Taxation Law 1 Reviewer

BAR OPERATION COMMITTEE
GENERAL PRINCIPLES OF TAXATION
A. TAXATION: ITS GENERAL CONCEPTS

1) Taxation as a power
As a power, taxation refers to the inherent power of the state to demand enforced
contributions for public purpose or purposes.
i. Nature of the power of taxation

 Inherent in sovereignty – The power of taxation is inherent in sovereignty as
an incident or attribute thereof, being essential to the existence of every
government. It can be exercised by the government even if the Constitution is
entirely silent on the subject.
a. Constitutional provisions relating to the power of taxation do not

operate as grants of the power to the government. They merely constitute
limitations upon a power which would otherwise be practically without limit.
b. While the power to tax is not expressly provided for in our constitutions,
its existence is recognized by the provisions relating to taxation.
In the case of Mactan Cebu International Airport Authority vs. Marcos,

Sept. 11, 1996, as an incident of sovereignty, the power to tax has been
described as “unlimited in its range, acknowledging in its very nature no
limits, so that security against its abuse is to be found only in the
responsibility of the legislative which imposes the tax on the constituency
who are to pay it.”
 Legislative in character – The power to tax is exclusively legislative and

cannot be exercised by the executive or judicial branch of the government.
 Subject to constitutional and inherent limitations – Although in one decided

case the Supreme Court called it an awesome power, the power of taxation is
subject to certain limitations. Most of these limitations are specifically
provided in the Constitution or implied there from while the rest are inherent
and they are those which spring from the nature of the taxing power itself
although, they may or may not be provided in the Constitution. For example
the power to tax may not be delegated except when provided for by the
constitution.
 Is the Power to Tax the Power to Destroy?

In the case of Churchill, et al. vs. Concepcion (34 Phil 969) it has been
ruled that:
The power to impose taxes is one so unlimited in force and so

searching in extent so that the courts scarcely venture to declare that it is
subject to any restriction whatever, except such as rest in the discretion of the
authority which exercise it. No attribute of sovereignty is more pervading,
and at no point does the power of government affect more constantly and
intimately all the relations of life than through the exaction made under it.
And in the notable case of McCulloch vs. Maryland, Chief Justice

Marshall laid down the rule that the power to tax involves the power to
destroy.
According to an authority, the above principle is pertinent only when

there is no power to tax a particular subject and has no relation to a case
where such right to tax exists. This opt-quoted maxim instead of being
regarded as a blanket authorization of the unrestrained use of the taxing
power for any and all purposes, irrespective of revenue, is more reasonably
construed as an epigrammatic statement of the political and economic axiom
that since the financial needs of a state or nation may outrun any human
calculation, so the power to meet those needs by taxation must not be limited
even though the taxes become burdensome or confiscatory. To say that “the
power to tax is the power to destroy” is to describe not the purposes for
which the taxing power may be used but the degree of vigor with which the
taxing power may be employed in order to raise revenue (I Cooley 179-181)
Prepared by TAX LAW COMMITTEE – Adviser: Atty. Jason Barlis, 1

2008 Chairman: Genevieve Shontogan, V.Chairman: Scarlet Banawol, Members: Kristine Beňas, Marie Mae Buliyat,
Wilhelmina Diwa, Feliza Kadatar, Charlene Lagua, Claryll Anne Laminato, Shandra Diane Mappang
2009 Chairman: Norwayne Salman, V.Chairman: Carlo Rimas, Members: Shayne Ann Basco, Lota Marie Buan, Marie Mae
Buliyat, Precious Madio, Jefferson Malacas, Karen Moster, Clarence Rimando, Genevieve Shontogan
 Constitutional Restraints Re: Taxation is the Power to Destroy

While taxation is said to be the power to destroy, it is by no means
unlimited. It is equally correct to postulate that the “power to tax is not the
power to destroy while the Supreme Court sits,” because of the constitutional
restraints placed on a taxing power that violated fundamental rights.
In the case of Roxas, et al vs. CTA (April 26, 1968), the SC reminds us
that although the power of taxation is sometimes called the power to destroy,
in order to maintain the general public’s trust and confidence in the
Government, this power must be used justly and not treacherously. The
Supreme Court held:
“The power of taxation is sometimes called also the power to destroy.

Therefore it should be exercised with caution to minimize injury to the
proprietary rights of a taxpayer. It must be exercised fairly, equally and
uniformly, lest the tax collector kill the ‘hen that lays the golden egg’. And, in
order to maintain the general public’ trust and confidence in the Government
this power must be used justly and not treacherously.”
The doctrine seeks to describe, in an extreme, the consequential

nature of taxation and its resulting implications, to wit:
a. The power to tax must be exercised with caution to minimize injury to
proprietary rights of a taxpayer;
b. If the tax is lawful and not violative of any of the inherent and
constitutional limitations, the fact alone that it may destroy an activity or
object of taxation will not entirely permit the courts to afford any relief; and
c. A subject or object that may not be destroyed by the taxing authority
may not likewise be taxed. (e.g. exercise of a constitutional right)
 Cases:
o Sison vs. Ancheta, 130 SCRA 654
o Municipality of Makati vs. Court of Appeals, 190 SCRA 206
ii. Importance of Taxation and the Lifeblood Doctrine
Rationale of Taxation - The Supreme Court held:
“It is said that taxes are what we pay for civilized society. Without taxes,
the government would be paralyzed for lack of the motive power to activate and
operate it. Hence, despite the natural reluctance to surrender part of one’s hard-
earned income to the taxing authorities, every person who is able must
contribute his share in the running of the government. The government for its
part is expected to respond in the form of tangible and intangible benefits
intended to improve the lives of the people and enhance their moral and material
values. The symbiotic relationship is the rationale of taxation and should dispel
the erroneous notion that it is an arbitrary method of exaction by those in the seat
of power.
Taxation is a symbiotic relationship, whereby in exchange for the

protection that the citizens get from the government, taxes are paid.”
(Commissioner of Internal Revenue vs. Algue, Inc., et al., L-28896, Feb. 17, 1988)
“The areas which used to be left to private enterprise and initiative and
which the government was called upon to enter optionally, and only because it
was better equipped to administer for the public welfare than is any private
individual or group of individuals, continue to lose their well-defined
boundaries and to be absorbed within activities that the government must
undertake in its sovereign capacity it is to meet the increasing social challenges of
the times. Hence, the need for more revenues.” (Justice Makalintal in Sison vs.
Ancheta, July 25, 1984)
iii. Justifications for the exercise of the taxing power

1. The Benefits-Protection Theory/Benefit-Received Theory
The basis of taxation is the reciprocal duty of protection between the
state and its inhabitants. In return for the contributions, the taxpayer receives the

general advantages and protection which the government affords the taxpayer
and his property.
Qualifications of the Benefit-Protection Theory:

a. It does not mean that only those who are able to pay and do pay taxes can
enjoy the privileges and protection given to a citizen by the government.
b. From the contributions received, the government renders no special or
commensurate benefit to any particular property or person.
c. The only benefit to which the taxpayer is entitled is that derived from his
enjoyment of the privileges of living in an organized society established and
safeguarded by the devotion of taxes to public purposes. (Gomez vs. Palomar, 25
SCRA 829)
d. A taxpayer cannot object to or resist the payment of taxes solely because no
personal benefit to him can be pointed out as arising from the tax. (Lorenzo vs.
Posadas, 64 Phil 353)
2. Necessity Theory
Taxes proceed upon the theory that the existence of the government is a
necessity; that it cannot continue without the means to pay its expenses; and that
for those means, it has the right to compel all citizens and properties within its
limits to contribute.
In a case, the Supreme Court held that:
Taxation is a power emanating from necessity. It is a necessary burden to

preserve the State’s sovereignty and a means to give the citizenry an army to
resist aggression, a navy to defend its shores from invasion, a corps of civil
servants to serve, public improvements designed for the enjoyment of the
citizenry and those which come with the State’s territory and facilities, and
protection which a government is supposed to provide. (Phil. Guaranty Co., Inc.
vs. Commissioner of Internal Revenue, 13 SCRA 775).
3. Lifeblood Theory
Taxes are the lifeblood of the government, being such, their prompt and
certain availability is an imperious need. (Collector of Internal Revenue vs. Goodrich
International Rubber Co., Sept. 6, 1965) Without taxes, the government would be
paralyzed for lack of motive power to activate and operate it.
iv. Purposes and Objectives of Taxation

1. Revenue – to provide funds or property with which the State promotes
the general welfare and protection of its citizens.
2. Non-Revenue [PR2EP]
a. Promotion of General Welfare – Taxation may be used as an implement of
police power in order to promote the general welfare of the people. [see Lutz vs.
Araneta (98 Phil 148) and Osmeňa vs. Orbos (G.R. No. 99886, Mar. 31, 1993)]
b. Regulation – As in the case of taxes levied on excises and privileges like

those imposed in tobacco or alcoholic products or amusement places like night
clubs, cabarets, cockpits, etc.
In the case of Caltex Phils. Inc. vs. COA (G.R. No. 92585, May 8, 1992), it
was held that taxes may also be imposed for a regulatory purpose as, for
instance, in the rehabilitation and stabilization of a threatened industry which is
affected with public industry like the oil industry.
c. Reduction of Social Inequality – this is made possible through the
progressive system of taxation where the objective is to prevent the under-
concentration of wealth in the hands of few individuals.
d. Encourage Economic Growth – in the realm of tax exemptions and tax

reliefs, for instance, the purpose is to grant incentives or exemptions in order to
encourage investments and thereby promote the country’s economic growth.
e. Protectionism – in some important sectors of the economy, as in the case

of foreign importations, taxes sometimes provide protection to local industries
like protective tariffs and customs duties. (Re Special Duties under the Tariff and
Customs Code; See also RA 8800 re Safeguard Measures Act)

2) Taxation as a process
As a process, it is a means by which the sovereign, through its law-making body,
raises revenue to defray the necessary expenses of the government. It is merely a way of
apportioning the costs of government among those who in some measures are privileged
to enjoy its benefits and must bear its burdens.
i. Stages in the tax process

1. Levy/Imposition
- the act of imposition by the legislature such as by its enactment of the
law.
- determination of the persons, property or excises to be taxed, the sum
or sums to be raised, the due date thereof and the time and manner of
levying and collecting taxes (strictly speaking, such refers to taxation)
2. Assessment and Collection

- the act of administration and implementation of the tax law by the
executive through its administrative agencies.
- consists of the manner of enforcement of the obligation on the part of
those who are taxed.
 The two processes together constitute the “taxation system”.
ii. Principles of a sound tax system

1. Fiscal Adequacy
- the sources of tax revenue should coincide with, and approximate the
needs of government expenditure. Neither an excess nor a deficiency of
revenue vis-à-vis the needs of government would be in keeping with the
principle.
- The principle of fiscal adequacy as a characteristic of a sound tax system
was originally stated by Adam Smith in his Canons of Taxation (1776), as:
“Every tax ought to be so contrived as both to take out and to keep out of
the pockets of the people as little as possible over and above what it
brings into the public treasury of the state.” It simply means that sources
of revenues must be adequate to meet government expenditures and
their variations. (ABAKADA vs. Ermita, G.R. 168056, Sept. 1, 2005)
2. Administrative Feasibility
- tax system should be capable of being properly and efficiently
administered by the government and enforced with the least
inconveniences to the taxpayer.
3. Theoretical Justice
- the tax burden should be in proportion to the taxpayer’s ability to pay
(ability-to-pay principle). The 1987 Constitution requires taxation to be
equitable and uniform.
** The non-observance of these canons, which are merely intended to make

the tax system sound, will not render the tax impositions by the taxing authority
invalid, except to the extent that specific constitutional or statutory limitations
are impaired.
B. THE CONCEPT AND CHARACTERISTICS OF TAXES (LEMP3S)

1. It is an enforced contribution
2. It is proportionate in character - It is ordinarily based on the taxpayer’s ability to pay.
3. It is levied by the law-making body of the State
4. The power to tax is a legislative power which under the Constitution only Congress can exercise
through the enactment of laws. Accordingly, the obligation to pay taxes is a statutory liability.
5. A tax is not a voluntary payment or donation. It is not dependent on the will or contractual
assent, express or implied, of the person taxed. Taxes are not contracts but positive acts of the
government.
6. It is generally payable in money

7. Tax is a pecuniary burden – an exaction to be discharged alone in the form of money which must
be in legal tender, unless qualified by law, such as RA 304 which allows backpay certificates as
payment of taxes.
8. It is levied on persons or property - A tax may also be imposed on acts, transactions, rights or
privileges.
9. It is levied for public purpose or purposes - Taxation involves, and a tax constitutes, a burden to
provide income for public purposes.
10. It is levied by the State which has jurisdiction over the persons or property. - The persons,
property or service to be taxed must be subject to the jurisdiction of the taxing state.
Scope of Legislative Taxing Power [S2 A P K A M]

1. subjects of Taxation (the persons, property or occupation etc. to be taxed)
2. amount or rate of the tax
3. purposes for which taxes shall be levied provided they are public purposes
4. apportionment of the tax
5. situs of taxation
6. method of collection
C. LIMITATIONS ON THE EXERCISE OF THE TAXING POWER

1) Inherent Limitations
i. Public Purpose
 Important Points to Consider:
a. If taxation is for a public purpose, the tax must be used:
a.1) for the support of the state or
a.2) for some recognized objects of governments or
a.3) directly to promote the welfare of the community (taxation as an
implement of police power)
b. The term “public purpose” is synonymous with “governmental purpose”; a

purpose affecting the inhabitants of the state or taxing district as a
community and not merely as individuals.
c. A tax levied for a private purpose constitutes a taking of property without

due process of law.
d. The purposes to be accomplished by taxation need not be exclusively

public. Although private individuals are directly benefited, the tax would
still be valid provided such benefit is only incidental.
e. The test is not as to who receives the money, but the character of the
purpose for which it is expended; not the immediate result of the
expenditure but rather the ultimate.
f. In the imposition of taxes, public purpose is presumed.
 Test in determining Public Purposes in tax

a. Duty Test – whether the thing to be threatened by the appropriation of
public revenue is something which is the duty of the State, as a government.
b. Promotion of General Welfare Test – whether the law providing the tax
directly promotes the welfare of the community in equal measure.
 Cases:
a. Pascual vs. Secretary of Public Works, 110 Phil 331
The Court allowed petitioner to maintain a taxpayer’s suit assailing the
constitutional soundness of Republic Act No. 920 appropriating P85,000 for the
construction, repair and improvement of feeder roads within private property.
All these cases involved the disbursement of public funds by means of a law.
b. Lutz vs. Araneta, 98 Phil 148

The basic defect in the plaintiff's position is his assumption that the tax
provided for in Commonwealth Act No. 567 is a pure exercise of the taxing
power. Analysis of the Act, and particularly of section 6 will show that the tax is
levied with a regulatory purpose, to provide means for the rehabilitation and
stabilization of the threatened sugar industry. In other words, the act is primarily
an exercise of the police power.

c. Gomez vs. Palomar, 25 SCRA 827
The eradication of a dreaded disease is a public purpose, but if by public
purpose the petitioner means benefit to a taxpayer as a return for what he pays,
then it is sufficient answer to say that the only benefit to which the taxpayer is
constitutionally entitled is that derived from his enjoyment of the privileges of
living in an organized society, established and safeguarded by the devotion of
taxes to public purposes. Any other view would preclude the levying of taxes
except as they are used to compensate for the burden on those who pay them
and would involve the abandonment of the most fundamental principle of
government that it exists primarily to provide for the common good.
ii. Inherently Legislative

 Rationale: Doctrine of Separation of Powers.
Taxation is purely legislative hence, Congress cannot delegate the power to
others.
 Coverage, Object, Nature, Extent, Situs

 Cases:
o Pepsi vs. Municipality of Tanauan, 69 SCRA 460
o Pepsi vs. City of Butuan, 24 SCRA 789
o
 Exceptions to non-delegation:
a. Delegation to the President (Art.VI. Sec. 28(2) 1987 Constitution) / Flexible
Tariff Clause
The power granted to Congress under this constitutional provision to
authorize the President to fix within specified limits and subject to such
limitations and restrictions as it may impose, tariff rates and other duties and
imposts include tariffs rates even for revenue purposes only. Customs duties
which are assessed at the prescribed tariff rates are very much like taxes which are
frequently imposed for both revenue-raising and regulatory purposes (Garcia vs.
Executive Secretary, et. al., G.R. No. 101273, July 3, 1992)
 Flexible Tariff Clause: Section 401 – Modification of Duty, Tariff and Customs
Code of the Philippines (TCCP)
 Provide the legal basis by which the President may: (1)
change the level and form of import duties, (2) impose an import quota or
ban imports, and (3) levy an additional duty on all imports.
b. Delegations to the Local Government (Art. X. Sec. 5, 1987 Constitution)

It has been held that the general principle against the delegation of
legislative powers as a consequence of the theory of separation of powers is
subject to one well-established exception, namely, that legislative power may be
delegated to local governments. The theory of non-delegation of legislative
powers does not apply in matters of local concern. (Pepsi-Cola Bottling Co. of the
Phil, Inc. vs. City of Butuan, et . al., L-22814, Aug. 28, 1968)
NOTE: In MCIAA vs. Marcos, the Supreme Court ruled that considering
the present provisions of the Constitution, Local Government Units’ power to tax
is no longer just a delegated power but a power granted by the Constitution.
c. Delegation to Administrative Agencies with respect to aspects of Taxation not

legislative in character.
Examples: assessment and collection
 Limitations on Delegation
a. It shall not contravene any Constitutional provisions or inherent limitations of
taxation;
b. The delegation is effected either by the Constitution or by validly enacted
legislative measures or statute; and
c. The delegated levy power, except when the delegation is by an express
provision of Constitution itself, should only be in favor of the local legislative
body of the local or municipal government concerned.
 Tax Legislation vis-à-vis Tax Administration

- Every system of taxation consists of two parts:
a. the elements that enter into the imposition of the tax [S2 A P K A M],
or tax regulation; and

b. the steps taken for its assessment and collection or tax administration
 If what is delegated is tax legislation, the delegation is invalid; but if what is

involved is only tax administration, the non-delegability rule is not violated.
iii. Territoriality
1) Territoriality or Situs of Taxation means “place of taxation” depending on the
nature of taxes being imposed.
2) It is an inherent mandate that taxation shall only be exercised on persons,
properties, and excise within the territory of the taxing power because:
b.1) Tax laws do not operate beyond a country’s territorial limit.
b.2) Property which is wholly and exclusively within the jurisdiction of
another state receives none of the protection for which a tax is supposed to be
compensation.
3) However, the fundamental basis of the right to tax is the capacity of the
government to provide benefits and protection to the object of the tax. A person
may be taxed, even if he is outside the taxing state, where there is between him
and the taxing state, a privity of relationship justifying the levy.
 Factors to Consider in determining Situs of Taxation

1) kind and Classification of the Tax
2) location of the subject matter of the tax
3) domicile or residence of the person
4) citizenship of the person
5) source of income
6) place where the privilege, business or occupation is being exercised
iv. International Comity

a. The property of a foreign state or government may not be taxed by
another.
b. The grounds for the above rule are:
b.1) sovereign equality among states
b.2) usage among states that when one enter into the territory of another,
there is an implied understanding that the power does not intend to
degrade its dignity by placing itself under the jurisdiction of the latter
b.3) foreign government may not be sued without its consent so that it is
useless to assess the tax since it cannot be collected
b.4) reciprocity among states
v. Tax Exemption of the Government

Reasons for Exemptions:
a.1) To levy tax upon public property would render necessary new taxes on
other public property for the payment of the tax so laid and thus, the
government would be taxing itself to raise money to pay over to itself;
a.2) In order that the functions of the government shall not be unduly impede;
and
a.3) To reduce the amount of money that has to be handed by the government
in the course of its operations.
 Unless otherwise provided by law, the exemption applies only to

government entities through which the government immediately and
directly exercises its sovereign powers (Infantry Post Exchange vs. Posadas, 54
Phil 866)
 Notwithstanding the immunity, the government may tax itself in the absence
of constitutional limitations.
 Government-owned or controlled corporations, when performing

proprietary functions are generally subject to tax in the absence of tax
exemption provisions in their charters or law creating them.
2) Constitutional Limitations
i. Due Process Clause

 Basis: Sec. 1 Art. 3 “No person shall be deprived of life, liberty or property without due
process of law x x x.”
 Requisites:
1. The interest of the public generally as distinguished from those of a particular
class require the intervention of the state;
2. The means employed must be reasonably necessary to the accomplishment for
the purpose and not unduly oppressive;
3. The deprivation was done under the authority of a valid law or of the
constitution; and
4. The deprivation was done after compliance with fair and reasonable method of
procedure prescribed by law.
 In a string of cases, the Supreme Court held that in order that due process of law
must not be done in an arbitrary, despotic, capricious, or whimsical manner.
 Cases:
 Villegas vs. Hiu Chiong Tsau Pao Ho, November 10, 1978
Requiring a person before he can be employed to get a permit
from the City Mayor of Manila who may withhold or refuse it at will is
tantamount to denying him the basic right of the people in the
Philippines to engage in a means of livelihood. While it is true that the
Philippines as a State is not obliged to admit aliens within its territory,
once an alien is admitted, he cannot be deprived of life without due
process of law which includes the means of livelihood. The shelter of
protection under the due process and equal protection clause is given to
all persons, both aliens and citizens.
 City of Baguio vs. De Leon, 25 SCRA 938

At any rate, it has been expressly affirmed by us that such an
"argument against double taxation may not be invoked where one tax is
imposed by the state and the other is imposed by the city ..., it being
widely recognized that there is nothing inherently obnoxious in the
requirement that license fees or taxes be exacted with respect to the same
occupation, calling or activity by both the state and the political
subdivisions thereof.
 Sison vs. Ancheta, GR L-59431, 25 July 1984

Equality and uniformity in taxation means that all taxable
articles or kinds of property of the same class shall be taxed at the same
rate. The taxing power has the authority to make reasonable and natural
classifications for purposes of taxation. Where the differentiation
conforms to the practical dictates of justice and equity, similar to the
standards of equal protection, it is not discriminatory within the
meaning of the clause and is therefore uniform.
 CIR vs. CA and Fortune, G.R. No. 119761, August 29, 1996
Unless there is due notice to the taxpaying public, due
compliance with Internal Revenue Tax rules and regulations may not be
reasonably expected. And most importantly, their strict enforcement
could possibly suffer from legal infirmity in the light of the constitutional
provision on `due process of law' and the essence of the Civil Code
provision concerning effectivity of laws, whereby due notice is a basic
requirement.
ii. Equal Protection Clause and the Rule on Uniformity of Taxation

 Basis: Sec.1 Art. 3 “ xxx Nor shall any person be denied the equal protection of the laws.

