Syllabus x Notes | TAXATION 1

I. Introduction
A. Income Tax Systems
1. Global Tax System
2. Schedular Tax System
3. Semi-schedular or semi-global tax system

Q: What are the kinds of income tax systems?

The types of income tax systems are as follows:
1. Global Tax System – where the taxpayer is required to lump up all items of income earned during a
taxable period and pay under a single set of income tax rates on these different items of income.
Note: Simply put, one rate for all types of gross income.

2. Schedular Tax System – where there are different tax treatments of different types of income so that
a separate tax return is required to be filed for each type of income and the tax is computed on a per
return or per schedule basis.
Note: Simply put, varying taxes are imposed on passive income.

3. Semi-Schedular or Semi-Global Tax System – where the tax system is either (a) global (e.g. taxpayer
with compensation income not subject to final withholding tax or business or professional income or
mixed income – compensation and business or professional income) or (b) schedular (e.g. taxpayer with
compensation, capital gains, passive income, or other income subject to final withholding tax) or (c)
both global and schedular may be applied depending on the nature of the income realized by the
taxpayer during the year.

The current method of taxation under the Tax Code belongs to a system which is partly schedular and
partly global.

Q: How do you distinguish “schedular treatment” from “global treatment” as used in income
taxation?

Schedular Global
The various types of income (i.e. compensation; All income received by the taxpayer are grouped
business/professional income) are classified together, without any distinction as to type or
accordingly and are accorded different tax nature of the income, and after deducting
treatments, in accordance with schedules therefrom expenses and other allowable
characterized by graduated tax rates. deductions, are subjected to tax at a graduated
or fixed rate (see TAN VS. DEL ROSARIO
Since these types of income are treated [OCTOBER 3, 1994]).
separately, the allowable deductions shall
likewise vary for each type of income.

Note: The Philippines had adopted both the global system and the schedular system of taxation. The
global system can be found in the income taxation of corporations. The Tax Code subjects them to either
the regular corporate income tax or minimum corporate income tax irrespective of the tax base.

On the other hand, the schedular system can be found in the income taxation of individuals where the
tax rates are progressive in character.
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B. Features of the Philippine Income Tax Law

1. Direct tax
2. Progressive tax
3. Comprehensive
4. Semi-schedular or semi-global tax system
5. National tax
6. Excise tax

Q: What are the features of the Philippine Income Tax system?

The Philippine tax system is:
1. Income tax is a direct tax because the tax burden is borne by the income recipient upon whom the tax
is imposed.
2. Income tax is a progressive tax since the tax base increases as the tax rate increases.
3. The Philippines has adopted the most comprehensive system of imposing income tax by adopting the
citizenship principle, resident principle and the source principle.
4. The Philippines follows the semi-schedular or semi-global system of income taxation.
5. National tax – collected by the national government
6. Excise tax – it is a burden imposed on the right or privilege of a person to earn or receive income

C. Criteria in Imposing Philippine Income Tax

1. Citizenship principle
2. Residence principle
3. Source principle

Q: What are the criteria in imposing Philippine income tax?

1. Citizenship or nationality principle – A citizen of the Philippines is subject to Philippine income tax (a)
on his worldwide income, if he resides in the Philippines (b) only on his Philippine source income, if he
qualifies as a non-resident citizen where his foreign-source income shall be tax-exempt.

2. Residence or domicile principle – An alien is subject to Philippine income tax because of his residence
in the Philippines. A resident alien is liable to pay Philippine income tax only from his income from
Philippine sources but is tax-exempt from foreign-source income

3. Source of income principle – An alien is subject to Philippine income tax because he derives income
from sources within the Philippines. Thus, a non-resident alien or non-resident foreign corporation is
liable to pay Philippine income tax on income from sources within the Philippines

D. Taxable Period
1. Calendar Year, Sec. 22 (P), NIRC
2. Fiscal Year, Sec. 22 (Q), NIRC; Secs. 43, 44, 46 NIRC
3. Short Period, Sec. 47, NIRC

Read Section 22(P) and (Q), Tax Code

Q: What are the different taxable periods provided for in the Tax Code?
1. Calendar period or calendar year – is an accounting period which starts from January 1 and ends on
December 31
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2. Fiscal period or fiscal year - is an accounting period of 12 months ending on the last day of any month
other than December 31.
3. Short period – is an accounting period wherein income shall be computed on the basis of a period less
than 12 months.

Read Section 43, Tax Code

Q: What is the general rule for computing the taxpayer’s taxable income?
The taxable income shall be computed upon the basis of the taxpayer’s annual accounting period – fiscal
year or calendar year as the case may be.

Q: Can an individual compute his income on the basis of a fiscal year?

No. Individual taxpayers cannot use the fiscal period. They are required to use only the calendar year.
(RR 2-40). This would include Estates and Trusts and General Professional Partnerships

Q: Is a corporation required to use only the calendar year?

No. As a general rule, income tax returns, whether individuals or for corporations, are required to be
made and their income computed for each calendar year. However, corporations may with the approval
of the CIR, file their returns and compute their income on the basis of a fiscal year. (see Section 43, Tax
Code).

Q: In what instances shall taxable income be computed on the basis of calendar year?
1. Taxpayer’s accounting period is other than fiscal year
2. Taxpayer has no annual accounting period
3. Taxpayer does not keep books
4. Taxpayer is an individual
5. Taxpayer is a general professional partnership
6. Taxpayer is an estate or a trust

Q: In what instances shall taxable income be computed on the basis of a short period?
The general rule is that the taxable period is always 12 months. The exceptions (where a taxpayer may
have a taxable period of less than 12 months) are:
1. Taxpayer, other than an individual, changes his accounting period from fiscal to calendar year or from
calendar year to fiscal year or from one fiscal year to another (Section 46, Tax Code)
2. Taxpayer dies
3. Corporation is newly organized
4. Corporation is dissolved
5. Tax period is terminated by the CIR by authority of law (Section 6(D), Tax Code)

Read Section 46, Tax Code

Q: Can a taxpayer change his accounting period?

Yes, but this applies only to corporate taxpayers. If the corporate taxpayer wishes to change his
accounting period from fiscal to calendar year, from calendar year to fiscal year, or from one fiscal year
to another, the net income shall, with the approval of the CIR, be computed on the basis of such new
accounting period. (see Section 46, Tax Code)

II. Concept of Income

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A. Income Tax Defined

Q: What are the types of Philippine Income Tax (under Title II of the NIRC)?
The types of Income tax under Title II of the NIRC are:
1. Graduated income tax on individuals
2. Normal corporate income tax on corporations
3. Minimum corporate income tax on corporations
4. Special income tax on certain corporations (e.g. private educational institutions, FCDUs, and
international carriers)
5. Capital gains tax on sale or exchange of unlisted shares of stock of a domestic corporation classified as
a capital asset
6. Capital gains tax on sale or exchange of real property located in the Philippines and classified as a
capital asset
7. Final withholding tax on certain passive investment incomes
8. Fringe benefit tax
9. Branch profit remittance tax; and
10. Tax on improperly accumulated earnings.

Q: Define Income tax.

Income tax is a tax on all yearly profits arising from property, professions, trades and offices.

In CONWI V. CTA [AUGUST 31, 1992], the Supreme Court defined income as an amount of money
coming to a person or corporation within a specified time, whether as payment for services, interest, or
profit from investment.

Q: What is the nature of income tax?

An income tax is an excise tax and not a tax on property. It is levied upon the privilege of receiving
income or profit.

As stated by the Supreme Court in REPUBLIC OF THE PHILIPPINES VS. MANILA ELECTRIC COMPANY
[NOVEMBER 15, 2002], income tax is imposed on an individual or entity as a form of excise tax or a tax
on the privilege of earning income. In exchange for the protection extended by the State to the
taxpayer, the government collects taxes as a source of revenue to finance its activities.

Q: What are the general principles of income taxation?

