the corpus or income of the fund be used for, or be diverted to, any purpose other than for the exclusive benefit of the said officials and employees. (b) Any amount received by an official or employee or by his heirs from the employer as a consequence of separation of such official or employee from the service of the employer because of death, sickness or other physical disability or for any cause beyond the control of the said official or employee. (c) The provisions of any existing law to the contrary notwithstanding, social security benefits, retirement gratuities, pensions and other similar benefits received by resident or nonresident citizens of the Philippines or aliens who come to reside permanently in the Philippines from foreign government agencies and other institutions, private or public. (d) Payments of benefits due or to become due to any person residing in the Philippines under the laws of the United States administered by the United States Veterans Administration. (e) Benefits received from or enjoyed under the Social Security System in accordance with the provisions of Republic Act No. 8282. (f) Benefits received from the GSIS under Republic Act No. 8291, including retirement gratuity received by government officials and employees. (7) Miscellaneous Items. (a) Income Derived by Foreign Government. Income derived from investments in the Philippines in loans, stocks, bonds or other domestic securities, or from interest on deposits in banks in the Philippines by (i) foreign governments, (ii) financing institutions owned, controlled, or enjoying refinancing from foreign governments, and (iii) international or regional financial institutions established by foreign governments. (b) Income Derived by the Government or its Political Subdivisions. Income derived from any public utility or from the exercise of any essential governmental function accruing to the Government of the Philippines or to any political subdivision thereof. (c) Prizes and Awards. Prizes and awards made primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement but only if: (i) The recipient was selected without any action on his part to enter the contest or proceeding; and (ii) The recipient is not required to render substantial future services as a condition to receiving the prize or award. (d) Prizes and Awards in Sports Competition. All prizes and awards granted to athletes in local and international sports competitions and tournaments whether held in the Philippines or abroad and sanctioned by their national sports associations. (e) 13th Month Pay and Other Benefits. Gross benefits received by officials and employees of

public and private entities: Provided, however, That the total exclusion under this subparagraph shall not exceed Thirty thousand pesos (P30,000) which shall cover: (i) Benefits received by officials and employees of the national and local government pursuant to Republic Act No. 6686; (ii) Benefits received by employees pursuant to Presidential Decree No. 851, as amended by Memorandum Order No. 28, dated August 13, 1986; (iii) Benefits received by officials and employees not covered by Presidential Decree No. 851, as amended by Memorandum Order No. 28, dated August 13, 1986; and (iv) Other benefits such as productivity incentives and Christmas bonus: Provided, further, That the ceiling of Thirty thousand pesos (P30,000) may be increased through rules and regulations issued by the Secretary of Finance, upon recommendation of the Commissioner, after considering, among others, the effect on the same of the inflation rate at the end of the taxable year. (f) GSIS, SSS, Medicare and Other Contributions. GSIS, SSS, Medicare and Pag-Ibig contributions, and union dues of individuals. (g) Gains from the Sale of Bonds, Debentures or other Certificate of Indebtedness. Gains realized from the sale or exchange or retirement of bonds, debentures or other certificate of indebtedness with a maturity of more than five (5) years. (h) Gains from Redemption of Shares in Mutual Fund. Gains realized by the investor upon redemption of shares of stock in a mutual fund company as defined in Section 22(BB) of this Code.

1. Compensation for Personal Services a. in money b. in kind i) Convenience-of-the-employer rule INTEREST INCOME 1. Taxable 2. Not Taxable 3. Imputed Interest on inter-company loans/advances INCOME UNDER LEASE AGREEMENT (Sec. 49, RR-2)

1. Rent 2. Obligations of lessor to third parties assumed and paid by lessee 3. Advance Rental 4. Leasehold Improvements DIVIDEND INCOME

Dividend represents a distribution of the profits by a corporations 1. Kinds of dividends recognized in law a. Cash - when taxable, the measure of income is the amount of money received b. Property - when taxable, the measure of income is the FMV of the property received. A dividend paid in shares of stocks of another corporation, or in treasury stocks, is a property dividend. c. Stock Held: "Stock dividends" are not "income," the same cannot be taxed under that provision of Act No. 2833 which provides for a tax upon income. Under the guise of an income tax, property which is not an income cannot be taxed.

2. Measure of income in cash and property dividend

3. stock dividend a. When taxable - if it gives the shareholder an interest different from that which his former stock represented i) Measure of Income - FMV of the shares of stocks received b. When not taxable - if the new shares confer no different interest or rights than the old

i) Adjusted cost per share where the stock received as dividend is all of substantially the same character or preference as the stock upon which the stock dividend is paid, the cost of each share shall be equal to the cost of the old shares divided by the total number of the old and new shares. The new basis per share is used in computing any gain or loss upon any subsequent sale of the shares.

4. Liquidated Dividend

5. Essentially Equivalent to distribution of taxable dividends General Rule Section 83(b) of the 1939 NIRC was taken from Section 115(g)(1) of the U.S. Revenue Code of 1928. It laid down the general rule known as the proportionate test wherein stock dividends once issued form part of the capital and, thus, subject to income tax. Specifically, the general rule states that:A stock dividend representing the transfer of surplus to capital account shall not be subject to tax. Having been derived from a foreign law, resort to the jurisprudence of its origin may shed light. Under the US Revenue Code, this provision originally referred to stock dividends only, without any exception. Stock dividends, strictly speaking, represent capital and do not constitute income to its recipient. So that the mere issuance thereof is not yet subject to income tax as they are nothing but an enrichment through increase in value of capital investment. As capital, the stock dividends postpone the realization of profits because the fund represented by the new stock has been transferred from surplus to capital and no longer available for actual distribution. Income in tax law is an amount of money coming to a person within a specified time, whether as payment for services, interest, or profit from investment. It means cash or its equivalent. It is gain derived and severed from capital, from labor or from both combined - so that to tax a stock dividend would be to tax a capital increase rather than the income. In a loose sense, stock dividends issued by the corporation, are considered unrealized gain, and cannot be subjected to income tax until that gain has been realized. Before the realization, stock dividends are nothing but a representation of an interest in the corporate properties. As capital, it is not yet subject to income tax. It should be noted that capital and income are different. Capital is wealth or fund; whereas income is profit or gain or the flow of wealth. The determining factor for the imposition of income tax is whether any gain or profit was derived from a transaction. The Exception However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent it represents a distribution

of earnings or profits accumulated after March first, nineteen hundred and thirteen. (Emphasis supplied). Although redemption and cancellation are generally considered capital transactions, as such, they are not subject to tax. However, it does not necessarily mean that a shareholder may not realize a taxable gain from such transactions. Simply put, depending on the circumstances, the proceeds of redemption of stock dividends are essentially distribution of cash dividends, which when paid becomes the absolute property of the stockholder. Thereafter, the latter becomes the exclusive owner thereof and can exercise the freedom of choice. Having realized gain from that redemption, the income earner cannot escape income tax. As qualified by the phrase such time and in such manner, the exception was not intended to characterize as taxable dividend every distribution of earnings arising from the redemption of stock dividends. So that, whether the amount distributed in the redemption should be treated as the equivalent of a taxable dividend is a question of fact, which is determinable on the basis of the particular facts of the transaction in question. No decisive test can be used to determine the application of the exemption under Section 83(b) The use of the words such manner and essentially equivalent negative any idea that a weighted formula can resolve a crucial issue - Should the distribution be treated as taxable dividend. On this aspect, American courts developed certain recognized criteria, which includes the following: 1) the presence or absence of real business purpose, 2) the amount of earnings and profits available for the declaration of a regular dividend and the corporations past record with respect to the declaration of dividends, 3) the effect of the distribution as compared with the declaration of regular dividend, 4) the lapse of time between issuance and redemption, 5) the presence of a substantial surplus and a generous supply of cash which invites suspicion as does a meager policy in relation both to current earnings and accumulated surplus. A. Interest 1. Interest Deductible From Gross Income (1) In General. The amount of interest paid or incurred within a taxable year on indebtedness in connection with the taxpayer's profession, trade or business shall be allowed as deduction from gross income: Provided, however, That the taxpayer's otherwise allowable deduction for interest expense shall be reduced by an amount equal to the following percentages of the interest income subjected to final tax: Forty-one percent (41%) beginning January 1, 1998; Thirty-nine percent (39%) beginning January 1, 1999; and Thirty-eight percent (38%) beginning January 1, 2000. (2) Exceptions. No deduction shall be allowed in respect of interest under the succeeding

subparagraphs: (a) If within the taxable year an individual taxpayer reporting income on the cash basis incurs an indebtedness on which an interest is paid in advance through discount or otherwise: Provided, That such interest shall be allowed as a deduction in the year the indebtedness is paid: Provided, further, That if the indebtedness is payable in periodic amortizations, the amount of interest which corresponds to the amount of the principal amortized or paid during the year shall be allowed as deduction in such taxable year; (b) If both the taxpayer and the person to whom the payment has been made or is to be made are persons specified under Section 36(B); or (c) If the indebtedness is incurred to finance petroleum exploration. (3) Optional Treatment of Interest Expense. At the option of the taxpayer, interest incurred to acquire property used in trade, business or exercise of a profession may be allowed as a deduction or treated as a capital expenditure.