1. Equal protection of the laws signifies that all persons subject to legislation
shall be treated under circumstances and conditions both in the privileges
conferred and liabilities imposed
2. This doctrine prohibits class legislation which discriminates against some and
favors others.
 Cases:
 Association of Customs Brokers vs. Manila, 93 Phil 107

While the tax in the Ordinance refers to property tax and it is
fixed ad valorem, it is merely levied on all motor vehicles operating
within Manila with the main purpose of raising funds to be expended
exclusively for the repair, maintenance and improvement of the streets
and bridges in said city. The ordinance imposes a license fee although
under the cloak of an ad valorem tax to circumvent the prohibition in the
Motor Vehicle Law. Further, it does not distinguish between a motor
vehicle for hire and one which is purely for private use. Neither does it
distinguish between a motor vehicle registered in Manila and one
registered in another place but occasionally comes to Manila and uses its
streets and public highways. The distinction is necessary if the ordinance
intends to burden with tax only those registered in Manila as may be
inferred from the word “operating” used therein. There is an inequality
in the ordinance which renders it offensive to the Constitution.
 Ormoc Sugar Central vs. Ormoc Treasurer, 17 February 1968

The taxing ordinance should not be singular and exclusive as to
exclude any subsequently established sugar central, of the same class as
plaintiff, for the coverage of the tax. As it is now, even if later a similar
company is set up, it cannot be subject to the tax because the ordinance
expressly points only to Ormoc City Sugar Company, Inc. as the entity to
be levied upon.
 Philreca vs. DILG. 10 June 2003

Supreme Court held that there is reasonable classification under the
Local Government Code to justify the different tax treatment between
electric cooperatives covered by P.D. No. 269, as amended, and electric
cooperatives under R.A. No. 6938. First, substantial distinctions exist
between cooperatives under P.D. No. 269, as amended, and cooperatives
under R.A. No. 6938. Second, the classification of tax-exempt entities in
the Local Government Code is germane to the purpose of the law.
Finally, Sections 193 and 234 of the Local Government Code permit
reasonable classification as these exemptions are not limited to existing
conditions and apply equally to all members of the same class.
NOTE: see also Tio vs. Videogram, 151 SCRA 208.
 Requisites for a Valid Classification

1. Must not be arbitrary
2. Must not be based upon substantial distinctions
3. Must be germane to the purpose of law.
4. Must not be limited to existing conditions only; and
5. Must apply equally to all members of a class.
iii. Freedom of Religion

 Basis: Sec. 5 Art. III. “No law shall be made respecting an establishment of
religion or prohibiting the free exercise thereof. The free exercise and enjoyment
of religious profession and worship, without discrimination or preference, shall
forever be allowed. x x x”

1. License fees/taxes would constitute a restraint on the freedom of worship as
they are actually in the nature of a condition or permit of the exercise of the right.
2. However, the Constitution or the Free Exercise of Religion clause does not
prohibit imposing a generally applicable sales and use tax on the sale of religious
materials by a religious organization. (see Tolentino vs. Secretary of Finance, 235
SCRA 630)
 Cases:
 Free Exercise Clause
o American Bible Society vs. City of Manila, 101 Phil 386
In the case at bar the license fee herein involved is imposed upon
appellant for its distribution and sale of bibles and other religious
literature. It may be true that in the case at bar the price asked for the
bibles and other religious pamphlets was in some instances a little bit
higher than the actual cost of the same but this cannot mean that
appellant was engaged in the business or occupation of selling said

"merchandise" for profit. SC believes that the provisions of City of
Manila Ordinance No. 2529, as amended, cannot be applied to appellant,
for in doing so it would impair its free exercise and enjoyment of its
religious profession and worship as well as its rights of dissemination of
religious beliefs.
With respect to Ordinance No. 3000, as amended, which requires the

obtention the Mayor's permit before any person can engage in any of the
businesses, trades or occupations enumerated therein, SC do not find
that it imposes any charge upon the enjoyment of a right granted by the
Constitution, nor tax the exercise of religious practices.
 Tolentino vs. Secretary of Finance, 25 August 1994

The registration requirement is a central feature of the VAT system,
designed to provide a record of tax credits because any person who is
subject to the payment of the VAT pays an input tax, even as he collects
an output tax on sales made or services rendered. The registration fee is
thus a mere administrative fee, one not imposed on the exercise of a
privilege, much less a constitutional right.
iv. Freedom of Speech and of the Press

 Basis: Sec. 4 Art. III. No law shall be passed abridging the freedom of speech, of
expression or of the press xxx “

1. There is curtailment of press freedom and freedom of thought if a tax is levied
in order to suppress the basic right of the people under the Constitution.
2. A business license may not be required for the sale or contribution of printed
materials like newspaper for such would be imposing a prior restraint on press
freedom
3. However, an annual registration fee on all persons subject to the value-added
tax does not constitute a restraint on press freedom since it is not imposed for the
exercise of a privilege but only for the purpose of defraying part of cost of
registration.
v. Uniformity, Equitability and Progressivity of Taxation

 Basis: Sec. 28(1) Art. VI. The rule of taxation shall be uniform and equitable. The
Congress shall evolve a progressive system of taxation.

1. Uniformity (equality or equal protection of the laws) means all taxable
articles or kinds or property of the same class shall be taxed at the same rate.
A tax is uniform when the same force and effect in every place where the
subject of it is found.
2. Equitable means fair, just, reasonable and proportionate to one’s ability to
pay.
3. Progressive system of Taxation places stress on direct rather than indirect
taxes, or on the taxpayers’ ability to pay
4. Inequality which results in singling out one particular class for taxation or
exemption infringes no cons938titutional limitation. (See Commissioner vs.
Lingayen Gulf Electric, 164 SCRA 27)
5. The rule of uniformity does not call for perfect uniformity or perfect equality,
because this is hardly attainable.
 Cases:
o Tolentino vs. Secretary of Finance
c. Indeed, regressivity is not a negative standard for courts to enforce.
What Congress is required by the Constitution to do is to "evolve a progressive
system of taxation." This is a directive to Congress, just like the directive to it to
give priority to the enactment of laws for the enhancement of human dignity and
the reduction of social, economic and political inequalities (Art. XIII, Sec. 1), or
for the promotion of the right to "quality education" (Art. XIV, Sec. 1). These
provisions are put in the Constitution as moral incentives to legislation, not as
judicially enforceable rights.
o City of Baguio vs. De Leon, 25 SCRA

vi. Non-imprisonment for non-payment of poll tax
 Basis: Sec. 20 Art. III. “No person shall be imprisoned for debt or non-payment of
poll tax.”

1.The only penalty for delinquency in payment is the payment of surcharge in the
form of interest at the rate of 24% per annum which shall be added to the unpaid
amount from due date until it is paid. (Sec. 161, LGC)
2. The prohibition is against “imprisonment” for “non-payment of poll tax”. Thus,
a person is subject to imprisonment for violation of the community tax law other
than for non-payment of the tax and for non-payment of other taxes as prescribed
by law.
vii. Non-impairment Clause

 Basis: Sec. 10 Art. III. “No law impairing the obligation of contract shall be
passed.”

1. A law which changes the terms of the contract by making new conditions, or
changing those in the contract, or dispenses with those expressed, impairs the
obligation.
2.The non-impairment rule, however, does not apply to public utility franchise
since a franchise is subject to amendment, alteration or repeal by the Congress
when the public interest so requires. (See MERALCO vs. Province of Laguna, G.R.
No. 131359, May 5, 1999)
 Cases:
o Cagayan Power and Light Co. vs. CIR, G.R. No. 60126, September 25, 1985
SC held that Congress could impair petitioner's legislative
franchise by making it liable for income tax from which heretofore it
was exempted by virtue of the exemption provided for in its franchise.
Republic Act No. 5431, in amending section 24 of the Tax Code by
subjecting to income tax all corporate taxpayers not expressly exempted
therein and in section 27 of the Code, had the effect of withdrawing
petitioner's exemption from income tax.
o Casanova s. Hord, 8 Phil 125
o RCPI vs. Provincial Assessor of South Cotabato, G.R. 131359, May 5, 1999
o City Government of Quezon City vs. Bayantel, G.R. No. 162015, March 6,
2006
viii. Tax Exemption of Traditional Exemptees

- Taxation of Properties Actually, Directly and Exclusively used for
Religious, Charitable and Educational Purposes
 Basis: Sec. 28(3) Art. VI. “Charitable institutions, churches and parsonages or
convents appurtenant thereto, mosques, non-profit cemeteries, and all lands,
building, and improvements actually, directly and exclusively used for religious,
charitable or educational purposes shall be exempt from taxation.”

a. Test of the tax exemption: the use and not ownership of the property
b. To be tax-exempt, the property must be actually, directly and exclusively used
for the purposes mentioned.
c. The word “exclusively” means “primarily’.
NOTE: But see Lung Center vs. QC, 29 June 2004 stating that “exclusively”
means “solely”.
d. The exemption is not limited to property actually indispensable but extends to
facilities which are incidental to and reasonably necessary for the
accomplishment of said purposes.
e. The constitutional exemption applies only to property tax.
f. However, it would seem that under existing law, gifts made in favor or
religious charitable and educational organizations would nevertheless qualify
for donor’s gift tax exemption. (Sec. 101(9)(3), NIRC)
 Cases:
 Lladoc vs. CIR, 14 Phil 292

Manifestly, gift tax is not within the exempting provisions (Art VI, Sec.
28 (3)). A gift tax is not a property tax, but an excise tax imposed on the
transfer of property by way of gift inter vivos, the imposition of which on
property used exclusively for religious purposes, does not constitute an
impairment of the Constitution.
 Abra Valley College vs. Aquino, 15 June 1988

The test of exemption from taxation is the use of the property for
purposes mentioned in the Constitution. Under the 1935 Constitution, the
trial court correctly arrived at the conclusion that the school building as well
as the lot where it is built should be taxed, not because the second floor of the
same is being used by the Director and his family for residential purposes,
but because the first floor thereof is being used for commercial purposes.
However, since only a portion is used for purposes of commerce, it is only
fair that half of the assessed tax be returned to the school involved.
 Bishop of Nueva Segovia vs. Provincial Board of Ilocos Norte, 51 Phil 352
The Supreme Court included in the exemption a vegetable garden in an
adjacent lot and another lot formerly used as a cemetery. It was clarified that
the term "used exclusively" considers incidental use also. Thus, the
exemption from payment of land tax in favor of the convent includes, not
only the land actually occupied by the building but also the adjacent garden
devoted to the incidental use of the parish priest. The lot which is not used
for commercial purposes but serves solely as a sort of lodging place also
qualifies for exemption because this constitutes incidental use in religious
functions.
 Herrera vs. QC Board of Assessment Appeals, 30 September 1961

Within the purview of the Constitutional exemption from taxation, the
St. Catherine's Hospital is a charitable institution, and the fact that it admits
pay-patients does not bar it from claiming that it is devoted exclusively to
benevolent purposes, it being admitted that the income derived from pay-
patients is devoted to the improvement of the charity wards. The existence of
"St. Catherine's School of Midwifery" does not, and cannot, affect the
exemption to which St. Catherine's Hospital is entitled under our
fundamental law. On the contrary, it furnishes another ground for
exemption.
Similarly, the garage in the building above referred to which was

obviously essential to the operation of the school of midwifery and were
entitled to transportation thereto for Mrs. Herrera received no compensation
as directress of St. Catherine's Hospital were incidental to the operation of
the latter and of said school, and, accordingly, did not affect the charitable
character of said hospital and the educational nature of said school.
 Lung Center of the Philippines vs. QC, 29 June 2004

The portions of the land leased to private entities as well as those parts of
the hospital leased to private individuals are not exempt from such taxes. On
the other hand, the portions of the land occupied by the hospital and
portions of the hospital used for its patients, whether paying or non-paying,
are exempt from real property taxes.
ix. Tax Exemption of Non-stock, non-profit educational institutions

 Basis: Sec. 4 (3), Art. XIV. All revenues and assets of non-stock, non-profit
educational institutions used actually, directly, and exclusively for educational
purposes shall be exempt from taxes and duties. Upon the dissolution or
cessation of the corporate existence of such institutions, their assets shall be
disposed of in the manner provided by law.
 Department of Finance Order No. 137-87, dated Dec. 16, 1987

The following are some of the highlights of the DOF order governing the tax
exemption of non-stock, non-profit educational institutions:
1. The tax exemption is not only limited to revenues and assets derived
strictly from school operations like income from tuition and other
miscellaneous fees such as matriculation, library, ROTC, etc. fees, but it also
extends to incidental income derived from canteen, bookstore and dormitory
facilities.

2. In the case, however, of incidental income, the facilities mentioned must
not only be owned and operated by the school itself but such facilities must be
located inside the school campus. Canteens operated by mere concessionaires
are taxable.
3. Income which is unrelated to school operations like income from bank
deposits, trust fund and similar arrangements, royalties, dividends and rental
income are taxable.
4. The use of the school’s income or assets must be in consonance with the
purposes for which the school is created; in short, use must be school-related,
like the grant of scholarships, faculty development, and establishment of
professional chairs, school building expansion, library and school facilities.
 Case: CIR vs. CA, 14 October 1998 (YMCA)

o YMCA is not an educational institution within the purview of Article XIV,
Section 4, paragraph 3 of the Constitution. The term “educational
institution” or “institution of learning” has acquired a well-known technical
meaning, of which the members of the Constitutional Commission are
deemed cognizant. Under the Education Act of 1982, such term refers to
schools. The school system is synonymous with formal education, which
“refers to the hierarchically structured and chronological graded learnings
organized and provided by the formal school system and for which
certification is required in order for the learner to progress through the
grades or move to the higher levels.” The Court has examined the
“Amended Articles of Incorporation” and “By-Laws” of the YMCA, but
found nothing in them that even hints that it is a school or an educational
institution.
x. Tax Exemptions of Revenues and Assets, including grants, endowments,

donations or contributions to Educational Institutions
 Basis: Sec. 4(4) Art. XIV. “Subject to the conditions prescribed by law, all grants,
endowments, donations or contributions used actually, directly and exclusively
for educational purposes shall be exempt from tax.”

1. The exemption granted to non-stock, non-profit educational institution covers
income, property, and donor’s taxes, and custom duties.
2. To be exempt from tax or duty, the revenue, assets, property or donation must
be used actually, directly and exclusively for educational purpose.
3. In the case or religious and charitable entities and non-profit cemeteries, the
exemption is limited to property tax.
4. The said constitutional provision granting tax exemption to non-stock, non-
profit educational institution is self-executing.
5. Tax exemptions, however, of proprietary (for profit) educational institutions
require prior legislative implementation. Their tax exemption is not self-
executing.
6. Lands, Buildings, and improvements actually, directly, and exclusively used
for educational purposed are exempt from property tax, whether the
educational institution is proprietary or non-profit.
xi. Origin or Revenue, Appropriation and Tariff Bills

 Basis: Sec. 24 Art. VI. “All appropriation, revenue or tariff bills, bill authorizing
increase of the public debt, bills of local application, and private bills shall originate
exclusively in the House of Representatives, but the Senate may propose or concur
with amendments.”
 Under the above provision, the Senator’s power is not only to “only concur with
amendments” but also “to propose amendments”. (Tolentino vs. Sec. of Finance, supra)
xii. Flexible Tariff Clause

- Delegation of Legislative Authority to Fix Tariff Rates, Imports and Export
Quotas

 Basis: Sec. 28(2) Art. VI “x x x The Congress may, by law, authorize the President
to fix within specified limits, and subject to such limitations and restrictions as it
may impose, tariff rates, import and export quotas, tonnage and wharfage dues,
and other duties or imposts within the framework of the national development
program of the government.
xiii. Voting Requirements in connection with the Legislative Grant for tax
exemption
 Basis: Sec. 28(4) Art. VI. “No law granting any tax exemption shall be passed
without the concurrence of a majority of all the members of the Congress.”
 The above provision requires the concurrence of a majority not of attendees

constituting a quorum but of all members of the Congress.
xiv. Non-impairment of the Supreme Courts’ jurisdiction in Tax Cases

 Basis: Sec. 5 (2) Art. VIII. “The Congress shall have the power to define, prescribe,
and apportion the jurisdiction of the various courts but may not deprive the
Supreme Court of its jurisdiction over cases enumerated in Sec. 5 hereof.”
Sec. 5 (2b) Art. VIII. “The Supreme Court shall have the following
powers: x x x(2) Review, revise, modify or affirm on appeal or certiorari x x x
final judgments and orders of lower courts in x x x all cases involving the legality
of any tax, impost, assessment, or toll or any penalty imposed in relation
thereto.”
xv. Taxation by Local Government Units
3) The Doctrine of Judicial Non-Interference / Power of Judicial Review in Taxation

The courts cannot review the wisdom or advisability or expediency of a tax. The
court’s power is limited only to the application and interpretation of the law.
Judicial action is limited only to review where involves:

1. The determination of validity on the tax in relation to constitutional precepts or
provisions.
2. The determination, in an appropriate case, of the application of the law.
4) Taxpayer’s Suit
It is only when an act complained of, which may include legislative enactment,
directly involves the illegal disbursement of public funds derived from taxation that the
taxpayer’s suit may be allowed.
D. FORMS OF ESCAPE FROM TAXATION

1) Resulting to Losses to Government’s Revenue
i. Tax Evasion
 the use of the taxpayer of illegal or fraudulent means to defeat or lessen
the payment of a tax.
 an illegal practice where a person, organization or
corporation intentionally avoids paying his/her/its true tax liability.
Those caught evading taxes are generally subject to criminal charges and
substantial penalties.
 Indicia of Fraud in Taxation
a. Failure to declare for taxation purposes true and actual income
derived from business for two consecutive years, and
b. Substantial underdeclaration of income tax returns of the
taxpayer for four consecutive years coupled with overstatement of deduction.
 Evasion of the tax takes place only when there are no proceeds. Evasion
of Taxation is tantamount, fiscally speaking, to the absence of taxation
ii. Tax Avoidance

 is the use by the taxpayer of legally permissible alternative tax rates or
method of assessing taxable property or income in order to avoid or
reduce tax liability.
 is the legal utilization of the tax regime to one's own advantage, in order
to reduce the amount of tax that is payable by means that are within the
law.

 Tax Avoidance is not punishable by law, a taxpayer has the legal right to
decrease the amount of what otherwise would be his taxes or altogether
avoid by means which the law permits.
Distinction between Tax Evasion and Avoidance

Tax Evasion vs. Tax Avoidance
accomplished by legal procedures or
means which maybe contrary to the
accomplished by breaking the letter of
intent of the sponsors of the tax law but
the law
nevertheless do not violate the letter of
the law
iii. Tax Exemption

 is a grant of immunity, express or implied, to particular persons or
corporations from the obligations to pay taxes.
 Nature of Tax Exemption

1. It is merely a personal privilege of the grantee
2. It is generally revocable by the government unless the exemption
is founded on a contract which is protected from impairment, but the
contract must contain the other essential elements of contracts, such as,
for example, a valid cause or consideration.
3. It implies a waiver on the part of the government of its right to
collect what otherwise would be due to it, and in this sense is prejudicial
thereto.
4. It is not necessarily discriminatory so long as the exemption has
a reasonable foundation or rational basis.
 Rationale of tax Exemption

Public interest would be subserved by the exemption allowed
which the law-making body considers sufficient to offset monetary loss
entailed in the grant of the exemption. (CIR vs. Bothelo Shipping Corp., L-
21633, June 29, 1967; CIR vs. PAL, L-20960, Oct. 31, 1968)
 Grounds for Tax Exemptions

1. May be based on a contract in which case, the public represented
by the Government is supposed to receive a full equivalent therefore
2. May be based on some ground of public policy, such as, for
example, to encourage new and necessary industries.
3. May be created in a treaty on grounds of reciprocity or to lessen
the rigors of international double or multiple taxation which occur where
there are many taxing jurisdictions, as in the taxation of income and
intangible personal property.
 Equity, not a ground for Tax Exemption

There is no tax exemption solely on the ground of equity, but
equity can be used as a basis for statutory exemption. At times the law
authorizes condonation of taxes on equitable considerations. (Sec 276,
277, Local Government Code)
 Kinds of Tax Exemptions

1. As to basis
a. Constitutional Exemptions – Immunities from taxation which
originate from the Constitution
b. Statutory Exemptions – Those which emanate from Legislation
2. As to form
a. Express Exemption – Whenever expressly granted by organic or
statute of law
b. Implied Exemption – Exist whenever particular persons, properties
or excises are deemed exempt as they fall outside the scope of the taxing
provision itself
3. As to extent
a. Total Exemption – Connotes absolute immunity

b. Partial Exemption – One where collection of a part of the tax is
dispensed with
 Principles Governing the Tax Exemption

1. Exemptions from taxation are highly disfavored by law, and he who
claims an exemption must be able to justify by the clearest grant of organic or
statute of law. (Asiatic Petroleum vs. Llanes, 49 PHIL 466; Collector of Internal
Revenue vs. Manila Jockey Club, 98 PHIL 670)
2. He who claims an exemption must justify that the legislative
intended to exempt him by words too plain to be mistaken. (Visayan Cebu
Terminal vs. CIR, L-19530, Feb. 27, 1965)
3. He who claims exemptions should convincingly prove that he is
exempt
4. Tax exemptions must be strictly construed (Phil. Acetylene vs. CIR, L-
19707, Aug. 17, 1967)
5. Tax Exemptions are not presumed. (Lealda Electric Co. vs. CIR, L-
16428, Apr. 30, 1963)
6. Constitutional grants of tax exemptions are self-executing (Opinion
No. 130, 1987, Sec. Of Justice)
7. Tax exemption is personal.
8. Deductions for income tax purposes partake of the nature of tax
exemptions, hence, they are strictly construed against the tax payer
9. A tax amnesty, much like a tax exemption is never favored or
presumed by law (CIR vs. CA, G.R. No. 108576, Jan. 20, 1999)
10. The rule of strict construction of tax exemption should not be applied
to organizations performing strictly religious, charitable, and educational
functions
2) Not Resulting to Losses

i. Shifting
 Transfer of the burden of a tax by the original payer or the one on whom
the tax was assessed or imposed to another or someone else
 Impact of taxation – is the point at which a tax is originally imposed.
 Incidence of Taxation – is the point on which a tax burden finally rests or
settles down.
 Relations among Shifting, Impact and Incidence of Taxation – the
impact is the initial phenomenon, the shifting is the intermediate
process, and the incidence is the result.
 Kinds of Shifting:
1. Forward Shifting – the burden of tax is transferred from a factor of
production through the factors of distribution until it finally
settles on the ultimate purchaser or consumer
2. Backward Shifting – effected when the burden of tax is transferred
from the consumer or purchaser through the factors of
distribution to the factor of production
3. Onward Shifting – this occurs when the tax is shifted two or more
times either forward or backward
ii. Capitalization
 the reduction in the price of the taxed object equal to the capitalized
value of future taxes which the purchaser expects to be called upon to
pay
iii. Transformation
 The method whereby the manufacturer or producer upon whom the tax
has been imposed, fearing the loss of his market if he should add the tax
to the price, pays the tax and endeavours to recoup himself by
improving his process of production thereby turning out his units of
products at a lower cost.
3) Illustrative Cases
i. Republic vs. Heirs of Cesar Jalandoni, 20 Sept 1965
Record shows that the three lots alleged to have been excluded in the return were
already declared in the earlier return submitted by Bernardino Jalandoni as part of
his property and his wife for purposes of income tax, there is reason to believe that
their omission from the return submitted by Cesar Jalandoni was merely due to an
honest mistake or inadvertence as properly explained by appellants. We can hardly

dispute this conclusion as it would be stretching too much the imagination if we
would find that, because of such inadvertence, which appears to be
inconsequential, the heirs of the deceased deliberately omitted from the return the
three lots with the only purpose of defrauding the government after declaring
therein as asset of the estate property worth P1,324,555.80.
The same thing may be said with regard to the alleged undervaluation of certain
sugar and rice lands reported by Cesar Jalandoni for the same can at most be
considered as the result of an honest difference of opinion and not necessarily an
intention to commit fraud.
Finally, SC finds it unreasonable to impute with regard to the appraisal made by

appellants of the shares of stock of the deceased simply because Cesar Jalandoni
placed in his return an aggregate market value instead of mentioning the book
value declared by said corporations in the returns filed by them with the Bureau of
Internal Revenue. The fact that the value given in the returns did not tally with the
book value appearing in the corporate books is not in itself indicative of fraud
especially when it is taken into consideration the circumstance that said book value
only became known several months after the death of the deceased. Moreover, it is
a known fact that stock securities frequently fluctuate in value and a mere
difference of opinion in relation thereto cannot serve as proper basis for assessing
an intention to defraud the government.
ii. CIR vs. Norton and Harrisson, 31 August 1964

Based on an over-all appraisal of the circumstances presented by the facts of the
case, it yields to the conclusion that the Jackbilt is merely an adjunct, business
conduit or alter ego, of Norton and Harrison and that the fiction of corporate
entities, separate and distinct from each, should be disregarded. This is a case
where the doctrine of piercing the veil of corporate fiction, should be made to
apply.
It may not be amiss to state in this connection, the advantages to Norton in

maintaining a semblance of separate entities. If the income of Norton should be
considered separate from the income of Jackbilt, then each would declare such
earning separately for income tax purposes and thus pay lesser income tax. The
combined taxable Norton-Jackbilt income would subject Norton to a higher tax.
Thus the SC held that Norton & Harrison is liable for the deficiency sales taxes
assessed against it by the appellant Commissioner of Internal Revenue
iii. Philippine Acetylene vs. CIR, 17 August 1967