Under Section 23, Title II, Tax Code, the general principles are:

Resident Citizen taxable on all income derived from sources

within and outside the Philippines
Non-Resident Citizen taxable only on income derived from sources
within the Philippines
[By definition of a non-resident citizen, this
applies to an overseas contract worker (a citizen
working and deriving income from abroad)]
Alien (whether resident or non-resident) taxable only on income derived from sources
within the Philippines.
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Domestic corporation taxable on all income

derived from sources within and outside the
Philippines
Foreign corporation taxable only on income derived from sources
within the Philippines
(This applies whether the foreign corporation is
engaged or not in trade or business in the
Philippines)

Note: Simply put, only resident citizens and domestic corporations are taxable on their worldwide income
(both income inside and outside the Philippines) while the other types of individual and corporate
taxpayers (i.e. non-resident citizen, non-resident alien, foreign corporation) are taxable only on income
derived from sources within the Philippines.

a) Definition

Q: Define income for tax purposes.

Income means the gain derived from capital, from labor, or from both combined, including profits
gained from dealings in property or as well as any asset clearly realized whether earned or not.

Income may be defined as the amount of money coming to a person or corporation within a specified
time, whether as payment for services, interest or profit from investment.

It refers to all wealth which flows into the taxpayer other than as a mere return on capital. (RR No.2)
Thus, as stated in FISHER V. TRINIDAD [OCTOBER 30, 1922], mere advance in the value of property or a
corporation in no sense constitutes the income specified in the law. Such advance constitutes and can
be treated merely as an increase in capital.

b) Nature

Q: What is the nature of income?

Income is that flow of services rendered by that capital by the payment of money from it or any other
benefit rendered by a fund of capital in relation to such fund through a period of time. Income is the
“fruit” of capital or labor severed from the “tree.” (see MADRIGAL VS. RAFFERTY [AUGUST 7, 1918]).

Q: What is the difference between income and capital?

Capital Income
A fund or property existing at one distinct point Denotes a flow of wealth during a definite period
in time of time
Means all the wealth which flows into the
taxpayer other than a mere return on capital
Gain derived and severed from capital. (see
CHAMBER OF REAL ESTATE AND BUILDER’S
ASSOCIATION, INC. V. ROMULO [MARCH 9,
2010]).
Capital is wealth Service of wealth
 Syllabus x Notes | TAXATION 1

Defined as "profits or gains" (see MADRIGAL VS.

RAFFERTY [AUGUST 7, 1918]).

Q: Are stock dividends income or capital?

Generally, stock dividends represent capital and do not constitute as income to its recipient. Mere
issuance thereof is not yet subject to income tax as they are nothing but an enrichment through
increase in value of capital investment. Such are considered unrealized gain and cannot be subjected to
income tax until that gain has been realized.

As explained by the Supreme Court in FISHER V. TRINIDAD [OCTOBER 30, 1922], when a corporation
issues stock dividends, it shows that the corporation’s accumulated profits have been capitalized,
instead of distributed to the stockholders or retained as surplus available for distribution. The
stockholder receives nothing out of the corporate assets for his separate use and benefit but a
representation of his increased interest in the capital of the corporation. The capital still belongs to the
corporation as there is no separation of interest.

However, stock dividends constitute as income if a corporation redeems stock issued so as to make a
distribution. This is essentially equivalent to the distribution of a taxable dividend the amount so
distributed in the redemption considered as taxable income. (see COMMISSIONER VS. MANNING
[AUGUST 7, 1975])

Q: Is money received as exemplary damages (punitive damages) income?

Yes. In COMMISSIONER V. GLENSHAW GLASS CO. [348 U.S. 426], Glenshaw Co was engaged in a
protracted litigation with Hartford-Empire Co where the former demanded exemplary damages for
fraud and treble damages for injury to its business by reason of the latter’s violation of federal antitrust
laws. The parties settled. Glenshaw did not report the money received as damages from the settlement
in its income tax return. The Commissioner assessed Glenshaw for the deficiency. Glenshaw contended
that punitive damages, as windfalls flowing from culpable conduct of third parties are not taxable
income. The US Supreme Court held that money received as damages must be reported as they
constitute income. The mere fact that such payments were extracted from wrongdoers cannot detract
from their character as taxable income. The Court also stated that punitive damages cannot be classified
as gifts.

Q: Is money received as compensatory damages income?

Yes. In MURPHY V. IRS [493 F.3d 170], the US Court of Appeals (District of Columbia), held that the
amount received as compensatory damages on for emotional distress and loss of reputation constitutes
taxable income.
Note: It must be noted, however, that in the Murphy case, what was involved was physical injuries. Note
under our Tax Code, amounts received as compensation for personal injuries are excluded from gross
income and hence, not taxable. Thus, we must make a distinction. If it’s non-physical injuries like mental
anguish, the damages are included in gross income and hence taxable but if it’s physical injuries, it is
excluded from gross income.

Madrigal v. Rafferty, 38 Phil 414 – Income Tax Defined

1. TAXATION; INCOME TAX; PURPOSES. — The Income Tax Law of the United States in force in the Philippine Islands has
selected income as the test of faculty in taxation. The aim has been to mitigate the evils arising from the inequalities of
 Syllabus x Notes | TAXATION 1

wealth by a progressive scheme of taxation, which places the burden on those best able to pay. To carry out this idea, public
considerations have demanded an exemption roughly equivalent to the minimum of subsistence. With these exceptions, the
Income Tax Law is supposed to reach the earnings of the entire non-governmental property of the country.

2. ID.; ID.; INCOME CONTRACTED WITH CAPITAL AND PROPERTY. — Income as contrasted with capital or property is to be
the test. The essential difference between capital and income is that capital is a fund; income is a flow. Capital is wealth,
while income is the service of wealth. "The fact is that property is a tree, income is the fruit; labor is a tree, income the fruit;
capital is a tree, income the fruit." (Waring v. City of Savannah [1878], 60 Ga., 93.)

3. ID.; ID.; "INCOME:" DEFINED. — Income means profits or gains.

4. ID.; ID.; CONJUGAL PARTNERSHIPS. —The provisions of the Civil Code concerning conjugal partnerships have no
application to the Income Tax Law. The higher schedules of the additional tax provided by the Income Tax Law directed at
the incomes of the wealthy may not be partially defeated by reliance on provisions in our Civil Code dealing with the
conjugal partnership. The aims and purposes of the Income Tax Law must be given effect.

7. ID.; ID.; ID. — The Income Tax Law does not look on the spouses as individual partners in an ordinary partnership.

***
FACTS:
Vicente Madrigal and Susana Paterno Were legally married prior to January 1, 1914, thus contracted
under the provisions of law concerning conjugal partnerships.

On 1915, Madrigal declared a total net income for the year 1914 for the sum of P296,302.73 which,
according to him, represented the income of the conjugal partnership existing between himself and
his wife Paterno. Thus, in order to determine the additional income tax, the total net income should
be divided into two equal parts, one-half to be considered the income of Madrigal and the other half
the income of Paterno.

 The Attorney-General of the Philippine agreed with petitioner Madrigal.

 The US-CIR reversed the opinion of the Attorney-General.

Thus, Madrigal paid under protest the amount of P9,668.21, constituting the amount assessed by the
CIR. Madrigal and his wife Paterno filed an action to recover the P3,786.08, representing allegedly
erroneously collected additional tax, from the CIR in the CFI of Manila.

 The trial court ruled in favor of defendant CIR.

ARGUMENTS OF THE PARTIES:

Plaintiff:
Citing the Civil Code provisions on conjugal partnerships, in determining the additional income tax,
the income should first be divided into two equal parts.

Defendant:
Conjugal partnership has no bearing on income considered as income; and that the distinction must
be drawn between the ordinary form of commercial partnership and the conjugal partnership of
spouses

ISSUE:
WON the income of Madrigal should be divided into two equal parts, because of the conjugal
 Syllabus x Notes | TAXATION 1

partnership existing between him and his wife Paterno?

