LECTURE NOTES

TAXATION 1
Atty. Arnel A. dela Rosa, CPA, REB, REA

INCOME TAXATION

Preliminaries

Define Income Tax

Income Tax has been defined as a tax on all yearly profits arising from property, professions,
trades or offices, or as a tax on a person’s income, emoluments, profits and the like. (61 CJS
1559).

What is the nature of income tax?

Income tax is generally regarded as an excise tax. It is not levied upon a person, property, funds,
or profits as such but the right of a person to receive income or profit.

Case/s:

1. Republic v. MERALCO, G.R. No. 141314, November 15, 2002. Case: ERB provisionally
granted Meralco’s application for rate revision subject to the examination by the COA of
the latter’s books and records. COA subsequently recommended to exclude Meralco’s
income tax as part of its operating expense for purposes of rate determination and the
use of the net average investment method of computing the proportionate value of the
properties used by Meralco during the text year for the determination of the rate base.
ERB adopted Meralco’s recommendation holding that the income tax should not be treated
as operating expense as this should be borne by the stockholders who are the recipients
of the income or profits realized from the operations of their business; hence, should not
be passed on the customers. Held: he ERB correctly ruled that income tax should not
be included in the computation of operating expenses of a public utility. Income
tax paid by a public utility is inconsistent with the nature of operating expenses. In general,
operating expenses are those which are reasonably incurred in connection with business
operations to yield revenue or income. They are items of expenses which contribute or
are attributable to the production of income or revenue. As correctly put by the ERB,
operating expenses should be a requisite of or necessary in the operation of a utility,
recurring, and that it redounds to the service or benefit of customers. Income tax, it
should be stressed, is imposed on an individual or entity as a form of excise tax
or a tax on the privilege of earning income. In exchange for the protection extended
by the State to the taxpayer, the government collects taxes as a source of revenue to
finance its activities. Clearly, by its nature, income tax payments of a public utility
are not expenses which contribute to or are incurred in connection with the
 production of profit of a public utility. Income tax should be borne by the
taxpayer alone as they are payments made in exchange for benefits received
by the taxpayer from the State. No benefit is derived by the customers of a
public utility for the taxes paid by such entity and no direct contribution is
made by the payment of income tax to the operation of a public utility for
purposes of generating revenue or profit. Accordingly, the burden of paying
income tax should be Meralco’s alone and should not be shifted to the
consumers by including the same in the computation of its operating expenses.
The principle behind the inclusion of operating expenses in the determination of a just
and reasonable rate is to allow the public utility to recoup the reasonable amount of
expenses it has incurred in connection with the services it provides. It does not give the
public utility the license to indiscriminately charge any and all types of expenses incurred
without regard to the nature thereof, i.e., whether or not the expense is attributable to
the production of services by the public utility. To charge consumers for expenses incurred
by a public utility which are not related to the service or benefit derived by the customers
from the public utility is unjustified and inequitable. While the public utility is entitled to a
reasonable return on the fair value of the property being used for the service of the public,
no less than the Federal Supreme Court of the United States emphasized: [t]he public
cannot properly be subjected to unreasonable rates in order simply that stockholders may
earn dividends If a corporation cannot maintain such a [facility] and earn dividends for
stockholders, it is a misfortune for it and them which the Constitution does not require to
be remedied by imposing unjust burdens on the public.

2. CREBA v. Romulo, G.R. No. 160756, March 9, 2010. Held: Certainly, an income tax is
arbitrary and confiscatory if it taxes capital because capital is not income. In other words,
it is income, not capital, which is subject to income tax. However, the MCIT is not a tax
on capital. The MCIT is imposed on gross income which is arrived at by deducting the
capital spent by a corporation in the sale of its goods, i.e., the cost of goods and other
direct expenses from gross sales. Clearly, the capital is not being taxed.

Give the functions of income tax.

The following may be mentioned:

1. To provide large amounts of revenues;

2. To offset regressive sales and consumption taxes; and
3. Together with estate tax, to mitigate the evils arising from the inequalities in the
distribution of income and wealth which are considered deterrents to social progress by
progressive scheme of taxation. (Report of the Tax Commission of the Philippines, Vol. II
[1938], p. 12. See also Madrigal v. Rafferty, 38 Phil. 414, as cited in De Leon)

What are the features of the Philippine Income Tax Law?

Our present income tax system can be said to have the following features:

1. It has adopted a comprehensive tax situs by using nationality, residence, and source rules.
 2. The individual income tax system is mainly progressive in nature in that it provides, in
general, graduated rates of income tax. Corporations, in general, are taxed at a flat rate
of 30%.
3. It has retained more schedular than global features with respect to individual taxpayers
but has maintained a more global treatment on corporations. (Mamalateo)

Discuss, Differentiate Global v. Schedular Tax Systems

Global system of taxation is one where the taxpayer is required to lump all items of income earned
during the taxable period and pay tax under a single set of income tax rates on these different
income tax items.

A schedular system of taxation provides for a different tax treatment of different types of income
so that a separate tax return is required to be filed for each type of income and is computed on
a per return basis.

Under a schedular system, the various types/items of income (e.g. compensation, business/
professional income etc.) are classified accordingly and are accorded different tax treatments, in
accordance with schedules characterized by graduated tax rates. Since these types of income
are treated separately, the allowable deductions shall likewise vary for each income tax.

Under the global system, all income received by the taxpayer are grouped together, without any
distinction as to the type or nature of the income, and after deducting therefrom expenses and
allowable deductions, are subject to tax at a graduated or fixed rate. (Mamalateo)

To which Tax System (Global or Schedular) can we say that the method of taxation
under the NIRC belong?

The present NIRC uses partly global and partly schedular.

Note: “What may instead be perceived to be apparent from the amendatory law [RA7496] is the
legislative intent to increasingly shift the income tax system towards the schedular approach in
the income taxation of individual taxpayers and to maintain, by and large, the present global
treatment on taxable corporations. We certainly do not view this classification to be arbitrary and
in appropriate.” (Tan v. del Rosario, G.R. No. 109289, October 3, 1994)

What is the basis of the right of a government to tax income?

Partnership Theory. The right of a government to tax income emanates from its partnership
in the production of income, by providing the protection, resources, incentive, and proper climate
for such production. (Commissioner v. Lednicky, L-18169, L-18262, L21434, July 31, 1964).

CASES:
1. Commissioner v. Lednicky, supra. The question in this case is whether a citizen of the
United Sates residing in the Philippines, who derives income wholly from sources
 within the Philippines, may deduct from his gross income the taxes that he paid to the
US government for the taxable year. Held: Much stress is laid on the thesis that if the
respondent taxpayers are not allowed to deduct the income taxes they are required to
pay to the government of the United States in their return for Philippine income tax, they
would be subjected to double taxation. What respondents fail to observe is that double
taxation becomes obnoxious only where the taxpayer is taxed twice for the benefit of
the same governmental entity (cf. Manila vs. Interisland Gas Service, 52 Off. Gaz. 6579;
Manuf. Life Ins. Co. vs. Meer, 89 Phil. 357). In the present case, while the taxpayers would
have to pay two taxes on the same income, the Philippine government only receives the
proceeds of one tax. As between the Philippines, where the income was earned and where
the taxpayer is domiciled, and the United States, where that income was not earned and
where the taxpayer did not reside, it is indisputable that justice and equity demand that
the tax on the income should accrue to the benefit of the Philippines. Any relief from the
alleged double taxation should come from the United States, and not from the Philippines,
since the former's right to burden the taxpayer is solely predicated on his citizenship,
without contributing to the production of the wealth that is being taxed. Aside from not
conforming to the fundamental doctrine of income taxation that the right of a
government to tax income emanates from its partnership in the production of
income, by providing the protection, resources, incentive, and proper climate
for such production, the interpretation given by the respondents to the revenue law
provision in question operates, in its application, to place a resident alien with only
domestic sources of income in an equal, if not in a better, position than one who has both
domestic and foreign sources of income, a situation which is manifestly unfair and short
of logic. Finally, to allow an alien resident to deduct from his gross income whatever taxes
he pays to his own government amounts to conferring on the latter the power to reduce
the tax income of the Philippine government simply by increasing the tax rates on the
alien resident. Every time the rate of taxation imposed upon an alien resident is increased
by his own government, his deduction from Philippine taxes would correspondingly
increase, and the proceeds for the Philippines diminished, thereby subordinating our own
taxes to those levied by a foreign government. Such a result is incompatible with the
status of the Philippines as an independent and sovereign state.

2. CIR v. British Overseas Airline Corp. G.R. No. L-65773-74, April 30, 1987. The site of the
source of payments is the Philippines. The flow of wealth proceeded from, and occurred
within, Philippine territory, enjoying the protection accorded by the Philippine government.
In consideration of such protection, the flow of wealth should share the burden of
supporting the government.

3. CREBA v. Romulo, G.R. No. 160756, March 9, 2010. Domestic corporations owe their
corporate existence and their privilege to do business to the government. They also
benefit from the efforts of the government to improve the financial market and to ensure
a favorable business climate. It is therefore fair for the government to require them to
make a reasonable contribution to the public expenses.

What are the general principles of income taxation in the Philippines? (Sec. 23)

Except when otherwise provided in this Code:

 (A) A citizen of the Philippines residing therein is taxable on all income derived from sources
within and without the Philippines;
(B) A non-resident 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;
(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.

State/Discuss the criteria in imposing Philippine Income Tax

The following are the criteria in imposing Philippine Income Tax

1. Citizenship Principle – a citizen of the Philippines is subject to Philippine income tax:

(a) on worldwide income, if he resides in the Philippines; or b) only on his income from
sources within the Philippines if he qualifies as a non-resident citizen.

2. Residence Principle – All income derived by persons residing in the Philippines, whether
citizens or aliens, whether domestic or foreign corporations, shall be subject to income
tax on the income derived from sources from the Philippines.

3. Source Principle – All income derived from sources within the Philippines shall be
subject to income tax.

What is the Doctrine of Situs of Taxation?

No state may tax anything not within its jurisdiction without violating the due process clause of
the constitution. The taxing power of a estate does not extend beyond its territorial limits, but
within such limits it may tax persons, property, income or business. (Manila Gas Corp. v. CIR,
G.R. No. 42780, January 17, 1930).

What are the current rules on situs of taxation?

The state may impose taxes on persons subject to the jurisdiction of its sovereignty, and on
property located within its territory. The tax laws of a state can have no extraterritorial operation.
Sec. 23, NIRC:
Taxpayer Situs
Resident Citizen Taxable on income from sources both within and without
the Philippines
Domestic Corporation Taxable on income from sources both within and without
the Philippines
Non-Resident Citizen Taxable on income from sources within the Philippines
Resident/Non-Resident Alien Taxable on income from sources within the Philippines
Foreign Corporation Taxable on income from sources within the Philippines

Summary of Section 42, NIRC with respect to certain Income payments.

Income Situs of Taxation

Interest Residence of the debtor or obligor
Dividends If received from a domestic corporation – Income from
Within the Phils.

If received from a foreign corporation – Income from

Services
Rentals and Royalties
Sale of Real Property
Sale of personal property
Gain on sale of shares of stock in a
domestic corporation
Within the Philippines unless less than 50% of the gross
income of such foreign corporation for the 3-year period
ending with the close of its taxable year preceding the
declaration of dividends was derived from sources within
the Phils.
Place of performance of the service
Location or use of the property or interest in such
property
Location of the real property
Place of sale
Income from within the Philippines regardless of where
the shares are sold

CASES:

1. Tan v. del Rosario, G.R. No. 109289, October 3, 1994. Facts: In this case, Petitioners
questioned the validity of Sec. 6, RR 2-93 promulgated by Respondents pursuant to the
RA 496 (SNITS). Petitioners contends that the RR would apply to partners of a general
professional partnerships the SNITS, when in, during the deliberations of the Congress,
the SNITS is intended not to apply to corporations or to partnerships. Held: There is,
then and now, no distinction in income tax liability between a person who practices his
profession alone or individually and one who does it through partnership (whether
registered or not) with others in the exercise of a common profession. Indeed, outside of
the gross compensation income tax and the final tax on passive investment income, under
the present income tax system all individuals deriving income from any source whatsoever
are treated in almost invariably the same manner and under a common set of rules. We
can well appreciate the concern taken by petitioners if perhaps we were to consider
Republic Act No. 7496 as an entirely independent, not merely as an amendatory, piece of
legislation. The view can easily become myopic, however, when the law is understood, as
 it should be, as only forming part of, and subject to, the whole income tax concept and
precepts long obtaining under the National Internal Revenue Code. To elaborate a little,
the phrase "income taxpayers" is an all embracing term used in the Tax Code, and it
practically covers all persons who derive taxable income. The law, in levying the tax,
adopts the most comprehensive tax situs of nationality and residence of the
taxpayer (that renders citizens, regardless of residence, and resident aliens
subject to income tax liability on their income from all sources) and of the
generally accepted and internationally recognized income taxable base (that
can subject non-resident aliens and foreign corporations to income tax on their
income from Philippine sources). In the process, the Code classifies taxpayers into
four main groups, namely: (1) Individuals, (2) Corporations, (3) Estates under Judicial
Settlement and (4) Irrevocable Trusts (irrevocable both as to corpus and as to income).

2. CIR v. British Overseas Airline Corp., G.R. No. L-65773-74, April 30, 1987. (On
source principle; BOAC Doctrine) Facts: CIR assessed BOAC deficiency income taxes
on the sale of tickets in the Philippines while having neither landing rights the Philippines
nor being granted a CPCN. The sale of tickets was done thru its general agent in the
Philippines. Did the “flow of wealth” come from “sources within the
Philippines”? Held: The source of an income is the property, activity or service that
produced the income. For the source of income to be considered as coming from the
Philippines, it is sufficient that the income is derived from activity within the Philippines.
In BOAC's case, the sale of tickets in the Philippines is the activity that produces the
income. The tickets exchanged hands here and payments for fares were also made here
in Philippine currency. The site of the source of payments is the Philippines. The flow of
wealth proceeded from, and occurred within, Philippine territory, enjoying the protection
accorded by the Philippine government. In consideration of such protection, the flow of
wealth should share the burden of supporting the government. A transportation ticket is
not a mere piece of paper. When issued by a common carrier, it constitutes the contract
between the ticket-holder and the carrier. It gives rise to the obligation of the purchaser
of the ticket to pay the fare and the corresponding obligation of the carrier to transport
the passenger upon the terms and conditions set forth thereon. The ordinary ticket issued
to members of the traveling public in general embraces within its terms all the elements
to constitute it a valid contract, binding upon the parties entering into the relationship.

BOAC further contended that since the services are rendered outside the Philippines,
the income should be considered as derived outside the Philippines; hence it is not liable
to pay income tax in the Philippines. Held: The absence of flight operations to and from
the Philippines is not determinative of the source of income or the site of income taxation.
Admittedly, BOAC was an off-line international airline at the time pertinent to this case.
The test of taxability is the "source"; and the source of an income is that activity ... which
produced the income. Unquestionably, the passage documentations in these cases were
sold in the Philippines and the revenue therefrom was derived from a activity regularly
pursued within the Philippines. And even if the BOAC tickets sold covered the "transport
of passengers and cargo to and from foreign cities", it cannot alter the fact that income
from the sale of tickets was derived from the Philippines. The word "source" conveys one
essential idea, that of origin, and the origin of the income herein is the Philippines.
3. South African Airways v. CIR, G.R. No. 180356, February 16, 2010. Facts: SAA is a
foreign corporation organized under the laws of South Africa. In the Phils., it is an
international air carrier having no landing rights in the country. It has a general sales
agent in the Phils. who sells passage documents for compensation or commission for
petitioner’s off-line flights for the carriage of goods and cargo between ports or points
outside the territorial jurisdiction of the Philippines. SAA is not registered with the SEC as
a corporation, branch office, or partnership, and has no license to do business in the
Philippines. For the taxable year 2000, it paid its 2.5% Gross Philippine Billings. Later, it
claimed refund with the BIR contending that it erroneously paid BPB, which BIR dismissed.
CTA ruled that SAA is a foreign corporation engaged in business in the Philippines. It is
not liable to pay GPB but liable to pay 32% normal income tax on its income derived from
the sale of passage documents in the Philippines. Issue: WON the income derived from
the sale of passage documents covering petitioner’s off-line flights is a Philippine-source
subject to Philippine income tax. Held: Yes. As held in CIR v. BOAC, off-line air carriers
having general sales agents in the Philippines are engaged in or doing business in the
Philippines and their income from sales of passage documents here is income from within
the Philippines. Thus, as in that case, SC held that off-line air carrier is liable for the 32%
tax on its taxable income.

SAA contends that BOAC case is not applicable as it was decided under the 1939 Tax
Code. According to SAA, the 1939 Tax Code, taxes resident foreign corporation on all
income from sources within the Philippines. On the other hand, SAA interprets Sec.
28(A)(3)(a) (re Tax on GPB) the 1997 NIRC to the effect that since it is an international
carrier that does not maintain flights to or from the Philippines, thereby having no GPB as
defined, is exempt from paying any income at all. In other words, SAA contends that the
existence of Sec. 28(A)(3)(a) precludes the application of Sec. 28(A)(1) (re: normal
income tax of 32% effective January 1, 2000). Held: The difference cited by petitioner
between the 1939 and 1997 NIRCs with regard to taxation of off-line carriers are more
apparent than real. We point out that Sec. (28(A)(3)(a) of the 1997 NIRC does not, in
any categorical term, exempt all international air carries from the coverage of Sec.
28(A)(1) of the 1997 NIRC. Certainly, had legislatures intentions been to completely
exclude all international air carriers from the application of the general rule under Sec.
28(A)(1), it would have used the appropriate language to do so; but the legislature did
not. Thus, the logical interpretation of such provision is that, if Sec. 28(A)(3)(a) is
applicable, then the general rule under Sec. 29(A)(1) would not apply. If, however, Sec.
28(A)(3)(a) does not apply, a resident foreign corporation, whether an international air
carrier or not, would be liable for the tax under Sec. 28(A)(1). Clearly, no difference exists
between British Overseas Airways and the instant case, wherein petitioner claims that the
former case does not apply. Thus, BOAC applies to the instant case. The findings therein
that an off-line air carrier is doing business in the Philippines and that income from the
sale of passage documents here is Philippine-source income must be upheld. x x x In the
instant case, the general rule is that resident foreign corporations shall be liable for a 32%
income tax on their income from within the Philippines, except for resident foreign
corporations that are international carriers that derive income "from carriage of persons,
excess baggage, cargo and mail originating from the Philippines" which shall be taxed at
2 1/2% of their Gross Philippine Billings. Petitioner, being an international carrier with no
flights originating from the Philippines, does not fall under the exception. As such,
petitioner must fall under the general rule. This principle is embodied in the Latin maxim,
 exception firmat regulam in casibus non exceptis, which means, a thing not being
excepted must be regarded as coming within the purview of the general rule. To reiterate,
the correct interpretation of the above provisions is that, if an international air carrier
maintains flights to and from the Philippines, it shall be taxed at the rate of 2 1/2% of its
Gross Philippine Billings, while international air carriers that do not have flights to and
from the Philippines but nonetheless earn income from other activities in the country will
be taxed at the rate of 32% of such income.

Note: In this case, the SC also discussed the evolution of Tax on Gross Philippine Billings.

4. Alexander Howden & Co. Ltd v. Collector, G.R. No. L-19392, April 14, 1965. Facts:
Pursuant to the re-insurance contracts (prepared and signed by the foreign reinsurers in
England and sent to Manila where CIO signed them), Commonwealth Insurance Co. (CIO),
a domestic corporation, remitted P798,297.47 to Alexander Howden & Co. Ltd. On behalf
of AHCL, CIO filed in April 1952 an income tax return declaring the sum of P798,297.47
with accrued interest therein in the amount of P4,985.77, as AHCL’s gross income for CY
1951. It also paid to BIR P66,112.00 income tax thereon. Within the prescriptive period,
AHCL filed its claim for refund of P65,115 (excluding the tax on the interest) invoking an
earlier ruling of the BIR stating that it exempted from withholding tax reinsurance
premiums received from domestic insurance company by foreign insurance companies not
authorized to do business in the Philippines. Issue: Are portions of premiums earned
from insurances locally underwritten by a domestic corporation, ceded to and received by
non-resident foreign reinsurance companies, thru a non-resident insurance broker,
pursuant to reinsurance contracts signed by the reinsurers abroad but signed by the
domestic corporation in the Philippines, subject to income tax or not? Held: Appellants
would impress upon this Court that the reinsurance premiums came from sources outside
the Philippines, for these reasons: (1) The contracts of reinsurance, out of which the
reinsurance premiums were earned, were prepared and signed abroad, so that their situs
lies outside the Philippines; (2) The reinsurers, not being engaged in business in the
Philippines, received the reinsurance premiums as income from their business conducted
in England and, as such, taxable in England; and, (3) Section 37 of the Tax Code,
enumerating what are income from sources within the Philippines, does not include
reinsurance premiums. The source of an income is the property, activity or service
that produced the income. The reinsurance premiums remitted to appellants
by virtue of the reinsurance contracts, accordingly, had for their source the
undertaking to indemnify Commonwealth Insurance Co. against liability. Said
undertaking is the activity that produced the reinsurance premiums, and the
same took place in the Philippines. In the first place, the reinsured, the
liabilities insured and the risks originally underwritten by Commonwealth
Insurance Co., upon which the reinsurance premiums and indemnity were
based, were all situated in the Philippines. Secondly, contrary to appellants'
view, the reinsurance contracts were perfected in the Philippines, for
Commonwealth Insurance Co. signed them last in Manila. The American cases
cited are inapplicable to this case because in all of them the reinsurance contracts were
signed outside the jurisdiction of the taxing State. And, thirdly, the parties to the
reinsurance contracts in question evidently intended Philippine law to govern. Article 11
thereof provided for arbitration in Manila, according to the laws of the Philippines, of any
dispute arising between the parties in regard to the interpretation of said contracts or
 rights in respect of any transaction involved. Furthermore, the contracts provided for the
use of Philippine currency as the medium of exchange and for the payment of Philippine
taxes. Appellants should not confuse activity that creates income with business in the
course of which an income is realized. An activity may consist of a single act; while
business implies continuity of transactions. An income may be earned by a corporation in
the Philippines although such corporation conducts all its businesses abroad. Precisely,
Section 24 of the Tax Code does not require a foreign corporation to be engaged in
business in the Philippines in order for its income from sources within the Philippines to
be taxable. It subjects foreign corporations not doing business in the Philippines to tax for
income from sources within the Philippines. If by source of income is meant the business
of the taxpayer, foreign corporations not engaged in business in the Philippines would be
exempt from taxation on their income from sources within the Philippines. Furthermore,
as used in our income tax law, "income" refers to the flow of wealth. Such flow, in the
instant case, proceeded from the Philippines. Such income enjoyed the protection of the
Philippine Government. As wealth flowing from within the taxing jurisdiction of the
Philippines and in consideration for protection accorded it by the Philippines, said income
should properly share the burden of maintaining the government. Appellants further
contend that reinsurance premiums not being among those mentioned in Section 37 of
the Tax Code as income from sources within the Philippines, the same should not be
treated as such. Section 37, however, is not an all-inclusive enumeration. It states that
"the following items of gross income shall be treated as gross income from sources within
the Philippines." It does not state or imply that an income not listed therein is necessarily
from sources outside the Philippines. As to appellants' contention that reinsurance
premiums constitute "gross receipts" instead of "gross income", not subject to income tax,
suffice it to say that, as correctly observed by the Court of Tax Appeals, "gross receipts"
of amounts that do not constitute return of capital, such as reinsurance premiums, are
part of the gross income of a taxpayer. At any rate, the tax actually collected in this case
was computed not on the basis of gross premium receipts but on the net premium income,
that is, after deducting general expenses, payment of policies and taxes.

5. CIR v. Baier-Nickel, G.R. No. 153793, August 29, 2006. Facts: Juliane Baier-Nickel, a
non-resident German, is the President of JUBANITEX, a domestic corporation. JBN was
appointed and engaged as JUBANITEX’s commission agent who will receive 10%
commission on all sales actually concluded and collected through her efforts. In 1995,
JBN received the amount of P1,707,772.64 representing her sales commission and for
which the corresponding tax of P170,777.26 was withheld. JBN filed her income return
reporting the said amounts as her income and income tax due. Later on, JBN, thru her
attorney-in-fact, filed a claim for refund contending that her sales commission income is
not taxable in the Philippines because the same was a compensation for her services
rendered in Germany and therefore considered as income from sources outside the
Philippines. Held: Pursuant to Section 25 of the NIRC, non-resident aliens, whether or
not engaged in trade or business, are subject to Philippine income taxation on their income
received from all sources within the Philippines. Thus, the keyword in determining the
taxability of non-resident aliens is the income’s "source." The Supreme Court has said, in
a definition much quoted but often debated, that income may be derived from three
possible sources only: (1) capital and/or (2) labor; and/or (3) the sale of capital assets.
If the income is from labor the place where the labor is done should be decisive; if it is
done in this country, the income should be from "sources within the United States." If the
 income is from capital, the place where the capital is employed should be decisive; if it is
employed in this country, the income should be from "sources within the United States."
If the income is from the sale of capital assets, the place where the sale is made should
be likewise decisive. The source of an income is the property, activity or service that
produced the income. For the source of income to be considered as coming from the
Philippines, it is sufficient that the income is derived from activity within the Philippines
The settled rule is that tax refunds are in the nature of tax exemptions and are to be
construed strictissimi juris against the taxpayer. To those therefore, who claim a refund
rest the burden of proving that the transaction subjected to tax is actually exempt from
taxation. In the instant case, the appointment letter of respondent as agent of JUBANITEX
stipulated that the activity or the service which would entitle her to 10% commission
income, are "sales actually concluded and collected through [her] efforts." What she
presented as evidence to prove that she performed income producing activities abroad,
were copies of documents she allegedly faxed to JUBANITEX and bearing instructions as
to the sizes of, or designs and fabrics to be used in the finished products as well as
samples of sales orders purportedly relayed to her by clients. However, these documents
do not show whether the instructions or orders faxed ripened into concluded or collected
sales in Germany. At the very least, these pieces of evidence show that while respondent
was in Germany, she sent instructions/orders to JUBANITEX. As to whether these
instructions/orders gave rise to consummated sales and whether these sales were truly
concluded in Germany, respondent presented no such evidence. Neither did she establish
reasonable connection between the orders/instructions faxed and the reported monthly
sales purported to have transpired in Germany.

6. National Development Corporation v. CIR, G.R. No. L-53961, June 30, 1987.
Facts: The national Development Company entered into contracts in Tokyo with several
Japanese shipbuilding companies for the construction of twelve ocean-going vessels. The
purchase price was to come from the proceeds of bonds issued by the Central Bank. Initial
payments were made in cash and through irrevocable letters of credit. Fourteen
promissory notes were signed for the balance by the NDC and, as required by the
shipbuilders, guaranteed by the Republic of the Philippines. Pursuant thereto, the
remaining payments and the interests thereon were remitted in due time by the NDC to
Tokyo. The vessels were eventually completed and delivered to the NDC in Tokyo. The
NDC remitted to the shipbuilders in Tokyo the total amount of US$4,066,580.70 as interest
on the balance of the purchase price. No tax was withheld. The Commissioner then held
the NDC liable on such tax in the total sum of P5,115,234.74. Negotiations followed but
failed. The BIR thereupon served on the NDC a warrant of distraint and levy to enforce
collection of the claimed amount. The NDC went to the Court of Tax Appeals. The BIR
was sustained by the CTA except for a slight reduction of the tax deficiency in the sum of
P900.00, representing the compromise penalty. The NDC then came to this Court in a
petition for certiorari contending that the Japanese shipbuilders were not subject to tax
under the above provision because all the related activities — the signing of the contract,
the construction of the vessels, the payment of the stipulated price, and their delivery to
the NDC — were done in Tokyo. Held: The law, however, does not speak of activity but
of "source," which in this case is the NDC. This is a domestic and resident corporation
with principal offices in Manila. As the Tax Court put it: It is quite apparent, under the
terms of the law, that the Government's right to levy and collect income tax on interest
received by foreign corporations not engaged in trade or business within the Philippines
 is not planted upon the condition that 'the activity or labor — and the sale from which the
(interest) income flowed had its situs' in the Philippines. The law specifies: 'Interest
derived from sources within the Philippines, and interest on bonds, notes, or other
interest-bearing obligations of residents, corporate or otherwise.' Nothing there speaks of
the 'act or activity' of non-resident corporations in the Philippines, or place where the
contract is signed. The residence of the obligor who pays the interest rather than the
physical location of the securities, bonds or notes or the place of payment, is the
determining factor of the source of interest income. (Mertens, Law of Federal Income
Taxation, Vol. 8, p. 128, citing A.C. Monk & Co. Inc. 10 T.C. 77; Sumitomo Bank, Ltd., 19
BTA 480; Estate of L.E. Mckinnon, 6 BTA 412; Standard Marine Ins. Co., Ltd., 4 BTA 853;
Marine Ins. Co., Ltd., 4 BTA 867.) Accordingly, if the obligor is a resident of the Philippines
the interest payment paid by him can have no other source than within the Philippines.
The interest is paid not by the bond, note or other interest-bearing obligations, but by the
obligor. (See Mertens, Id., Vol. 8, p. 124.) Here in the case at bar, petitioner National
Development Company, a corporation duly organized and existing under the laws of the
Republic of the Philippines, with address and principal office at Calle Pureza, Sta. Mesa,
Manila, Philippines unconditionally promised to pay the Japanese shipbuilders, as obligor
in fourteen (14) promissory notes for each vessel, the balance of the contract price of the
twelve (12) ocean-going vessels purchased and acquired by it from the Japanese
corporations, including the interest on the principal sum at the rate of five per cent (5%)
per annum. And pursuant to the terms and conditions of these promissory notes, which
are duly signed by its Vice Chairman and General Manager, petitioner remitted to the
Japanese shipbuilders in Japan during the years 1960, 1961, and 1962 the sum of
$830,613.17, $1,654,936.52 and $1,541.031.00, respectively, as interest on the unpaid
balance of the purchase price of the aforesaid vessels. The law is clear. Our plain duty is
to apply it as written. The residence of the obligor which paid the interest under
consideration, petitioner herein, is Calle Pureza, Sta. Mesa, Manila, Philippines; and as a
corporation duly organized and existing under the laws of the Philippines, it is a domestic
corporation, resident of the Philippines. (Sec. 84(c), National Internal Revenue Code.) The
interest paid by petitioner, which is admittedly a resident of the Philippines, is on the
promissory notes issued by it. Clearly, therefore, the interest remitted to the Japanese
shipbuilders in Japan in 1960, 1961 and 1962 on the unpaid balance of the purchase price
of the vessels acquired by petitioner is interest derived from sources within the Philippines
subject to income tax under the then Section 24(b)(1) of the National Internal Revenue
Code.

What are the types of Philippine Income Taxes?

The following are the types of Income Taxes in the Philippines:

1. Graduated income tax on individuals;
2. Normal corporate income tax on corporations;
3. Gross Income Tax
4. Minimum corporate income tax (MCIT);
5. Special Income Tax / Preferential Rates on certain corporations
6. Capital Gains Tax on sale or exchange of unlisted shares of stocks of domestic
corporation classified as capital asset;
 7. Capital Gains Tax on sale or exchange of real properties located in the Philippines and
classified as capital asset.
8. Final withholding tax on certain passive income;
9. Fringe Benefit Tax
10. Branch Profit Remittance Tax
11. Tax on improperly accumulated retained earnings;

Define “Taxable Period”.

Taxable period means the calendar year, or the fiscal year (see. Sec. 22(Q)) ending during such
calendar year, upon the basis of which the net income is computed under the NIRC. It includes,
in the case of a return made for a fractional part of a year, the period for which such return is
made. (Sec. 22(P), NIRC). (relate to Sec. 74)

What are the different kinds of Income Taxpayers?

A. Individual Taxpayers:

1. Resident Citizen – A citizen of the Philippines residing in the Philippines.

2. Non-Resident Citizen – means [Sec. 22(E)]:

a. A citizen of the Philippines who establishes to the satisfaction of the Commissioner

the fact of his physical presence abroad with a definite intention to reside therein;
b. A citizen of the Philippines who leaves the Philippines during the taxable year to
reside abroad, either as an immigrant or for employment on a permanent basis;
c. A citizen of the Philippines who works and derives income from abroad
d. 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 Philippines shall likewise be treated as a non-resident citizen 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;
e. The taxpayer shall submit proof to the Commissioner to show his intention of
leaving the Philippines to reside permanently abroad or to return to and reside in
the Philippines as the case maybe.

3. Resident Alien – individual whose residence is within the Philippines and who is not a
citizen thereof. [Sec. 22(F)];

4. Non-Resident Alien – individual whose residence is not within the Philippines and who
is not a citizen thereof. [Sec. 22(G)]

5. Minimum Wage Earner – a worker in the private sector paid the statutory minimum
wage, or to an employee in the public sector with compensation income of not more than
the statutory minimum wage in the non-agricultural sector where he/she is assigned. [Sec.
22(HH)]
B. Corporations – include partnerships, no matter how created or organized, joint stock
companies, joint accounts, associations, or insurance companies (but do not include
general professional partnership 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 an operating or consortium agreement under a service
contract with the Government). [Sec. 22(B)]

1. Domestic – those created or organized in the Philippines or under its laws. [Sec. 22(C)]

2. Foreign – corporation which is not domestic.

a. Resident Foreign Corporation – foreign corporation engaged in trade or

business within the Philippines.

b. Non-resident Foreign Corporation – foreign corporation not engaged in trade

or business within the Philippines.

Case: CIR v. British Overseas Airline Corp., supra. Issue: Whether or not BOAC
was a resident foreign corporation. Held: It is our considered opinion that BOAC is a
resident foreign corporation. There is no specific criterion as to what constitutes "doing"
or "engaging in" or "transacting" business. Each case must be judged in the light of its
peculiar environmental circumstances. 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 incident to, and in progressive
prosecution of commercial gain or for the purpose and object of the business
organization. "In order that a foreign corporation may be regarded as doing business
within a State, there must be continuity of conduct and intention to establish a continuous
business, such as the appointment of a local agent, and not one of a temporary
character. BOAC, during the periods covered by the subject - assessments, maintained a
general sales agent in the Philippines, That general sales agent, from 1959 to 1971, "was
engaged in (1) selling and issuing tickets; (2) breaking down the whole trip into series of
trips — each trip in the series corresponding to a different airline company; (3) receiving
the fare from the whole trip; and (4) consequently allocating to the various airline
companies on the basis of their participation in the services rendered through the mode
of interline settlement as prescribed by Article VI of the Resolution No. 850 of the IATA
Agreement." Those activities were in exercise of the functions which are normally incident
to, and are in progressive pursuit of, the purpose and object of its organization as an
international air carrier. In fact, the regular sale of tickets, its main activity, is the very
lifeblood of the airline business, the generation of sales being the paramount objective.
There should be no doubt then that BOAC was "engaged in" business in the Philippines
through a local agent during the period covered by the assessments. Accordingly, it is a
resident foreign corporation subject to tax upon its total net income received in the
preceding taxable year from all sources within the Philippines
 C. General Professional Partnership – partnership formed by persons for the sole
purpose of exercising their common profession, no part of income of which is derived from
engaging in any business.

D. Estates and Trusts – An estate is created by operation of law when an individual dies,
leaving properties to his compulsory heirs or other heirs, while trust is a legal arrangement
whereby the owner of property transfers ownership to a person who is to hold and control
the property according to the owner’s instructions for the benefit of a designated person.

Case/s:

1. Oña, et. al. v. Commissioner, G.R. No. 19342, May 25, 1972. Facts: Petitioner
Lorenzo Lorenzo Oña is the court appointed administrator of the estate of his late wife.
In the settlement of estate proceedings, he submitted a project of partition of the estate
among the heirs (Lorenzo and his five children), which the court approved. Despite the
approval of the project of partition, no attempt was made to divide the properties; instead,
Lorenzo used the money to rehabilitate the properties. The properties remained under the
management of Lorenzo who used the properties in business by leasing or selling them
and investing the income derived therefrom and the proceeds of the sales in real
properties and securities. The properties and investments gradually increased, income
earned was recorded in the books kept by Lorenzo where corresponding shares of the
Lorenzo and his children in the net income for the year are also known. However, they
did not actually receive their shares in the yearly profits. Thereafter, CIR held that the
petitioners formed an unregistered partnership; hence subject to corporate income tax.
Held: It is thus incontrovertible that petitioners did not, contrary to their contention,
merely limit themselves to holding the properties inherited by them. Indeed, it is admitted
that during the material years herein involved, some of the said properties were sold at
considerable profit, and that with said profit, petitioners engaged, thru Lorenzo T. Oña, in
the purchase and sale of corporate securities. It is likewise admitted that all the profits
from these ventures were divided among petitioners proportionately in accordance with
their respective shares in the inheritance. In these circumstances, it is Our considered
view that from the moment petitioners allowed not only the incomes from their respective
shares of the inheritance but even the inherited properties themselves to be used by
Lorenzo T. Oña as a common fund in undertaking several transactions or in business, with
the intention of deriving profit to be shared by them proportionally, such act was
tantamount to actually contributing such incomes to a common fund and, in effect, they
thereby formed an unregistered partnership within the purview of the above-mentioned
provisions of the Tax Code. It is but logical that in cases of inheritance, there should be
a period when the heirs can be considered as co-owners rather than unregistered co-
partners within the contemplation of our corporate tax laws aforementioned. Before the
partition and distribution of the estate of the deceased, all the income thereof does belong
commonly to all the heirs, obviously, without them becoming thereby unregistered co-
partners, but it does not necessarily follow that such status as co-owners continues until
the inheritance is actually and physically distributed among the heirs, for it is easily
conceivable that after knowing their respective shares in the partition, they might decide
to continue holding said shares under the common management of the administrator or
executor or of anyone chosen by them and engage in business on that basis. Withal, if
this were to be allowed, it would be the easiest thing for heirs in any inheritance to
 circumvent and render meaningless Sections 24 and 84(b) of the National Internal
Revenue Code. It is true that in Evangelista vs. Collector, 102 Phil. 140, it was stated,
among the reasons for holding the appellants therein to be unregistered co-partners for
tax purposes, that their common fund "was not something they found already in
existence" and that "it was not a property inherited by them pro indiviso," but it is certainly
far-fetched to argue therefrom, as petitioners are doing here, that ergo, in all instances
where an inheritance is not actually divided, there can be no unregistered co-partnership.
As already indicated, for tax purposes, the co-ownership of inherited properties is
automatically converted into an unregistered partnership the moment the said common
properties and/or the incomes derived therefrom are used as a common fund with intent
to produce profits for the heirs in proportion to their respective shares in the inheritance
as determined in a project partition either duly executed in an extrajudicial settlement or
approved by the court in the corresponding testate or intestate proceeding. The reason
for this is simple. From the moment of such partition, the heirs are entitled already to
their respective definite shares of the estate and the incomes thereof, for each of them to
manage and dispose of as exclusively his own without the intervention of the other heirs,
and, accordingly he becomes liable individually for all taxes in connection therewith. If
after such partition, he allows his share to be held in common with his co-heirs under a
single management to be used with the intent of making profit thereby in proportion to
his share, there can be no doubt that, even if no document or instrument were executed
for the purpose, for tax purposes, at least, an unregistered partnership is formed. This is
exactly what happened to petitioners in this case.

2. Gatchalian v. Collector, G.R. No. L-45425, April 29, 1939. Facts. Gatchalian and 14
other individuals, the petitioners, each contributed money to purchase sweepstakes ticket;
the ticket won third price in the sum of P50,000.00. CIR assessed tax thereon contending
that Gatchalian. et. al., formed an unregistered partnership. Held: There is no doubt
that if the plaintiffs merely formed a community of property the latter is exempt from the
payment of income tax under the law. But according to the stipulation facts the plaintiffs
organized a partnership of a civil nature because each of them put up money to buy a
sweepstakes ticket for the sole purpose of dividing equally the prize which they may win,
as they did in fact in the amount of P50,000 (article 1665, Civil Code). The partnership
was not only formed, but upon the organization thereof and the winning of the prize, Jose
Gatchalian personally appeared in the office of the Philippines Charity Sweepstakes, in his
capacity as co-partner, as such collection the prize, the office issued the check for P50,000
in favor of Jose Gatchalian and company, and the said partner, in the same capacity,
collected the said check. All these circumstances repel the idea that the plaintiffs organized
and formed a community of property only. Having organized and constituted a partnership
of a civil nature, the said entity is the one bound to pay the income tax which the
defendant collected under the aforesaid section 10 (a) of Act No. 2833, as amended by
section 2 of Act No. 3761. There is no merit in plaintiff's contention that the tax should be
prorated among them and paid individually, resulting in their exemption from the tax.

3. Pascual v. Commissioner, G.R. No. 78133, October 18, 1988. Facts: On June 22,
1965, petitioners bought two (2) parcels of land from Santiago Bernardino, et al. and on
May 28, 1966, they bought another three (3) parcels of land from Juan Roque. The first
two parcels of land were sold by petitioners in 1968 toMarenir Development Corporation,
while the three parcels of land were sold by petitioners to Erlinda Reyes and Maria Samson
on March 19,1970. Petitioners realized a net profit in the sale made in 1968 in the amount
of P165,224.70, while they realized a net profit of P60,000.00 in the sale made in 1970.
The corresponding capital gains taxes were paid by petitioners in 1973 and 1974 by
availing of the tax amnesties granted in the said years. However, in a letter dated March
31, 1979 of then Acting BIR Commissioner Efren I. Plana, petitioners were assessed and
required to pay a total amount of P107,101.70 as alleged deficiency corporate income
taxes for the years 1968 and 1970. Petitioners protested the said assessment in a letter
of June 26, 1979 asserting that they had availed of tax amnesties way back in 1974. In
a reply of August 22, 1979, respondent Commissioner informed petitioners that in the
years 1968 and 1970, petitioners as co-owners in the real estate transactions formed an
unregistered partnership or joint venture taxable as a corporation under Section 20(b)
and its income was subject to the taxes prescribed under Section 24, both of the National
Internal Revenue Code that the unregistered partnership was subject to corporate income
tax as distinguished from profits derived from the partnership by them which is subject to
individual income tax; and that the availment of tax amnesty under P.D. No. 23, as
amended, by petitioners relieved petitioners of their individual income tax liabilities but
did not relieve them from the tax liability of the unregistered partnership. Hence, the
petitioners were required to pay the deficiency income tax assessed. Issue: Did the
petitioner’s form an unregistered partnership? Held: In the present case, there is no
evidence that petitioners entered into an agreement to contribute money, property or
industry to a common fund, and that they intended to divide the profits among
themselves. Respondent commissioner and/ or his representative just assumed these
conditions to be present on the basis of the fact that petitioners purchased certain parcels
of land and became co-owners thereof. In the instant case, petitioners bought two (2)
parcels of land in 1965. They did not sell the same nor make any improvements thereon.
In 1966, they bought another three (3) parcels of land from one seller. It was only 1968
when they sold the two (2) parcels of land after which they did not make any additional
or new purchase. The remaining three (3) parcels were sold by them in 1970. The
transactions were isolated. The character of habituality peculiar to business transactions
for the purpose of gain was not present. The sharing of returns does not in itself establish
a partnership whether or not the persons sharing therein have a joint or common right or
interest in the property. There must be a clear intent to form a partnership, the existence
of a juridical personality different from the individual partners, and the freedom of each
party to transfer or assign the whole property. In the present case, there is clear evidence
of co-ownership between the petitioners. There is no adequate basis to support the
proposition that they thereby formed an unregistered partnership. The two isolated
transactions whereby they purchased properties and sold the same a few years thereafter
did not thereby make them partners. They shared in the gross profits as co- owners and
paid their capital gains taxes on their net profits and availed of the tax amnesty thereby.
Under the circumstances, they cannot be considered to have formed an unregistered
partnership which is thereby liable for corporate income tax, as the respondent
commissioner proposes. And even assuming for the sake of argument that such
unregistered partnership appears to have been formed, since there is no such existing
unregistered partnership with a distinct personality nor with assets that can be held liable
for said deficiency corporate income tax, then petitioners can be held individually liable as
partners for this unpaid obligation of the partnership p. 7 However, as petitioners have
availed of the benefits of tax amnesty as individual taxpayers in these transactions, they
are thereby relieved of any further tax liability arising therefrom.
 INCOME

Definition of Income

Statutory definition:

Income, in the broad sense, means all wealth which flows into the taxpayer other than as a
mere return of capital. It includes the forms of income specifically described as gain and profits,
including gains derived from the sale or other disposition of capital assets. (RR 2-40; see also
Madrigal v. Rafferty, supra).

