Define:

Income tests in syllabus BIR Rulings

Realization/Severance test
There is no taxable income until there is a separation from capital of something of exchangeable
value, thereby supplying the realization or transmutation which would result in the receipt of
income.

Income is not deemed realized until the fruit has been plucked from the tree EISNER V.
MACOMBER [252 US 426]

Claim of Right Doctrine/Doctrine of Ownership, Command or Control

The power to dispose of income is the equivalent of ownership of it. The exercise of that power
to procure the payment of income to another is the enjoyment and hence the realization of the
income by him who exercises it. The dominant purpose of the revenue laws is the taxation of
income to those who earn or otherwise create the right to receive it and enjoy the benefit of it
when paid HELVERING V. HORST [311 U.S. 112]

Economic Benefits Test/Doctrine of Proprietary Interest

Where stock, options, shares of stock or other assets are transferred by an employer to an
employee to secure better
services they are plainly compensation which is taxable income COMMISSIONER V. LABUE
[351 US 243]

All Events Test Income is reportable when all the events have occurred that fix the taxpayer’s
right to receive the income and the amount can be determined with reasonable accuracy. CIR V.
ISABELA CULTURAL CORPORATION, G.R. NO. 172231, FEBRUARY 12, 2007

Flow of Wealth Test The test of taxability is the source (the property, activity or service that
produced the income determins whether any gain was derviced from the transaction
COLLECTOR V. ADMINISTRATRIX OF THE ESTATE OF ECHARRI, G.R. NO.
45544, APRIL 25, 1939.

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RMC/RMOs Best evidence obtainable rule
Q: Explain the best obtainable evidence rule.

The rule is that an assessment must made based on the best evidence obtainable. In CIR V.
HANTEX TRADING [MARCH 31, 2005], the Supreme Court opined that assessments must be
based on actual facts. It ruled that “best evidence” includes the corporate and accounting records
of the taxpayer who is subject of the assessment process while the best evidence obtainable does
not include mere photocopies of records and documents. Such photocopies have no probative
value and cannot be used as basis for any deficiency taxes against the taxpayer.

Note: (1) The BIR is allowed to make or amend a tax return from his own knowledge or obtained through
testimony or otherwise. (see CIR v. Hantex Trading Co. [March 31, 2005])

(2) The rule is that in the absence of accounting records of a taxpayer, his tax liability may be determined
by estimation. The CIR is not required to compute such tax liabilities with mathematical exactness (Ibid)

IAET (note that prescriptive period for assessment does not apply)
What is an improperly accumulated earnings tax?

This is the income tax imposed on a corporation if its earnings and profits are accumulated
(undistributed) instead of being divided and distributed to its stockholders.
An improperly accumulated earnings tax (IAET) equal to 10% is imposed for each taxable year
on the improperly accumulated taxable income of each corporation.
It is imposed on domestic corporations which are classified as closely-held corporations.
Q: Define “improperly accumulated taxable income.”

The term “improperly accumulated taxable income” means taxable income adjusted by:

1. Income exempt from tax

2. Income excluded from gross income
3. Income subject to final tax; and
4. The amount of net operating loss carry-over deducted; and
5. Reduced by the sum of:
a. dividends actually or constructively paid;
b. and b. income tax paid for the taxable year c. amount reserved for the reasonable needs
of the business117

In relation to 5(c), RMC 35-2011 [March 14, 2011] states that the amount that may be retained,
taking into consideration the reasonable needs of the business shall be 100% of the paid-up
capital or the amount contributed to the corporation representing the par value of the shares of
stock. Any excess capital over and above the par shall be excluded.

Q: What is the purpose and nature of IAET?

The imposition of IAET discouraged tax avoidance through corporate surplus accumulation.
When corporations do not declare dividends, income taxes are not paid on the undeclared
dividends received by the shareholders. The tax on improper accumulation of surplus is
essentially a penalty tax designed to compel corporations to distribute earnings so that the said
earnings by shareholders could, in turn, be taxed (see CYNAMID PHILIPPINES INC VS. CA
[JANUARY 20, 2000]) The IAET is being imposed in the nature of a penalty to the corporation
for the improper accumulation of its earnings, and as a form of deterrent to the avoidance of tax
upon shareholders who are supposed to pay dividends tax on the earnings distributed to them by
the corporation
Q: What corporations are subject to IAET?
As a general rule, the IAET shall apply to every corporation formed or availed for the purpose of
avoiding the income tax with respect to its shareholders or the shareholders of any other
corporation, by permitting earnings and profits accumulate instead of being divided or
distributed.