RULING:

NO.

RATIO:
The Income Tax Law does not look on the spouses as individual partners in an ordinary partnership.
The higher schedules of the additional tax directed at the incomes of the wealthy may not be partially
defeated by reliance on provisions in our Civil Code dealing with the conjugal partnership and having
no application to the Income Tax Law. The aims and purposes of the Income Tax Law must be given
effect.

Susana Paterno has an inchoate right in the property of her husband Vicente Madrigal during the life
of the conjugal partnership. Susana Paterno has no absolute right to one-half the income of the
conjugal partnership. Susana Paterno cannot make a separate return in order to receive the benefit of
the exemption which would arise by reason of the additional tax.

SC DISCUSSED…

Income Tax Defined - A tax on income is not a tax on property.

Income Defined - "Income," as here used, can be defined as "profits or gains."

Capital v. Income - Income as contrasted with capital or property is to be the test. The essential
difference between capital and income is that capital is a fund; income is a flow. A fund of property
existing at an instant of time is called capital. A flow of services rendered by that capital by the
payment of money from it or any other benefit rendered by a fund of capital in relation to such fund
through a period of time is called income. Capital is wealth, while income is the service of wealth.
(Determining the distinction is important, because in this case, we learn that the conjugal partnership
of spouses pertains to capital)

Fisher v. Trinidad, 43 Phil 973 – Income Tax Defined

1. INCOME DEFINED AS THAT WORD IN THE INTERNAL REVENUE LAW. — An income may be defined as the amount or
money coming to a person or corporation within a specified time, whether as payment for services, interest, or profit from
investment. A mere advance in the value of the property of a person or corporation in no sense constitutes the "income
specified in the revenue law. Such advance constitutes and can be treated merely as an increase of capital. An income
means cash received or its equivalent; it does not mean chooses in action or unrealized increments in the value of the
property. The revenue law with reference to the income tax employs the term "income" in its natural and obvious sense, as
importing something distinct from principal or capital.

2. DIVIDENDS OF CORPORATIONS, DEFINED. — A dividend is defined as a corporate profit set aside, declared, and ordered
by the directors to be paid to the stockholders on demand or at a fixed time. Until the dividend is declared, the corporate
profits belong to the corporation and not to the stockholders, and are liable for the payment of the debts of the corporation.

3. STOCK DIVIDENDS. DEFINED. — A stock dividend, when declared, is merely a certi ficate of stock which evidences the
interest of the stockholder in the increased capital of the corporation. There is a clear distinction between a cash dividend
and a stock dividend. The one is a disbursement to the stockholder of accumulated earnings, and the corporation parts
irrevocably with all interest therein; the other involves no disbursement by the corporation; the corporation parts with
 Syllabus x Notes | TAXATION 1

nothing to its stockholder. When a cash dividend is declared and paid to stockholders, such cash becomes the absolute
property of the stockholders and cannot be reached by the creditors of corporation in the absence of fraud. The property
represented by a stock dividend, however, still being the property of corporation, and not of the stockholder, it may be
reached by an execution against the corporation, and sold as a part of the property of the corporation. In such a case, if all of
the property of the corporation is sold under execution, then the stockholders certainly could not be charged with having
received an income by virtue of the issuance of the stock dividend. If the ownership of the property represented by a stock
dividend is still in the corporation and not in the holder of such stock, certainly such stock cannot be regarded as income to
the stockholder. The stockholder has received nothing but a representation of an interest in the property of the corporation
and, as a matter of fact, he may never receive anything, depending upon the final outcome of the business of the
corporation.

FACTS:
The Philippine American Drug Company was a corporation duly organized and existing under the laws
of the Philippine. Appellant Fisher was a stockholder of PADC. The company declared a "stock
dividend." Upon demand of the appellee CIR, the appellant paid under protest the sum of P889.91 as
income tax on said stock dividend.

ARGUMENTS OF THE PARTIES:

Appellant Fisher cites decisions of the Supreme Court of the US that "stock dividends" were capital
and not an "income" and therefore not subject to the "income tax law.

Appellee CIR argues that Act No. 2833 which provides that "Stock dividend shall be considered
income, to the amount of the earnings or profits distributed" does not violate the Jones Law; and that
US decisions should not be followed in interpreting the statute in force in the Ph.

ISSUE: WON "stock dividends" are "income" that can be taxed (or are taxable) under that provision of
Act No. 2833

RULING:

NO.

The Philippine Legislature may provide for the payment of an income tax, but it cannot, under the
guise of an income tax, collect a tax on property which is not an "income." The Philippine Legislature
cannot impose a tax upon "property" under a law which provides for a tax upon "income" only. A
statute providing for an income tax cannot be construed to cover property which is not, in fact,
income.

(The court mentioned several definitions of the word "income". Please refer to the full text.)
Mr. Justice Pitney: the term "income" in its natural and obvious sense, as importing something
distinct from principal or capital and conveying the idea of gain or increase arising from corporate
activity.

Stock dividends is not income, it represents undistributed increase in the capital of corporations of
firms, joint stock companies, etc., for a particular period. In the case of D'Ooge vs. Leeds (176 Mass.,
558, 560) it was held that stock dividends in such cases were regarded as capital and not as income.

The stockholder who receives a stock dividend has received nothing but a representation of this
 Syllabus x Notes | TAXATION 1

increased interest in the capital of the corporation. There has been no separation or segregation of
his interest. All the property or capital of the corporation still belongs to the corporation. There has
been no separation of the interest of the stockholder from the general capital of the corporation. The
stockholder, by virtue of the stock dividend, has no separate or individual control over the interest
represented thereby, further than he had before the stock dividend was issued. He cannot use it for
the reason that it is still the property of the corporation and not the property of the individual holder
of the stock dividend. A certificate of stock represented by the stock dividend is simply a statement of
his proportional interest or participation in the capital of the corporation. For bookkeeping purposes,
a corporation, by issuing stockholders, evidenced by a capital stock account. The receipt of a stock
dividend in no way increases the money received by the stockholder nor his cash account at the close
of the year. It simply shows that there has been an increase in the amount of the capital of the
corporation during the particular period, which may be due to an increased business or to a natural
increase of the value of the capital due to business, economic, or another reason.

B. When is income taxable?

1. Existence of income
2. Realization of income
a. Tests of Realization
Fisher v. Trinidad, Ibid.
b. Actual v. constructive receipt
Limpan v. CIR, 17 SCRA 703
Republic v. dela Rama, 18 SCRA 861
3. Recognition of Income

Q: When is income taxable? (elements of a taxable income)

Income, gain or profit is subject to income tax when the following conditions are present:
1. There is income, gain or profit (existence of income)
2. The income, gain or profit is not exempt from income tax.
3. The income, gain or profit is received or realized during the taxable year; (realization of income)

Note: As to (1) – for tax purposes, income does not only refer to the money a taxpayer receives but
includes anything of value.
As to (2) – An income may have other elements but the law may specifically exclude the same from
income for tax purposes i.e. certain passive incomes excluded from income as they are already subject to
final taxes.
As to (3) – Even if there is material gain, not excluded by law, if the material gain is not yet realized by
the taxpayer, then there is no income to speak of.

Fisher v. Trinidad, Ibid. – Tests of Realization

(See facts above.)

ISSUE: WON there was a realization of income when the company declared "stock dividends"?

RULING:
 Syllabus x Notes | TAXATION 1

NO.

The dividend normally is payable in money and when so paid, then only does the stockholder realize a
profit or gain, which becomes his separate property, and thus derive an income from the capital that
he has invested. Until that is done the increased assets belong to the corporation and not to the
individual stockholders.