Jurisprudential definitions:

Income may be defined as the gain derived from capital, from labor, or from both combined,
including profits gained through sale or conversion of capital. Mere growth or increment of value
in a capital investment is not income; income is essentially a gain or profit, in itself, of
exchangeable value, proceeding from capital, severed from it, and derived or received by the
taxpayer for his separate use, benefit, and disposal. (Eisner v. Macomber, 252 U.S. 189, March
8, 1920).

Income may be defined as an amount of money coming to a person or corporation within a

specified time, whether as payment for services, interest or profit from investment. Unless
otherwise specified, it means cash or its equivalent. Income can also be thought of as flow of
the fruits of one's labor. (Conwi v. CTA, G.R. No. 48532, August 31, 1992)

The New Standard Dictionary, edition of 1915, defines an income as "the amount of
money coming to a person or corporation within a specified time whether as payment or
corporation within a specified time whether as payment for services, interest, or profit from
investment." Webster's International Dictionary defines an income as "the receipt, salary;
especially, the annual receipts of a private person or a corporation from property." Bouvier, in his
law dictionary, says that an "income" in the federal constitution and income tax act, is used in its
common or ordinary meaning and not in its technical, or economic sense. (146 Northwestern
Reporter, 812) Mr. Black, in his law dictionary, says "An income is the return in money from one's
business, labor, or capital invested; gains, profit or private revenue." "An income tax is a tax on
the yearly profits arising from property , professions, trades, and offices. The Supreme Court of
the United States, in the case of Gray vs. Darlington (82 U.S., 653), said in speaking of income
that mere advance in value in no sense constitutes the "income" specified in the revenue law as
"income" of the owner for the year in which the sale of the property was made. Such advance
constitutes and can be treated merely as an increase of capital. (In re Graham's Estate, 198 Pa.,
216; Appeal of Braun, 105 Pa., 414.) (Fisher v. Trinidad, G.R. No. L-17518, October 30, 1922)

What is the nature of Income?

Income is the flow of services rendered by the capital by the payment of money from it or any
benefit rendered by the fund of capital in relation to such fund through a period of time. (Fisher
v. Trinidad, supra)

Distinguish Income from Capital

Income as contrasted with capital or property is to be the test. The essential difference
between capital and income is that capital is a fund; income is a flow. A fund of property
existing at an instant of time is called capital. A flow of services rendered by that capital by the
payment of money from it or any other benefit rendered by a fund of capital in relation to such
fund through a period of time is called an income. Capital is wealth, while income is the service
of wealth. (See Fisher, "The Nature of Capital and Income.") The Supreme Court of Georgia
expresses the thought in the following figurative language: "The fact is that property is a tree,
income is the fruit; labor is a tree, income the fruit; capital is a tree, income the fruit."
(Madrigal v. Rafferty, supra)

What are the requisites for Income to be Taxable?

They are as follows:

1. There must be gain or profit. In other words, there must in fact be income, whether in
cash or its equivalent;
2. The gains must be realized or received. This implies that not all economic gains constitute
taxable income. Thus, mere increase in the value of property is not income but merely
an unrealized increase in capital. (But see, as discussed below, BIR Ruling No. 29-1998
for the exception);
3. The gain must not be excluded by law or treaty from taxation. This implies that not all
income is required to be included in the computation of taxable income. (CIR v. CTA,
G.R. No. 108576, January 20, 1999; see also: CREBA v. Romulo, supra)

Is the purpose as to why or how the income was earned a requirement before an
income may be subjected to income tax?

No. Any business purpose as to why or how the income was earned by the taxpayer is not a
requirement. Income tax is assessed on income received from any property, activity, or service
that produces the income because the Tax Code stands as an indifferent neutral party on the
matter where income comes from. (CIR v. CTA, supra).

When is income considered received?

Income is received not only when it is actually or physically transferred to a person but even
when it is merely constructively. Thus, Sec. 52 of RR No. 2-40 provides: “Income which is
credited to the account of the taxpayer and which may be drawn upon him at any time is subject
to tax for the year during which so credited or set apart, although not then actually reduced to
possession. To constitute receipt in such case, the income must be credited to the taxpayer
without any substantial limitation or restriction as to the time and manner of payment or condition
upon which payment is to be made.

Give examples of constructive receipt of income.

1. Matured interest coupon which are due and payable but not yet collected by the taxpayer
should be included in his gross income for the year during which coupon matured (Sec.
53, RR 2-40)
2. Interest credited to the savings bank deposit is income to the depositor when credited.
(Ibid)
3. The share in the profits of a partner in a general professional partnership is regarded as
received by him although not yet distributed. (Ibid. see also Sec. 31(A)(11), NIRC);
4. Dividends applied by the corporation against the indebtedness of a stockholder are taxable
income to the stockholder. (Sec. 50, RR. 2-40);
5. Rental payments refused by the lessor, when lessee tendered payment and the latter
made a judicial deposit of the rental due. (Limpan Investment Corp. v. Commissioner, 17
SCRA 703).

What is the purpose of the doctrine of constructive receipt of income?

The doctrine is designed to prevent the taxpayer on the cash basis from deferring or postponing
the actual receipt of taxable income. Without the rule, the taxpayer can conveniently select the
year in which he will report his income.

What are the different tests in determining whether an income is earned or realized
for tax purposes?

1. Realization Test. Unless income is realized (i.e. there is actual or constructive receipt
of cash or something of value), there is no taxable income.

2. Severance Test. In order that an income may exist, it is necessary that there be a
separation from capital of something of exchangeable value. The income required a
realization of gain.

3. Economic Benefit Test. Any economic benefit to the employee that increases his net
worth, whatever may have been the mode by which it is effected, is taxable.

Note: As a general rule, mere increase in the value of property without actual realization,
either through sale or other disposition, is not taxable. However, if by reason of appraisal,
the cost basis of property is increased and the resulting 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 the new basis due to appraisal is taxable under the economic
benefit principle. (BIR Ruling No. 029-98, March 19, 1998).
 4. Doctrine of Proprietary Interest / Substantial Alteration of Interest Test.
Income is earned when there is a substantial alteration in the interest of a taxpayer, i.e.
increase in the proportionate share of a stockholder in a corporation.

5. Claim of Right Doctrine. A taxable gain is conditioned upon the presence of a claim of
right to the alleged gain and the absence of a definite unconditional obligation to return
or repay that which would otherwise constitute the gain. In the claim of right doctrine, if
a taxpayer receives money or other property and treats it as its own under a claim of right
that the payments are made absolutely and not contingently, such amounts are included
in the taxpayer’s income, even though the right to the income has not been perfected at
that time. It does not matter that the taxpayer’s title to the property is in dispute and
that the property may later on be recovered from the taxpayer. ( Separate Concurring
Opinion of J. Castaneda, Jr. in CIR v. Meralco, CTA EB Case No. 773, May 8, 2012, citing
Merten’s The Law of Federal Taxation.)

6. Control Test. The power to procure the payment of income and enjoy the benefit
thereof determines who is subject to tax.

7. All Events Test. It is applied in recognizing income or liability under accrual method of
accounting. For taxpayer using the accrual method, the determinative question is, when
do the facts present themselves in such a manner that the taxpayer must recognize
income or expense? The accrual of income and expense is permitted when the all-events
test has been met. This requires: (1) fixing of the right to income or liability to pay; and
(2) the availability of the reasonable accurate determination of such income or liability.

Cases:

1. Fisher v. Trinidad, G.R. L-17518, October 30, 1922. Facts: That during the year 1919
the Philippine American Drug Company was a corporation duly organized and existing
under the laws of the Philippine Islands, doing business in the City of Manila; that he
appellant was a stockholder in said corporation; that said corporation, as result of the
business for that year, declared a "stock dividend"; that the proportionate share of said
stock divided of the appellant was P24,800; that the stock dividend for that amount was
issued to the appellant; that thereafter, in the month of March, 1920, the appellant, upon
demand of the appellee, paid under protest, and voluntarily, unto the appellee the sum
of P889.91 as income tax on said stock dividend. For the recovery of that sum (P889.91)
the present action was instituted. The defendant demurred to the petition upon the
ground that it did not state facts sufficient to constitute cause of action. The demurrer
was sustained and the plaintiff appealed. Issue: WON stock dividend is an income.
Held: For bookkeeping purposes, when stock dividends are declared, the corporation or
company acknowledges a liability, in form, to the stockholders, equivalent to the
aggregate par value of their stock, evidenced by a "capital stock account." If profits have
been made by the corporation during a particular period and not divided, they create
additional bookkeeping liabilities under the head of "profit and loss," "undivided profits,"
"surplus account," etc., or the like. None of these, however, gives to the stockholders as
a body, much less to any one of them, either a claim against the going concern or
corporation, for any particular sum of money, or a right to any particular portion of the
asset, or any shares sells or until the directors conclude that dividends shall be made a
part of the company's assets segregated from the common fund for that purpose. The
dividend normally is payable in money and when so paid, then only does the stockholder
realize a profit or gain, which becomes his separate property, and thus derive an income
from the capital that he has invested. Until that, is done the increased assets belong to
the corporation and not to the individual stockholders. When a corporation or company
issues "stock dividends" it shows that the company's accumulated profits have been
capitalized, instead of distributed to the stockholders or retained as surplus available for
distribution, in money or in kind, should opportunity offer. Far from being a realization of
profits of the stockholder, it tends rather to postpone said realization, in that the fund
represented by the new stock has been transferred from surplus to assets, and no longer
is available for actual distribution. The essential and controlling fact is that the stockholder
has received nothing out of the company's assets for his separate use and benefit; on the
contrary, every dollar of his original investment, together with whatever accretions and
accumulations resulting from employment of his money and that of the other stockholders
in the business of the company, still remains the property of the company, and subject to
business risks which may result in wiping out of the entire investment. Having regard to
the very truth of the matter, to substance and not to form, the stockholder by virtue of
the stock dividend has in fact received nothing that answers the definition of an "income."
(Eisner vs. Macomber, 252 U.S., 189, 209, 211.) The stockholder who receives a stock
dividend has received nothing but a representation of his increased interest in the capital
of the corporation. There has been no separation or segregation of his interest. All the
property or capital of the corporation still belongs to the corporation. There has been no
separation of the interest of the stockholder from the general capital of the corporation.
The stockholder, by virtue of the stock dividend, has no separate or individual control over
the interest represented thereby, further than he had before the stock dividend was
issued. He cannot use it for the reason that it is still the property of the corporation and
not the property of the individual holder of stock dividend. A certificate of stock
represented by the stock dividend is simply a statement of his proportional interest or
participation in the capital of the corporation. For bookkeeping purposes, a corporation,
by issuing stock dividend, acknowledges a liability in form to the stockholders, evidenced
by a capital stock account. The receipt of a stock dividend in no way increases the money
received of a stockholder nor his cash account at the close of the year. It simply shows
that there has been an increase in the amount of the capital of the corporation during the
particular period, which may be due to an increased business or to a natural increase of
the value of the capital due to business, economic, or other reasons. We believe that the
Legislature, when it provided for an "income tax," intended to tax only the "income" of
corporations, firms or individuals, as that term is generally used in its common
acceptation; that is that the income means money received, coming to a person or
corporation for services, interest, or profit from investments. We do not believe that the
Legislature intended that a mere increase in the value of the capital or assets of a
corporation, firm, or individual, should be taxed as "income." Such property can be
reached under the ordinary from of taxation. If the ownership of the property represented
by a stock dividend is still in the corporation and to in the holder of such stock, then it is
difficult to understand how it can be regarded as income to the stockholder and not as a
part of the capital or assets of the corporation. (Gibbsons vs. Mahon, supra.) the
stockholder has received nothing but a representation of an interest in the property of the
corporation and, as a matter of fact, he may never receive anything, depending upon the
 final outcome of the business of the corporation. The entire assets of the corporation may
be consumed by mismanagement, or eaten up by debts and obligations, in which case
the holder of the stock dividend will never have received an income from his investment
in the corporation. A corporation may be solvent and prosperous today and issue stock
dividends in representation of its increased assets, and tomorrow be absolutely insolvent
by reason of changes in business conditions, and in such a case the stockholder would
have received nothing from his investment. In such a case, if the holder of the stock
dividend is required to pay an income tax on the same, the result would be that he has
paid a tax upon an income which he never received. Such a conclusion is absolutely
contradictory to the idea of an income. An income subject to taxation under the law must
be an actual income and not a promised or prospective income.

2. Eisner v. Macomber, 252 U.S. 189, March 8, 1920. Held: Income may be defined as
the gain derived from capital, from labor, or from both combined, including profits gained
through sale or conversion of capital. Mere growth or increment of value in a capital
investment is not income; income is essentially a gain or profit, in itself, of exchangeable
value, proceeding from capital, severed from it, and derived or received by the taxpayer
for his separate use, benefit, and disposal. A stock dividend, evincing merely a transfer
of an accumulated surplus to the capital account of the corporation, takes nothing from
the property of the corporation and adds nothing to that of the shareholder; a tax on such
dividends is a tax on capital increase, and not on income, and, to be valid under the
Constitution, such taxes must be apportioned according to population in the several states.

3. CIR v. CA, G.R. No. 108576, January 20, 1999. Facts: Don Andres Soriano, a citizen
and resident of the United States, formed the corporation "A. Soriano Y Cia", predecessor
of ANSCOR, with a P1,000,000.00 capitalization divided into 10,000 common shares at a
par value of P100/share. ANSCOR is wholly owned and controlled by the family of Don
Andres, who are all nonresident aliens. In 1937, Don Andres subscribed to 4,963 shares
of the 5,000 shares originally issued. In 1945, ANSCOR's authorized capital stock was
increased to P2,500,000.00 divided into 25,000 common shares with the same par value.
Don Andres' increased his subscription to 14,963 common shares. A month later, Don
Andres transferred 1,250 shares each to his two sons, Jose and Andres, Jr., as their initial
investments in ANSCOR. Both sons are foreigners. From 1947-1963, ANSCOR declared
stock dividends. On December 30, 1964 Don Andres died. As of that date, the records
revealed that he has a total shareholdings of 185,154 shares. Correspondingly, one-half
of that shareholdings or 92,577 shares were transferred to his wife, Doña Carmen Soriano,
as her conjugal share. The other half formed part of his estate. A day after Don Andres
died, ANSCOR increased its capital stock to P20M and in 1966 further increased it to P30M.
Stock dividends worth 46,290 and 46,287 shares were respectively received by the Don
Andres estate and Doña Carmen from ANSCOR. Hence, increasing their accumulated
shareholdings to 138,867 and 138,864 common shares each. On June 30, 1968, pursuant
to a Board Resolution, ANSCOR redeemed 28,000 common shares from the Don Andres'
estate. By November 1968, the Board further increased ANSCOR's capital stock to P75M.
About a year later, ANSCOR again redeemed 80,000 common shares from the Don Andres'
estate. As stated in the Board Resolutions, ANSCOR's business purpose for both
redemptions of stocks is to partially retire said stocks as treasury shares in order to reduce
the company's foreign exchange remittances in case cash dividends are declared. In 1973,
after examining ANSCOR's books of account and records, Revenue examiners issued a
report proposing that ANSCOR be assessed for deficiency withholding tax-at-source,
pursuant to Sections 53 and 54 of the 1939 Revenue Code for the year 1968 and the
second quarter of 1969 based on the transactions of exchange and redemption of stocks.
Issue: Whether or not ANSCOR’s redemption of stocks from its stockholders as well as
the exchange of common with preferred shares can be considered as “essentially
equivalent to distribution of taxable dividends” making the proceeds thereof taxable.
Held: YES. The bone of contention is the interpretation and application of Section 83(b)
of the 1939 Revenue Act 38 which provides: “Sec. 83. Distribution of dividends or assets
by corporations. — (b) Stock dividends — A stock dividend representing the transfer of
surplus to capital account shall not be subject to tax. However, if a corporation cancels or
redeems stock issued as a dividend at such time and in such manner as to make the
distribution and cancellation or redemption, in whole or in part, essentially equivalent to
the distribution of a taxable dividend, the amount so distributed in redemption or
cancellation of the stock shall be considered as taxable income to the extent it represents
a distribution of earnings or profits accumulated after March first, nineteen hundred and
thirteen.” Sec. 83(b) of the 1939 NIRC [note: now Sec. 73(B), NIRC] was taken from
the Section 115(g)(1) of the U.S. Revenue Code of 1928. It laid down the general rule
known as the proportionate test wherein stock dividends once issued form part of the
capital and, thus, subject to income tax. Specifically, the general rule states that: A stock
dividend representing the transfer of surplus to capital account shall not be subject to tax.
Stock dividends, strictly speaking, represent capital and do not constitute income to its
recipient. So that the mere issuance thereof is not yet subject to income tax as they are
nothing but an "enrichment through increase in value of capital investment." The
exception provides that the redemption or cancellation of stock dividends, depending on
the "time" and "manner" it was made, is essentially equivalent to a distribution of taxable
dividends," making the proceeds thereof "taxable income" "to the extent it represents
profits". The exception was designed to prevent the issuance and cancellation or
redemption of stock dividends, which is fundamentally not taxable, from being made use
of as a device for the actual distribution of cash dividends, which is taxable. Simply put,
depending on the circumstances, the proceeds of redemption of stock dividends are
essentially distribution of cash dividends, which when paid becomes the absolute property
of the stockholder. Thereafter, the latter becomes the exclusive owner thereof and can
exercise the freedom of choice. Having realized gain from that redemption, the income
earner cannot escape income tax. For the exempting clause of Section, 83(b) to
apply, it is indispensable that: (a) there is redemption or cancellation; (b) the
transaction involves stock dividends and (c) the "time and manner" of the
transaction makes it "essentially equivalent to a distribution of taxable
dividends." Redemption is repurchase, a reacquisition of stock by a corporation which
issued the stock 89 in exchange for property, whether or not the acquired stock is
cancelled, retired or held in the treasury. Essentially, the corporation gets back some of
its stock, distributes cash or property to the shareholder in payment for the stock, and
continues in business as before. In the case, ANSCOR redeemed shares twice. But where
did the shares redeemed come from? If its source is the original capital subscriptions upon
establishment of the corporation or from initial capital investment in an existing enterprise,
its redemption to the concurrent value of acquisition may not invite the application of Sec.
83(b) under the 1939 Tax Code, as it is not income but a mere return of capital. On the
contrary, if the redeemed shares are from stock dividend declarations other than as initial
capital investment, the proceeds of the redemption is additional wealth, for it is not merely
a return of capital but a gain thereon. It is not the stock dividends but the proceeds of
its redemption that may be deemed as taxable dividends. At the time of the last
redemption, the original common shares owned by the estate were only 25,247.5 91 This
means that from the total of 108,000 shares redeemed from the estate, the balance of
82,752.5 (108,000 less 25,247.5) must have come from stock dividends. In the absence
of evidence to the contrary, the Tax Code presumes that every distribution of corporate
property, in whole or in part, is made out of corporate profits such as stock dividends.
The capital cannot be distributed in the form of redemption of stock dividends without
violating the trust fund doctrine. With respect to the third requisite, ANSCOR redeemed
stock dividends issued just 2 to 3 years earlier. The time alone that lapsed from the
issuance to the redemption is not a sufficient indicator to determine taxability. It is a must
to consider the factual circumstances as to the manner of both the issuance and the
redemption. The issuance of stock dividends and its subsequent redemption must be
separate, distinct, and not related, for the redemption to be considered a legitimate tax
scheme. Redemption cannot be used as a cloak to distribute corporate earnings. ANSCOR
invoked two reasons to justify the redemptions — (1) the alleged "filipinization" program
and (2) the reduction of foreign exchange remittances in case cash dividends are declared.
The Court is not concerned with the wisdom of these purposes but on their relevance to
the whole transaction which can be inferred from the outcome thereof. It is the "net effect
rather than the motives and plans of the taxpayer or his corporation". The test of taxability
under the exempting clause, when it provides "such time and manner" as would make the
redemption "essentially equivalent to the distribution of a taxable dividend", is whether
the redemption resulted into a flow of wealth. If no wealth is realized from the redemption,
there may not be a dividend equivalence treatment. The test of taxability under the
exempting clause of Section 83(b) is, whether income was realized through the
redemption of stock dividends. The redemption converts into money the stock dividends
which become a realized profit or gain and consequently, the stockholder's separate
property. Profits derived from the capital invested cannot escape income tax. As realized
income, the proceeds of the redeemed stock dividends can be reached by income taxation
regardless of the existence of any business purpose for the redemption. Otherwise, to rule
that the said proceeds are exempt from income tax when the redemption is supported by
legitimate business reasons would defeat the very purpose of imposing tax on income.
The issuance and the redemption of stocks are two different transactions. Although the
existence of legitimate corporate purposes may justify a corporation's acquisition of its
own shares under Section 41 of the Corporation Code, such purposes cannot excuse the
stockholder from the effects of taxation arising from the redemption. Even if the said
purposes support the redemption and justify the issuance of stock dividends, the same
has no bearing whatsoever on the imposition of the tax herein assessed because the
proceeds of the redemption are deemed taxable dividends since it was shown that income
was generated therefrom. The proceeds thereof are essentially considered equivalent to
a distribution of taxable dividends. As "taxable dividend" under Section 83(b), it is part of
the "entire income" subject to tax under Section 22 in relation to Section 21 120 of the
1939 Code. Moreover, under Section 29(a) of said Code, dividends are included in "gross
income". As income, it is subject to income tax which is required to be withheld at source.
4. Javier v. CA, G.R. No. 78953, July 31, 1991. Facts: On June 3, 1977 Victoria Javier,
petitioner’s wife, received from Prudential Bank and Trust Company the amount of
$999,973.70 remitted by her sister through some banks in the US, among which is Mellon
Bank. On June 29, 1977, Mellon Bank filed a complaint against the petitioner, his wife,
and other defendants, claiming that the remittance of $1,000,000.00 was a clerical error
and should have been $1,000.00 only and praying that the excess of $990,000 be
returned. On November 5, 1997, an information was filed against petitioner and wife for
estafa alleging that they have misappropriated, misapplied, or converted to her own
personal use the amount of $999,000.00. On March 1978, petitioner filed his income tax
return for taxable year 1977 which contained a footnote stating: “Taxpayer was recipient
of some money received from abroad which he presumed to be a gift but turned out to
be an error and is now subject of litigation.” Because of the footnote, acting CIR assessed
Javier for deficiency taxes. Held: Taxable, but the return could not be considered as
having been fraudulently filed; there was a mere “error of fact or law” which does not
constitute fraud, and that the footnote was practically an invitation for investigation and
Javier had literally “laid down his cards on the table.”

5. Limpan Investment Corp. v. CIR, G.R. L-21570, July 26, 1966. Facts: Limpan is a
domestic corporation engaged in the business of leasing real properties. Among its real
properties are lots and buildings in Manila and Pasay City acquired from Isabelo Lim and
his mother. After filing income tax returns for 1956 and 1957, tax examiners discovered
that the corporation had understated its rental incomes by 20K and 81K during said years.
CIR demanded payment of deficiency tax and surcharge. Petitioner argued that those
amounts were either deposited in court by the tenants or have not yet received. Issue:
WON there was an undeclared income. Held: Yes. Petitioner admitted that it had
undeclared more than half of the amount, therefore it was incumbent upon the
corporation to establish the remainder of its pretensions by clear and convincing evidence
which is lacking in this case. The withdrawal in 1958 of the deposits in court pertaining
to 1957 rental income is no sufficient justification for the non-declaration of said income
in 1957 since the deposit was resorted due to the petitioner’s refusal to accept the same,
and was not the fault of its tenants; hence, petitioner is deemed to have constructively
received such rentals in 1957. The payment by the sub-tenant should have been reported
as rental income in said year as it is still income regardless of source.

6. Fernandez v. CIR, G.R. No. L-21551, September 30, 1969. Facts: For the year 1950,
respondent determined that petitioner had an increase in net worth in the sum of
P30,050.00, and for the year 1951, the sum of P1,382.85. These amounts were treated
by respondent as taxable income of petitioner for said years. It appears that petitioner had
an account with the Manila Insurance Company, the records bearing on which were lost.
When its records were reconstituted the amount of P349,800.00 was set up as its liability
to the Manila Insurance Company. It was discovered later that the correct liability was only
319,750.00, or a difference of P30,050.00, so that the records were adjusted so as to
show the correct liability. The correction or adjustment was made in 1950. Respondent
contends that the reduction of petitioner's liability to Manila Insurance Company resulted
in the increase of petitioner's net worth to the extent of P30,050.00 which is taxable. Held:
This is erroneous. The principle underlying the taxability of an increase in the net worth
of a taxpayer rests on the theory that such an increase in net worth, if unreported and
 not explained by the taxpayer, comes from income derived from a taxable source. (See
Perez v. Araneta, G.R. No. L-9193, May 29, 1957; Coll. vs. Reyes, G.R. Nos. L- 11534 &
L-11558, Nov. 25, 1958.) In this case, the increase in the net worth of petitioner for 1950
to the extent of P30,050.00 was not the result of the receipt by it of taxable income. It
was merely the outcome of the correction of an error in the entry in its books relating to
its indebtedness to the Manila Insurance Company. The Income Tax Law imposes a tax
on income; it does not tax any or every increase in net worth whether or not derived from
income. Surely, the said sum of P30,050.00 was not income to petitioner, and it was error
for respondent to assess a deficiency income tax on said amount. The same holds true
in the case of the alleged increase in net worth of petitioner for the year 1951 in the sum
of P1,382.85. It appears that certain items (all amounting to P1,382.85) remained in
petitioner's books as outstanding liabilities of trade creditors. These accounts were
discovered in 1951 as having been paid in prior years, so that the necessary adjustments
were made to correct the errors. If there was an increase in net worth of the petitioner,
the increase in net worth was not the result of receipt by petitioner of taxable
income." The Commissioner advances no valid grounds in his brief for contesting the Tax
Court's findings. Certainly, these increases in the taxpayer's net worth were not taxable
increases in net worth, as they were not the result of the receipt by it of unreported or
unexplained taxable income, but were shown to be merely the result of the correction of
errors in its entries in its books relating to its indebtedness to certain creditors, which had
been erroneously overstated or listed as outstanding when they had in fact been duly
paid. The Tax Court's action must be affirmed.

7. Rutkin v. US, 343 US 130, March 24, 1952. Facts: Petitioner, Rutkin, was indicted for
willfully attempting to evade taxes and defeat a large part of his income and victory taxes
for 1943. He was charged with filing a false and fraudulent return stating his net income
to be $18,966.64, whereas he knew that it was $268,622.04. That difference, which would
increase his tax liability from $6,843.93 to $222,408.32, was due largely to his omission
from his original return of $250,000 received by him in cash from Joseph Reinfeld. The
United States claims that this sum was obtained by petitioner by extortion and as such
was taxable income. Petitioner contests both the fact that the money was obtained by
extortion and the conclusion of law that it was taxable income if so obtained. He contends
also that he did not willfully attempt to evade or defeat the tax. Petitioner was found guilty
by a jury in the United States District Court for the District of New Jersey, fined $10,000
and sentenced to four years in prison. Issue: WON money obtained from extortion is
income taxable to the extortioner. Held: An unlawful gain, as well as a lawful one,
constitutes taxable income when its recipient has such control over it that, as a practical
matter, he derives readily realizable economic value from it. That occurs when cash, as
here, is delivered by its owner to the taxpayer in a manner which allows the recipient
freedom to dispose of it at will, even though it may have been obtained by fraud and his
freedom to use it may be assailable by someone with a better title to it. Such gains are
taxable in the yearly period during which they are realized. This statutory policy is invoked
in the interest of orderly administration. '(C)ollection of the revenue cannot be
delayed, nor should the Treasury be compelled to decide when a possessor's claims are
without legal warrant.' National City Bank v. Helvering, 2 Cir., 98 F.2d 93, 96. There is no
 adequate reason why assailable unlawful gains should be treated differently in this respect
from assailable lawful gains. Certainly there is no reason for treating them more leniently

8. Helvering v. Horst, 311 US 112 (1940). Facts: Respondent, the owner of negotiable
bonds, detached from the bonds negotiable interest coupons shortly before their due date
and delivered them as a gift to his son who in the same year collected them at maturity.
Petitioner ruled that under § 22 of the Revenue Act of 1934, 48 Stat. 686, the interest
payments were taxable, in the years when paid, to respondent donor who reported this
income on the cash receipts basis. The court of appeals reversed an order sustaining the
tax. Held: The rule that income is not taxable until realized has never been taken to
mean that a taxpayer who has fully enjoyed the benefit of the economic gain represented
by his right to receive income, can escape taxation because he has not himself received
payment. One who gives away his right to interest income in advance of payment does
not escape taxation because he did not actually receive the money. His obvious exercise
of such control supports the idea that he had earned the interest and that it was taxable
to him. The dominant purpose of the income tax laws is the taxation of income to those
who earn or otherwise create the right to receive it and who enjoy the benefit of it when
paid. In this case, the Court noted that the rule that income is not taxable until realized
has never been taken to mean that the taxpayer even on the cash receipts basis, who has
fully enjoyed the benefit of the economic gain represented by his right to receive income,
can escape taxation because he has not himself received payment of it from his
obligor. The Court posited that the taxpayer has equally enjoyed the fruits of his labor or
investment and obtained the satisfaction of his desires whether he collects and uses the
income to procure those satisfactions, or whether he disposes of his right to collect it as
the means of procuring them. In this case, the Court ruled that although the donor, by
the transfer of the coupons, has precluded any possibility of his collecting them himself,
he has nevertheless, by his act, procured payment of the interest as a valuable gift to a
member of his family. As such, the Court held that that the deficiency was properly
assessed against respondent because when respondent gave the gift of the coupons, he
separated his right to interest payments from his investment and procured the payment
of the interest to his donee and enjoyed the economic benefits of the income in the same
manner and to the same extent as though the transfer were of earnings.

9. CIR v. Isabela Cultural Corp., G.R. No. 17223, February 12, 2007. Facts: During the
audit of ICC’s books for taxable year 1986, the following BIR disallowed the following
expenses: a) expenses for auditing services for the year 1985; b) expenses for legal
services for the years 1984 and 1985; and c) expenses for security services for 1986.
Moreover, the BIR alleged that ICC understated it’s interest income on the three
promissory notes from Realty Investment Inc. Held: Accounting methods for tax
purposes comprise a set of rules for determining when and how to report income and
deductions. In the instant case, the accounting method used by ICC is the accrual method.
Revenue Audit Memorandum Order No. 1-2000, provides that under the accrual method
of accounting, expenses not being claimed as deductions by a taxpayer in the current year
when they are incurred cannot be claimed as deduction from income for the succeeding
year. Thus, a taxpayer who is authorized to deduct certain expenses and other allowable
deductions for the current year but failed to do so cannot deduct the same for the next
year. The accrual method relies upon the taxpayer’s right to receive amounts or its
obligation to pay them, in opposition to actual receipt or payment, which characterizes
the cash method of accounting. Amounts of income accrue where the right to receive
them become fixed, where there is created an enforceable liability. Similarly, liabilities are
accrued when fixed and determinable in amount, without regard to indeterminacy merely
of time of payment. For a taxpayer using the accrual method, the determinative question
is, when do the facts present themselves in such a manner that the taxpayer must
recognize income or expense? The accrual of income and expense is permitted when the
all-events test has been met. This test requires: (1) fixing of a right to income or liability
to pay; and (2) the availability of the reasonable accurate determination of such income
or liability. The all-events test requires the right to income or liability be fixed, and the
amount of such income or liability be determined with reasonable accuracy. However, the
test does not demand that the amount of income or liability be known absolutely, only
that a taxpayer has at his disposal the information necessary to compute the amount with
reasonable accuracy. The all-events test is satisfied where computation remains uncertain,
if its basis is unchangeable; the test is satisfied where a computation may be unknown,
but is not as much as unknowable, within the taxable year. The amount of liability
does not have to be determined exactly; it must be determined with
"reasonable accuracy." Accordingly, the term "reasonable accuracy" implies
something less than an exact or completely accurate amount. The propriety of
an accrual must be judged by the facts that a taxpayer knew, or could
reasonably be expected to have known, at the closing of its books for the
taxable year. Accrual method of accounting presents largely a question of fact; such
that the taxpayer bears the burden of proof of establishing the accrual of an item of
income or deduction. Corollarily, it is a governing principle in taxation that tax exemptions
must be construed in strictissimi juris against the taxpayer and liberally in favor of the
taxing authority; and one who claims an exemption must be able to justify the same by
the clearest grant of organic or statute law. An exemption from the common burden
cannot be permitted to exist upon vague implications. And since a deduction for income
tax purposes partakes of the nature of a tax exemption, then it must also be strictly
construed. In the instant case, the expenses for professional fees consist of expenses for
legal and auditing services. The expenses for legal services pertain to the 1984 and 1985
legal and retainer fees of the law firm Bengzon Zarraga Narciso Cudala Pecson Azcuna &
Bengson, and for reimbursement of the expenses of said firm in connection with ICC’s tax
problems for the year 1984. As testified by the Treasurer of ICC, the firm has been its
counsel since the 1960’s. From the nature of the claimed deductions and the span of time
during which the firm was retained, ICC can be expected to have reasonably known the
retainer fees charged by the firm as well as the compensation for its legal services. The
failure to determine the exact amount of the expense during the taxable year when they
could have been claimed as deductions cannot thus be attributed solely to the delayed
billing of these liabilities by the firm. For one, ICC, in the exercise of due diligence could
have inquired into the amount of their obligation to the firm, especially so that it is using
the accrual method of accounting. For another, it could have reasonably determined the
amount of legal and retainer fees owing to its familiarity with the rates charged by their
long time legal consultant. As previously stated, the accrual method presents largely a
question of fact and that the taxpayer bears the burden of establishing the accrual of an
expense or income. However, ICC failed to discharge this burden. As to when the firm’s
performance of its services in connection with the 1984 tax problems were completed, or
whether ICC exercised reasonable diligence to inquire about the amount of its liability, or
whether it does or does not possess the information necessary to compute the amount of
said liability with reasonable accuracy, are questions of fact which ICC never established.
It simply relied on the defense of delayed billing by the firm and the company, which
under the circumstances, is not sufficient to exempt it from being charged with knowledge
of the reasonable amount of the expenses for legal and auditing services. In the same
vein, the professional fees of SGV & Co. for auditing the financial statements of ICC for
the year 1985 cannot be validly claimed as expense deductions in 1986. This is so because
ICC failed to present evidence showing that even with only "reasonable accuracy," as the
standard to ascertain its liability to SGV & Co. in the year 1985, it cannot determine the
professional fees which said company would charge for its services. ICC thus failed to
discharge the burden of proving that the claimed expense deductions for the professional
services were allowable deductions for the taxable year 1986. Hence, per Revenue Audit
Memorandum Order No. 1-2000, they cannot be validly deducted from its gross income
for the said year and were therefore properly disallowed by the BIR. As to the expenses
for security services, the records show that these expenses were incurred by ICC in
1986 and could therefore be properly claimed as deductions for the said year. Anent the
purported understatement of interest income from the promissory notes of Realty
Investment, Inc., we sustain the findings of the CTA and the Court of Appeals that no
such understatement exists and that only simple interest computation and not a
compounded one should have been applied by the BIR. There is indeed no stipulation
between the latter and ICC on the application of compounded interest. Under Article 1959
of the Civil Code, unless there is a stipulation to the contrary, interest due should not
further earn interest.

-END-
 LECTURE NOTES

TAXATION 1
Atty. Arnel A. dela Rosa, CPA, REB, REA

INCOME TAXATION

GROSS INCOME [SEC. 32(A)]

State the general statutory definition of gross income?

Section 32 of the NIRC provides for the general statutory definition of Gross Income, to wit:

“Except when otherwise provided in this Title [referring to Title II – Tax on Income], gross
income means all income derived from whatever source, including (but not limited to) the
following items:

(1) Compensation for services in whatever form paid, including, but not limited to fees,
salaries, wages, commissions, and similar items;
(2) Gross Income derived from the conduct of trade or business or the exercise of a
profession;
(3) Gains derived from dealings in property;
(4) Interests;
(5) Rents;
(6) Royalties;
(7) Dividends;
(8) Annuities;
(9) Prizes and winnings;
(10) Pensions; and
(11) Partner’s distributive share from the net income of the general professional
partnership.

What is the concept of “income from whatever source derived”? What does the said
phrase embrace?

The words “income from any source whatever“ disclose a legislative policy to include all income
not expressly exempted within the class of taxable income under our laws. (CIR v. British
Overseas Airways Corp., G.R. No. L-65773-74, April 30, 1987; see also CIR v. Air India, G.R. No.
72443, January 29, 1988)

The phrase embraces all income not expressly exempted within the class of taxable income under
our laws, irrespective of the voluntary or involuntary action of the taxpayer in producing the gains
and whether derived from legal or illegal sources. (De Leon citing Gutierrez v. Collector, CTA
Case No. 65, August 31, 1965)
Gross Income vs. Net Income vs. Taxable Income

Gross Income (Sec. 32A) is all income subject to tax. Net Income refers to gross income less
allowable deductions and exemptions. Taxable Income (Sec. 31) is the pertinent items of
gross income specified in the Code, less deductions, if any, authorized for such types of income
by this Code or other special laws.

a. Compensation Income

What Comprises Compensation Income

Compensation income, in general, means all remuneration for services performed by an employee
for his employer under an employer-employee relationship, unless specifically excluded by the
Code.

The name by which the remuneration for services is designated is immaterial. Thus, salaries,
wages, emoluments and honoraria, commissions, allowances (e.g. transportation, representation,
entertainment, and the like); fees including director’s fees, if the director is, at the same time an
employee of the employer/corporation; taxable bonuses and fringe benefits except those which
are subject to the fringe benefit tax under Section 33 of the Code and allowable “de minimis”
benefits; taxable pensions and retirement pay; and other income of a similar nature constitute
compensation income. (Sec. 2(a), RR 8-2018).

The basis upon which the remuneration is paid is immaterial in determining the whether the
remuneration constitutes compensation. Thus, it may be paid on the basis of piece-of-work, or
a percentage of profits; and may be paid hourly, daily, weekly, monthly or annually.

Remunerations for services constitute compensation even if the employer-employee relationship

no longer exist at the time of payment as the long as the services where rendered at the time
the relationship was in effect .

Employer-Employee Relationship, defined

Employer-Employee Relationship exists when a person for whom services were performed
(employer) has the right to control and direct an individual who performs the services (employee),
not only as to the result of the work to be accomplished but also as to the details, methods and
means by which it is accomplished. An employee is subject to the control of the employer not
only as to what shall be done, but how it shall be done. It is not necessary that the employer
actually exercises the right to direct or control the manner in which the services are performed.
It is sufficient that there exists a right to control the manner of doing the work. (Sec. 2(e), RR 8-
2018)
Some rules on inclusion of the corresponding amount of income from compensation
for services rendered.

1. If payment is made in case, the full amount received is subject to tax;

2. If the services are paid for with something other than money, the fair market value of the
thing taken in payment is the amount to be included as income (Sec. 31, RR 2-40)
3. If the services were rendered at a stipulated price, the absence of evidence to the
contrary, such price shall be presumed to be the fair market value of the compensation
received (Ibid);
4. Compensation paid to an employee of a corporation in its stock is to be treated as if the
corporation sold the stock for the market value and paid the employee in cash (Ibid);
5. Where living quarters are furnished in addition to cash salary, the rental value of such
quarters should be reported as income (Ibid) [except in case the same is subject to FBT
or furnished for the convenience of the employer.]

Are all Allowances given/furnished to the Employee by the Employer considered

Compensation Income?

General Rule – Yes.

Exceptions: If the allowances are:
1. given for the convenience of the employer (“Convenience of the Employer Rule”; see
BIR Ruling DA 013-2008, January 16, 2008); or
2. by their nature, necessary to employer’s business, trade or profession; or
3. subject to Fringe Benefit Tax; or
4. considered Allowable De Minimis Benefits; or
5. RATA given to government officials and employees under the GAA (BIR Ruling No. 062-
91)

Notes:
a. Any amount paid specifically, either as an advance or reimbursement for travelling,
representation and other bona fide ordinary and necessary expenses incurred or
reasonably expected to be incurred by the employee in the performance of his duties are
not compensation subject to withholding, if:
i. It must be ordinary and in the pursuit of trade, business of profession;
ii. Must be liquidated in accordance with specific requirements of substantiation (Sec.
34, NIRC). The excess advances over the actual expenses shall constitute taxable
income if not returned to the employer.
iii. If pre-computed on a daily basis, no substantiation requirement is required. (BIR
Ruling DA 013-2008)
b. Representation and Transportation Allowances (RATA) given to government officials and
employees under the General Appropriations Act are deemed reimbursement for expenses
incurred in the performance of the duties of the recipient government officials and
employees and thus are not considered as additional compensation taxable under the
regular individual income tax and subject to withholding tax. (BIR Ruling No. 062-91).

Convenience of Employer Rule, concept

Under this rule, fringe benefits and allowances furnished to the employee for and as a necessary
incident to the performance of his duties are not taxable.