As provided in RR 2-01, this refers to all domestic corporations which are classified as closely
held corporations. A closely held corporation are those at least 50% in value of the outstanding
capital stock or at least 50% of the total combined voting power of all classes of stock is owned
directly or indirectly by not more than 20 individuals.

As exceptions, the IAET shall not apply to:

1. Publicly-held corporations
2. Banks and other non-bank financial intermediaries; and
3. Insurance companies
4. GPPs
5. Non-taxable joint ventures
6. Enterprises registered under SEZs (see RR 2-01 [FEBRUARY 12, 2001]).

Q: What is the main factor to consider in holding a corporation liable for IAET?

The touchstone of the liability is the purpose behind the accumulation of the income and not the
consequences of the accumulation. Thus, if the failure to pay dividends is due to some other
causes, such as the use of undistributed earnings and profits for the reasonable needs of the
business, such purpose would not generally make the accumulated or undistributed earnings
subject to the tax. However, if there is a determination that a corporation has accumulated
income beyond the reasonable needs of the business, the 10% improperly accumulated earnings
tax shall be imposed. [see RR 2-01 [FEBRUARY 12, 2001]).
Q: What circumstances are indicative of a purpose to avoid the income tax with respect to
shareholders?

The fact that any corporation is a mere holding company or investment company shall be prima
facie evidence of a purpose to avoid the tax upon its shareholders or members. (see Section
29(C)(1), Tax Code)

NOLCO
Q: What is a net operating loss?

Net Operating loss refers to the excess of allowable deduction over gross income of a business
for any taxable year.

Q: What are the requisites for the deductibility of NOLCO from gross income?

1. The net operating loss of the business or enterprise

2. for any taxable year immediately preceding the current taxable year
3. which had not been previously offset as deduction from gross income
4. shall be carried over as a deduction from gross income
5. for the next 3 consecutive taxable years immediately following the year of such loss
6. Provided, any net loss incurred in a taxable year during which the taxpayer was exempt from
income tax shall not be allowed as a deduction
7. Provided, further, a net operating loss carryover shall be allowed only if there has been no
substantial change in the ownership of the business or enterprise.
Q: Who are the taxpayers who are entitled to the deduct NOLCO from gross income?

1. Any individual engaged in trade or business or in the exercise of his profession

2. Domestic and resident foreign corporations subject to normal corporate income tax

Q: Discuss the relationship between NOLCO and the Minimum Corporate Income Tax
(MCIT)

Domestic and resident foreign corporations are liable to the 2% MCIT (computed based on gross
income) whenever the amount of MCIT is greater than the normal income tax due (which would
be computed with the benefit of NOLCO if any). Thus, such corporation cannot enjoy the benefit
of NOLCO when it is subject to MCIT.

Q: Will the three-year reglementary period on the carry-over of NOLCO continue to run
notwithstanding that the corporation is subject to MCIT (and hence, cannot avail of the
benefit of NOLCO)?

Yes. RR 14-01 [AUGUST 27, 2001] provides that the three-year reglementary period on the
carry-over of NOLCO shall continue to run notwithstanding the fact that the corporation paid its
income tax under the MCIT computation

Q: XYZ entered into a merger agreement with ABC. Under this agreement, the rights,
properties, privileges, powers and franchises of the said ABC were to be transferred,
assigned and conveyed to XYZ as the surviving corporation. Before merger, the company
had over preceding years accumulated losses. XYZ claimed these losses as a deduction
against its gross income. Should the deduction be allowed?

No. In PAPER INDUSTRIES CORPORATION OF THE PHILIPPINES VS. COURT OF

APPEALS [DECEMBER 1, 1995], the Supreme Court ruled that the deduction was improper.
NOLCO of the taxpayer shall not be transferred or assigned to another person, whether directly
or indirectly, such as, but not limited to, the transfer or assignment thereof through merger,
consolidation or any form of business combination of such taxpayer with another person. To
allow the deduction claimed by the surviving corporation would be to permit one corporation or
enterprise to benefit from the operating losses accumulated by another corporation or enterprise.
Q: If several corporations enter an agreement to integrate their respective businesses, can each of
the corporations continue to carry-over their respective net operating losses?

It depends on the nature of the integration plan. In BIR RULING 30-00 [AUGUST 10, 2000],
three cement companies (Republic, Fortune and Blue Circle) sought the opinion of the CIR on
the tax implications of their integration plan. With regard to NOLCO, the CIR held that since,
under the plan, the corporation are not dissolved but merely integrated for a specific bona fide
purpose, the net operation losses of each of the cement corporations are preserved after the
proposed share swap and may be carried over and claimed as a deduction from their respective
gross income because there is no substantial change in the ownership of either of the three
cement companies.