When a corporation or company issues "stock dividends" it shows that the company's accumulated
profits have been capitalized, instead of distributed to the stockholder or retained as surplus available
for distribution, in money or in kind, should opportunity offer. Far from being a realization of profits
of the stockholder, it tends rather to postpone said realization, in that the fund represented by the
new stock has been transferred from surplus to assets, and no longer is available for actual
distribution. The essential and controlling fact is that the stockholder has received nothing out of the
company's assets for his separate use and benefit; on the contrary, every dollar of his original
investment, together with whatever accretions and accumulations resulting from employment of his
money and that of the other stockholders in the business of the company, still remains the property
of the company, and subject to business risks which may result in wiping out the entire investment.
Having regard to the very truth of the matter, to substance and not to form, the stockholder by virtue
of the stock dividend has in fact received nothing that answers the definition of an "income." (Eisner
vs. Macomber, 252 U. S., 189, 209, 211.)

Income from Dividends vs. Stock Dividends

One is an actual receipt of profits; the other is receipt of a representation of the increased value of
the assets of a corporation. The stockholder who receives a stock dividend has received nothing but a
representation of this increased interest in the capital of the corporation.

Extraordinary Cash Dividends v. Stock Dividends

One is a disbursement to the stockholders of accumulated earning, and the corporation at once parts
irrevocably with all interest therein. The other involves no disbursement by the corporation. It parts
with nothing to the stockholders. The latter receives, not an actual dividend, but certificates of stock
which evidence in a new proportion his interest in the entire capital.

HOWEVER…
It may be argued that a stockholder might sell the stock dividend which he had acquired. If he does,
then he has received in fact, an income and such income, like any other pro fit which he realizes from
the business, is an income and he may be taxed thereon.

Q: When is income considered received/realized for income tax purposes?

1. If actually or physically received by the taxpayer (actual receipt)
2. If constructively received by the taxpayer (constructive receipt)
(see Section 52, RR No. 2)

Q: Distinguish actual receipt from constructive receipt.

Actual receipt Constructive receipt

may be actual or physical receipt occurs when money consideration or its
equivalent is placed at the control of the person
 Syllabus x Notes | TAXATION 1

who rendered the service without restriction by

the payor (see Section 4.108-A, RR 16-2005).

Q: What is constructive receipt doctrine?

The constructive receipt doctrine provides than an item is treated as income when it is credited to the
account of the taxpayer, or made unconditionally available to the taxpayer; no physical possession is
required. (see Section 52, RR No. 2-40)

Income is received not only when it is actually handed to a taxpayer but also when it is merely
constructively received by him. In LIMPAN INVESTMENT V. CIR [JULY 26, 1966], the lessees opted to
deposit their payments when the lessor refused to accept the same in 1957. The lessor did not report
these payments in his 1957 income tax return. The Supreme Court held that the failure to report the
said rental income is unjustified as, when the payments were deposited, the lessor was deemed to have
constructive received such rentals.

Limpan v. CIR, 17 SCRA 703 – Actual v. Constructive Receipt

CONSTRUCTIVE RECEIPT OF INCOME; CASE AT BAR. — The withdrawal in 1958 of the deposits in court pertaining to the 1957
rental income is not sufficient justification for the non-declaration of said income in 1957, since the deposit was resorted to
due to the refusal of petitioner to accept the same, and was not the fault of its tenants; hence, petitioner is deemed to have
constructively received such rentals in 1957. The payment by the subtenant in 1957 should have been reported as rental
income in said year, since it is income just the same regardless of its source.

***
FACTS:

Petitioner Limpan Inv. Corp. is a domestic corporation engaged in the business of leasing real
properties. Its principal stockholders are the spouses Lim. Its president and chairman of the board is
the same Isabelo P. Lim. Its real properties consist of several lots and buildings in Manila and in Pasay
City. Petitioner corporation duly filed its 1956 and 1957 income tax returns, reporting its net incomes
and paying the corresponding taxes.

Sometime in 1958 and 1959, the BIR conducted an investigation, and found that petitioner had
undeclared rental incomes.

Petitioner denied having received or collected the unreported rental income. It reasoned that:
-Isabelo Lim was the one who collected and received from certain tenants but only turned the same
over to petitioner corporation in 1959;
-that a certain tenant (Go Tong) deposited in court his rentals amounting to P10,800.00, over which
the corporation had no actual or constructive control;
-that a sub-tenant paid P4,200.00 which ought not be declared as rental income

Examiners of reposndent BIR presented that the tenants regularly paid their rentals to the petitioner
or its president, but that these payments were not declared in the corresponding returns

CTA ordered Petitioner Limpan Inv. Corp. to pay respondent CIR:

Deficiency income taxes (1956 and 1957) - P7,338.00 and P30,502.50
50% surcharge
5% surcharge
 Syllabus x Notes | TAXATION 1

1% monthly interest from June 30, 1959 to the date of payment

Hence, this appeal.

ISSUE: WON the petitioner is liable to pay the tax imposed on the undeclared rental income?

RULING:

YES.

Petitioner admitted, through its own witness (Vicente G. Solis), that it had undeclared more than 1/2
of the amount (P12,100.00 out of P20,199.00) of rental income for 1956 and more than 1/3 of the
amount (P29,350.00 out of P81,690.00) of unreported rental income for the year 1957.

The withdrawal in 1958 of the deposits in court pertaining to the 1957 rental income is not a
sufficient justification for the non-declaration of said income in 1957, since the deposit was
resorted to due to the refusal of petitioner to accept the same, and was not the fault of its tenants;
hence, petitioner is deemed to have constructively received such rentals in 1957.

The payment by the sub-tenant in 1957 should have been reported as rental income in said year,
since it is income just the same regardless of its source.

Republic v. dela Rama, 18 SCRA 861 – Actual v. Constructive Receipt

If the debts to which the dividends were applied really existed, and were legally demandable and chargeable against the
deceased, there was constructive receipt of the dividends; if there were no such debts, then there was no constructive
receipt.

ABSENCE OF CONSTRUCTIVE RECEIPT OF DIVIDEND BY DECEASED OR HEIR; ASSESSMENT AND NOTICES THEREOF WITHOUT
LEGAL EFFECT; CASE AT BAR. — The application of the dividends to the alleged personal accounts of the deceased did not
constitute such constructive payment to the estate or the heirs that could become the basis for a tax assessment on the said
dividends because, with respect to the first debt, there was no proof adduced to show its existence and validity; and with
respect to the second debt, to which the dividends were partly applied, it was composed of accounts due from an entity
separate and distinct from the deceased and whose debts could not be charged against the deceased even if the latter was
the principal owner thereof, in the absence of proof of substitution of debtor. There being no basis for the assessment of the
income tax, the assessment and the sending of the corresponding notices did not have any basis. The assessment and the
notices did not therefore produce any legal effect that would warrant the collection of the tax.

***

FACTS:
In 1951, the executor-administrator of the estate of the late Esteban de la Rama, Eliseo Hervas, filed
income tax returns of the estate for the year 1950, declaring a net income of P22,796.59, and paid
P3,919.00 for income tax.

BIR later claimed that the estate received cash dividends of P86,800.00 from the De la Rama
Steamship Company, Inc. in 1950. Such amount however, was not declared by Eliseo.

The BIR made an assessment of deficiency income tax against the estate in the sum of P56,032.50.
Letters were sent to the heirs of de la Rama. When the deficiency was unpaid, the Republic of the
 Syllabus x Notes | TAXATION 1

Philippines filed a complaint against the heirs of Esteban de la Rama with the CFI of Manila on 1961.

ARGUMENTS:
The defendants contended that that no cash dividends of P86,800.00 had been paid to the estate.
During trial, it was found out from the evidence that the P86,800.00 was applied to the obligation
(debts) of the estate to the company.

Plaintiff-appellant Republic contends that the crediting of accounts in the books of the company
constituted a constructive receipt (by the estate or the heirs) of the dividends, and this dividend was
an income and was, therefore, taxable.

The lower court dismissing the complaint.