Overtime, transportation allowance and duty allowance on night, graveyard shift, outstation or
out of town allowance for carrying on the business of the employer are not subject to fringe
benefit tax for being the convenience of the employer. Moreover, when they are pre-computed
on daily basis and paid while on assignment, they likewise are not subject to income tax and
withholding tax. (BIR Ruling DA 013-2008, January 16, 2008)

Case: Collector v. Hendereson, G.R. No. L-12954, February 28, 1961. Held: The evidence
presented at the hearing of the case substantially supports the findings of the Court of Tax
Appeals. The taxpayers are childless and are the only two in the family. The quarters, therefore,
that they occupied at the Embassy Apartments consisting of a large sala, three bedrooms, dining
room, two bathrooms, kitchen and a large porch, and at the Rosaria Apartments consisting of a
kitchen, sala dining room, two bedrooms and a bathroom, exceeded their personal needs. But
the exigencies of the husband-taxpayer's high executive position, not to mention social standing,
demanded and compelled them to live in a more spacious and pretentious quarters like the ones
they had occupied. Although entertaining and putting up houseguests and guests of the husband-
taxpayer's employer-corporation were not his pre-dominant occupation as president, yet he and
his wife had to entertain and put up houseguests in their apartments. That is why his employer-
corporation had to grant him allowances for rental and utilities in addition to his annual basic
salary to take care of those extra expenses for rental and utilities in excess of their personal
needs. Hence, the fact that the taxpayers had to live or did not have to live in the apartments
chosen by the husband-taxpayer's employer-corporation is of no moment, for no part of the
allowances in question redounded to their personal benefit or was retained by them. Their bills
for rental and utilities were paid directly by the employer-corporation to the creditors (Exhibit AA
to DDD, inclusive; pp. 104, 170-193, t.s.n.). Nevertheless, as correctly held by the Court of Tax
Appeals, the taxpayers are entitled only to a ratable value of the allowances in question, and only
the amount of P4,800 annually, the reasonable amount they would have spent for house rental
and utilities such as light, water, telephone, etc., should be the amount subject to tax, and the
excess considered as expenses of the corporation. Likewise, the findings of the Court of Tax
Appeals that the wife-taxpayer had to make the trip to New York at the behest of her husband's
employer-corporation to help in drawing up the plans and specifications of a proposed building,
is also supported by the evidence. The parts of the letters written by the wife-taxpayer to her
husband while in New York and the letter written by the husband-taxpayer to Mr. C. V. Starr
support the said findings (Exhibits U-2, V-1, W-1, X). No part of the allowance for travelling
expenses redounded to the benefit of the taxpayers. Neither was a part thereof retained by them.
The fact that she had herself operated on for tumors while in New York was but incidental to her
stay there and she must have merely taken advantage of her presence in that city to undergo
the operation.
Are the Fees paid to the Corporation’s Director Compensation?

Yes, if he is likewise an employee of the Corporation (See definition of Compensation Income).

If the Director is not an employee of the Corporation, he is considered as a seller of services,

hence the Director’s Fees is considered as Business Income subject to Income Tax and possibly
Value Added Tax. (See RMC 34-2008, April 15, 2008)

Are Tips/Gratuities/Service Charges (RA No. 11360) considered compensation? Tax

Implication?

Tips and gratuities paid directly to an employee by a customer which are not accounted for by
the employee to the employer are taxable compensation income but not subject to withholding
tax.

Tips and gratuities/services charges which are: a) part of the bill to be paid directly by the
customer to the employer, or b) paid directly to the employee by the customer with an obligation
to account and remit the same to the employer, are taxable compensation income subject to
withholding tax.

What are De Minimis Benefits? Are these considered compensation income? What
are the tax implications? (See relevant provisions of RR No. 2-98, as amended by: RR Nos:
15-2011, 8-2012, 1-2015, 11-2018)

De Minimis Benefits are benefits of relatively small values provided by the employer to the
employee on top of the basic compensation intended for the general welfare of the employees.
Being of relatively small values, the same is not being considered as a taxable compensation and
as such, not subject to income tax and, consequently, withholding tax on compensation.

The following enumerates the updated list of non-taxable de minimis benefits:

1. Monetized unused vacation leave credits of private employees not exceeding ten (10) days
during the year;
2. Monetized value of vacation and sick leave credits paid to government officials and
employees;
3. Medical cash allowance to dependents of employees, not exceeding P1,500 per employee
or P250 per month;
4. Rice subsidy of P2,000 or one (1) sack of 50 kgs. rice per month amounting to not more
than P2,000;
5. Uniform and clothing allowance not exceeding P6,000 per annum;
6. Actual medical assistance, e.g. medical allowance to cover medical and healthcare needs,
annual medical/executive check-up, maternity assistance, and routine consultation, not
exceeding P10,000 per annum;
 7. Laundry allowance of not exceeding P300 per month;
8. Employees achievement awards, e.g. length of service or safety achievement, which must
be in the form of tangible personal property other than cash or gift certificate, with an
annual monetary value not exceeding P10,000 received by the employee under an
established written plan which does not discriminate in favor of highly paid employees;
9. Gifts made during Christmas and major anniversary celebrations not exceeding P5,000
per annum;
10. Daily meal allowance for overtime work and night/graveyard shift not exceeding 25% of
the basic minimum wage on per region basis;
11. Benefits received by an employee by virtue of a collective bargaining agreement (CBA)
and productivity incentive schemes provided that the total monetary value received from
both CBA and productivity incentive schemes combined do not exceed P10,000 per
employee per taxable year.

Note that all other benefits given by the employers which are not included in the above
enumeration shall not be considered as de-minimis; and hence shall either be subject to income
tax (consequently, to withholding tax on compensation, if given to rank and file employees) OR
fringe benefit tax (if given to managerial or supervisory employees).

Further, any amount or value given to employee above the limits provided above are subject
either to income tax (consequently, to withholding tax on compensation, if given to rank and file
employee) or fringe benefit tax (if given to managerial or supervisory employees).

However, such other benefit or amount paid in excess of the limit, if not subject to Fringe Benefit
Tax, shall be considered in computing the P90,000 exemption on 13th month pay and other
benefits as provided in Sec. 32(B)(7)(e), NIRC.

b. Business/Professional Income

General Formula in determining gross income from business, trade or exercise of

profession (See. Sec. 27(A), NIRC; Sec. 43, RR 2-40)

Gross Sales/Gross Receipts Pxxxxxx

Less: Sales Returns, Allowances & Discounts Pxxxxxx
Net Sales/Receipts Pxxxxxx
Less: Cost of Sales Pxxxxxx
Gross Profit from Sales Pxxxxxx
Add: Other Income/Gains Pxxxxxx
Gross Income Pxxxxxx
=====

In determining the gross income, subtractions should not be made for depreciation, depletion,
selling expenses, losses, or for items not ordinarily used in computing the cost of good sold.
How is gross income (and net income) from “long term contracts determined?

It is determined using percentage of completion method. (Sec. 48, NIRC).

c. Gains Derived from Dealings in Property

What is included in gross income derived from dealings in property?

It includes all income derived from the disposition of property, whether real, personal, or mixed,
for money (sale) or for other property (exchange) or for a combination of both, which result in
gain (or loss) because of the difference between the taxpayer’s investment in what he disposed
of and the value of what he received. The general rule is that the entire amount of gain (or loss,
as the case maybe) arising therefrom is a taxable gain (or a deductible loss).

How is gain (or loss) from sale or exchange of property computed? [Sec. 40 (A), NIRC]

Formula: Amount realized less basis or adjusted basis = gain (loss)

What the meaning of amount realized?

It means the sum of money plus the fair market value of the property [FMV is defined in Section
6(E), i.e. ZV or the FMV as determined by the Assessor)

What is the Basis for determining Gain or Loss from Sale or Disposition of Property?
[Sec. 40(B)]

1. Cost if the property is acquired by purchase on or after March 1, 1913;

2. The Fair Market Price or Value as of the date of acquisition, if acquired by inheritance;
3. If the property is acquired by Gift, the same basis as if it would be in the hands of the
donor or last preceding owner by whom it was not acquired by gift, except that if such
basis is greater than the fair market value of the property at the time of the gift, then for
purposes of determining the loss, the basis shall be such fair market value;
4. If the property was acquired for less than an adequate consideration in money or money’s
worth, the basis is the amount paid by the transferee for the property; or
5. The basis as defined in Section 40(C)(5) if the property is acquired under a tax-free
exchanges transaction under Section 40(C)(2).

Note: We shall discuss this in detail when we take up Section 40.

 d. Passive Income

Define Passive Income.

Income in which the taxpayer merely waits for the amount to come in. It consists of interest,
dividends, royalties, and rental income.

What is included in income derived from interest?

Interest income is only such interest as arises from indebtedness, i.e. compensation for the loan
or forbearance of money, goods, or credits. Unless exempted by law, interest received by a
taxpayer, whether or not usurious, is taxable.

What is included in income derived from rent/royalty.

Rents may be derived not only from real estate but also from the use of personal property. Like
rents, royalties are payments for the use of property. They include earnings from copyrights,
trademarks, patents, and natural resources under lease.

Buildings/Improvements constructed or introduced by the Lessee.

Buildings constructed or improvements introduced by the lessee pursuant to the lease which will
become the property of the lessor at the expiration or termination of the lease without
compensating the lessee for the value thereof, is taxable income of the lessor.

Lessor may choose the following methods of reporting income.

a) He may report as income at the time when such building or improvement are completed
at fair market value of such building or improvements subject to the lease; or

b) He may spread over the life of the lease the estimated depreciated value of such buildings
or improvements at the termination of the lease and report as income for each year of
the lease an aliquot part thereof. (Sec. 49, RR 2-40).

Illustration:

X leased his lot to Y for 10 years at an annual rent of P120,000.00. Y, pursuant to the
lease contract, erected a building on the lot with a cost of P2,000,000.00 with estimated life of
25 years. The building will become the property of X after the term of the lease. How much is
the rental income to be reported by Y during Year 1 if lease started on January 1, 2019? Assume
the building was completed on the same date.

Pre-termination of the lease, effect.

If for any other reason than a bona fide purchase from the lessee by the lessor the lease is
terminated, so that the lessor becomes into possession or control of the property prior to the time
originally fixed for the termination of the lease, the lessor receives additional income for the year
in which the lease is so terminated to the extent that the value of such buildings or improvements
when he became entitled to such possession exceeds the amount already reported as income on
account of the erection of such buildings or improvements. No appreciation in value due to
causes other than the premature termination of the lease shall be included. (Ibid.)

Illustration: In the above example, how much additional income should X report if the lease is
pre-terminated on January 1, 2026?

Destruction of the buildings/improvements prior to the expiration of the lease.

If the buildings or improvements are destroyed prior to the expiration of the lease, the lessor is
entitled to deduct as a loss for the year when such destruction takes place the amount previously
reported as income because of the erection of such buildings or improvement, less any salvage
value of the lease to the extent that such loss was not compensated for by insurance. (Ibid.)

Illustration. Same problem, however, on January 1, 2022, the building was destroyed. How much
loss is to be recognized by X, if there is a salvage value of P20,000.00 without insurance? How
about if there is an insurance of P500,000?

How is income from Dividends Treated For Income Tax Purposes?

Dividends means any distribution made by a corporation out of its earnings or profits and payable
to its shareholders, whether in money or in other property. [Sec. 73(A), NIRC]

Cash Dividend – taxable to the extent of the cash received.

Property Dividend – taxable to the extent of the fair market value of the property received at the
time of its distribution.

Stock Dividend – general rule, not taxable, except:

a. In case there is a redemption or cancellation of stocks issued as a dividend, the amount
so distributed in redemption or cancellation of the stock shall be taxable to the extent that
it represents a distribution of earnings [Section 73(B), NIRC];
b. In case there is a resulting change in the proportionate interest of the stockholder in the
corporation (applying doctrine of proprietary interest), to the extent of the fair market
value of the new stocks issued;
c. In case the stockholder subsequently sells the stock dividend (severance test), will only
result in taxable gain from sale of capital asset (i.e. not the entire proceeds is taxable)
[Sec. 253, RR 2-40];
Script dividend (i.e. promissory note is given], taxable to the extent of the fair market value
of the script dividend;
 Liquidating Dividend – gain realized or loss sustained by the stockholder, whether individual
or corporation, is taxable income or a deductible loss, as the case maybe [Sec. 73(A), NIRC].

EXCLUSIONS FROM GROSS INCOME [SEC. 32(B)]

Under the 1997 NIRC, “Exclusions” refer to items that are not included in the determination of
gross income either because:
1. They represent return of capital or are not income, gain, or profit; or
2. They are subject to another kind of internal revenue tax;
3. They are income, gain, profit that are expressly exempt from income tax under the
constitution, tax treaty, the Tax Code, or a general or special law.

Who may avail of these Exclusions?

Generally, all taxpayers may avail of the exclusions unless expressly excluded by law.

1. Life Insurance – proceeds of life insurance policies paid to heirs or beneficiaries upon
the death of the insured, whether in a single lumpsum or otherwise, but if such amounts
are held by the insurer under an agreement to pay interest thereon, the interest
payments shall be included in the gross income.

Case: El Oriente Fabrica de Tabacos v. Posadas, G.R. No. 34774, September 21,
1913. Fact: Petitioner insured the life of its Manager, paying the premiums thereon, and
made designated itself as the beneficiary thereof. Manager died, petitioner received the
proceeds of the life insurance policy but did not report the same as part of its gross
income, hence assessed by the CIR. Held: x x x considering the lack of express
legislative intention to tax the proceeds of life insurance policies paid to corporate
beneficiaries on this subject, the clause is inserted “exempt from the provisions of this
law,” we deem it reasonable to hold the proceeds of the life insurance policy in question
as representing an indemnity and not taxable income.

2. Return of Premium – the amount received by the insured, as a return of premiums paid
by him under life insurance, endowment, or annuity contracts, either during the term or
at the maturity of the term mentioned in the contract or upon surrender of the contract.

(Note: If such amounts [when added to the amount already received before the taxable
year under such contract] exceeds the aggregate premiums or considerations paid
[whether or not paid during the taxable year], then the excess shall be included in the
gross income.)

3. Gifts, bequests, and devises – The value of the property acquired by gift, bequest,
devise, or descent: Provided, however, that the income from such property, as well as
gift, bequest, devise, or descent of income from any property, in cases of transfers of
undivided interest, shall be included in the gross income.
 (Note: If the amount received is on account of services rendered, whether constituting
a demandable debt or not, or the use of the opportunity to use a capital, the receipt is
income [Pirovano v. Commissioner, 14 SCRA 832)

4. Compensation for Injuries or Sickness – Amounts received, through Accident or

Health Insurance or under Workmen’s Compensation Act, as compensation for personal
injuries or sickness, plus the amount of any damages received, whether by suit or
agreement, on account of such injuries or sickness.

(Note: The phrase “personal injuries” should be given a restrictive meaning to only refer
to physical injuries. The theory for this is that recoupment on account of such losses is
not income, since it is not derived from capital, from labor or from both combined. And
the fact that the payment of compensation for such loss was voluntary does not change
its exempt status. It was in fact compensation for a loss, which impaired petitioner’s
capital.)

5. Income Exempt under Treaty – Income of any kind, to the extent required by any
treaty obligation binding upon the Government of the Philippines.

6. Retirement Benefits, Pensions, Gratuities, etc. –

a. Retirement benefits received under RA 7641, AND those received by officials and
employees of private firms, whether individual or corporate, in accordance with a
reasonable private benefit plan maintained by the employer; Provided:

i. That the retiring official or employee has been in service of the same employer
for at least 10 years and is not less than 50 years of age at the time of his
retirement;
ii. That the benefits granted under this subparagraph shall be availed of by an
official or employee only once.

Reasonable private benefit plan means a pension, gratuity, stock bonus or

profit-sharing plan maintained by an employer for the benefit of some or all of his
officials or employees, wherein contributions are made by such employer for the
officials or employees, or both, for the purpose of distributing to such officials and
employees the earnings and principal of the fund thus accumulated, and wherein
it is provided that at no time shall any part of the corpus or income of the fund
be used for, or be diverted to, any purpose than for the exclusive benefit of the
said officials and employees.

(Compare this to Section 60(B), NIRC.)

(Notes: Aside from the conditions mentioned above, the plan must likewise be approved by
the BIR pursuant to RR No. 2-98.

In case the conditions set forth above is not met, then the retirement benefits shall
be included in the gross income.)
 Case: Santos v. Servier Philippines, Inc., G.R. No. 166377, November 28,
2008. Facts: Servier was constrained to terminate Santos’ employment
(employee for 8 years) because the latter had not fully recovered mentally and
physically from her illness. As a consequence thereof, Santos was offered, among
others, a retirement plan benefits of P1,063,841. However, of the said amount,
only P701,454.89 was paid to her, the difference was allegedly withheld for tax
purposes. Servier likewise failed to give the other benefits promised to her. Hence,
Santos filed case before the NLRC. Held: For retirement benefits to be exempt
from withholding tax, the taxpayer is burdened to prove the concurrence of the
following: (1) a reasonable private plan is maintained by the employer; (2) the
retiring official or employee has been in the service of the same employer for at
least 10 years; (3) the retiring official or employee is not less than 50 years of age
at the time of retirement; and (4) the benefit had been availed of only once.
Petitioner was qualified for disability retirement. At the time of such retirement,
petitioner was only 41 years of age; and had been in the service for more or less
8 years. As such, the above provision is not applicable for failure to comply with
the age and length of service requirements. Therefore, respondent cannot be
faulted for deducting from petitioner’s total retirement benefits the amount of
P362,386.87, for taxation purposes.

b. Any amount received by an official or employee or by his heirs from the employer
as a consequence of separation of such official or employee from the service of
the employer because of death, sickness or other physical disability, or for any
cause beyond the control of the said official or employee.

(Notes: “for any cause beyond the control of the said official or employee connotes
involuntariness on the part of the said official or employee; separation must not be asked or
initiated by the official or employee. Thus, separation pay given or paid by the employer will
form part of the gross income if the employee initiates the separation.)

Case: PLDT v. CIR, GR No. 157264, January 31, 2008. (Separation pay due to
redundancy) Held: Proof of receipt by employees of the pay and the remittance
of the withholding tax to the BIR are material to the claim for refund of erroneously
paid withholding tax on separation pay. Also, it must be shown that employees
declared the income and the tax paid to the BIR through withholding.

Case: Re: Request of Atty. Bernardo Zialcita, Admin Matter No. 90-6-015-
SC, October 18, 1990. Issue: The issue here is the tax treatment of the
commutation of his accumulated leave credits (terminal leave pay) of Atty. Zialcita.
Held: 1) Upon his compulsory retirement, he is entitled to the commutation of his
accumulated leave credits to its money value. Within the purview of Section
28(B)(7)(b) [now Section 32(B)(6)(B)] of the NIRC, compulsory retirement may
be considered as a “cause beyond the control of the said official or employee”.
Consequently, the amount that he received by way of commutation of his
accumulated leave credits as a result of his compulsory retirement, or his terminal
 leave pay, falls with the enumerated exclusions from the gross income and is
therefore not subject to tax. 2) The terminal leave pay of Atty. Zialcita may
likewise be viewed as a "retirement gratuity received by government officials and
employees" which is also another exclusion from gross income as provided for in
Section 28(b), 7(f) of the NIRC. A gratuity is that paid to the beneficiary for past
services rendered purely out of generosity of the giver or grantor. (Peralta v.
Auditor General, 100 Phil, 1051 [1957]) It is a mere bounty given by the
government in consideration or in recognition of meritorious services and springs
from the appreciation and graciousness of the government. (Pirovano v. De
la Rama Steamship Co., 96 Phil. 335, 357 [1954]) When a government employee
chooses to go to work rather than absent himself and consume his leave credits,
there is no doubt that the government is thereby benefited by the employee's
uninterrupted and continuous service. It is in cognizance of this fact that laws
were passed entitling retiring government employees, among others, to the
commutation of their accumulated leave credits. That which is given to him after
retirement is out of the Government's generosity and an appreciation for his having
continued working when he could very well have gone on vacation. Section 286
of Revised Administrative Code, as amended by RA 1081, provides that "whenever
any officer, employee or laborer of the Government of the Philippines shall
voluntarily resign or be separated from the service through no fault of his own, he
shallbe entitled to the commutation of all accumulated vacation and/or sick leave
to his credit: xxx." (Underlining supplied) Executive Order No. 1077, mentioned
above, later amended Section 286 by removing the limitation on the number of
leave days that may be accumulated and explicitly allowing retiring government
employees to commute their accumulated leaves. The commutation of
accumulated leave credits may thus be considered a retirement gratuity, within
the import of Section 28(b), 7(f) of the NIRC, since it is given only upon retirement
and in consideration of the retiree's meritorious services. It is clear that the law
expresses the government's appreciation for many years of service already
rendered and the clear intention to reward faithful and often underpaid workers
after the official relationship had been terminated.

c. The provisions of any existing law to the contrary notwithstanding, social security
benefits, retirement gratuities, pensions and other similar benefits received by
resident or non-resident citizens of the Philippines or aliens who come to reside
permanently in the Philippines from foreign government agencies and other
institutions, private or public.

d. Payments of benefits due or to become due to any person residing in the

Philippines under the laws of United States administered by the United States
Veterans Administration.

e. Benefits received from or enjoyed under the Social Security System in accordance
with the provisions of RA 8282;
 f. Benefits received from the GSIS under RA No. 8291, including retirement gratuity
received by government officials and employees.

7. Miscellaneous Items –

a. Income Derived by Foreign Government – Income derived from investments in the

Philippines in loans, stocks, bonds, or other domestic securities, or from interest
on deposits in banks in the Philippines by (i) foreign governments, (ii) financing
institutions owned, controlled, or enjoying refinancing from foreign governments;
and (iii) international or regional financial institutions established by foreign
governments.

b. Income Derived by the Government or its Political Subdivisions – Income derived

from any public utility or from the exercise of any essential governmental functions
accruing to the government of the Philippines or to any political subdivision.

c. Prizes and Awards. – Prizes and awards made primarily in recognition of religious,
charitable, educational, artistic, literary, or civic achievement but only if:

i. The recipient was selected without any action on his part to enter the contest
or proceedings; and
ii. The recipient is not required to render substantial future services as a condition
to receiving the prize or award.

(Note: if the conditions are not met, such as when the taxpayer nominated himself to the award,
the prize/award is part of the gross income)

d. Prizes and Awards in Sports Competition – All prizes and awards granted to
athletes in local and international sports competitions and tournaments whether
held in the Philippines or abroad and sanctioned by their national sports
association.

(Note: If the conditions are not met, such as when the competition is not sanctioned by the
national sports association, the prize or awards are part of the gross income)

e. 13th Month Pay and Other Benefits – Gross benefits received by officials and
employees of public and private entities; Provided, however, That the total
exclusion under this subparagraph shall not exceed ninety thousand (P90,000.00)
which shall cover:

i. Benefits received by officials and employees of the national and local

government pursuant to RA NO. 6686;
 ii. Benefits received by employees pursuant to PD NO. 851, as amended by
Memorandum Order No. 28, dated August 13, 1986;

iii. Benefits received by officials and employees not covered by PD No. 851, as
amended by Memorandum Order No. 28, dated August 13, 1986; and

iv. Other benefits such as productivity incentives and Christmas Bonus

(Note: The amount in excess is part of the gross income of the employee or
official)

f. GSIS, SSS, Medicate and other Contributions – GSIS, SSS, Medicare and Pag-Ibig
contributions and union dues of individuals.
g. Gains from the Sale of Bonds, Debentures, and other Certificate of Indebtedness
– Gains realized from the sale or exchange or retirement of bonds, debentures or
other certificate of indebtedness with a maturity of five (5) years.

(Note: If the maturity is less than 5 years, the gain is included in the gross income)

h. Gains from Redemption of Shares in Mutual Fund. Gains realized by the investor
upon redemption of shares of stocks in a mutual fund company as defined in
Section 22(BB) of this Code.

DEDUCTIONS FROM GROSS INCOME

Defined

Deductions are items or amounts which the law allows to be deducted from gross income in order
to arrive at net or taxable income.

What is the treatment of return of capital?

Income tax is levied by law only on income; hence, the amount representing return of capital
(e.g. cost of goods sold) should be deducted from the proceeds of sale and should not be subject
to income tax.

Distinguish Exclusions from Deductions

Exclusion (Sec. 32(B)) Deduction (Sec. 34)

Refer to flow of wealth which are not treated Refer to the amounts which the law allows to
as part of the gross income because: a) these be subtracted from the gross income in order
to arrive at the net income.
 are exempted by law or statute; or b) they do
not come within the definition of income
Pertain to the computation of gross income Pertain to the computation of net income
Something earned by the taxpayer which do Something spent or paid in earning the gross
not form part of the gross income income

Deduction vs. Tax Credits

Deductions are the expenses and other allowable deductions as provided by law which are
incurred for engaging in trade, business or profession, deducted from the gross income to arrive
at the net or taxable income.

Tax Credits are amount of tax previously paid by the taxpayer which later on can be claimed as
tax credit from the tax liability of the taxpayer. It is deducted from the computed tax liability to
arrive at tax still due. (E.g. Creditable Withholding Tax)

Give the basic principles governing deductions

1. The taxpayer seeking a deduction must point to some specific provision of the statute
authorizing the deduction;
2. He must be able to prove that he is entitled to the deduction authorized or allowed (Atlas
Consolidated Mining v. Commissioner, G.R. No. L-26911, January 21, 1981)

Note: Deductions for income tax purposes partake of the nature of a tax exemption; hence, just
like tax exemptions, deductions must be construed in strictissimi juris against the taxpayer.

May Deductions be created by implication?

No. Deductions have generally been deemed to be a matter of legislative grace. They are allowed
only where there is a clear provision in the statute for the deduction claimed; and where particular
deductions are authorized by the statute, no other may be made. The taxpayer has the burden
of justifying the allowance of any deduction claimed by him.

May the taxpayer deduct lesser amount of deductions or not to deduct at all?

Definitely. For income tax purposes a taxpayer is free to deduct from its gross income a lesser
amount, or not to claim any deduction at all. What is prohibited by the income tax law is to
claim a deduction beyond the amount authorized therein. (CIR V. Phoenix Assurance Co., Ltd.,
G.R. No. L-19727, May 20, 1965)

Basis: Lifeblood doctrine

Who are not allowed to claim deductions?

 1. Individuals receiving compensation income;
2. Non-Resident aliens not engaged in trade or business;
3. Aliens (also Filipinos similarly situated) employed in ROHQ, RAHQ, OBU, Petroleum
Contractors;
4. Non-Resident Foreign Corporations;
5. Income subject to Final Withholding Tax

In general, what are the deductions from gross income authorized by the NIRC?

1. Itemized or Actual Deductions – These are the allowable deductions enumerated

under Section 34 of the NIRC.

2. Optional Standard Deductions – is a standard deduction in an amount not exceeding

40% of the gross sales/receipt of individuals, other than non-resident aliens, or 40% of
gross income corporations in lieu of the itemized deductions.

What are the itemized deductions under Section 34?

The allowable itemized deductions from gross income are:

1. Expenses
2. Interests on indebtedness
3. Taxes in connection with taxpayer’s business, trade or profession;
4. Losses
5. Bad debts
6. Depreciation
7. Depletion of oil and gas wells and mines
8. Charitable and other contributions
9. Research and Development expenditures
10. Contribution to pension trust

Special deductions
1. Deductions allowed to private proprietary educational institutions and hospitals that are
non-profit [Sec. 34(A)(2)];
2. Deductions allowed to insurance companies (Sec. 37);
3. Deductions allowed to Estates and Trusts (Sec. 61)

What are the items not deductible in computing net income?

1. Personal, living and family expenses (note: Section 35 on Personal Exemptions for
Individual Taxpayer has been repealed by RA 10963, TRAIN Law);
2. Any amount paid out for new building or permanent improvements, or betterment made
to increase the value of any property or estate, except intangible drilling and development
cost in petroleum operations;
 3. Any amount expended in restoring property or in making good the exhaustion thereof for
which an allowance is or has been made;
4. Premiums paid on any life insurance policy covering the life of any officer or employee, or
of any person financially interested in any trade or business carried on by the taxpayer,
individual or corporate, when the taxpayer is directly or indirectly a beneficiary under such
policy.
5. Losses from sale or exchanges of property between related parties;
6. Losses from wash sales of stocks or securities unless the claim is made by a dealer in
stock or securities and with respect to a transaction made in the ordinary course of
business of such dealer;
7. Non-deductible taxes
8. Non-deductible losses;
9. Non-deductible interests

Rules on Optional Standard Deduction [Sec. 34(L)]

1. Who are allowed to avail?

a. Individuals except non-resident alien;
b. Domestic and Resident Foreign Corporation
c. General Professional Partnership and its individual partners but may be availed only
once, either the GPP or the partners

2. Rate
a. Individuals – 40% of Gross Sales or Gross Receipts
b. Corporation – 40% of Gross Income as defined in Sec. 32
c. GPP – 40% of ? (the law is silent) but under RR No. 8-2018, its was interpreted to
mean 40% of gross income. See below

3. OSD/Itemized Deduction, how elected. The default deduction is Itemized Deduction;

thus, unless the taxpayer signifies in his return his/its intention to avail of the OSD, he is
deemed to have availed the itemized deduction. Such election of the option, when the
return is made, shall be irrevocable for the taxable year for which the return is made. The
election to claim either the itemized deduction or the OSD for the taxable year must be
signified by checking the appropriate box in the ITR filed for the first quarter of the taxable
year or the initial quarter of the taxable year after the commencement of a new
business/practice of profession. Once the election is made, it must be consistently applied
to all the succeeding quarterly returns and in the final income tax return for the taxable
year.

4. Substantiation requirements. No need to keep records of the expenses. However, the

individual taxpayer shall keep such records pertaining to his gross sales/receipts, while
the corporation, its records pertaining to its gross income as defined under Section 32.

5. Submission of Financial Statement – Individuals who opted OSD, no need to submit FS.

Determination of the OSD for GPPs and Partners of GPPs (RR No. 8-2011)
GPP is not subject to income tax imposed pursuant to Section 26 of the Tax Code, as
amended. However, the partners shall be liable to pay income tax on their separate and
individual capacities for the respective distributive shares in the net income of the GPP.

The GPP is not a taxable entity for income tax purposes since it is only acting as a “pass
through” entity where its income is ultimately taxed to the partners comprising it. Section 26
of the Tax Code, as amended, likewise provides that – “For purposes of computing the
distributive shares of the partners, the net income of the GPP shall be computed in the same
manner as a corporation.” As such, a GPP may claim either the itemized deductions allowed
under Section 34 of the Code or in lieu thereof, it can opt to avail of the OSD allowed to
corporations in claiming the deductions in an amount not exceeding forty percent (40%) of
its gross income.

xxx

The distributable net income of the partnership may be determined by claiming either
itemized deductions or OSD. The share in the net income of the partnership, actually or
constructively received, shall be reported as taxable income of each partner. The partners
comprising the GPP can no longer claim further deduction from their distributive share in the
net income of the GPP and are not allowed to avail of the 8% income tax rate option since
their distributive share from the GPP is already net of cost and expenses.

If the partners also derive other income from trade, business or practice of profession apart
and distinct from the share in the net income of the GPP, the deduction can be claimed from
the other income would either be the itemized deductions or OSD.
 LECTURE NOTES

TAXATION 1
Atty. Arnel A. dela Rosa, CPA, REB, REA

INCOME TAXATION

INDIVIDUAL INCOME TAX

References:
a. Section 24 to 26, NIRC
b. RR No. 8-2018
https://www.bir.gov.ph/images/bir_files/internal_communications_1/Full%20Text%2
0RR%202018/RR%20No.%208-2018.pdf

A. PERSONS SUBJECT TO INDIVIDUAL INCOME TAX

For income tax purposes, individuals are classified into:

1. Citizen

a. Resident citizen (RC) – is a citizen of the Philippines who was permanent

home or place of abode in the Philippines to which s/he intends to return
whenever s/he is absent for business or pleasure.

b. Non-resident citizen (NRC) – is a citizen of the Philippines who: a)

establishes the fact of his/her physical presence abroad with the definite
intention to reside therein; b) leaves the country to reside abroad, either as an
immigrant or for employment on a permanent basis; (c) works and derives
income abroad and whose employment thereat requires him to be physically
present abroad most of the time during the taxable year; or d) who has been
considered non-resident citizen previously and who arrives in the Philippines at
anytime during the taxable year to reside permanently in the Philippines shall be
treated as non-resident citizen for the taxable year in which he arrives in the
Philippines with respect to his income abroad until the date of his arrival in the
Philippines. [Sec. 22 E)]

2. Alien

a. Resident alien (RA) – is an individual who is not a citizen of the Philippines but
whose residence is within the Philippines. [Sec. 22(F)]
 b. Non-resident alien (NRA) – is an individual who is not a citizen of the
Philippines and whose residence is not within the Philippines. [Sec. 22(G)]

i. A non-resident alien is deemed engaged in trade or business in

the Philippines (NRAETBP) if s/he has stayed in the Philippines for an
aggregate period of more than 180 days during any calendar year. [Sec.
25(A)(1)]

ii. Non-Resident alien NOT engaged in trade or business in the

Philippines (NRANETBP) – aggregate period of stay in the Philippines
is 180 days or less.

iii. Alien Individual employed in Regional or Area Headquarters

(RAHQ) or Regional Operating Headquarters (ROHQ) of
Multinational Companies.

➢ RAHQ – branch established by multinational companies and which

headquarters do not earn or derive income from the Philippines and
which acts as supervisory, communications and coordinating center for
their affiliates, subsidiaries, or branches in the Asia-Pacific Region [Sec.
22(DD)]

➢ ROHQ – branch established in the Philippines by multinational

companies which are engaged in any of the following services: general
administration and planning; business planning and coordination;
sourcing and procurement of raw materials and components; corporate
finance advisory services; marketing control and sales promotion;
training and personnel management; logistics services; research and
development services and product development; technical support and
maintenance; data processing and communications; and business
development. [Sec. 22(EE)]

iv. Alien Individual Employed by Offshore Banking Unit (OBU)

OBU – branch, subsidiary, or affiliate of a foreign banking corporation which

is duly authorized by the BSP to transact offshore banking business in the
Philippines. [Sec. 45, CBP Circular No. 1389, series of 1993]

Offshore Banking – refers to the conduct of banking transaction in foreign

currencies involving the receipts of funds principally from external
sources, and, as allowed by BSP, from internal sources and utilization of
such funds. (ibid)

v. Alien Individual Employed by Petroleum Service Contractor and

Subcontractor (PSCS)

3. Minimum Wage Earners (MWE)– worker in the private sector paid the statutory
minimum wage, or to an employee of the public sector with compensation income of not
 more than the statutory minimum wage in the non-agricultural sector where s/he is
assigned. [Sec. 229(HH)]

➢ Statutory Minimum Wage – refer to the rate fixed by the Regional Tripartite
Wage and Productivity Board, as defined by the Bureau of Labor and Employment
Statistics (BLES) of the DOLE. [Sec. 22(GG)]

B. INCOME SUBJECT TO TAX

1. Compensation Income (CI) – consists of income arising from employer-employee

relationship such as salaries, wages, emoluments and honoraria, commissions, taxable
bonuses and fringe benefits, taxable allowances (such as transportation, entertainment,
and the like), non-monetary compensation, director’s fees and the like (when the
director is also an employee), taxable pensions and retirement pay, amounts drawn as
salaries by partners of a general professional partnership, and other incomes of similar
nature unless specifically exempted or excluded by the Tax Code or other laws;

2. Business Income / Professional Income (BI)– consists of business and/or trade

income, fees from the exercise of profession, gains from sale or exchange of business
assets, commissions, rental income, and other income of similar nature.

3. Passive Income (PI) – consists of interests from bank deposits (including yields and
other monetary benefits from deposit substitutes and trust fund and similar
arrangements), royalties, prizes and other winnings, and dividends, unless specifically
exempted or excluded by the Tax Code or special law.

4. Gains from Dealings in Properties (GDP)– includes capital gains on sale of capital
assets, both real and personal properties, including shares of stocks.

5. Other Sources (OS) – e.g. informer’s reward, excess/unutilized campaign

funds/campaign contributions (pursuant to RR 7-2011), discovery of hidden treasures,
income from illegal sources, etc.

C. DETERMINATION OF TAXABLE INCOME

1. Citizen

a. RC – on income derived from sources within and without the Philippines, as

follows:

i. On CI – Taxable Income for compensation earners is the gross

compensation income less non-taxable income/benefits such as,
but not limited to, the 13th Month Pay and other Benefits (subject
to limitation pursuant to Sec. 32(B) and RR No. 8-2018) de minimis
benefits, and employee’s shares in the SSS, GSIS, PHIC, Pag-Ibig
Contributions) and union dues.
 ii. On BI – on net income basis, i.e. gross income from business/trade or
exercise of profession less either (a) itemized deduction, or (b) optional
standard deduction equivalent to an amount not exceeding 40% of gross
sales or gross receipts.

iii. On PI– on the gross amount thereof

iv. On GDP – on net capital gains thereof; except in case of sale of real
estate classified as capital asset, the taxable income is the amount of the
gains presumed to have been realized by the taxpayer, i.e. higher of
the selling price or the fair market value.

v. On OS – on gross amount thereof

b. NRC – taxed similarly as a resident citizen on incomes from sources within the
Philippines.

2. Aliens

a. RA – taxed similarly as a resident citizen on incomes derived from sources

within the Philippines.

b. NRA:

i. NRAETBP – taxed similarly as a resident citizen on incomes derived from

sources within the Philippines.

ii. NRANETBP – taxed on gross income from sources within the

Philippines

iii. Employed by RAHQ/ROHQ/OBU/Petroleum Services

Contractor/Subcontractor – taxed on gross income derived from such
employment.

D. EXCLUSIONS FROM GROSS INCOME

➢ See previous discussions on Sec. 32(B), NIRC.

➢ Additional Notes:

o Regarding compensation for injuries or sickness including damages received

[Sec. 32(B)(4). Republic Act No. 10369, entitled “An Act Providing for
Reparation and Recognition of Victims of Human Rights During the Marcos
Regime, Documentation of Said Violations, Appropriating Funds Therefor and
 For Other Purposes” (approved on February 25, 2013), provides for the
exemption from any type of tax of the reparation received by any qualified
human rights violation victim (HRVV) or the legal heirs of a deceased or
involuntary disappeared HRVV or such other person named by the executor
or administrator of the deceased or involuntary disappeared HRVV’s estate.

E. DEDUCTIONS FROM GROSS INCOME

1. RC

a. CI – non-taxable income/benefits (e.g. 13th month pay and other benefits,

subject to limitation), de minimis benefits, and employee’s share in SSS, GSIS,
Pag-Ibig, and PHIC contributions and union dues are allowed to be deducted
from the gross compensation income (See RR 8-2018).

(Note: the previous deductions/exemptions allowed, i.e. premium payments on

health/hospitalization, personal and additional exemptions for each dependent
has been removed under the TRAIN Law.)

b. BI – see previous discussions on Allowable Deductions.

Additional deduction. A lawyer or professional partnership rendering actual free

legal services, as defined by the Supreme Court, shall be entitled to an allowable
deduction from the gross income, the amount that could have been collected for
the actual free legal services rendered or up to ten percent (10%) of the gross
income derived from the actual performance of the legal profession, whichever is
lower; Provided, that the actual free legal services herein contemplated shall be
exclusive of the minimum sixty (60)-hour mandatory legal aid services rendered
to indigent litigants as required under the Rule on Mandatory Legal Aid Services
for Practicing Lawyers, under BAR Matter No. 2012 issued by the Supreme Court.
(Section 5, RA 9999, a.k.a. “Free Legal Assistance Act of 2010”, February 23,
2010)

c. PI – No deduction allowed.

d. GDP – generally, no deduction allowed. In case of sale of shares of stocks

issued by the domestic corporation and which are classified as capital asset,
capital losses are deducted from the capital gains.

e. OS – no deduction allowed.

2. NRC, RA – same deductions from BI allowed to RC.

3. NRAETBP – same deductions allowed from BI allowed to RC and subject to the same
conditions and limitations, except on the following items of deductions:
 a. Taxes – the deduction for taxes shall be allowed only if and to the extent that
they are connected with income from sources within the Philippines;

b. Losses – losses deductible shall be those actually sustained during the year
sustained in business, trade or exercise of a profession conducted within the
Philippines and not compensated for by insurance or other forms of indemnity.

c. Depreciation – a reasonable allowance for the deterioration of property arising

out of its use or employment or its non-use in the business, trade, or profession
on properties located in the Philippines.

d. Depletion of oil and gas wells and mines – the allowance for depletion of oil
and gas wells or mines is authorized only with respect to oil and gas wells or
mines located within the Philippines.

4. NRANETBP – No deductions allowed.

5. Aliens Employed by RAHQ, ROHQ, OBU, PSCS – no deductions allowed.

F. ITEMS NOT DEDUCTIBLE FROM GROSS INCOME (applicable to all Individual

Taxpayers)

1. Personal, living, or family expenses;

2. Amounts paid out for new buildings or for permanent improvements, or betterments
made which tend to increase the value of any property or estate;

3. Amounts spent for restoring property or in making good the exhaustion thereof for
which an allowance is or has been made;

4. Premiums paid on any life insurance policy covering the life of any officer or employee,
or of any person financial interested in any trade or business carried on by the taxpayer,
where the taxpayer is directly or indirectly a beneficiary under such policy;

5. Losses from sales or changes of property under certain conditions. (see previous
discussions on capital losses)

G. PERSONAL EXEMPTIONS – no more personal exemptions allowed under the TRAIN

Law.

H. INCOME TAX RATES

CITIZENS:
1. RC – on the total taxable income (i.e. CI, BI, PI, GDP, OS, except those that are subject
to Final Withholding Tax) from sources within and without the Philippines, the following
Tax Schedules [Sec. 24(A)(2) shall apply:

a. Effective January 1, 2018 until December 31, 2022

Amount of Taxable Income Tax Due

Over But Not Over Plus % In Excess of
P250,000.00 0%
P250,000.00 P400,000.00 P0.00 20% P250,000.00
P400,000.00 P800,000.00 P30,000.00 25% P400,000.00
P800,000.00 P2,000,000.00 P130,000.00 30% P800,000.00
P2,000,000.00 P8,000,000.00 P490,000.00 32% P2,000,000.00
P8,000,000.00 P2,410,000.00 35% P8,000,000.00

b. Effective January 1, 2023

Amount of Taxable Income Tax Due

Over But Not Over Plus % In Excess of
P250,000.00 0%
P250,000.00 P400,000.00 P0.00 15% P250,000.00
P400,000.00 P800,000.00 P22,500.00 20% P400,000.00
P800,000.00 P2,000,000.00 P102,500.00 25% P800,000.00
P2,000,000.00 P8,000,000.00 P402,500.00 30% P2,000,000.00
P8,000,000.00 P2,202,500.00 35% P8,000,000.00

Notes:
➢ For married individuals, the husband and wife, subject to the provisions of
Section 52, NIRC, shall compute separately their individual income tax based on their
respective total taxable income.
➢ If any income cannot be definitely attributed or identified as income exclusively
earned or realized by either of the spouses, the same shall be equally divided
between the spouses.

2. NRC - same as RC, but only on sources within the Philippines.

3. Filipinos employed and occupying the same position as those aliens employed
by RAHQ, ROHQ, OBU, PSCS –15% of Gross CI received therefrom. [Sec.
25(C)(D)(E); RR 12-2001]

➢ But effective January 1, 2018- Tax Schedule applies pursuant to the Veto
of PRRD to the Train Law.