2. Interest Not Deductible No deduction is allowed in respect of interest under the following: a. ADVANCE INTEREST - if within the taxable year an individual taxpayer reporting income on the cash basis incurs an indebtedness on which an interest is paid in advance through discount or otherwise Provided, that such interest shall be allowed as a deduction in the year the indebtedness is paid. Provided further, that if the indebtedness is payable in periodic amortizations the amount of interest which corresponds to the amount of the principal amortized or paid during the year shall be allowed as a deduction in such taxable year. **under this provision, the phrase "within the taxable year" assumes a modified meaning. For example, a taxpayer using the cash basis method of accounting borrows money in which interest is paid in advance through discount. He obtains a loan of P1,000,000 in October 1998 subject to 20% interest; hence, after paying the advance interest of P200,000 he receives only P 800,000.00 Can the borrower/taxpayer claim the deduction when he files his ITR in April 1999? It depends on w/n the principal obligation had been paid. i. if the entire principal obligation had been paid, then the entire amount of interest can be claimed as itemized deduction ii. if only 1/2 of the obligation has been paid, only 1/2 interest can be claimed as itemized deduction; iii. if no payment had been paid on the principal obligation, the advance interest paid cannot be claimed as deduction on the year that it was paid.

b. PERSONS UNDER 36b - if both the taxpayer and the person to whom the payment has been made or is to be made are persons specified under section 36B, namely: i. between members of a family ii. between an individual and a corporation more than 50% in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual; and iii. between two corporations more than 50% in value of the outstanding stock of each of which is owned, directly or indirectly, by or for the same individual; iv. between the grantor and a fiduciary of any trust; or v. between the fiduciary of a trust and the fiduciary of another trust if the same person is a grantor with respect to each trust vi. between a fiduciary or a trust and a beneficiary c. PETROLEUM OPERATION - if the indebtedness is incurred to finance petroleum operation.

3. Prepaid Interest Of Individual On Cash Method Of Accounting Comm. V. Vda De Prieto (109 Phil 592) Facts: Vda. de Prieto conveyed by way of gifts to her 4 children real property with a total assessed value of P892,497.50. After the filing of the gift tax returns, CIR appraised the real property donated for gift tax purposes at P1,231,268.00 and assessed the total sum of P117,706.50 as donor's gift tax, interests and compromises due thereon. Of the total sum of P117,706.50 paid by respondent the sum of P55,978.65 represents the total interest on account of delinquency. This sum of P55,978.65 was claimed as deduction. Petitioner, however, disallowed the claim and as a consequence of such disallowance assessed respondent for 1954 the total sum of P21,410.38 as deficiency income tax due on the aforesaid P55,978.65, including interest, surcharge and compromise for the late payment. Issue: w/n the interest paid by respondent for the late payment of her donor's tax is deductible from her gross income Held: YES. 1) Under the law, for interest to be deductible, it must be shown that there be an indebtedness, that there should be interest upon it, and that what is claimed as an interest deduction should have been paid or accrued within the year. It is here conceded that the interest paid by respondent was in consequence of the late payment of her donor's tax, and the same was paid within the year it is sought to be deducted.

2) The term "indebtedness" has been defined as an unconditional and legally enforceable obligation for the payment of money. Within the meaning of that definition, it is apparent that a tax may be considered an indebtedness. "Although taxes already due have not, strictly speaking, the same concept as debts, they are, however, obligations that may be considered as such. Where statute imposes a personal liability for a tax, the tax becomes, at least in a board sense, a debt. It follows that the interest paid by herein respondent for the late payment of her donor's tax is deductible from her gross income under section 30 (b) of the Tax Code above quoted. 3) The uniform ruling is that interest on taxes is interest on indebtedness and is deductible. 4) In conclusion, we are of the opinion and so hold that although interest payment for delinquent taxes is not deductible as tax under Section 30(c) of the Tax Code and section 80 of the Income Tax Regulations, the taxpayer is not precluded thereby from claiming said interest payment as deduction under section 30(b) of the same Code.

4. Reduction Of Interest Expense On Interest Income Subjected To Final Tax Under TRA of 1997

5. RR 13-2000 (Nov. 20, 2000) Requirement for deductibility of Interest Expense SEC. 3. TAX INCENTIVES ACCRUING TO THE ADOPTING PRIVATE ENTITY. A pre-qualified adopting private entity, which enters into an Agreement with a public school, shall be entitled to the following tax incentives: (a) Deduction from the gross income of the amount of contribution/donation that were actually, directly and exclusively incurred for the Program, subject to limitations, conditions and rules set forth in Section 34(H) of the Tax Code, plus an additional amount equivalent to fifty percent (50%) of such contribution/donation subject to the following conditions: (1) That the deduction shall be availed of in the taxable year in which the expenses have been paid or incurred; (2) That the taxpayer can substantiate the deduction with sufficient evidence, such as official receipts or delivery receipt and other adequate records (2.1) The amount of expenses being claimed as deduction; (2.2) The direct connection or relation of the expenses to the adopting private entitys participation in the Adopt-a-School Program. The adopting private entity shall also provide a list of projects and/or activities undertaken and the cost of each undertaking, indicating in particular where and how the assistance has been utilized as supported by the Agreement; and (2.3) Proof or acknowledgment of receipt of the contributed/donated property by the recipient public

school. (3) That the application, together with the approved Agreement endorsed by the National Secretariat, shall be filed with the Revenue District Office (RDO) having jurisdiction over the place of business of the donor/adopting private entity, copy furnished the RDO having jurisdiction over the property, if the contribution/donation is in the form of real property. (b) Exemption of the Assistance made by the donor from payment of donors tax pursuant to Sections 101 (A)(2) and (B)(1) of the Tax Code of 1997.

B. Taxes Sec. 34, C, NIRC (1) In General. - Taxes paid or incurred within the taxable year in connection with the taxpayer's profession, trade or business, shall be allowed as deduction, except (a) The income tax provided for under this Title; (b) Income taxes imposed by authority of any foreign country; but this deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of paragraph (3) of this subsection (relating to credits for taxes of foreign countries); (c) Estate and donor's taxes; and (d) Taxes assessed against local benefits of a kind tending to increase the value of the property assessed. Provided, That taxes allowed under this Subsection, when refunded or credited, shall be included as part of gross income in the year of receipt to the extent of the income tax benefit of said deduction. (2) Limitations on Deductions. - In the case of a nonresident alien individual engaged in trade or business in the Philippines and a resident foreign corporation, the deductions for taxes provided in paragraph (1) of this Subsection (C) shall be allowed only if and to the extent that they are connected with income from sources within the Philippines. (3) Credit Against Tax for Taxes of Foreign Countries. - If the taxpayer signifies in his return his desire to have the benefits of this paragraph, the tax imposed by this Title shall be credited with: (a) Citizen and Domestic Corporation. - In the case of a citizen of the Philippines and of a domestic corporation, the amount of income taxes paid or incurred during the taxable year to any foreign country; and (b) Partnerships and Estates. - In the case of any such individual who is a member of a general professional partnership or a beneficiary of an estate or trust, his proportionate share of such taxes of the general professional partnership or the estate or trust paid or incurred during the taxable year to a foreign country, if his distributive share of the income of such partnership or trust is reported for taxation under this Title. An alien individual and a foreign corporation shall not be allowed the credits against the tax for the