Letter of Authority
Q: Enumerate the steps in the assessment process (simplified)

1. The CIR or Revenue Regional Director (RD) issues a Letter of Authority (LA) to the Revenue
Officer (RO)
2. The RO conducts an Audit within 120 days from date of issuance and service of the LOA
3. RO sends Notice of Informal Conference (NIC)
4. Taxpayer responds within 15 days from receipt of NIC
5. The Assessment Division of the Revenue Regional Office or CIR or his duly authorized
representative issues a Preliminary Assessment Notice
6. Taxpayer responds within 15 days from receipt of PAN via a “Reply”
7. The CIR or his duly authorized representative issues a Formal Letter of Demand and
Assessment Notice (FAN) which may be objected to via “Protest” within 30 days from receipt of
the FAN

Note: (1) The Letter of Authority is the authority given to the revenue officer to perform
assessment functions. There must be a grant of authority before any revenue officer can conduct
an examination or assessment and the revenue officer must not go beyond the authority given
[CIR v. SONY PHILIPPINES [NOVEMBER 17, 2010].

(2) A LA that was issued to cover an audit of “unverified prior years” is invalid. A LA should
cover a taxable period not exceeding one taxable year. The practice of issuing LOAs covering
audit of “unverified prior years” is prohibited. If the audit of a taxpayer shall include more than
one taxable period, the other periods shall be specifically indicated. (see RMO 43-90
[SEPTEMBER 20, 1990]. In CIR V. SONY PHILIPPINES [NOVEMBER 17, 2010], a Letter
of Authority was issued covering the period 1997 and unverified prior years. The deficiency
VAT assessment was based on records from January to March 1998. The Supreme Court held
that the CIR went beyond the scope of their authority as indicated in the LOA. Further, the fact
that the LOA covers unverified prior years invalidates it and a VAT deficiency assessment made
on the basis thereof must be disallowed.

transitional input tax

The first VAT law is found in Executive Order No. 273 (E.O. 273), which amended several
provisions of the then National Internal Revenue Code of 1986 (Old NIRC). E.O. No. 273 likewise
accommodated the potential burdens of the shift to the VAT system by allowing newly liable VAT-
registered persons to avail of a transitional input tax credit, as provided for in Section 105 of the
old NIRC, as amended by E.O. No. 273. Said Section 105 is quoted, thus:

SEC. 105. Transitional input tax credits. – A person who becomes liable to value-added tax or any
person who elects to be a VAT-registered person shall, subject to the filing of an inventory as
prescribed by regulations, be allowed input tax on his beginning inventory of goods, materials and
supplies equivalent to 8% of the value of such inventory or the actual value-added tax paid on such
goods, materials and supplies, whichever is higher, which shall be creditable against the output
tax.

The provisions of Section 105 of the NIRC, on the transitional input tax credit, had remained intact
despite the enactment of Rep. Act No. 7716. Said provisions would however be amended following
the passage of the new National Internal Revenue Code of 1997 (New NIRC), also officially known as
Rep Act No. 8424. The section on the transitional input tax credit was renumbered from Section 105
of the Old NIRC to Section 111(A) of the New NIRC. The new amendments on the transitional input
tax credit are relatively minor, hardly material to the case at bar. They are highlighted below for easy
reference:

Section 111. Transitional/Presumptive Input Tax Credits. -

(A) Transitional Input Tax Credits. - A person who becomes liable to value-added tax or any person
who elects to be a VAT-registered person shall, subject to the filing of an inventory according to rules
and regulations prescribed by the Secretary of finance, upon recommendation of the Commissioner,
be allowed input tax on his beginning inventory of goods, materials and supplies equivalent for eight
percent (8%) of the value of such inventory or the actual value-added tax paid on such goods, materials
and supplies, whichever is higher, which shall be creditable against the output tax.7 (Emphasis
supplied).

Rep. Act No. 8424 also made part of the NIRC, for the first time, the concept of "presumptive input tax
credits," with Section 111(b) of the New NIRC providing as follows:

(B) Presumptive Input Tax Credits. -

(1) Persons or firms engaged in the processing of sardines, mackerel and milk, and in manufacturing
refined sugar and cooking oil, shall be allowed a presumptive input tax, creditable against the output
tax, equivalent to one and one-half percent (1 1/2%) of the gross value in money of their purchases of
primary agricultural products which are used as inputs to their production.