ALIENS:

4. RA – same as RC, but only on sources within the Philippines

5. NRAETBP – same as RC, but only on sources within the Philippines

6. NRANETBP – 25% final tax on the gross CI, BI, PI, GDP, OS, including other fixed
and determinable gains, profit and income, except: a) on capital gains on sale or
exchange of shares of stocks issued by a domestic corporation not traded through the
local stock exchange, and b) capital gains on the sale or exchange of real property
classified as capital asset.

7. Aliens employed by RAHQ, ROHQ, OBU, PSCS - 15% of Gross CI received

therefrom. [Sec. 25(C)(D)(E); RR 12-2001]

➢ But effective January 1, 2018- Tax Schedule applies pursuant to the Veto
of PRRD to the Train Law.

See also: RR No. 8-2018, RMC No. 116-2019

SPECIAL RULES:

8. MWE – Their taxable income is exempt from payment of income tax. Also exempt from
income tax are MWE’s holiday pay, overtime pay, nightshift differential, and hazard pay
received by such MWE.

9. PURELY SELF-EMPLOYED INDIVIDUALS and/or PROFESSIONALS WHOSE

GROSS INCOME DO NOT EXCEED THE VALUE ADDED TAX (VAT) THRESHOLD
AS PROVIDED IN SECTION 109(BB):

Options:

a) 8% Tax on Gross Sales or Gross Receipts and other non-operating income in

excess of P250,000.00; OR

b) Tax Schedule

Note: Presently, the VAT threshold is P3,000,000.00

10. MIXED INCOME EARNERS (those earning both CI and BI)

a) On their CI – Tax Schedule Applies; AND

b) On their BI: Options:

i. If their Gross Sales/Gross Receipts and other Non-Operating Income

Do not exceed VAT Threshold:

aa) Tax Schedule; OR

bb) 8% Tax on Gross Sales/Gross Receipts and other Non-Operating

Income in excess of P250,000.00
 ii. If the Gross Sales/Gross Receipts and Other Non-Operating Income
Exceeds the VAT Threshold – Tax Schedule

I. FINAL WITHHOLDING TAX RATES ON CERTAIN PASSIVE INCOME (see Table

for the Summary)

J. CAPITAL GAINS TAXES ON SALE OF SHARES OF STOCKS ISSUED BY

DOMESTIC CORPORATION – see previous discussion

Taxpayer is: Capital Gains Tax Is:

RC, NRC, RA, NRAETBP 15% of the net capital gains during the year
[Secs. 24(C); 25(A)(3) ]

NRANETBP 15% of the net capital gains during the year

[Sec. 25(B), last sentence]

Alien individuals employed in R/AHQ, 15% of the net capital gains during the year
ROHQ, OBU, and PSCS [Sec. 25(E)]

If the shares of stocks is issued by a foreign corporation, the capital gains is subject to the
0 to 35% per Tax Schedule, except when seller is a NRANETB, in which case, the
same shall be subject to final withholding tax of 25%.

K. CAPITAL GAINS TAX ON SALE OF REAL PROPERTY LOCATED IN THE

PHILIPPINES HELD AS CAPITAL ASSET – see previous discussion

Seller/Taxpayer is: Capital Gains Tax is

6% of the Gross Selling Price or FMV
RC, NRC, RA per Tax Declaration or Zonal Value,
whichever is higher. [Sec. 24(D)]

Note: The law uses the term “gains

presumed to have been realized from sale”;
hence, actual gains need not be computed.
NRAETBP Same, [Sec. 25(A)(3)]
NRANETBP Same [Sec. 25(B) last sentence)
Alien individuals employed in R/AHQ, ROHQ, Same [Sec. 25(E)]
OBU, and PSCS

If real property sold is located outside of the Philippines:

1. Included in 0% to 35% Tax Schedule – if individual Seller is a RC;
2. Not Taxable – if Individual Seller is other than a RC.
 Passive Income RC NRC RA NRAETBP NRANETBP

A. Interest
1. Interest on any bank deposit and yield or any other 20% 20% 20% 20% 25%
monetary benefit from deposit substitutes and from trust
fund and similar arrangements
2. Interest income on long term deposits or investment in
form of savings, common or individual trust fund, deposit
substitutes, investment management accounts and other
investments evidenced by certificates in such form
prescribed by the BSP

Holding Period:

a. More than 5 years Exempt Exempt Exempt Exempt 25%

b. 4 years to less than 5 years 5% 5% 5% 5%

c. 3 years to less than 4 years 12% 12% 12% 12%

d. Less than 3 years 20% 20% 20% 20%

3. Interest Income from a depositary bank under the 15% 20% 15% 20% 25%
expanded foreign currency deposit system

B. Royalties
4. In General 20% 20% 20% 20% 25%
5. On Books, other literary works, and musical compositions 10% 10% 10% 10% 25%
6. On Cinematographic films and similar works 25% 25%

C. Prizes and Other Winnings

7. Prizes

a. Less than P10,000.00 0% to 35% 0% to 35% 0% to 35% 0% to 35% 25%

Tax Schedule Tax Schedule Tax Schedule Tax Schedule

b. Above P10,000.00 20% 20% 20% 20% 25%

8. Other Winnings 20% 20% 20% 20% 25%

9. Winnings from Philippine Charity Sweepstakes and Lotto:
 a. Less than P10,000.00 Exempt Exempt Exempt Exempt 25%

b. Above P10,000.00 20% 20% 20% Exempt 25%

D. Dividends/Share in the Net Income

10. Cash/Property Dividend actually or constructively 10% 10% 10% 20% 25%
received from domestic corporation, or from joint stock
company, insurance and mutual fund companies, ROHQ
of multinational company, or on the share of an
individual partner in the distributable net income
of a partnership (except GPP), which is he is a partner,
or on the share of an individual in the net income of an
association, joint account, or a joint venture or
consortium taxable as a corporation of which is he a
member or co-venturer.

E. Others
11. Informer’s Reward 10% 10% 10% 10% 10%

Notes:
1. Unless stated, the tax base is the amount of the passive income.
2. The above Passive Income are derived from sources within the Philippines. If sourced without the Philippines, then it will be
included in the Taxable Income subject to the Tax Schedule of RC only (since the other individual taxpayers are taxed only
on sources within the Philippines)
L. ADMINISTRATIVE PROVISIONS/REQUIREMENTS

1. Filing of Returns

a. Individuals required to file an income tax return [Sec. 51(A)(1)]

i. Every Filipino citizen residing in the Philippines;

ii. Every Filipino citizen residing outside the Philippines, on his income from
sources within the Philippines;

iii. Every alien residing in the Philippines, on income derived from sources within
the Philippines; and

iv. Every non-resident alien engaged in trade or business in the Philippines or in

the exercise of profession in the Philippines.

b. Individuals NOT required to file an income tax return [Sec. 51(A)(2)

i. Individual whose taxable income does not exceed P250,000.00 under Section
24(A)(2)(a); provided, that a citizen of the Philippines and any alien individual
engaged in business or practice of profession within the Philippines shall file an
income tax return, regardless of the amount of gross income;

ii. An individual with respect to pure compensation income, as defined in Section

32(A)(1), derived from sources within the Philippines, the income tax on which
has been correctly withheld under the provisions of Section 79; Provided, that
an individual deriving compensation concurrently from two or more employees
at any time during the taxable year shall file an income tax return;

iii. An individual whose sole income has been subjected to final withholding tax
pursuant to Section 57; and

iv. A minimum wage earner or an individual who is exempt from income tax
pursuant to the provision of the Tax Code and other laws, general or special.

NOTE: any individual not required to file an income tax return may nevertheless be
required to file an information return pursuant to rules and regulations prescribed
by the Secretary of Finance, upon recommendation of the Commissioner. [Sec.
51(A)(3)]

c. Substituted Filing [Sec. 51-A] – Individual taxpayers receiving purely

compensation income, regardless of amount, from only one employer in the
Philippines for the calendar year, the income tax of which has been withheld
correctly by the said employer (tax due equals tax withheld) shall not be
required to file an annual ITR. The certificate of withholding file by the respective
employers, duly stamped “received” by the BIR, shall be tantamount to the
substituted filing of income tax returns by said employees.

d. Number of Copies of the ITR to be filed – duplicate [Sec. 51(A)(4)]

e. Content of the ITR [Sec. 51(A)(5)] – The ITR shall consist of maximum of four
(4) pages in paper form or electronic form, and shall only contain the following
information:

i. Personal profile and information;

ii. Total gross sales, receipts or income from compensation for services
rendered, conduct of trade or business or the exercise of profession, except
income subject to final tax;
iii. Allowable deductions;
iv. Taxable income as defined in Section 31;
v. Income tax due and payable.

f. Where to File [[Sec. 51(B)] – Except in cases where the Commissioner otherwise
permits, the return shall be filed with:
i. Authorized agent bank;
ii. Revenue District Officer;
iii. Collection Agent;
iv. Duly authorized Treasurer of the city or municipality in which such person
has his legal residence or principal place of business in the Philippines;
v. Office of the Commissioner, if the taxpayer has no legal residence or place
of business in the Philippines

g. When to File [Sec. 51(C)]

i. Individual Income Tax Return – on or before April 15 of each year

covering income for the preceding taxable year

ii. Individual subject to tax on capital gains

➢ From sale of shares of stocks not traded thru a local stock exchange –
within 30 days from each transaction and a final consolidated
return on or before April 15 of each year covering all stock
transactions of the preceding taxable year;

➢ From sale or disposition of real property under Section 24(D) – within

30 days following each sale or other disposition

h. Husband and Wife who do not derived income purely from compensation
[Sec. 51(D)]

➢ Joint filing/only one return is required

➢ Unless, where it is impracticable for the spouses to file one return, each
spouse may file a separate return
• but the returns shall be consolidated by the BIR for verification
purposes

i. Income of Unmarried Minors [Sec. 51(E)] – income of unmarried minors

derived from property received from a living parent shall be included in return of
the parent, except when:
 i. when the donor’s tax has been paid on such property; or
ii. when the transfer of such property is exempt from donor’s tax.

j. Persons Under Disability [Sec. 51(F)] – If the taxpayer is unable to make his
own return, the return may be made by his duly authorized agent or representative
or by the guardian or other person charged with the care of his person or property,
the principal and his representative or guardian assuming the responsibility of
making the return and incurring penalties provided for erroneous, false, or
fraudulent returns.

k. Signature Presumed Correct [Sec. 51(G)] – the fact that an individual’s name is
signed to a filed return shall be prima facie evidence for all purposes that the
return was actually signed by him.

2. Payment of Income Tax [Sec. 51]

In General: Paid at the time of filing of the return

Installment Payment – When the tax due is more than P2,000, the individual taxpayer may
opt to pay the tax in two (2) equal installments;
➢ First installment – due and payable at the time of filing;
➢ Second installment – on or before October 15 following the close of the taxable
year
➢ If any installment is not paid, the whole amount of tax becomes due and
payable together with the delinquency penalties

3. Payment of Capital Gains Tax –

➢ Shall be paid on the date the return is filed by the person liable thereto;
➢ If seller submits proof of his intention to avail the benefit of exemption of capital gains
tax, no such payment shall be required;
➢ In case of failure to qualify for exemption, the tax due on the gains realized from the
original transaction shall be immediately become due and payable, and subject to
penalties;
➢ If the seller having paid the tax, submits proof of intent within 6 months from the
registration of the document transferring the real property, he shall be entitled to a
refund of such tax upon verification of his compliance with the requirements for such
exemption;
➢ No registration of any document transferring real property shall be effected by the
Registry of Deeds unless the Commissioner or his duly authorized representative has
certified that such transfer has been reported, and the taxes imposed, if any, has been
paid.
 LECTURE NOTES

TAXATION 1
Atty. Arnel A. dela Rosa, CPA, REB, REA

INCOME TAXATION

FRINGE BENEFIT TAX

[SEC. 33, NIRC; RR NO. 3-98 as amended by RR 8-2018]

Fringe benefits, defined

Fringe Benefits – means any good, service, or other benefit furnished or granted in cash or in
kind other than the basic compensation, by an employer to an individual employee (except rank
and file employees as defined) such as, but not limited to:
(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 the 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) Expense for foreign travel;
(8) Holiday and vacation expenses;
(9) Educational assistance to the employee or his dependents; and
(10) Life or health insurance and other non-life insurance premiums or similar amounts
in excess of what the law allows.

What is the applicable Fringe Benefit Tax (FBT) Rate?

a. General Rule: 35% of the Grossed-Up Monetary Value (GMV) of the Fringe Benefit (FB),
effective January 1, 2018
Formula: 35% x GMV
b. Special Rates:
a. 25% of the GMV – if the FB is received by a non-resident alien not engaged in
trade or business (NRANETB) in the Philippines;
b. 15% of the GMV – if the FB is received by alien individuals and Filipinos employed
in regional or area headquarters (RAHQ), regional operating headquarters
(ROHQ), offshore banking units (OBU), or foreign service contractor (FSC)
engaged in petroleum operations in the Philippines

How is GMV determined?

It is determined by dividing the actual monetary value of the FB by the difference between 100%
and the applicable FBT Rate. Thus, generally, the GMV is actual monetary value of the FBT
divided by 65% (100% - 35%). If the recipient of the FB is a NRANETB, the divisor would be
75% (100%-25%) ; while if the recipient are aliens or Filipinos working in OBU, R AHQ, ROHQ,
and FSC engaged in petroleum operations, the divisor would be 85% (100% - 15%).

Note: The Grossed Up Monetary Value, not the actual or monetary value, of the fringe
benefit is deductible from the Gross Income pursuant to Section 34(A)(1)(a)(i), NIRC.

Who is liable to pay FBT?

The Employer (as a withholding agent) whether individual, GPP or corporation, regardless of
whether the corporation is taxable or not, or the government or its instrumentalities, is liable to
remit the fringe benefit tax to the BIR once the benefit is given to managerial or supervisory
employees.

What is the nature of FBT?

It is a Final Withholding Tax. Hence, the FBT cannot be used to pay the income tax liability of
the employer-taxpayer. Moreover, the Fringe Benefits subject to FBT are not to be included in
the taxable compensation income of the employee.

Who are considered “Rank and File Employees”

They are the employees who are holding neither managerial nor supervisory position as defined
under the existing provisions of the Labor Code of the Philippines, as amended.

➢ Supervisory Employees – those who, in the interest of the employer, effectively

recommend such managerial actions if the exercise of such authority is not merely
routinary or clerical in nature but requires the use of independent judgment;
➢ Managerial Employees – those who are vested with the powers or prerogatives to lay
down and execute management policies, and/or to hire, transfer, suspend, lay-off, recall,
discharge, assign, or discipline employees.

What is the tax treatment of the fringe benefits given to Rank and File Employees?
It shall be treated as part of their compensation income subject to income tax and consequently,
to withholding tax.

What fringe benefits are not subject to FBT?

1. Fringe benefits which are NOT considered as GROSS INCOME [Sec. 33(A)]
a. If it is required or necessary to the business of the employer;
b. If it is for the convenience or advantage of the employer

2. Fringe benefits which are EXCLUDED from GROSS INCOME, e.g.:

a. Retirement Benefits
b. GSIS, SSS, Medicare and other contributions (to the extent of the employer’s
mandatory contribution)
c. Fringe benefits which are authorized and exempted under special laws [Sec.
33(C)], such as the 13th Month Pay and Other Benefits, with a ceiling of
P90,000.00. [Sec. 32(B)(7)(e)]
 3. Fringe benefits which are EXEMPT from FBT [Sec. 33(C)]
a. Contributions of the employer for the benefit of the employee to retirement,
insurance, and hospitalization;
b. Benefits given to Rank and File Employees, whether granted under a collective
bargaining agreement or not; and
c. De minimis benefits – see previous discussion

Note: The exemption of any FB from FBT shall not be interpreted to mean exemption from any
other income tax under the Tax Code except if the same is expressly exempt from any other
income tax under the Tax Code or under other existing laws.

Rules on Housing Benefits

Housing Privilege Monetary Value (MV) (to be grossed up

to arrive at the GMV or Tax Base)
1. Lease of residential property for the Value of the Benefit (VB) is the amount of
residential use of the employees rental paid thereon by the employer as
evidenced by the lease contract.

MV = 50% of the VB
2. Assignment of residential property VB = 5% of the fair market value of the land
owned by the employer for use of and improvement as per Tax Declaration
employees (FMB) OR Zonal Value (ZV) per BIR, whichever
is higher;

MV = 50% of the VB
3. Purchase by the employer of a VB = on annual basis, 5% of the acquisition
residential property in installment for cost, exclusive of interest
the use of the employee
MV = 50% of the VB
4. Purchase of residential property and VB = FMV or ZV, whichever is higher
transfers ownership thereof in the
name of the employee MV = full VB
5. Purchase of residential property and VB = (FMV or ZV, w/ever is higher) less Cost
transfers ownership thereof in the to Employee
name of the employee for the latter’s
use, at a price less than employer’s MV = full VB
acquisition cost

Non-Taxable Housing Benefits

1. Housing privilege of military officials of the AFP (reason: State shall provide its soldiers
with necessary quarters which are within or accessible from military camp so that they
can be readily on call to meet the exigencies of their military service)
2. Housing unit which are adjacent to the premises of a business or factory, i.e. located
within the maximum of 50 meters from the perimeter of the business premises. (reason:
this is already considered for the convenience of the employer)
 3. Temporary housing for an employee who stays in a housing unit for three (3) months or
less (reason: may be considered as for the convenience of the employer)

Rules on Expense Account

a. If incurred by employee but which are paid by his employer – taxable FB, except when
the expenditures are duly receipted for and in the name of the employer and the
expenditure do not partake the nature of a personal expense attributable to the employee.
b. If paid for by employee but reimbursed by employer – taxable FB, same exception as item
(a);
c. Personal expenses of the employee (e.g. groceries for personal consumption of the
employee and his family members) paid or reimbursed by the employer to the employee
– taxable fringe benefits regardless of whether the same is receipted for in the name of the
employer;
d. Representation and transportation expense which are fixed in amounts and are regularly
received by the employees as part their monthly compensation income – taxable
compensation income subject to income tax.

Rules on Motor Vehicle of any kind

Motor Vehicle Benefit Monetary Value (MV) (to be grossed up

to arrive at the GMV or Tax Base)
1. Employer purchases the motor vehicle Value of the Benefit (VB) is the acquisition cost
in the name of the employee,
regardless whether for use by the MV = Full VB
employee partly for his personal
purpose and partly for the benefit of
his employer.
2. Employer provides the employee with VB is the acquisition cost
cash for the purchase of a motor
vehicle, the ownership is placed in the MV = Full VB
name of the employee, regardless
whether for use by the employee partly Unless the same was subjected to a
for his personal purpose and partly for
withholding tax as compensation income
the benefit of his employer
under RR 2-98, as amended
3. Employer purchases the car on VB is acquisition cost exclusive of interest
installment basis, the ownership is
transferred in the name of the MV = Full VB
employee, regardless whether for use
by the employee partly for his personal
purpose and partly for the benefit of
his employer
4. Employer shoulders a portion of the VB = amount shouldered by the employer
amount of the purchase price of a
motor vehicle, ownership is placed in MV = Full MV
the name of the employee, regardless
whether for use by the employee partly
 for his personal purpose and partly for
the benefit of his employer
5. Employer owns and maintains a fleet VB = acquisition cost of all the motor vehicles
of motor vehicles for the use of the NOT normally used for sales, freight, delivery
business and the employees service and other non-personal purpose
divided by 5 years

MV = 50% of the VB
6. Employer leases and maintains fleet of VB = amount of rental payments for the motor
motor vehicle for the use of the vehicles NOT normally used for sales, freight,
business and the employees delivery service and other non-personal
purpose

MV = 50% of the VB
7. Employee uses aircrafts, including Treated as business use; not subject to FBT
helicopters, owned and maintained by
the employer
8. Employee uses Yacht owned and VB = Depreciation of the yacht at an estimated
maintained, or leased, by the employer useful life of 20 years.

MV = VB

Unless, the use of the yacht is considered as

entertainment, amusement or recreational
expenses under RR 10-2002 (see previous
discussions on Allowable Deductions)

Rules on Interest on Loan at less than market rate

a. If the employer lends money to his employee free of interest or at a rate lower than
12%, such interest foregone by the employer or the difference of the interest assumed
by the employee and the rate of 12% is a taxable FB;

b. Benchmark interest rate is 12%. Note: The BSP already lowered the legal interest rate
to 6%. Despite this, the benchmark interest rate to be used is still 6% until BIR issues a
subsequent regulation adopting 6% as the new benchmark rate.

Rules on membership fees, etc.

Membership fees, dues, and other expenses borne by the employer for his employee, in social
and athletic clubs or similar organizations – these expenditures are treated as taxable FB of the
employee in full.

Rules on Expenses for Foreign Travel

a. Reasonable business expenses paid for by the employer for the foreign travel of his
employee for the purpose of attending business meetings or conventions – NOT
TAXABLE BENEFITS.
 ➢ Inland travel expenses (expenses for food, beverages and local transportation) except
lodging cost in a hotel (or similar establishment) amounting to average US$300.00 or
less per day – NOT TAXABLE BENEFITS
➢ Cost of economy and business class airplane ticket shall not be subject to FBT.
However, 30% of the cost of first-class airplane ticket shall be subject to FBT
➢ Expenses should be supported by documents proving the actual occurrence of the
meetings and conventions; otherwise, the entire cost of the ticket, including cost of
hotel accommodation and other expenses incident thereto are TAXABLE FB.
o Proofs required: a) The business meetings shall be evidenced by official
communications from business associates abroad indicating the purpose of the
meetings. b) Business conventions shall be evidenced by official
invitations/communications from the host organization or entity abroad.
b. Travelling expenses which are paid by the employer for the travel of the family members
of the employee = Taxable FB

Rules on Educational Assistance to Employee or his Dependents

a. General Rule: Cost of educational assistance to the employee borne by the employer –
Taxable FB.

Except: Scholarship grant to the employee by the employer not taxable if the education or
study involved is directly connected with the employer’s trade, business or profession, and
there is a written contract between them that the employee is under obligation to remain in
the employ of the employer for a period of time that they have mutually agreed upon.
Reason for the exception: the expenditure is considered as incurred for the convenience and
furtherance of the employer’s trade or business.

b. Cost of educational assistance extended by the employer to the dependents of the employee
= Taxable FB.

Except: When the assistance was provided through a competitive scheme under the
scholarship program of the company.

Rules on Life or Health Insurance and other Non-Life Insurance Premiums, etc. in excess of
what the law allows
a. The cost of life or health insurance and other non-life insurance premiums borne by the
employer for his employee = Taxable FB.
b. Exceptions: a) contributions of the employer for the benefit of the employee pursuant to
existing laws, such as SSS, GSIS, or similar contributions arising from the provision of any
other existing laws; and b) the cost of premiums borne by the employer for the group
insurance of his employees.
Note: Contributions to SSS, GSIS are likewise excluded from Gross Income to the
extent of the employer’s mandatory contributions only.
 LECTURE NOTES

TAXATION 1
Atty. Arnel A. dela Rosa, CPA, REB, REA

INCOME TAXATION

CORPORATE INCOME TAX

[SEC. 27 TO 30, NIRC]

A. CORPORATION SUBJECT TO TAX

1. Domestic Corporation (DC) [Sec. 22(B) and (C)] – is a corporation created or

organized in the Philippines or under its laws which shall include partnerships, no
matter created or organized joint-stock companies, joint accounts, associations, or
insurance companies, but excludes:

a. General professional partnerships

b. Joint venture or consortium 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.

Cases:
a. Pascual v. CIR, G.R. No. 78133, October 18, 1988. Held: In the present
case, there is no evidence that petitioners entered into an agreement to
contribute money, property or industry to a common fund, and that they
intended to divide the profits among themselves. Respondent commissioner
and/ or his representative just assumed these conditions to be present on the
basis of the fact that petitioners purchased certain parcels of land and became
co-owners thereof. In the instant case, petitioners bought two (2) parcels of
land in 1965. They did not sell the same nor make any improvements thereon.
In 1966, they bought another three (3) parcels of land from one seller. It was
only 1968 when they sold the two (2) parcels of land after which they did not
make any additional or new purchase. The remaining three (3) parcels were
sold by them in 1970. The transactions were isolated. The character of
habituality peculiar to business transactions for the purpose of gain was not
present. The sharing of returns does not in itself establish a partnership
whether or not the persons sharing therein have a joint or common right or
interest in the property. There must be a clear intent to form a partnership, the
existence of a juridical personality different from the individual partners, and
the freedom of each party to transfer or assign the whole property. In the
present case, there is clear evidence of co-ownership between the petitioners.
There is no adequate basis to support the proposition that they thereby formed
an unregistered partnership. The two isolated transactions whereby they
purchased properties and sold the same a few years thereafter did not thereby
make them partners. They shared in the gross profits as co- owners and paid
their capital gains taxes on their net profits and availed of the tax amnesty
thereby. Under the circumstances, they cannot be considered to have formed
 an unregistered partnership which is thereby liable for corporate income tax, as
the respondent commissioner proposes.

b. Ona v. CIR, G.R. No. L-19342, May 25, 1972. Held: The Tax Court found
that instead of actually distributing the estate of the deceased among
themselves pursuant to the project of partition approved in 1949, "the
properties remained under the management of Lorenzo T. Oña who used said
properties in business by leasing or selling them and investing the income
derived therefrom and the proceed from the sales thereof in real properties and
securities," as a result of which said properties and investments steadily
increased yearly from P87,860.00 in "land account" and P17,590.00 in "building
account" in 1949 to P175,028.68 in "investment account," P135.714.68 in "land
account" and P169,262.52 in "building account" in 1956. And all these became
possible because, admittedly, petitioners never actually received any share of
the income or profits from Lorenzo T. Oña and instead, they allowed him to
continue using said shares as part of the common fund for their ventures, even
as they paid the corresponding income taxes on the basis of their respective
shares of the profits of their common business as reported by the said Lorenzo
T. Oña. It is thus incontrovertible that petitioners did not, contrary to their
contention, merely limit themselves to holding the properties inherited by them.
Indeed, it is admitted that during the material years herein involved, some of
the said properties were sold at considerable profit, and that with said profit,
petitioners engaged, thru Lorenzo T. Oña, in the purchase and sale of
corporate securities. It is likewise admitted that all the profits from these
ventures were divided among petitioners proportionately in accordance with
their respective shares in the inheritance. In these circumstances, it is Our
considered view that from the moment petitioners allowed not only the incomes
from their respective shares of the inheritance but even the inherited properties
themselves to be used by Lorenzo T. Oña as a common fund in undertaking
several transactions or in business, with the intention of deriving profit to be
shared by them proportionally, such act was tantamonut to actually
contributing such incomes to a common fund and, in effect, they thereby
formed an unregistered partnership within the purview of the above-mentioned
provisions of the Tax Code. It is but logical that in cases of inheritance, there
should be a period when the heirs can be considered as co-owners rather than
unregistered co-partners within the contemplation of our corporate tax laws
aforementioned. Before the partition and distribution of the estate of the
deceased, all the income thereof does belong commonly to all the heirs,
obviously, without them becoming thereby unregistered co-partners, but it does
not necessarily follow that such status as co-owners continues until the
inheritance is actually and physically distributed among the heirs, for it is easily
conceivable that after knowing their respective shares in the partition, they
might decide to continue holding said shares under the common management
of the administrator or executor or of anyone chosen by them and engage in
business on that basis. Withal, if this were to be allowed, it would be the
easiest thing for heirs in any inheritance to circumvent and render meaningless
Sections 24 and 84(b) of the National Internal Revenue Code. It is true that
in Evangelista vs. Collector, 102 Phil. 140, it was stated, among the reasons for
holding the appellants therein to be unregistered co-partners for tax purposes,
that their common fund "was not something they found already in existence"
and that "it was not a property inherited by them pro indiviso," but it is
 certainly far-fetched to argue therefrom, as petitioners are doing here,
that ergo, in all instances where an inheritance is not actually divided, there
can be no unregistered co-partnership. As already indicated, for tax purposes,
the co-ownership of inherited properties is automatically converted into an
unregistered partnership the moment the said common properties and/or the
incomes derived therefrom are used as a common fund with intent to produce
profits for the heirs in proportion to their respective shares in the inheritance as
determined in a project partition either duly executed in an extrajudicial
settlement or approved by the court in the corresponding testate or intestate
proceeding. The reason for this is simple. From the moment of such partition,
the heirs are entitled already to their respective definite shares of the estate
and the incomes thereof, for each of them to manage and dispose of as
exclusively his own without the intervention of the other heirs, and, accordingly
he becomes liable individually for all taxes in connection therewith. If after such
partition, he allows his share to be held in common with his co-heirs under a
single management to be used with the intent of making profit thereby in
proportion to his share, there can be no doubt that, even if no document or
instrument were executed for the purpose, for tax purposes, at least, an
unregistered partnership is formed. This is exactly what happened to petitioners
in this case.

c. Obillos v. CIR, G.R. No. L-68118, October 29, 1985. Held: We hold that it is
error to consider the petitioners as having formed a partnership under article
1767 of the Civil Code simply because they allegedly contributed P178,708.12
to buy the two lots, resold the same and divided the profit among themselves.
To regard the petitioners as having formed a taxable unregistered partnership
would result in oppressive taxation and confirm the dictum that the power to
tax involves the power to destroy. That eventuality should be obviated. As
testified by Jose Obillos, Jr., they had no such intention. They were co-owners
pure and simple. To consider them as partners would obliterate the distinction
between a co-ownership and a partnership. The petitioners were not engaged
in any joint venture by reason of that isolated transaction. Their original
purpose was to divide the lots for residential purposes. If later on they found it
not feasible to build their residences on the lots because of the high cost of
construction, then they had no choice but to resell the same to dissolve the co-
ownership. The division of the profit was merely incidental to the dissolution of
the co-ownership which was in the nature of things a temporary state. It had to
be terminated sooner or later.

d. Afisco Insurance v. CIR, G.R. No. L-112675, January 25, 1999. Held:
Unregistered partnerships and associations are considered as corporations for
tax purposes. Under the old internal revenue code, “A tax is hereby imposed
upon the taxable net income received during each taxable year from all sources
by every corporation organized in, or existing under the laws of the Philippines,
no matter how created or organized”. Ineludibly, the Philippine legislature
included in the concept of corporations those entities that resembled them such
as unregistered partnerships and associations. Insurance pool in the case at
bar is deemed a partnership or association taxable as corporation. In the case
 at bar, petitioners-insurance companies formed a Pool Agreement, or an
association that would handle all the insurance business covered under their
quota-share reinsurance treaty and surplus reinsurance treaty with Munich is
considered a partnership or association which may be taxed as a corporation.

e. Collector v. Batangas Transportation Company, G.R. No. L-9692, January

6, 1958. The theory of the Collector is the Joint Emergency Operation was a
corporation distinct from the two respondent companies, as defined in section
84 (b), and so liable to income tax under section 24, both of the National
Internal Revenue Code. After hearing, the C.T.A. found and held, citing
authorities, that the Joint Emergency Operation or joint management of the
two companies "is not a corporation within the contemplation of section 84 (b)
of the National Internal Revenue Code much less a partnership, association or
insurance company", and therefore was not subject to the income tax under
the provisions of section 24 of the same Code, separately and independently of
respondent companies; so, it reversed the decision of the Collector assessing
and demanding from the two companies the payment of the amount of
P54,143.54 and/or the amount of P148,890.14. Held: In the present case,
the two companies contributed money to a common fund to pay the sole
general manager, the accounts and office personnel attached to the office of
said manager, as well as for the maintenance and operation of a common
maintenance and repair shop. Said common fund was also used to buy spare
parts, and equipment for both companies, including tires. Said common fund
was also used to pay all the salaries of the personnel of both companies, such
as drivers, conductors, helpers and mechanics, and at the end of each year, the
gross income or receipts of both companies were merged, and after deducting
therefrom the gross expenses of the two companies, also merged, the net
income was determined and divided equally between them, wholly and utterly
disregarding the expenses incurred in the maintenance and operation of each
company and of the individual income of said companies. From the standpoint
of the income tax law, this procedure and practice of determining the net
income of each company was arbitrary and unwarranted, disregarding as it did
the real facts in the case. There can be no question that the receipts and gross
expenses of two, distinct and separate companies operating different lines and
in some cases, different territories, and different equipment and personnel at
least in value and in the amount of salaries, can at the end of each year be
equal or even approach equality. Those familiar with the operation of the
business of land transportation can readily see that there are many factors that
enter into said operation. Much depends upon the number of lines operated
and the length of each line, including the number of trips made each day. Some
lines are profitable, others break above even, while still others are operated at
a loss, at least for a time, depending, of course, upon the volume of traffic,
both passenger and freight. In some lines, the operator may enjoy a more or
less exclusive operation, while in others, the competition is intense, sometimes
even what they call "cutthroat competition". Sometimes, the operator is
involved in litigation, not only as the result of money claims based on physical
injuries or deaths occasioned by accidents or collisions, but litigations before
the Public Service Commission, initiated by the operator itself to acquire new
lines or additional service and equipment on the lines already existing, or
litigations forced upon said operator by its competitors. Said litigation causes
expense to the operator. At other times, operator is denounced by competitors
 before the Public Service Commission for violation of its franchise or franchises,
for making unauthorized trips, for temporary abandonment of said lines or of
scheduled trips, etc. In view of this, and considering that the Batangas
Transportation and the Laguna Bus operated different lines, sometimes in
different provinces or territories, under different franchises, with different
equipment and personnel, it cannot possibly be true and correct to say that the
end of each year, the gross receipts and income in the gross expenses of two
companies are exactly the same for purposes of the payment of income tax.
What was actually done in this case was that, although no legal personality
may have been created by the Joint Emergency Operation, nevertheless, said
Joint Emergency Operation joint venture, or joint management operated the
business affairs of the two companies as though they constituted a single
entity, company or partnership, thereby obtaining substantial economy and
profits in the operation. For the foregoing reasons, and in the light of our ruling
in the Evangelista vs. Collector of Internal Revenue case, supra, we believe and
hold that the Joint Emergency Operation or sole management or joint venture
in this case falls under the provisions of section 84 (b) of the Internal Revenue
Code, and consequently, it is liable to income tax provided for in section 24 of
the same code.

f. Philex Mining v. CIR, G.R. No. 148187, April 16, 2008. Held: An
examination of the "Power of Attorney" reveals that a partnership or
joint venture was indeed intended by the parties. Under a contract of
partnership, 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. While a corporation, like petitioner, cannot generally
enter into a contract of partnership unless authorized by law or its charter, it
has been held that it may enter into a joint venture which is akin to a particular
partnership. x x x Perusal of the agreement denominated as the "Power
of Attorney" indicates that the parties had intended to create a
partnership and establish a common fund for the purpose. They also
had a joint interest in the profits of the business as shown by a 50-50
sharing in the income of the mine. Under the "Power of Attorney",
petitioner and Baguio Gold undertook to contribute money, property and
industry to the common fund known as the Sto. Niño mine. In this regard, we
note that there is a substantive equivalence in the respective contributions of
the parties to the development and operation of the mine. Pursuant to
paragraphs 4 and 5 of the agreement, petitioner and Baguio Gold were to
contribute equally to the joint venture assets under their respective accounts.
Baguio Gold would contribute P11M under its owner’s account plus any of its
income that is left in the project, in addition to its actual mining claim.
Meanwhile, petitioner’s contribution would consist of its expertise in the
management and operation of mines, as well as the manager’s account which
is comprised of P11M in funds and property and petitioner’s "compensation" as
manager that cannot be paid in cash. x x x The wording of the parties’
agreement as to petitioner’s contribution to the common fund does not detract
from the fact that petitioner transferred its funds and property to the project as
specified in paragraph 5, thus rendering effective the other stipulations of the
contract, particularly paragraph 5(c) which prohibits petitioner from
withdrawing the advances until termination of the parties’ business relations. As
can be seen, petitioner became bound by its contributions once the transfers
 were made. The contributions acquired an obligatory nature as soon as
petitioner had chosen to exercise its option under paragraph 5. X X In this
case, the totality of the circumstances and the stipulations in the
parties’ agreement indubitably lead to the conclusion that a
partnership was formed between petitioner and Baguio Gold.

2. Foreign Corporation (FC) [Sec. 22 (D), (H) and (I)]

a. Resident Foreign Corporation (RFC) – is one which is organized or existent

under the laws of any other country but is engaged in trade or business in the
Philippines;

b. Non-Resident Foreign Corporation (NRFC) – is one which is organized

under the laws or any foreign country and not engaged in trade or business in
the Philippines but is deriving income from sources within the Philippines.

Cases:
a. Far East International Import and Export Corp. v. Nankai Kogyo Co.
Ltd, G.R. No. L-13525, November 30, 1962. Held: A single act may bring the
corporation under the purview of “doing business” if such act is not merely
incidental or casual, but it is for such character as distinctly to indicate a
purpose on the part of the foreign corporation to do other business in the state,
and to make the state a basis of operations for the conduct of a part of
corporation’s business. In this case, Nankai representatives: 1) made inquiry as
to the Philippine operations of mines and; 2) allegedly set up an office in
Luneta Hotel. It reveals Nankai’s purpose to continue engaging business in the
Philippines even after receiving the steel scrap. It is clear that Nankai’s
transaction in the Philippines is only the beginning, as it indicates that Nankai
intends to build a base in this jurisdiction.

b. South African Airways v. CIR, 612 SCRA 665

B. DETERMINATION OF TAXABLE INCOME

1. DC – taxable on the entire taxable income derived from sources within and without
the Philippines [Sec. 23(E)]. Taxable Income is the amount equal to gross income
less allowable deduction (Sec. 31);

Note: Pursuant to RA No. 9856 (An Act Providing the Legal Framework for Real Estate
Investment Trust [REIT] and for Other Purposes), REIT will be subject to the income
tax on the taxable net income as defined in Chapter V of the NIRC instead of the
taxable net income as defined in the said Act, upon the occurrence of the following: (i)
failure to maintain its status as public company; (ii) failure to maintain the listed status
of the investor securities on the registered entity and the registration of the investor
securities by the SEC; and/or (iii) failure to distribute at least 90% of its distributable
income required under Section 7 of the said Act.

2. RFC – taxed similarly as a domestic corporation on incomes derived from sources

within the Philippines [Secs. 23(F), 27(A)]
 3. NRFC – taxable upon the entire gross income received from all sources within the
Philippines [Sec. 28(A)]

C. EXCLUSIONS – Section 32(B) – see previous discussion

D. DEDUCTIONS FROM GROSS INCOME – Sections 34 to 40;

2. DC – See previous discussion

Additional deductions:
a. Health institutions are allowed to deduct from gross income up to twice the amount
incurred in complying with the provisions of RA 7600 (Entitled: “An Act Providing
Incentives to All Government and Private Health Institutions With Rooming-In and
Breast-Feeding Practices and for Other Purposes”, approved on June 2, 1992);

b. Discounts given to senior citizens and persons with disability under RA 9257
(Entitled: “An Act Granting Additional Benefits and Privileges to Senior Citizens
Amending for the Purpose RA 7432, Otherwise Known as “An Act to Maximize the
Contribution of Senior Citizens to Nation Building, Grant Benefits and Special
Privileges and for Other Purposes”, approved, February 26, 2004) and RA 9442
(Entitled: “Magna Carta for Disabled Persons, and for Other Purposes”, Approved,
April 30, 2007), as amended, respectively;

c. 50% of the expenses incurred for the adopt-a-school program pursuant to RA 8575
(Entitled: “An Act Establishing an “Adopt-a-School Program” Providing Incentives
Therefore, and for Other Purposes”, Approved on February 14, 1998)

3. RFC – Same deduction allowed to domestic corporation and conditions and limitations
except on the following items of deductions:

a. Taxes – the deductions for taxes shall be allowed only if and to the extent that
they are connected with income from sources within the Philippines;

b. Losses – losses deductible shall be those actually sustained during the taxable
year incurred in business, trade or exercise of profession conducted within the
Philippines and not compensated for by insurance or other forms of indemnity;

c. Bad Debts – the deductions for bad debts shall be allowed only if they arise in the
course of business or trade conducted within the Philippines;

d. Depreciation – a reasonable allowance for the deterioration of property arising

out of its use or employment or its non-use in the business, trade, or profession on
properties located in the Philippines;

e. Depletion of oil and gas well and mines – the allowance for depletion of oil and
gas well or mines is authorized only with respect to oil and gas wells or mines
located within the Philippines

4. NRFC – no deduction allowed

E. NON-DEDUCTIBLE ITEMS – same as the items not deductible from gross income under
Individual Income Tax

F. EXEMPTIONS [Sec. 30]

The following are exempt from the payment of corporate income tax, subject to certain
conditions:
1. Labor, agricultural, or horticultural organization not organized principally for profit;
2. Mutual savings bank not having a capital represented by shares, and cooperative bank
without capital stock organized and operated for mutual purposes and without profit;
3. A beneficiary society, order or association, operating for the exclusive benefit of the
members such as fraternal organization operating under the lodge system, or a mutual
aid association or a non-stock corporation organized by employees providing for the
payment of life, sickness, accident, or other benefits exclusively to the members of
such society, order, or association, or nonstock corporation or their dependents;
4. Cemetery company owned and operated exclusively for the benefit of its members;
5. Non-stock corporation or association organized and operated exclusively for religious,
charitable, scientific, athletic, or cultural purposes, or for the rehabilitation of veterans,
no part of their income or asset shall belong to or inures to the benefit of any member,
organizer, or any specific person (See: RR No. 14-2007);
6. 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;
7. Civic league or organization not organized for profit but operated exclusively for the
promotion of social welfare;
8. A nonstock and nonprofit educational institution (See: Art. XIV, Sec. 4(3)
Constitution; RMC No. 76-2003)
9. Government educational institution;
10. Farmers’ or other mutual typhoon or fire insurance company, mutual ditch or irrigation
company, mutual or cooperative telephone company, or like organization of a purely
local character, the income of which consists solely of assessments, dues, and fees
collected from members for the sole purpose of meeting its expenses;
11. Farmers’, fruit growers’, or like association organized and operated as a sales agent for
the purpose of marketing the products of its members and turning back to them the
proceeds of sales, less the necessary selling expenses on the basis of the quantity of
produce finished by them;

Notwithstanding the provisions in the preceding paragraphs, the income of whatever kind
and character of the foregoing organizations from any of their properties, real or personal,
and from any of their activities conducted for profit regardless of the disposition made of
such income, shall be subject to tax imposed under the Code.

Case:
CIR v. DLSU, G.R. No. 196596, November 9, 2016; Held: Thus, we declare the last
paragraph of Section 30 of the Tax Code without force and effect for being contrary to the
Constitution in so far as it subjects to tax the income and revenues of non-stock, non-
profit educational institutions used actually, directly and exclusively for educational
purposes.