Sales tax are paid by the manufacturer or producer who must make a true and
complete return of the amount of his, her or its gross monthly sales, receipts or
earnings or gross value of output actually removed from the factory or mill,
warehouse and to pay the tax due thereon. The tax imposed by Section 186 of the
Tax Code is a tax on the manufacturer or producer and not a tax on the purchaser
except probably in a very remote and inconsequential sense. Accordingly, its levy
on the sales made to tax-exempt entities like the Napocor is permissible. On the
other hand, there is nothing in the language of the Military Bases Agreement to
warrant the general exemption granted by General Circular V-41 (1947). Thus, the
expansive construction of the tax exemption is void; and the sales to the VOA are
subject to the payment of percentage taxes under Section 186 of the Tax Code.
Therefore, tax exemption is strictly construed and exemption will not be held to be
conferred unless the terms under which it is granted clearly and distinctly show
that such was the intention.
iv. CIR vs. American Rubber, 29 November 1966

In Philippine Packing Corporation vs. Collector of Internal Revenue (100 Phil.
545 et seq.), it was ruled that the exemption from sales tax established in Section
188(b) of the Internal Revenue Tax Code in favor of sales of agricultural products,
whether in their original form or not, made by the producer or owner of the land
where produced is not taken away merely because the produce undergoes
processing at the hand of said producer or owner for the purpose of working his
product into a more convenient and valuable form suited to meet the demand of an
expanded market; that the exemption was not designed in favor of the small
agricultural producer, already exempted by the subsequent paragraphs of the same
Section 188, but that said exemption is not incompatible with large scale

agricultural production that incidentally required resort to preservative processes
designed to increase or prolong marketability of the product.
v. CIR vs. John Gotamco and Sons, 27 February 1987

Direct taxes are those that are demanded from the very person who, it is
intended or desired, should pay them; while indirect taxes are those that are
demanded in the first instance from one person in the expectation and intention
that he can shift the burden to someone else. Herein, the contractor’s tax is payable
by the contractor but it is the owner of the building that shoulders the burden of
the tax because the same is shifted by the contractor to the owner as a matter of
self-preservation. Such tax is an “indirect tax” on the organization, as the payment
thereof or its inclusion in the bid price would have meant an increase in the
construction cost of the building.
Hence, the Contractee’s (WHO) exemption from “indirect taxes” implies that
contractor (Gotamco) is exempt from contractor’s tax.
vi. Maceda vs. Macaraig, 31 May 1991, 8 June 1993

NAPOCOR is a non-profit public corporation created for the general good and
welfare, and wholly owned by the government of the Republic of the Philippines.
From the very beginning of the corporation’s existence, NAPOCOR enjoyed
preferential tax treatment “to enable the corporation to pay the indebtness and
obligation” and effective implementation of the policy enunciated in Section 1 of
RA 6395. From the preamble of PD 938, it is evident that the provisions of PD 938
were not intended to be strictly construed against NAPOCOR. On the contrary,
the law mandates that it should be interpreted liberally so as to enhance the tax
exempt status of NAPOCOR. It is recognized principle that the rule on strict
interpretation does not apply in the case of exemptions in favor of government
political subdivision or instrumentality. In the case of property owned by the state
or a city or other public corporations, the express exception should not be
construed with the same degree of strictness that applies to exemptions contrary to
the policy of the state, since as to such property “exception is the rule and taxation
the exception.”
vii. Contex vs. CIR, G.R. No. 151135, July 2, 2004

Exemptions from VAT are granted by express provision of the Tax Code or
special laws. Under Zero-rating, all VAT is removed from the zero-rated goods,
activity or firm. In contrast, exemption only removes the VAT at the exempt stage,
and it will actually increase, rather than reduce the total taxes paid by the exempt
firm’s business or non-retail customers. It is for this reason that a sharp distinction
must be made between zero-rating and exemption in designating a value-added
tax.
Apropos, the petitioner’s claim to VAT exemption in the instant case for its
purchases of supplies and raw materials is founded mainly on Section 12 (b) and
(c) of Rep. Act No. 7227, which basically exempts them from all national and local
internal revenue taxes, including VAT and Section 4 (A)(a) of BIR Revenue
Regulations No. 1-95.
On this point, petitioner rightly claims that it is indeed VAT-Exempt and this fact
is not controverted by the respondent. In fact, petitioner is registered as a NON-
VAT taxpayer per Certificate of Registration issued by the BIR. As such, it is
exempt from VAT on all its sales and importations of goods and services.
viii. CIR vs. Estate of Benigno Toda, Jr., G.R. No. 147188, September 14, 2004
Tax evasion connotes the integration of three factors: (1) the end to be achieved,
i.e., the payment of less than that known by the taxpayer to be legally due, or the
non-payment of tax when it is shown that a tax is due; (2) an accompanying state of
mind which is described as being “evil,” in “bad faith,” “willful,” or “deliberate
and not accidental”; and (3) a course of action or failure of action which is
unlawful. All these factors are present in the instant case.
The scheme resorted to by CIC in making it appear that there were two sales of
the subject properties, i.e., from CIC to Altonaga, and then from Altonaga to RMI
cannot be considered a legitimate tax planning. Such scheme is tainted with fraud.

Here, it is obvious that the objective of the sale to Altonaga was to reduce the
amount of tax to be paid especially that the transfer from him to RMI would then
subject the income to only 5% individual capital gains tax, and not the 35%
corporate income tax. Altonaga’s sole purpose of acquiring and transferring title of
the subject properties on the same day was to create a tax shelter. Altonaga never
controlled the property and did not enjoy the normal benefits and burdens of
ownership. The sale to him was merely a tax ploy, a sham, and without business
purpose and economic substance. Doubtless, the execution of the two sales was
calculated to mislead the BIR with the end in view of reducing the consequent
income tax liability.
ix. John Hay Peoples Alternative Coalition vs. Lim, et.al., G.R. No. 119775, October
24, 2003
It is clear that under Section 12 of R.A. No. 7227 it is only the Subic SEZ which
was granted by Congress with tax exemption, investment incentives and the like.
There is no express extension of the aforesaid benefits to other SEZs still to be
created at the time via presidential proclamation.
While the grant of economic incentives may be essential to the creation and
success of SEZs, free trade zones and the like, the grant thereof to the John Hay
SEZ cannot be sustained. The incentives under R.A. No. 7227 are exclusive only to
the Subic SEZ, hence, the extension of the same to the John Hay SEZ finds no
support therein.
More importantly, the nature of most of the assailed privileges is one of tax
exemption. It is the legislature, unless limited by a provision of the state
constitution that has full power to exempt any person or corporation or class of
property from taxation, its power to exempt being as broad as its power to tax.
The challenged grant of tax exemption would circumvent the Constitution’s

imposition that a law granting any tax exemption must have the concurrence of a
majority of all the members of Congress.
x. See also: CIR vs. Yutivo and Sons (1961) and CIR vs. Seagate Technology (Phils.), G.R.
No. 153866, 11 February 2005.
E. RULES OF CONSTRUCTION OF TAX LAWS

1) On the interpretation and construction of tax statutes, legislative intention must be considered.
2) In case of doubt, tax statutes are construed strictly against the government and liberally construed
in favor of the taxpayer.
3) The rule of strict construction against the government is not applicable where the language of the
tax law is plain and there is no doubt as to the legislative intent.
4) The exemptions (or equivalent provisions, such as tax amnesty and tax condonation) are not
presumed and when granted are strictly construed against the grantee.
5) The exemptions, however, are construed liberally in favor of the grantee in the following:
i. When the law so provides for such liberal construction;
ii. Exemptions from certain taxes granted under special circumstances to special classes of
persons;
iii. Exemptions in favor of the Government, its political subdivisions;
iv. Exemptions to traditional exemptees, such as, those in favor of charitable institutions.
6) The tax laws are presumed valid.
7) The power to tax is presumed to exist.
 Case: CIR vs. CA and Ateneo, 18 April 1997

The doctrine in the interpretation of tax laws is that “(a) statute will not be construed as imposing
a tax unless it does so clearly, expressly, and unambiguously. . . . (A) tax cannot be imposed
without clear and express words for that purpose. Accordingly, the general rule of requiring
adherence to the letter in construing statutes applies with peculiar strictness to tax laws and the
provisions of a taxing act are not to be extended by implication.” In case of doubt, such statutes
are to be construed most strongly against the government and in favor of the subjects or citizens
because burdens are not to be imposed nor presumed to be imposed beyond what statutes
expressly and clearly import.
Ateneo’s Institute of Philippine Culture never sold its services for a fee to anyone or was ever
engaged in a business apart from and independently of the academic purposes of the university.
Funds received by the Ateneo de Manila University are technically not a fee. They may however

fall as gifts or donations which are “tax-exempt” as shown by private respondent’s compliance
with the requirement of Section 123 of the National Internal Revenue Code providing for the
exemption of such gifts to an educational institution.
F. THE CONCEPT OF TAX LAWS

1) Nature
 Prospectivity of Tax Laws
General Rule: Taxes must only be imposed prospectively
Exception: The language of the statute clearly demands or express that it shall have a
retroactive effect.
 Important Points to Consider

1. In order to declare a tax transgressing the due process clause of the
Constitution it must be so harsh and oppressive in its retroactive application (Fernandez
vs. Fernandez, 99 PHIL934)
2. Tax laws are neither political nor penal in nature they are deemed
laws of the occupied territory rather than the occupying enemy. (Hilado vs. Collector, 100
PHIL 288)
3. Tax laws not being penal in character, the rule in the Constitution
against the passage of the ex post facto laws cannot be invoked, except for the penalty
imposed.
2) Sources
i. Constitution
 Other Constitutional Provisions related to Taxation
1. Subject and Title of Bills (Sec. 26(1) 1987 Constitution)
“Every Bill passed by Congress shall embrace only one subject which
shall be expressed in the title thereof.”
NOTE: In the Tolentino E-VAT case, supra, the E-vat, or the

Expanded Value Added Tax Law (RA 7716) was also questioned on the
ground that the constitutional requirement on the title of a bill was not
followed.
2. Power of the President to Veto items in an Appropriation, Revenue

or Tariff Bill (Sec. 27(2), Art. VI of the 1987 Constitution)
The President shall have the power to veto any particular

item or items in an Appropriation, Revenue or Tariff bill but the veto
shall not affect the item or items to which he does not object.”
3. Appropriation of Public Money for the benefit of any Church, Sect, or

System of Religion (Sec. 29(2), Art. VI of the 1987 Constitution)
”No public money or property shall be appropriated, applied, paid
or employed, directly or indirectly for the use, benefit, support of any
sect, church, denomination, sectarian institution, or system of religion or
of any priest, preacher, minister, or other religious teacher or dignitary as
such except when such priest, preacher, minister or dignitary is assigned
to the armed forces or to any penal institution, or government orphanage
or leprosarium.”
4. Taxes levied for Special Purpose (Sec. 29(3), Art. VI of the 1987
Constitution)
“All money collected or any tax levied for a special purpose
shall be treated as a special fund and paid out for such purpose only. It
the purpose for which a special fund was created has been fulfilled or
abandoned the balance, if any, shall be transferred to the general funds
of the government.”
An example is the Oil Price Stabilization Fund created under

P.D. 1956 to stabilize the prices of imported crude oil.

In a decided case, it was held that where under an executive

order of the President, this special fund is transferred from the general
fund to a “trust liability account,” the constitutional mandate is not
violated. The OPSF, according to the court, remains as a special fund
subject to COA audit (Osmeňa vs. Orbos, et al., G.R. No. 99886, Mar. 31,
1993)
5. Allotment to Local Governments

Basis: Sec. 6, Art. X of the 1987 Constitution
“Local Government units shall have a just share, as
determined by law, in the national taxes which shall be automatically
released to them.”
ii. Statutes
iii. Issuances by the Secretary of Finance
iv. Administrative Issuance by the BIR
Cases:
 CIR vs. CA and Fortune, G.R. No. 119761, 29 August 1996
Prior to the issuance of RMC 37-93, the brands were in the
category of locally manufactured cigarettes not bearing foreign brands,
subject to 45% ad valorem tax. Without RMC 37-93, the enactment of
RA7654 would not have new tax rate consequences on the company’s
products. In issuing RMC 37-93, the BIR legislated under its quasi-
legislative authority and not simply interpreted the law. When an
administrative rule goes beyond merely providing for the means that can
facilitate or render least cumbersome the implementation of the law but
substantially adds to or increases the burden of those governed. It
behooves the agency to accord at least to those directly affected a chance
to be heard, and thereby be duly informed, before that new issuance is
given the force and effect of law.
 PB Com vs. CIR, 28 January 1999

When the Acting Commissioner of Internal Revenue issued
RMC 7-85, changing the prescriptive period of two years to ten years on
claims of excess quarterly income tax payments, such circular created a
clear inconsistency with the provision of Section 230 of 1977 NIRC. In so
doing, the BIR did not simply interpret the law; rather it legislated
guidelines contrary to the statute passed by Congress.
v. Tax Ordinances
vi. Tax Treaties
 exist between many countries on a bilateral basis to prevent double
taxation
 See CIR vs. SC Johnson and Son, 26 June 1999
G. OTHER DOCTRINES IN TAXATION

 Imprescriptibility of Taxes
General Rule: Taxes are imprescriptible
Exception: When provided otherwise by the tax law itself.
Example: NIRC provides for statutes of limitation in the assessment and collection of taxes
therein imposed
Important Point to Consider
 The law on prescription, being a remedial measure, should be liberally construed to afford
protection as a corollary, the exceptions to the law on prescription be strictly construed. (CIR vs.
CA. G.R. No. 104171, Feb. 24, 1999)
 Doctrine of Equitable Recoupment

It provides that a claim for refund barred by prescription may be allowed to offset unsettled tax
liabilities should be pertinent only to taxes arising from the same transaction on which an
overpayment is made and underpayment is due.
This doctrine, however, was rejected by the Supreme Court, saying that it was not convinced of
the wisdom and proprietary thereof, and that it may work to tempt both the collecting agency and
the taxpayer to delay and neglect their respective pursuits of legal action within the period set by
law. (Collector vs. UST, 104 PHIL 1062)

INCOME TAXATION
BASIC CONCEPT OF PHILIPPINE INCOME TAXATION
A. CONCEPT OF INCOME
1. INCOME , defined;
It is understood as follows:
a. Income is all wealth that flows into the taxpayer other than a mere return of
capital;
b. It includes all gains or profit as well as gains from sale or transfer of property
whether real or personal, ordinary or capital asset;
c. The gains derived from capital, from labor, or both combined, provided it is
understood to include profit gained through a sale or conversion of capital
assets( Black Law Dictionary);
d. The amount of money coming to a person or corporation within specified time,
whether as payment for services, interest or profit from investment. ( Fisher Vs.
Trinidad 43 Phil 973, Conwi vs. CTA 213 SCRA 83)
2. CAPITAL, defined
Accumulated goods, possessions and assets used for the production of profits and
wealth.
- Owner’s equity in the business.
3. INCOME vs. CAPITAL

Income as contrasted with the capital
1. The essential difference between capital and income is that capital is a fund while,
income is a flow;
2. Capital is wealth while, income is the service of wealth;
3. The fact is that property is the tree, income is the fruit; labor is the tree, income is the
fruit; capital is the tree, income is the fruit. (Madrigal vs. Rafferty 38 Phil 414)
B. Forms of Income
Income may either be received in the form of:
1. Cash – income pertains to money or money substitutes derived as
compensation or earning derived from labor, practice of profession and conduct of business.
2. Property – income denotes the earned right of ownership over tangible
or intangible thing as a result of labor, business or practice of profession.
3. Services – income based on the performance received in payment for the
work previously rendered by one person to another.
4. Combination of cash, services or property.
C. Classification of Income
1. Compensation Income – the gain derived from labor especially
employment such as salaries and commission.
2. Profession or Business Income – the value derived from an exercise of
profession, business or utilization of capital assets. e.g. income derived from sale of assets
used in trade or business
3. Passive Income – income in which the taxpayer merely waits for the
amount to come in. e. g. interest derived from bank accounts
4. Capital Gain – an income derived from the sale of assets not used in
trade or business. e.g. income from sale of personal property
B. TEST APPLIED IN DETERMINING THE EXISTENCE OF INCOME
1. Severance test/ realization test

- as a capital or investment is not income subject to tax, the gain or profit derived from
the exchange or transaction of said capital by the taxpayer for his separate used
benefit and disposal is income subject to tax.
- There is no taxable income until there is separation from capital of something of
exchangeable value, thereby supplying the realization or transmutation that would
result in the receipt of income.
- Under this doctrine, in order that income may exist, it is necessary that there be a
separation from capital of something of exchangeable value.

2. TAX benefit rule

 Economic benefit rule -That even without the sale or other disposition if by reason of
appraisal, the cost basis is used as the new tax base for purposes of computing the
allowable depreciation expense, the net difference between the original cost basis
and new basis due to appraisal is taxable.
An income is constructively received by a person when - it is credited to the
amount of or segregated in his favor and which maybe drawn by him at any time
without any limitations e. g.:
o Interest credited on savings bank deposits dividends applied by the
corporation against the indebtedness of stockholder
o Share in the profit of a partner in General Professional Partnership
3. Claim of right doctrine

 applicable only in those instances where money is taken, it does not involve the
money or other proceeds from embezzled or stolen personal or other property. Thus,
proceeds of stolen or embezzled property are taxable income, because even income
from illegal sources is taxable. Ownership thereof is not in issue; the culprit has an
obligation to return the same.
4. Income from whatever sources

 All income not expressly excluded or exempted from the class of taxable income,
irrespective of the voluntary or involuntary action of the taxpayer in producing the
income.
C. REQUISITES FOR THE TAXABILITY OF AN INCOME
1. Existence of a gain - Gain is a sine qua non or an indispensable requisite to the existence of
taxable income. If a taxpayer receives no profit from his labor or transaction, then such
condition will not give rise to taxability of income.
 There must be a value received in the form of cash or its equivalent as a result of rendition of
service or earnings in excess of capital invested.
 A mere expectation of profits is not an income
 A transaction whereby nothing of exchangeable value comes to or is received by the
taxpayer does not give rise to or create taxable income.
 Items or amounts received which do not add to the taxpayer’s net worth or redound to his
benefits such as amounts merely deposited or entrusted to him are not considered as gains
(CIR vs. Tours specialist, 183 SCRA 402).
 Gain need not be necessarily in cash. It may be in form of payment, reduction or cancellation
of T’s indebtedness, or gain from exchange of property.
2. Realization of a gain
a. Actual gain – gain must be realized and receive.
b. Constructive receipt – profit is set aside, declared
- When an income is credited to the account of or set aside for, a taxpayer and which
may be drawn by him at any time, without any substantial limitation or condition
upon which payment is to be made.
GENERAL RULE: A mere increase in the value of property without actual realization, either
through sale or other disposition, is not taxable. The increase in value is a mere unrealized increase
in capital.
EXCEPT: ECONOMIC BENEFIT PRINCIPLE (BIR RULING NO. 029 – 98, MARCH 19, 1998)
- That even without the sale or other disposition if by reason of appraisal, the cost
basis is used as the new tax base for purposes of computing the allowable depreciation
expense, the net difference between the original cost basis and new basis due to appraisal is
taxable.
 An income is constructively received by a person when - it is credited to the amount of or

segregated in his favor and which maybe drawn by him at any time without any limitations
e. g.:
 Interest credited on savings bank deposits
 Dividends applied by the corporation against the indebtedness of stockholder
 Share in the profit of a partner in General Professional Partnership
3. Gains must not be excluded (sec 32b)

- any amount receive by an officer or employee or by his heirs from the employer as a
consequence of separation from service because of death, sickness or other physical disability
or for any other cause beyond his control.
 The gain must not be exempted.
 Property or money received by a taxpayer in which he has “no business transaction right to
retain, but a duty to return “To the one person from whom it was received is not considered
as income (e. g. payment by mistake). Reason: The receipt is offset by a liability to the party
making the excess payment. However, where the duty to return is unclear, the recipient may
be required to pay the tax.
D. THE PHILIPPINE INCOME TAX SYSTEM
1. Type of income tax systems

a. Schedular system vs. Global system
Schedular system
- a system employed where the income tax treatment varies and is made to depend on
the kind or category of taxable income of the taxpayer.
- the system that itemizes the different oncom and provide for varied percentages of
tax, to be applied thereto. It has different rates.
* individual taxpayer fallows the scheduler tax system because their income from
different sources are classified into compensation income, business income, passive
income, capital gain derived from sale of shares of stock or sale of real property. These
incomes are categorized and treated differently.
Global income tax system

- it is a tax system whereby gross compensation income is aggregated (globalized)
with the net income from business, trade or profession to arrive at the global taxable
income ( after allowable exemption) which taxable aggregate income is then
subjected to a unitary progressive graduated rates of 0% to 32%.
 corporate taxpayer adopts the global system of taxation. There is no

classification of income from different sources with certain exceptions. All
income of corporate taxpayer are globalized and tax at 32%.
Distinctions between schedular and global treatment in income tax
1. Under the scheduler treatment there are different tax rates while under the global treatment there
is a unitary or single tax rate;
2. Under the shedular treatment there are different categories of taxable income while under the
global treatment there is no need for classification as all taxpayer are subjected to single rate;
3. Shedular is usually used in the income of individual taxpayer while global is usually applied to
corporation.
b. Schedular rates of taxes vs. Schedular system
2. Philippine income tax system as a semi global/ mixed system.
E. CRITERIA IN IMPOSING PHILIPPINE INCOME TAXES
1. Place where income was earned

- income is taxable depending on the nature of taxpayer. Citizens of the Philippines and
domestic corporation are taxable on income from all sources whether earned within or
without; non residents citizen, resident alien, non resident alien and foreign corporation are
taxable on income only from sources realized within the Philippines.
2. Residency- test of residency

- maintenance of residence here in the Philippines.
- Actual physical presence in the Philippines
- Though there is an intention to return, if the Taxpayer temporarily resides in the
Philippines on an extended stay.
3. Citizenship
F. THE INCOME TAXPAYER AND THE GENERAL PRINCIPLE OF THEIR TAXABILITY (Tax Situs
for Income Purposes)
1. General principle of income taxation (sec 23 NIRC)

Except when otherwise provided by NIRC:
a. A citizen of the Philippines residing therein is taxable on all income derived from sources
within and without the Philippines;
b. A nonresident citizen is taxable only on income derived from sources within the Philippines;
c. An individual citizen of the Philippines who is working and deriving income from abroad as
an overseas contract worker is taxable only on income derived from sources within the
Philippines: Provided, That a seaman who is a citizen of the Philippines and who receives
compensation for services rendered abroad as a member of the complement of a vessel
engaged exclusively in international trade shall be treated as an overseas contract worker;
d. An alien individual, whether a resident or not of the Philippines, is taxable only on income
derived from sources within the Philippines;
e. A domestic corporation is taxable on all income derived from sources within and without
the Philippines; and
f. A foreign corporation, whether engaged or not in trade or business in the Philippines, is
taxable only on income derived from sources within the Philippines.
2. Individual Taxpayer
a.) Classification of Individual Taxpayer
1. Citizens of the Philippines may be classified into;

(a) Resident Citizens (RC) -> those residing in the Phils.
(b) Non-resident Citizens -> those not residing in the Phils.
 A “non-resident citizens” means (sec. 22 (E) National Internal Revenue Code (NIRC):
1. One who establishes to the satisfaction of the Commissioner of Internal Revenue
(CIR) the fact of his physical presence abroad with a definite intention to reside
therein.
2. A citizen of the Phils. who leaves the country during the taxable year to reside
abroad, either as immigrant or for employment or on permanent basis.
3. A citizen of the Phils. who works and derive from abroad and whose employment
thereat requires him to be physically present abroad most of the time during the
taxable year.
4. A citizen who has been previously considered as non-resident citizen and who
arrives in the Phils. at any time during the taxable year to reside permanently in the
country. (He shall be considered a NRC for the taxable year in which he arrives in
the Phils. with respect to his income derived from sources abroad until the date of
his arrival in the Phils.)
Rev. Regulations. No. 9-73, November 26, 1973 - The continuity of residence abroad is not
essential. If physical presence is established, such physical presence for the calendar year is not
interrupted by reasons of travels to the Phils.
2. Aliens / Foreigners
(a.) Resident aliens (RA) -> those residing in the Philippines though not a citizen thereof.
(b.) Non resident aliens (NRA) -> those not residing in the Phils.
1.) Those engaged in trade or business in the Phils. (NRAETB)
2.) Those not engaged in trade / business in the Phils. (NRANETB).
 A “non-resident alien” individual who came to the Phils. and stayed therein for an aggregate
period of more than 180 days during any calendar year shall be deemed a NRA doing business
in the Phils.
 The term “engaged in trade / business” denotes habitually or sustained activity.
 “Resident aliens” are those who are actually present in the Phils. and who are not mere
transients or sojourners. For tax purposes a resident alien is:
1.) An alien who lives in the Phils. with no definite intention to stay as a resident.
2.) One who comes in the Phils. for definite purposes which in its very nature would
require on extended stay and to that end, makes his home temporarily in the Phils.
3.) An alien who stay within the Phils. for more than 12 months from the date of his
arrival in the Phils.
Residence does not mean mere physical presence. What makes an alien resident or a non-
resident alien is his intention with regard to the length and nature of his stay.
b.) Personal and Additional Exemptions