ISSUE: WON the said application of the dividends to the personal accounts of the deceased Esteban
de la Rama constituted constructive receipt by the estate or the heirs, thus taxable

RULING:

NO.
(If the debts to which the dividends were applied really existed, and were legally demandable and
chargeable against the deceased, there was constructive receipt of the dividends; if there were no
such debts, then there was no constructive receipt.)

As to the first debt, it does not even appear that the De la Rama Steamship Co., Inc. had ever filed a
claim against the estate in connection with that indebtedness. As to the second debt, to which the
dividends were partly applied, were accounts "due from Hijos de I. de la Rama, Inc." The alleged
debtor here was an entity separate and distinct from the deceased. If that was so, its debts could not
be charged against the deceased.

Under the National Internal Revenue Code, income tax is assessed on income that has been received,
Thus, Section 21 of the Code requires that the income must be received by an individual before a tax
can be levied thereon. Section 56 also requires receipt of income by an estate before an income tax
can be assessed thereon.

Hence, if income has not been received, no income tax can be assessed thereon. Inasmuch as the
income was not received either by the estate, or by the heirs, neither the estate nor the heirs can be
liable for the payment of income tax therefor.

Q: When is income recognized?

Following the realization principle, income is generally recognized when both the following conditions
are met:
1. The earning process is complete or virtually complete
2. An exchange has taken place
(see MANDARIN HOTELS V. CIR, CTA CASE NO, 5046, MARCH 24, 1997]

4. Methods of accounting for taxable income and deductible expenses

a. Cash v. accrual method of accounting, Secs. 43-45,
 Syllabus x Notes | TAXATION 1

NIRC; Sec. 51-53 Rev. Regs. No. 2-40

b. Installment v. deferred payment v. percentage of completion (in long term contracts), Secs.
48, 49, NIRC; Sec. 44, RR No. 2-40
c. Distinction between tax accounting and financial accounting

Q: What are two main accounting methods that may be used by taxpayers?
The methods are:
1. Cash Method – a method of accounting whereby all items of gross income received during the year
shall be accounted for in such taxable year and that only expenses actually paid shall be claimed as
deductions during the year
2. Accrual Method – method of accounting for income in the period it is earned, regardless of whether it
has been received or not. Expenses are accounted for in the period they are incurred and not in the
period they are paid.
Note: Other methods would include (1) Installment method; (2) Percentage of Completion Method and
(3) Crop year basis.30

Q: Distinguish cash method from accrual method of accounting.

Cash method Accrual method

income is reported in the year payments are income is reported in the year it is earned while
received while expenses are deducted in the year expenses are deducted in the year it is incurred,
paid regardless of receipt or disbursement of cash

Q: Can a taxpayer use a combination of two or more methods of accounting?

No. The rule is that a taxpayer may use any one method of accounting but not a combination of two or
more methods of accounting for each type of business during the taxable year. The use of a hybrid
method of accounting is not allowed (see CONSOLIDATED MINES VS. CTA [AUGUST 29, 1974])

Q: Explain the installment method

Installment Method is a method of accounting considered appropriate when collections of the proceeds
of sales and incomes extend over relatively long periods of time and there is strong possibility that full
collection will not be paid. As customers make installment payments, the seller recognizes the gross
profit on sale in proportion to the cash collected during the year. (see Section 49, Tax Code)

Q: A sold lots to ABC Corp and was paid less than 25%, the balance was covered by 4 checks. On the
same day, the checks were discounted (exchange for cash at an amount lower than face value). A
reported as income for the year of the sale only the cash amount received from sale and excluded the
amount received from the discounted checks. The balance was reported as income only in the next
four years.

A argues that initial payment excludes evidence of indebtedness. Is A’s contention correct?

Yes. As held in BANAS V. CA [FEBRUARY 10, 2000], The transaction remains to be an instalment (not
cash) sale as the law expressly excludes evidence of indebtedness in the determination of how much
was paid for the year. However, even if the proceeds of discounted note is not considered as part of the
initial payment, the income realized from the discounting itself is still a separate taxable income in the
year it was converted into cash because it was at this year that there was actual gain on the discounted
notes.
 Syllabus x Notes | TAXATION 1

Q: Explain the percentage of completion method.

Percentage of Completion Method is a method of accounting applicable in the case of a building,
installation, or construction contract covering a period in excess of one year, whereby gross income
derived from such contract may be reported upon the basis of percentage of completion. (see Section
48, Tax Code)

Q: Explain the deferred payment method.

Deferred payment method is a method of accounting considered when payments are made at a later
date.
When the asset sold is an ordinary asset or a capital asset other than property subject to capital gains
tax, the income from deferred payment sale of property may be reported under the instalment method
or deferred payment method.

Tax Accounting and Financial Accounting

C. Tests in determining income

1. Realization Test
Eisner v. Macamber, 252 US 189
Fisher v. Trinidad, Ibid.
2. Claim of right doctrine or doctrine of ownership, command or control
3. Economic benefit test / Doctrine of proprietary interest
4. Severance Test

Q: Enumerate the different tests for income determination and define each.
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, The power to dispose of income is the equivalent
Command or Control 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 Where stock, options, shares of stock or other
Interest 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]
 Syllabus x Notes | TAXATION 1

All Events Test (Not included in the syllabus) 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

Eisner v. Macamber, 252 US 189 – Realization Test

What is or is not "income" within the meaning of the Amendment must be determined in each case according to truth and
substance, without regard to form. P. 252 U. S. 206.

Income may be defined as the gain derived from capital, from labor, or from both combined, including profit gained through
sale or conversion of capital. P. 252 U. S. 207.

Mere growth or increment of value in a capital investment is not income; income is essentially a gain or profit, in itself, of
exchangeable value, proceeding from capital, severed from it, and derived or received by the taxpayer for his separate use,
benefit, and disposal. Id.

A stock dividend, evincing merely a transfer of an accumulated surplus to the capital account of the corporation, takes
nothing from the property of the corporation and adds nothing to that of the shareholder; a tax on such dividends is a tax on
capital increase, and not on income, and, to be valid under the Constitution, such taxes must be apportioned according to
population in the several states. P. 252 U. S. 208.

***
FACTS:

Standard Oil Company of California is a corporation with an authorized capital stock of $100,000,000.
Mrs. Macomber owned 2,200 share of the stocks.

In January, 1916, the company issue additional shares and then declared a stock dividend. Mrs.
Macomber received an additional 1,100 shares of stock. Of these shares (198.77 shares, par value
$19,877) represented surplus earned by the company after March 1, 1913.

The IRS treated the $19,877 as taxable income under the Revenue Act of 1916 which provided that a
“stock dividend was considered income to the amount of its cash value”. Mrs. Macomber was then
called upon by the CIR to pay, and she did pay under protest the income tax imposed under the said
law.

Mrs. Macomber filed for the recovery of the tax paid from the Collector.

ARGUMENTS:
She argued that that provision in the Revenue Act of 1916 was unconstitutional because it was a
direct tax not apportioned per population; since a stock dividend was not income, a legislative
provision subjecting it to income tax was not constitutional under the 16th Amendment.

The District Court held that the stock dividend was not income.

ISSUE: WON the Congress may tax, as income, a stock dividend from profits accumulated by the
corporation
 Syllabus x Notes | TAXATION 1

RULING:

NO.

The Supreme Court affirmed the District Court holding for the taxpayer that a stock dividend is not
income. The Revenue Act of 1916 provision subjecting stock dividends to tax was held
unconstitutional.

If a stock dividend is not considered income, it cannot be subject to income tax under the 16th
Amendment. In applying the 16th Amendment, it is important to distinguish between capital and
income, as only income is subject to income tax. It provides that “The Congress shall have power to
lay and collect taxes on incomes, from whatever source derived, without apportionment among the
several states and without regard to any census or enumeration."