CIR v. CA, 298 SCRA 83, Held: Rental Income regardless of disposition is taxable
 Notes:

a. Under RMO 20-13, as amended by RMO 28-13, corporations and associations

enumerated under Section 30 of the 1997 NIRC, must secure a tax exemption
ruling or certificate to confirm their tax-exempt status. In case of failure to
secure a tax exemption ruling, RMO 34-14 provides that the concerned non-stock,
non-profit entity is duty bound to prove compliance with the conditions laid down
by the law and other pertinent administrative issuances in the event of tax
investigation to be exempt from income tax. Non-stock, non-profit entities that fail
to renew their tax exemption ruling before the lapse of its validity period may still
file their applications with the RDO where they are registered and the same shall
already be treated as a new application. RMC 08-2014, on the other hand,
provides that failure on the part of the non-stock, non-profit entities to present
valid, current and subsisting Tax Exemption Ruling to the appropriate withholding
agents shall subject them to the payment of withholding taxes due on their
transactions while failure of withholding agents to withhold, notwithstanding the
lack of Tax Exemption Ruling, shall cause the imposition of penalties under Section
251 and other pertinent provisions of the Tax Code.

b. Republic Act No. 10165 (entitled: Foster Care Act of 2012) provides for the
exemption from the payment of corporate income tax of the income derived by
child-caring or child-placing institutions licensed by the DSWD to implement the
foster care program under the said Act;

c. See RMC 51-2014 wherein the BIR clarifies the inurement prohibition applicable to
non-stock, non-profit corporations/associations/organizations

d. Interest Income of religious organization is subject to tax, regardless of disposition;

bank deposits are personal property (BIR Ruling 512, October 21, 1998; Ruling No.
58, April 5, 1991)

e. Gain from sale of land and building of religious organization used for same purpose
is an isolated transaction; thus exempt from income tax; its rents, dividends, profits
from business are taxable. (Manila Polo Club, CTA Case nO. 293, August 31,
1959; Bir Ruling No. 569, November 29, 1988, April 2, 1998)

G. TAX BASE AND TAX RATES

1. DC –

a. In general, the higher between:

i. Regular Corporate Income Tax (RCIT) - 30% of the Taxable Net

Income (TNI) (Sec. 31) derived from sources within and without the
Philippines; and

ii. Minimum Corporate Income Tax (MCIT) [Sec. 27(E)] – 2% of the

Gross Income as of the end of the taxable year [Sec. 27(E); See
discussion on MCIT below).
b. Proprietary Educational Institution and Hospitals – 10% of the TNI;
➢ If the gross income from unrelated trade, business or other activity exceeds
50% of the total gross income derived by such educational institutions or
hospital from all sources – RCIT of 30% of the TNI applies.
➢ “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.
➢ “Proprietary educational institution” – means any private school maintained
and administered by private individuals or groups with an issued permit to
operate from DepEd, CHED, or TESDA, as the case maybe, in accordance
with existing laws and regulations.

Cases:
CIR v. St. Luke’s Medical Center, G.R. No. 195909, September 26, 2012. Held:
Section 27(B) of the NIRC imposes 10% preferential tax rate on the income of
(1) proprietary non-profit educational institutions and (2) proprietary non-profit
hospitals. The only qualification for hospitals is that they must be proprietary
and non-profit. “Proprietary” means private, following the definition of a
“proprietary educational institution” as “any private school maintained and
administered by private individuals or groups” with a government permit.
“Non-profit” means no net income or asset accrues to or benefits any member
or specific person, with all the net income or asset devoted to the institution’s
purposes and all its activities conducted for profit. “Non-profit” does not
necessary mean charitable.

Central Mindanao State University v. DAR, 25 SCRA 86 (1992)

Abra Valley College v. Aquino, 162 SCRA 106 (1988)

c. Government-Owned or -Controlled Corporation [Sec. 27(C)]– general

rule applies

➢ Not taxable GOCCs are: a) SSS; b) GSIS; c) PHIC; and d) Local Water
Districts (LWDs, pursuant to RA 10026, March 11, 2010);
➢ PAGCOR is now taxable pursuant to RA 9337;
➢ PCSO was expressly exempt from income tax under RA 9337; however, the
exemption is no longer apparent under RA 10963 (TRAIN Law) – Does this
mean, its exemption was withdrawn?

Case: PAGCOR v. CIR, G.R. No. 215427, December 10, 2014. Section 1 of RA
9337, amending Section 27(c) of RA 8424, by excluding petitioner from the
enumeration of GOCC’s exempt from corporate income tax, is valid and
constitutional. In addition, we hold that: 1) Petitioner’s tax privilege of paying
5% franchise tax in lieu of all other taxes with respect to its income from
gaming operations, pursuant to PD 1869, as amended, is not repealed or
amended by Section 1(c) of RA 9337; 2) Petitioner’s income from gaming
operations is subject to the 5% franchise tax only; and 3) petitioner’s income
from other related services is subject to corporate income tax only.

d. Optional Corporate Income Tax (GIT)

 i. Effective January 1, 2000, the President, upon the recommendation of
the Secretary of Finance, allow corporations the option to be taxed at
15% of gross income, after the following conditions have been
satisfied:
1. Tax effort ratio – 20% of the Gross National Product (GNP);
2. A ratio of 40% of income tax collection to total tax revenues;
3. A VAT tax effort of 4% of the GNP; and
4. A 0.9% ratio of the Consolidated Public Sector Financial Position
(CPSFP) to GNP
ii. GIT is available only to firms whose ratio of cost of sales to gross
sales/receipts from all sources does not exceed 55%;
iii. Election of the GIT option by a corporation shall be irrevocable for 3
consecutive taxable years during which the corporation is qualified
under the scheme;
iv. “Gross Income” derived from business shall be equivalent to the gross
sales less sales returns, discounts and allowances and cost of goods
sold;
v. “Cost of Goods Sold” (COGS) shall include all business expense
directly incurred to produce the merchandise to bring them to their
present location and use.

2. RFC

a. In general [Sec. 28(A)(1)– The higher between:

i. Regular Corporate Income Tax (RCIT) - 30% of the Taxable Net

Income (TNI) (Sec. 31) derived from sources within the Philippines;
and
ii. Minimum Corporate Income Tax (MCIT) [Sec. 27(E)] – 2% of the
Gross Income as of the end of the taxable year [Sec. 27(E); See
discussion on MCIT below).

b. Optional 15% GIT – under the same conditions as DC

c. International Carrier (See also RA No. 10378 [entitled: An Act Recognizing

the Principle of Reciprocity as Basis of the Grant of Income Tax Exemptions to
International Carriers and Rationalizing Other Taxes Imposed Thereon, etc.]
March 7, 2013) – An international carrier doing business in the Philippines shall
pay a tax of 2 ½ % on its “Gross Philippine Billings” (GPB)

i. GPB of International Air Carrier – refers to the amount of gross revenue

derived from carriage of persons, excess baggage, cargo, and mail or
originating from the Philippines in continuous and uninterrupted flight,
irrespective of the place of sale or issue and the place of payment of the
ticket or passage document;
➢ Tickets revalidated, exchanged and/or indorsed to another
international airline form part of the GPB if the passenger boards a
plane in a port or point in the Philippines;
➢ Flight which originates from the Philippines, but transshipment of
passenger takes place at any point outside the Philippines on another
 airline, only the aliquot portion of the cost of the ticket corresponding
to the leg flown from the Philippines to the point of transshipment
shall form part of GPB

ii. GPB of International Shipping – means gross revenue whether for

passenger, cargo or mail originating from the Philippines up to final
destination, regardless of the place of sale or payment of the passage or
freight document.

iii. International carriers doing business in the Philippines may avail of a

preferential rate or exemption from tax herein imposed on their gross
revenue derived from the carriage of persons and their excess baggage
on the basis of an applicable tax treaty or international agreement to
which the Philippines is a signatory or on the basis of reciprocity such
that an international carrier, whose home country grants income tax
exemption to Philippine carriers, shall likewise be exempt from the tax
imposed under this provision.

Cases:
CIR v. Tokyo Shipping, G.R. No. 68252, May 25, 1995. Held: Pursuant to Section
24(b)(2) of the NIRC, a resident foreign corporation engaged in the transport of cargo is
liable for taxes depending on the amount of income it derived from sources within the
Philippines. Thus, before such a tax liability can be enforced the taxpayer must be shown
to have earned income sourced from the Philippines.

Association of International Shipping Lines vs. Secretary of Finance and CIR,

G.R. No. 222239, January 15, 2020. Held: Gross Philippine Billings (GPB) covers gross
revenue from transportation of passengers, cargo, and/or mail originating from the
Philippines up to final destination. Any other income, therefore, is subject to the regular
income tax rate. Demurrage and Detention Charges are not part of Gross Philippine
Billings being not related to the carriage of passenger, cargo, or mail from the Philippines.
Demurrage and Detention fees are not deemed within the scope of GPB. For demurrage
fees “which are in the nature of rent for the use of property of the carrier in the
Philippines, is considered income from Philippine source and is subject to income tax under
the regular rate as the other types of income of the on-line carrier.” On the other hand,
detention and other charges “relating to outbound cargoes and inbound cargoes are all
considered Philippine-sourced income of international sea carriers they being collected for
the use of property or rendition of services in the Philippines, and are subject to the
Philippine income tax under the regular rate.”

South African Airways v. CIR, G.R. No. 180356, February 16, 2010 – see previous
digest

d. Offshore Banking Units (OBU) [Sec. 28(A)(4)] – Income derived by

OBU authorized by the BSP, from foreign currency transactions with non-
residents, other offshore banking units, local commercial banks, including
branches of foreign banks that may be authorized by the BSP to transact with
OBUs – exempt from all taxes;
 ➢ Net Income from such transactions as may be specified by the
Secretary of Finance, upon the recommendation of the Monetary
Board – subject to regular income tax payable by banks;

➢ Interest income derived from foreign currency loans granted to

residents other than OBUs or local commercial banks, including local
branches of foreign banks that may be authorized by the BSP to
transact business with OBUs – 10% final tax

e. Regional or Area Headquarters (RAHQ) as defined in Sec. 22(DD) – not

subject to income tax [Sec. 28(A)(6)(a)]

f. Regional Operating Headquarters (ROHQ) as defined in Section 22(EE) –

10% of taxable income [Sec. 28(A)(6)(b)]

g. Branch Profits Remittance Tax (BPRT) [Sec. 28(A)(5)] – any profit

remitted by branch to its head office – subject to 15% BPRT based on the
total profits applied or earmarked without any deduction for the tax
component thereof (except those activities which are registered with the
PEZA)
➢ The tax shall be collected and paid in the same manner as provided in
Sections 57 and 58;
➢ Interests, dividends, rents, royalties, including remuneration for
technical services, salaries, wages, premiums, annuities, emoluments
or other fixed and determinable annual, periodic or casual gains,
profits, income and capital gains received by a foreign corporation
during each taxable year from all sources within the Philippines shall
not be treated as branch profits unless the same are effectively
connected with the conduct of its trade or business in the Philippines.

Case/s
Deutsche Ban AG Manila Branch v. CIR, G.R. No. 188550, August 19,
2013. Held: Tax conventions are drafted with a view towards the
elimination of international juridical double taxation, which is defined as the
imposition of comparable taxes in two or more states on the same taxpayer
in respect of the same subject matter and for identical periods. A
corporation who has paid 15% Branch Profit Remittance Tax has the right
to avail (by way of refund) of the benefit of a preferential tax rate of 10%
BPRT in accordance with the RP-Germany Tax Treaty despite non-
compliance with an application with ITAD at least 15 days before the
transactions for a lower rate. Bearing in mind the rationale of tax treaties,
the requirements for the application for the availment of tax treaty relief as
required by RMO No. 1-2000 should not operate to divest entitlement to the
relief as it would constitute violation of the duty required by good faith in
complying with a tax treaty.

Bank of America NT & SA v. CA, G.R. No. 103092, July 21, 1994. Held:
In the 15% remittance tax, the law specifies its own tax base on the “profit
remitted abroad”. There is absolutely nothing equivocal or uncertain about
the language of the provision. The tax is imposed on the amount sent
 abroad, and the law (then in force) calls for nothing further. The taxpayer
is a single entity, and it should be understandable if, such as in this case, it
is a local branch of a corporation, using its own local fund, which remits the
tax to the Philippine Government.

CIR v. Marubeni, G.R. No. 76573, September 14, 1989.

3. NRFC
a. In general – 30% final tax (effective January 1, 2009) of the gross income
received during each taxable year from sources within the Philippines, such as
interest, dividends, rents, royalties, salaries, premiums (except reinsurance
premiums), annuities, emoluments or other fixed or determinable annual,
periodic or casual gains, profits and income, and capital gains except capital
gains subject to final withholding tax under Sec. 28(B)(5)(c) [on sale of shares
of stocks issued by DC not traded thru the local stock exchange]

b. Non-Resident Cinematographic Film Owner, Lessor or Distributor –

25% of its gross income from all sources within the Philippines.

c. Non-Resident Owner or Lessor of Vessels Chartered by Philippine

Nationals – 4 ½% of gross rental, lease or charter fees from leases or
charters to Filipino citizens or corporations, as approved by the Maritime
Industry Authority (MARINA)

d. Non-Resident Owner or Lessor of Aircraft, Machineries and Other

Equipment – 7 ½% of gross rentals or fees

Cases:
NV Reederif Amsterdam v. CIR, G.R. No. 46029, June 23, 1988. Held: Petitioner N.V.
Reederij "AMSTERDAM" is a foreign corporation not authorized or licensed to do business
in the Philippines. It does not have a branch office in the Philippines and it made only two
calls in Philippine ports, one in 1963 and the other in 1964. In order that a foreign
corporation may be considered engaged in trade or business, its business transactions
must be continuous. A casual business activity in the Philippines by a foreign corporation,
as in the present case, does not amount to engaging in trade or business in the Philippines
for income tax purposes. The Court reproduces with approval the following disquisition of
the respondent court — A corporation is itself a taxpaying entity and speaking generally,
for purposes of income tax, corporations are classified into (a) domestic corporations and
(b) foreign corporations. (Sec. 24(a) and (b), Tax Code.) Foreign corporations are further
classified into (1) resident foreign corporations and (2) non-resident foreign corporations.
(Sec. 24(b) (1) and (2). Tax Code.) A resident foreign corporation is a foreign corporation
engaged in trade or business within the Philippines or having an office or place of business
therein (Sec. 84(g), Tax Code) while a non- resident foreign corporation is a foreign
corporation not engaged in trade or business within the Philippines and not having any
office or place of business therein. (Sec. 84(h), Tax Code.) A domestic corporation is taxed
on its income from sources within and without the Philippines, but a foreign corporation is
taxed only on its income from sources within the Philippines. (Sec. 24(a), Tax Code; Sec.
16, Rev. Regs. No. 2.) However, while a foreign corporation doing business in the
Philippines is taxable on income solely from sources within the Philippines, it is permitted
 to deductions from gross income but only to the extent connected with income earned in
the Philippines. (Secs. 24(b) (2) and 37, Tax Code.) On the other hand, foreign
corporations not doing business in the Philippines are taxable on income from all sources
within the Philippines, as interest, dividends, rents, salaries, wages, premiums, annuities
Compensations, remunerations, emoluments, or other fixed or determinable annual or
periodical or casual gains, profits and income and capital gains" The tax is 30% (now
35%) of such gross income. (Sec. 24 (b) (1), Tax Code.) At the time material to this case,
certain corporations were given special treatment, namely, building and loan associations
operating as such in accordance with Section 171 of the Corporation Law, educational
institutions, domestic life insurance companies and for" foreign life insurance companies
doing business in the Philippines. (Sec. 24(a) & (c), Tax Code.) It bears emphasis,
however, that foreign life insurance companies which were not doing business in the
Philippines were taxable as other foreign corporations not authorized to do business in the
Philippines. (Sec. 24(c) Tax Code.) Now to the case at bar. Here, petitioner N.V. Reederij
"Amsterdam" is a non-resident foreign corporation, organized and existing under the laws
of The Netherlands with principal office in Amsterdam and not licensed to do business in
the Philippines. (pp. 8-81, CTA records.) As a non-resident foreign corporation, it is thus a
foreign corporation, not engaged in trade or business within the Philippines and not having
any office or place of business therein. (Sec. 84(h), Tax Code.) As stated above, it is
therefore taxable on income from all sources within the Philippines, as interest, dividends,
rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments,
or other fixed or determinable annual or periodical or casual gains, profits and income and
capital gains, and the tax is equal to thirty per centum of such amount, under Section
24(b) (1) of the Tax Code. The accent is on the words of--`such amount." Accordingly,
petitioner N. V. Reederij "Amsterdam" being a non-resident foreign corporation, its taxable
income for purposes of our income tax law consists of its gross income from all sources
within the Philippines. The law seems clear and specific. It thus calls for its application as
worded as it leaves no leeway for interpretation. The applicable provision imposes a tax on
foreign corporations falling under the classification of non-resident corporations without
any exceptions or conditions, unlike in the case of foreign corporations engaged in trade or
business within the Philippines which contained (at the time material to this case) an
exception with respect to foreign life insurance companies. Adherence to the provision of
the law, which specifies and determines the taxable income of, and the rate of income tax
applicable to, non-resident foreign corporations, without mentioning any exceptions, would
therefore lead to the conclusion that petitioner N.V.Reederij "Amsterdam" is subject to
income tax on gross income from all sources within the Philippines.

H. FINAL TAX ON CERTAIN PASSIVE INCOME

Passive Income DC RFC NRFC

[Sec. 27(D)] [Sec. 28(A)(7)]
Interest
1. Interest on any currency bank deposit and 20% 20% 30%
yield or other monetary benefit from deposit
substitutes and from trust funds and similar
arrangements
2. Interest derived by a domestic 15% 7 ½% -
corporation/resident foreign
corporation from a depositor bank under
the expanded foreign currency deposit (FCD)
system
3. Interest derived by a depository bank
 under the expanded FCD system from foreign Exempt from all Exempt from all -
currency transactions with non-residents, taxes taxes
offshore banking units in the Philippines, local
commercial banks that may be authorized by
BSP to transact business with FCD system
units and other depository banks under the
expanded FCD system;

Net Income from such transaction as may be RCIT payable by RCIT payable by
specified by the Secretary of Finance, upon Banks Banks
the recommendation of the Monetary Board;

Interest income from foreign currency loans 10% 10%

granted by such depository bank under said
expanded system to residents other than
offshore banking units in the Philippines or
other depository banks under the expanded
system

Income of non-residents (whether individuals or Exempt from Exempt from

corporations) from transactions with income tax income tax
depository banks under the expanded system

4. Interest on foreign loans contracted on or - - 20%

after August 1, 1986
Royalties
5. Royalties 20% 20% 30%
Dividends
6. Intercorporate Dividends (Dividends received Not subject to Not subject to -
by a DC/RFC from a DC Tax tax under Title
II, NIRC
7. Dividend (cash or property) received by a - - 30%
NRFC from a domestic corporation which shall
be collected and paid as provided in Section
57(A)

If tax sparring rule applies - - 15%

Notes:
e. Rates are Final Taxes, unless specified
f. The foregoing passive income are derived from sources within the Philippines. If these are derived from sources
abroad, then these will be included as part of Gross Income pursuant to Section 32(A).
g. Tax Sparring Rule allows imposition of lower tax rate on dividends received by NRFC from domestic corporation if
the country in which the NRFC is domiciled allows a matching credit against the tax due from NRFC taxes deemed
to have been paid in the Philippines equivalent to 15% (effective January 1, 2009), which represents the difference
between the regular income tax of 30% and the 15% tax on dividends.

Cases:
CIR v. Solidbank, G.R. No. 148191, November 25 2003
Orion Land Inc. v. CIR, CTA Case No. 7086, January 10, 2008
CIR v. Marubeni, 177 SCRA 500
CIR v. SC Johnson and Sons, 309 SCRA 87 (1999)

CIR v. Proctor and Gamble, G.R. No. 66836, December 2, 1991. Held: Section 24(B)(1) of
the NIRC states that an ordinary 35% [now 30%] tax rate will be applied to dividends remittances
to non-resident corporate stockholders of a Philippine corporation. This rate goes down to 15%
only if the country of domicile of the foreign corporation “shall allow” such foreign corporation a
tax credit for “taxes deemed paid in the Philippines” applicable against the tax payable to the
domiciliary country by the foreign stockholder corporation.
I. CAPITAL GAINS TAX ON SALE OF SHARES OF STOCKS ISSUED BY DOMESTIC
CORPORATION NOT TRADED THRU THE LOCAL STOCK EXCHANGE

See previous discussion

Corporate Taxpayer Tax Rate

Domestic Corporation
Resident Foreign Corporation
Non-resident Foreign Corporation
15% of the net capital gains during the year
[Sec. 27(D)(2)]
Net capital gains is Not Over P100K - 5%
Any amount In excess of P100K – 10%
[Sec. 28(A)(7)(c)
Net capital gains is Not Over P100K - 5%
Any amount In excess of P100K – 10%
[Sec. 28(B)(5)(c)

J. CAPITAL GAINS TAX ON SALE, EXCHANGE OF REAL PROPERTY CONSIDERED AS

CAPITAL ASSET – see previous discussion

Corporate Taxpayer Tax Rate

Domestic Corporation
Resident Foreign Corporation
Same [Sec. 27(D)(5)]
Real property located in the Philippines,
regardless of the classification, sold by a
resident FC shall be subject to creditable
withholding tax and income tax. [Sec.
28(A)(1)]

Note: actual gain be computed.

Non-Resident Foreign Corporation Real property located in the Philippines,
regardless of the classification, sold by a
resident FC shall be subject to final
withholding tax [Sec. 28(B)(1)]

Note: Actual gains need not be computed

since the taxes imposed on NRFC is based on
gross.

Other notes:
1. Where sale of land was made between PEZA-registered enterprises subject to 5%
preferential tax “in lieu of all other taxes”, the same is not subject to 6% CGT. (DA
Ruling No. 025-2008, January 22, 2008)
2. Sale of real property held for investment by a holding company and not engaged in
real estate business is subject to 6% CGT (and DST) but exempt from VAT (DA Ruling
No. 11-2008, January 15, 2008)

K. MINIMUM CORPORATE INCOME TAX (MCIT) [SEC. 27(E)]

See: Revenue Regulation No. 9-98, August 25, 1998
 1. MCIT Rate – 2% of the Gross Income
➢ Gross Income means gross sales less sales returns, discounts and allowances
and cost of goods sold
➢ Cost of Goods Sold – include all business expenses directly incurred to
produce the merchandise to bring them to their present location and use.
2. When Imposed – when the 30% RCIT is less than the MCIT
3. When applicable – beginning on the fourth taxable year immediately following the
year in which the corporation commenced its business operations
4. Excess MCIT Carry Forward – Any excess of the MCIT over the RCIT (or normal
income tax) shall be carried forward and credited against the normal income tax for
the 3 immediately succeeding taxable years
5. Relief from MCIT under Certain Conditions – The Secretary of Finance is authorized
to suspend the imposition of the MCIT on any corporation which suffers losses on
account of prolonged labor dispute, or because of force majeure, or because of
legitimate business reverses

Case:
CREBA v. Exec. Secretary, G.R. No. 160756, March 9, 2010. Held: The imposition of the
MCIT is constitutional. An income tax is arbitrary and confiscatory if it taxes capital,
because it is income, and not capital, which is subject to income tax. However, MCIT is
imposed on gross income which is computed by deducting the gross sales the capital
spent by a corporation in the sale of its goods, i.e. the cost of goods and other direct
expenses, from the gross sales. Clearly, the capital is not being taxed.

Manila Banking Corp. v. CIR, G.R. No. 168118, August 28, 2006. Held: Let it be
stressed that RR No. 9-98, implementing R.A. 8424 imposing MCIT on corporations,
provides that for purposes of this tax, the date when business operations commence is
the year in which the domestic corporation registered with the BIR. However, under RR
No. 4-95, the date of commencement of operations of thrift banks, such as petitioner, is
the date the particular thrift bank was registered with the SEC or the date when the
Certificate of Authority to Operate was issued to it by the Monetary Board of the BSP,
whichever comes later. Clearly then, RR No. 45-95, not RR No. 9-98 applies to petitioner,
being a thrift bank. It is, therefore, entitled to grace period of 4 years counted from June
23, 1999 when it was authorized by the BSP to operate as a thrift bank. Consequently, it
should only pay its minimum corporate income tax four years from 1999.

L. IMPROPERLY ACCUMULATED EARNINGS TAX (IAET) [Sec. 29]

See: RR No. 2-200, February 12, 2001
https://www.bir.gov.ph/images/bir_files/old_files/pdf/rr02_01.pdf

1. Tax Rate – 10% of the improperly accumulated taxable income

➢ The IAE Tax is in addition to other taxes imposed under Title II of the NIRC
➢ Improperly Accumulated Income (IAT) means taxable income adjusted by:
a. Income exempt from tax;
b. Income excluded from gross income;
c. Income subject to final tax;
d. 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
2. Applicability – IAET applies to domestic corporations and which are classified as
closely-held corporation formed or availed for the purpose of avoiding the income
tax with respect to its shareholders or the shareholders of any other corporations,
permitting earnings and profits to accumulate instead of being divided or
distributed.
a. Closely-held corporation are those corporations at least 50% in value of the
outstanding capital stock or at least 50% of the total combined voting power
of all classes of stocks entitled to vote is owned directly or indirectly by or for
not more than 20 individuals. Domestic corporations not falling under the
said definition are, therefore, considered publicly-held corporation
b. Determination of whether or not a domestic corporation is closely held
corporation in so far as such determination is based on stock ownership:
i. Stocks not owned by individuals – stock owned directly or indirectly by or
for a corporation, partnership, estate or trust shall be considered as being
owned proportionately by its shareholders, partners or beneficiaries;
ii. Family and Partnership Ownership – an individual shall be considered as
owning the stock owned, directly or indirectly, by or for his family, or by
or for his partner. For this purpose, the “family of an individual” includes
his brothers and sisters (whether whole or half-blood), spouse, ancestors
and lineal descendants;
iii. Options to Acquire Stocks – if any person has option to acquire stocks,
such stock shall be considered as owned by such person. An option to
acquire such an option and each one of a series of option shall be
considered as an option to acquire such stocks
iv. Constructive Ownership as Actual Ownership – stock constructively owned
by reason of (i) or (iii) hereof shall, for purposes of applying (i) or (ii), be
treated as actually owned by such persons; but stock constructively
owned by individual by reason of (ii) shall not be treated as owned by him
for purposes of again applying such paragraph in order to make another
constructive owner of such stock.
3. Exceptions – does not apply to:
a. Publicly-held corporations
b. Banks and other nonbank financial intermediaries;
c. Insurance companies
d. Taxable partnerships
e. GPPS
f. Non-taxable joint ventures
Enterprises duly registered with PEZA, BCDA, and under special economic zones
declared by law which enjoy payment of special tax rate on their registered
operations or activities in lieu of other taxes, national or local

4. Evidence of Purpose to Avoid Tax

a. Prima facie evidence – the fact that any corporation is a mere holding
company or investment company shall be prima facie evidence of a purpose
to avoid the tax upon its shareholders or members
b. Evidence Determinative of Purpose – the fact that earnings or profits of a
corporation are permitted to accumulate beyond the reasonable needs of the
business shall be determinative of the purpose to avoid the tax upon its
shareholders or members unless the corporation, by a clear preponderance of
evidence, shall provide to the contrary.
 Reasonable needs of the business include the reasonably anticipated
needs of the business

5. Determination of Reasonable Needs of the Business

a. Immediacy Test – “reasonable needs of the business” is construed to mean
the immediate needs of the business, including reasonably anticipated needs.
In either case, the corporation should be able to prove an immediate need for
the accumulation of the earnings and profits, or the direct correlation of
anticipated needs to such accumulation of profits. Otherwise, such
accumulation would be deemed to be not for the reasonable needs of the
business and the penalty tax will apply.
b. The following constitute accumulation of earnings for the reasonable needs of
the business:
i. Allowance for the increase in the accumulation of earnings up to 100% of
the paid-up capital of the corporation as of Balance Sheet Date, inclusive
of accumulation taken from other years;
ii. Earnings reserved for definite corporate expansion projects or programs
requiring capital expenditures as approved by the Board of Directors or
equivalent body;
iii. Earnings reserved for buildings, plants, or equipment acquisition as
approved by the Board of Directors or equivalent body;
iv. Earnings reserved for compliance with any loan covenants or pre-existing
obligations established under a legitimate business agreement;
v. Earnings required by law or applicable regulation to be retained by the
corporation or in respect of which there is legal prohibition against its
distribution;
vi. In the case of subsidiaries of foreign corporations in the Philippines, all
undistributed earnings intended or reserved for investments within the
Philippines as can be proven by corporate records and/or relevant
documentary evidence.

6. Case: Cyanamid Philippines, Inc. v. CA, G.R. No. 108067, January 20, 2000.
Held: The provision discouraged tax avoidance through corporate surplus
accumulation. When corporations do not declare dividends, income taxes are not
paid on the undeclared dividends received by the shareholders. The tax on
improper accumulation of surplus is essentially a penalty tax designed to compel
corporations to distribute earnings so that the said earnings by shareholders could,
in turn, be taxed. Relying on decisions of the American Federal Courts, petitioner
stresses that the accumulated earnings tax does not apply to Cyanamid, a wholly
owned subsidiary of a publicly owned company. 10 Specifically, petitioner cites
Golconda Mining Corp. v. Commissioner, 507 F .2d 594, whereby the U.S. Ninth
Circuit Court of Appeals had taken the position that the accumulated earnings tax
could only apply to a closely held corporation. A review of American taxation
history on accumulated earnings tax will show that the application of the
accumulated earnings tax to publicly held corporations has been problematic.
Initially, the Tax Court and the Court of Claims held that the accumulated earnings
tax applies to publicly held corporations. Then, the Ninth Circuit Court of Appeals
ruled in Golconda that the accumulated earnings tax could only apply to closely
held corporations. Despite Golconda, the Internal Revenue Service asserted that
the tax could be imposed on widely held corporations including those not controlled
by a few shareholders or groups of shareholders. The Service indicated it would not
follow the Ninth Circuit regarding publicly held corporations. In 1984, American
legislation nullified the Ninth Circuit’s Golconda ruling and made it clear that the
accumulated earnings tax is not limited to closely held corporations. Clearly,
Golconda is no longer a reliable precedent. The amendatory provision of Section 25
of the 1977 NIRC, which was PD 1739, enumerated the 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. Besides, the rule on
enumeration is that the express mention of one person, thing, act, or consequence
is construed to exclude all others. Laws granting exemption from tax are construed
strictissimi juris against the taxpayer and liberally in favor of the taxing power.
Taxation is the rule and exemption is the exception. The burden of proof rests
upon the party claiming exemption to prove that it is, in fact, covered by the
exemption so claimed, 16 a burden which petitioner here has failed to discharge.
Another point raised by the petitioner in objecting to the assessment, is that
increase of working capital by a corporation justifies accumulating income.
Petitioner asserts that respondent court erred in concluding that Cyanamid need
not infuse additional working capital reserve because it had considerable liquid
funds based on the 2.21:1 ratio of current assets to current liabilities. Petitioner
relies on the so-called "Bardahl" formula, which allowed retention, as working
capital reserve, sufficient amounts of liquid assets to carry the company through
one operating cycle. The "Bardahl" formula was developed to measure corporate
liquidity. The formula requires an examination of whether the taxpayer has
sufficient liquid assets to pay all of its current liabilities and any extraordinary
expenses reasonably anticipated, plus enough to operate the business during one
operating cycle. Operating cycle is the period of time it takes to convert cash into
raw materials, raw materials into inventory, and inventory into sales, including the
time it takes to collect payment for the sales.
Using this formula, petitioner contends, Cyanamid needed at least P33,763,624.00
pesos as working capital. As of 1981, its liquid asset was only P25,776,991.00.
Thus, petitioner asserts that Cyanamid had a working capital deficit of
P7,986,633.00. Therefore, the P9,540,926.00 accumulated income as of 1981 may
be validly accumulated to increase the petitioner’s working capital for the
succeeding year. We note, however, that the companies where the "Bardahl"
formula was applied, had operating cycles much shorter than that of petitioner. In
Atlas Tool Co., Inc. v. CIR, the company’s operating cycle was only 3.33 months or
27.75% of the year. In Cataphote Corp. of Mississippi v. United States, the
corporation’s operating cycle was only 56.87 days, or 15.58% of the year. In the
case of Cyanamid, the operating cycle was 288.35 days, or 78.55% of a year,
reflecting that petitioner will need sufficient liquid funds, of at least three quarters
of the year, to cover the operating costs of the business. There are variations in
the application of the "Bardahl" formula, such as average operating cycle or peak
operating cycle. In times when there is no recurrence of a business cycle, the
working capital needs cannot be predicted with accuracy. As stressed by American
authorities, although the "Bardahl" formula is well-established and routinely applied
by the courts, it is not a precise rule. It is used only for administrative convenience.
Petitioner’s application of the "Bardahl" formula merely creates a false illusion of
exactitude. Other formulas are also used, e.g. the ratio of current assets to current
liabilities and the adoption of the industry standard. The ratio of current assets to
current liabilities is used to determine the sufficiency of working capital. Ideally, the
 working capital should equal the current liabilities and there must be 2 units of
current assets for every unit of current liability, hence the so-called "2 to 1" rule.

M. ADMINISTRATIVE PROVISIONS

7. Corporation return [Sec. 52(A)]

ii. What to file – a true and accurate: i) quarterly income tax return; and b) final or
adjustment return
iii. Required to file – every corporation, except foreign corporations not engaged in
trade or business in the Philippines (i.e. NRFC);
iv. How many copies – duplicate
v. In What Form? – paper or electronic form
vi. How many pages? – maximum of 4 pages
vii. Who must file – by the i) President; or (ii) vice president; or (iii) other principal
officer; AND by (i) the treasurer; or (ii) assistant treasurer
viii. Contents of the Return: (i) Corporate Profile and information; (ii) Gross sales,
receipts or income from services rendered, or conduct of trade or business, except
income subject to final tax as provided under the Tax Code; (iii) Allowable
Deductions; (iv) Taxable Income as defined in Section 31; (5) Income Tax Due and
Payable

The foregoing provisions shall not affect the implementation of TIMTA

2. Taxable Year of Corporation [Sec. 52(B)]

ix. Corporation may employ either calendar year or fiscal year as the basis for filing its
income tax return;
x. Corporation shall not change the accounting period without prior approval from the
Commissioner in accordance with Section 47 of the Code

3. Return of Corporation Contemplating of Dissolution or Reorganization [Sec.

52(C)]
xi. Who are covered under this rule? – Every corporation (i) planning for its
dissolution, or (ii) for liquidation of the whole or any part of its capital stock, (iii)
corporation which has been notified of possible involuntary dissolution by the SEC;
xii. What to file? – a correct return to the Commissioner, verified under oath, setting
thereof the terms of resolution or plan and such other information as may be
required under rules and regulations
xiii. When to file? – within 30 days after the adoption by the corporation of a resolution
of such plan, etc.
xiv. Certificate of Tax Clearance issued by the BIR – must be submitted by the
corporation to the SEC prior to the issuance by the SEC of a Certificate of
Dissolution or Reorganization

4. Return on Capital Gains Tax from Sale of Shares of Stocks Not Traded thru
local exchange [Sec. 52(D)]
xv. Return must be filed within 30 days after each transaction
xvi. Final consolidated return of all transaction during the taxable year shall be filed on
or before the 15th day of the fourth month following the close of the taxable year.
 5. Extension of Time to File Return [Sec. 53]
xvii. May be granted by the Commissioner in meritorious cases, subject to the provisions
of Section 56

6. Returns of Receiver, Trustees in Bankruptcy or Assignees [Sec. 54]

xviii. Case/s covered – when receivers, trustees in bankruptcy or assignees are operating
the property or business of a corporation subject to tax
xix. What to file – returns of net income as and for such corporation,
xx. Form of the return – same as a corporation
xxi. Liable to pay tax – tax due on the income as returned by the receivers, trustees or
assignees shall be assessed and collected in the same manner as if assessed
directly against the organization of whose business or properties they have control
or custody

7. Payment of Tax [Sec. 56]

xxii. In general – payment to be made upon filing of return
xxiii. In case of tramp vessels, the shipping agent and/or husbanding agents, and in
their absence, the captain thereof are required to file the return herein provided
and pay the tax due thereon before their departure. Upon failure of said agents or
captains to file the return and pay the tax, the Bureau of Customs is authorized to
hold the vessel and prevent its departure until proof of payment of the tax is
presented or a sufficient bond is filed to answer for the tax due.
xxiv. Installment payment of tax due – Not available to corporate taxpayers

8. Payment of Capital Gains Tax on sale or exchange of real property classified

as Capital Asset [Sec. 56(A)(3)]
xxv. Paid on the date the return is filed by the person liable thereto

Cases:
State Land Investment Corp. v. CIR, G.R. No. 171956, January 18, 2008
Rhombus Energy Inc. v. CIR, G.R. No. 206362, August 1, 2018
 LECTURE NOTES

TAXATION 1
Atty. Arnel A. dela Rosa, CPA, REB, REA

INCOME TAXATION

DEDUCTIONS FROM GROSS INCOME (CHAPTER VII, NIRC)

Defined

Deductions are items or amounts which the law allows to be deducted from gross income in order
to arrive at net or taxable income.

What is the treatment of return of capital?

Income tax is levied by law only on income; hence, the amount representing return of capital
(e.g. cost of goods sold) should be deducted from the proceeds of sale and should not be subject
to income tax.

Distinguish Exclusions from Deductions

Exclusion (Sec. 32(B)) Deduction (Sec. 34)

Refer to flow of wealth which are not treated
as part of the gross income because: a) these
are exempted by law or statute; or b) they do
not come within the definition of income
Pertain to the computation of gross income
Something earned by the taxpayer which do
not form part of the gross income
Refer to the amounts which the law allows to
be subtracted from the gross income in order
to arrive at the net income.
Pertain to the computation of net income
Something spent or paid in earning the gross
income

Deduction vs. Tax Credits

Deductions are the expenses and other allowable deductions as provided by law which are
incurred for engaging in trade, business or profession, deducted from the gross income to arrive
at the net or taxable income.

Tax Credits are amount of tax previously paid by the taxpayer which later on can be claimed as
tax credit from the tax liability of the taxpayer. It is deducted from the computed tax liability to
arrive at tax still due. (E.g. Creditable Withholding Tax)

Give the basic principles governing deductions

 1. The taxpayer seeking a deduction must point to some specific provision of the statute
authorizing the deduction;
2. He must be able to prove that he is entitled to the deduction authorized or allowed (Atlas
Consolidated Mining v. Commissioner, G.R. No. L-26911, January 21, 1981)

Note: Deductions for income tax purposes partake of the nature of a tax exemption; hence, just
like tax exemptions, deductions must be construed in strictissimi juris against the taxpayer.

May Deductions be created by implication?

No. Deductions have generally been deemed to be a matter of legislative grace. They are allowed
only where there is a clear provision in the statute for the deduction claimed; and where particular
deductions are authorized by the statute, no other may be made. The taxpayer has the burden
of justifying the allowance of any deduction claimed by him.

May the taxpayer deduct lesser amount of deductions or not to deduct at all?

Definitely. For income tax purposes a taxpayer is free to deduct from its gross income a lesser
amount, or not to claim any deduction at all. What is prohibited by the income tax law is to
claim a deduction beyond the amount authorized therein. (CIR V. Phoenix Assurance Co., Ltd.,
G.R. No. L-19727, May 20, 1965)

Basis: Lifeblood doctrine

Who are not allowed to claim deductions?

1. Individuals receiving compensation income;

2. Non-Resident aliens not engaged in trade or business;
3. Aliens (also Filipinos similarly situated) employed in ROHQ, RAHQ, OBU, Petroleum
Contractors;
4. Non-Resident Foreign Corporations;
5. Income subject to Final Withholding Tax

In general, what are the deductions from gross income authorized by the NIRC?

1. Itemized or Actual Deductions – These are the allowable deductions enumerated

under Section 34 of the NIRC.

2. Optional Standard Deductions – is a standard deduction in an amount not exceeding

40% of the gross sales/receipt of individuals, other than non-resident aliens, or 40% of
gross income corporations in lieu of the itemized deductions.

Rules on Optional Standard Deduction [Sec. 34(L)]

 1. Who are allowed to avail?
a. Individuals except non-resident alien;
b. Domestic and Resident Foreign Corporation
c. General Professional Partnership and its individual partners but may be availed only
once, either the GPP or the partners

2. Rate
a. Individuals – 40% of Gross Sales or Gross Receipts
b. Corporation – 40% of Gross Income as defined in Sec. 32
c. GPP – 40% of ? (the law is silent) but under RR No. 8-2018, its was interpreted to
mean 40% of gross income. See below

3. OSD/Itemized Deduction, how elected. The default deduction is Itemized Deduction;

thus, unless the taxpayer signifies in his return his/its intention to avail of the OSD, he is
deemed to have availed the itemized deduction. Such election of the option, when the
return is made, shall be irrevocable for the taxable year for which the return is made. The
election to claim either the itemized deduction or the OSD for the taxable year must be
signified by checking the appropriate box in the ITR filed for the first quarter of the taxable
year or the initial quarter of the taxable year after the commencement of a new
business/practice of profession. Once the election is made, it must be consistently applied
to all the succeeding quarterly returns and in the final income tax return for the taxable
year.

4. Substantiation requirements. No need to keep records of the expenses. However, the

individual taxpayer shall keep such records pertaining to his gross sales/receipts, while
the corporation, its records pertaining to its gross income as defined under Section 32.

5. Submission of Financial Statement – Individuals who opted OSD, no need to submit FS.

Determination of the OSD for GPPs and Partners of GPPs (RR No. 8-2018)

GPP is not subject to income tax imposed pursuant to Section 26 of the Tax Code, as amended.
However, the partners shall be liable to pay income tax on their separate and individual capacities
for the respective distributive shares in the net income of the GPP.

The GPP is not a taxable entity for income tax purposes since it is only acting as a “pass through”
entity where its income is ultimately taxed to the partners comprising it. Section 26 of the Tax
Code, as amended, likewise provides that – “For purposes of computing the distributive shares
of the partners, the net income of the GPP shall be computed in the same manner as a
corporation.” As such, a GPP may claim either the itemized deductions allowed under Section 34
of the Code or in lieu thereof, it can opt to avail of the OSD allowed to corporations in claiming
the deductions in an amount not exceeding forty percent (40%) of its gross income.

xxx
 The distributable net income of the partnership may be determined by claiming either itemized
deductions or OSD. The share in the net income of the partnership, actually or constructively
received, shall be reported as taxable income of each partner. The partners comprising the GPP
can no longer claim further deduction from their distributive share in the net income of the GPP
and are not allowed to avail of the 8% income tax rate option since their distributive share from
the GPP is already net of cost and expenses.

If the partners also derive other income from trade, business or practice of profession apart and
distinct from the share in the net income of the GPP, the deduction can be claimed from the other
income would either be the itemized deductions or OSD.

What are the itemized deductions under Section 34?