 Nature & Purpose: Personal and additional exemptions are fixed amounts which are in the
nature of deduction and are intended to substitute for the disallowance of personal or living expenses as
deductible items.
 Reciprocity means that the foreign country where the nonresident alien is a citizen or subject grants
exemption to Filipinos not residing there but doing trade or business, or exercising profession
therein.
 The extent of personal exemptions allowed to such non-resident alien shall be in the amount equal
to the exemptions allowed in the income tax law in the country of which he is a subject or citizen,
to citizens of the Phils. not resident in such country not to exceed the amount fixed under our laws.
(Sec. 36 [D], NIRC).
Personal Exemptions for RC, NRC, and RA
Taxpayer Exemption (amount)

1. Single person including a married person
P 20k
judicially decreed as legally separated
2. Each married person P 32k
3. Head of family P 25k
HEAD OF FAMILY – is one who is unmarried or legally separated man or woman with;
(1) One or both parents –

(a) Living with the taxpayer.
(b) Dependent upon the taxpayer for their chief support.
(2) One or more brothers -
(a) Living with the taxpayer
(b) Dependent upon the T for chief support
(c) Not more than 21 yrs. of age
(d) Not married
(e) Not gainfully employed
(3) One or more legitimate recognized natural / legally adopted children.
(b) living with the Taxpayer
(c) dependent upon the Taxpayer for chief support
(d) not more than 21 yrs. of age
(e) not married
(f) not gainfully employed
 Regardless of age, such children, brothers or sisters qualify a Taxpayer as head of family is they are
incapable of self-support because of mental or physical defect.
 “CHIEF SUPPORT” -> means principal or main support. More than fifty percent (50%) being
provided to certain dependents is enough. This phrase does not necessarily mean that the dependent
derives no name at all, he may still derive income but the same is insufficient to support him.
 “LIVING WITH” -> requires the Taxpayer and his dependent to actually be residing together but
temporary absence from their common residence brought by face of circumstances such as:
(a) The Taxpayer is away on business
(b) The dependent who may be boarding elsewhere is in pursuit of education.
 “GAINFULLY EMPLOYED” means that the dependent will only qualify as such if he derives no
income for himself, or he is employed but his income is not sufficient to support him independently
outside of the principal/chief support afforded to him by the taxpayer.
 RA 7432 in relation to exemptions

 RA 7432 (approved April 23, 1992) expressly allows a qualified senior citizens to be claimed as
dependents by those who care for them whether a relative or not.
Additional Exemption
Rule: An additional exemption of P8,000 is granted to Taxpayer for each, but not exceeding four (4) of
his :
(a) Legitimate, illegitimate and/or legally adopted children
(b) Living with the Taxpayer
(c) Chiefly dependent upon him for support
(d) Not more than 21 yrs. old

(e) Unmarried
(f) Not gainfully employed.
 Take note of the following rules:

1.) Personal exemption of married persons:
a. If not legally separated, each spouse is entitled to P32k as personal exemption.
b. If legally separated, each is entitled to P20k as a single individual unless qualifies as head of
family.
c. Where only one (1) of the spouses is deriving income, only such spouse shall be allowed the
personal exemption.
2.) For additional exemption

a.) For married individuals can be claimed by only 1 of the spouses.
b.) For legally separated spouses, it can be claimed only by the spouse who has custody of the
children; but the amount claimed by both shall not exceed the maximum allowed.
c.) Additional exemption can be claimed only by the “husband” unless:
i. he waives his right in favor of his wife;
ii. the husband is working abroad; or
iii. the wife is the one deriving income.
3.) The law requires that married individuals, the husband and wife although required to file one (1)
income tax return, should nevertheless compute their individual income separately. If any income
of the spouses cannot be definitely attributable to or identifiable as income exclusively earned as
realized by either of the spouses, the same shall be divided equally between the spouses.
 Rules on change of Status

 These are:
1.) If the taxpayer marries or should have additional dependent(s) during the taxable year,
the taxpayer may claim the corresponding additional exemption, as the case may be, in
full for such year.
2.) If the taxpayer dies during the taxable year, his estate may still claim the personal and
additional exemption for himself and his dependents as if he died at the close of such
year.
3.) If the spouse or any of the dependents dies or if any of such dependents marries,
becomes twenty-one (21) years old or becomes gainfully employed during the taxable
year, the taxpayer may still claim the same exemptions as if the spouse or any of the
dependents died, or as if such dependents married, became twenty-one (21) years old or
become gainfully employed at the close of such year.
 Any income or gain derived in which a final tax is imposed shall no longer be included in the taxable
net income of the taxpayer (applicable only to citizens and aliens)
 Final tax is imposed without deduction. Neither is the provision on personal additional applicable.
 Aliens employed by RAHQs & ROHQs, OBUs, Petroleum service contractor & subcontractor of a
multinational corporations are entitled to 15% tax, only on those:
 Salaries, wages, annuities, honoraria and the like as received from such RAHQs
or ROHQs.
 Provided that the same tax treatment is extended to Filipino employees having
the same position in such entities.
3. Tax on corporations (Corporate Taxpayers)
a.) Corporation defined (Sec. 24(b) Tax Code) - The term shall include partnership, no matter how created
or organized, joint stock companies, joint accounts, or insurance companies, but does not include general
professional partnerships and a joint venture or consortium formed for the purpose of undertaking
construction projects or engaging in petroleum, coal, geothermal and other energy operations pursuant to
operating or consortium agreement under a service contract with the government.
General professional partnership (GPP) - are formed by persons for the role purpose of exercising their
common profession, no part of the income of which is derived from engaging in any trade & business.
Corporations are classified into two classes namely:

(1) Domestic -> those created or organized in the Phils. or under its laws.

(2) Foreign -> those created organized or existing under any laws other than those of the Phils.
and they are either;
 Resident foreign = those foreign corporation engaged in trade or business within

the Phils.
 Non-resident = those foreign corporation not engaged in trade or business within
the Phils.
“DOING OR ENGAGING IN” or “TRANSACTING BUSINESS”

-> The term implies a continuity of commercial dealings and arrangements and contemplates to that
extent, the performance of acts or works or the exercise of some of the functions normally insistent to and
in the progressive prosecution of commercial gain or for the purpose and the object of the business
organization (Comm. vs. British Overseas Airways Corporation – BOAC case 149 S 395)
A. Tax On Domestic Corporation (Sec. 27 of NIRC)

Except as otherwise provided in the Tax Code, Domestic corporations duly organized and existing
under the Philippine laws shall be subject to the following tax rates based on their gross income derived
from sources within or without the Phils.
35% - for 1997 and prior years

34% - effective January 01, 1998
(1) Proprietary Educational Institutions / non-profit hospitals - Except those income subject to final tax,
proprietary educational institutions/ non-profit are taxable with the tax rate of 10% on their gross
income.
 Proprietary Educational Institution means any private school maintained and administered by
private individuals or groups within an issued permit from the DECS, CHED or TESDA.
 Predominance Test / Preponderance Test means that if the gross income from unrelated trade,
business or other activity exceeds 50% of the total gross income derived by any educational
institution or hospital from all sources the normal tax shall be imposed on the entire taxable
income.
 “Unrelated trade, business or other activity” means any trade business or other activity, the
conduct of which is not substantially related to the exercise or performance by such educational
institution or hospital of its primary purpose or function.
 Article XIV Sec. 4 (3) of the Constitution provides that “all revenues and assets of non-stock and
non-profit educational institution used actually, directly and exclusively for educational
purposes are exempt from taxes and duties.
(2) Government owned or controlled corporations (GOCCs) – GOCCs, agencies or its instrumentality
shall pay applicable corporate income tax rates except: GSIS, SSS, PHIC, PCSO and PAGCOR.
Tax Imposed on Domestic corporations
(1.) Normal Corporate Income Tax (NCIT) -> the tax rate of 32% (as of Jan. 1, 2000) is imposed on any
income derived, within and without the Phils. Except on those passive income (Section 27 (A) NIRC)
(2.) Gross Income Tax Option -> The President upon the recommendation of the Secretary of Finance
may, effective January 1, 2000, allow corporations the option to be taxed at fifteen percent (15%) of
gross income provided that the following conditions are met therein:
a. a tax effort ratio of 20% of GNP
b. a ratio of 40% of income tax collection to total tax revenues
c. a VAT effort of 4% of GNP and
d. a 0.9% ratio of the Consolidated Public Sector Final Position (CPSFP) to Gross National
Product (GNP)
 The option to be taxed based on gross income shall be available only to firms whose ratio of
cost of sales to gross sales or receipts from all sources does not exceed fifty-five percent (55%).

 The election of the gross income tax option shall be irrevocable for three (3) consecutive taxable
years during which the corporation is qualified under the scheme.
Definition of Terms
a. “Gross Income” derived from business shall be equivalent to gross sales returns, discounts and
allowance and cost of goods.
b. “Cost of goods sold” shall include all business expenses directly incurred to produce the
merchandize to bring them to their present location and use.
c. For trading and merchandising concern, “Cost of goods sold” shall include the invoice cost of the
goods sold, plus import duties freight in transporting the goods to the place where the goods are
actually sold, including insurance while the goods are in transit.
d. For manufacturing concern, “Cost of goods manufactured and sold” shall include all costs of
production of finished goods, such as raw materials used, direct labor and manufacturing
overhead, freight cost, insurance premiums and other costs incurred to bring the raw materials to
the factory or warehouse.
e. In sale of service, “gross income” means gross receipt less sales returns, allowance and discounts.
(3.) Minimum Corporate Income Tax (MCIT) -> a tax rate of 2% is imposed on the gross income of
domestic corporations and resident foreign corporations.
Rationale: MCIT is designed to forestall the prevailing practice of corporation or over-claiming

deductions in order to reduce their income tax payments.
 Requisites:
a. It is imposed beginning the fourth (4th) taxable year immediately following the taxable yr. in
which such corporation starts its business operation.
b. It is imposable only if such corporation has zero or negative taxable income or whenever the
amount of MCIT is greater than the Normal Corporate Income Tax (NCIT) due from such
corporation.
 Carry Forward of Excess Minimum Tax

-> any excess of the minimum corporate income tax (MCIT) over the normal income tax shall
be carried forward on an annual basis and credited against the normal income tax for the three
(3) immediately succeeding taxable yrs.
 Instances when MCIT may be suspended by the Secretary of Finance

-> The Sec. of Finance, upon recommendation of the Commissioner may suspend the
imposition of MCIT, upon showing that the corporation suffers losses due to any of the
following causes:
a. Prolonged labor dispute (e.g. strikes for more than 6 months)
b. Legitimate business reverses (e.g. theft)
c. Force majeure (e.g. war)
(4.) Final tax on certain Passive Income

-> refer to previous note
The following corporations are not subject to MCIT

(1.) Proprietary Educational Institution if enjoys preferential tax rate
(2.) Non-profit hospitals
(3.) Depository banks under expended FCDU
(4.) International carriers
(5.) Offshore Banking Units
(6.) ROHQs of resident foreign corp.
(7.) Other corporations not subject to the normal tax rate
B. Tax on Foreign Corporations (Sec. 28 of NIRC)

(1.) Resident Foreign Corporation Engaged in Trade or business in the Phils. (RFC) - Foreign Corporation
shall be taxed on income derived from sources “within” the Philippines.
Tax Imposed on Resident Foreign Corporation (RFC)
(1.) NCIT -> 32% effective Jan. 01, 2000 and thereafter
(2.) Gross Income Tax Option -> 15% tax rate on gross income of RFC is also applicable.

(3.) Minimum Corporate Income Tax (MCIT) -> 2% based on gross income is also applicable
(4.) Tax on Branch Profits Remittances -> subject to 15% based on the “total profits” applied or
earmarked for remittance w/o any deduction for the tax component thereof:
except : Those activities registered w/ the PEZA; interests dividends, rents and royalties;
remuneration for technical services, salaries, and wages; premiums, annuities,
emoluments; capital gains, profit and income.
(5.) Final tax on certain Passive Income - the same tax rates as imposed to domestic corporation = is also
applicable to RFC except: the imposition of capital gain tax (6%) on sale of real property (capital asset)
located in the Phils.
 A different tax rate is imposed on the following RFCs
(a.) Int’l carrier -> 2 ½% on Gross Philippine Billing

 Int’l air carrier = “Gross Philippine Billings” refer to the amount of gross revenue from (a) carriage
of persons, excess baggage cargo and mail originating from the Phils. in a (b) continuous and
uninterrupted flight, irrespective of the place of sale or issue and the place of payment of the ticket
or passage document.
 Take note: For a flight w/c originates from the Phils. but transhipment of passenger takes place at
any port outside the Phils., only the aliquot portion of the cost of the ticket corresponding to the
leg flow from the Phils. to the point of transhipment shall form part of the GPB.
 In International shipping, “Gross Phil. Billing” means gross revenue whether for passenger, cargo or
mail originating from the Philippines up to the final destination regardless of the place of sale or
payments of the passage or freight documents.
(b) Regional / Area Headquarters (RAHQs) -> tax exempt

-> These are branches established in the Phils. by a multinational companies but they do not earn
or derive income here and their functions are limited to being a supervisory communication and
coordinating center for their affiliates.
(c.) Regional Operating Headquarters (ROHQs) -> subject to 10% tax.

-> these are branches established in the country by multinational companies which are engaged
in any of the following:
 general administration & planning;
 business planning
 business development (and the like)
(d.) Offshore Banking Units authorized by Bangko Sentral ng Pilipinas

EXCEPT: RA 9294.
(2.) Non-Resident Foreign Corporations (NRFCNETB) - are subject to 32% tax rate (effective Jan. 1, 2000
and thereafter) on all income derived from sources within the Phils. except on certain passive
income
 NRFCs are not entitled to deduction as well as exemption (personal and additional exemption)
 TAX SPARING RULE / CREDIT

- provides that a final withholding tax at the rate of 15% shall be imposed for the amount of cash
and /or property dividends received from a domestic corporation by non-resident Foreign
corporation subject to the condition that the country in which the NRFC is domiciled shall allow a
credit against the tax due from NRFC taxes deemed to have been paid in the Phils. equivalent to
17% which represents the difference between the regular income tax rate of 32% and the usual
corporate rate of 15%.
Take note:
 Tax sparing credit applies only when the conditions for its availment are clearly established by the
taxpayer. Since the concession is in the nature of a tax exemption.
 The 15% reduced tax must actually be paid and the 17% must be deemed paid tax.
 The 15% tax on dividends is applicable if the country where the recipient NREC is domiciled does
not imposed any tax on dividend received by said recipient foreign corporation (BIR Ruling,
March 30, 1977)
Improperly accumulated earnings tax (IAET) (sec. 29 NIRC)

 Nature and Purpose: The improperly accumulated earning tax of 10% in addition to the regular
corporate income tax shall apply to every corporation formed or availed for the purpose of
avoiding of any other corporation by permitting earnings and profit to accumulate instead of being
divided or distributed.
 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
(4) The amount of NOLCO deducted and reduced by the sum of:
a. Dividends actually or constructively paid and
b. Income tax paid for the Taxable year.
Formula: Taxable income

add: Income exempt from tax
Income subject to final tax
Income excluded from gross income
Amount of NOLCO deducted
Less: Dividends actually or constructively paid
Income tax paid for the yr.
Improperly accumulated Taxable
Income
 Improperly Accumulated Earnings Tax does not apply to the following:

(1.) Banks and other non-banks financial intermediaries
(2.) Publicly held corporations
(3.) Insurance companies
 Presumptions of Improper accumulations - There is a “prima facie” evidence of a purpose by a

corporation to avoid the tax upon its shareholders or members:
(1) Where the corporation is a mere holding company.

(2) Where the corporation is an investment company where more than 50% of its outstanding stock is
owned directly/ indirectly by one person during the taxable year.
(3) Where the corporation permits its earnings or profits to be accumulated “beyond the reasonable
needs of the business”.
“Reasonable needs of the business” includes the reasonably anticipated needs of the business e.g.
investment of corporation’s profits in a business related to taxpayer’s business.
 Purpose: To compel the corporations to distribute dividends to the stockholders (subject to

dividend tax)
 Instances of Reasonable Accumulations:

(1) It is retained for working capital needed by the business
(2) It is invested in addition to plant property and equipment reasonably by the business
(3) In accordance with contract obligations, it is placed to the credit of a sinking fund for the purposes
of retiring bonds issued by the corporation.
 FROM TAXES ON CORPORATIONS (Sec. 30 of NIRC): The following shall not be taxed in respect to
income received by them:
(a.) Labor, agricultural or horticultural organization not organized principally for profit.
(b.) Mutual savings bank not having a capital stock represented by shares and cooperative banks
w/o capital stock organized and operated for mutual purposes and without profit.
(c.) A beneficiary society or association operating for exclusive benefit of the members or a mutual
aid association or non-stock corporation organized by employees providing benefits exclusively
to its members or their dependents.
(d.) Cemetery company owned and operated for the exclusive benefits of its member
(e.) Non-stock corporation or association organized and operated exclusively for religious,
scientific, athletic, or cultural purposes, or for the rehabilitation of veterans, no part of it net
income or asset shall belong to or inure to the benefit of any member, organizer, or officer or
any specific person
(f.) Business league chamber of commerce, or board of trade not organized for profit and no part of
the net income of which inures to the benefit of any private stockholder or individual

(g.) Civic league or association not organized for profit but operated exclusively for the promotion
of social welfare
(h.) A non-stock and non-profit educational institution.
NOTE: Refer to Article XIV Section 4(3), 1987 Constitution.
(i.) Farmers’ fruit growers or like organization organized and operated as sales agent for the
purpose of marketing the products of its member.
(j.) Farmers’ or other mutual typhoon or fire insurance company or like organization of a purely
local character, the income of which consists solely of assessment, dues and fees collected from
members for the sole purpose of meeting its expenses.
(k.) Government educational institution
Income of whatever kind and character of the foregoing organizations from any of their
properties, real or personal or from any of their activities “conducted for profit” regardless of the
disposition made of such income shall be subject to tax.
C. Tax on Partnership and Co-ownership

PARTNERSHIP is a contract whereby two or more persons bind themselves to contribute money,
property, or industry to a common fund with the intention of dividing the profits among themselves.
 Exemptions from taxes on corporations (Sec. 30 of NIRC): The following shall not be taxed in respect
to income received by them:
(a.) Labor, agricultural or horticultural organization not organized principally for profit.
(b.) Mutual savings bank not having a capital stock represented by shares and cooperative banks
(c.) A beneficiary society or association operating for exclusive benefit of the members or a mutual
(d.) Cemetery company owned and operated for the exclusive benefits of its member
(e.) Non-stock corporation or association organized and operated exclusively for religious,
any specific person
(f.) Business league chamber of commerce, or board of trade not organized for profit and no part of
(g.) Civic league or association not organized for profit but operated exclusively for the promotion
of social welfare
(h.) A non-stock and non-profit educational institution.
NOTE: Refer to Article XIV Section 4(3), 1987 Constitution.
(i.) Farmers’ fruit growers or like organization organized and operated as sales agent for the
(j.) Farmers’ or other mutual typhoon or fire insurance company or like organization of a purely
(k.) Government educational institution
Partnership not subject to income tax, which include the following;
a. General Professional partnership

b. Joint venture or consortium agreement formed for the purpose of undertaking
 construction projects or
 engaging in petroleum, coal, geothermal and other energy operations pursuant to an
operating or consortium agreement under a service contract with the government.
Partnership subject to income tax / Business Partnership
-> All other partnership except GPP and Joint Venture, no matter how created or organized
are considered corporation subject to corporate income tax.
 BIR RULING No. 162 June 11, 1987

 A partner’s contribution of real property to the partnership fund is not subject to income tax.
CO-OWNERSHIP is created whenever the ownership of an undivided thing or right belongs to different
persons.

GEN. RULE: Co-ownership is exempt from income tax because the activities of the co-owners are usually
limited to the “preservation” of the properties owned in common and the collection of the income
therefrom.
EXCEPTIONS: (When co-ownership is subject to tax).
(1) When the income of the co-ownership is invested by the co-owners in other income-producing
properties or income-producing activities, and
(2) When there is no attempt to divide inherited property for more than ten (10) years and the said
property was not under any administration proceedings nor held in trust, an unregistered
partnership is deemed to exist.
 Tax liability of co-owners -> The co-owners in exempt co-ownership shall be viable for income tax
only in their separate and individual capacity.
 Filing of return -> The owners shall report and include in their respective personal income tax
returns their shares of the net income of the co-ownership.
4. Tax on Estates and Trusts (sec. 60. NIRC)
Estate is the mass of property, rights and obligations left behind by the decedent upon his death.
 Estates may be classified as follows:
1. Estates not under judicial settlement - are subject to income tax generally as mere co-
ownership.
- The tax liability on income of the co-ownership levied directly on the co-owners. Thus, the heirs
shall include in their respective returns their distributive shares of the net income of the estate.
2. Estates under judicial settlement - are subject to income tax in the same manner as individual.
- Income received during the settlement of the estate is taxable to the fiduciary (guardian,
executor, trustee, and administrator).
- The return should be filed by executor or administrator of the trust.
Trust is an arrangement created by will or co-agreement under which title to property is passed to another
for conservation or investment with the income therefrom and ultimately the corpus (principal) to be
distributed in accordance with the directions of the creator as expressed in the governing instrument.
 2 Kinds of Trust :
1. Irrevocable Trust -> is considered as a separate taxpayer.
2. Revocable Trust -> is one where at anytime the power to revest the title to any part of the corpus
of the trust is vested:
(a.) in the grantor (creator of the trust) either alone or in conjunction with any person not having a
substantial adverse interest in the disposition of such part of the corpus or the income
therefrom; or
(b.) in any person not having a substantial adverse interest in the disposition of such part of the
corpus or the income therefrom.
NOTE: The tax shall be imposed on taxable income of the grantor.
 Various trusts subject to income tax.

(1.) Trust where income is accumulated for the benefit of certain or uncertain persons or persons
with contingent interest.
(2.) Trust where income is accumulated or held for future distribution under the terms of the will or
trust.
(3.) Trust where income is to be distributed currently by the fiduciary to the beneficiaries.
(4.) Trust where income collected by a guardian of an infant is held or distributed as the court may
direct.
(5.) Trust where income in the discretion of the fiduciary may be either distributed to the
beneficiaries or accumulated.
 Exempt Trust - The tax imposed on estate and trust does not apply to EMPLOYER’S TRUST
provided that the following conditions are satisfied:
(1.) The employee’s trust forms part of a pensions, stocks, bonus or profit sharing plan of an
employer for the benefit of some or all of its employees.