A stock dividend reflects the corporation transferring an amount from "surplus" (retained earnings) to
"capital stock." Such a transaction is merely a bookkeeping entry and "affects only the form, not the
essence, of the "liability" acknowledged by the corporation to its own shareholders ... it does not alter
the pre-existing proportionate interest of any stockholder or increase the intrinsic value of his holding
or of the aggregate holdings of the other stockholders as they stood before." An increase to the value
of capital investment is not income. Nothing of value has been taken from the corporation and given
to the shareholder as is the case with a cash dividend.

In addition, since the shareholder receives no cash, in order to pay any tax on a stock dividend, he
might have to convert the stock into cash - he has no wherewithal to pay from the nature of the
transaction. "Nothing could more clearly show that to tax a stock dividend is to tax a capital increase,
and not income, than this demonstration that in the nature of things it requires conversion of capital
in order to pay the tax"

Fisher v. Trinidad, Ibid. – Realization Test

(See facts above.)

ISSUE: WON there was a realization of income when the company declared "stock dividends"?

RULING:

NO.

The dividend normally is payable in money and when so paid, then only does the stockholder realize a
profit or gain, which becomes his separate property, and thus derive an income from the capital that
he has invested. Until that is done the increased assets belong to the corporation and not to the
individual stockholders.

When a corporation or company issues "stock dividends" it shows that the company's accumulated
profits have been capitalized, instead of distributed to the stockholder or retained as surplus available
for distribution, in money or in kind, should opportunity offer. Far from being a realization of profits
 Syllabus x Notes | TAXATION 1

of the stockholder, it tends rather to postpone said realization, in that the fund represented by the
new stock has been transferred from surplus to assets, and no longer is available for actual
distribution. The essential and controlling fact is that the stockholder has received nothing out of the
company's assets for his separate use and benefit; on the contrary, every dollar of his original
investment, together with whatever accretions and accumulations resulting from employment of his
money and that of the other stockholders in the business of the company, still remains the property
of the company, and subject to business risks which may result in wiping out the entire investment.
Having regard to the very truth of the matter, to substance and not to form, the stockholder by virtue
of the stock dividend has in fact received nothing that answers the definition of an "income." (Eisner
vs. Macomber, 252 U. S., 189, 209, 211.)

Income from Dividends vs. Stock Dividends

One is an actual receipt of profits; the other is receipt of a representation of the increased value of
the assets of a corporation. The stockholder who receives a stock dividend has received nothing but a
representation of this increased interest in the capital of the corporation.

Extraordinary Cash Dividends v. Stock Dividends

One is a disbursement to the stockholders of accumulated earning, and the corporation at once parts
irrevocably with all interest therein. The other involves no disbursement by the corporation. It parts
with nothing to the stockholders. The latter receives, not an actual dividend, but certificates of stock
which evidence in a new proportion his interest in the entire capital.

HOWEVER…
It may be argued that a stockholder might sell the stock dividend which he had acquired. If he does,
then he has received in fact, an income and such income, like any other pro fit which he realizes from
the business, is an income and he may be taxed thereon.

III. Kinds of Taxpayers

A. Individual Taxpayers
1. Citizens — Sec. 1, Art. IV, Philippine Constitution
a. Resident citizens (RC), Secs. 22 (A) (1) (a), and 23(A), NIRC
b. Non-resident citizens (NRC), Secs. 22 (E), 23 (B) and (C), 24 (A) (1) (b), NIRC
183-day rule — Sec. 2 (c), RR 01-79
RR No. 01-11, as amended
2. Aliens
a. Resident aliens (RA), Sec. 22 (F), NIRC; Sec. 5 (last paragraph), RR No. 02-40
b. Non-resident aliens (NRA)
i. NRA engaged in trade or business in the Philippines (NRA-ETB)
180-day test, Sec. 25 (A) (1), NIRC
ii. NRA not engaged in trade or business in the Philippines (NRA-NETB),
Sec. 25 (B), NIRC
c. Special Class of Individual Employees
i. Aliens employed by RHQs, AHQs, ROHQs of MNCs, Secs. 22 (DD), 22 (EE), 25 (C), NIRC; RR
11-10
ii. Aliens employed by OBUs, Sec. 25 (D), NIRC
iii. Aliens employed by petroleum service contractors, subcontractors, Sec. 25, NIRC
3. Estates and Trusts — Art. 1440, Civil Code
4. Co-ownerships
 Syllabus x Notes | TAXATION 1

5. General Professional Partnerships, Secs. 22(B) and 26, NIRC; RMC 003-12

1. Citizens

Note: It is important to know the classification of Philippine citizens on whether they are resident
citizens or non-resident citizens to determine what incomes are subject to tax in the Philippines.
Resident citizens are taxable on all income derived from sources within and without the Philippines
while non-resident citizens are taxable only on income derived from sources within the Philippines. (see
Section 22, Tax Code)

Q: Who is a resident citizen?

A resident citizen is a citizen of the Philippines without the intention of transferring his physical presence
abroad whether to stay permanently or temporarily as an overseas contract worker.

Q: Who are citizens of the Philippines?

The following are considered citizens of the Philippines:
1. Those who are citizens of the Philippines at the time of the adoption of the Constitution
2. Those whose fathers or mothers are citizens of the Philippines
3. Those born before January 17, 1973 of Filipino mothers, who elect Philippine Citizenship upon
reaching the age of majority; and
4. Those who are naturalized in accordance with law

Read Section 22(E), Tax Code

Q: Who is a non-resident citizen?

The term “non-resident citizen” means a citizen of the Philippines:
1. who establishes to the satisfaction of the Commissioner the fact of his physical presence abroad with
intention to reside therein
2. who leaves the Philippines during the taxable year to reside abroad either as an immigrant or for
employment on a permanent basis
3. one who works and derives income from abroad and whose employment thereat requires him to be
physically present abroad most of the time during the taxable year.
4. who has been previously considered a non-resident citizen and who arrives in the Philippines at any
time during the taxable year to reside permanently in the Philippines with respect to his income derived
from sources abroad
[See Section 22(E), NIRC]

Note that Section 2, RR No. 01-79 [January 8, 1979] enumerates who are deemed “non-resident
citizens:”

1. Immigrant – one who leaves the Philippines to reside abroad as an immigrant for which a foreign visa
has been secured
2. Permanent employee – one who leaves the Philippines to reside abroad for employment on a more or
less permanent basis
3. Contract worker – one who leaves the Philippines on account of a contract of employment which is
renewed from time to time under such circumstance as to require him to be physically present abroad
most of the time (not less than 183 days)
 Syllabus x Notes | TAXATION 1

Q: Should a non-resident citizen file an income tax return or information return covering his income
earned abroad?
No. Previously, under RR No. 01-79, non-resident citizens were required to do so. In RR No. 9-99, non-
resident citizens were required to file an information return.

However, under RR 05-01 [July 31, 2001], non-resident citizens are no longer required to file an income
tax return or information return on their income derived from sources outside the Philippines.

Q: What is meant by the phrase “most of the time” as used in determining whether a citizen who
derives income from abroad and is physically present abroad is a non-resident?
RR No. 01-79 states that to be physically present abroad most of the time during the taxable year, a
contract worker must have been outside the Philippines for not less than 183 days during such taxable
year.
Note: As can be seen from the wording of RR No. 01-79, “most of the time” applies to a contract worker.
In BIR Ruling 33-00 [September 5, 2000], however, the CIR held that for overseas contract workers, the
time spent abroad is not material as all that is required is for the worker’s employment contract to pass
through and be registered with the POEA.

Q: If a natural-born Philippine citizen who became a citizen of the United States is later on granted
Philippine dual citizenship under RA 9225, is he required to pay taxes for income earned in the United
States?
No. In BIR Ruling DA-095-05 [March 29, 2005], the CIR held that such a person would be a non-resident
citizen, and hence, will not be required to pay Philippine tax for income earned in the United States.