taxes of foreign countries allowed under this paragraph. (4) Limitations on Credit. - The amount of the credit taken under this Section shall be subject to each of the following limitations: (a) The amount of the credit in respect to the tax paid or incurred to any country shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer's taxable income from sources within such country under this Title bears to his entire taxable income for the same taxable year; and (b) The total amount of the credit shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer's taxable income from sources without the Philippines taxable under this Title bears to his entire taxable income for the same taxable year. (5) Adjustments on Payment of Incurred Taxes. - If accrued taxes when paid differ from the amounts claimed as credits by the taxpayer, or if any tax paid is refunded in whole or in part, the taxpayer shall notify the Commissioner; who shall redetermine the amount of the tax for the year or years affected, and the amount of tax due upon such redetermination, if any, shall be paid by the taxpayer upon notice and demand by the Commissioner, or the amount of tax overpaid, if any, shall be credited or refunded to the taxpayer. In the case of such a tax incurred but not paid, the Commissioner as a condition precedent to the allowance of this credit may require the taxpayer to give a bond with sureties satisfactory to and to be approved by the Commissioner in such sum as he may require, conditioned upon the payment by the taxpayer of any amount of tax found due upon any such redetermination. The bond herein prescribed shall contain such further conditions as the Commissioner may require. (6) Year in Which Credit Taken. - The credits provided for in Subsection (C)(3) of this Section may, at the option of the taxpayer and irrespective of the method of accounting employed in keeping his books, be taken in the year which the taxes of the foreign country were incurred, subject, however, to the conditions prescribed in Subsection (C)(5) of this Section. If the taxpayer elects to take such credits in the year in which the taxes of the foreign country accrued, the credits for all subsequent years shall be taken upon the same basis and no portion of any such taxes shall be allowed as a deduction in the same or any succeeding year. (7) Proof of Credits. - The credits provided in Subsection (C)(3) hereof shall be allowed only if the taxpayer establishes to the satisfaction of the Commissioner the following: (a) The total amount of income derived from sources without the Philippines; (b) The amount of income derived from each country, the tax paid or incurred to which is claimed as a credit under said paragraph, such amount to be determined under rules and regulations prescribed by the Secretary of Finance; and (c) All other information necessary for the verification and computation of such credits. Sec. 80-82, RR-2 Sec. 80. Taxes in general.As a general rule, taxes are deductible with the exception of those with respect to which the law does not permit deduction. However, in the case of a nonresident alien

individual and a foreign corporation, deduction is allowed only if and to the ex that the taxes for which deduction is claimed are connected with income from sources within the Philippines. Import duties paid to the proper customs officers, and business, occupation, license, privilege, excise and stamp taxes and any other taxes of every name or nature paid directly to the Government of the Philippines or to any political subdivision thereof, are deductible. The word taxes means taxes, proper and no deduction should be allowed for amounts representing interest, surcharge, or penalties incident to delinquency. Postage is not a tax. Automobile registration fees are considered taxes. Taxes are deductible at most only by the person upon whom they are imposed. Thus the merchants sales tax imposed by law upon sales is not deductible by the individual purchaser even though the tax may be billed to him as a separate item. In computing the net income of an individual no deduction is allowed for the tax is imposed upon his interest as shareholder of a bank or other corporation, which are paid by the corporation without reimbursements from the taxpayer. The amount so paid should not be included in the income of the shareholder. In the case of corporate bonds or other obligations containing a tax-free covenant clause, the corporation paying a tax or any part of it for someone else pursuant to its agreement is not entitled to deduct such payment from gross income on any ground. Sec. 81. Income tax imposed by the government of the Philippines. The law does not permit the deduction of the income tax paid to or accrued in favor of the Government of the Philippines, and in no case may the taxpayer avail of such deduction. Sec. 82. Income, war-profits, and excess-profits taxes imposed by the authority of a foreign country. Income, war-profits, and excess-profits taxes imposed by the authority of a foreign country (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 allowing credits against the tax for taxes of foreign countries. In the case of a citizen of a foreign country residing in the Philippines whose income from sources within such foreign country is not subject to income tax, only that portion of the taxes paid to such foreign country which corresponds to his net income subject to the Philippine income tax shall be allowed as deduction.

1. Deductible From Gross Income GENERAL RULE: Taxes paid or incurred within the taxable year in connection with the taxpayer's profession, trade or business, shall be allowed as deduction. ** Import duties paid to the proper customs officers and business, occupation, license, privilege, excise

and stamp taxes and any other taxes of every name or nature paid directly to the Government of the Philippines or to any political subdivision thereof, are deductible. The word "taxes" means taxes proper and no deduction shall be allowed for amounts representing interest, surcharge, or penalties incident to delinquency. Postage is not a tax. Automobile registration fees are considered taxes. Taxes are deductible as such only by the person upon whom they are imposed. Thus the merchants sales tax imposed by law upon sales is not deductible by the individual purchasers even though the tax may be billed to him as a separate item. EXCEPTIONS: a. Income tax b. Income taxes imposed by authority of any foreign country (but this deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of tax credits paid to foreign countries) c. Estate and donor's taxes d. Taxes assessed against local benefits of a kind tending to increase the value of the property assessed. Provided, that the taxes allowed under this subsection, when refunded or credited shall be included as part of gross income in the year of receipt to the extent of the income tax benefit of said deduction. Others (under Sec 80-82, RR2): a. Taxes paid by a nonresident alien individual and a foreign corporation - taxes are deductible only if and to the extent that the taxes for which deduction is claimed are connected with income from sources within the Philippines; b. Income tax imposed by the Philippine government - the law does not allow the deduction of the income tax paid to or accrued in favor of the government and in no case may the taxpayer avail of such deduction; c. income, war profits, and excess profits taxes imposed by the authority of a foreign country - allowed as deductions only if the taxpayer does not signify in his return his desire to have to any extent the benefits of the provisions of law allowing credits against the tax for taxes of foreign countries. In the case of a citizen of a foreign country residing in the Philippines whose income from sources within such foreign country is not subject to income tax, only that portion of the taxes paid to such foreign country which corresponds to his net income subject to the Philippine income tax shall be allowed as deduction.

** In computing the net income of an individual, no deduction is allowed for the tax is imposed upon his interest as shareholder of a bank or other corporation, which are paid by the corps w/o reimbursements from the taxpayer. The amount so paid should not be included in the income of the shareholder.

** In case of corporate bonds or other obligations containing a tax-free covenant clause, the corporation paying a tax or any part of it for someone else pursuant to its agreement is not entitled to deduct such payment from gross income on any ground.

2. Not deductible from Gross Income Sec. 82-83, RR-2 Sec. 82. Income, war-profits, and excess-profits taxes imposed by the authority of a foreign country. Income, war-profits, and excess-profits taxes imposed by the authority of a foreign country (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 allowing credits against the tax for taxes of foreign countries. In the case of a citizen of a foreign country residing in the Philippines whose income from sources within such foreign country is not subject to income tax, only that portion of the taxes paid to such foreign country which corresponds to his net income subject to the Philippine income tax shall be allowed as deduction. Sec. 83. Estate, inheritance, and gift taxes; taxes assessed against local benefits. Estates, inheritance, and gist taxes are not deductible. So-called taxes, more properly assessments, paid for local benefits, such as street, sidewalk, and other like improvements, imposed because of and measured by some benefit inuring directly to the property against which the assessment is levied, do not constitute an allowable deduction from gross income. A tax is considered assessed against local benefits when the property subject to the tax is limited to the property benefited. Special assessments are not deductible, even though an incidental benefit may inure to the public welfare. The taxes deductible are those levied for the general public welfare, by the proper taxing authorities at a like rate against all property in the territory over which such authorities have jurisdiction. When assessments are made for the purpose of maintenance or repair of local benefits, the taxpayer may deduct assessments paid as an expense incurred in business, if the payment of such assessments is necessary to the conduct of his business. When the assessments are made for the purpose of constructing local benefits, the payments by the taxpayer are in the nature of capital expenditures and are not deductible. Where assessments are made for the purpose of both construction and maintenance or repairs, the burden is on the taxpayer to show the allocation of the amounts assessed to the different purposes. If the allocation can not be made, none of the amounts so paid is deductible.

3. Meaning of the term taxes

Sec. 80, RR-2 The word taxes means taxes, proper and no deduction should be allowed for amounts representing interest, surcharge, or penalties incident to delinquency. Postage is not a tax. Automobile registration fees are considered taxes.