(2.) Contributions are made to the trust by such employer, or employees, or both for the purpose of
distributing to such employees the earnings and principal of the trust and accumulated by the
trust in accordance with such plan.
(3.) No part of the corpus or income shall be used for or diverted to, purpose other than for the
exclusive benefit of his employees.
 Consolidation of income in trusts

(1.) If there are two or more trusts created
(2.) The same are created by the same person (grantor)
(3.) and the beneficiary of such is the same person in each instance.
Take note: Rules applicable in the computation of the tax on estates and trusts:
(1.) The same rules in the determination of gross income for individuals are applicable.
(2.) The same deductions allowed to an individual taxpayer are also allowed, in addition of the
following deductions:
(a.) amount of its income which is to be distributed currently to the beneficiaries, and
(b.) Amounts of its income for the taxable year which is properly paid or credited during
such year to any heir, legatee, or beneficiary, but the amount so allowed as a deduction
shall be included in computing the taxable income of the heir, legatee, or beneficiary.
(3.) Personal Exemption of P20k is also applicable

(4.) The graduated rates of tax used for individuals taxpayers are also applicable
 The deductions mentioned are not available to TRUSTS administered in foreign country.
G. SOURCES OF INCOME
1. Services / compensation
- all kind of compensation for services rendered as a result of employer-employee relationship.
- It includes;
a. salaries, wages, fees, allowances;
b. commissions paid to salesperson or those paid in insurance premium;
c. compensation paid for services on the basis of percentage on profits;
d. honoraria, director’s fee;
e. bonuses, tips;
f. allowance for transportation, representation or entertainment;
g. pensions or retiring allowance paid by private persons or by the government;
h. amount receive from refraining from rendering services
i. Christmas gift based upon fixed percentile of salaries given to employees during holidays
j. Amount receive as an special award for special services
k. Prize won in competitive contest conducted for non commercial or commercial purposes
l. Proceeds from profit sharing and other benefit received in cash or in kind.
To be taxable the requisites are:
1. it must arise from personal service under an employee-employer relationship
2. it is in the nature of income to the recipient.
 Tips or gratuities paid directly to an employee by a customer of the employer which is not
accounted for by the employee to the employer are considered taxable income.
1. Compensation for services in whatever form paid, including but not limited to;
a. Salaries – refer to earnings received periodically for regular work other than manual labor.
b. Wages – are earnings received usually according to specified intervals of work, as by the
hour, day or week.
c. Fees - amount received by an employee for the services rendered to the employer.
d. Commission – refers to percentage of total or a certain quota of sales volume attained as
part of incentives, such a sales commission.
e. Similar items – like pension or retiring allowance.
 A pension awarded to a person where no services have been rendered are mere gifts or
gratuities and not taxable as income. They are subject to donor’s tax payable by the
donee.
 Compensation for personal services is taxable when:
a. Income for services rendered is taxable in the year of receipt. (cash basis)
b. Cash, property or services earned during the taxable year though not actually received are
deemed to have accrued to the taxpayer and are classified as income (accrual basis).

 Forms of Compensation
a. money
b. in kind
 Compensation paid to an employee of a corporation in its stock is to be treated as if
the corporation sold the stock for its market value and paid to the employee in cash.
 Living quarters furnished to the employee in addition to cash salary. The rental value
should be reported as income.
 Meals given to employee, the value thereof substitutes income.
CONVENIENCE OF THE EMPLOYER RULE

- The allowances furnished to the employee which are for the convenience and
advantage of the employer or for proper performance of the employees’ duty, shall
not be taxable on the part of the employee receiving the same.
- REQUISITES:
a. They must be furnished within the employer business premises.
b. The employer accepts the same as a condition of his employment
--- Promissory notes or other evidence of indebtedness received in payment of services are considered
as income to the extent of their fair market value.
--- An individual who performs services for a creditor, who in consideration thereof cancels his
debt, income to that amount is realized by the debtor as compensation for his services. However, if the
creditor condones /cancels the debt without any service rendered by the debtor, the amount of such debt is a gift
and need not be included in the gross income of the debtor. The amount is subjects to donor’s tax.
c. Both in money and in kind.
2. Interest income
- refers to the compensation for the use of money or forbearance for its used or arising from
indebtedness.
- An earning derived from depositing or lending of money, goods or credits.
GENERAL RULE: Interest received by a taxpayer, whether usurious or not, is subject to income tax.
EXCEPT: When interest income is exempted by law from income tax.

- Central bank circular No. 416, dated July 29 1974, increased and fixed the legal rate of interest
at 12% per annum applicable to loans or forbearance of money, goods or credit and court
judgment thereon pursuant to the Usury law. Later on December 10, 1982, it amended its
previous Circular and directed that rate of interest including commissions, premiums, fees and
other charges, on loan or forbearance of money, goods or credit Regardless of their maturity
and whether secured or unsecured that may be collected by any person, whether natural or
juridical shall not be subject to any ceiling prescribed under the Usury Law, as amended.
However, the 6% legal rate of interest under the Civil Code remained valid and still applies to
other kind of monetary judgment which has nothing to do with loans or forbearance of money,
goods or credits.
- Interest may refer, also to interest income from peso bank deposit which is subject to final tax
of 20%. However, this interest income is not included to the gross income but, together with
other withholding taxes, it is deductible form the tax due to arrive at the amount still payable
or refundable, as the case may be. ( NDC vs. CIR 151 SCRA 472)
 Contractor’s tax is a tax imposed upon the privilege of engaging business - it is generally in the
nature of excise tax on the exercise of privilege of selling services or labor rather than a sale of
products and is directly collectible form the person exercising the privilege.
- being an excise tax it cannot be levied by levying authority where the said privilege or business
is done outside its jurisdiction. Like property tax, it cannot be imposed on a disposition outside
the levying district. (CIR vs. Marubeni Corp. GR. No. 137377, Dec. 18, 2001)
3. Dividends
- Means any distributions made by a stock corporation to its stockholders out of its earnings or profits
and payable to its stockholders in money or other property.
- a corporate profit set aside, declared and ordered by the Board of Directors to be paid to the
Stockholders on demand or at a fixed time. It may be classified into:
1. Cash dividend
2. property dividend

3. stock dividend
4. liquidating dividend
5. script dividend
6. other dividend indirectly paid
NON – TAXABLE INTER – CORPORATE PRINCIPLE

 Dividends from the domestic/resident corporations and shares in profits of taxable
partnerships received by domestic/resident corp. are exempt from income tax.
 Sources of dividends payment: Every dividend declared by a corporation is presumed to
come from the “most recently accumulated profit”.
 Taxable dividends include the following:
(a) Cash Dividend – a dividend paid in cash and is taxable to the extent of the cash
received.
(b) Liquidating dividend – a dividend distributed to the SHs upon dissolution of the
corporation.
(c) Scrip Dividend – issued in a form of promissory note and it is taxable in its Fair
Market Value.
(d) Indirect dividend – when a corporation forgives the indebtedness of its stockholders,
the transaction has the effect of payment of dividend to the extent of the amount of
the debt.
(e) Property dividend — a dividend paid in property of a corporation such as stock
investment, bands or securities held by the corporation and to the extent of the FMV
of the property received at the time of the distribution.
(f) Stock Dividend – Involves the transfer of a portion of retained earnings to capital
stock by action of stockholders. It simply means the capitalization of retained
earnings.
GENERAL RULE: A mere issuance of stock dividends is not subject to income tax, because it merely
represents capital and it does not constitute income to its recipient. Before disposition thereof, stock
dividends are nothing but a representation of interest in the corporate entity.
EXCEPTIONS: When stock dividends are subject to tax:
a.) These shares are later redeemed for a consideration by the corporation or otherwise
conveyed by the stockholder to the extent of such contribution. Under the NIRC, if a
corporation, after the distribution of a non-taxable stock dividend, proceeds to cancel or
redeem its stock at such time and in such manner as to make the distribution and
cancellation or redemption essentially equivalent to the distribution of a tax of a taxable
dividend, the amount received in redemption or cancellation of the stock shall be treated as
a taxable dividend to the extent that it represents a distribution of earnings or profits. (Sec.73
(B), NIRC). Depending on the circumstances, corporate earnings may be distributed under
the guise of initial capitalization by declaring the stock dividends previously issued and
later redeem or cancel said dividends by paying cash to the stockholder. This process
amounts to distribution of taxable dividends which is just delayed so as to escape the tax.
(CIR vs. CA, 301 SCRA 152)
b.) The recipient is other than the stockholder. (Bachrach vs. Seifert, 57 PHIL 483)
c.) A change in the stockholder’s equity results by virtue of the stock dividend issuance.
Stock dividend is classified into:

(1). Non – taxable – is one where the new shares confer the same rights and interest as the old share.
There is no change in the corporate identity. After the distribution thereof, there is no change in the
proportionate interest of SHs.
(2). Taxable Stock dividend – is one where there either has been a change of corporate identity or a
change in the nature of the shares, where the proportionate interest of the SHs changes.
 Under the corp. code, stock dividend being one payable in capital stock, cannot
be declared out of outstanding capital stock but from retained earnings of the
corporation.
 Where corporate earnings are used to purchase outstanding stocks treated as
treasury stock (stocks issued and fully paid for and subsequently reacquired by the
corporation of purchase, redemption or through same other means) as a technical but
prohibited device, to avoid the effects of income taxation, distribution of said corporate
earnings in the form of stock dividend will subject SHs receiving them to income tax. The
corporation parting with a portion of its earnings “to buy” the outstanding stock is in
ultimate effect and result making a distribution of such earnings to the stockholders.
(Commissioner vs. Manning, 66 SCRA 14)

4. Gains derived from dealings in property

– refers to the income derived from the sale and or exchange of assets, which result in gain because of
the excess of the amount of value received by the taxpayer.
GENERAL RULE: The entire amount of the gain or loss arising from the transaction shall be taxable or
deductible, or the case may be.
Note: (Gross Income from sources within the Philippines)

* Gains, profits, and income from the sale of real property located in the Phils. and
* Gains, profits, and income from sale of personal property, treated as derived entirely from the country
where it is sold.
 Exception to the rule: gain from the sale of shares of stock in a domestic corporation which is
treated as derived entirely from sources within the Phils. regardless of where the shares are sold.
 Passage of title test: it is the prevailing view that in ascertaining the place of sale, the
determination of where and when the title to the goods passes from the seller to the buyer is
decisive.
5. Royalty Income
– these are the compensations or payments for the use of property and are paid to the owner of a right.
6. Rental Income
– refers to earning derived from leasing real estate as well as personal property. It includes all other
obligations assumed to be paid by the lessee to the third party in behalf of the lessor.
 Taxes paid by the tenant (lessee) to or for a lessor for a business property are additional
rent and constitute income taxable to the lessor.
 Advanced rentals:
(a). if the advanced rental is a Security Deposit which restricts the lessor as to its use -- such
amount shall be “excluded” in the determination of rental income.
(b). If the advance rental is Prepaid Rental received without restriction as to its use – the entire
amount is “taxable” in the year it is received.
 Permanent improvements made by the lessee on leased property.

When the lessee makes improvements on the leased property and the said improvements
will belong to the lessor upon the expiration of the lease contract, the lessor may report the
income there from upon either by the following methods:
(a). Outright method – the lessor will report as income the FMV (fair market value) of the
improvements on the year of completion.
(b). Spread out method – the lessor may spread over the life of the lease the estimated
depreciated value of such improvements at the termination of the lease and report as income
of each year of the lease an aliquot part theory.
 Income resulting from pre – mature termination of the lease contract.

RULES:
1. If the improvement is destroyed before the termination of the lease contract -- the
lessor is entitled to “deduct” as a loss for the year when such destruction takes place
the amount previously reported as income.
2. If the lease is terminated prior to the expiration of the lease contract for any reason,
other than a bonafide sale to the lessor – the lessor received “additional income” for
the year the value of the improvements exceed the amount of income already
reported.
 Income of corporation from leased property. Where the property of a corporation is

leased to the lessee in consideration that the latter shall pay in lieu of rental an amount
equivalent to a certain rate of dividend on the lessor’s capital stock; it shall be considered
as;
(a). Rentals (income) – to lessee and lessor (income to the corp.)
(b). Dividend from the lessor corporation – as far as the shareholders are
concerned.
Rent and royalties

- rent is the consideration for the use of property, real or personal paid by the lessee to a lessor
through a contract of lease by which the latter temporarily grants the enjoyment of certain
property to the former who undertakes to pay rent or a price certain thereof, for which contract to
last for a definite on indefinite period, but in no case to exceed 99 years.
- Royalties on the other hand, are payment for the use of property which includes earning from
copy right, trademarks, patents, and natural resources under a lease. Royalties are subject to final
tax as follows:
a. 10% for books, literary works and musical composition;
b. 20% for the use of other property.
DETERMINATION OF GROSS INCOME AND THE RULES ON INCLUSIONAND EXCLUSION FROM

GROSS INCOME
A. The Concept of Gross Income
a. Gross Income, definition

- means all income derived during a taxable year by a taxpayer from whatever source,
whether legal or illegal.
 The term “derived from whatever source “implies the inclusion of all income under the law,
irrespective of the voluntary or involuntary action of the taxpayer in producing the gains.
 It includes illegal gains arising from – gambling, betting, lotteries extortion and fraud.
b. Gross Income v. Gross Sales/ Receipts
Where gross income pertains to all income during a taxable year derived from
whatever source, gross sales or gross receipts, however, refers to the total invoice value of
sales, before deducting for customer discounts, allowances, or returns. Gross Income
derived from business shall be equivalent to gross sales returns, discounts and allowance
and cost of goods.
B. The General Rules on Inclusion and Exclusion of Income Items
a. Taxable Income, Definition (sec 31)

– means the pertinent items of gross income less the deductions and/or personal and
additional exemptions, if any, authorized for such types of income by the NIRC or other special
laws
b. Inclusions (sec 32A)

Items included in the determination of Gross Income, but not limited to the following; (C
- G2IR2P3AD)
1. Compensation for services in whatever form paid, including but not limited to;
a. Salaries – refer to earnings received periodically for regular work other than
manual labor.
b. Wages – are earnings received usually according to specified intervals of work, as
by the hour, day or week.
c. Fees - amount received by an employee for the services rendered to the employer.
d. Commission – refers to percentage of total or a certain quota of sales volume
attained as part of incentives, such a sales commission.
e. Similar items – like pension or retiring allowance.
2. Gross income derived from the conduct of trade, business or the exercise of a profession.

3. Gains derived from dealings in property – refers to the income derived from the sale and
or exchange of assets, which result in gain because of the excess of the amount of value received by
the taxpayer.
4. Royalty Income – these are the compensations or payments for the use of property and are
paid to the owner of a right.
5. Rental Income – refers to earning derived from leasing real estate as well as personal
property. It includes all other obligations assumed to be paid by the lessee to the third
party in behalf of the lessor.
6. Interest Income - an earning derived from depositing or lending of money, goods or

credits.
GENRULE: Interest received by a taxpayer, whether usurious or not, is subject to income

tax.
EXCEPT: When interest income is exempted by law from income tax.
7. Prizes and winnings
8. Pension -refers to allowance paid regularly to a person on his retirement or to his

dependents on his death, in consideration of past services, meritorious work, age, loss or
injury.
9. Partner’s distributive profits from the net income of a General Professional Partnership.
NOTE: Gen. Professional Partnership - is created by a group of individuals for the

purpose of exercising their common profession.
E. g. Law firm
10. Annuities - amount payable yearly or at other regular intervals for a certain or uncertain
period ; they also represent as installment payments for life insurance sold by insurance
companies.
 If the part of annuity payments represent “interest” = taxable income.

 If the annuity is a mere return of premium = not taxable.
11. Dividends - Means any distributions made by a stock corporation to its SH’s
(stockholders) out of its earnings or profits and payable to its SH’s in money or other
property.
c. Exclusion under the Code. (LAGI C MR G2) (sec32 B)
1). Life Insurance Proceed

The proceeds of life insurance policies paid to the heirs or beneficiaries upon the
death of the insured, whether in a single sum or otherwise.
 Reason for exclusion: The contract of insurance is a contract of indemnity hence, the
proceeds thereof are considered indemnity rather than a gain or profits.
 Instances when proceeds from insurance are taxable:

a.) Where proceeds are held by the insurer under an agreement to pay interest. The
interest is included in determination of gross income.
b.) Where the transfer is for valuable consideration.
2.) Amount Received by Insured as Return of Premium

The amount received by the insured as a return of premiums paid by him under
life insurance, endowment, or annuity contracts, either during the term or at the maturity
of the term of the contract or upon surrender.
 Reason for the exclusion: The return of premium is a mere return of capital.
However, where the included in the gross amount received exceed the aggregate premiums
paid, the excess shall be income.
3.) Gift, Bequests, and Devises

The value of the property acquired by gift, devise, or descent shall be excluded.
However, the income from such property, as well as gift, bequest, devise, or descent of

income from property, in cases of transfers of divided interest, shall be included in gross
income.
4). Income Exempt under Treaty

Income of any kind, to the extent required by any treaty obligation binding upon
the Government of the Philippines.
5.) Compensation for Injuries or Sickness

Amounts received, through Accident or Health Insurance or under Workmen’s
Compensation Acts, as compensation for personal injuries or sickness, plus the amounts
of any damages received, whether by suit or agreement, on the account of such injuries
or sickness.
 Example of damages recovered from personal injuries: Moral damages for personal
injuries.
 If the award of damages is to compensate loss of property or an award of damages to
compensate loss of income / profits, such is subject to tax.
6.) Retirement Benefits, Pension, Gratuities, etc.
7.) Miscellaneous Items

a.) Income derived by Foreign Government – Income derived from investments in the
Philippines in loans, stocks, bonds or other domestic securities or from interest on
deposits in banks in the Philippines by:
(i) Foreign governments,
(ii) Financing institutions owned, controlled or enjoying refinancing from foreign
governments, and
(iii) International or regional financial institutions established by foreign governments.
b.) Income derived by the Government or its Political Subdivision – Income derived
from any public utility or from the exercise of any essential governmental function
accruing to the Government of the Philippines or to any political subdivision thereof.
c.) Prizes and Award - Prizes and award to be excluded, the following conditions must
concur;
(1) Prizes and award made primarily in recognition of religious, charitable,
scientific, educational, artistic, literary, or civic achievement.
(2) The recipient was selected without any action on his part to enter the contest or
proceeding.
(3) The recipient is not required to render substantial future services as a condition
in receiving the award.
d.) Prizes and Award in Sports Competition - All prizes and award granted to athletes in
local and international sports competitions and tournaments whether held in the Phils.
Or abroad and sanctioned by sports associations.
e.) 13th Month Pay and Other Benefits - The total exclusion shall not exceed P30k.
f.) GSIS, SSS, Medicare and Other Contributions
g.) Gains from the Sale of Bonds, Debentures or other Certificates of Indebtedness with
maturity of more than five (5) years.
h.) Gains from Redemption of Shares in Mutual Fund.
C. The Rules as Applied to Compensation Income and Other Benefits
1) Taxability of Compensation Income and the Application of the Employer’s Convenience

Rule
 Compensation Income, defined

- all kinds of compensation for services rendered as a result of an employer-employee
relationship. They include:
a. salaries, wages, fees, allowances;
b. commissions paid to salespersons or those paid on insurance premiums;
c. compensation for services on the basis of a percentage of profits;
d. honoraria, director’s fees;
e. bonuses, tips;

f. allowances for transportation, representation and entertainment;
g. pensions or retiring allowances paid by private persons or by the government
(excepts pensions exempt by law from tax)
h. amounts received for refraining from rendering services (also constitute taxable
income)
i. Christmas gifts based upon fixed percentile of salaries given to employees
during the holidays;
j. amounts received as award for special services or for suggestions to employer or
for the prevention of theft/robbery
k. prizes won in competitive contests conducted for commercial or non-commercial
purposes
l. proceeds from profit sharing and other benefits paid in cash or in kind.
 Forms of Compensation
a. money
b. in kind
 Compensation paid to an employee of a corporation in its stock is to be treated as if
the corporation sold the stock for its market value and paid to the employee in cash.
 Living quarters furnished to the employee in addition to cash salary. The rental value
should be reported as income.
 Meals given to employee, the value thereof substitutes income.
EMPLOYER’S CONVENIENCE RULE

The allowances furnished to the employee which are for the convenience and
advantage of the employer or for proper performance of the employees’ duty, shall not
be taxable on the part of the employee receiving the same.
REQUISITES:
a. They must be furnished within the employer business permit.
b. The employer accepts the same as a condition of his employment
--- Promissory notes or other evidence of indebtedness received in payment of services are
considered as income to the extent of their fair market value.
--- An individual who performs services for a creditor, who in consideration thereof
cancels his debt, income to that amount is realized by the debtor as compensation for his
services. However, if the creditor condones /cancels the debt without any service rendered by
the debtor, the amount of such debt is a gift and need not be included in the gross income
of the debtor. The amount is subjects to donor’s tax.
c. Both in money and in kind.
2) Retirement Payments, Pensions and Gratuities

Retirements benefits received under RA 7641 and those received by officials and
employees of private firms in accordance with reasonable PRIVATE BENEFIT PLAN.
Requisites:
(1.) The retiring official or employees has been in service of the same employer for at
least ten years.
(2.) Is not less than 50 yrs. of age at the time of his retirement.
(3.) And is available to official or employee only once.
 Private retirement benefit plan

 A “reasonable private benefit plan” means a pension; gratuity, stock bonus or profit
sharing plan maintained by an employer for the benefit of some or all of his employees –
a.) wherein contributions are made by such employer or employees, or both, for the
purpose of distributing to such employer the earnings and principal of the fund thus
accumulated; and
b.) wherein said plan provides that at no time shall any part of the principal or income
of the fund be used for, or be diverted to, any purpose other than for the exclusive benefit of
said employee
3) Separation Payments
Any amount received by an official or employees or by his heirs from the employer as a
“consequence of separation from service due to death, sickness or other physical disability
beyond the control of the said official or employer.

4) Leave Benefits
The terminal leave pay of government employees whose employment is co-terminus is
exempt since it falls within the meaning of the phrase “for any cause beyond the control of the
said official or employees” (BIR Ruling 143-98)
5) 13th Month Pay and other Bonuses

13th month pay equivalent to the mandatory one (1) month basic salary of officials and
employees (national or local), including GOCC, and of private offices received after the 12 th
month ay beginning 1994 and similar benefits, provided the total amount is P30k and below,
likewise exempt from withholding tax but any amount in excess thereto shall be taxable and
also subject to withholding tax
6) SSS/GSIS/other contributions (Phil-Health/Pag-ibig) and Union Dues
7) Fringe Benefits (Sec 33)

 Fringe benefit, defined
means any good, service or other benefit furnished or granted in cash or in kind
by an employer to an individual employee (except rank-and-file employees) such as but
not limited to the following:
1. housing;
2. expense account;
3. vehicle of any kind;
4. household personnel, such as maid, driver and others;
5. interest on loan at less than market rate to the extent of the difference
between the market rate and actual rate granted;
6. membership fees, dues and other expenses borne by the employer for the
employee in social and athletic clubs or other similar organizations;
7. expenses for foreign travel;
8. holiday and vacation expenses;
9. educational assistance to the employee or his dependents;
10. life or health insurance and other non-life insurance premiums or similar
amounts in excess of what the law allows.
 Pursuant to Revenue Regulations No. 3 – 98 (dated May 21, 1998) implementing section 33
of the Tax Code, the special treatment of fringe benefits shall be applied to fringe benefits
given or furnished to managerial or supervising employees and not to the rank and file.
 Rank and file – means all employees who are holding neither managerial nor supervisory.
 Managerial Employee – is one who is vested with powers or prerogatives to lay down and
execute management policies and/or to hire, transfer, lay – off, recall, discharge, assign, or
discipline employees.
 Supervisory Employees – are those who, in the interest of the employer, effectively
recommend such managerial actions if the exercise of such authority is not merely
routinely or clerical in nature but requires the use of independent judgment.
 The regulation does not cover those benefits properly forming part of compensation income
subject to withholding tax.
 Fringe Benefit Tax (FBT) – refers to monetary burden imposed on any good, services or
other benefits furnished or granted by an employer, in cash or in kind, in addition to basic
salaries, to an individual employee, except rank and file employee.
VALUATION OF THE FRINGE BENEFITS
Fringe Benefit (forms) Value of Fringe Benefits

1). Money The value is the amount received
2). Property with owner ship transferred to the Fair market value of the property
employee.
3). Property w/o transfer of ownership Depreciation value of the property
D. The Rules as Applied to Trade/Business or Professional Income

(a). Determination of gross income in case of manufacturing, merchandising or mining business.
Formula: Gross Income = (Gross Sales – cost of goods sold) + other income
(b). Income from a long term contract – long term contract means building, installation and
construction contract covering a period in excess of one year.

NOTE: any income derived from these contracts shall be reported upon the basis
of Percentage of Completion.
(c). Income from farming may be reported in any of the following methods:
(1). Cash basis – no inventory is used in determining profits.