The allowable itemized deductions from gross income are:

1. Expenses
2. Interests on indebtedness
3. Taxes in connection with taxpayer’s business, trade or profession;
4. Losses
5. Bad debts
6. Depreciation
7. Depletion of oil and gas wells and mines
8. Charitable and other contributions
9. Research and Development expenditures
10. Contribution to pension trust

Special deductions
1. Deductions allowed to private proprietary educational institutions and hospitals that are
non-profit [Sec. 34(A)(2)];
2. Deductions allowed to insurance companies (Sec. 37);
3. Deductions allowed to Estates and Trusts (Sec. 61)

What are the items not deductible in computing net income?

1. Personal, living and family expenses (note: Section 35 on Personal Exemptions for
Individual Taxpayer has been repealed by RA 10963, TRAIN Law);
2. Any amount paid out for new building or permanent improvements, or betterment made
to increase the value of any property or estate, except intangible drilling and development
cost in petroleum operations;
3. Any amount expended in restoring property or in making good the exhaustion thereof for
which an allowance is or has been made;
4. Premiums paid on any life insurance policy covering the life of any officer or employee, or
of any person financially interested in any trade or business carried on by the taxpayer,
individual or corporate, when the taxpayer is directly or indirectly a beneficiary under such
policy.
5. Losses from sale or exchanges of property between related parties;
 6. Losses from wash sales of stocks or securities unless the claim is made by a dealer in
stock or securities and with respect to a transaction made in the ordinary course of
business of such dealer;
7. Non-deductible taxes
8. Non-deductible losses;
9. Non-deductible interests

Itemized Deductions

The principle is recognized that when a taxpayer claims a deduction, he must point to some
specific provision of the statute in which that deduction is authorized and must be able to prove
that he is entitled to the deduction which the law allows. As previously adverted to, the law
allowing expenses as deduction from gross income for purposes of the income tax is Section 30
(a) (1) of the National Internal Revenue which allows a deduction of "all the ordinary and
necessary expenses paid or incurred during the taxable year in carrying on any trade or business."
An item of expenditure, in order to be deductible under this section of the statute, must fall
squarely within its language. (Atlas Consolidated Mining v. CIR, G.R. No. L-26911, January
27, 1981)

A. BUSINESS EXPENSES

In general, what are the business expenses that are allowed by law to be deducted from gross
income?

All the ordinary and necessary expenses paid or incurred during the taxable year in carrying
on or which are directly attributable to, the development, management, operation and/or
conduct of the trade, business or exercise of profession [Sec. 34(A)(1)(a), NIRC].

What are the requisites in order that an expense may be deductible for income tax purposes?

1. The expense must be ordinary and necessary;

Ordinary – when it is common to incur in the trade or business of the taxpayer as

distinguished from capital expenditures. The payments, however, need not be habitual
in the sense that taxpayer will have to make them often.

Necessary – if it is appropriate and helpful to the taxpayer’s business or if it is to be

intended to realize a profit or to minimize a loss (Cebu Terminal v. Coll, CTA Case No. 28,
June 29, 1957).

Capital Expenditures – An expenditure that benefits not only the current period but
also future periods. It is not deductible but depreciable, except, if the taxpayer is a non-
 profit proprietary educational institution which may elect either to deduct the capital
expense of depreciate it.

Examples of Capital Expenditures:

a. Litigation expenses in defense of a title to mining properties (Atlas Consolidated v.

CIR, supra). These will become part of cost of the property.
b. One-time stock listing expenses as compared to the annual recurring fees paid to
the stock exchange. (Atlas Consolidated v. CIR, supra)
c. Advertising expense designed to stimulate future sales of a merchandise (CIR v.
General Foods, Inc. G.R. No. 143672, April 24, 2003, discussed below)

2. It must be reasonable in amount.

The phrase “ordinary and necessary” implies that the expense must be reasonable. (See
CIR v. General Foods, Inc. supra)

Cases on Requisite Nos. 1 & 2:

Atlas Consolidated Mining v. CIR, supra. [T]he statutory test of deductibility where
it is axiomatic that to be deductible as a business expense, three conditions are imposed,
namely: (1) the expense must be ordinary and necessary, (2) it must be paid or incurred
within the taxable year, and (3) it must be paid or incurred in carrying in a trade or
business. In addition, not only must the taxpayer meet the business test, he must
substantially prove by evidence or records the deductions claimed under the law,
otherwise, the same will be disallowed. The mere allegation of the taxpayer that an item
of expense is ordinary and necessary does not justify its deduction. While it is true that
there is a number of decisions in the United States delving on the interpretation of the
terms "ordinary and necessary" as used in the federal tax laws, no adequate or satisfactory
definition of those terms is possible. Similarly, this Court has never attempted to define
with precision the terms "ordinary and necessary." There are however, certain guiding
principles worthy of serious consideration in the proper adjudication of conflicting claims.
Ordinarily, an expense will be considered "necessary" where the expenditure is
appropriate and helpful in the development of the taxpayer's business. It is "ordinary"
when it connotes a payment which is normal in relation to the business of the taxpayer
and the surrounding circumstances. The term "ordinary" does not require that the
payments be habitual or normal in the sense that the same taxpayer will have to make
them often; the payment may be unique or non-recurring to the particular taxpayer
affected. There is thus no hard and fast rule on the matter. The right to a deduction
depends in each case on the particular facts and the relation of the payment to the type
of business in which the taxpayer is engaged. The intention of the taxpayer often may be
the controlling fact in making the determination. Assuming that the expenditure is
ordinary and necessary in the operation of the taxpayer's business, the answer to the
question as to whether the expenditure is an allowable deduction as a business expense
must be determined from the nature of the expenditure itself, which in turn depends on
the extent and permanency of the work accomplished by the expenditure.
 Aguinaldo Industries v. CIR, G.R. No. L-29790, February 25, 1982. Facts: Aguinaldo
Industries, in its income tax returns, claimed a deduction from its gross income the
amount of P61,187.48 as additional remuneration paid to the officers of the corporation.
It was found out that this amount was taken from the net profit of an isolated transaction,
i.e. sale of land not in the ordinary course of its business or trade. It appears as well that
the sale was effected thru a broker who earned commission of P51,723.72. Held: The
bonus given to the officers of the petitioner as their share of the profit realized from the
sale of petitioner's Muntinlupa land cannot be deemed a deductible expense for tax
purposes, even if the aforesaid sale could be considered as a transaction for carrying on
the trade or business of the petitioner and the grant of the bonus to the corporate officers
pursuant to petitioner's by-laws could, as an intra-corporate matter, be sustained. The
records show that the sale was effected through a broker who was paid by petitioner a
commission of P51,723.72 for his services. On the other hand, there is absolutely no
evidence of any service actually rendered by petitioner's officers which could be the basis
of a grant to them of a bonus out of the profit derived from the sale. This being so, the
payment of a bonus to them out of the gain realized from the sale cannot be considered
as a selling expense; nor can it be deemed reasonable and necessary so as to make it
deductible for tax purposes.

ESSO v. CIR, G.R. Nos. L-28508-9, July 7, 1989. Facts: In this case, ESSO claimed as
ordinary and necessary expenses the amount of P340,822.04 representing margin fees it
paid to the Central Bank on its profit remittances to its New York head office. Held:
Citing the requirements stated in Atlas Consolidated Mining v CIR, the SC held that ESSO
has not shown that the remittance to the head office of part of its profits was made in the
furtherance of its own trade of business. The petitioner merely presumed that all
corporate expenses are necessary and appropriate in the absence of a showing that they
are illegal or ultra vires. The public respondent is correct when it asserts that "the
paramount rule is that claims for deductions are a matter of legislative grace and do not
turn on mere equitable considerations The taxpayer in every instance has the burden
of justifying the allowance of any deduction claimed." It is clear that ESSO, having
assumed an expense properly attributable to its head office, cannot now claim this as an
ordinary and necessary expense paid or incurred in carrying on its own trade or business.

3. It must have been paid or incurred during the taxable year;

If the taxpayer keeps his/its books on the cash receipts basis, then expenses are
deductible in the year they are paid. If on the accrual basis, then in the year they are
incurred, whether paid or not.

All Events Test. It is applied in recognizing income or liability under accrual method
of accounting. For taxpayer using the accrual method, the determinative question is,
when do the facts present themselves in such a manner that the taxpayer must recognize
income or expense? The accrual of income and expense is permitted when the all-events
test has been met. This requires: (1) fixing of the right to income or liability to pay; and
(2) the availability of the reasonable accurate determination of such income or liability.
Case: CIR v. Isabela Cultural Corp., G.R. No. 17223, February 12, 2007. Facts:
During the audit of ICC’s books for taxable year 1986, the following BIR disallowed the
following expenses: a) expenses for auditing services for the year 1985; b) expenses for
legal services for the years 1984 and 1985; and c) expenses for security services for 1986.
Moreover, the BIR alleged that ICC understated it’s interest income on the three
promissory notes from Realty Investment Inc. Held: Accounting methods for tax
purposes comprise a set of rules for determining when and how to report income and
deductions. In the instant case, the accounting method used by ICC is the accrual method.
Revenue Audit Memorandum Order No. 1-2000, provides that under the accrual method
of accounting, expenses not being claimed as deductions by a taxpayer in the current year
when they are incurred cannot be claimed as deduction from income for the succeeding
year. Thus, a taxpayer who is authorized to deduct certain expenses and other allowable
deductions for the current year but failed to do so cannot deduct the same for the next
year. The accrual method relies upon the taxpayer’s right to receive amounts or its
obligation to pay them, in opposition to actual receipt or payment, which characterizes
the cash method of accounting. Amounts of income accrue where the right to receive
them become fixed, where there is created an enforceable liability. Similarly, liabilities are
accrued when fixed and determinable in amount, without regard to indeterminacy merely
of time of payment. For a taxpayer using the accrual method, the determinative question
is, when do the facts present themselves in such a manner that the taxpayer must
recognize income or expense? The accrual of income and expense is permitted when the
all-events test has been met. This test requires: (1) fixing of a right to income or liability
to pay; and (2) the availability of the reasonable accurate determination of such income
or liability. The all-events test requires the right to income or liability be fixed, and the
amount of such income or liability be determined with reasonable accuracy. However, the
test does not demand that the amount of income or liability be known absolutely, only
that a taxpayer has at his disposal the information necessary to compute the amount with
reasonable accuracy. The all-events test is satisfied where computation remains uncertain,
if its basis is unchangeable; the test is satisfied where a computation may be unknown,
but is not as much as unknowable, within the taxable year. The amount of liability
does not have to be determined exactly; it must be determined with
"reasonable accuracy." Accordingly, the term "reasonable accuracy" implies
something less than an exact or completely accurate amount. The propriety of
an accrual must be judged by the facts that a taxpayer knew, or could
reasonably be expected to have known, at the closing of its books for the
taxable year. Accrual method of accounting presents largely a question of fact; such
that the taxpayer bears the burden of proof of establishing the accrual of an item of
income or deduction. Corollarily, it is a governing principle in taxation that tax exemptions
must be construed in strictissimi juris against the taxpayer and liberally in favor of the
taxing authority; and one who claims an exemption must be able to justify the same by
the clearest grant of organic or statute law. An exemption from the common burden
cannot be permitted to exist upon vague implications. And since a deduction for income
tax purposes partakes of the nature of a tax exemption, then it must also be strictly
construed. In the instant case, the expenses for professional fees consist of expenses for
legal and auditing services. The expenses for legal services pertain to the 1984 and 1985
legal and retainer fees of the law firm Bengzon Zarraga Narciso Cudala Pecson Azcuna &
Bengson, and for reimbursement of the expenses of said firm in connection with ICC’s tax
problems for the year 1984. As testified by the Treasurer of ICC, the firm has been its
 counsel since the 1960’s. From the nature of the claimed deductions and the span of time
during which the firm was retained, ICC can be expected to have reasonably known the
retainer fees charged by the firm as well as the compensation for its legal services. The
failure to determine the exact amount of the expense during the taxable year when they
could have been claimed as deductions cannot thus be attributed solely to the delayed
billing of these liabilities by the firm. For one, ICC, in the exercise of due diligence could
have inquired into the amount of their obligation to the firm, especially so that it is using
the accrual method of accounting. For another, it could have reasonably determined the
amount of legal and retainer fees owing to its familiarity with the rates charged by their
long time legal consultant. As previously stated, the accrual method presents largely a
question of fact and that the taxpayer bears the burden of establishing the accrual of an
expense or income. However, ICC failed to discharge this burden. As to when the firm’s
performance of its services in connection with the 1984 tax problems were completed, or
whether ICC exercised reasonable diligence to inquire about the amount of its liability, or
whether it does or does not possess the information necessary to compute the amount of
said liability with reasonable accuracy, are questions of fact which ICC never established.
It simply relied on the defense of delayed billing by the firm and the company, which
under the circumstances, is not sufficient to exempt it from being charged with knowledge
of the reasonable amount of the expenses for legal and auditing services. In the same
vein, the professional fees of SGV & Co. for auditing the financial statements of ICC for
the year 1985 cannot be validly claimed as expense deductions in 1986. This is so because
ICC failed to present evidence showing that even with only "reasonable accuracy," as the
standard to ascertain its liability to SGV & Co. in the year 1985, it cannot determine the
professional fees which said company would charge for its services. ICC thus failed to
discharge the burden of proving that the claimed expense deductions for the professional
services were allowable deductions for the taxable year 1986. Hence, per Revenue Audit
Memorandum Order No. 1-2000, they cannot be validly deducted from its gross income
for the said year and were therefore properly disallowed by the BIR. As to the expenses
for security services, the records show that these expenses were incurred by ICC in
1986 and could therefore be properly claimed as deductions for the said year. Anent the
purported understatement of interest income from the promissory notes of Realty
Investment, Inc., we sustain the findings of the CTA and the Court of Appeals that no
such understatement exists and that only simple interest computation and not a
compounded one should have been applied by the BIR. There is indeed no stipulation
between the latter and ICC on the application of compounded interest. Under Article 1959
of the Civil Code, unless there is a stipulation to the contrary, interest due should not
further earn interest.

4. It must be paid or incurred in carrying on any trade or business or exercise of

profession;

Case: Hospital de San Juan De Dios v. CIR, G.R. No. L-31305, May 10, 1990. Held:
The Supreme Court ruled in the negative. The CTA found that petitioner failed to establish
by competent proof that its receipt of interest and dividends constituted the carrying on
of a trade or business so as to warrant the deductibility of the expenses incurred in their
realization. Petitioner could have easily required any of its responsible officials to testify
on this regard but it failed to do so. Under this circumstances and coupled with the fact
 that the interest and dividends here in question are merely incidental income to
petitioner’s main activities, which is the operation of its hospital and nursing school, the
conclusion becomes inevitable that petitioner’s activity never go beyond that of a passive
investor, which under existing jurisprudence do not come within the purview of carrying
on any trade or business.

5. It must be substantiated by adequate proof.

Rule: No deduction from gross income shall be allowed x x x unless the taxpayer
substantiate with sufficient evidence, such as official receipts or other adequate records:
(i) the amount of the expense being deducted, and (b) the direct connection or relation
of the expense being deducted to the development, management, operation and/or
conduct of the trade, business or profession of the taxpayer.

Exception: Cohan Rule (Cohan v. Commissioner, 39 F. 2d 540, 1930) – In this case,

despite inadequate records, Cohan was allowed was allowed to a deduction based on
close approximation. Generally, the effect of the Cohan decision extends to the
deductibility of business expenses where the taxpayer clearly incurred business expenses,
but kept inadequate records. In order words, this Cohan Rule allows taxpayers to deduct
some of their business-related expenses even if the receipts have been lost or misplaced
so long as they are reasonable and credible.

Best Evidence Obtainable Rule [Sec. 6(B), NIRC]. When a report required by law
as a basis for the assessment of any national internal revenue tax shall not be forthcoming
within the time fixed by laws or rules and regulation or when there is a reason to believe
that any such report is false, incomplete or erroneous, the Commissioner shall assess the
proper tax on the best evidence obtainable.

Cases:

Pilmico-Mauri Foods Corp, G.R. No. 175651, Sept. 14, 2016: Held: To support
deductions for business expense, official receipts and sales invoices must meet the
requirements provided for in Section 238 of the 1977 Tax Code.

Jumbo East Realty v. CIR, CTA Case No. 8380, March 16, 2015. Held: In the absence
of accounting records or other documents necessary for the determination of taxpayer’s
internal revenue tax liability, Section 6(B) of the Tax Code requires that the assessment
of the tax be determined based on the “Best Evidence Obtainable” Under Section
2.4(c) of RMC 23-2000, which prescribes the procedures on the assessment of deficiency
internal revenue taxes based on “Best Evidence Obtainable” under Section 6(B) of the Tax
Code, in case when there is showing that the expenses has been incurred by the taxpayer
but the exact amount of such expenses cannot be ascertained due to absence of
documentary evidence, the BIR can make an estimate of the deduction that may be
allowed in computing the taxpayer’s taxable income, and the disallowance of 50% of the
taxpayer’s claimed deduction is valid. In the instant case, while the taxpayer was able to
submit the various official receipts to support the its deductions for operating expenses
and taxes and licenses, the same were denied admission by the CTA for the taxpayer’s
failure to present the original copies for comparison. Hence, considering that the
 taxpayer’s claimed deductions were not adequately supported by documentary evidence,
the CTA upheld the disallowance of the operating expenses as well as the taxes and
licenses claimed by the taxpayer. However, since the taxpayer actually incurred the
expenses, the CTA deemed it proper to apply the 50% approximation provided under
Sections 2.3 and 2.4(c) of RMC No. 23-2000. Thus, in computing the taxable income of
the taxpayer, the taxpayer may only deduct 50% of the total amount it claimed for
operating expenses, including taxes and licenses.

Sy Po v. CTA, CIR, G.R. No. 81446, August 18, 1988. Held: The rule on the “best
evidence obtainable” applies when a tax report required by law for the purpose of
assessment is not available or when the tax report is incomplete or fraudulent.

6. If the expense is subject to withholding tax, proof of payment to the BIR must be
shown.

Rule: Any amount paid or payable which is otherwise deductible from or taken into
account in computing gross income or for which depreciation or amortization may be
allowed shall be allowed as a deduction only if it is shown that the tax required to be
deducted and withheld therefrom has been paid to the BIR. [Sec. 34(K])

Instances when a deduction is allowed where no withholding of tax was made

(Revenue Regulation No. 6-2018)
https://www.bir.gov.ph/images/bir_files/internal_communications_1/Full%20Text%20R
R%202018/RR%20No.%206-2018.pdf

a. The payee reported the income and pays the income tax due thereon and the
withholding agent pays the tax including the interest incident to the failure to
withhold the tax, and surcharges, if applicable, at the time of the
audit/investigation or reinvestigation/reconsideration;

b. The recipient/payee failed to report the income on the due date thereof but the
withholding agent/taxpayer pays the tax, including the interest incident to the
failure to withhold the tax, and surcharges, if applicable, at the time of the
audit/investigation or reinvestigation/reconsideration;

c. The withholding agent erroneously underwithheld the tax but pays the difference
between the correct amount and the amount of tax withheld including the interest,
incident to such error, and surcharges, if applicable, at the time of
audit/investigation or reinvestigation/reconsideration.

See: RR Nos. 11-2018 and 14-2018 relative to the list of income payments
subject to withholding taxes.
https://www.bir.gov.ph/images/bir_files/internal_communications_1/Full%20Text%20R
R%202018/RR%20No.%2011-2018/RR%20No.%2011-2018.pdf
https://www.bir.gov.ph/images/bir_files/internal_communications_1/Full%20Text%20R
R%202018/RR%20No.%2014-2018.pdf
Note: Income payments to registered enterprises availing of income tax holidays are not
subject to creditable withholding tax. (BIR Ruling DA 030-2008, June 23, 2008)

Cases:

a. FEBTC v. CA, CTA, G.R. No. 129130, December 9, 2005. CDB (which later on merged
with FEBTC, the latter being the surviving company) filed its ITR reflecting therein a
negative net income (or net loss). Since there is no tax against which to credit or
offset taxes withheld by CDB, the result was that CDB had excess creditable
withholding tax. Thus, filed for a claim for refund. In denying the claim for refund,
the CA held that the evidence presented by FEBTC consisting of: (1) confirmation
receipts, payment orders, and official receipts issued by the Central Bank and the BIR
with CDB as the payor; (2) Income Tax Returns for 1990 and 1991 with attached
financial statements filed by petitioner with the BIR; and, (3) a list prepared by the
Accounting Department of petitioner purportedly showing the CDB schedule of
creditable withholding tax applied for refund for 1990 and 1991, all failed to clearly
establish that the taxes arising from the sale of its acquired assets sometime in 1990
and 1991 were properly withheld and remitted to the BIR. The CA likewise ruled that
it was incumbent upon petitioner to present BIR Form No. 1743.1 as required under
Revenue Regulation 6-85 to conclusively prove its right to the refund. It held that
petitioner's failure to do so was fatal to its cause.

Held: Petitioner has not sufficiently presented a case for the application of an
exception from the rule.

Firstly, the CA cannot be faulted for not lending credence to petitioner's contention
that it withheld, for its own account, the creditable withholding taxes on the sale of
its acquired assets. In our withholding tax system, possession of the amount that is
used to settle the tax liability is acquired by the payor as the withholding agent of the
government. For this reason, the Tax Code imposes, among others, certain obligations
upon the withholding agent to monitor its compliance with this duty. These include
the filing of the quarterly withholding tax returns, the submission to the payee, in
respect of his or its receipts during the calendar quarter or year, of a written statement
showing the income or other payments made by the withholding agent during such
quarter or year and the amount of the tax deducted and withheld therefrom, and the
filing with the BIR of a reconciliation statement of quarterly payments and a list of
payees and income payments. Codal provisions on withholding tax are mandatory
and must be complied with by the withholding agent. This is significant in that a
taxpayer cannot be compelled to answer for the non-performance by the withholding
agent of its legal duty to withhold unless there is collusion or bad faith. In addition,
the former could not be deemed to have evaded the tax had the withholding agent
performed its duty.

On the other hand, it is incumbent upon the payee to reflect in his or its own return
the income upon which any creditable tax is required to be withheld at the source.
 Only when there is an excess of the amount of tax so withheld over the tax due on
the payee's return can a refund become possible.

A taxpayer must thus do two things to be able to successfully make a claim for the
tax refund: (a) declare the income payments it received as part of its gross income
and (b) establish the fact of withholding. On this score, the relevant revenue
regulation provides as follows:

Section 10. Claims for tax credit or refund. -- Claims for tax credit or refund
of income tax deducted and withheld on income payments shall be given
due course only when it is shown on the return that the income payment
received was declared as part of the gross income and the fact of
withholding is established by a copy of the statement duly issued by the
payor to the payee (BIR Form No. 1743.1) showing the amount paid and
the amount of tax withheld therefrom.

As mentioned, petitioner relies heavily on the confirmation receipts with the

corresponding official receipts and payment orders to support its case. Standing alone,
however, these documents only establish that CDB withheld certain amounts in 1990
and 1991. It does not follow that the payments reflected in the confirmation receipts
relate to the creditable withholding taxes arising from the sale of the acquired
properties. The claim that CDB had excess creditable withholding taxes can only be
upheld if it were clearly and positively shown that the amounts on the various
confirmation receipts were the amounts withheld by virtue of the sale of the acquired
assets. On this point, the CA correctly pronounced:

The confirmation receipts alone, by themselves, will not suffice to prove

that the taxes reflected in the income tax returns are the same taxes
withheld from CDB's income payments from the sale of its acquired assets.
This is because a cursory examination of the said Confirmation Receipts,
Payment Orders and Official Receipts will show that what are reflected
therein are merely the names of the payors and the amount of tax. The
nature of the tax paid, or at the very least, the income payments from
which the taxes paid were withheld are not reflected therein. If these are
the only entries that are found on these proferred documents, We cannot
begrudge the Respondent Court from nurturing veritable doubts on the
nature and identity of the taxes withheld, when it declared, in part, in its
Decision ( Annex 'A of the Petition ) that, 'It can not well be said that
the amounts paid and remitted to the BIR were for CDB's account and not
for the other possible payees of withholding taxes which CDB may also be
liable to remit as a withholding agent x x x .

Petitioner, apparently aware of the foregoing deficiency, offered into evidence a CDB
Schedule of Creditable Withholding Tax for the period 1990 to 1991 prepared by
petitioner's representative to show that the taxes CDB withheld did, indeed, pertain to the
taxes accruing on the sale of the acquired assets. The CA, however, found the same to
be 'self-serving and unverifiable and therefore 'barren of evidentiary weight. We accord
this finding on an issue of fact the highest respect and we will not set it aside lightly.
It bears emphasis that questions on whether certain items of evidence should be accorded
probative value or weight, or rejected as feeble or spurious, or whether the proofs on one
side or the other are clear and convincing and adequate to establish a proposition in issue,
are without doubt questions of fact. This is true regardless of whether the body of proofs
presented by a party, weighed and analyzed in relation to contrary evidence submitted by
the adverse party, may be said to be strong, clear and convincing. Whether certain
documents presented by one side should be accorded full faith and credit in the face of
protests as to their spurious character by the other side; whether inconsistencies in the
body of proofs of a party are of such gravity as to justify refusing to give said proofs
weight all these are issues of fact. Questions like these are not reviewable by us. As a
rule, we confine our review of cases decided by the CA only to questions of law raised in
the petition and therein distinctly set forth. We note that without the CDB Schedule, no
evidence links the Confirmation Receipts, Payment Orders and Official Receipts to the
taxes allegedly withheld by CDB on the sale of the acquired assets.

As to the annual income tax returns for 1990 and 1991 presented by petitioner, we must
stress that the mere admission into the records of these returns does not automatically
make their contents or entries undisputed and binding facts. Mere allegations by petitioner
of the figures in its returns are not a sufficient proof of the amount of its refund
entitlement. They do not even constitute evidence adverse to respondent, against whom
these are being presented.

Furthermore, we note that in the proceedings below, respondent Commissioner of Internal

Revenue (CIR) raised the fact that there was a discrepancy in the excess creditable
withholding tax reflected in the returns with the amounts sought to be refunded by
petitioner. Whereas the 1990 and 1991 Income Tax Returns indicated that CDB had excess
creditable withholding tax in the amounts of P535,310 and P357,511, respectively, the
amounts claimed by petitioner as indicated in the CDB Schedule were P512,940.50 for
1990 and P242,774.50 for 1991. The records are bereft of any explanation for such
discrepancy. This further undermines petitioner's contentions, and its reliance on the CDB
Schedule.

Petitioner also asserts that the confusion or difficulty in the implementation of Revenue
Memorandum Circular 7-90 was the reason why CDB took upon itself the task of
withholding the taxes arising from the sale, to ensure accuracy. Assuming this were true,
CDB should have, nevertheless, accomplished the necessary returns to clearly identify the
nature of the payments made and file the same with the BIR. Section 2 of the circular
clearly provides that the amount of withholding tax paid by a corporation to the BIR during
the quarter on sales or exchanges of property and which are creditable against the
corporation's tax liability are evidenced by Confirmation/Official Receipts and covered by
BIR Form Nos. 1743W and 1743-B. On the other hand, Revenue Regulation 6-85 states
that BIR Form No. 1743.1 establishes the fact of withholding. Since no competent
evidence was adduced by petitioner, the failure to offer these returns as evidence of the
amount of petitioner's entitlement during the trial phase of this case is fatal to its
cause. For its negligence, petitioner 'cannot be allowed to seek refuge in a liberal
application of the [r]ules. The liberal interpretation and application of rules apply only in
proper cases of demonstrable merit and under justifiable causes and circumstances.
 b. Barcelon, Roxas Securities v. CIR, G.R. No. 157064, August 7, 2006. In this case,
petitioner was assessed for deficiency income tax for failure to withhold taxes on
salaries, bonuses, and allowances. The substantive issue, however, was cancelled as
the assessment was already barred by prescription.

7. It must not be against law or public policy.

Any expense incurred for entertainment, amusement or recreation that is contrary to law,
morals, public policy or public order shall in no case be allowed as a deduction.
34(A)(1)(a)(iv)]

No deduction from gross income x x x for any payment made, directly or indirectly, to an
official or employee of the national government, or to an official or employee of a
government-owned or -controlled corporation, or to an official or employee or
representative of a foreign government, or to a private corporation, general professional
partnership, or similar entity, if the payment constitutes a bribe or kickback. [Sec.
34(A)(1)(c)].

Specific Ordinary and Necessary Business Expenses that may be Deducted. [Sec.
34(A)(1)(a).

a. A reasonable allowance for salaries, wages, and other forms of compensation for
personal services actually rendered, including the grossed-up monetary value of fringe
benefit furnished or granted by the employer to the employee, provided that the Fringe
Benefit Tax thereof has been paid.

Requisites on deductibility of compensation for personal services:

a. The payments are reasonable;

b. They are, in fact, payments for personal services actually rendered (Sec. 70, RR
2-40);
c. If the compensation is a fringe benefits, the Fringe Benefit Tax must have been
paid.

Rules on the deductibility of the bonuses to employees. See C.M. Hoskins v. CIR, G.R.
No. L-24059, November 28, 1969; Kuenzle & Strieff v. CIR, G.R. No. L-18840, May 29,
1969)

a. the payment of the bonuses is in fact compensation;

b. it must be for personal services actually rendered; and
c. the bonuses, when added to the salaries, are 'reasonable . . . when measured by
the amount and quality of the services performed with relation to the business of
the particular taxpayer'
Factors to consider in determining reasonableness of a given bonus as compensation

There is no fixed test for determining the reasonableness of a given bonus as

compensation. This depends upon many factors, one of them being 'the amount and
quality of the services performed with relation to the business.' Other tests suggested are:
payment must be 'made in good faith'; 'the character of the taxpayer's business, the
volume and amount of its net earnings, its locality, the type and extent of the services
rendered, the salary policy of the corporation'; 'the size of the particular business'; 'the
employees' qualifications and contributions to the business venture'; and 'general
economic conditions' (4 Mertens, Law of Federal Income Taxation, Secs. 25.44, 25.49,
25.50, 25.51, pp. 407-412). However, 'in determining whether the particular salary or
compensation payment is reasonable, the situation must be considered as whole.
Ordinarily, no single factor is decisive it is important to keep in mind that it seldom
happens that the application of one test can give satisfactory answer, and that ordinarily
it is the interplay of several factors, properly weighted for the particular case, which must
furnish the final answer. (C.M. Hoskins v. CIR, supra)

b. Reasonable allowance for travel expenses, here or abroad, while away from home in
pursuit of trade, profession or business;

What does the term “travelling expenses” include?

Travelling expenses, as ordinarily understood, include transportation expenses and meals

and lodging incurred while away from home solely in the pursuit of a trade or business.
(Secs. 65, 66, RR 2-40)

Requisites for the allowance of a travelling expense deduction

1. The expense must be reasonable and necessary;

2. They must be incurred or paid “while away from home”;
3. They must be paid or incurred in the conduct of trade or business.

Meaning of “while away from home”

Every taxpayer has the so-called tax “home”. It means his principal place of business,
employment, or post or station where he is employed and not necessarily the place of his
residence. Thus, a taxpayer who operates his business in Manila has his tax-home in
Manila although he may reside elsewhere. However, if he goes, let us say, to Cebu on a
business trip, then he is allowed deductions for his plane fare, meals, and hotel
accommodation because these travelling expenses while away from home. (De Leon)

Distinguish transportation expenses from travelling expenses

The ordinary and necessary transportation expenses of the taxpayer incurred in

connection with the pursuit of his business are deductible. They are different from the
transportation expenses included in the term “travelling expenses”. So, a taxpayer
operating his business in Manila is allowed transportation expenses from his office to his
 customer’s place of business and back. But his transportation expenses from his residence
to his office and back are not deductible as they are considered personal expenses. (De
Leon)

c. A reasonable allowance for rentals and/or other payments which are required as a
condition for the continued use or possession, for purposes of the trade, business or
profession, of property to which the taxpayer has not taken or is not taking title or in
which has no equity other than that of a lessee, user, or possessor;

Operating Lease – a lease in which all risks and rewards related to asset ownership
remain with the lessor. The ownership of the asset remains with the lessor for the entire
lease term; thus, the lessee will have to return the asset upon the expiration of the
lease term.

Finance Lease (or Capital Lease) – the risks and rewards related to asset ownership
are transferred to the lessee. The ownership of the property is transferred to the lessee
at the end of the lease term; hence, lessee will not, in general, return the property to the
lessor at the expiration of the lease.

Notes:

1. When a leasehold is acquired for business purpose for a specified sum, the taxpayer
may take as a deduction an aliquot part of such sum each year based on the number
of years the lease has to run. (Sec. 74, RR No. 2-40)

2. Real property taxes on the leased property paid by the tenant to the landlord are
treated as additional rent and hence, constitute a deductible item to the tenant and
taxable income to the landlord, the amount of tax being deductible by the latter. (Ibid)

3. Cost borne by the lessee in erecting a building or making permanent improvements of

the land of which he is the lessee is a capital expenditure and not deductible as a
business expense. In order to return to such taxpayer his capital investment, an
annual deduction may be made from gross income of an amount equal to the cost of
such improvement divided by the number of years remaining of the term of the lease
or life of the building, whichever is shorter in duration.

Annual Deduction = Cost of the building

Lease Term or Useful Life, whichever is shorter

d. A reasonable allowance for entertainment, amusement and recreation (EAR)

expenses during the taxable year, that are directly connected to the development,
management and operation of the trade, business or profession of the taxpayer, or that
are directly related to or in furtherance of the conduct of his or its trade, business or
exercise of a profession not to exceed such ceilings as the Secretary of Finance may, by
rules and regulations prescribe, upon recommendation of the Commissioner, taking into
account the needs as well as the character of the industry of the taxpayer; Provided, That
any expense incurred for entertainment, amusement or recreation that is contrary to law,
morals, public policy or public order shall in no case be allowed as a deduction.
See: Revenue Regulation No. 10-2002
https://www.lawphil.net/administ/bir/rr/rr10_02.pdf

Who are allowed to claim EAR expense?

1. Individual taxpayers engaged in business, including taxable estate and trusts;
2. Individuals engaged in the practice of profession;
3. Domestic corporations;
4. Resident foreign corporations;
5. General professional partnerships, including its members

What comprises EAR?

It includes representation expenses and/or depreciation or rental expense relating to
entertainment facilities.

Representation expenses – refer to expenses incurred by a taxpayer in connection

with the conduct of his trade, business, or exercise of profession, in entertaining, providing
amusement and recreation to, or meeting with, a guest or guests at a dining place, place
of amusement, country club, theater, concert, play, sporting event, and similar events or
places. For purposes of the regulation, representation expense shall not refer to fixed
representation allowances that are subject to withholding tax on wages pursuant to
appropriate revenue regulation.

In the case particularly of a country, golf, sports club, or any other similar club where the
employee or officer of the taxpayer is the registered member and the expenses incurred
thereto are paid for by the taxpayer, there shall be a presumption that such expenses are
fringe benefits subject to fringe benefit tax unless the taxpayer can prove that these are
actually representation expenses. For purposes of proving that said expense is a
representation expense and not fringe benefits, the taxpayer should maintain receipts and
adequate records that indicate the (a) amount of expense; (b) date and place of expense;
(c) purpose of expense; (d) professional or business relationship of expense; (e) name of
person and company entertained with contact details.

Entertainment Facilities – refer to (1) yacht, vacation home or condominium; and (2)
any similar item of real or personal property used by the taxpayer primarily for the
entertainment, amusement or recreation of guests or employees. To be considered
entertainment facility, such yacht, vacation home, or condominium, or item of real or
personal property must be owned or form part of the taxpayer’s trade, business, or
profession, or rented by such taxpayer, for which the taxpayer claims a depreciation or
rental expense. A yacht shall be considered an entertainment facility under this regulation
if its use is in fact not restricted to specified officers or employees or positions in such a
manner as to make the same a fringe benefit for purposes of imposing fringe benefit tax.

Guests – persons or entities with which the taxpayer has direct business relations, such
as but not limited to, clients/customers or prospective clients/customers. The term shall
not include employees, officers, partners, directors, stockholders, or trustees of the
taxpayer.
What are NOT considered EAR expenses?
1. Expenses which are treated as compensation or fringe benefits for services rendered
under an employer-employee relationship, pursuant to RR No. 2-93, 3-98 and
amendments thereto;
2. Expenses for charitable or fund-raising events;
3. Expenses for bona fide business meetings of stockholders, partners, or directors;
4. Expenses for attending or sponsoring an employee to a business league or professional
organization meeting;
5. Expenses for events organized for promotion, marketing and advertising including
concerts, conferences, seminars, workshops, conventions, and other similar events;
6. Other expenses of similar nature.

Notwithstanding the foregoing, such items of exclusions may, nonetheless, qualify as

items of deductions under Section 34 of the Tax Code, subject to conditions for
deductibility stated therein.

What are the REQUSITES for the deductibility of EAR Expenses?

1. It must be paid or incurred during the taxable year;
2. It must be: (i) directly connected to the development, management and operation of
the trade, business or profession of the taxpayer; or (ii) directly related to or in
furtherance of the conduct of his or its trade, business or exercise of profession;
3. It must not be contrary to law, morals, good customs, public policy or public order;
4. It must not have been paid, directly or indirectly, to an official or employee of the
national government, or any local government unit, or of any GOCC, or of a foreign
government, or to a private individual, or corporation, or GPP, or a similar entity, if it
constitutes a bribe, kickback or other similar payment;
5. It must be duly substantiated by adequate proof. The official receipts, or invoices, or
bills or statements of accounts should be in the name of the taxpayer claiming the
deduction; and
6. The appropriate amount of withholding tax, if applicable, should have been withheld
therefrom and paid to the BIR.

CEILING ON EAR

1. 0.50% of the net sales (i.e. gross sales less returns/allowances and sales discount)
– for taxpayers engaged in the sale of goods or properties;

2. 1.00% of the net revenue (i.e. gross revenue less discounts) – for taxpayers
engaged in sale of services, including exercise of profession and use or lease of
properties.

3. If the taxpayer derives income from both sale of goods/properties and service, the
allowable EAR expense shall in all cases be determined based on apportionment
formula taking into consideration the percentage of the net sales/net revenue
to the total net sales/net revenue but in no case shall exceed the maximum
percentage ceiling provided in the regulation.
 Apportionment formula:

Net Sales/Net Revenue x Actual Expense

Total Net Sales and Revenue

Notwithstanding the ceiling imposed on such expense, the claimed expense shall be
subject to verification and audit for purposes of determining its deductibility as well as
compliance with the substantiation requirements. However, if after verification a
taxpayer is found to have shifted the amount of the EAR to any other expense, in
order to avoid being subjected to ceiling herein prescribed, the amount shifted shall be
disallowed in its totality, without prejudice to such penalties as may be imposed by the
Tax Code.

Reporting Requirement.
The taxpayer is required to use in its financial statement and income tax return the
account title “entertainment, amusement and recreation expense”, or in the alternative,
disclose in the notes to financial statement the amount corresponding thereto when
recording expenses paid or incurred of the nature as defined in the revenue regulation
(10-2002). However, such expense should be reported in the taxpayer’s income tax return
as a separate expense item.

e. Other Examples of Business Expenses

Advertising Expense

Case: CIR v. General Foods, Inc. G.R. No. 143672, April 24, 2003. Held: There is
yet to be a 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 on a number 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. In the case at bar, the P9,461,246 claimed
as media advertising expense for "Tang" alone was almost one-half of its total claim for
"marketing expenses." Aside from that, respondent-corporation also claimed P2,678,328
as "other advertising and promotions expense" and another P1,548,614, for consumer
promotion. Furthermore, the subject P9,461,246 media advertising expense for "Tang"
was almost double the amount of respondent corporation’s P4,640,636 general and
administrative expenses. We find the subject expense for the advertisement of a single
product to be inordinately large. Therefore, even if it is necessary, it cannot be considered
an ordinary expense deductible under then Section 29 (a) (1) (A) of the NIRC. Advertising
is generally of two kinds: (1) advertising to stimulate the current sale of merchandise or
use of services and (2) advertising designed to stimulate the future sale of merchandise
or use of services. The second type involves expenditures incurred, in whole or in part, to
create or maintain some form of goodwill for the taxpayer’s trade or business or for the
industry or profession of which the taxpayer is a member. If the expenditures are for the
advertising of the first kind, then, except as to the question of the reasonableness of
amount, there is no doubt such expenditures are deductible as business expenses. If,
however, the expenditures are for advertising of the second kind, then normally they
should be spread out over a reasonable period of time. We agree with the Court of Tax
Appeals that the subject advertising expense was of the second kind. Not only was the
amount staggering; the respondent corporation itself also admitted, in its letter protest to
the Commissioner of Internal Revenue’s assessment, that the subject media expense was
incurred in order to protect respondent corporation’s brand franchise, a critical point
during the period under review. The protection of brand franchise is analogous to the
maintenance of goodwill or title to one’s property. This is a capital expenditure which
should be spread out over a reasonable period of time. Respondent corporation’s venture
to protect its brand franchise was tantamount to efforts to establish a reputation. This
was akin to the acquisition of capital assets and therefore expenses related thereto were
not to be considered as business expenses but as capital expenditures. True, it is the
taxpayer’s prerogative to determine the amount of advertising expenses it will incur and
where to apply them. Said prerogative, however, is subject to certain considerations. The
first relates to the extent to which the expenditures are actually capital outlays; this
necessitates an inquiry into the nature or purpose of such expenditures. The second,
which must be applied in harmony with the first, relates to whether the expenditures are
ordinary and necessary. Concomitantly, for an expense to be considered ordinary, it must
be reasonable in amount. The Court of Tax Appeals ruled that respondent corporation
failed to meet the two foregoing limitations. We find said ruling to be well founded.
Respondent corporation incurred the subject advertising expense in order to protect its
brand franchise. We consider this as a capital outlay since it created goodwill for its
business and/or product. The P9,461,246 media advertising expense for the promotion of
a single product, almost one-half of petitioner corporation’s entire claim for marketing
expenses for that year under review, inclusive of other advertising and promotion
expenses of P2,678,328 and P1,548,614 for consumer promotion, is doubtlessly
unreasonable.

Cost of Repairs

Rules:
1. Expenses for repairs are deductible if such repairs are incidental or ordinary, that is,
made to keep the property used in the trade or business of the taxpayer in an ordinarily
efficient operating condition (Sec. 68, RR No. 2-40);

2. Repairs in the nature of replacement to the extent that they arrest deterioration and
prolong the life of the property are capital expenditures (distinguished from
maintenance and incidental repairs) and should be debited against the corresponding
allowance for depreciation (Secs. 68, 120, RR 2-40). Thus, the construction of a
hollow block fence with iron grills around the compound of the taxpayer was properly
disallowed because it involved an addition which prolonged the life of the property
and materially increased its value. (Alhambra Cigar v. Coll., 105 Phil. 1337; Comm. V.
Soriano, CTA, G.R. No. L-26893, March 21, 1971)
 B. INTEREST [SEC. 34(B), RR NO. 13-2000]

Interest – shall refer to the payment for the use or forbearance or detention of money,
regardless of the name it is called or denominated. It includes the amount paid for the borrower’s
use of money during the term of the loan, as well as for his detention of money after the due
date for its repayment.