4. Tax Credits vs. Tax Deduction CIR v. Lednicky, et al. (11 SCRA 609) Facts: The respondents, V.E. Lednicky and Maria Valero Lednicky, are husband and wife, both American citizens residing in the Philippines, and have derived all their income from Philippine sources for the taxable years in question. In compliance with Phil tax law, they filed their income tax return for 1955 and 1956. In 1956, they filed an amended income tax return claiming a tax deduction for federal income taxes which they paid to the United States in the year 1955. In 1959, they likewise claimed a similar tax deduction for the 1956 return. Comm of IR failed to answer the claim for refund, thus they filed a petition with the Tax Court. Issue: whether a US citizen residing in the Philippines who derives income wholly from sources within the Republic of the Philippines, may deduct from his gross income the income taxes he has paid to the US government for the taxable year on the strength of sec 30 (c-1) of the Phil Internal Revenue Code?[1] Held: 1. The wording of Sec 30 shows the code's intent that the right to deduct income taxes paid to foreign government from the taxpayer's gross income is given only as an ALTERNATIVE to his right to claim a tax credit for such foreign income taxes under Sec 30 so that unless the alien resident has a right to claim such tax credit if he so chooses, he is precluded from deducting the foreign income taxes from his gross income. The law provides that the deduction shall be allowed if the taxpayer in his return does not signify his desire to have the benefits of tax credits for taxes paid to foreign countries. Thus, the statutes assumes that the taxpayer in question may also signify his desire to claim a tax credit and waive the deduction. 2. No double credit (i.e, for claiming twice the benefits of his payment of foreign taxes, by deduction from gross income and by tax credit) exists here. This danger cannot exist if the taxpayer cannot claim benefit under either of these headings at his option, so that he must be entitled to a tax credit (respondent here are NOT entitled to tax credit because all their income is derived from Phil sources), or the option to deduct from gross income disappears altogether. 3. No double taxation exists. Double taxation becomes obnoxious only when the taxpayer is taxed twice

for the benefit of the same governmental entity. In the present case, although the taxpayer would have to pay two taxes on the same income but the Philippine government only receives the proceeds of one tax, there is no obnoxious double taxation.

5. Fines and Penalties Guttierez v. Collector (14 SCRA 33) Fines and penalties paid for late payment of taxes are not deductible. Gutierrez also claimed for deduction the fines and penalties which he paid for late payment of taxes. While Section 30 allows taxes to be deducted from gross income, it does not specifically allow fines and penalties to be so deducted. Deductions from gross income are matters of legislative grace; what is not expressly granted by Congress is withheld. Moreover, when acts are condemned by law and their commission is made punishable by fines or forfeitures, to allow them to be deducted from the wrongdoer's gross income, reduces, and so in part defeats, the prescribed punishment.

E. LOSSES Sec. 93-101, RR-2 1. Kinds of Taxpayers and their losses Individuals To be fully deductible: it must not be compensated by insurance and incurred in a taxpayers trade or incurred in any transaction entered into for profit or of property connected with the trade or business if arising from fires, storm, shipwreck, or other casualty, or from robbery, theft or embezzlement. No loss shall be allowed as deduction if at the time of filing of the return, such loss has been claimed as deduction for estate or inheritance tax purposes in the estate or inheritance tax return. Corporations Can deduct losses actually sustained and charged off within the year and not compensated for by insurance or otherwise. Nonresident alien and foreign corporations

Can deduct losses sustained in business or trade conducted within the Philippines, losses of property within the Philippines arising from fires, storms, shipwreck or other casualty and from robbery, theft or embezzlement, and losses actually sustained in transactions entered into for profit in the Philippines, although not connected with their trade or business, not compensated by insurance or otherwise. Summary: Requisites for deductibility of losses Must be incurred in trade, business or profession of the taxpayer, or of property connected with the trade, business or profession, arising from fires, storms, shipwreck, or other casualties, or from robbery, theft or embezzlement; Must be actually sustained and not merely anticipated, and must be charged off within the taxable year; Must be evidenced by closed and completed transaction; Must not be compensated for by insurance or other form of indemnity A sworn declaration of loss sustained from casualty or robbery, theft or embezzlement during the taxable year must be filed with the Bureau of Internal Revenue within a period of not less than 30 days nor more than 90 days from the date of discovery of the casualty; Must not have been claimed as deduction in the estate tax return. 2. Completed Transactions Fernandez Hermanoz v. CIR, 29 SCRA 552 Facts: Fernandez Hermanos Inc. is a domestic corporation organized for the principal purpose of engaging in business as an investment company. The CIR disallowed the following deductions: 1. losses in Mati Lumber Co in 1950 2. losses or bad debts in Palawan Manganese Mines Inc in 1951 3. losses in Balamban Coal Mines in 1950 and 1951 4. losses in Hacienda Dalupiri and Hacienda Samal from 1950-1954 Held: The Supreme Court discussed the allowance or disallowance of each in the following manner: 1. Allowed. These losses represent the shares of stock (worth P8,050) petitioner acquired from Mati in Jan. 1, 1948. The petitioner was correct in writing off and claiming as a deduction in 1950 the amount on the ground that the lumber company had ceased operations and became insolvent in that year. The CIR was incorrect in arguing that since the company still owned a sawmill and some equipment, the shares of stock still had value. The proper assessment would be to treat as income for the year in which petitioner gets the proceeds from the liquidation of those assets. 2. Disallowed. These losses represent part of the loans extended by the petitioner to its 100% owned subsidiary. Petitioner advanced financial assistance to Palawan from 1945 to 1952. By way of payment, Palawan was to give petitioner 15% of net profits. Whether Palawan was able to pay the loans or not

because it continued to operate at a loss is immaterial. Petitioner cannot properly claim as a loss the advances given to Palawan in 1951 for that year. There can be no partial writing off as a loss or bad debt under the Tax Code. Those losses or bad debts ascertained within the taxable year are deductible in full or not at all. Petitioner continued to give Palawan advances even beyond 1951. It was only in 1956 when Palawan decided to cease operations. 3. Disallowed. These losses represent sums spent by the petitioner for the operation of its Balamban coal mines in 1950 and 1951. The petitioner should have treated them as losses in 1952 when the mines were abandoned and not in 1950 and 1951 on the ground that the mines made no sales of coal during those years. 4. Allowed. These losses represent sums spent by petitioner for the operation of the 2 haciendas. The amounts were properly reported as deductions for the correct years. The only reason why the CIR disallowed them was on the ground that the farms were operated solely for pleasure or as a hobby and not for profit. But the Supreme Court is not convinced, and being for business, the petitioner may properly deduct the same. 3. Special Rules on losses a) Voluntary Removal of Buildings If the building is demolished by the owner for some practical reasons, say the building is no longer safe, then the loss which was sustained in a closed and completed transaction is deductible from gross income. If the taxpayer buys real estate with an existing old building with the intention of demolishing it and constructing a new one, then the loss sustained in demolishing the old building is not deductible from gross income, 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. Sec. 97, RR-2 b) Loss of Useful Value of Assets When, through some change in business conditions, the usefulness in the business of some or all of the capital assets is suddenly terminated, so that the taxpayer discontinues the business or discards such assets permanently from use in such business, he may claim as deduction the actual loss sustained. In determining the amount of the loss, adjustment must be made for improvements, depreciation, the salvage value of the property. This exception to the rule requiring a sale or other disposition of property in order to establish a loss requires proof of some unforeseen cause by reason of which the property has been prematurely discarded, as for example:

1. where any increase in the cost or change in the manufacture of any product makes it necessary to abandon such manufacture, to which special machinery is exclusively devoted, or 2. where legislation directly or indirectly makes the continued profitable use of the property impossible. This exception DOES NOT APPLY 1. to a case where the useful life of property terminates solely as a result of those gradual process for which depreciation allowance are authorized. 2. to inventories other than capital assets This exception applies to buildings only when they are permanently abandoned or permanently devoted to a radically different use, and to machinery only when its use as such is permanently abandoned. Sec. 98, RR-2 c) Shrinkage in value of Stocks A person possessing stock of a corporation cannot subtract from gross income any amount claimed as a loss merely on account of shrinkage in value of a stock through fluctuation of the market or otherwise. The loss allowable in such case is that wholly suffered when the stock is disposed of. If stock of a corporation becomes worthless, its cost or other basis determined in accordance with these regulations may be deducted by the owner in the taxable year in which the stock became worthless, provided a satisfactory showing of its worthlessness is made, as in the case of bad debts. Sec. 99, RR-2

4. Wagering Losses Deductible only to the extent of gains from such transactions. Example, if winnings amounted to 10,000 and the losses amounted to 6,000, only 4,000 of the net winnings is taxable. However, if the winnings are 5,000 and losses are 6,000, the 1,000 net losses cannot be claimed as a deduction from gross income.

5. Substantation of Losses RR 12-77 In general the amount of casualty loss deductible is the difference between the FMV of the property immediately before and the FMV after the casualty, but not exceeding the cost or book value of the

property, reduced by any insurance or other compensation received. In case of total destruction of property used in business, the net book value of the property immediately before the loss should be used as the basis of claiming the loss, reduced by any amount of insurance or compensation received. In case of partial destruction of property used in business, the replacement cost to restore the property to its normal operating condition should be used in computing deductible loss, but in no case should it be more than the net book value immediately before the casualty. Depreciation over the remaining useful life is computed by dividing the replacement cost by the remaining useful life of the property.