(2). Accrual basis – an inventory is used in determining profits.
(3). Crop basis – it is generally used when the farmer is engaged in producing crops which
take more than a year to gather and dispose of from the time of planting.
E. The Rules as Applied to Passive Income
a. Royalties, Prizes and Winnings

Royalties
 Royalties are subject to 20% final withholding tax
 Royalties on publication of books, literary works, musical composition are subject to
10% final withholding tax
Prizes and winnings

GEN RULE: Prizes and winnings whether in cash or in kind are taxable.
 Prizes and winnings are subject to 20% final tax.
Provided; 1. more than P10k
2.won in the Philippines
 Where the amount of prizes or winning is P10k or less – subject to schedular rate.
b. Interest Income from Bank Deposits and Deposit Substitutes

 Savings deposits
- subject to 20% final withholding tax
 Time deposits
- longer than 5 years exempt from final withholding tax
- if pre-terminate, subject to final withholding tax
4 years – less than 5 years 5%
3 years – less than 4 years 12%
Less than 3 years 20%
 Foreign currency deposits

- subject to 7.5% final withholding tax
- except: OCW/Seamen opening foreign currency deposits
c. Dividends
 Cash dividends are subject to 10% final withholding tax
 other kinds of dividends are not subject to final withholding tax
NON – TAXABLE INTER – CORPORATE PRINCIPLE

 Dividends from the domestic corporation and shares in profits of taxable
partnerships received by domestic corp. are exempt from income tax.
 Sources of dividends payment: Every dividend declared by a corporation is
presumed to come from the “most recently accumulated profit”.
 Taxable dividends include the following:
i) Cash Dividend – a dividend paid in cash and is taxable to the extent of the
cash received.
ii) Liquidating dividend – a dividend distributed to the SHs upon dissolution
of the corporation.
iii) Scrip Dividend – issued in a form of promissory note and it is taxable in
its FMV
iv) Indirect dividend – when a corporation forgives the indebtedness of its
stockholders, the transaction has the effect of payment of dividend to the extent
of the amount of the debt.
v) Property dividend—a dividend paid in property of a corporation such as
stock investment, bands or securities held by the corporation and to the extent
of the FMV of the property received at the time of the distribution.
vi) Stock Dividend -- Involves the transfer of a portion of retained earnings to
capital stock by action of stockholders. It simply means the capitalization of
retained earnings.

GENRULE: A mere issuance of stock dividends is not subject to income tax, because it
merely represents capital and it does not constitute income to its recipient. Before
disposition thereof, stock dividends are nothing but a representation of interest in the
corporate entity.
EXCEPTIONS: When stock dividends are subject to tax;
1. These shares are later redeemed for a consideration by the corporation or

otherwise conveyed by the stockholder to the extent of such contribution. Under
the NIRC, if a corporation, after the distribution of a non-taxable stock dividend,
proceeds to cancel or redeem its stock at such time and in such manner as to make
the distribution and cancellation or redemption essentially equivalent to the
distribution of a tax of a taxable dividend, the amount received in redemption or
cancellation of the stock shall be treated as a taxable dividend to the extent that it
represents a distribution of earnings or profits. (Sec.73 (B), NIRC). Depending on
the circumstances, corporate earnings may be distributed under the guise of initial
capitalization by declaring the stock dividends previously issued and later redeem
or cancel said dividends by paying cash to the stockholder. This process amounts
to distribution of taxable dividends which is just delayed so as to escape the tax.
(CIR vs. CA, 301 SCRA 152)
2. The recipient is other than the stockholder. (Bachrach vs. Seifert, 57 PHIL 483)
3. A change in the stockholder’s equity results by virtue of the stock dividend
issuance.
Stock dividend is classified into;

(1). Non – taxable – is one where the new shares confer the same
rights and interest as the old share. There is no change in the corporate identity.
After the distribution thereof, there is no change in the proportionate interest of SHs.
(2). Taxable Stock dividend – is one where there either has been a
change of corporate identity or a change in the nature of the shares, where the
proportionate interest of the SHs changes.
 Under the corp. code, stock dividend being one payable in capital stock, cannot
be declared out of outstanding capital stock but from retained earnings of the
corporation.
 Where corporate earnings are used to purchase outstanding stocks treated as
treasury stock (stocks issued and fully paid for and subsequently reacquired by the
corporation of purchase, redemption or through same other means) as a technical but
prohibited device, to avoid the effects of income taxation, distribution of said corporate
earnings in the form of stock dividend will subject SHs receiving them to income tax. The
corporation parting with a portion of its earnings “to buy” the outstanding stock is in
ultimate effect and result making a distribution of such earnings to the stockholders.
(Commissioner vs. Manning, 66 SCRA 14)
4. Sale of Real Property Classified as Capital Asset

- subject to 6% final withholding tax
5. Sale of Shares of Stocks Not Listed nor Traded in the Stock Exchange (based on
gain)
P100k and below 5%
More than P100k 10%
F. The Rules as Applied to Other Sources of Income

(a) Cancellation of Indebtedness
(b) Income from Lease and Leasehold Improvements
(c) Income from Installment Transactions
 As a general rule, the whole profit accruing from a sale of property is taxable as
income in the year the sale is made. But, if not all of the sale price is received during
such year, and a statute provides that income shall be taxable in the year in which it
is "received," the profit from an installment sale is to be apportioned between or
among the years in which such instalments are paid and received. (Banas vs. CA,
G.R. No. 102967, February 10, 2000)
(d) Income from Long-Term Construction Projects

G. Exclusions by Reason of Special Laws
a. Prizes received by winners in charity horse race sweepstakes from PCSO.

b. Back pay benefits
c. Income of cooperative marketing association
d. Salaries and stipends in dollars received by non – Filipino citizens on the technical staff of
IRRI (International Rice Research Institutes).
e. Supplemental allowances per diem, benefits received by officer or employees of the Foreign
Service.
f. Income from bonds and securities for sale in the international market.
DEDUCTIONS FROM GROSS INCOME
A. The Concept of Allowable Deductions

a. DEDUCTIONS, defined
 These are items that are originally part and must be included in the taxpayer’s
gross income but are allowed to be subtracted therefrom to determine the net
income.
b. DEDUCTIONS vs. EXCLUSIONS
DEDUCTIONS EXCLUSIONS (Non-taxable items)

1. Deductions are disbursements, expenses or 1. These are certain items which could be
losses that the law allows to reduce gross properly taxed as income yet the law
income. They represent generally, though not specifically exclude then from taxation either
exclusively expenditures, other than the capital on the basis of public consideration or from the
expenditures, connected with the production of fact that the transmutation of economic gain is
income. not essentially the result of labor and efforts of
the taxpayer.
2. The allowable deductions from gross income 2. They are not included in the income tax
are limited to those that are related to the return unless information regarding them is
taxpayer’s business or profession; the only specifically called for.
exceptions are a.) charitable contributions and
b.) some kinds of losses.
3. Taxpayers who are taxed only for net income 3. It may be availed of by all kinds of taxpayers.
within the Philippines (NRAEBI and RFC) can
only claim deductions incurred in carrying on
such business in the Philippines.
c. DEDUCTIONS WHEN ALLOWED

 Deductions are matters of legislative grace. A taxpayer can only deduct an item
or amount from gross income if there is a law authorizing such a deduction. The
taxpayer must be able to point to the specific provision of the statute authorizing
such deduction and that he must be able to prove that he is entitled to it.
 These allowable deductions can be availed of only if it is shown that the tax
required to be deducted and withheld therefrom has been paid to the BIR (Rev.
Reg. No. 2, April 17, 1998)
d. DEDUCTIONS vs. TAX CREDIT

1. Tax credit – it is the right of an income taxpayer to deduct from income tax
payable the foreign income tax he has paid to his foreign country subject t
limitations.
- Subtracted from the tax itself
- It reduces the taxpayer’s liability dollar for dollar.
 Deductions – subtracted from the gross income before the tax is computed
- It reduces the taxable income upon which the tax liability is calculated.
CASES:
i. CIR vs. Central Luzon Drug Corp., April 15, 2005
A tax credit differs from a tax deduction. On the one hand, a tax credit
reduces the tax due, including – whenever applicable – the income tax that is
determined after applying the corresponding tax rates to taxable income. A
tax deduction, on the other, reduces the income that is subject to tax in order
to arrive at taxable income. To think of the former as the latter is to avoid, if

not entirely confuse the use. A tax credit is used only after the tax has been
computed, a tax deduction, before.
ii. CIR vs. Central Luzon Drug Corp., June 26, 2006
The 20% discount required by RA 7432 to be given to senior citizens is a
tax credit, not a deduction from the gross sales of the establishment
concerned. The definition of tax credit found in Sec. 2(1) of Rev. Reg. No. 2-
94 is erroneous as it refers to a tax credit as the amount representing the 20%
discount that “shall be deducted by the said establishment from their gross
sales for VAT and other percentage tax purposes.”
iii. Bicolandia Drug Corp. vs. CIR, June 22, 2006

The term “cost” in Sec. 4(a) of RA No. 7432 (Senior Citizens Act) refers to
the amount of the 20% discount extended by a private establishment to
senior citizens in their purchase of medicines. This amount shall be applied
as a tax credit and may be deducted from the tax liability of the entity
concerned, if there is no current tax due or the establishment reports a net
loss for the period, the period may be carried over to the succeeding taxable
year.
B. KINDS OF ALLOWABLE DEDUCTIONS

1. Itemized or Actual Deductions – items or amounts, which the law allows to be deducted from
gross income in order to arrive at taxable income.
2. Optional Stand Deductions – These are deductions in lieu of the itemized deductions. It us 10%
of the gross income of the taxpayer from business or profession.
3. Special Deductions – these are deductions allowed to be deducted in addition to the itemized
deductions allowable to corporations which may be availed of by insurance companies, mutual
insurance companies, mutual marine insurance companies, assessment insurance companies,
estates and trusts and private educational institutions.
C. THE OPTIONAL STANDARD DEDUCTION (OSD)

 These are deductions in lieu of the itemize deductions. It is 10% of the gross income of
the taxpayer from business or profession.
o Only citizens and resident aliens in business, trade or profession may elect the
OSD.
o Corporations are not allowed to choose OSD.
o The choice must be signified in the income tax return of the taxpayer and once
chosen, it is irrevocable for the taxable year for which the return is made.
o No need to include financial statements in the return of OSD was claimed.
o It cannot be used as a deduction from compensation income.
D. ITEMIZED DEDUCTIONS: Concepts, Kinds, Rules and Requisites

 Who can claim the itemized deductions?
1. Corporations
2. General Professional Partnership
3. Individuals engaged in trade, business or profession
4. Estate and Trust engaged in trade or business
 If the taxpayer failed to elect the kind if deduction in his income tax, he shall be
considered as having availed himself of the itemized deduction.
a) General Business Expenses

- Capital Expenditure vs. Ordinary Expenditure
 Property Acquired must have a useful life of not more than one year to
qualify as an ORDINARY EXPENDITURE.
o Deductible in full if many receipt
 If it has a useful life of more than one year, then the expenditure is
CAPITAL EXPENDITURE.
o Gradual deduction only.
- Rule Re: Proprietary Education Institutions

Expenses to Private Educational Institutions – those undertaken to
achieve improvements in education activities and expansion of school facilities.
- The taxpayer has the option:

i. To deduct expenditures otherwise considered as capital outlays of
depreciable assets incurred for the expansion of school facilities; or
ii. To deduct allowance for depreciation thereof.
- Where the expansion has been claimed as a deduction, no further claims for
yearly depreciation of the school facilities are allowed.
- Reasonableness Test
a. CIR vs. Gen. Foods, Inc. April 24, 2003
- There is yet to be clear-cut criteria or fixed test for determining the
reasonableness of an advertising expense. There being no hard and fast
rule on the matter, the right to a deduction depends n a no. of factors
such as but not limited to: the type and size of business in which the
taxpayer is engaged; the volume and amount of its net earnings; the
nature of the expenditure itself; the intention of the taxpayer and the
general economic conditions. It is the interplay of these, among other
factors and properly weighed, that will yield a proper evaluation.
b. CM Hoskins vs. CIR, Nov. 28, 1969

1. Other tests suggested are: a.) payment must be made in good faith; b.)
the character of the taxpayer’s business; c.) the volume and amount of its
net earnings; d.) the size of a particular business; e.) the employees’
qualifications and contributions to the business venture; and f.) general
economic conditions.
- Representation Expense
Requisites:
- It must be ordinary, reasonable and necessary;
- It must be directly connected or related to or in furtherance of the conduct
of his trade, business or exercise of a profession;
- It must not be contrary to law, morals, public policy or public order;
- It must not exceed the ceiling that may be prescribed by the Sec. of Finance;
and
- It must be supported by official receipts or adequate records.
- Substantiation Rule and the Cohan Doctrine

 Substantiation Doctrine
1. All business expense deductions must be substantiated with:
a. Receipts or adequate records;
b. Amount of expense;
c. Date and place of expense;
d. Purpose of expense; and
e. Professional or business relationship of expense.
 COHAN Doctrine
- Authority of the BIR to allow a taxpayer to deduct a certain percentage
even without receipt provided the surrounding circumstances will
show that the expense is incurred.
- Case:
a. Gancayco vs. Collector, 1 SCRA 980
- Representation expenses cannot be allowed as an
income tax deduction in the absence of receipts, invoices
or vouchers supporting said expenses and in case the
taxpayer cannot specify the items constituting said
expenses.
b) Bad Debts
Requisites for Deductibility of Bad Debts:
i. There must be a valid and subsisting debt;
ii. The debt must be actually ascertained to be worthless and uncollectible
during the taxable year;
iii. The obligation is not between related parties;
iv. The debt is charged off within the year; and

v. The debt must be connected with the trade, business or profession of the
taxpayer.
Tax Benefit Rule

 This doctrine holds that a recovery of bad debts previously deducted from
gross income constitutes taxable income if in the year the account was
written off, the deduction resulted in a tax benefit, e.g., in the reduction of
taxable income of the taxpayer.
 This doctrine can only be availed of by a Creditor and never by a Debtor.
c) Interests
i. Requisites for Deductibility

1. There is an indebtedness;
2. The indebtedness must be that of the taxpayer;
3. In connection with taxpayer’s profession, trade or business;
4. There is liability to pay interest on the debt;
5. The interest must have been paid or incurred within the year;
6. It must be legally due and stipulated in writing;
7. It must not be expressly disallowed by law to be deducted from
taxpayer’s gross income;
8. It must be within the limit set by law; and
9. It must not be in favor of a relative.
ii. On Capital Expenditure

 Whenever a taxpayer opts to claim interest expense as a capital
expenditure, he can validly claim deduction out of the annual depreciation
of the property and not the amount of interest paid.
iii. Rules Re: Deductibility

 Interest payment to be deductible must be incurred within the taxable year
on indebtedness connected with the taxpayer’s profession, trade or
business. However, if the interest was paid on indebtedness incurred or
continued to purchase or carry obligations the interest upon which is
exempt from taxation as income, then the interest payment shall be
deductible.
iv. Tax Arbitrage Scheme (Rev. Regs. 13-2000)
v. Interest on Tax Delinquencies

Case: CIR vs. Itogon Suyoc Mines, July 29, 1969
The NIRC provides that interest upon the amount determined as a deficiency
shall be assessed and shall be paid upon notice and demand from the CIR at the
rate therein specified (Sec. 51(d), NIRC). The imposition of the monthly interest
to the State for the delay in paying the tax and for the concomitant use by the
taxpayer of the funds that rightfully should be in the government’s hands.
d) Taxes
i. Requisites for Deductibility
 Paid or incurred within the taxable year;
 Must not be specifically excluded by law from being
deducted from taxpayer’s gross income; and
 Deductible only by the person(s) upon whom the tax is
imposed by law.
ii. Deductible Taxes

 Import duties
 Business taxes – VAT, other percentage taxes and excise
taxes
 Privilege or occupation taxes, licenses
 Documentary stamp taxes
 Income war-profits and excess-profits taxes imposed by
the authority of any foreign country only if the taxpayer
does not signify in his return his desire to have any
extent the benefits of the provisions of law allowing
credits against the tax for taxes of foreign countries

 Any other taxes of every amount and nature paid
directly to the government or any political subdivision.
iii. Non-deductible Taxes

 Income Tax
 Estate and gift taxes
 Special assessment or levies on properties
 Energy Tax
 Taxes not related with the trade, business or profession of the taxpayer
 Taxes which are final
 Income taxes imposed by authority of any foreign country if the taxpayer
signifies in his return, his intention to avail of tax credit for the said
taxes.
e) Depreciation
i. Properties subject to depreciation
 Tangible property susceptible to wear and tear, to decay or decline from
natural causes, to exhaustion and to obsolescence due to the normal
process of the art or due to inadequacy of the property to meet growing
needs of the business.
Ex. Machines and equipment that must be replaced by new invention.
 Intangible property, the use of which in trade or business is of limited

duration like patents, copyrights, royalties and franchises.
ii. Allowable modes of depreciation

 Straight-line method – this method spreads the total depreciation over
the useful life of the assets.
 Declining-balance method – this method uses a rate to the declining
book value of the assets.
 Working-hours method – the total working hours of the machine until
its retirement is estimated and a charge per hour is determined.
 Unit of production method – the estimated service life is stated in units
of products instead of working hours.
 Sum-of-the-years digit method – this is a method of depreciation where
bigger depreciation expenses are provided during the early years of the
fixed assets which gradually diminish until the total depreciation is
equal the cost of the assets.
 Any other method which may be prescribed by the Dept. of Finance
upon recommendation of the CIR.\
f) Depletion
i. This is the removal, extraction or exhaustion of a natural resource such as
mines and gas wells as a result of production or severance from such mines
or walls.
g) Losses
 Requisites:
a. The loss must be that of the taxpayer;
b. Actually sustained during the taxable year;
c. Not compensated by insurance or other form of indemnity;
d. Evidenced by a closed and completed transaction;
e. Not claimed as a deduction for estate tax purposes; and
f. If it is a casualty loss, must be reported to the concerned authorities within
prescribed time (45 days).
 Types of Losses:
ORDINARY LOSSES CAPITAL LOSSES SPECIAL LOSSES

 Occurs when the expenses  Can be deductible  Kinds:
are more than gross only from capital gains g. Wagering losses –
income or sale of ordinary deductible only to the
asset extent of gain or winnings.
 To a domestic corporation  Subject to the Loss h. Losses on wash sales of
– all losses actually Limitation Rule stocks – not deductible
sustained and charged off because these are

within the taxable year considered as artificial
and not compensated for loss.
by insurance or other form i. Abandonment losses in
of indemnity. petroleum operation and
 To RC or a NRAETB –  Kinds of capital losses: producing well.
losses actually sustained a. Losses from sale or j. Losses due to voluntary
during the year in trade, exchange of capital removal of building
business or profession assets incident to renewal or
conducted within the b. Losses resulting from replacements – deductible
Phils. and not securities becoming expense from gross
compensated by insurance worthless and which income.
or other form of are capital assets k. Loss of useful value of
indemnity. c. Losses due to failure to assets due to changes in
exercise privilege or business conditions.
option to buy or sell l. Losses from sales or
property exchanges of property
between related taxpayers.
m. Loss of farmers.
 Net Operating Loss Carry Over (NOLCO)

o Case: PICOP vs. CIR, Dec. 01, 1995
 It is thus clear that under our law, and outside the special
realm of BOI-registered enterprises, there is no such thing as
a carry-over of net operating loss. To the contrary, losses must
be deducted against current income in the taxable year when such
losses were incurred. Moreover, such losses may be charged off
only against income earned in the same taxable year when the losses
were incurred.
o NOLCO – This refers to the excess of allowable deduction over

gross income. It can be carried over as a deduction from gross
income for the next 3 consecutive years immediately following
the year of such loss.
o 75% Interest Retention Rule

 NOLCO should be allowed only if there has been no
substantial change in the ownership of the business or
enterprise in that
 Not less than 75% in nominal value of outstanding issued
shares if the business is in the name of a corporation, is held
by or on behalf of the same persons; or
 Not less than 75% of the paid up capital of the corporation, if
the business is in the name of a corporation, is held by or on
behalf of the same persons.
h) Charitable Contributions
i. With Limitation
1. Donations to the government of the Phils. or any of its agencies or political
subdivisions for exclusively public purposes.
2. Donations to accredited domestic corp. or associations organized and operated
exclusively for religious, charitable, scientific, youth and sports development,
cultural, educational, rehabilitation of veterans, social welfare institution and
NGO.
ii. Deduction in full

1. Donations to the government or political subdivisions including fully owner
GOCCs to be used exclusively in undertaking priority activities in –
educational, health, youth and sport devt. provided however, that any
donation to the government NOT in accordance with the priority plan shall
be the subject to the limitation of 5% or 10%.
2. Donations to foreign institutions or international organizations in
compliance with agreements, treaties or commitments.
3. Donations to accredited NGO’s.
4. Donations to traditional exemptees.
i) Pension Trusts

 An employer establishing or maintaining a pension trust to provide for the
payment of reasonable amount transferred or paid into such trust during the
taxable year in excess of such contributions, but only if such amount:
i. Has not theretofore been allowed as a deduction;
ii. Is apportioned in equal parts over a period of 10 consecutive years in
which the transfer or payment is made.
j) Research and Development Costs

i. Amount Deductible – amount rateably distributed over a period of 60
months beginning the month, taxpayer realized benefits from such
expenditures.
k) Other Forms of Deductions (Sec. 37 NIRC)

a. Special Deductions Allowed to Insurance Companies;
b. Mutual Insurance Companies;
c. Mutual Marine Insurance Companies;
d. Assessment Insurance Companies;
e. Estates and Trusts; and
f. Private Educational Institutions
Insurance companies
 Whether domestic or foreign, doing business in the Phils., they are allowed to deduct, in
addition to the itemized deductions under Section 34 of the Tax Code, the following:
1.) Net additions, if any, required by law to be made within the year to reserve funds, and
2.) Sums other than dividends paid within the year on policy and annuity contracts. The
released reserve shall be treated as income for the year of release. (Sec. 37, [A], NIRC, Sec.
126, Regs.)
Mutual insurance companies

 These companies (other than mutual life & mutual marine) are allowed to deduct from
gross income the following:
1.) Any portion of the premium deposits returned to the policy holders
2.) Such portion of the premium deposits as are retained for the payment of losses, expenses
and reinsurance reserves. (Sec. 37, B, NIRC; Sec. 127, Regs.)
Mutual marine insurance companies

 They are entitled to deduct from gross income the following:
1.) Amounts repaid to policy holders on account of premium previously paid by them; and
2.) Interest paid upon those amounts between the ascertainment date and the date of its
payment. (Sec. 37, [C], NIRC, Sec. 128, Regs.)
Assessment insurance companies

 Whether domestic or foreign, they may deduct in a taxable year the sum actually
deposited with the officers of the govt. of the Phils., pursuant to law as additions to
guarantee or reserve funds. (Sec. 37 [D], NIRC).
SPECIAL INCOME TAX TREATMENT OF GAINS AND LOSSES

FROM DEALINGS IN PROPERTY
A. Background of the special rules
B. Ordinary Assets v. Capital Assets

Ordinary Assets – refer to properties held by the taxpayer in the pursuit of his profession, trade
or business, they are:
i. Stock in Trade;
ii. Property of a kind which would properly be included in the inventory if on hand at the
close of the taxable year;
iii. Property held by the taxpayer primarily for sale to customers in the ordinary course of
trade or business;
iv. Property used in trade or business which is subject to the allowance for depreciation; and
v. Real property used in trade or business. (Sec. 39, [A], NIRC)
Capital Asset means property held by the taxpayer (whether or not connected with his trade or
business) but does not include:
i. Stock in trade;

ii. Property of a kind which would properly be included in the inventory if on hand at the
close of the taxable year;
iii. Property held by the taxpayer primarily for sale to customers in the ordinary course of
trade or business;
iv. Property used in trade or business which in subject to the allowance for depreciation; and
v. Real property used in trade or business. (Sec. 39, [A], NIRC)
 This is an enumeration by exclusion, all others not enumerated are capital assets.
C. Rules on Ordinary Gains and Losses

Ordinary income (ordinary gain) – includes any gain from the sale or exchange of property
which is not a capital asset (Sec. 22, [Z], NIRC)
Ordinary Loss – includes any loss from the sale or exchange of property which is not a capital
asset. (Sec. 22, [Z], NIRC)
 Income Tax Treatment on the Sale or Exchange of Ordinary Assets

 The general rule in income taxation apply both as to the gain and as to the loss, any gain shall
be reported as ordinary income and any loss may be allowed as a deduction in gross income.
 Exemplification of Rules
 If an individual taxpayer is engaged in real estate business or is a real estate dealer, the gains
he may derive from the said activity will be considered as ordinary income and the losses he
may incur is deductible from his gross income. The 6% tax imposed on the sale of real
property which is a capital asset is inapplicable to him.
 If a domestic corporation is engaged in real estate business, the gains it may derive from said
activity is considered as ordinary income and any loss incurred is considered as an ordinary
loss. The loss is deductible from the corporation’s ordinary income and from its income from
any other source whether ordinary or capital.
 Ordinary losses (whether the taxpayer is an individual or a corporation) are deductible

either from ordinary gains or capital gains.
D. Special Rules on Capital Transactions (Capital Gains and Losses)
a. Rules on Real Property Classified as Capital Asset