Theoretical Interest – it is an interest calculated or computed (and not incurred or paid) for
the purpose of determining the “opportunity cost” of investing funds in a given business. Such
theoretical interest does not arise from a legally demandable interest-bearing obligation incurred
by the taxpayer who wishes to find out, i.e. whether he would have been better off by lending
out his funds and earning interest rather than investing such funds in his business. It is not
deductible as it does not represent a charge arising under an interest-bearing
obligation.

Requisites for deductibility of interest

1. There must be indebtedness;
2. There should be an interest expense paid or incurred upon such indebtedness;
3. The indebtedness must be that of the taxpayer;
4. The indebtedness must be connected with the taxpayer’s trade or business or exercise of
profession;
5. The interest expense must have been paid or incurred during the taxable year;
6. The interest must have been stipulated in writing;
7. The interest must be legally due;
8. The interest arrangement must not be between related taxpayers;
9. In case of interest incurred to acquire property used in trade, business or exercise of
profession, the same was not treated as capital expenditure.
10. The interest must not be incurred to finance petroleum operations;
11. The interest must not expressly disallowed by law to be deducted from gross income of
the taxpayer

Rules on deductibility of interest expense

General Rule: In general, the amount of interest expense paid or incurred within the taxable
year of indebtedness in connection with the taxpayer’s trade, business or exercise of profession,
shall be allowed as a deduction from the gross income.

Limitation: The amount of interest expense paid or incurred by the taxpayer in connection with
his trade, business or exercise of profession shall be reduced by an amount equal to
(beginning 2009 per RA 9337) of interest income earned which had been subjected to
final withholding tax.

Reason for the Limitation. To discourage the so-called “back-to-back” loans where a taxpayer
secures a loan from a bank, turns around and invests the loan proceeds in money market
placement (which earns interest). By imposing the limit as to the amount of interest expense
 that can be deducted from gross income, the previous practice of tax arbitrage was absolutely
nullified.

Tax Arbitrage – in general, this can be defined as the process of exploiting the differences in
the price of an asset by simultaneously buying and selling it. In the Philippine tax landscape, this
pertains to the proceeds of a taxpayer's loan obtained in connection with the operations of his
trade, business or exercise of profession which is afterwards invested, and the interest income
derived from the said investment had been subjected to final withholding tax. It may also mean
as a method of borrowing without entering a debtor/creditor relationship, often to resolve
financing and exchange control problems. In tax cases, back to back loan is used to take
advantage of the lower of tax on interest income and higher rate of tax on interest expense
deduction.

Other Deductible Interest Expense

1. Interest on taxes, such as those paid for deficiency or delinquency, since taxes are
considered. However, fines, penalties, and surcharges on account of taxes are not
deductible. on deduction;
2. Interest paid by a corporation on script dividend;
3. Interest on deposits paid by authorized banks of the BSP to depositors if it is shown that
the tax on such interest was withheld;
4. Interest paid by a corporate taxpayer who is liable under a mortgage upon real property
of which the said corporation is the legal or equitable owner, even though it is not directly
liable for the indebtedness.

Case: CIR v. Palanca, G.R. No. L-16626, October 29, 1966. Held: Interest on delinquent
estate and inheritance tax is deductible from gross income. The rule is settled that although
taxes already due is not, strictly speaking, the same concept as a debt, they are however,
obligations that may be considered as such. In CIR v. Prieto, the Court explicitly announced that
while the distinction between “taxes” and “debts” is recognized in this jurisdiction, the variance
in their legal conception does not extend to the interest paid on them.

Non-Deductible Interest Expense

1. If within the taxable year, an individual taxpayer reporting on a cash basis incurs an
indebtedness on which an interest is paid in advance through discount or otherwise.
Provided, that such interest shall be allowed as a deduction in the year the indebtedness
is paid; Provided further, that if the indebtedness is payable in periodic amortizations, the
amount of interest expense which corresponds to the amount of principal amortized or
paid during the year shall be allowed as a deduction in such taxable year.
2. Interest paid on indebtedness between related parties as defined in Section 36(B), NIRC;
3. If the indebtedness is incurred to finance petroleum exploration;
4. Interest on preferred stock, which in reality is dividend;
5. Interest on unpaid salaries and bonuses;
6. Interest calculated for cost keeping on account of capital or surplus invested which does
not represent charges arising under an interest-bearing obligation (theoretical interest);
7. Interest paid when there is no stipulation for the payment thereof.
Optional Treatment of Interest Expense
At the option of the taxpayer, interest incurred to acquire property used in trade, business
may be allowed as a deduction or treated as capital expenditure [Sec. 34(B)(3), NIRC]

C. TAXES [Sec. 34(C)]

TAXES, as used in Sec. 34(C) means taxes proper, and therefore no deductions are allowed for:
a. Interest;
b. Surcharges;
c. Penalties or fines incident to delinquency (Sec. 80, RR No. 2)

Requisites for Deductibility

1. Must be in connection with taxpayer’s business, trade or exercise of profession;
2. Must be imposed by law on, and payable by taxpayer (direct tax; see exceptions below)
3. Paid or incurred during the taxable year.

Taxes NOT Deductible

1. Income taxes provided under Title II of NIRC, including final taxes, e.g. Final Withholding
Taxes on Certain Passive Income, Capital Gains Tax, Fringe Benefit Tax, etc.)
See: Republic v. MERALCO, G.R. No. 141369, November 14, 2002, as previously
discussed)
2. Income taxes imposed by authority of any foreign country [but deduction is allowed if the
taxpayer does not signify his intention of availing Tax Credit for Taxes of Foreign Countries
under Sec. 34(C)(3 and 4)]
3. Estate and donor’s Tax;
4. Special assessments;

Tax Benefit Rule – Taxes allowed as deductions, when refunded or credited, shall be included
as part of the gross income in the year of receipt to the extent of the income tax benefit of said
deduction.

Rule applicable to Non-Resident Alien Engaged in Trade or Business (NRAETB) and Resident
Foreign Corporation (RFC)
Taxes paid or incurred are allowed as deductions only if and to the extent that they are connected
from income within the Philippines.

TAX CREDITS [Sec. 34(C)(3 and 4)]

Defined
Tax credit is the right of an income taxpayer’s right to deduct from the income tax due the amount
of tax he has paid to a foreign country subject to limitations.

Rationale for Tax Credit

Sometimes instead of merely allowing a deduction from income, the amount of certain foreign
taxes paid by the taxpayer is credited on his income tax. Tax credit is allowed to lessen the
 harshness of taxation in case where the same income is subject to a foreign tax and to the
Philippine income tax (De Leon).

Distinguish Tax Deduction and Tax Credit

See CIR v. Central Luzon Drug Store, G.R. No. 159647, April 15, 2005, see digest below)

Who may claim Tax Credit

1. Citizen and Domestic Corporation – in the case of a citizen of the Philippines and of
a domestic corporation, the amount of income taxes paid or incurred during the taxable
year to any foreign country; and
2. Partnerships and Estates – in the case of any such individual who is a member of a
general professional partnership or a beneficiary of an estate or trust, his proportionate
share of such taxes of the GPP or the estate or trust paid or incurred during the taxable
year to a foreign country, if his distributive share of the income of such partnership or
trust is reported for taxation under this Title.

An alien individual and a foreign corporation shall not be allowed the credits against the
tax for taxes of foreign countries allowed under this paragraph (Sec. 34(C)(3), NIRC)

See: CIR v. Lednicky, L-18169, L-18262, L21434, July 31, 1964. Held: Much stress
is laid on the thesis that if the respondent taxpayers are not allowed to deduct the income
taxes they are required to pay to the government of the United States in their return for
Philippine income tax, they would be subjected to double taxation. What respondents fail
to observe is that double taxation becomes obnoxious only where the taxpayer is taxed
twice for the benefit of the same governmental entity (cf. Manila vs. Interisland Gas
Service, 52 Off. Gaz. 6579; Manuf. Life Ins. Co. vs. Meer, 89 Phil. 357). In the present
case, while the taxpayers would have to pay two taxes on the same income, the Philippine
government only receives the proceeds of one tax. As between the Philippines, where the
income was earned and where the taxpayer is domiciled, and the United States, where
that income was not earned and where the taxpayer did not reside, it is indisputable that
justice and equity demand that the tax on the income should accrue to the benefit of the
Philippines. Any relief from the alleged double taxation should come from the United
States, and not from the Philippines, since the former's right to burden the taxpayer is
solely predicated on his citizenship, without contributing to the production of the wealth
that is being taxed. Aside from not conforming to the fundamental doctrine of
income taxation that the right of a government to tax income emanates from
its partnership in the production of income, by providing the protection,
resources, incentive, and proper climate for such production, the interpretation
given by the respondents to the revenue law provision in question operates, in its
application, to place a resident alien with only domestic sources of income in an equal, if
not in a better, position than one who has both domestic and foreign sources of income,
a situation which is manifestly unfair and short of logic. Finally, to allow an alien resident
to deduct from his gross income whatever taxes he pays to his own government amounts
to conferring on the latter the power to reduce the tax income of the Philippine
government simply by increasing the tax rates on the alien resident. Every time the rate
of taxation imposed upon an alien resident is increased by his own government, his
 deduction from Philippine taxes would correspondingly increase, and the proceeds for the
Philippines diminished, thereby subordinating our own taxes to those levied by a foreign
government. Such a result is incompatible with the status of the Philippines as an
independent and sovereign state.

Limitation on Credit.
The amount of the credit taken under this Section shall be subject to each of the following
limitations:

a. Per Country Limitation. The amount of the credit in respect to the tax paid or incurred
to any country shall not exceed the same proportion of the tax against which such credit
is taken, which the taxpayer’s taxable income from sources within such country under this
Title bears to his entire taxable income for the same taxable year.
This is expressed in the following formula:

Taxable Income (TI) from Foreign Country X Phil. Income Tax = Tax Credit Limit
TI from all sources

b. Over All Limitation. The total amount of the credit shall not exceed the same proportion
of the tax against which such credit is taken, which the taxpayer’s taxable income from
sources without the Philippines taxable under this Title bears his entire taxable income for
the same taxable year.

This is expressed in the following formula:

Taxable Income (TI) from Outside Sources X Phil. Income Tax = Tax Credit Limit
TI from all sources

The allowable tax credit is the “lower amount” between the tax credit limit computed under
(a) and (b).

Adjustments on Payment of Incurred Taxes

If accrued taxes when paid differ from the amounts claimed as credits by the taxpayer, or if any
tax paid is refunded in whole or in part, the taxpayer shall notify the Commissioner, who shall re-
determine the amount of tax due for the year or years affected, and the amount of tax upon such
redetermination, if any, shall be paid by the taxpayer upon notice and demand by the
Commissioner, or the amount of tax overpaid, if any, shall be credited or refunded to the taxpayer.
In the case of such a tax incurred but not paid, the Commissioner as a condition precedent to the
allowance of this credit may require the taxpayer to give a bond with sureties satisfactory to and
to be approved by the Commissioner in such sum as he may require, conditioned upon the
payment by the taxpayer of any amount of tax found due upon any such redetermination. The
bond herein prescribed shall contain such further conditions as the Commissioner may require.

Year in Which Credit Taken

The credits provided for in Section 34(C)(3) may, at the option of the taxpayer and irrespective
of the method of accounting employed in keeping his books, be taken in the year in which the
taxes of the foreign country were incurred, subject, however, to the conditions prescribed in
 Section 34(C)(5). If the taxpayer elects to take such credits in the year in which the taxes of the
foreign country accrued, the credits for all subsequent years shall be taken upon the same basis,
and no portion of any such taxes shall be allowed as a deduction in the same or any succeeding
year.

Proof of Credits
The credits provided in Section 34(C)(3) shall be allowed only if the taxpayer establishes to the
satisfaction of the Commissioner the following:
a. The total amount of income derived from sources without the Philippines;
b. The amount of income derived from each country, the tax paid or incurred to which is
claimed as a credit, such amount to be determined under rules and regulations prescribed
by the Secretary of Finance;
c. All other information necessary for the verification and computation of such credits.

Senior Citizens Discount as Tax Credit

Case: CIR v. Central Luzon Drug Store, G.R. No. 159647, April 15, 2005: Held. The 20
percent discount required by the law to be given to senior citizens is a tax credit, not merely a tax
deduction from the gross income or gross sale of the establishment concerned. A tax credit is
used by a private establishment only after the tax has been computed; a tax deduction, before
the tax is computed. RA 7432 unconditionally grants a tax credit to all covered entities.

The Supreme Court likewise made the following discussions:

Tax Credit versus Tax Deduction

Although the term is not specifically defined in our Tax Code, tax credit generally refers to an
amount that is "subtracted directly from one’s total tax liability." It is an "allowance against the
tax itself” or "a deduction from what is owed by a taxpayer to the government. Examples of tax
credits are withheld taxes, payments of estimated tax, and investment tax credits.

Tax credit should be understood in relation to other tax concepts. One of these is tax deduction -
- defined as a subtraction "from income for tax purposes, or an amount that is "allowed by law
to reduce income prior to [the] application of the tax rate to compute the amount of tax which is
due. An example of a tax deduction is any of the allowable deductions enumerated in Section 34
of the Tax Code.

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 issue. A tax credit is used only after the tax has been
computed; a tax deduction, before.

Tax Liability Required for Tax Credit

Since a tax credit is used to reduce directly the tax that is due, there ought to be a tax
liability before the tax credit can be applied. Without that liability, any tax credit application will
be useless. There will be no reason for deducting the latter when there is, to begin with, no
existing obligation to the government. However, as will be presented shortly, the existence of a
tax credit or its grant by law is not the same as the availment or use of such credit. While the
grant is mandatory, the availment or use is not.

If a net loss is reported by, and no other taxes are currently due from, a business establishment,
there will obviously be no tax liability against which any tax credit can be applied. For the
establishment to choose the immediate availment of a tax credit will be premature and
impracticable. Nevertheless, the irrefutable fact remains that, under RA 7432, Congress has
granted without conditions a tax credit benefit to all covered establishments.

Although this tax credit benefit is available, it need not be used by losing ventures, since there is
no tax liability that calls for its application. Neither can it be reduced to nil by the quick yet callow
stroke of an administrative pen, simply because no reduction of taxes can instantly be effected.
By its nature, the tax credit may still be deducted from a future, not a present, tax liability,
without which it does not have any use. In the meantime, it need not move. But it breathes.

Prior Tax Payments Not Required for Tax Credit

While a tax liability is essential to the availment or use of any tax credit, prior tax payments are
not. On the contrary, for the existence or grant solely of such credit, neither a tax liability nor a
prior tax payment is needed. The Tax Code is in fact replete with provisions granting or
allowing tax credits, even though no taxes have been previously paid.

[I]t is evident that prior tax payments are not indispensable to the availment of a tax credit. Thus,
the CA correctly held that the availment under RA 7432 did not require prior tax payments by
private establishments concerned.31 However, we do not agree with its finding that the carry-over
of tax credits under the said special law to succeeding taxable periods, and even their application
against internal revenue taxes, did not necessitate the existence of a tax liability.

The examples above show that a tax liability is certainly important in the availment or use, not
the existence or grant, of a tax credit. Regarding this matter, a private establishment reporting
a net loss in its financial statements is no different from another that presents a net income. Both
are entitled to the tax credit provided for under RA 7432, since the law itself accords that
unconditional benefit. However, for the losing establishment to immediately apply such credit,
where no tax is due, will be an improvident usance.

D. LOSSES [Sec. 34(D) and related provisions]

For purpose of deduction from gross income, what does losses comprehend?
The term implies an unintentional parting with something of value. It is used in the income tax
law in a very broad sense to comprehend all losses which are not general or natural to the ordinary
courses of business and are not covered under some other heading such as bad debts, inventory
losses, depreciations, etc.

General Requisites for Deductibility

1. Actually sustained during the taxable year;
2. Connected with the trade, business or profession;
3. Evidenced by a closed and completed transaction (CIR v. Asturias Sugar Central, G.R.
No. L-15013, August 31, 1961);
 4. Not compensated for by insurance or other form of indemnity;
5. Not claimed as a deduction for estate tax purposes
6. Notice of loss must have been filed with the BIR within 45 days from the date of discovery
of the casualty or robbery, theft, or embezzlement

*Close and completed transaction is one which the facts indicate the transaction
sufficiently final to ascertain that a loss has occurred. (The Coca Cola Exports v. CIR, CTA
Case NO. 5238, December 19, 1997)

What losses may aliens and resident foreign corporation deduct from gross income?
1. Those incurred in the trade or business in the Philippines
2. Losses in transactions entered into for profit in the Philippines.

Categories/Types of Losses
1. Ordinary Losses
2. Capital Losses [Sec. 39]
3. NOLCO (Sec. 34(D)(3)]
4. Casualty Losses
5. Wagering Losses
6. Losses on wash sales of stocks (Sec. 38)
7. Abandonment Losses

Ordinary Losses
These are incurred in the ordinary course of the taxpayer’s trade, business or exercise of
profession.

Includes any loss from the sale or exchange of property which is not a capital asset. [Sec.
22(Z)]

Capital Losses (Sec. 39)

This includes the following:
1. Losses from sale or exchange of capital assets;
2. Losses resulting from securities becoming worthless and which are capital assets;
3. Losses from short sales of property;
4. Losses due to failure to exercise privilege or option to buy or sell property

Meaning of Capital Assets

Capital Assets means property held by the taxpayer (whether or not connected with his
business) but does not include the following:
1. Stock in trade of the taxpayer or other property of a kind which would be included in the
inventory of the taxpayer if at hand at the close of the taxable year;
2. Property held by the taxpayer primarily for sale to customers in the ordinary course of his
business;
3. Property used in the trade or business, of a character which is subject to the allowance
for depreciation;
4. Real property used in trade or business of the taxpayer
Limitation on Capital Losses
Losses from sales or exchanges of capital assets shall be allowed only to the extent of the gains
from such sale or exchange.

Net Capital Gains – excess of gains from sale or exchanges of capital assets over the loss
from such sales or exchanges.
➢ Included in the taxable Gross Income

Net Capital Loss - excess of loss from sale or exchanges of capital assets over the gain
from such sales or exchanges.
➢ Not deductible, but may be carried over the next taxable year, subject to condition

Percentage Taken Into Account in Computing Net Capital Gains / Net Capital Loss upon
sale or exchange of Capital Asset (Does not apply to Corporate Taxpayers):

1. 100% if the capital asset has been held for not more than 12 months;
2. 50% if the capital asset has been held for more than 12 months

Exception to the Limitation on Capital Losses

If a bank or trust company incorporated under the laws of the Philippines, a substantial part of
whose business is the receipt of deposits, sells any bond, debenture, note, or certificate or other
evidence of indebtedness issued by any corporation (including by the government or political
subdivision thereof), with interest coupons or in registered form, any loss resulting from such sale
shall not be subjected to the foregoing limitation and shall not be included in the determining the
applicability of such limitation to other losses.

Net Capital Loss Carry-over

If any taxpayer, other than a corporation, sustain in any taxable year a net capital loss, such loss
(in an amount not in excess of the net income for such year) shall be treated in the succeeding
taxable year as a loss from sale or exchange of capital asset held for not more than twelve
months.

Retirement of Bonds
Amounts received by the holder upon the retirement of bonds, debentures, notes or other
certificates or other evidence of indebtedness (including those issued by the government or
political subdivision thereof) with interest coupons or in registered form, shall be considered as
amounts received in exchange therefor.

Capital Gains from Short Sales

Gains or losses from short sales of property shall be considered as gains or losses from sales or
exchange of capital assets;

Short sale is a transaction in which the seller sells securities which he does not own and,
therefore, cannot himself supply the securities for delivery, in expectation of the decline in their
price. The seller, in this case, is a mere speculator his purpose being to postpone delivery until
some later date when he hopes to purchase the securities at a price lower than that received on
his sale and thereby make a profit. But should the price of the securities go up, he incurs a loss.
 It is not deemed consummated until the delivery of the property to cover the short sale.
If the short sale is made through a broker and the broker borrows property to make delivery, the
short sale is not deemed consummated until the obligation of the seller created by the short sale
is finally discharged by the delivery of property to the broker to replace the property borrowed
by such broker.

Failure to exercise privilege or option to buy or sell property

Gains or losses attributable to the failure to exercise privilege or option to buy or sell property
shall be considered as capital gains or losses.

Securities becoming worthless.

Losses from shares of stock, held as capital asset, which have become worthless during the
taxable year shall be treated as capital loss as of the end of the year. However, this loss is not
deductible against the capital gains realized from the sale, barter, exchange or other forms of
disposition of shares of stocks during the taxable year, but must be claimed against other capital
gains to the extent provided for under Section 34 of the Tax Code. For the net capital gains tax
to apply, there must be actual disposition of shares of stocks held as capital asset, and the capital
gain and capital loss used as the basis in determining net capital gains, must be derived and
incurred respectively, from a sale, barter, exchange or other disposition of shares of stocks. (RR
No. 6-2008)

Loss resulting from shrinkage in the value of stock

A person possessing stock of a corporation cannot deduct from gross income any amount claimed
as a loss merely on account of shrinkage in value of such stock through the fluctuation of the
market or otherwise. The loss allowable in such case is that actually suffered when the stock is
disposed. (Sec. 99, RR No. 2-40)

Note: We shall discuss how to compute ordinary/capital gains or losses when we take
up Section 40

Net Operating Loss Carry Over (NOLCO) [Sec. 34(D)(3); See also RR No. 14-2001 ]
https://www.bir.gov.ph/images/bir_files/old_files/pdf/rr14_01.pdf

Definition of Net Operating Loss

Excess of Allowable Deductions over Gross Income of the Business in a taxable year.

Net Operating Loss Carry Over (NOLCO)

NOL be carried over as a deduction from gross income for the next 3 consecutive years
immediately following the year of such loss.

For mines other than oil and gas wells, a net operating loss without the benefit of incentives
provided for under EO 226, as amended, incurred in any of the first 10 years of operation may
be carried over for the next 5 years immediately following the year of loss. The entire amount
of the loss shall be carried over to the first of the 5 taxable years, and any portion of such loss
 which exceeds the taxable income of such first year shall be deducted in like manner from the
taxable income of the next remaining four (4) years.

Requisites for application of NOLCO

1. The taxpayer was not exempt from income tax in the year of loss of such net operating
loss;
2. The loss was not incurred in a taxable year during the taxpayer was exempt from income
tax;
3. There has been no substantial change in the ownership of the business or enterprise.
There is no substantial change in the ownership of the business when:
a. Not less than 75% in nominal value of the outstanding shares is held by or on
behalf of the same persons; or
b. Not less than 75% of the paid up capital is held by or on behalf of the same person

General Principles and Policies re NOLCO

1. The allowance for deduction of NOLCO shall be limited only to the NOL accumulated
beginning January 1, 1998;
2. In general, NOLCO shall be allowed as a deduction from gross income of the same
taxpayer who sustained and accumulated the NOL regardless of the change in its
ownership. This rule shall also apply in the case of merger where the taxpayer is the
surviving entity;
3. Unless otherwise provided in the regulation, NOLCO of the taxpayer shall not be
transferred or assigned to another person, whether directly or indirectly, such as but not
limited to, the transfer or assignment thereof through merger, consolidation, or any form
of business combination of such taxpayer with another person;
4. NOLCO shall be allowed if there has been no substantial change in the ownership of the
business or enterprise;
5. Unless otherwise provided in the regulation, an individual (including estate and trust)
engaged in trade or business or in the exercise of profession, or a domestic or resident
foreign corporation may be allowed to claim deduction of his/its corresponding NOLCO.
Provided that a taxpayer who claims optional standard deduction shall not simultaneously
claim deduction of the NOLCO; Provided further, that the 3-year reglementary period shall
continue to run notwithstanding the fact that the aforesaid taxpayer who availed of the
OSD during the said period;
6. The 3-year reglementary period on the carry-over of NOL shall continue to run
notwithstanding the fact that the corporation paid its income tax under the MICT
computation;
7. NOLCO shall be availed on a “first-in-first-out” basis;
8. The NOL incurred by a taxpayer in the year in which a substantial change in ownership in
such taxpayer occurs shall not be affected by such change in ownership, notwithstanding
items 3 and 4 above.

Taxpayers/Corporations NOT entitled to claim deduction of NOLCO

1. Offshore Banking Unit (OBU) of a foreign banking corporation, and Foreign Currency
Deposit Unit (FCDU) of a domestic or foreign banking corporation, duly authorized as such
by the BSP;
2. An enterprise registered with the Board of Investment (BOI) with respect to BOI-
registered activity enjoying the Income Tax Holiday incentive. Its accumulated NOL
 incurred or sustained during the period of such Income Tax Holiday shall not qualify for
purposes of NOLCO;
3. An enterprise registered with the Philippine Economic Zone Authority (PEZA), pursuant to
RA 7916, as amended, with respect to PEZA-registered business activity. Its accumulated
NOL incurred or sustained during the period of such Income Tax Holiday shall not qualify
for purposes of NOLCO;
4. An enterprise registered under RA 7227, otherwise known as the Bases Conversion and
Development Act of 1992, e.g. SBMA-registered enterprise, with respect to its registered
business activity. Its accumulated NOL incurred or sustained during the period of such
Income Tax Holiday shall not qualify for purposes of NOLCO;
5. Foreign corporations engaged in international shipping or air carriage business in the
Philippines; and
6. In general, any person, natural or juridical, enjoying exemption from income tax, pursuant
to the provisions of the Code or any special law, with respect to its operation during the
period for which the aforesaid exemption is applicable. Its accumulated NOL incurred or
sustained during the period of such Income Tax Holiday shall not qualify for purposes of
NOLCO.

Casualty Losses
Losses incurred for properties actually used in the business enterprise that were damaged or lost
due to casualties (shipwrecks, fire, storms, natural calamities).

Requisites for deductibility (RR No. 31-2009)

https://www.bir.gov.ph/images/bir_files/old_files/pdf/47679RMO%2031-2009.pdf

1. A taxpayer engaged in trade or business may be entitled to claim, as business deduction,

casualty losses for properties actually used in the business enterprise that were damaged
and reported as losses in the appropriate declaration filed with the BIR. The loss of asset
not used in the ordinary course of business and/or are personal in nature shall therefore
not be allowed.
2. Properties that shall be reported as casualty losses must have been properly recorded as
part of the taxpayer’s asset in the taxpayer’s accounting records and financial statements
in the year immediately preceding the occurrence of the loss, with the cost of acquisition
clearly established and recorded. Otherwise, the claim for deduction shall not be allowed.
3. The recovery of casualty losses through insurance claims shall be governed by the
guidelines set forth in RR N. 12-77. Moreover, the amount of loss that shall be
compensated by insurance coverage shall not be claimed as a deductible loss;
a. If the insurance proceeds exceed the net book value of the damaged assets, such
excess shall be subjected to the regular income tax, but not to VAT, since the
indemnification is not of actual sale of goods by the insured to the insurer;
4. In addition to the policies prescribed in RR No. 12-77 relative to the substantiation of
casualty losses arising from typhoons and other natural disasters, the following guidelines
shall be observed:
a. The deduction of assets as capital (should be casualty?) losses must be recorded
in accounting reports, with the adjustment of the applicable accounts. The
accounting entry to record this action is illustrated as follows:
 Debit: Casualty Losses xxxxx
Accumulated Depreciation xxxxx
Credit: Property/Asset Account xxxxx

In the event of a total loss/destruction of properties used in the business

enterprise, the net book value (cost less accumulated depreciation) immediately
preceding the natural disaster shall be used as the basis in claiming casualty losses,
and shall be reduced by the amount of insurance proceeds received.

b. The restoration of the damaged property, or the acquisition of new property to

replace it, must be properly recorded and recognized as either: a) repairs expense;
or b) a capitalized asset.

The appropriate of this property shall be governed by the financial accounting and
tax accounting rules, and must take into account the nature of the transaction, the
value of the amounts involved, and other factors.

Proof of Loss
1. Photographs of the property/ies before the typhoon;
2. Photographs of the property/ies after the typhoon showing the extent of the damage
sustained;
3. Documentary evidence for determining the cost or valuation of the damaged property/ies,
such as, but not limited to: cancelled checks, vouchers, receipts, and other evidence of
loss;
4. Insurance policy, if any;
5. Police report, in case of robbery/theft during the typhoon and/or as a consequence of
looting. Failure to report a theft to the police can be held against the taxpayer. However,
a mere report of an alleged theft or robbery to the police authorities is not considered
conclusive proof of the loss arising therefrom.

Wagering Losses [Sec. 34(D)(6)]

Losses from wagering transactions (losses) are allowed only to the extent of the gains from such
transaction. If there are no gambling winnings, no gambling losses can be claimed as deduction.

Deemed to apply to individuals only.

Losses on Wash Sales on Stocks or Securities (Sec. 38)

Definition of Wash Sales

Wash sale is a sale or other disposition of stock or securities where substantially identical shares
are acquired or purchased within a period beginning 30 days before the date of such sale or
disposition and ending 30 days after such date, the taxpayer has acquired (by purchase or by
exchange upon which the entire gain or loss was recognized by law), or has entered into a
contract or option so to acquire, substantially identical stock or securities.
Conditions for the existence of wash sale
1. The sale or other disposition of stock or securities resulted at a loss;
2. There was an acquisition or contract or option for acquisition for acquisition of stock or
securities within 30 days before the sale or 30 days after the sale; and
3. The stock or securities sold were substantially the same as those acquired within the 61-
day period.
Note: the acquisition must be by purchase or exchange upon which the entire amount of
gain or loss was recognized by law.

Are losses from wash sale deductible?

No. This is an exception to the rule that losses from sales or exchange of stock or securities are
deductible as losses from sales or exchange of property.

See rules with respect to losses from wash sales of shares of stocks (Revenue Regulation No.
6-2008) https://www.bir.gov.ph/images/bir_files/old_files/pdf/39882rr%20no.%206-2008.pdf

However, when the wash sale is made by a dealer in stock or securities and with respect to a
transaction made in the ordinary course of the business of such dealer, losses from such sale is
deductible.

Are gains from wash sale taxable?

Yes. Section 28 apply only to losses.

What is meant by “substantially identical stock or securities”

It means stock or securities of the same class or which are similar on their important features.
The following are NOT substantially identical:
1. Common stock and preferred stock
2. Voting stock and non-voting stock
3. Stock of X Corporation and Stock of Y Corporation; and
4. Bonds which differ as to interest rates or where one is secured by a mortgage and the
other is not; but not where the only difference is the date of maturity because
“substantially identical” does not mean precise correspondence. (De Leon)

Abandonment Losses (in petroleum operation and producing wells)

Rules [Sec. 34(D)(7)]:

1. In case the contract area where petroleum operations are undertaken is partially or wholly
abandoned, all accumulated explorations and development expenditures related thereto
shall be allowed as a deduction;
2. In case the producing well is abandoned, the unamortized cost thereof as well as the
undepreciated cost of equipment directly used therein, shall be allowed in the year the
well, equipment or facility is abandoned.
Other Rules
*Losses due to voluntary removal of building incident to renewal or replacement – deductible
from gross income. However, if the demolition is in view of erecting a new building, it will be
considered that the taxpayer sustained no deductible loss
*Loss of useful value of capital asset due to changes in business conditions – deductible only to
the extent of actual loss sustained (after adjustment for improvements, depreciation and salvage
value).
*Losses from sale or exchange of property between related parties (Sec. 36(B) – non deductible
*Losses from illegel transactions – not deductible

E. BAD DEBTS [SEC. 24(E), RR NO. 5-1999 as amended by RR 25-2002]

https://www.bir.gov.ph/images/bir_files/old_files/pdf/rr99_05.pdf
https://www.bir.gov.ph/images/bir_files/old_files/pdf/1751rr25_02.pdf

Bad Debts – debts due to the taxpayer which are actually ascertained to be worthless and
charged off within the taxable year. Refers to the those debts resulting from the worthlessness
or uncollectibility, in whole or in part, of amounts due the taxpayer by others, arising from money
lent or from uncollectible amounts of income from goods sold or services rendered.

Requisites for Deductibility

1. Existing indebtedness due to the taxpayer which must be valid and legally demandable;
2. Connected with the taxpayer’s trade, business or practice of profession;
3. Must not be sustained in a transaction entered into between related parties [Sec. 36(B)];
4. Actually ascertained to be worthless and uncollectible as of the end of the taxable year;
5. Actually charged off in the books of accounts of the taxpayer as of the end of the taxable
year.

Before a taxpayer may charge off and deduct a debt, he must ascertain and be able to to
demonstrate with reasonable degree of certainty the uncollectibility of the debt.

In Collector v. Goodyear, G.R. No. L-22265, December 22, 1967, the Supreme Court held that
in ascertaining worthlessness, two facts must be proven:
1. That the taxpayer did in fact ascertain the debt to be worthless, in the year for which
deduction is sought; and
2. That in so doing, he acted in good faith. Good faith does not require that the taxpayer
be an “incorrigible optimist” but on the other hand, he may not be “unduly pessimistic”.

Cases:

Philippine Refining Company v. CIR, G.R. No. 118794, May 8, 1996 Held: We find that
said accounts have not satisfied the requirements of the "worthlessness of a debt". Mere
testimony of the Financial Accountant of the Petitioner explaining the worthlessness of said
debts is seen by this Court as nothing more than a self-serving exercise which lacks probative
value. There was no iota of documentary evidence (e.g., collection letters sent, report from
investigating fieldmen, letter of referral to their legal department, police report/affidavit that
the owners were bankrupt due to fire that engulfed their stores or that the owner has been
murdered. etc.), to give support to the testimony of an employee of the Petitioner. Mere
allegations cannot prove the worthlessness of such debts in 1985. Hence, the claim for
deduction of these thirteen (13) debts should be rejected. This pronouncement of respondent
Court of Appeals relied on the ruling of this Court in Collector vs. Goodrich International
Rubber Co., which established the rule in determining the "worthlessness of a debt." In said
case, we held that for debts to be considered as "worthless," and thereby qualify as "bad
debts" making them deductible, the taxpayer should show that (1) there is a valid and
subsisting debt. (2) the debt must be actually ascertained to be worthless and uncollectible
during the taxable year; (3) the debt must be charged off during the taxable year; and (4)
the debt must arise from the business or trade of the taxpayer. Additionally, before a debt
can be considered worthless, the taxpayer must also show that it is indeed uncollectible even
in the future. Furthermore, there are steps outlined to be undertaken by the
taxpayer to prove that he exerted diligent efforts to collect the debts, viz.: (1)
sending of statement of accounts; (2) sending of collection letters; (3) giving the
account to a lawyer for collection; and (4) filing a collection case in court. x x x The
contentions of PRC that nobody is in a better position to determine when an obligation
becomes a bad debt than the creditor itself, and that its judgment should not be substituted
by that of respondent court as it is PRC which has the facilities in ascertaining the collectibility
or uncollectibility of these debts, are presumptuous and uncalled for. The Court of Tax Appeals
is a highly specialized body specifically created for the purpose of reviewing tax cases.
Through its expertise, it is undeniably competent to determine the
issue of whether or not the debt is deductible through the evidence presented before it.

Philex Mining v. CIR, G.R. No. 148187, April 16, 2008. Facts: Petitioner deducted from
its gross income the amount of P112,136,000.00 as “loss on settlement of receivables from
Baguio Gold against reserves and allowances”. BIR disallowed such deduction and for which
it assessed petitioner for deficiency income tax. Petitioner protested arguing that the
deduction must be allowed since all the requisites for a bad debt deduction were satisfied;
that the debt arose out of a valid management contract (as embodied in the Special Power of
Attorney) it entered into with Baguio Gold; that the bad debt deduction represents the
advances and payments made by petitioner which, pursuant to the management contract,
formed part of Baguio Gold’s “pecuniary obligations” to the petitioner; that due to Baguio
Gold’s irreversible losses, it became evident that it would not be able to recover the advances
and payments it made in behalf of Baguio Gold; that for a debt to be considered worthless,
petitioner claimed that it was neither required to institute a judicial action for collection against
the debtor nor to sell or dispose of collateral assets in satisfaction of the debt. It is enough
that a taxpayer exerted diligent efforts to enforce collection and exhausted all reasonable
means to collect. BIR denied petitioner’s protest for lack of legal and factual basis. It held
that the alleged debt was not ascertained to be worthless since Baguio Gold remained existing
and had not filed a petition for bankruptcy; and that the deduction did not consist of a valid
and subsisting debt considering that, under the management contract, petitioner was to be
paid fifty percent (50%) of the project’s net profit. The CTA rejected petitioner’s assertion
that the advances it made for the Sto. Nino mine were in the nature of a loan. It instead
characterized the advances as petitioner’s investment in a partnership with Baguio Gold for
the development and exploitation of the Sto. Nino mine. The CTA held that the "Power of
Attorney" executed by petitioner and Baguio Gold was actually a partnership agreement. Since
the advanced amount partook of the nature of an investment, it could not be deducted as a
bad debt from petitioner’s gross income. The CTA likewise held that the amount paid by
petitioner for the long-term loan obligations of Baguio Gold could not be allowed as a bad
debt deduction. At the time the payments were made, Baguio Gold was not in default since
its loans were not yet due and demandable. What petitioner did was to pre-pay the loans as
evidenced by the notice sent by Bank of America showing that it was merely demanding
payment of the installment and interests due. Moreover, Citibank imposed and collected a
"pre-termination penalty" for the pre-payment. Held: An examination of the "Power of
Attorney" reveals that a partnership or joint venture was indeed intended by the
parties. Under a contract of partnership, 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. While a corporation, like petitioner, cannot generally enter into a contract
of partnership unless authorized by law or its charter, it has been held that it may enter into
a joint venture which is akin to a particular partnership. x x x Perusal of the agreement
denominated as the "Power of Attorney" indicates that the parties had intended
to create a partnership and establish a common fund for the purpose. They also
had a joint interest in the profits of the business as shown by a 50-50 sharing in
the income of the mine. Under the "Power of Attorney", petitioner and Baguio Gold
undertook to contribute money, property and industry to the common fund known as the Sto.
Niño mine. In this regard, we note that there is a substantive equivalence in the respective
contributions of the parties to the development and operation of the mine. Pursuant to
paragraphs 4 and 5 of the agreement, petitioner and Baguio Gold were to contribute equally
to the joint venture assets under their respective accounts. Baguio Gold would
contribute P11M under its owner’s account plus any of its income that is left in the project, in
addition to its actual mining claim. Meanwhile, petitioner’s contribution would consist of
its expertise in the management and operation of mines, as well as the manager’s account
which is comprised of P11M in funds and property and petitioner’s "compensation" as
manager that cannot be paid in cash. x x x The wording of the parties’ agreement as to
petitioner’s contribution to the common fund does not detract from the fact that petitioner
transferred its funds and property to the project as specified in paragraph 5, thus rendering
effective the other stipulations of the contract, particularly paragraph 5(c) which prohibits
petitioner from withdrawing the advances until termination of the parties’ business relations.
As can be seen, petitioner became bound by its contributions once the transfers were made.
The contributions acquired an obligatory nature as soon as petitioner had chosen to exercise
its option under paragraph 5. X X In this case, the totality of the circumstances and
the stipulations in the parties’ agreement indubitably lead to the conclusion that
a partnership was formed between petitioner and Baguio Gold. First, it does not
appear that Baguio Gold was unconditionally obligated to return the advances made by
petitioner under the agreement. Paragraph 5 (d) thereof provides that upon termination of
the parties’ business relations, "the ratio which the MANAGER’S account has to the owner’s
account will be determined, and the corresponding proportion of the entire assets of the STO.
NINO MINE, excluding the claims" shall be transferred to petitioner. As pointed out by the
Court of Tax Appeals, petitioner was merely entitled to a proportionate return of the mine’s
assets upon dissolution of the parties’ business relations. There was nothing in the agreement
that would require Baguio Gold to make payments of the advances to petitioner as would be
recognized as an item of obligation or "accounts payable" for Baguio Gold. Thus, the tax
court correctly concluded that the agreement provided for a distribution of assets of the Sto.
Niño mine upon termination, a provision that is more consistent with a partnership than a
creditor-debtor relationship. It should be pointed out that in a contract of loan, a person who
receives a loan or money or any fungible thing acquires ownership thereof and is bound to
 pay the creditor an equal amount of the same kind and quality. In this case, however, there
was no stipulation for Baguio Gold to actually repay petitioner the cash and property that it
had advanced, but only the return of an amount pegged at a ratio which the manager’s
account had to the owner’s account. In this connection, we find no contractual basis for the
execution of the two compromise agreements in which Baguio Gold recognized a debt in favor
of petitioner, which supposedly arose from the termination of their business relations over the
Sto. Nino mine. The "Power of Attorney" clearly provides that petitioner would only be entitled
to the return of a proportionate share of the mine assets to be computed at a ratio that the
manager’s account had to the owner’s account. Except to provide a basis for claiming the
advances as a bad debt deduction, there is no reason for Baguio Gold to hold itself liable to
petitioner under the compromise agreements, for any amount over and above the proportion
agreed upon in the "Power of Attorney". Next, the tax court correctly observed that it was
unlikely for a business corporation to lend hundreds of millions of pesos to another corporation
with neither security, or collateral, nor a specific deed evidencing the terms and conditions of
such loans. The parties also did not provide a specific maturity date for the advances to
become due and demandable, and the manner of payment was unclear. All these point to the
inevitable conclusion that the advances were not loans but capital contributions to a
partnership. The strongest indication that petitioner was a partner in the Sto Niño mine is
the fact that it would receive 50% of the net profits as "compensation" under paragraph 12
of the agreement. The entirety of the parties’ contractual stipulations simply leads to no other
conclusion than that petitioner’s "compensation" is actually its share in the income of the joint
venture. X X All told, the lower courts did not err in treating petitioner’s advances
as investments in a partnership known as the Sto. Nino mine. The advances were
not "debts" of Baguio Gold to petitioner inasmuch as the latter was under no
unconditional obligation to return the same to the former under the "Power of
Attorney". As for the amounts that petitioner paid as guarantor to Baguio Gold’s creditors,
we find no reason to depart from the tax court’s factual finding that Baguio Gold’s debts were
not yet due and demandable at the time that petitioner paid the same. Verily, petitioner pre-
paid Baguio Gold’s outstanding loans to its bank creditors and this conclusion is supported by
the evidence on record.

Equitable Doctrine of Tax Benefit/Tax Benefit Rule

This doctrine holds that a recovery of a bad debt previously deducted from gross income
constitutes taxable income if in the year the account was written off, the deduction resulted in a
tax benefit, i.e. in the reduction of taxable income of the taxpayer.

When are bad debts deductible by aliens and resident foreign corporations?
They are deductible if they have arisen in the course of business or trade within the Philippines
and actually ascertained to be worthless and charged off within the year.

F. DEPRECIATION

Definition
Depreciation is the gradual diminution in the useful value of tangible property used in trade,
profession or business resulting from exhaustion, wear and tear, and obsolescence. The term is
 also applied to amortization of the value of intangible assets, the use of which in trade or business
is definitely limited in duration. (Basilan Estate v. Comm., G.R. No. L-22492, September 5,
1967).