As used in this Subsection, the term 'processing' shall mean pasteurization, canning and activities
which through physical or chemical process alter the exterior texture or form or inner substance of a
product in such manner as to prepare it for special use to which it could not have been put in its original
form or condition.

(2) Public works contractors shall be allowed a presumptive input tax equivalent to one and one-half
percent (1 1/2%) of the contract price with respect to government contracts only in lieu of actual input
taxes therefrom (Fort Bonifacio vs. CIR)

CTA jurisdiction (division, en banc)

Q: What are the cases within the exclusive appellate jurisdiction to review by appeal of the
CTA en banc?

a. Decisions or resolutions on MRs or MNTs of the Court in Division in the exercise of its
exclusive appellate jurisdiction over:

i. Cases arising from administrative agencies ii. Local tax cases decided by the RTCs in the
exercise of their original jurisdiction iii. Tax collection cases decided by RTCs in the exercise of
their original jurisdiction involving final and executory assessments for taxes, fees, charges, and
penalties, where the principal amount of taxes and penalties claimed is less than P1,000,000 iv.
Criminal offenses arising from violations of the NIRC or TCC and other laws administered by
the BIR or BOC
b. Decisions, resolutions or orders on MRs or MNTs of the Court in Division in the exercise of
its exclusive original jurisdiction over:

i. Tax Collection cases ii. Cases involving criminal offenses arising from violations of the NIRC
or TCC and other laws administered by the BIR or BOC

c. Decisions, resolutions or orders of the RTCs in the exercise of its appellate jurisdiction over:

i. Local tax cases ii. Tax Collection cases iii. Criminal offenses arising from violations of the
NIRC or TCC and other laws administered by the BIR or BOC

d. Decisions of the CBAA in the exercise of its appellate jurisdiction over cases involving
assessment and taxation of real property originally decided by the provincial or city board of
assessment appeals.

(see Section 2, Rule 4, A.M. No. 05-11-07-CTA)

Read Section 3(a), Rule 4, RRCTA

Q: What are the cases within the exclusive appellate jurisdiction to review by appeal of the
CTA in division?

a. Decisions of the CIR

i. In cases involving disputed assessments, refunds of internal revenue taxes, fees or

other charges, penalties in relation thereto; or
ii. ii. Other maters arising under the NIRC or other laws administered by the BIR

b. Inaction by the CIR where the NIRC provides a specific period of action
 i. In cases involving disputed assessments, refunds of internal revenue taxes, fees or
other charges, penalties in relation thereto, or
ii. ii. Other matters arising under the NIRC or other laws administered by the BIR

c. Decisions, orders or resolutions of the RTCs in local tax cases decided or resolved by them in
the exercise of their original jurisdiction

d. Decisions of the Commissioner of Customs

i. In cases involving liability for customs duties, fees, or other money charges, seizure,
detention or release of property affected, fines, forfeitures of other penalties in
relation thereto; or
ii. ii. Other matters arising under the Customs Law or other laws administered by the
Bureau of Customs

e. Decisions of the Secretary of Finance on customs cases elevated to him automatically for
review from decisions of the Commissioner of Customs which are adverse to the Government
under Section 2315 of the TCC

f. Decisions of the DTI Secretary in the case of non-agricultural product, commodity or article
and the DA Secretary in case of agricultural product, commodity or article, involving dumping
and countervailing duties under Sections 301 and 302 of the TCC and safeguard measures under
the Safeguard Measures Act (RA 8800) where either party may appeal the decision to impose or
not to impose said duties

(see Section 3(a), Rule 4, A.M. No. 05-11-07-CTA)

Note: Any dispute or controversy involving national internal revenue taxes or customs duties not
falling within the purview of the exclusive appellate jurisdiction of the CTA must fall within the
jurisdiction of the regular courts. A taxpayer’s suit impugning he constitutionality of a tax
statute, for example, even if involving the NIRC or TCC would fall within the jurisdiction of the
regular courts.
Q: When is a decision of the CIR appealable to the CTA?

First view: The appealable decision is the one which categorically stated that the CIR’s action
on the disputed assessment is final. [COMMISSIONER OF INTERNAL REVENUE VS.
UNION SHIPPING CORPORATION (MAY 21, 1990)]

Second view: There is no need for a categorical statement. So long as the tenor of the decision is
that the dispute of the taxpayer is denied, it is appealable. (see SURIGAO ELECTRIC V. CTA
[JUNE 28, 1974])

A survey of cases would indicate that the second view is followed. There is no need for a
categorical
statement that the action is final. The rationale is that to let the taxpayer defer the period is to
unduly put in his hand the collection of taxes.