(1.) Definition of terms:
i. Capital gain is the gain from the sale or exchange of capital assets.
ii. Capital loss is the loss incurred from the sale or exchange of capital assets.
iii. Net Capital gain is the excess of the gains from sales or exchange of capital assets over
the losses from such sales or exchanges (Sec. 39, [A, 2], NIRC).
iv. Net capital Loss is the excess of the losses from sales or exchanges of capital assets
over the gains from such sales or exchanges. (Sec. 39, [A, 3], NIRC).
(2.) Tax Treatment of Capital gains and Capital losses
a.) As to Individual Taxpayers
a.1) On personal property classified as capital asset (other than shares of stock)
The following are the applicable rules:

a. The percentages of gain or loss to be taken into account shall be -
 100% if the capital asset has been held for 12 months or less; and
 50% if the capital asset has been held for more than 12 months (holding
period rule)
b. Capital losses shall be deducted only to the extent of the capital gains (loss
limitation rule)
c. Net Capital Loss Carry Over Rule is applicable.
a.2) On real property classified as capital assets
The following are the applicable rules;

a. A final capital gains tax is imposed on individuals including estates and
trusts computed as follows:

tax base: gross selling price or fair market value, whichever is higher
tax rate: 6%
b. The tax is imposed on capital gains presumed to have been realized from
the sale, exchange or disposition of real property located in the Phils.
classified as capital assets including pacto de retro sales and other forms of
conditional sales (such as mortgage foreclosure sale)
c. The tax shall be in lieu of the income tax imposed on individuals under
graduated rates in Sec. 24, [A].Capital gains from sale of real property
shall not be included in the gross income of the individual taxpayer.
d. There are two situations wherein the 6% final tax rate may not be
applied, to wit:
i. If the real property classified as capital asset is sold to the
government or any of its political subdivisions or to gov’t.
owned or controlled corporations, the 6% final tax rate or the
graduated income tax rates may be used on the actual gain of the
taxpayer, at the option of the taxpayer; and
ii. If the principal residence of the individual taxpayer is sold and
the proceeds of the sale is used to acquire or construct a new
residence within 18 months from the date of the sale, the sale is
exempt from income tax provided:
B.1) That the Commissioner is notified by the taxpayer within
thirty (30) days from the date of the sale or disposition through a
prescribed return of his intention to avail of tax exemption;
B.2) The tax exemption can only be availed of once every ten (10)
years; and
B.3) If there is no full utilization of the proceeds of the sale or
disposition, the portion of the gain presumed to have been
realized from the sale or disposition shall be subject to capital
gains tax.
e. The sale of rights over realty, although classified as real property under
the Civil Code, is not subject to capital gains tax because the situs of these
rights follow their owner who may not be located in the Phils. Only real
property located in the Phils. is subject to capital gains tax. (Sec. 24 [b, 1],
NIRC; BIR Ruling No. 083-99, June 22, 1999).
b. Rules on Gains or Losses From Sale of Shares of Stocks Not Listed or Traded in the Stock
Exchange by Non-dealers in Securities
a. A final capital gains tax is imposed on capital gain from sale of shares of stock,
computed as follows:
1. On non-listed stocks or on sales of shares (listed or unlisted with stock
exchanges): not effected through the stock exchanges:
5% on net capital gains not over P100, 000
10% on net capital gains in excess of P100, 000
(Sec. 24, [C], 25 [B], 27 [D, 2], 28 [A, 7, C], [B, 5,
C])
2. For sale of shares listed and traded in the stock exchange the same shall be
exempt from income tax but it shall be subject to a Stock Transfer Tax of ½ of
1% of the Gross Selling Price.
b. The final capital gains tax is in lieu of the ordinary income tax on individuals,
corporations and other taxpayers (estates & trusts).
c. The net capital gains on stock transactions shall not be included in the gross
income of the seller or transferor in computing his income tax liability.
d. It is a final tax, which shall in no case, be allowed as a deduction against

income or credited against income tax or any other tax
e. Also subject to a stock transfer tax at a different rate are shares of stock sold or
exchanged through initial public offering.

c. Rules Regarding Other Capital Assets
A. Loss Limitation Rule provides that Capital losses are deductible only to the extent of
capital gains.
B. Holding Period Rule refers to the percentages of the gain or loss taken into account in
computing the net capital gain net capital loss and net income. The percentages are:
- 100% - if the capital asset has been held for not more than twelve (12) months
(short-term); and
- 50% - if the capital asset has been held for more than twelve (12) months (long-
term)
 The holding period of capital assets is only applicable to individual taxpayer and not
to corporations.
C. Net Capital Loss Carry Over (NCLCO) Rule means that:

i. If any taxpayer, other than a corporation, sustains in any taxable year a net
capital loss;
ii. Such net capital loss cannot be deducted from ordinary income due to
the loss limitation rule;
iii. Such loss could be carried over to the next taxable year (not thereafter) as a
deduction against net capital gain in an amount not in excess of the taxable income
(i.e. net income before exemptions) in the year the loss was sustained; and
iv. Such loss shall be treated as a loss from the sale or exchange of capital
assets held for not more than twelve (12) months. (Sec. 39, [D], NIRC)
 Limitation on Capital losses

General Rule: Capital losses are allowed only to the extent of capital gains.
Exception: Any loss sustained by a domestic bank or trust company from the
sale of bonds, debentures, notes or certificates or other evidences of indebtedness issued by
any corporation including those issued by the government is considered as an ordinary loss
and deductible from ordinary income.
Reason: Banks and trust companies are considered as dealers in securities, hence,
these securities are considered as property primarily held for sale to customers in the ordinary
course of business.
E. Special Capital Transactions
 The following are considered as sales or exchanges of capital assets:

1. Retirement of bonds with interest coupons or in registered form
 Amounts received by the holder upon the retirement of bonds, debentures, notes or
certificates or other services of indebtedness issued by any corporation (including those
issued by a gov’t. or political subdivision thereof) with the interest coupons or in
registered forms, shall be considered as amounts received in exchange thereof. (Sec. 39, [E],
NIRC)
2. Short sales of property

 A short sale takes place when a seller first make a sale of stock or security which he does
not own (he merely borrows the stock certificate through or from his stock broker) and
subsequently buys or covers the stock to complete the transaction.
The seller sells the shares short in the expectation of a decrease in value thereof
within a reasonably short period of time. He covers his short sale when the expected decrease
in the value materializes or when the time for the return of the borrowed shares comes.
1.) Failure to exercise privilege or option to buy or sell property

 Gains or losses attributable to the failure to exercise privileges or options to buy and sell
property shall be considered as capital gains or losses, such as the option given to a
taxpayer to buy an agricultural land is a capital asset and the gain or the loss that may be
incurred by him from the disposition of said option is either a capital gain or a capital loss.
2.) Securities becoming worthless

 If any securities which are capital assets are ascertained to be worthless and written off
during the taxable year, the loss resulting therefrom in the case of a taxpayer other than a

bank or a trust company incorporated under the laws of the Phils. a substantial part of
whose business is the receipt of deposits, is considered a capital loss.
3.) Distribution in liquidation

 If, in liquidation or dissolution, the corporation acquires its own stock and exchanges its
assets (land) for the shares, the shareholders who surrendered their shares for land shall
likewise be subject to the capital gains tax prescribed under Section 24 (C) of the Tax
Code.
Gains or losses from liquidating dividends are considered as capital gains or losses
inasmuch as liquidating dividends are considered as full payment from the corporation in
exchange for stocks held by the stockholders.
4.) Readjustment of interest in a general professional partnership

 When a partner retires from a general professional partnership or the partnership is
dissolved, he realizes a gain or loss measured by the difference between the price he
received for his interest and cost to him of his interest in the partnership.
F. Wash Sale
- is a sale of securities where substantially identical securities are acquired or purchased within a
61-day period beginning 30 days before the sale and ending 30 days after the sale. (Sec. 38, [A],
NIRC).
Requisites for non-deductibility:
1) The sale or other disposition of stocks or securities resulted in a loss;

2) There was an acquisition, or contract or option for acquisition of stock or securities
within thirty (30) days before the sale or thirty (30) days after the sale; and
3) The stock or securities sold where substantially the same as those acquired within the 61-
day period.
 The word “acquired” means acquired by purchase or by an exchange, and
comprehends cases where the taxpayer has entered into a contract or option within
the sixty-one-day period to acquire by a purchase or by such an exchange (Sec. 131,
[f], Regs.)
 “Substantially identical” means that the stock must be of the same class, or in the
case of bonds, the terms thereof must be the same.
The following are not substantially identical:

i. The common stock and the preferred stock of the same corporation;
ii. A non-voting stock and a stock with voting power;
iii. The stock of the corporation and the stock of another corporation; and
iv. Two series of bonds where one is secured by a mortgage and the other is not; or which
differ as to interest rates.
G. Installment Sales v. Deferred Sales
Installment Sale is a sale in which proceeds are received over a period of time. Gain on an
installment sale is recognized as the selling price received, not including interest. Proceeds are received in
more than one tax year.
H. Instances When Gains are Taxable But Losses are Non-deductible
TRANSACTIONS RESULTING IN TAXABLE GAINS BUT NON-RECOGNITION OF LOSSES

a. Transactions between related taxpayers (Sec, 36, NIRC)
b. Illegal transactions
c. Wash sales (except those made by dealers in securities)
d. Exchanges not solely in kind in mergers and consolidations
1) If in connection with an exchange described earlier resulting in non-recognition of

gains or losses, an individual, a shareholder, a security holder or a corporation receives
not only stock or securities permitted to be received without the recognition of gain or
loss, but also money and/or property, the gain, if any, but not the loss, shall be recognized but in
an amount not in excess of the sum of the money and the fair market value of such other
property received.
Provided, that as to the shareholder, if the money and/or property received

has the effect of a distribution of a taxable dividend, there shall be taxed as dividend to the
shareholder an amount of the gain recognized not in excess of his proportionate share of

the undistributed earnings and profits of the corporation, the remainder if any, of the
gain recognized shall be treated as a capital gain. (Sec. 40, [3, a])
2) If a corporation which is a party to the merger or consolidation receives not only

stock permitted to be received without the recognition of gain or loss, but also money
and/or property, and does not distribute it in pursuance of the plan of merger or consolidation, the
gain, if any, shall be recognized in an amount not in excess of the sum of such money and
the fair market value of such other property so received, which is not distributed. (Sec.
40, C,[3, b])
3) If a taxpayer receives stock or securities which would be permitted to be received

without the recognition of the gain if it were the sole consideration, and as part of
consideration, another party to the exchange assumes a liability of the taxpayer, or
acquires from the taxpayer property subject to a liability, then such assumption or
acquisition shall not be treated as money and/or other property, and, therefore any gain or loss
would still not be recognized if no money and/or property was involved in the exchange.
4) If the amount of the liabilities assumed plus the amount of the liabilities to
which the property is subject, exceed the total of the adjusted basis of the property
transferred pursuant to such exchange, then such shall be considered as a gain from the
sale or exchange of a capital asset or of property, which is not a capital asset, as the case
may be. (Sec. 40, [C, 4], NIRC)
e. Sales or exchanges which are not at arms length
I. Instances when Gains and Losses are Not Recognized for Tax purposes
SALES OR EXCHANGES RESULTING IN

NON-RECOGNITION OF GAINS OR LOSSES
a) Exchange solely in kind (exchange of property solely for stocks) in legitimate

mergers or consolidations.
- A corporation which is a party to a merger or consolidation
exchanges property solely for stock in a corporation which is a party to the merger
or consolidation;
- A corporation which is a party to a merger or consolidation

receives in exchange for property not only stock of another corporation but also money
and/or other property and distributes it in pursuance of the plan of merger or
consolidation. [Section 40(c)(3)(6)(i)]
- A shareholder exchanges stock in a corporation which is a party to

the merger or consolidation solely for the stock of another corporation, also a
party to the merger or consolidation.
- A security holder of a corporation which is a party to the merger

or consolidation exchanges his securities in such corporation solely for stock or
securities in another corporation, a party to the merger or consolidation.
b) Transfer or exchange of property for stock resulting in acquisition of corporate

control
 A person exchanges his property for stock or unit of participation in a
corporation of which as a result of such exchange said person, alone or
together with others, not exceeding four persons, gains control of said
corporation
 “Control” means ownership of stocks in a corporation possessing at least
51% of the total voting power of all classes of stock entitled to vote.
 The items enumerated above are also called “tax-exempt exchanges.”
TAXATION OF INCOME OF INDIVIDUAL TAXPAYERS
A. Classification of Individual Taxpayers and the Factors affecting their Taxability

 Citizens of the Philippines may be classified into:
a.) Resident Citizens (RC)
 Citizens of the Philippines who are taxed on their income within and without the country
 Individual who is:
 engaged in trade or business

 In the exercise of his profession
 Employed, earning purely compensation income
 Not engaged in trade or business or in the exercise of his profession nor employed
but has some income
 Has mixed income
b.) Non-resident Citizens (NRC)

 Those not residing in the Philippines
 A Filipino citizen who: (sec. 22 (E) National Internal Revenue Code (NIRC)
 One who establishes to the satisfaction of the Commissioner of Internal Revenue
(CIR) the fact of his physical presence abroad with a definite intention to reside
therein.
 A citizen of the Philippines who leaves the country during the taxable year to
reside abroad, either as immigrant or for employment or on permanent basis.
 A citizen of the Philippines who works and derive from abroad and whose
employment thereat requires him to be physically present abroad most of the
time during the taxable year.
 A citizen who has been previously considered as non-resident citizen and who
arrives in the Philippines at any time during the taxable year to reside
permanently in the country. (He shall be considered a NRC for the taxable year
in which he arrives in the Philippines with respect to his income derived from
sources abroad until the date of his arrival in the Philippines)
NOTE: Rev. Regulations. No. 9-73, November 26, 1973 - The continuity of residence abroad is not
essential. If physical presence is established, such physical presence for the calendar year is not
interrupted by reasons of travels to the Philippines.
Three types of Non resident Citizen

a. Immigrants
b. Employees of a foreign entity on a permanent basis
c. overseas contract workers
Immigrants and Employees of a foreign entity on a permanent basis are treated as NRC from the
time they depart from the Philippines. However, overseas contract workers must be physically present
abroad most of the time during the calendar year to qualify as NRC.
An overseas contract worker (OCW) is taxable only on income derived from sources within the
Philippines. Sec 23(b) (c)
A seaman is considered as an OCW provided the following requirements are present:

a. receives compensation for services rendered abroad as a member of the complement of a
vessel, and
b. such vessel is engaged exclusively in international trade.
 Aliens or foreigners
a.) Resident aliens (RA)
 Those residing in the Philippines though not a citizen thereof.
 RA is taxed only on income within the Philippines
 RA is one who comes to the Philippines for a definite purpose which is in its nature
would require an extended stay, and makes his home temporarily in the country
b.) Non resident aliens (NRA)

 Those not residing in the Philippines and not a citizen of the Philippines
Those engaged in trade or business in the Philippines (NRAETB)
 This includes the performance of the functions of a public office. It shall not include
performance off services as an employee
 An alien whose aggregate period of stay in the Philippines is more than 180 days
during any calendar year.
Those not engaged in trade / business in the Philippines (NRANETB).
 An alien whose aggregate period of stay in the Philippines does not exceed 180
days during any calendar year regardless of whether he actually engages himself in
trade or business in the Philippines.
c.) Special Aliens

 Individuals employed by:
 Regional or area headquarters and regional operating headquarters on
multinational companies (MNC) in the Philippines

 Offshore banking units (OBU) established in the Philippines
 Foreign Service contractors or sub contractors engaged in petroleum operations
in the Philippines.
 They are taxed only at 15% preferential income tax rate on their gross compensation
income from sources within the Philippines
B. Rules Applicable to Returnable Income
C. Rules Applicable to Passive Income
Rates of Tax on Certain Passive Income of Individual Taxpayer
Tax Rate & Tax Base

CITIZEN &
Passive Income (Subject to Final Tax) NRAETB NRANETB
RA
1. Royalties 20% 20% -
except:
(a) Books, literacy works 10% 10%
(b) musical compositions 10% 10%
2. Prizes (exceeding P10k) & other 20% 20% -
winnings (except: PCSO & LOTTO
winnings)
3. Interest on bank deposits 20% 20% -
4. Interest under Expanded foreign 7.5% exempt Exempt
currency deposit system
5. Interest on long-term deposits
> 5 yrs.
< 3 yrs. exempt exempt exempt
3 to < 4 yrs. 20% 20% 20%
12% 12% 12%
6. Dividend from Domestic corporation, 10% 10% 10%
joint stock company insurance or
mutual fund comp. and ROHQs of
Multinational comp.
7. Capital gains from the sale of real 6% (GSP/ 6% 6%
property located in the Phils. FMV,
whichever
is higher)
8. Sales of Shares of Stocks not traded in 5% - not 5% 5%
local exchange exceeding
P100k 10% 10%
10% -
amount in
excess of
P100k
9. Cash and/ or property dividends
 beginning Jan. 1998 6% 20% 25%
 beginning Jan. 1999 8%
 beginning Jan. 2000 10%
 Any income or gain derived in which a final tax is imposed shall no longer be included in the taxable
net income of the taxpayer (applicable only to citizens and aliens)

 Final tax is imposed without deduction. Neither is the provision on personal additional applicable.
 Aliens employed by RAHQs & ROHQs, OBUs, Petroleum service contractor & subcontractor of a
multinational corporations are entitled to 15% tax, only on those:
 Salaries, wages, annuities, honoraria and the like as received from such RAHQs
or ROHQs.
 Provided that the same tax treatment is extended to Filipino employees having
the same position in such entities.
D. Personal Exemptions
 Nature & Purpose: Personal exemptions are fixed amounts which are in the nature of
deduction and are intended to substitute for the disallowance of personal or living expenses as
deductible items.
 Basic Personal Exemptions

Individuals who are either earning compensation income, engaged in business or deriving
income from the practice of profession are entitled to personal exemptions as follows:
For single individual or married individual judicially decreed as legally separated with no
qualified dependents………………………………...P 20,000.00
For head of family…………………………………………………...….....P 25,000.00
For each married individual *………………………………………........P 32,000.00
Note: In case of married individuals where only one of the spouses is deriving gross income, only
such spouse will be allowed to claim the personal exemption.
Basic Personal Exemptions for RC, NRC, and RA

Taxpayer Exemption (amount)
1. Single person including a married person judicially decreed as
P 20k
legally separated
2. Head of family P 25k
3. Each married person P 32k
HEAD OF FAMILY - is one who is unmarried or legally separated man or woman with;
(1) One or both parents –
(a) Living with the taxpayer.
(b) Dependent upon the taxpayer for their chief support.
(2) One or more brothers -
(a) Living with the taxpayer
(b) Dependent upon the taxpayer for chief support
(c) Not more than 21 yrs. of age
(d) Not married
(e) Not gainfully employed
(3) One or more legitimate recognized natural / legally adopted children.
(a) living with the Taxpayer
(b) dependent upon the Taxpayer for chief support
(c) not more than 21 yrs. of age
(d) not married
(e) not gainfully employed
 Regardless of age, such children, brothers or sisters qualify a Taxpayer as head of family is they are
incapable of self-support because of mental or physical defect.
 “CHIEF SUPPORT” - means principal or main support. More than fifty percent (50%) being provided
to certain dependents is enough. This phrase does not necessarily mean that the dependent derives
no name at all, he may still derive income but the same is insufficient to support him.
 “LIVING WITH” - requires the Taxpayer and his dependent to actually be residing together but
temporary absence from their common residence brought by face of circumstances such as:
(a) The Taxpayer is away on business
(b) The dependent who may be boarding elsewhere is in pursuit of education.

 “GAINFULLY EMPLOYED” means that the dependent will only qualify as such if he derives no
income for himself, or he is employed but his income is not sufficient to support him independently
outside of the principal/chief support afforded to him by the taxpayer.
 RA 7432 in relation to exemptions

 RA 7432 (approved April 23, 1992) expressly allows a qualified senior citizen to be claimed as
dependents by those who care for them whether a relative or not.
 Additional Exemptions
An additional exemption of P8, 000 is granted to Taxpayer for each, but not exceeding four (4) of his:
(a) Legitimate, illegitimate and/or legally adopted children
(b) Living with the Taxpayer
(c) Chiefly dependent upon him for support
(d) Not more than 21 yrs. old
(e) Unmarried
(f) Not gainfully employed.
The maximum amount of P 2,400 premium payments on health and/or hospitalization insurance can be
claimed if:
 Family gross income yearly should not be more than P 250,000
 For married individuals, the spouse claiming the additional exemptions for the qualified
dependents shall be entitled to this deduction
Persons entitled to personal and additional exemption

Taxpayer PE AE HHIP
1.Resident citizen √ √ √
√ (for income derived √ (income from
2.Non- resident (NRC) X
w/in) w/in)
√ (income from
3. Resident alien (RA) √ (w/in) √
w/in)
√ (by way of
4. NRAETB X X
reciprocity)
5. NRANEBT X X X
6. Estate √ (only up to P20k) X X
7. Trust √ (only up to P20k) X X
 Reciprocity means that the foreign country where the nonresident alien is a citizen or subject grants
exemption to Filipinos not residing there but doing trade or business, or exercising profession
therein.
 The extent of personal exemptions allowed to such non-resident alien shall be in the amount equal
to the exemptions allowed in the income tax law in the country of which he is a subject or citizen,
to citizens of the Philippines not resident in such country not to exceed the amount fixed under
our laws. (Sec. 36 [D], NIRC).
 Rules on change of Status

 These are:
1.) If the taxpayer marries or should have additional dependent(s) during the taxable year,
the taxpayer may claim the corresponding additional exemption, as the case may be, in
full for such year.
2.) If the taxpayer dies during the taxable year, his estate may still claim the personal and
additional exemption for himself and his dependents as if he died at the close of such
year.
3.) If the spouse or any of the dependents dies or if any of such dependents marries,
becomes twenty-one (21) years old or becomes gainfully employed during the taxable
year, the taxpayer may still claim the same exemptions as if the spouse or any of the
dependents died, or as if such dependents married, became twenty-one (21) years old or
become gainfully employed at the close of such year.
E. Taxation of Married Individuals

1. Personal exemption of married persons:
 If not legally separated, each spouse is entitled to P32k as personal exemption.
 If legally separated, each is entitled to P20k as a single individual unless qualifies as head of
family.