6. Foreign Exchange Losses Bir Ruling 144-85 Issue: Whether foreign exchange losses, which have accrued by reason of devaluation, are deductible for income tax purposes? Held: Foreign exchange losses which have accrued by reason of devaluation but where remittances have not yet been made are not deductible for income tax purposes. - the annual decrease in the value of property is not normally allowable as a loss. To be allowable, the loss must be realized. - When foreign currency acquired in connection with a transaction in the regular course of business is disposed of, ordinary gain or loss results from the fluctuations. The loss is deductible only for the year it is actually sustained. It is sustained during the year in which the loss occurs as evidenced by closed and completed transaction and as fixed by identifiable events occurring in that year. A closed transaction is a taxable event which has been consummated. No taxable event has as yet been consummated prior to the remittance of the scheduled amortization. Accordingly, foreign exchange losses sustained as a result of devaluation of the peso vis--vis the foreign currency, but which remittance of scheduled amortization consisting of principal and interest payments on a foreign loan has not actually been made are not deductible from gross income for income tax purposes. Interbank Guiding Rate RMC No. 26-85 Beginning Jan. 1, 1985, the conversion rate to be applied shall be the prevailing interbank reference rate for the day of the transaction. In the event that the foreign exchange rate as stated in the above paragraph (a) is impractical or not feasible, the average interbank reference during the year shall apply. For the purpose of converting the tax liability in US dollar to Philippine peso, the prevailing interbank rate at the time of payment shall be applied when paid before the due date of the tax or the prevailing

interbank reference rate at the due date of tax when paid on or after the due date of the tax. When currency involved is other than US dollar, the foreign currency shall first be converted to US dollar at the prevailing exchange rates between the two currencies. This circular does not apply to transaction covered by RMC 30-84 regarding the imposition of additional 1% gross receipt tax on buying and selling of foreign exchange of peso by bank, non-bank financial intermediaries and other authorized foreign exchange dealers or agents and RMC 32-84 in determining the cost basis of certain commodities imported beginning Jan. 1, 1984, the value and prices thereof are quoted in foreign currency.

7. Abandonment of Losses In case a contract area where petroleum operations are undertaken is partially or fully abandoned, all accumulated exploration and development expenditures pertaining thereto shall be allowed as deduction; however, those incurred before Jan. 1, 1979 can be deducted only from income derived from the same contract area. In all cases, notice of abandonment shall be filed with the Commissioner. The unamortized cost of a producing well subsequently abandoned, and the undepreciated cost of equipment directly used therein are also deductible in the year such well, equipment or facility is abandoned by the contractor. If such abandoned well is recentered and production is resumed, or if such equipment or facility is restored into service, the said costs shall be included as part of gross income in the year of resumption or restoration and shall be amortized or depreciated.

8. Net Operating Loss Carry-Over (NOLCO) The net operating loss of the business or enterprise for any taxable year immediately preceding the current taxable year, which had not been previously offset as deduction from gross income shall be carried over as a deduction from gross income for the next 3 consecutive taxable years immediately following the year of such loss, provided that any net loss incurred in a taxable year during which the taxpayer is exempt from income tax shall not be allowed as a deduction. The deduction is allowed only if there has been no substantial change in the ownership of the business or enterprise in that a. Not less than 75% in nominal value of outstanding issued shares, if the business is in the name of a corporation, is held by or on behalf of the same persons; or b. Not less than 75% of the paid up capital of the corporation, if the business is in the name of a corporation, is held by or on behalf of the same persons. For mines other than oil and gas wells, a net operating loss without the benefit of incentives provided

under EO No. 226,as amended, incurred in any of the first 10 years of operation may be carried over as a deduction, from taxable income for the next 5 years immediately following the year of such loss. The entire amount of the loss shall be carried over to the first of the 5 taxable years following the loss, and any portion of such loss which exceeds the taxable income of such first year shall be deducted in like manner from the taxable income of the next remaining 4 years. Net operating loss = excess of allowable deductions over gross income.

RR 14-2001 a) Three Year Period b) No substantial Change in Ownership (75% Rule) F. BAD DEBTS 1. Requirements for Deductibility I. there must be an existing indebtedness due to the taxpayer which must be valid and legally demandable II. it must be connected with the taxpayers trade, business, or practice of profession III. it must not be sustained in a transaction entered into between related parties enumerated under Sec. 36 (b) IV. it must be actually charged off the books of accounts of the taxpayer as of the end of the taxable year. V. It must be actually ascertained to be worthless and uncollectible as of the end of the taxable year. *Before a debt can be ascertained to be worthless, the creditor must have taken all reasonable steps to collect within the period of prescription, and in the light of the following circumstances, acting in good faith, he may justify an ascertainment of worthlessness of a debt: i. insufficiency of collateral ii. bankruptcy or insolvency iii. loss of evidence of indebtedness iv. disappearance of debtor, who fled leaving no properties v. death of debtor leaving no properties vi. injury to debtor incapacitating him from work vii. fruitless efforts to collect small amounts from debtors scattered all over the country.

Collector v. Goodrich, 21 SCRA 1336 CRITERIA FOR ASCERTAINING WORTHLESSNESS OF DEBTS.- The statute permits the deduction of debts "actually ascertained to be worthless within the taxable year" obviously to prevent arbitrary action by the taxpayer to unduly avoid tax liability. The ascertainment of worthlessness of bad debts requires proof of two facts: (1) that the taxpayer did in fact ascertain the debt to be worthless in the year the deduction is sought; and (2) in so doing, he acted in good faith. Good faith is not enough. The taxpayer must show that he had reasonably investigated the relevant facts and had drawn a reasonable inference from the information thus obtained by him. WHERE SMALL AMOUNTS ARE INVOLVED, WRITING THEM OFF, WHEN JUSTIFIED.- Considering the small amounts involved, the taxpayer may be justified in feeling that the unsuccessful efforts therefore exerted to collect the same would suffice to warrant their being written off. "It is foolish to spend good money after bad."

2. Tax Benefit Rule RR 5-99 The recovery of bad debts previously claimed as deduction shall be included as part of gross income in the year of recovery to the extent of the income tax benefit of said deduction. Under the tax benefit rule, the recovery of amounts deducted in previous years from gross income become taxable income unless to the extent thereof, the deduction did not result in any tax benefit to the taxpayer. Example: If in the year the taxpayer claimed deduction of bad debts written-off, he realized a reduction of the income tax due from him on account of the said deduction, his subsequent recovery thereof from his debtor shall be treated as a receipt of realized taxable income. Conversely, if the said taxpayer did not benefit from the deduction of the said bad debt written-off because it did not result to any reduction of his income tax in the year of such deduction (i.e. where the result of his business operation was a net loss even without deduction of the bad debts written-off), then his subsequent recovery thereof shall be treated as a mere recovery or return of capital, hence, not treated as receipt of realized taxable income. - not deductible. - Refer to E10 above on who are related taxpayers.

3. Bad Debts between Related Parties

Losses from sale or exchange of property that are not deductible - those made between related taxpayers. Who are related taxpayers? members of a family (brothers/sisters of the whole or half blood, spouse, ancestors and lineal descendants an individual and corporation, if the individual owns, directly or indirectly, more than 50% in value of the outstanding stock two corporations, if more than 50% in value of the outstanding stock in both is owned, directly or indirectly, by the same individual, if either one of such corporations was a personal holding company or a foreign personal holding company the grantor and a fiduciary of any trust fiduciary of a trust and the fiduciary of another trust if the same person is a grantor with respect to each trust fiduciary of a trust and a beneficiary of such trust. Sec. 30 [b], NIRC) (B) Mutual savings bank not having a capital stock represented by shares, and cooperative bank without capital stock organized and operated for mutual purposes and without profit; 4. Requirements for Deductibility of Bad Debts including banks RR 5-99 See F1 on requirements In the case of banks, in lieu of requisite no. 5 above, the BSP, thru its Monetary board, shall ascertain the worthlessness and uncollectibility of the bad debts and it shall approve the writing off of the said indebtedness from the banks books of accounts at the end of the taxable year. The bank though should still comply with requisites nos. 1-4 as enumerated above before it can avail of the benefit of deduction. Amount not deductible i. if partially secured by a mortgage, the portion not covered by the mortgage is deductible. ii. In case of insolvency of the debtor, the difference between the amount of the claim and the amount received in distribution of assets of the bankrupt. iii. The difference between the amount received by a creditor of a decedent in distribution of the assets of the decedents estate and the amount of the claim. iv. The purchase price paid by a purchaser of accounts receivable which cannot be collected and