2. Alien

Note: It is important to know the classification of alien taxpayers to know (1) the tax rates to be imposed
on their income derived from sources within the Philippines and (2) allowable exemptions and
deductions.

non-resident alien not engaged resident alien (RA) or non-

in trade or business (NRANETB) resident alien engaged in trade
or business (NRAETB)
As to Tax rates Subject to a flat tax of 25% on Subject to the graduated
income within the Philippines income tax rates
(see Section 25(B), Tax Code) (see Section 23, Tax Code)
As to Deductions Cannot avail of deductions Can avail of deductions
Exemptions – Resident aliens
are allowed personal and
additional exemptions while
non-resident aliens engaged in
trade or business in the
Philippines are entitled to
personal exemptions only by
way of reciprocity and not to
additional exemptions.
 Syllabus x Notes | TAXATION 1

Read Section 22(F) and (G), Tax Code

Q: Who is a resident alien?

A resident alien is an individual whose residence is within the Philippines, but who is not a citizen

Q: How is the residency of an alien determined?

An alien is considered a non-resident if he stays here for a definite short period of time.
An alien will be considered a resident if the stay here is either:
1. definite and extended;
2. indefinite
An alien actually present in the Philippines who is not a mere transient or sojourner is a resident of the
Philippines for purposes of the income tax.

In GARRISON V. CA [JULY 19, 1990], in resolving the contention of US nationals that they cannot be
considered resident aliens as they intend to go back to the US on termination of their employment in
the Philippines, the Supreme Court held that what the law requires is merely physical or bodily presence
in a given place for a period of time, not the intention to make it a permanent place of abode.

The Supreme Court further held that, as laid clearly in RR No. 2, whether an alien is a transient or not is
determined by his intentions with regard to the length and nature of his stay . A mere floating intention
indefinite as to time, to return to another country is not sufficient to constitute him as a transient. If he
lives in the Philippines and has no definite intention as to his stay, he is a resident . One who comes to
the Philippines for a definite purpose, which in its nature may be promptly accomplished, is a
transient. But if his purpose is of such a nature that an extended stay may be necessary for its
accomplishment, and to that end the alien makes the Philippines his temporary home, he becomes a
resident, although he intends to return to his domicile abroad.

Q: When is the residence of an alien considered lost?

RR 2 provides that an alien who has acquired residence in the Philippines retains his status as a resident
until he abandons the same and actually departs from the Philippines. An intention to change his
residence does not change his status as a resident alien to that of a non-resident alien.

Q: Who is a non-resident alien?

A non-resident alien is an individual:
1. whose residence is not within the Philippines; and
2. who is not a citizen thereof
Note: Determination is by his intention with regard to the length and nature of his stay (see Section 5,
RR 2). Again, remember, that an alien is considered a non-resident if he stays here for a definite short
period of time.

Q: What are two kinds of non-resident aliens?

1. Engaged in trade, business, or the practice of a profession in the Philippines
2. Not engaged in trade business, trade or exercise of a profession within the Philippines

Read Section 25(A)(1), Tax Code

Q: How do you determine if a non-resident alien is engaged in trade or business?

 Syllabus x Notes | TAXATION 1

Once a taxpayer is determined to be a non-resident alien, the test to determine whether the alien is a
non-resident alien engaged in trade or business is whether his total aggregate stay for a taxable year
exceeds 180 days (6 months)

3. Estates and Trusts — Art. 1440, Civil Code

Note: This is discussed first because they should be properly treated as individuals as their taxable
income is computed in the same manner and on the same basis as in the case of an individual (see
Section 61, Tax Code)

Q: Define estate for purposes of income taxation.

The Tax Code does not provide a definition. However, Atty. Domondon suggests that the word “estate”
refers to the mass of properties and assets left behind by the deceased. The income that is subject to
income taxation is the “income received by estates of deceased persons during the period of
administration or settlement of the estate.” (see Section 60, Tax Code) 20

Q. How are the incomes of estates and trusts taxed?

The taxable income of estates and trusts is computed in the same manner and on the same basis as in
the case of an individual subject to certain exceptions
Read Section 61, Tax Code

Q: To whom shall the income of a trust be taxable to?

If the trust instrument is irrevocable, the income shall be taxable to the fiduciary.
If the trust instrument is revocable, the income shall be taxable to the grantor.

Q: Is the tax imposed on trusts applicable to all trusts?

No. If the trust is an employee’s trust which forms part of an employer’s pension, stock or profit-sharing
plan that complies with the requirements of tax exemption under Section 60(B) of the NIRC, its income
would be exempt from income tax.

4. Co-ownerships

Note: Co-ownerships have been included in this discussion because in most cases, the Court has been
asked to determine whether there exists a taxable (unregistered) partnership and not a mere co-
ownership.

Q: Is a co-ownership taxable as a corporation?

No. The common ownership of property does not by itself create a partnership between the owners,
though they may use it for purposes of making gains. Article 1769(3) of the Civil Code provides that “the
sharing of gross returns does not by itself establish a partnership whether or not the persons sharing
them have a joint or common right or interest in any property from which the returns are derived.

Q: A and B, co-owners, bought 3 parcels of land in one transaction and bought 2 more parcels of land
in another. They decided to sell the 3 parcels to C and the 2 parcels to D. They realized a net profit
gain and paid CGT. CIR assessed them for deficiency corporate income tax. Is the co-ownership taxable
as a corporation?
No. A co-ownership who own properties which produce income should not automatically be considered
partners of an unregistered partnership, or a corporation, within the purview of the income tax law. The
 Syllabus x Notes | TAXATION 1

essential elements of a partnership are two, namely: (a) an agreement to contribute money, property or
industry to a common fund; and (b) intent to divide the profits among the contracting parties. Here,
there is no evidence that petitioners entered into an agreement to contribute money, property or
industry to a common fund, and that they intended to divide the profits among themselves. The sharing
of returns does not in itself establish a partnership whether or not the persons sharing therein have a
joint or common right or interest in the property. There must be a clear intent to form a partnership, the
existence of a juridical personality different from the individual partners, and the freedom of each party
to transfer or assign the whole property. (see OBILLOS v. CIR [OCTOBER 29, 1985] and PASCUAL V. CIR
[OCTOBER 18, 1988]).

Q: A group of insurance companies in the Philippines decided to form a pool and entered into a
reinsurance treaty with a non-resident reinsurance company. Is such a pool subject to corporate taxes
and withholding taxes on dividends paid to the non-resident reinsurance company?
Yes. Where several local insurance ceding companies enter into a Pool Agreement or an association that
would handle all the insurance businesses covered under their quota-share reinsurance treaty and
surplus reinsurance treaty with a non-resident foreign reinsurance company, the resulting pool having a
common fund, and functions through an executive board and its work is indispensable, beneficial and
economically useful to the business of the ceding companies and the foreign firm, such circumstances
indicate a partnership or an association taxable as a corporation (see AFISCO INSURANCE CORPORATION
VS. CIR [JANUARY 25, 1999])

Q: A and B inherited properties. They did not partition the same and instead invested them to a
common fund and divide the profits therefrom. Should they be classified as an unregistered
partnership subject to corporate income tax?
Yes. The income from inherited properties may be considered as individual income of the respective
heirs only as long as the inheritance or estate is not distributed, or, at least, partitioned. But the
moment their respective known shares are used as part of the common assets of heirs to be used in
making profits, it is but proper that the income from such shares should be considered as part of the
taxable income of an unregistered partnership. (see ONA V. CIR [MAY 25, 1972]).

Note: Thus, we make a distinction. Before the partition of property, the income of the co-ownership
arising from the death of a decedent is not subject to income tax, if the activities of the co-owners are
limited to the preservation of the property and the collection of the income therefrom. However, after
partition, should the co-owners invest the income of the co-ownership in any income-producing
properties, they would be constituting themselves into an unregistered partnership which is
consequently subject to income tax as a corporation.