 Where only one (1) of the spouses is deriving income, only such spouse shall be allowed the
personal exemption.
2. For additional exemption

a. For married individuals can be claimed by only 1 of the spouses.
b. For legally separated spouses, it can be claimed only by the spouse who has custody of the
children; but the amount claimed by both shall not exceed the maximum allowed.
c. Additional exemption can be claimed only by the “husband” unless:
i. he waives his right in favor of his wife
ii. the husband is working abroad
iii. the wife is the one deriving income.
3. The law requires that married individuals, the husband and wife although required to file one (1)
income tax return, should nevertheless compute their individual income separately. If any income of
the spouses cannot be definitely attributable to or identifiable as income exclusively earned as realized
by either of the spouses, the same shall be divided equally between the spouses.
F. Taxation of Minors
Income of unmarried minors derived from property received by the living parent shall be included in
the return of the parent except:
a. when donor’s tax has been paid on such property, or
b. when transfer of such property is exempt from donor’s tax.
G. Tax Returns and Other Administrative Requirements
Tax Return - this is a report made by the taxpayer to the BIR of all gross income received during the
taxable year, the allowable deductions including exemptions, the net taxable income, the income tax
rate, the income tax due, the income tax withheld, if any, and the income tax still to be paid or
refundable.
Individuals Required to File Income Tax Return

1. Resident Citizen
2. Non-Resident Citizen on income from within the Philippines
3. Resident alien on income from within the Philippines
4. NRAETB on income from within the Philippines
5. an individual (citizen/aliens) engaged in business or practice of a profession within the
Philippines regardless of the amount of gross income
6. Individual deriving compensation income concurrently from two or more employers at any time
during the taxable year and
7. Individual whose pure compensation income derived from sources within the Philippines exceed
P60,000.
Individuals Exempt from Filing Income Tax Return

1. individuals whose gross income does not exceed total personal and additional exemptions
2. individuals with respect to pure compensation income derived from sources within the
Philippines, the income tax on which has been correctly withheld
3. individuals whose sole income has been subjected to final withholding tax, and
4. individuals who are exempt from income tax
Where To File
1. legal residence- authorized agent bank; Revenue District Officer; Collection agent or duly
authorized treasurer
2. Principal Place of business
3. Office of the Commissioner
Time for Filing

April 15- for those earning sole compensation or solely business, practice of profession or
combination of business and compensation
Extension of Time to File Return

The Commissioner may on meritorious cases grant a reasonable extension of time for filing
income tax return and may subject the imposition of twenty percent (20%) interest per annum from
the original due date.
TAXATION OF INCOME OF CORPORATE TAXPAYERS

A. Definition of a Corporation
CORPORATION (Sec. 24(b) Tax Code)

- The term shall include partnership, no matter how created or organized, joint stock companies,
joint accounts, or insurance companies, but does not include general professional partnerships
and a joint venture or consortium formed for the purpose of undertaking construction projects or
engaging in petroleum, coal, geothermal and other energy operations pursuant to operating or
consortium agreement under a service contract with the government.
GENERAL PROFESSIONAL PARTNERSHIP (GPP)

- are formed by persons for the role purpose of exercising their common profession, no part of the
income of which is derived from engaging in any trade & business.
B. Tests In Determining The Existence Of A Corporation
C. Tests Applied To Partnerships, Co-Ownerships, And Estates

1. Evangelista vs. CIR (102 Phil 140)
 The term “partnerships” does not only refer to partnerships in its technical meaning.
 The phrase “no matter how created or organized” includes that a joint venture need not
be undertaken in any of the standard forms or in conformity with the usual requirements
of the law on partnerships in order that one could be deemed to be so for tax purposes
 Also included are joint accounts and associations, none of which have a legal personality
of its own independent of that of its members
2. Ona vs. CIR (45 SCRA 74)

 co- ownerships become taxable in the event co-owners used the properties as a common
fund with intent to produce profits
3. Obillos vs. CIR (October 19, 1985)

 mere sharing of gross returns does not of itself establish or constitute a taxable
partnership, whether or not the persons sharing them have joint or common interest
 there is no taxable partnership where the children of Obillos had no intention to divide
profits among themselves
 there must be an unmistakable intention to form a partnership or joint venture
 a sale of co-ownership property does not necessarily establish that intention
4. Pascual and Dragon vs. CIR (October 18, 1988)

 mere sharing of gross returns does not of itself establish or constitute a taxable partnership
 where two persons purchased two parcels of land in 1965 and another three parcels in
1966, which they later sold at a profit
 the character of habituality peculiar to business transactions for the purposes of gain must
be present
 the sharing of returns is but a consequence of a joint or common interest in the property
 there must be a clear intention to form a partnership
5. Afisco Insurance Corp. vs. CIR ( January 25, 1999)

 a pool of machinery insurers is a taxable association or corporation as an unregistered
partnership
 Reasons:
(1) The pool has a common fund, consisting of money and other valuables that are
deposited in the name and credit of the pool. This common fund pays for the
administration and operation expenses of the pool.
(2) The pool functions through an executive board which resembles the board of directors
of a corporation, composed of one representative for each of the ceding companies.
(3) True, the pool itself is not a reinsurer and does not issue any insurance policy:
however, its work is indispensable, beneficial and economically useful to the business
of the ceding companies and Munich, because without it they would not have received
their premiums. The ceding companies share “in the business ceded to the pool” and in
the “expenses” according to a “Rules of Distribution” annexed to the Pool Agreement.
Profit motive or business is, therefore, the primordial reason for the pool’s formation.
D. Kinds of Corporations
1. Domestic
 those created or organized in the Philippines or under its laws.
2. Foreign

 those created organized or existing under any laws other than those of the Philippines, and
they are either:
a. Resident
 those foreign corporation engaged in trade or business within the Philippines
b. Non-resident
 those foreign corporation not engaged in trade or business within the Philippines
“DOING OR ENGAGING IN” or “TRANSACTING BUSINESS”

- The term implies a continuity of commercial dealings and arrangements and contemplates to
that extent, the performance of acts or works or the exercise of some of the functions normally
insistent to and in the progressive prosecution of commercial gain or for the purpose and the
object of the business organization (Comm. vs. British Overseas Airways Corporation – BOAC case
149 S 395)
E. Rules Applicable To Passive Income

1. Tax Sparing Rule
- provides that a final withholding tax at the rate of 15% shall be imposed for the amount of
cash and /or property dividends received from a domestic corporation by non-resident
Foreign corporation subject to the condition that the country in which the NRFC is domiciled
shall allow a credit against the tax due from NRFC taxes deemed to have been paid in the
Phils. equivalent to 17% which represents the difference between the regular income tax rate
of 32% and the usual corporate rate of 15%.
Note:
1. Tax sparing credit applies only when the conditions for its availment are clearly established by
the taxpayer. Since the concession is in the nature of a tax exemption.
2. The 15% reduced tax must actually be paid and the 17% must be deemed paid tax.
3. The 15% tax on dividends is applicable if the country where the recipient NREC is domiciled
does not imposed any tax on dividend received by said recipient foreign corporation (BIR
Ruling, March 30, 1977)
a. CIR vs. Procter and Gamble PMC (160 SCRA 560 and 204 SCRA 377)
Procter and Gamble (Phil.) is a domestic corporation and a wholly-owned
subsidiary of Procter and Gamble (USA), a non-resident foreign corporation. Over a
number of years, PCMC-Phil. had paid income tax on its net income, and from the
remaining net profits, dividends were declared. An income tax of 35% on the
dividends were withheld by it and paid to the BIR.
It invoked the tax-sparing credit provision of the NIRC, filed a claim for refund
of the 20% point portion of the 35% point whole tax paid. The CTA ordered the
refund. The SC ruled that the preferential 15% tax is inapplicable to the case because
of the failure of the claimant to :
(1) show the actual amount credited by the US Government;
(2) present the US income tax returns of PCMC-USA, the parent company;
(3) submit a duly authenticated document evidencing the tax credit of the 20%
differential.
However, this case was reversed by the Supreme Court in an en banc resolution
(204 SCRA 377; Dec. 2, 1991) and ruled on the applicability of the preferential 15% tax
because it was established that the NIRC does not require that the US tax law deems
the parent company to have paid the 20% of tax waived by the Philippines. The
NIRC only requires that the US shall allow PCMC-USA “deemed paid” tax credit
equivalent to 20%.
F. Taxes on Corporations
1)Tax On Domestic Corporation (Sec. 27 of NIRC)
Except as otherwise provided in the Tax Code, Domestic corporations duly organized and
existing under the Philippine laws shall be subject to the following tax rates based on their gross
income derived from sources within or without the Phils.
35% - for 1997 and prior years

 Proprietary Educational Institutions / non-profit hospitals - Except those income subject to final
tax, proprietary educational institutions/ non-profit are taxable with the tax rate of 10% on their
gross income.
 Proprietary Educational Institution means any private school maintained and administered by
private individuals or groups within an issued permit from the DECS, CHED or TESDA.
 Predominance Test / Preponderance Test means that if the gross income from unrelated trade,
business or other activity exceeds 50% of the total gross income derived by any educational
institution or hospital from all sources the normal tax shall be imposed on the entire taxable
income.
 “Unrelated trade, business or other activity” means any trade business or other activity, the
conduct of which is not substantially related to the exercise or performance by such educational
institution or hospital of its primary purpose or function.
 Article XIV Sec. 4 (3) of the Constitution provides that “all revenues and assets of non-stock and
non-profit educational institution used actually, directly and exclusively for educational
purposes are exempt from taxes and duties.
 Government owned or controlled corporations (GOCCs) – GOCCs, agencies or its instrumentality

shall pay applicable corporate income tax rates except: GSIS, SSS, PHIC, PCSO and PAGCOR.
Specific Taxes Imposed on Domestic Corporations
(1.) Normal Corporate Income Tax (NCIT) - the tax rate of 32% (as of Jan. 1, 2000) is imposed
on any income derived, within and without the Phils. Except on those passive income
(Section 27 (A) NIRC)
(2.) Gross Income Tax Option - The President upon the recommendation of the Secretary of
Finance may, effective January 1, 2000, allow corporations the option to be taxed at
fifteen percent (15%) of gross income provided that the following conditions are met
therein:
a. a tax effort ratio of 20% of GNP
b. a ratio of 40% of income tax collection to total tax revenues
c. a VAT effort of 4% of GNP and
d. a 0.9% ratio of the Consolidated Public Sector Final Position (CPSFP) to Gross
National Product (GNP)
Note:
1. The option to be taxed based on gross income shall be available only to firms whose
ratio of cost of sales to gross sales or receipts from all sources does not exceed fifty-
five percent (55%).
2. The election of the gross income tax option shall be irrevocable for three (3)
consecutive taxable years during which the corporation is qualified under the scheme.
Definition of Terms
 “Gross Income” derived from business shall be equivalent to gross sales returns, discounts
and allowance and cost of goods.
 “Cost of goods sold” shall include all business expenses directly incurred to produce the
merchandize to bring them to their present location and use.
 For trading and merchandising concern, “Cost of goods sold” shall include the invoice cost of
the goods sold, plus import duties freight in transporting the goods to the place where the
goods are actually sold, including insurance while the goods are in transit.
 For manufacturing concern, “Cost of goods manufactured and sold” shall include all costs of
production of finished goods, such as raw materials used, direct labor and manufacturing
overhead, freight cost, insurance premiums and other costs incurred to bring the raw
materials to the factory or warehouse.
 In sale of service, “gross income” means gross receipt less sales returns, allowance and
discounts.
(3.) Minimum Corporate Income Tax (MCIT) - a tax rate of 2% is imposed on the gross
income of domestic corporations and resident foreign corporations.
Rationale: MCIT is designed to forestall the prevailing practice of corporation or

over-claiming deductions in order to reduce their income tax payments.

Requisites:
a. It is imposed beginning the fourth (4 th) taxable year immediately following the taxable
yr. in which such corporation starts its business operation.
b. It is imposable only if such corporation has zero or negative taxable income or
whenever the amount of MCIT is greater than the Normal Corporate Income Tax
(NCIT) due from such corporation.
 Carry Forward of Excess Minimum Tax

- any excess of the minimum corporate income tax (MCIT) over the normal income tax shall be
carried forward on an annual basis and credited against the normal income tax for the three (3)
immediately succeeding taxable yrs.
 Instances when MCIT may be suspended by the Secretary of Finance

- The Sec. of Finance, upon recommendation of the Commissioner may suspend the imposition
of MCIT, upon showing that the corporation suffers losses due to any of the following causes:
a. Prolonged labor dispute (e.g. strikes for more than 6 months)
b. Legitimate business reverses (e.g. theft)
c. Force majeure (e.g. war)
 Corporations not subject to MCIT

i. Proprietary Educational Institution if enjoys preferential tax rate
ii. Non-profit hospitals
iii. Depository banks under expended FCDU
iv. International carriers
v. Offshore Banking Units
vi. ROHQs of resident foreign corp.
vii. Other corporations not subject to the normal tax rate
(4.) Final tax on certain Passive Income

- refer to previous note
2) Tax on Foreign Corporations (sec. 28 of NIRC)

(a.) Resident Foreign Corporation Engaged in Trade or business in the Phils. (RFC) - Foreign
Corporations shall be taxed on income derived from sources “within” the Philippines.
Tax Imposed on Resident Foreign Corporation (RFC)

(1.) NCIT - 32% effective Jan. 01, 2000 and thereafter
(2.) Gross Income Tax Option - 15% tax rate on gross income of RFC is also
applicable.
(3.) Minimum Corporate Income Tax (MCIT) - 2% based on gross income is also
applicable
(4.) Tax on Branch Profits Remittances - subject to 15% based on the “total profits”
applied or earmarked for remittance w/o any deduction for the tax component thereof:
Except: Those activities registered w/ the PEZA; interests dividends, rents
and royalties; remuneration for technical services, salaries, and wages;
premiums, annuities, emoluments; capital gains, profit and income.
(5.) Final tax on certain Passive Income - the same tax rates as imposed to domestic
corporation = is also applicable to RFC except: the imposition of capital gain tax (6%) on
sale of real property (capital asset) located in the Phils.
Note: A different tax rate is imposed on the following RFCs

(a.) Int’l carrier - 2 ½% on Gross Philippine Billing
o Int’l air carrier = “Gross Philippine Billings” refer to the amount of gross revenue from (a)
carriage of persons, excess baggage cargo and mail originating from the Phils. in a (b)
continuous and uninterrupted flight, irrespective of the place of sale or issue and the place
of payment of the ticket or passage document.
o Note: For a flight w/c originates from the Phils. but transhipment of passenger takes
place at any port outside the Phils., only the aliquot portion of the cost of the ticket
corresponding to the leg flow from the Phils. to the point of transhipment shall form part
of the GPB.
o In International shipping, “Gross Phil. Billing” means gross revenue whether for passenger,
cargo or mail originating from the Phils. up to the final destination, regardless of the place
of sale or payments of the passage or freight documents.

 British Overseas Airways Corp. vs. CIR (149 SCRA 395)
- an international airline with no landing rights is considered doing
business in the Philippines
- Reasons:
a) Series of sale of transport documents (airline tickets)
b) Continuity of commercial transactions
c) Appointment of an agent is an indication that it is doing business in
the Philippines
- Note: This BOAC doctrine is modified by RR 15-2002 insofar as the Tax
Situs of transport documents is concerned. RR 15-2002 provides that the
sale of transport documents is the origin of the passenger, cargo, or
excess baggage, irrespective of place of sale and place of payment thereof
(b.) Regional / Area Headquarters (RAHQs) - tax exempt

- These are branches established in the Phils. by a multinational companies but they do not earn
or derive income here and their functions are limited to being a supervisory communication and
coordinating center for their affiliates.
(c.) Regional Operating Headquarters (ROHQs) - subject to 10% tax.

- These are branches established in the country by multinational companies which are engaged in
any of the following:
 general administration & planning;
 business planning
 business development (and the like)
(d.) Offshore Banking Units authorized by Bangko Sentral ng Pilipinas

EXCEPT: RA 9294.
(b.) Non-Resident Foreign Corporations (NRFCNETB) - are subject to 32% tax rate
(effective Jan. 1, 2000 and thereafter) on all income derived from sources within the
Phils. except on certain passive income (refer to Table #1).
Note: NRFCs are not entitled to deduction as well as exemption (personal and
additional exemption)
IMPROPERLY ACCUMULATED EARNINGS TAX (IAET) (Sec. 29 NIRC)

 Nature and Purpose: The improperly accumulated earning tax of 10% in addition to the regular
corporate income tax shall apply to every corporation formed or availed for the purpose of
avoiding of any other corporation by permitting earnings and profit to accumulate instead of being
divided or distributed.
 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
4) The amount of NOLCO deducted and reduced by the sum of:
a) Dividends actually or constructively paid and
b) Income tax paid for the Taxable year.
Formula: Taxable income

Add: Income exempt from tax
Income subject to final tax
Income excluded from gross income
Amount of NOLCO deducted
Less: Dividends actually or constructively paid
Income tax paid for the yr.
Improperly accumulated Taxable Income
 Improperly Accumulated Earnings Tax does not apply to the following:

1) Banks and other non-banks financial intermediaries
2) Publicly held corporations
3) Insurance companies
 Presumptions of Improper accumulations - There is a “prima facie” evidence of a purpose by a

corporation to avoid the tax upon its shareholders or members:
1) Where the corporation is a mere holding company.

2) Where the corporation is an investment company where more than 50% of its outstanding
stock is owned directly/ indirectly by one person during the taxable year.
3) Where the corporation permits its earnings or profits to be accumulated “beyond the
reasonable needs of the business”.
“Reasonable needs of the business” includes the reasonably anticipated needs of the business e.g.
investment of corporation’s profits in a business related to taxpayer’s business.
 Purpose: To compel the corporations to distribute dividends to the stockholders (subject to

dividend tax)
 Instances of Reasonable Accumulations:

1) It is retained for working capital needed by the business
2) It is invested in addition to plant property and equipment reasonably by the business
3) In accordance with contract obligations, it is placed to the credit of a sinking fund for the
purposes of retiring bonds issued by the corporation.
a. Cyanamid Phils. vs. CA (January 20, 2000)

If the CIR determined that the Corporation avoided the tax on shareholders by
permitting earnings or profits to accumulate, and the taxpayers contested such a
determination, the burden of proving the determination wrong, together with the
corresponding burden of first going forward with evidence, is on the taxpayer. This
applies even if the corporation is not a mere holding or investment company and does
not have an unreasonable accumulation of earnings or profits.
In order to determine whether profits are accumulated for the reasonable needs
of the business to avoid the surtax upon shareholders, it must be shown that the
controlling intention of the taxpayer is manifested at the time of accumulation, not
intentions declared subsequently, which are mere afterthoughts. Also, the accumulated
profits must be used within a reasonable time after the close of the taxable year.
Petitioner did not establish, by clear and convincing evidence that such accumulation of
profit was for the immediate needs of the business.
In 1981, the working capital of Cyanamid was more than twice its current
liabilities, projecting adequacy in working capital. Available income covered expenses or
indebtedness for that year, and there appeared no reason to expect an impending
'working capital deficit' which could have necessitated an increase in working capital, as
rationalized by petitioner.
Furthermore, Under Section 25 of the 1977 NIRC, as amended, the following
corporations exempt from the imposition of improperly accumulated tax: (a) banks; (b)
non-bank financial intermediaries; (c) insurance companies; and (d) corporations
organized primarily and authorized by the Central Bank of the Philippines to hold shares
of stocks of banks. Petitioner does not fall among those exempt classes.
G. Exempt Organizations and Corporations (Sec. 30 of NIRC)

The following shall not be taxed in respect to income received by them:
1. Labor, agricultural or horticultural organization not organized principally for profit.
2. Mutual savings bank not having a capital stock represented by shares and cooperative banks
3. A beneficiary society or association operating for exclusive benefit of the members or a mutual
4. Cemetery company owned and operated for the exclusive benefits of its member
5. Non-stock corporation or association organized and operated exclusively for religious,
any specific person
6. Business league chamber of commerce, or board of trade not organized for profit and no part of
7. Civic league or association not organized for profit but operated exclusively for the promotion
of social welfare
8. A non-stock and non-profit educational institution.
“All revenues and assets of non-stock, non-profit educational institutions used actually, directly,
and exclusively for educational purposes shall be exempt taxes and duties.” [Article XIV Section
4(3), 1987 Constitution.]
9. Farmers’ fruit growers or like organization organized and operated as sales agent for the

10. Farmers’ or other mutual typhoon or fire insurance company or like organization of a purely
11. Government educational institution
H. Tax Returns And Other Administrative Requirements
i. Who are required to file

a. Corporation subject to tax having existed during the taxable year, whether with income
or not
b. Corporation in the process of liquidation or receivership
c. Insurance company doing business in the Philippines or deriving income therein
d. Foreign corporation having income from within the Philippines
e. Those exempt from income tax under Section 30 of the NIRC but has not shown proof of
exemption
ii. What and when to file

Quarterly returns on the first three quarters to be filed within 60 days after the close of
the quarter basis and the final or adjusted return on the 15th day of the fourth month
following g the close of the fiscal or calendar year.
iii. When to pay

Pay as you file system. The tax subject of the return should be paid within same time the
return is filed.
Rates and Tax base on Corporate Taxpayers in General Taxpayers

Taxes Imposed (Tax Rates and Tax Base)
Domestic Corp. RFC NRFC
Net income Net Income Gross
Income
1.) Normal Corporate Income Tax (NCIT) 32% (Jan. 1, 2000) 32% 32%
2.) Minimum Corporate Income Tax
2% 2%
(MCIT)
3.) Branch Remittance Tax 15%
4.) Improperly Accumulated Earning Tax
10% 10% 10%
(IAET)
5.) Passive Incomes (Final tax)
a. Interest
 Peso bank deposits 20% 20%
 - Foreign Currency Deposit Units 7.5% 7.5% exempt
b. Royalties 20% 20%
c. Capital gains from sales of share of stock
not traded in the stock
< P100k
> P 100k 5% 5%
d. Income of a depository bank under Exempt (RA 9294) Exempt (RA 5%
Foreign Currency Deposit Units 9294) Exempt (RA
e. Capital gains from sale of real property 9294)
situated in the Phils. (capital assets) 10% 10%
6%
f. Interest on foreign loan 10% 10% 20%
g. Intercorporate dividends exempt exempt 15%


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BAR OPERATION COMMITTEE

GENERAL PRINCIPLES OF TAXATION

A. TAXATION: ITS GENERAL CONCEPTS

i. Nature of the power of taxation

a. Constitutional provisions relating to the power of taxation do not

In the case of Mactan Cebu International Airport Authority vs. Marcos,

 Legislative in character – The power to tax is exclusively legislative and

 Subject to constitutional and inherent limitations – Although in one decided

 Is the Power to Tax the Power to Destroy?

The power to impose taxes is one so unlimited in force and so

And in the notable case of McCulloch vs. Maryland, Chief Justice

According to an authority, the above principle is pertinent only when

Prepared by TAX LAW COMMITTEE – Adviser: Atty. Jason Barlis, 1

 Constitutional Restraints Re: Taxation is the Power to Destroy

“The power of taxation is sometimes called also the power to destroy.

The doctrine seeks to describe, in an extreme, the consequential

ii. Importance of Taxation and the Lifeblood Doctrine

Rationale of Taxation - The Supreme Court held:

Taxation is a symbiotic relationship, whereby in exchange for the

iii. Justifications for the exercise of the taxing power

Prepared by TAX LAW COMMITTEE – Adviser: Atty. Jason Barlis, 2

Qualifications of the Benefit-Protection Theory:

In a case, the Supreme Court held that:

Taxation is a power emanating from necessity. It is a necessary burden to

iv. Purposes and Objectives of Taxation

b. Regulation – As in the case of taxes levied on excises and privileges like

d. Encourage Economic Growth – in the realm of tax exemptions and tax

e. Protectionism – in some important sectors of the economy, as in the case

Prepared by TAX LAW COMMITTEE – Adviser: Atty. Jason Barlis, 3

i. Stages in the tax process

2. Assessment and Collection

 The two processes together constitute the “taxation system”.

ii. Principles of a sound tax system

** The non-observance of these canons, which are merely intended to make

B. THE CONCEPT AND CHARACTERISTICS OF TAXES (LEMP3S)

Prepared by TAX LAW COMMITTEE – Adviser: Atty. Jason Barlis, 4

Scope of Legislative Taxing Power [S2 A P K A M]

C. LIMITATIONS ON THE EXERCISE OF THE TAXING POWER

b. The term “public purpose” is synonymous with “governmental purpose”; a

c. A tax levied for a private purpose constitutes a taking of property without

d. The purposes to be accomplished by taxation need not be exclusively

 Test in determining Public Purposes in tax

b. Lutz vs. Araneta, 98 Phil 148

Prepared by TAX LAW COMMITTEE – Adviser: Atty. Jason Barlis, 5

ii. Inherently Legislative

 Coverage, Object, Nature, Extent, Situs

b. Delegations to the Local Government (Art. X. Sec. 5, 1987 Constitution)

c. Delegation to Administrative Agencies with respect to aspects of Taxation not

 Tax Legislation vis-à-vis Tax Administration

Prepared by TAX LAW COMMITTEE – Adviser: Atty. Jason Barlis, 6

 If what is delegated is tax legislation, the delegation is invalid; but if what is

 Factors to Consider in determining Situs of Taxation

iv. International Comity

v. Tax Exemption of the Government

 Unless otherwise provided by law, the exemption applies only to

 Government-owned or controlled corporations, when performing

Prepared by TAX LAW COMMITTEE – Adviser: Atty. Jason Barlis, 7

 City of Baguio vs. De Leon, 25 SCRA 938

 Sison vs. Ancheta, GR L-59431, 25 July 1984

ii. Equal Protection Clause and the Rule on Uniformity of Taxation

 Important Points to Consider:

Prepared by TAX LAW COMMITTEE – Adviser: Atty. Jason Barlis, 8

 Ormoc Sugar Central vs. Ormoc Treasurer, 17 February 1968

 Philreca vs. DILG. 10 June 2003