charged off as bad debts in his books. v. The amount absolved if the debt is compromised and the debtor is insolvent. SALE OR EXCHANGE OF PROPERTY A. CAPITAL ASSETS Sec. 39, NIRC - Capital Assets: The term capital assets means property held by the taxpayer (whether or not connected with his trade or business), but does NOT include stock in trade by the taxpayer, or other property of a kind which would properly be included in the inventory of a taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or property used in the trade or business, of a character which is subject to the allowance for depreciation provided in subsection F of 34, or real property used in trade or business of the taxpayer 1. Definition of capital asset RR NO. 7-2003, Dec. 27, 2002 Guidelines in determining whether a real property is capital or ordinary asset Providing the Guidelines in Determining Whether a Particular Real Property is a Capital Asset or an Ordinary Asset Pursuant to Section 39(A)(1) of the National Internal Revenue Code of 1997 for Purposes of Imposing the Capital Gains Tax under Sections 24(D), 25(A)(3), 25(B) and 27(D)(5), or the Ordinary Income Tax under Sections 24(A), 25(A) & (B), 27(A), 28(A)(1) and 28(B)(1), or the Minimum Corporate Income Tax (MCIT) under Sections 27(E) and 28(A)(2) of the same Code Scope. Pursuant to Section 244 of the National Internal Revenue Code of 1997 (Code), these Regulations are hereby promulgated to implement Sec. 39(A)(1), providing for the purpose the guidelines in determining whether a particular real property is a capital asset or an ordinary asset. SECTION 2. Definition Of Terms. For purposes of these Regulations, the following terms shall be defined as follows: a. Capital assets shall refer to all real properties held by a taxpayer, whether or not connected with his trade or business, and which are not included among the real properties considered as ordinary assets under Sec. 39(A)(1) of the Code. b. Ordinary assets shall refer to all real properties specifically excluded from the definition of capital assets under Sec. 39(A)(1) of the Code, namely: 1. Stock in trade of a taxpayer or other real property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year; or 2. Real property held by the taxpayer primarily for sale to customers in the ordinary course of his trade

or business; or 3. Real property used in trade or business (i.e., buildings and/or improvements) of a character which is subject to the allowance for depreciation provided for under Sec. 34(F) of the Code; or 4. Real property used in trade or business of the taxpayer. Real properties acquired by banks through foreclosure sales are considered as their ordinary assets. However, banks shall not be considered as habitually engaged in the real estate business for purposes of determining the applicable rate of withholding tax imposed under Sec. 2.57.2(J) of Revenue Regulations No. 2-98, as amended. c. Real property shall have the same meaning attributed to that term under Article 415 of Republic Act No. 386, otherwise known as the "Civil Code of the Philippines." d. Real estate dealer shall refer to any person engaged in the business of buying and selling or exchanging real properties on his own account as a principal and holding himself out as a full or parttime dealer in real estate. e. Real estate developer shall refer to any person engaged in the business of developing real properties into subdivisions, or building houses on subdivided lots, or constructing residential or commercial units, townhouses and other similar units for his own account and offering them for sale or lease. f. Real estate lessor shall refer to any person engaged in the business of leasing or renting real properties on his own account as a principal and holding himself out as lessor of real properties being rented out or offered for rent. g. Taxpayers engaged in the real estate business shall refer collectively to real estate dealers, real estate developers, and/or real estate lessors. Conversely, the term "taxpayers not engaged in the real estate business" shall refer to persons other than real estate dealers, real estate developers and/or real estate lessors. A taxpayer whose primary purpose of engaging in business, or whose Articles of Incorporation states that its primary purpose is to engage in the real estate business shall be deemed to be engaged in the real estate business for purposes of these Regulations. SECTION 3. Guidelines in Determining Whether a Particular Real Property is a Capital Asset or Ordinary Asset. a. Taxpayers engaged in the real estate business. Real property shall be classified with respect to taxpayers engaged in the real estate business as follows: 1. Real Estate Dealer. All real properties acquired by the real estate dealer shall be considered as ordinary assets. 2. Real estate Developer. All real properties acquired by the real estate developer, whether developed or undeveloped as of the time of acquisition, and all real properties which are field by the real estate developer primarily for sale or for lease to customers in the ordinary course of his trade or business or which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year and all real properties used in the trade or business, whether in the form of land, building, or other improvements, shall be considered as ordinary assets.

3. Real Estate Lessor. All real properties of the real estate lessor, whether land and/or improvements, which are for lease/rent or being offered for lease/rent, or otherwise for use or being used in the trade or business shall likewise be considered as ordinary assets. 4. Taxpayers habitually engaged in the real estate business. All real properties acquired in the course of trade or business by a taxpayer habitually engaged in the sale of real estate shall be considered as ordinary assets. Registration with the HLURB or HUDCC as a real estate dealer or developer shall be sufficient for a taxpayer to be considered as habitually engaged in the sale of real estate. If the taxpayer is not registered with the HLURB or HUDCC as a real estate dealer or developer, he/it may nevertheless be deemed to be engaged in the real estate business through the establishment of substantial relevant evidence (such as consummation during the preceding year of at least six (6) taxable real estate sale transactions, regardless of amount; registration as habitually engaged in real estate business with the Local Government Unit or the Bureau of Internal Revenue, etc.). A property purchased for future use in the business, even though this purpose is later thwarted by circumstances beyond the taxpayer's control, does not lose its character as an ordinary asset. Nor does a mere discontinuance of the active use of the property change its character previously established as a business property. b. Taxpayer not engaged in the real estate business. In the case of a taxpayer not engaged in the real estate business, real properties, whether land, building, or other improvements, which are used or being used or have been previously used in the trade or business of the taxpayer shall be considered as ordinary assets. These include buildings and/or improvements subject to depreciation and lands used in the trade or business of the taxpayer. A depreciable asset does not lose its character as an ordinary asset, for purposes of the instant provision, even if it becomes fully depreciated, or there is failure to take depreciation during the period of ownership. Monetary consideration or the presence or absence of profit in the operation of the property is not significant in the characterization of the property. So long as the property is or has been used for business purposes, whether for the benefit of the owner or any of its members or stockholders, it shall still be considered as an ordinary asset. Real property used by an exempt corporation in its exempt operations, such as a corporation included in the enumeration of Section 30 of the Code, shall not be considered used for business purposes, and therefore, considered as capital asset under these Regulations. Real property, whether single detached; townhouse; or condominium unit, not used in trade or business as evidenced by a certification from the Barangay Chairman or from the head of administration, in case of condominium unit, townhouse or apartment, and as validated from the existing available records of the Bureau of Internal Revenue, owned by an individual engaged in business, shall be treated as capital asset. c. Taxpayers changing business from real estate business to non-real estate business. In the case of a taxpayer who changed its real estate business to a non-real estate business, or who amended its

Articles of Incorporation from a real estate business to a non-real estate business, such as a holding company, manufacturing company, trading company, etc., the change of business or amendment of the primary purpose of the business shall not result in the re-classification of real property held by it from ordinary asset to capital asset. For purposes of issuing the certificate authorizing registration (CAR) or tax clearance certificate (TCL), as the case may be, the appropriate officer of the BIR shall at all times determine whether a corporation purporting to be not engaged in the real estate business has at any time amended its primary purpose from a real estate business to a non-real estate business. d. Taxpayers originally registered to be engaged in the real estate business but failed to subsequently operate. In the case of subsequent non-operation by taxpayers originally registered to be engaged in the real estate business, all real properties originally acquired by it shall continue to be treated as ordinary assets. e. Treatment of abandoned and idle real properties. Real properties formerly forming part of the stock in trade of a taxpayer engaged in the real estate business, or formerly being used in the trade or business of a taxpayer engaged or not engaged in the real estate business, which were later on abandoned and became idle, shall continue to be treated as ordinary assets. Real property initially acquired by a taxpayer engaged in the real estate business shall not result in its conversion into a capital asset even if the same is subsequently abandoned or becomes idle. Provided however, that properties classified as ordinary assets for being used in business by a taxpayer engaged in business other than real estate business as defined in Section 2(g) hereof are automatically converted into capital assets upon showing of proof that the same have not been used in business for more than two (2) years prior to the consummation of the taxable transactions involving said properties. f. Treatment of real properties that have been transferred to a buyer/transferee, whether the transfer is through sale, barter or exchange, inheritance, donation or declaration of property dividends. Real properties classified as capital or ordinary asset in the hands of the seller/transferor may change their character in the hands of the buyer/transferee. The classification of such property in the hands of the buyer/transferee shall be determined in accordance with the following rules: 1. Real property transferred through succession or donation to the heir or donee who is not engaged in the real estate business with respect to the real property inherited or donated, and who does not subsequently use such property in trade or business, shall be considered as a capital asset in the hands of the heir or donee. 2. Real property received as dividend by the stockholders who are not engaged in the real estate business and who do not subsequently use such real property in trade or business shall be treated as capital assets in the hands of the recipients even if the corporation which declared the real property dividend is engaged in real estate business. 3. The real property received in an exchange shall be treated as ordinary asset in the hands of the transferee in the case of a tax-free exchange by taxpayer not engaged in real estate business to a taxpayer who is engaged in real estate business, or to a taxpayer who, even if not engaged in real estate business, will use in business the property received in the exchange.