Q: A and B bought 3 parcels of land in 1976 and 2 parcels of land in 1977. In 1988 they sold the first
three to Z and the other two were sold to Y in 1989. A and B realized a net profit from the sale and
they individually paid he corresponding capital gains tax. The CIR assessed them for deficiency income
tax arguing that they formed an unregistered partnership. Is the contention of the CIR correct?
No. Isolated transactions by two or more persons do not warrant their being considered as an
unregistered partnership. They will instead be considered as mere co-owners; no corporate income tax
is due on mere co-ownerships.

5. General Professional Partnerships, Secs. 22(B) and 26, NIRC; RMC 003-12

General Professional Partnerships (GPP)

 Syllabus x Notes | TAXATION 1

Q: What is a GPP?
General professional partnership (GPP) are partnerships formed by persons for the sole purpose of
exercising their common profession, no part of the income of which is derived from engaging in any
trade or business.

Q: Is a GPP liable for income tax?

No. A GPP is not considered a taxable entity for income tax purposes. Section 26 of the NIRC provides
that persons engaging in business as partners in a GPP shall be liable for income tax only in their
separate and individual capacities computed on their respective distributive shares of the partnership
profit.

Q: Distinguish between a GPP and an ordinary business partnership.

Ordinary Business Partnership General Professional Partnerships

Treated as a corporation for income tax purposes Not itself an income taxpayer. The income tax is
and so subject to the corporate income tax imposed not on the professional partnership,
which is tax exempt, but on the partners
themselves in their individual capacity computed
on their distributive shares of partnership profits
(see CARAG, CABALLES, JAMORA AND SOMERA
LAW OFFICES VS. DEL ROSARIO [OCTOBER 3,
1994])

B. Corporation
1. Domestic corporation, defined, Sec. 22 (B), (C), (E), NIRC
2. Taxable Partnership or Business Partnership
3. Joint Venture (JV)
a. Exempt JV — RR 010-12
b. Taxable JV
4. Foreign Corporations — Secs. 22 (D) and 23 (F), NIRC
a. Resident foreign corporation (RFC), Sec. 22 (H), NIRC; Sec. 3 (d), Foreign Investments Act of
1991, as amended
b. Non-resident foreign corporation (NRFC), Sec. 22 (1), NIRC
c. Subsidiary v. branch of a foreign corporation

Read Section 22(C), (D), (H) and (I), Tax Code

Note: It is important to know the classification whether they are domestic corporations or foreign
corporations to determine what incomes are subject to tax in the Philippines. A domestic corporation is
taxed on its income from sources within and without the Philippines, but a foreign corporation is taxed
only on its income from sources within the Philippines.

It is important to know the kinds of foreign corporations for income taxation purposes to determine the
allowable deductions. While a resident foreign corporation is taxable on income solely from sources
within the Philippines, it is permitted to deductions from gross income but only to the extent connected
with income earned in the Philippines. On the other hand, non-resident foreign corporations cannot
avail of deductions. (see N.V. REEDERIJ “AMSTERDAM” VS. CIR [JUNE 23, 1988])
 Syllabus x Notes | TAXATION 1

Domestic corporation one created or organized in the Philippines or

under its laws.
Foreign Corporation one created or organized under the laws of a
foreign country.
Resident foreign Corporation a foreign corporation engaged in trade or
business within the Philippines or having an office
or place of business therein.
Non-resident foreign corporation a foreign corporation not engaged in trade or
business within the Philippines and not having
any office or place of business therein.

Q: ABC Corporation, a foreign corporation in Japan and licensed to engage in business in the
Philippines (hence, a resident foreign corporation) has equity investments in XYZ Company, a
domestic corporation. XYZ declared and paid cash dividends to ABC. XYZ directly remitted the cash
dividends to ABC’s head office in Japan (hence, a non-resident foreign corporation) not only of the
10% final dividend tax but also of the withheld 15% profit remittance tax based on the remittable
amount after deducting the final withholding tax of 10%. ABC argues that following the principal-
agent relationship theory, ABC is a resident foreign corporation subject only to the 10 %
intercorporate final tax on dividends received from a domestic corporation. Is ABC correct?
No. The general rule that a foreign corporation is the same juridical entity as its branch office in the
Philippines cannot apply here. This rule is based on the premise that the business of the foreign
corporation is conducted through its branch office, following the principal agent relationship theory. It is
understood that the branch becomes its agent here. So that when the foreign corporation transacts
business in the Philippines independently of its branch, the principal-agent relationship is set aside. The
transaction becomes one of the foreign corporation, not of the branch. Consequently, the taxpayer is
the foreign corporation, not the branch or the resident foreign corporation. Corollarily, if the business
transaction is conducted through the branch office, the latter becomes the taxpayer, and not the foreign
corporation. (see MARUBENI CORPORATION VS. CIR [SEPTEMBER 14, 1989]).

Q: XYZ is a foreign shipping company. It does not have a branch office in the Philippines and it made
only two calls in Philippine ports. What kind of foreign corporation is XYZ?
XYZ is a foreign corporation not authorized or licensed to do business in the Philippines. In order that a
foreign corporation may be considered engaged in trade or business, its business transactions must be
continuous. A casual business activity in the Philippines by a foreign corporation does not amount to
engaging in trade or business in the Philippines for income tax purposes. Accordingly, its taxable income
for purposes of our income tax law consists of its gross income from all sources within the Philippines.
(see N.V. REEDERIJ “AMSTERDAM” VS. CIR [JUNE 23, 1988])

2. Partnerships

Q: Is a partnership liable for income tax?

Yes. The term “corporations” includes partnerships, no matter how created or organized.

Q: What are the kinds of partnerships under the Tax Code?

 Syllabus x Notes | TAXATION 1

1. Taxable partnerships – these are business partnerships or partnerships which are organized for the
purpose of engaging in trade or business. They are subject to income tax as if they were corporations
whether or not registered with the SEC as a partnership
2. Exempt partnerships – these are partnerships not considered as taxable entities for income tax
purposes i.e. General Professional Partnerships).

Q: How do you determine if a partnership is taxable? (elements of a taxable partnership)

1. An intent to form the same
2. Generally participating in both profits and losses
3. Such a community of interest, as far as third persons are concerned as enables each party to make
contract, manage he business and dispose of the whole property.

3. Joint venture and consortium

Q: Are joint ventures taxable?

Generally, yes.
As an exception, a joint venture or consortium undertaking construction projects or engaged in
petroleum operations with an operating contract with the government are not liable for income tax.

Q: What are the requirements in order for a joint venture formed for construction purposes be not
liable for income tax?
In RR No. 010-12 [JUNE 1, 2012], a joint venture or consortium formed for the purpose of undertaking
construction projects which is not considered as a taxable corporation should be:
1. For the undertaking of a construction project;
2. Should involve joining or pooling of resources by licensed local contractors, licensed by the Philippine
Contractors Accreditation Board (PCAB) of the DTI;
3. The local contractors are engaged in construction business;
4. The joint venture itself must likewise be duly licensed as such by the PCAB

Absent one of the requirements, the joint venture formed for construction purposes shall be considered
a taxable corporation.

Q: May joint ventures involving foreign contractors be treated as a non-taxable corporation?

Yes, provided that the member foreign contractor is:
1. covered by a special license as contractor by the PCAB; and
2. construction project is certified by the appropriate government office as a foreign
financed/internationally-funded project and that international bidding is allowed under the bilateral
agreement between the Philippine government; and foreign/international financing institution.

Q: Two local contractors entered into a joint development agreement to construct a residential
subdivision. One local contractor shall contribute the parcel of land while the other shall contribute
the construction and development of the parcel of land into a subdivision. Each shall receive an
allocation of saleable house and lot units from the project. Is the joint venture liable for income tax?
No. In BIR Ruling No. 108-2010 [October 19, 2010],23 involving a joint venture between Avida and
Aurora, the CIR held that the joint development agreement between the two is not subject to income
tax because joint ventures formed by local contractors for construction purposes are deemed as not
falling under the definition of a taxable corporation.