g. Treatment of real property subject of involuntary transfer. In the case of involuntary transfers of real properties, including expropriation or foreclosure sale, the involuntariness of such sale shall have no effect on the classification of such real property in the hands of the involuntary seller, either as capital asset or ordinary asset, as the case may be. 2. Definition of Income Sec 22 (z) the term ordinary income includes any gain from sale or exchange of property which is not a capital asset. Any gain from the sale or exchange of property which is treated or considered under other provisions of this title, as ordinary income shall be treated as gain from the sale or exchange of property which is not a capital asset as defined in sec 39 A. Calasanz v.CIR 144 SCRA 664 (October 9, 1986) Facts: Ursula Calasanz inherited from her father an agricultural land. Improvements were introduced to make such land saleable and later in it was sold to the public at a profit. The Revenue examiner adjudged Ursula and her spouse as engaged in business as real estate dealers and required them to pay the real estate dealers tax. Issue: Whether or not the gains realized from the sale of the lots are taxable in full as ordinary income or capital gains taxable at capital gain rates? Held: The activities of Calasanz are indistinguishable from those invariably employed by one engaged in the business of selling real estate. One strong factor is the business element of development which is very much in evidence. They did not sell the land in the condition in which they acquired it. Inherited land which an heir subdivides and makes improvements several times higher than the original cost of the land is not a capital asset but an ordinary asses. Thus, in the course of selling the subdivided lots, they engaged in the real estate business and accordingly the gains from the sale of the lots are ordinary income taxable in full. 3. Net capital gain, net capital loss Net Capital Gain-means the excess of the gains from the sales or exchanges of capital assets over the losses from such sales or exchanges. Net Capital Loss-means the excess of the losses from sales or exchanges of capital assets over the gains from such sales or exchanges.

4. Ordinary loss Ordinary loss- includes any loss from the sale or exchange of property which is not a capital asset. 5. Percentage Taken into Account Percentage Taken into Account- in the case of a taxpayer, other than a corporation, only the following percentages of the gain or loss recognized upon the sale or exchange of a capital asset shall be taken into account in computing net capital gain, net capital loss, and net income: a. one hundred percent (100%) if the capital asset has been held for not more than 12 months b. fifty percent (50%) if the capital asset has been held for more than12 months 6. Limitation on Capital Loss Limitation on Capital Loss - Losses from sales or exchanges of capital assets shall be allowed only to the extent of the gains from such sales or exchanges. A. DETERMINATION OF GAIN OR LOSS FROM SALE OR TRANSFER OF PROPERTY 1. Computation of gain or loss Sec 40, NIRC: computation of gain or loss: the gain from sale or other disposition of property shall be the excess of the amount realized therefrom over the basis or adjusted basis for determining gain, and the loss shall be the excess of the basis or adjusted basis for determining loss over the amount realized. The amount realized from the sale or other disposition of property shall be the sum of money received plus the fair market value of the property received. 2. Cost or Basis for Income Tax Purposes The basis of property shall bea. the cost thereof in the case of property acquired on or after March 1, 1913, if such property was acquired by purchase b. the fair market price or value as of the date of acquisition, if the same was acquired by inheritance c. if the property was acquired by gift, the basis shall be the same as if it would be in the hands of the donor, except if that if such basis is greater than the fair market value of the property at the time of the gift, then for the purpose of determining loss, the basis shall be such fair market value d. if the property was acquired for less than an adequate consideration in money or moneys worth, the basis is the amount paid by the transferee for the property

3. Exchange of Property Tax-free exchange General rule: upon exchange or sale of property, the entire amount of the gain or loss, as the case may be, shall be recognized. Exception: no gain or loss shall be recognized if in pursuance of a plan of merger or consolidationa. a corporation, which is a party to a merger or consolidation, exchanges property solely for stock in a corporation, which is a party to the merger or consolidation b. a shareholder exchanges stock in a corporation, which is a party to the merger or consolidation, solely for the stock of another corporation also a party to the merger or consolidation c. a security holder of a corporation, which is a party to the merger of consolidation exchanges his securities in such corporation, solely for stock or securities in another corporation, a party to the merger or consolidation. i. Merger or Consolidation BIR Ruling No. 383-87, Nov. 25, 1987 This is a ruling as to whether the merger of Delta Farms, Inc. (DFI) and Evergreen Farms, Inc. (EFI) qualifies as a tax-exempt re-organization under Section 35(c)(2) of the Tax Code, as amended. It is represented that DFI and EFI are both domestic corporations duly registered to engage in agricultural development projects in the Philippines; that 70% of the equity of both corporations are owned by Mr. Juanito R. Ignacio (Ignacio) while 30% thereof, belongs to Philippine Packing Corporation (PPC) which is another domestic corporation and its four (4) individual nominees who are merely holders of one qualifying share each; that prompted by the desire of both companies to achieve efficiency and economy of operation by reducing administrative and operating costs and to strengthen DFI, a merger has been proposed wherein EFI shareholders will exchange all their EFI shares solely for shares in DFI; that as a result of the merger, DFI will be the surviving corporation which will continue to be owned 70% by Ignacio and 30% by PPC, with EFI then ceasing to exist, that based on the Audited Financial Statements of EFI as of March 31, 1987, since the net worth of EFI is P16,338,495.00, EFI stockholders shall receive the equivalent amount in DFI shares of stock or P163,384.95 DFI shares with a par value of P100.00 per share; that considering that 809,750 shares of EFI with a par value of P10.00 per share are issued and outstanding, one (1) DFI share shall be issued for approximately 4.9561EFI shares; that Ignacio shall receive 114,369.41 DFI shares for his 566,825 EFI shares, while PPC shall receive 40,015.48 DFI shares for its 242,925 EFI shares (including the four (4) qualifying shares in the names of its four (4) nominees; that in order to avoid fractional shares, Ignacio and PPC agree that the latter shall waive in favor of the former its fractional share, with the additional payment by Ignacio of P5.00 to complete one (1) whole share, that the Articles of Incorporation of DFI shall simultaneously be amended

to increase its authorized capital stock by P40 million, or from P10 million to P50 million, and at least 25% of which increase or P16,338,500.00 equivalent to 163,385 shares shall be issued as aforementioned in exchange for the 809,750 outstanding shares of EFI worth of P16,338,495.00 and the additional payment in cash of P5.00 as aforementioned, that after the effective date of the merger, all EFI stockholders will become DFI stockholders, and that simultaneous with the merger the Articles of Incorporation of the surviving corporation, DFI shall be amended and its name shall be Evergreen Farms, Inc. immediately after the effectivity of the merger. RULING: The above reorganization is a merger within the contemplation of Section 35(c)(2) and (5(b) of the Tax Code because a corporation (DFI) acquired all of the properties of another corporation (EFI) solely for stocks, the transaction undertaken being for a bona fide business purpose and not solely for the purpose of escaping the burden of taxation. Accordingly, the transfer by EFI of all its assets and liabilities to DFI solely, in exchange for the latter's shares of stock shall not give rise to the recognition of gain or loss pursuant to Section 35(c)(2) of the Tax Code. No gain or loss shall be recognized to EFI upon the distribution of DFI shares to EFI stockholders in complete redemption of their stocks under Section 35(c)(2) of the Tax Code. No gain or loss shall be recognized to EFI stockholders upon the exchange of their stocks solely for DFI stocks under Section 35(c)(2) of the Tax Code. The basis of the assets received by DFI shall be the same as it would be in the hands of EFI. The basis of DFI stocks received by the stockholders of EFI shall be the same as the basis of the EFI stocks surrendered in exchange therefor. If the total liabilities to be assumed by DFI upon effective merger date exceed the historical or original acquisition cost (cost basis) of the assets transferred by EFI, the excess shall be recognized as gain of EFI. It is understood, however, that upon the subsequent sale or exchange of the assets or shares of stocks acquired by the parties, the gain derived from such sale or exchange shall be subject to income tax. The abovementioned transactions shall not be subject to the gift tax as there is no intention to donate on the part of any of the parties. However, in order that the above-described reorganization can be considered a merger under Section 35(c)(2) of the Tax Code, the parties to the merger should comply with the following requirements: A. The plan of reorganization should be adopted by each of the corporations, parties thereto, the adoption being shown by the acts of its duly constituted responsible officers and appearing upon the official records of the corporation. Each corporation, which is a party to the reorganization, shall file, as part of its return for the taxable year within which the reorganization occurred, a complete statement of all facts pertinent to the non-recognition of gain or loss in connection with the reorganization, including: (1) A copy of the plan of reorganization, together with a statement executed under the penalties of perjury showing in full the purposes thereof and in detail all transactions incident to or pursuant to the

Plan. (2) A complete statement of the cost or other basis of all property, including all stocks or securities, transferred incident to the plan. (3) A statement of the amount of stock or securities and other property or money received from the exchange, including a statement of all distributions or other disposition made thereof. The amount of each kind of stock or securities and other property received shall be stated on the basis of the fair market value thereof at the date of the exchange. (4) A statement of the amount and nature of any liabilities assumed upon the exchange, and the amount and nature of any liabilities to which any of the property acquired in the exchange is subject. B. Every taxpayer, other than a corporation a party to the reorganization, who received stock or securities and other property or money upon a tax-free exchange in connection with a corporate reorganization shall incorporate in his income tax return for the taxable year in which the exchange takes place a complete statement of all facts pertinent to the non-recognition of gain or loss upon such exchange including: (1) A statement of the cost or other basis of the stock or securities transferred in the exchange; and (2) A statement in full of the amount of stock or securities and other property or money received from the exchange, including any liabilities assumed upon the exchange, and any liabilities to which property received is subject. The amount of each kind of stock or securities and other property (other liabilities assumed upon the exchange) received shall be set forth upon the basis of the fair market value thereto at the date of the exchange. C. Permanent records in substantial form shall be kept by every taxpayer who participates in a tax-free exchange in connection with a corporate reorganization showing the cost or other basis of the transferred property or money received (including any liabilities assumed on the exchange, or any liabilities to which any of the properties received were subject), in order to facilitate the determination of gain or loss from a subsequent disposition of such stock or securities and other property received from the exchange. In addition to the foregoing requirements, permanent records in substantial form must be kept by the corporations participating in the merger showing the information listed above in order to facilitate the determination of gain or loss from a subsequent disposition of the stock received as a consequence of the merger. COMMISSIONER v. RUFINO, L-33665-68 Facts: The private respondents were the majority stockholders of the defunct Eastern Theatrical Co. It had an original capital stock of P500,000.00, which was increased in 1949 to P2,000,000.00, divided into 200,000 shares at P10.00 per share, and was organized to engage in the business of operating theaters, opera houses, places of amusement and other related business enterprises, more particularly the Lyric and Capitol Theaters in Manila. The President of this corporation (hereinafter referred to as the Old

Corporation) during the year in question was Ernesto D. Rufino. They are also the majority and controlling stockholders of another corporation, the Eastern Theatrical, Inc. This corporation is engaged in the same kind of business as the Old Corporation. The GeneralManager of this corporation (hereinafter referred to as the New Corporation) at the time was Vicente A. Rufino. In a special meeting of stockholders of the Old Corporation on December 17, 1958, to provide for the continuation of its business after the end of its corporate life, and upon the recommendation of its board of directors, a resolution was passed authorizing the Old Corporation to merge with the New Corporation by transferring all its business, assets, goodwill, and liabilities to the latter, which in exchange would issue and distribute to the shareholders of the Old Corporation one share for each share held by them in the said Corporation. It was expressly declared that the merger of the Old Corporation with the New Corporation was necessary to continue the exhibition of moving pictures at the Lyric and Capitol Theaters even after the expiration of the corporate existence of the former, in view of its pending booking contracts, not to mention its collective bargaining agreements with its employees. The aforesaid transfer was eventually made by the Old Corporation to the New Corporation, which continued the operation of the Lyric and Capitol Theaters and assumed all the obligations and liabilities of the Old Corporation beginning January 1, 1959. The Bureau of Internal Revenue examined later, resulting in the petitioner declaring that the merger of the aforesaid corporations was not undertaken for a bona fide business purpose but merely to avoid liability for the capital gains tax on the exchange of the old for the new shares of stock. Accordingly, he imposed the deficiency assessments against the private respondents. Held: The Court of Tax Appeals did not err in finding that no taxable gain was derived by the private respondents from the questioned transaction. There was a valid merger although the actual transfer of the properties subject of the Deed of Assignment was not made on the date of the merger. The Court finds no impediment to the exchange of property for stock between the two corporations being considered to have been effected on the date of the merger. That, in fact, was the intention, and the reason why the Deed of Assignment was made retroactive to January 1, 1959. Such retroaction provided in effect that all transactions set forth in the merger agreement shall be deemed to be taking place simultaneously on January 1. 1959, when the Deed of Assignment became operative. The certificates of stock subsequently delivered by the New Corporation to the private respondents were only evidence of the ownership of such stocks. Although these certificates could be issued to them only after the approval by the SEC of the increase in capitalization of the New Corporation, the title thereto, legally speaking, was transferred to them on the date the merger took effect, in accordance with the Deed of Assignment. Our ruling then is that the merger in question involved a pooling of resources aimed at the continuation and expansion of business and so came under the latter and intendment of the National Internal Revenue code, as amended by the above-cited law, exempting from the capital

gains tax exchanges of property effected under lawful corporate combinations. The basis consideration, of course, is the purpose of the merger, as this would determine whether the exchange of properties involved therein shall be subject or not to the capital gains tax. The criterion laid down by the law is that the merger "must be undertaken for a bona fide" business purpose and not solely for the purpose of escaping the burden of taxation." ii. Transfer of substantially all the assets The phrase substantially all the properties of another corporation is defined in BIR General Circular No V-253 dated July 16, 1957 to mean the acquisition by one corporation of at least 80% of the assets, including cash, of another corporation, which has the element of permanence and not merely momentary holding. iii. Transfer of Property for Shares of Stocks RMR No. 1-2001, 29 November 2001 Tax Consequences of Tax-Free Exchange of Property for Shares of Stock of a Controlled Corporation This Revenue Memorandum Ruling is issued to consolidate, provide, clarify and harmonize the existing guidelines on the tax consequences of a non-recognition transaction consisting of a tax-free exchange of property for shares of stock under Section 40(C)(2) of the Tax Code of 1997. This Revenue Memorandum Ruling shall apply solely and exclusively to, and may be relied upon only in situations in which the facts are substantially similar to the facts stated below, but subject to the principles of substance over form. I. FACTS 1. A domestic corporation (the "Transferor") owns certain property, consisting, for example, of the following: 1.1 Land encumbered by a real estate mortgage (REM); 1.2 Buildings; 1.3 100 shares of stock in G Corporation with a par value of P10 per share; 1.4 50 shares of stock in D Corporation without par value; 1.5 Unsecured receivables; 1.6 Loans to Q ("Borrower/Mortgagor"), secured by a real estate mortgage; 1.7 Cash. 2. X Corporation (the "Transferee") is a domestic corporation. 3. The Transferor transfers the property to the Transferee. In exchange, the Transferee issues shares to the Transferor out of the unissued portion of its existing authorized capital stock, or, if such existing authorized capital stock is insufficient, out of shares from an increase in the Transferee's authorized capital stock. The Transferor does not receive any money or property other than the aforementioned

shares of the transferee. 4. The property transferred by the Transferor-corporation constitutes less than 80% of the Transferor's assets, including cash. 5. In addition to the transfer of the property, the Transferee assumes liabilities of the Transferor. However, the sum total of the amount of liabilities assumed, plus the amount of the encumbrance or REM on the Land (as stated in Section 40(C)(4) of the Tax Code of 1997 "liabilities to which the property is subject") do not exceed the basis of the property transferred. 6. The shares are neither issued in payment for services, nor for settlement of an outstanding liability that arises from the performance of services rendered by the Transferor to the Transferee. 7. As a result of the above-mentioned transfer, the Transferor acquires at least 51% of the total outstanding capital stock of the Transferee entitled to vote.