Case: Basilan Estate v. Comm., G.R. No. L-22492, September 5, 1967. Facts: Basilan
Estates, Inc. claimed deductions for the depreciation of its assets up to 1949 on the basis of their
acquisition cost. As of January 1, 1950 it changed the depreciable value of said assets by
increasing it to conform with the increase in cost for their replacement. Accordingly, from 1950
to 1953 it deducted from gross income the value of depreciation computed on the reappraised
value. Issue: Whether depreciation shall be determined on the acquisition cost or on the
reappraised value of the assets. Held: Depreciation is the gradual diminution in the useful value
of tangible property resulting from wear and tear and normal obsolescence. The term is also
applied to amortization of the value of intangible assets, the use of which in the trade or business
is definitely limited in duration. Depreciation commences with the acquisition of the property and
its owner is not bound to see his property gradually waste, without making provision out of
earnings for its replacement. It is entitled to see that from earnings the value of the property
invested is kept unimpaired, so that at the end of any given term of years, the original investment
remains as it was in the beginning. It is not only the right of a company to make such a provision,
but it is its duty to its bond and stockholders, and, in the case of a public service corporation, at
least, its plain duty to the public. Accordingly, the law permits the taxpayer to recover gradually
his capital investment in wasting assets free from income tax. Precisely, Section 30 (f) (1) which
states: - (1)In general. — A reasonable allowance for deterioration of property arising out of its
use or employment in the business or trade, or out of its not being used: Provided, That when
the allowance authorized under this subsection shall equal the capital invested by the taxpayer .
. . no further allowance shall be made. . . . - allows a deduction from gross income for depreciation
but limits the recovery to the capital invested in the asset being depreciated. The income tax law
does not authorize the depreciation of an asset beyond its acquisition cost. Hence, a deduction
over and above such cost cannot be claimed and allowed. The reason is that deductions from
gross income are privileges, not matters of right. They are not created by implication but upon
clear expression in the law Moreover, the recovery, free of income tax, of an amount more than
the invested capital in an asset will transgress the underlying purpose of a depreciation allowance.
For then what the taxpayer would recover will be, not only the acquisition cost, but also some
profit. Recovery in due time thru depreciation of investment made is the philosophy behind
depreciation allowance; the idea of profit on the investment made has never been the underlying
reason for the allowance of a deduction for depreciation. Accordingly, the claim for depreciation
beyond P36,842.04 or in the amount of P10,500.49 has no justification in the law. The
determination, therefore, of the Commissioner of Internal Revenue disallowing said amount,
affirmed by the Court of Tax Appeals, is sustained.

Give the necessity of depreciation allowance

The necessity arises from the fact that certain property used in the business gradually approaches
a point where its usefulness is exhausted. By using the property, a gradual sale is made of it;
and the depreciation charged is the measure of the cost which has been sold. When the property
is disposed of after years of use, it is no longer the whole thing originally used.

Requisites for deductibility of depreciation

 1. The allowance for depreciation must be reasonable
2. It must be for property used in the trade or business (thus, capital assets or building used
by the taxpayer for his residence are not subject to allowance for depreciation); but see
discussion on EAR regarding entertainment facilities).
3. It must be charged off during the taxable year;
4. A statement on the allowance must be attached to the return

Property Held by One Person for Life with the Remainder to Another Person
The deduction shall be computed as if the life tenant was the absolute owner of the property,
and, as such the expense shall accrue to him (life tenant). (Life tenant – a person who is entitled
to the use of or the income from an asset during his or her lifetime).

Property Held In Trust

Allowable deduction shall be apportioned between the income beneficiaries and the trustees in
accordance with the pertinent provision of the instrument creating the trust or in the absence of
such provision, on the basis of the trust income allowable to each.

How is depreciation measured?

Depreciation Is a question of fact and is not measured by theoretical yardstick but should be
determined by consideration of actual facts. The reasonableness of any claim for depreciation
shall be determined upon the conditions known to exist at the end of the period for which the
return is made (Sec. 109, RR No. 2-40).

Methods of Depreciation [SEC 34(F)(2)]

The term “reasonable allowance” shall include, but not limited to an allowance computed in
accordance with the regulations prescribed by the Department of Finance, under any of the
following methods:
1. Straight-line method
2. Declining balance method using a rate not exceeding twice the rate which would have
been used had the annual allowance been computed under SLM;
3. Sum of years digit method
4. Any other method prescribed by the Dept. of Finance upon the recommendation of the
Commissioner

Straight line method – formula D=

C – SV
L
D = Depreciation
C = Acquisition Cost
SV = Salvage Value
L = Estimated Use

Illustration: An asset costing P1,000,000.00 has an estimated useful life of 5 years and
salvage value of P50,000. Compute the depreciation for 2019 if it was acquired on January
1, 2019.
 1,000,000 less P50,000 = P190,000
5 years

Note: For years 2 to 5, the taxpayer will report depreciation expense uniformly at
P190,000.00.

Declining Balance Method – Formula D

= R x BV
Where R = 1/L x A
A = not to exceed 200%

BV = C-AD

D = Depreciation
R = Declining Balance Rate
B = Book Value
C = Cost
AD = Accumulated Depreciation

Same illustration but the accelerator is 200%

First Step: Compute the Double Declining Rate (R).

1 / 10 years x 200%
= 20% x 200% = 40%
Note: If depreciation is computed using Straight Line Method, the Depreciation Rate is
20% annually.

Second Step: Compute the Depreciation

A B C D E
Year Rate Book Value Depreciation Accumulated
Depreciation
1 40% 1,000,000.00 400,000.00 400,000.00
2 40% 600,000.00 240,000.00 640,000.00
3 40% 360,000.00 144,000.00 784,000.00
4 40% 216,000.00 86,400.00 870,400.00
5 40% 129,600.00 51,840.00 922,240.00

Sum of Year’s Digit – Formula D

= R/SYD X (C-SV)
D = Depreciation
R = Remaining Useful Life of the Asset
SYD = Sum of Year’s Digit of the Useful Life of the Asset
C = Cost
SV = Salvage Value
 Same Illustration

First Step: Compute the SYD, which is the sum of the remaining useful lives of the asset

Year Remaining Useful Life

1 5
2 4
3 3
4 2
5 1
SYD ➔ 15
Second Step: Compute the Depreciation

A B C D E
Year R SYD C-SV Depreciation
1 5 15 950,000.00 316,666.67
2 4 15 950,000.00 253,333.33
3 3 15 950,000.00 190,000.00
4 2 15 950,000.00 126,666.67
5 1 15 950,000.00 63,333.33
Total ➔ 950,000.00

Agreement as to Useful Life on Which Depreciation is Based

The BIR and the taxpayer may agree in writing on the useful life of the property to be depreciated.
The agreed rate may be modified if justified by facts or circumstances. The change shall not be
effective before the taxable year on which notice in writing by certified mail or registered mail is
served by the party initiating.

Special Types of Depreciation

1. Petroleum Operations
a. Depreciation of all properties directly related to production of petroleum shall be
allowed under straight line method (SL) or declining balance method (DB)
b. May shift from DB to SL
c. Useful life: 10 years or shorter life as allowed by the Commissioner
d. Useful life of property not directly related to production: 5 years under SL method.
2. Mining Operations
a. Depreciating on all properties in mining operations other than petroleum
operations at the normal rate if expected life is less than 10 years
b. If expected life is more than 10 years, depreciation shall be any number of years
between 5 years and the expected life.

Depreciation deduction by NRAETB/NRFC

Only when such property is located in the Philippines
Limitation on Deductibility of Depreciation Expense relating to Vehicles (RR No. 12- 2012)
https://www.bir.gov.ph/images/bir_files/old_files/pdf/65716RR%20No%2012-2012.pdf

1. No deduction from gross income for depreciation shall be allowed unless the taxpayer
substantiate the purchase with sufficient evidence, such as official receipt or adequate
records;
2. Only one vehicle for land transport is allowed for the use of an official or employee, the
value of which shall not exceed P2,400,000.00;
3. No depreciation expense shall be allowed for yachts, helicopter, airplane and/or aircrafts,
and land vehicles which exceeds P2,400,000.00, unless the taxpayer’s main line of
business is transport operations or lease of transportation equipment and the vehicle
purchased are used in the said operation
4. All maintenance expense on account of non-depreciable vehicles for taxation purposes are
disallowed in its entirety;

G. DEPLETION [SEC. 34(G)]

Definition
Depletion is the exhaustion of natural resources like mines and oil and gas wells as a result of
production or severance from such mines or wells.

Theory and Purpose of Depletion Allowance

The theory of the allowance for depletion, as I the case that for depreciation, is that, as the
product of the mine is sold, a gradual sale is being made of the taxpayer’s capital interest in the
property. Depletion allowance enables the taxpayer to recover that capital interest free of income
tax, as its cost or on some other basis.

Persons entitled to depletion allowance

Only persons having economic interest in the property are entitled to depletion allowance. To
acquire an economic interest, the taxpayer must have a capital investment in the property and
not a mere economic advantage. The taxpayer must have acquired at least, by investment, any
interest in oil or gas, or mineral in place, and secures, by any form of legal relationship, income
derived from the extraction of the oil, gas or mineral to which he must look for a return of his
capital.

How shall depletion allowance be completed?

It shall be computed under the cost-depletion method as follows: [Sec. 34(G)(1)]

1. A reasonable allowance for depletion or amortization computed in accordance with the

rules and regulations prescribed by the Secretary of Finance, upon the recommendation
of the CIR;
 2. When the allowances shall be equal to the capital invested, no further allowance shall be
granted;
3. After production in commercial quantities has commenced, certain intangible
exploration and development drilling costs:
a. shall be deducted in the year incurred if such expenditures are incurred for non-
producing wells; OR
b. In case incurred for producing wells in the same contract area – options of the
taxpayer:
i. Deducted in full in the year incurred; OR
ii. Capitalized and amortized

Note: Intangible exploration and development drilling costs – refer to any cost
incurred in petroleum operation which in itself has no salvage value and which is incidental
to and necessary for the drilling of wells and preparation of wells for the production of
petroleum. Said cost shall not pertain to the acquisition of improvement of property of a
character subject to the allowance for depreciation except that the allowance for
depreciation on such property shall be deductible under Section 34(G).

4. Any intangible exploration, drilling and development expenses allowed as a deduction in

computing taxable income during the year shall not be taken into consideration in
computing the adjusted basis for purposes of computing allowable cost depletion.

What are the essential facts in determining the amount of cost depletion allowable?
1. The basis of the property (i.e. the pesos amount of the taxpayer’s capital or investment
in the property which he is entitled to recover tax-free during the period he is removing
the mineral in deposit);
2. The estimated total recoverable units in the property;
3. The number of units recovered during the taxable year.

In computing taxable income, may the taxpayer deduct exploration and development
expenditures paid or incurred during the taxable year?

Yes. In computing taxable income from mining operations, the taxpayer may, at his option,
deduct exploration and development expenditures accumulated as cost or adjusted basis for cost-
depletion as of date of prospecting, as well as exploration and development
expenditures paid or incurred during the taxable year, provided:
1. The amount deductible for exploration and development expenditures shall not exceed
25% of the net income from mining operations computed without the benefit of any tax
incentives under existing laws.
2. The actual exploration and development expenditures minus the 25% of the net income
from mining shall be carried forward to the succeeding years until fully deducted.

Notes: a) The election by the taxpayer to deduct the exploration and development expenditures
is irrevocable and shall be binding in succeeding taxable years.
b) This option applies only to the amounts paid or incurred for the exploration and development
of oil and gas.
 c) Net income from mining operation = gross income from operations less allowable
deductions which are necessary or related to mining operations.
d) Allowable deductions include mining, milling, and marketing expenses, and depreciation of
properties directly used in the mining operations (but excludes expenditures for the acquisition
or improvement of property of a character which is subject to allowance for depreciation)
c) Exploration expenditures means expenditures paid or incurred for the purpose of
ascertaining the existence, location, extent or quality of any deposit of ore or other mineral, and
paid or incurred before the beginning of the development stage of the mine or deposit.
d) Development expenditures means expenditures paid or incurred during the development
stage of the mine or other natural deposits. The development stage of a mine or natural deposit
shall begin at the time when deposits of ore or other minerals are shown to exist in sufficient
commercial quantity and quality and shall end upon commencement of actual commercial
extraction.

Is depletion allowance available even if the capital investment has been completely
recovered?
No. Under the cost-depletion method, the allowance shall be limited to the capital investment by
the taxpayer. The ceiling is intended to curb the practice of mining companies of inflating their
gross income so as to have bigger base on which to apply the percentage depletion, if assured
that such gross income could still be reduced substantially for purposes of computing the net
income, thereby avoiding the payment of the proper amount of income tax.

Distinguish Depletion from Depreciation

Both are predicated on the same basic premise of avoiding a tax on capital. However,
depreciation is based upon the concept of the exhaustion of a natural resource whereas
depreciation is based upon the concept of the exhaustion of the property, not otherwise a natural
resource, used in a trade or business or held of the production of income. Thus, depletion and
depreciation are made applicable to different types of assets. And a taxpayer may not deduct
that which the Tax Code allows as a deduction of another. (Consolidated Mines, Inc. v. CTA,
G.R. No. L-18843, August 29, 1974, in Footnote No. 36)

H. CHARITABLE and OTHER CONTRIBUTION [SEC. 34(H), see also SEC. 101, NIRC;
RR NOS. 13-98; 2-2003]
RR 13-98:
http://www.usig.org/countryinfo/laws/Philippines/Philippines%20Revenue%20Regulations.pdf
RR: 2-2003: https://lawphil.net/administ/bir/rr/rr02_03.pdf

How are charitable contributions classified?

1. Ordinary – Those which are subject to limitation as to the amount deductible from gross
income; and
2. Special – Those which are deductible in full from gross income
 Special (Deductible in Full) Ordinary (Deductible subject to
Limitation)

1. Recipient is: 1. Recipient is:

a. Government of the Philippines; a. Government of the Philippines;
b. Any of its agencies or political b. Any of its agencies or political
subdivisions; or subdivision
c. Any fully-owned government
corporation

For priority activity in: For a non-priority activity in any

a. Education areas mentioned under Donations
b. Health Deductible in Full, but must be
c. Youth and Sports Development exclusively for a public purpose
d. Human settlements
e. Science and Culture
f. Economic Development

2. Recipient is a: 2. Recipient is:

a. Foreign institution; or a. Social welfare institutions;
b. International organization b. Non-government organizations

With an agreement with the Philippine In accordance with the rules and
Government on the full deductibility of regulations promulgated by the
the donation, or in accordance with Secretary of Finance
special law.

3. Recipient is: 3. Recipient is an accredited

a. An accredited non-government domestic corporation or
organization (NGO), fully association organized and operated
organized/operated exclusively exclusively for the following purposes
for the following purposes: a. Religious;
b. Charitable;
i. Scientific; c. Scientific;
ii. Research; d. Youth and Sports Development;
iii. Educational; e. Cultural;
iv. Character Building and Youth f. Educational; or
and Sports Development; g. Rehabilitation of veterans
v. Health;
vi. Social welfare;
vii. Cultural Subject to the limitation (applicable if
viii. Charitable; or donation is made to any of the foregoing
ix. Combination of (i) to (viii) recipients):

And satisfying the following a. Individual – 10% of the taxable

conditions: income from trade, business, or
a. The donation must be utilized not exercise of profession before the
later than the 15th day of the 3rd contribution;
 month following the close of the
taxable year; b. Corporation – 5% of the taxable
b. The administrative expense must income from trade, business, or
not exceed 30% of the total exercise of profession before the
expenses; contribution;
c. Upon dissolution, assets must be
distributed to another non-profit
domestic corporation or to the
State.

Requisites for the deductibility of the Contribution

1. The contribution or gift must be actually paid or made;
2. To the Philippine government or any political subdivision thereof exclusively for
public purpose or to any accredited domestic corporations or associations
mentioned in the Tax Code;
3. It must not exceed 10% in case of individual, and 5% in case of corporation (except in
case when the donation is deductible in full) of the taxpayer’s taxable income derived from
business, trade or exercise of profession and computed without the benefit of the
contribution;
4. It must be evidenced by adequate records or receipts.

Valuation
The amount of any charitable contribution of property other than money shall be based on the
acquisition cost of the said property.

Substantiation Requirements
See Section 8, RR 13-98

Case: Mariposa Properties Inc. v. CIR, CTA Case No. 6402, 13 February 2007. Held: In
deciding on the BIR’s disallowance of deduction for donations made to private foundation, the
CTA required the donor to prove compliance of both the donor and donee with the requirements
for deductibility of the donations. Hence, for failure of the donor to present proof of the
foundation’s income tax return and audited financial statements, as well as the annual information
report of the foundation submitted to the BIR as required in the regulations, the deduction was
disallowed. Note: This was affirmed by the CTA En Banc per CTA EB Case NO. 371, April 12,
2008)

I. RESEARCH AND DEVELOPMENT [SEC. 34(I)]

How are Research and Development Expenditures treated taxwise?

Either as:
 1. Revenue Expenditures
Requisites:
a. Paid or incurred during the taxable year;
b. Ordinary and necessary expenses in connection with the trade, business or exercise
of profession;
c. Not chargeable to capital account.

2. Deferred Expenses
Requisites:
a. Paid or incurred during the taxable year in connection with the trade, business or
exercise of profession;
b. Not treated as ordinary and necessary expense;
c. Chargeable to capital account but not to property subject to depreciation or depletion.

NOTE: Amount ratably distributed over a period of 60 months beginning with the month
the taxpayer realized benefits from such expenditures.

What are excluded from Research and Development Expenditures?

1. Any expenditures for the acquisition or improvement of land or for the improvement of
the property to be used in connection with research and development subject to
depreciation and depletion;
2. Any expenditure paid or incurred for the purpose of ascertaining the existence, location,
extent or quality of any deposit of ore or other mineral including oil and gas

J. PENSION TRUST CONTRIBUTION [SEC. 34J), SEE ALSO/COMPARE WITH SECS.

32(B)(6) AND 60(B)]

When is deduction for Pension Trust Contribution applicable?

It is applicable only when the employer is establishing or maintaining pension trust to provide
payments of reasonable pensions to his employees.

Requisites for Deductibility

1. The employer must have established a pension or retirement plan to provide for the
payment of reasonable pensions to his employees;
2. The pension plan is reasonable and actuarially sound;
3. It must be funded by the employer;
4. The amount contributed must be no longer subject to the control or disposition of the
employer;
5. The payment has not been allowed as a deduction; and
6. The deduction is apportioned in equal parts over a period of 10 consecutive years
beginning with the year in which the transfer or payment is made

Amount that may be deducted

a. Contributions to the trust during the taxable year to cover the pension liability accruing
during the year, allowed as ordinary and necessary expense under Sec. 34(A); and
 b. Amount transferred or paid to the trust during the taxable year in excess of such
contribution to cover pension liability to the years prior to the taxable year (past service
cost) or so paid to place the trust in a sound financial basis provided: a) such has not
been allowed as a deduction; and b) the amount is apportioned in equal parts over a
period of 10 consecutive years beginning with the year in which the transfer or payment
is made. This is allowed as a deduction under Sec. 34(J).

Summary of Rules on Retirement Benefit Plan/Pension Trust

1. Exempt from Income Tax – Employees’ trust under Sec. 60(B);

2. Exclusion from Gross Income – amount received by the employee from the fund upon
compliance with certain conditions under Sec. 32(B)(6);
3. Deduction from Gross Income (Sec. 34(J):
a. Amount contributed by the employer during the taxable year into the pension plan
to cover pension liability accruing during the taxable year – considered as
ordinary and necessary expense under Sec. 34(A);
b. 1/10 of the reasonable amount paid by the employer to cover pension liability to
the years prior to the taxable year (past service cost), or so paid to place the trust
in a sound financial basis – deductible under Sec. 34(J).

SPECIAL Provisions Regarding Income and Deductions of Certain Corporations:

1. Expenses Allowable to Private Educational Institutions – In addition to the

expenses allowable under Chapter VII, a Private Educational Institution is allowed, at its
option either to:

a. Deduct expenditures otherwise considered as capital outlays of depreciable assets

incurred during the taxable year for the expansion of school facilities; OR
b. Deduct allowance for depreciation thereof under Section 34(F).

Private/Proprietary Educational Institution is any private school maintained and

administered by private individuals or groups with an issued permit to operate from the
DECS (now DepEd) or the CHED, or TESDA, as the case maybe, in accordance with
existing laws and regulations. [Sec. 27(B)]

2. Deductions Allowed to Insurance Companies, domestic or foreign doing business in

the Philippines [Sec. 37(A)]:
a. Net additions, if any, required by law to be made within the year to reserve funds;
and
b. Sums other than dividends paid within the year on policy and annuity contracts.

Note: the released reserve shall be treated as income for the year of release.

3. Mutual Companies. Mutual insurance companies (specifically, mutual fire, mutual

employers’ liability and mutual workmen’s compensation and mutual casualty insurance
companies) which require their members to make premium deposits to provide for losses
and expenses, are allowed to deduct from gross income:
 a. Any portion of the premium deposit returned to the policy-holders; or
b. Such portion of the premium deposits as are retained for the payment of losses,
expenses, and reinsurance reserves.

4. Mutual Marine Insurance Companies. Mutual marine insurance companies required to

include in their return of gross income the gross premiums collected and received by
them less amount paid for reinsurance, are allowed to deduct from gross income:
a. Amounts repaid to policy-holders on account of premiums previously paid by them;
and
b. Interest paid upon those amounts between the date of ascertainment and date of
its payment.

5. Assessment Insurance Companies, domestic or foreign:

Assessment insurance companies, whether domestic or foreign, may deduct in a taxable
year the sum actually deposited with the officers of the Government of the Philippines
pursuant to law as additions to guarantee or reserve funds.

6. Deductions allowed to Estate and Trust (Sec. 61) – to be discussed separately.

END
 LECTURE NOTES

TAXATION 1
Atty. Arnel A. dela Rosa, CPA, REB, REA

INCOME TAXATION

GENERAL PROFESSIONAL PARTNERSHIP

Tax Liability of Members of GPP (Sec. 26)

➢ GPP is not subject to income tax;
➢ Persons engaging in business as partners in a GPP shall be liable for income tax only in
their share and individual capacities;
➢ For purposes of computing the distributive share of partners, the net income of the
partnership shall be computed in the same manner as a corporation;
➢ Each partner shall report as gross income his distributive share, actually or constructively
received, in the net income of the partnership.

Returns of GPP (Sec. 53)

➢ GPPs are required to file income tax return
➢ In duplicate copy
➢ Setting forth: i) items of gross income; ii) deductions allowed; iii) names and TIN,
addresses, and shares of each partner

ESTATES AND TRUSTS [SECS. 60 to 66]

ESTATE – refers to the mass of properties left by a deceased person.

RULES ON TAXABILITY OF ESTATE

When a person who owns property dies, the following taxes are payable under the provisions of
the income tax law:
1. Income tax for individuals under Sections 24 and 25 (to cover the period beginning
January to the time of death)
2. Estate Income Tax under Section 60 if the estate is under administration or judicial
settlement.

ESTATE UNDER JUDICIAL SETTLEMENT

A. DURING THE PENDENCY OF THE SETTLEMENT
General Rule: An estate under judicial settlement is subject to income tax in the same
manner as individuals. Its status is the same as the status of the decedent prior to his death.
Exceptions:
1. The distribution to the heirs during the taxable year of estate income is deductible from
the taxable income of the estate. Such distributed income shall form part of the respective
heir’s taxable income. Where no such distribution to the heirs is made during the taxable
year that the income is earned, and such income is subjected to income tax payment by
the estate, the subsequent distribution thereof is no longer taxable on the part of the
recipient.
 B. TERMINATION OF THE JUDICIAL SETTLEMENT (WHERE THE HEIRS STILL DO
NOT DIVIDE THE PROPERTY)
1. If the heirs contribute to the estate money, property, or industry with the intention to
divide the profits between/among themselves, an unregistered partnership is created and
the estate becomes liable for the payment of corporate income tax. (Evangelista v.
Collector, G.R. No. L-9996, October 15, 1957; Ona v. CIR, G.R. No. L-19342, May 25,
1972)

2. If the heirs, without contributing money, property, or industry to improve the estate,
simply divide the fruits thereof between/among themselves, a co-ownership is created,
and individual income tax is imposed on the income received by each of the heirs, payable
in their separate and individual capacity (Pascual v. CIR, G.R. No. L-78133, October 18,
1988; Obillos v. Commissioner, G.R. No. L-68118, October 29, 1985)

C. ESTATE NOT UNDER JUDICIAL SETTLEMENT

Pending the extrajudicial settlement, either of the following situations may arise:
1. If the heirs contribute money, property, or industry to the estate with the intention of
dividing the profits among/between themselves, an unregistered partnership is created
and the estate becomes liable to pay corporate income tax; OR
2. If the heirs, without contributing money, property or industry to the estate, simply
divide the fruits thereof between/among themselves, a co-ownership is created and
income tax is imposed on the income received by each of the heirs, payable in their
separate and individual capacity.

TRUST – A right to the property, whether real or personal, held by one person for the benefit of
another.

WHEN TRUSTS ARE TAXABLE ENTITIES

1. A trust, the income of which is to be accumulated;
2. A trust in which the fiduciary may, at his discretion, either distribute or accumulate the
income

IRREVOCABLE TRUST (irrevocable both as to the corpus and as to the income)

Trust itself, through the trustee or fiduciary, is liable for the payment of income tax. Taxed
exactly in the same way as estate under judicial settlement and its status as an individual is that
of the trustor.

IMPOSITION OF TAX (Sec. 60)

The tax imposed upon individuals shall apply to the income of estates or of any kind of property
held in trust, including:
1. Income accumulated in trust for the benefit of unborn or unascertained person or persons
with contingent interest, and income accumulated or held for future distribution under the
terms of the will or trust;
2. Income which is to be distributed currently by the fiduciary to the beneficiaries, and
income collected by a guardian of an infant which is to be held or distributed as the court
may direct;
3. Income received by estates of deceased persons during the period of administration or
settlement of estate; and
4. Income which, in the discretion of the fiduciary, may be either distributed to the
beneficiaries or accumulated.
Exception/Exclusion [Sec. 60(B)]: Employees’ trust which form part of a pension, stock bonus, or
profit-sharing plan of an employer for the benefit of some or all of his employees (1) if
contributions are made to the trust by such employer, or employees, or both for the purpose of
distributing to such employees the earnings and principals of the fund accumulated by the trust in
accordance with such plan; and (2) if under the trust instrument it is impossible, at any time prior
to the satisfaction of all liabilities with respect to employees under the trust, for any part of the
corpus or income (within the taxable year or thereafter) used for, or diverted to, purposes other
than for the exclusive benefit of his employees.
➢ Any amount actually distributed to any employee or distributee shall be taxable to him in
the year in which so distributed to the extent that it exceeds the amount contributed by
such employee or distributee.

COMPUTATION AND PAYMENT [SEC. 60(C)]

In General – tax shall be computed upon the taxable income of the estate or trust and shall be
paid by the fiduciary, except as provided in Sec. 63 (relating to revocable trust) and Sec. 64
(relating to income for the benefit of the grantor)

Consolidation of Income of Two or More Trusts – when the creator and beneficiary are the same
in two or more trusts, the taxable income of all the trusts shall be consolidated and the tax shall
be computed on such consolidated income, and such proportion of the said tax shall be assessed
and collected from each trustee which the taxable income of the trust administered by him bears
to the consolidated income of the several trusts.

COMPUTATION OF TAXABLE INCOME [SEC. 61]

Rule: Computed in the same manner and on the same basis as in the case of an individual,
except that:
1. Allowed deductions
a. The amount of income of the estate or trust for the taxable year which is to be
distributed currently by the fiduciary to the beneficiaries, and
b. The amount of the income collected by the guardians of an infant which is to be
held or distributed as the court may direct
➢ such amount so allowed as deduction shall be included in computing the taxable
income of the beneficiaries, whether distributed to them or not;
➢ any amount allowed as such deduction shall not be allowed as a deduction
under subparagraph (B) (item 2 below) in the same or any succeeding taxable
year.

2. Additional allowed deduction in case of: (i) income received by estates of deceased
persons during the period of administration or settlement of the estate, and in the case of
(ii) income which, in the discretion of the fiduciary, may be either distributed to the
beneficiary or accumulated:
a. The amount of the income of the estate or trust of its taxable year, which is
properly paid or credited during such year to any legatee, heir, or beneficiary
➢ The amount so deducted shall be included in the computation of the taxable
income of the legatee, heir or beneficiary.
 3. The foregoing deductions (1) and (2) above, are not allowed in the case of a trust
administered in a foreign country. The amount of any income included in the return of
said trust shall not be included in computing the income of the beneficiaries.

EXEMPTION ALLOWED TO ESTATES AND TRUSTS (SEC. 62) – REPEALED BY THE TRAIN
LAW

REVOCABLE TRUST (SEC. 63) – where at any time the power to revest in the grantor title to
any part of the corpus of the trust is vested:
(1) in the grantor, either alone or in conjunction with any person not having substantial
adverse interest in the disposition of such part of the corpus or the income therefrom, or
(2) in any person not having a substantial adverse interest in the disposition of such part
of the corpus or the income therefrom;
> the income of such part of the trust shall be included in computing the taxable income
of the grantor.

INCOME FOR BENEFIT OF GRANTOR (SEC. 63) – Where, in the discretion of the grantor or
of any person NOT having substantial adverse interest in the disposition of part of the income of
the trust; OR, when any such part of the income of the trust:
1. Is or may be held or accumulated for future distribution to the grantor;
2. May be distributed to the grantor;
3. Is or may be applied to the payment of premiums upon policies of insurance on the life of
the grantor
➢ Then such part of the income of the trust shall be included in computing the taxable
income of the grantor.

FIDUCIARY RETURNS (SEC. 65)

1. Who are required to file returns – guardians, trustees, executors, administrators, receivers,
conservators, and all persons or corporations, acting in any fiduciary capacity
2. How many copies – duplicate
3. When required – when estate or trust has a gross income of P20,000.00 or over during the
taxable year.
4. Duty of such fiduciary or person filing the return – he shall take oath that he has sufficient
knowledge of the affairs of such person, trust or estate to enable him to make such return
and that the same is, to the best of his knowledge and belief, true and crrect,
5. Return made by or for one or two or more joint fiduciaries filed in the provide where such
fiduciaries reside, under such rules and regulation, shall be sufficient compliance with the
requirements

FIDUCIARIES INDEMNIFIED AGAINST CLAIMS FOR TAXES PAID (SEC. 66)

Trustees, executors, administrators, and other fiduciaries are indemnified against the claims or
demands of every beneficiary for all payments of taxes which they shall be required to make
under the law, and they shall have credit for the amount of such payments against the beneficiary
or principal in any accounting which they make as such trustees or other fiduciaries.
 LECTURE NOTES

TAXATION 1
Atty. Arnel A. dela Rosa, CPA, REB, REA

INCOME TAXATION

GAINS AND LOSSES FROM DEALINGS IN PROPERTY

(SEC. 40 and related provisions of NIRC)

A. MEASURE OF GAIN AND LOSS FROM SALE AND EXCHANGE OF PROPERTY

General Rule on the recognition of gain or loss upon the sale or exchange of property
The general rule is that the entire amount of the gain or loss, as the case maybe, shall be
recognized. [Sec. 40(C)(1)]

Exceptions to the General Rule

1. Transactions where gains and losses are not recognized (Tax Free Exchanges)
a. Exchange of property where the property received is not substantially different
from the property disposed of (Sec. 140, RR 2-40);
b. Exchange of property solely in kind in pursuant of corporate mergers and
consolidation [Sec. 40(C)(2)]
c. Exchange of by a person of his property for stock in a corporation as a result of
which said person alone or together with others not exceeding 4 persons, gains
control of the said corporation [Sec. 40(C)(2), last paragraph]

2. Transactions where gain is recognized but not the losses

a. Transactions between related taxpayers [Sec. 36(B)]
b. Illegal transactions (Sec. 96, RR 2-40)
c. Exchanges of property not solely in kind in pursuance of a corporate merger and
consolidation [Sec. 40(C)(3)]

Factors relevant in determining gain or loss from the disposition of property

1. Basis of property disposed of which in general is the cost at which the taxpayer acquired
the property;
2. Adjustments to the basis which may either take the form of additions (capital
expenditures) or recoveries (depreciation)
3. Amount Realized from the disposal of the property;
4. Nature and Character of the asset disposed of (whether capital asset or ordinary asset);
and
5. Period during which the property was held by the taxpayer (holding period).
 The last two (2) will determine whether the provision of capital gains and losses will apply,
and if so, to what extent.

Computation of gain or loss from the sale or disposition of the property [Sec. 40(A)]
1. The gain shall be the excess of the amount realized therefrom over the basis or adjusted
basis for determining gain;
2. The loss shall be the excess of the basis or adjusted basis for determining loss over the
amount realized;

Amount Realized
The amount realized from the sale or other disposition of property shall be the sum of money
plus the fair market value of the property (other than money) received.

Cost Basis of the Property Sold or Disposed of for purposes of computing the gain or loss
[Sec. 40(B)]
1. Property acquired by purchase on or after March 1, 1913 – its cost, i.e. its purchase price
plus expenses of acquisition (in relation to Sec. 136, RR No. 2-40);
2. Property acquired by inheritance – fair market value (FMV) as of the date of acquisition;
3. Property acquired by gift – the same as if it would be in the hands of the donors or the
last preceding owner by whom it was not acquired by gift, except that if such basis is
greater than the FMV at the time of the gift, for purposes of determining loss, the basis
shall be the FMV;
4. Property acquired for less than an adequate consideration in money or money’s worth –
the amount paid by the transferee for the property;
5. In case of mergers and consolidation – [Sec. 40(C)(5)] applies

Computation of gain (loss) from sale of property

Amount Realized (Selling Price) xxxxxx

Less: Basis (or adjusted basis) xxxxxx
Gain (loss) from the sale xxxxxx

Computation of gain (loss) from exchange of property

FMV of the property received in exchange xxxxxx

Less: Basis (or adjusted basis) of the property given) xxxxxx
Gain (loss) from the exchange

B. CORPORATE MERGER AND CONSOLIDATION

Tax Free Exchanges (no gain or loss from exchange of property by a corporation)
[Sec. 40(C)(2)]
 1. Exchanges of property in pursuance of a plan of merger or consolidation of corporations;
and
2. Exchanges of property as a consequence of which the taxpayer gains control of
corporation

For tax purposes, state the meaning of the terms “merger” and “consolidation”
The term “merger” or “consolidation” are understood to mean:
(i) ordinary merger (A + B = A or B) or ordinary consolidation (A + B = C); OR
(ii) the acquisition by one corporation of all or substantially all the properties of another
corporation solely for stocks (de facto merger)

Notes:
a. For a transaction to be regarded as merger or consolidation, it must be undertaken for a
bona fide purpose and not for the purpose of escaping the burden of taxation;
b. In determining whether a bona fide business purpose exists, each and every step of the
transaction shall be considered and the whole transaction or series of transactions shall
be treated as a single unit;
c. In determining whether the property transferred constitutes a substantial portion of the
property of the transferor, the term “property” shall be taken to include the cash
assets of the transferor.

What is a De Facto Merger? How is it different from a statutory merger?

See: Revenue Memorandum Ruling (RMR) No. 1-2002
https://www.bir.gov.ph/images/bir_files/old_files/pdf/3098rmr01_02.pdf

A de facto merger involves the acquisition by one corporation of all or substantially all the
properties of another solely for stock, pursuant to Sec.(40)(C)(6)(b) of the Tax Code. The phrase
“substantially all the properties of another corporation” is defined in BIR General Circular No. V-
253 dated July 16, 1957 to mean “the acquisition by one corporation of at least 80% of the assets,
including cash, of another corporation”, which has the element of permanence and not merely
momentary holding.

To constitute a de facto merger, the following elements must concur: (1) there must be a
transfer of all or substantially all of the properties of the transferor corporation solely for stocks;
and (2) it must be undertaken for a bona fide business purpose and not solely for the purpose of
escaping the burden of taxation.

One basic difference between a de facto merger and a statutory merger is that the Transferor
is not automatically dissolved in the case of the former. Likewise, there is no automatic transfer
to the Transferee of all the rights, privileges, and liabilities of the Transferor. It is, in fact, in
procedure, similar to a transfer to a controlled corporation under the same Section 40(C)(2) of
the Tax Code, except that at least 80% of the Transferor’s assets, including cash, are transferred
to the Transferee, with the element of permanence and not merely momentary holding. However,
a de facto merger and a transfer to a controlled corporation are different in that: (1) the
Transferor in a de facto merger is a corporation, while the transferor to a controlled corporation,
the transferor may either be a corporation or an individual; and (2) in de facto merger, there is
no requirement that the transferor gains control (i.e. 51% of the total voting powers of all classes
of stocks of the Transferee entitled to vote) of the Transferee as a pre-requisite to enjoying the
benefit of non-recognition of gain or loss. What is essential in a de facto merger is that the
Transferee acquires all or substantially all the properties of the Transferor.

Case: Premium Tobacco Redrying v. CIR, CTA Case No. 8897, July 18, 2017

In general, how is gain or loss resulting from a Merger or Consolidation (M/C) treated for
income tax purposes?
Under the Tax Code, the transaction may either of these consequences:
a. No gain or loss shall be recognized; or
b. Gain, but not the loss, shall be recognized

In connection with an exchange in pursuance of a plan of M/C, what are the instances where
no gain or loss shall be recognized (Tax-Free Exchanges)
No gain or loss shall be recognized to:
1. A corporation, a party to the M/C, which exchanges its property solely for stock in another
corporation, also a party to the M/C;
2. A shareholder who exchanges stock in a corporation solely in a corporation, a party to the
M/C for the stock of another corporation, also a party to the M/C;
3. A security holder who exchanges his securities in a corporation, a party to the M/C, for
stock or securities in another corporation, also a party to the M/C [Sec. 40(C)(2)];
4. A corporation, a party to the M/C, exchanges its property not only for stock but also money
and/or other property of another corporation, also a party to the M/C and distributes
such money and/or other property in pursuance of the plan of M/C [Sec. 40(C)(3)]

Notes: (a) The recognition of gain or loss from the transaction is merely deferred until the
transferor sells or exchanges the stocks acquired.
(b) Tax Consequences of Tax-Free Exchanges are discussed in RMR No. 1-2002

In connection with an exchange in pursuance of a plan of M/C, what are the instances when
only gain, no loss, shall be recognized?
Gain, but not loss, is recognized to:
1. An individual, a shareholder or security holder of a corporation which is a party to the M/C
who exchanges stock or securities in such corporation not only for stock but also for
money and/or property of another corporation, also a party to the M/C;
5. A corporation, a party to the M/C, which exchanges its property not only for stock, but
also for money and/or property of another corporation, a party to the M/C, and does not
distributes such money and/or other property in pursuance of the plan of M/C [Sec.
40(C)(3)]

Gain or Loss Recognition rules in case a person transfers his property to a corporation in
exchange for stock in such corporation as a result of which, said person, alone or together
with others not exceeding 4, gains control (at least 51% of the total voting power of all
classes of stocks entitled to vote) of the corporation:
 1. No gain or loss is recognized if the transfer is solely for stock of the corporation (tax-free
exchange);
2. Gain, but not loss, is recognized if the transfer is not only for stock, but also for money
and/or property

Limitation as to the amount taxable in instances where gain, but not the loss, is recognized.
1. For the stockholder, security holder, or person making the transfer:
a. The gain, if any, shall be recognized in an amount not in excess of the sum of the
money and the fair market value of the other properties received;
b. As to the shareholders, if the money and/or other property received has the effect
of a distribution of a taxable dividend, there shall be taxed as a dividend an amount
of the gain not in excess of his proportionate share in the undistributed earnings
and profits of the corporation, and the remainder, if any, of the gain recognized,
shall be treated as a capital gain.
2. For the corporation – The amount of gain, if any, shall be recognized in an amount not in
excess of the sum of money and the fair market value of the property received which is
not distributed under the plan of M/C.

Legal Effect if, in an M/C or in a transfer resulting in the acquisition of control of a

corporation, the taxpayer received stock or securities which would be permitted to be
received without recognition of gain if it were the sole consideration and as part of
consideration, the other party to the exchange assumes a liability of the taxpayer or
acquires his property subject to liability [Sec. 40(C)(4)(a)]
In such a situation, the 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 exchange.

Basis of the stock or security received if the exchange is one where neither gain nor loss
may be recognized, for the purpose of determining the gain or loss upon subsequent sale
thereof [SEC. 40(C)(5)(a)
The basis shall be the same as the basis of the property, stock, or security given in exchange,
less cash received and the fair market value of the property received, and increased by the
amount treated as dividend of the shareholder and the amount of any gain that was recognized
on the exchange.

Basis of the property, stock or security given in exchange

Less: Cash and FMV of the Property received in exchange
Add: Dividend and/or gain recognized
Basis of the stock or security received

Additional readings:
RR No. 18-2001: https://www.bir.gov.ph/images/bir_files/old_files/pdf/rr18_01.pdf re
Monitoring Guidelines of the Basis of Property Transferred and Shares Received.
RMO No. 32-2001: https://www.bir.gov.ph/images/bir_files/old_files/pdf/rmo2001-32.pdf
RMR No. 2-2002: https://www.bir.gov.ph/images/bir_files/old_files/pdf/3089rmr02_02.pdf
RMO No. 17-2016:
https://www.bir.gov.ph/images/bir_files/internal_communications_3/Full%20Text%20of%20RM
O%202016/RMO%20No.%2017-2016.pdf

De Leon, Discussions on Dealings in Property

Cases for Reading:

CIR v. Rufino, G.R. No. L-33665, 27 February 1987
Delpher Trades v. IAC, 157 SCRA 349
CIR v. Benigo Toda, 438 SCRA 290
CIR v. Dominium Realty and Construction Corp., CTA EB 1713, November 13, 2018

C. CAPITAL GAINS AND LOSSES

Included in the discussions on Allowable Deductions.

D. CAPITAL GAINS TAX ON STOCK TRANSACTION

How are capital gains derived from sale or exchange of stock issued by a Domestic
Corporation taxed? [Sec. 24(C)]
The provision of Section 39(B), notwithstanding, capital gains realized during each taxable year
by individuals or corporations from sale, exchange or disposition of shares of stocks in any
domestic corporation not traded in a local stock exchange are subject to a final tax as follows:

Taxpayer is: Capital Gains Tax Is:

Individual, whether citizen or resident
alien, and non-resident alien engaged
in trade or business in the PH
Individual who is a non-resident alien
not engaged in trade or business in
the PH
Alien individuals employed in R/AHQ,
ROHQ, OBU, and Petroleum Service
Contractor
Domestic Corporation
Resident Foreign Corporation
Non-resident Foreign Corporation
15% of the net capital gains during the year
[Secs. 24(C); 25(A)(3) ]
15% of the net capital gains during the year
[Sec. 25(B), last sentence]
15% of the net capital gains during the year
[Sec. 25(E)]
15% of the net capital gains during the year
[Sec. 27(D)(2)]
Net capital gains is Not Over P100K - 5%
Any amount In excess of P100K – 10%
[Sec. 28(A)(7)(c)
Net capital gains is Not Over P100K - 5%
 Any amount In excess of P100K – 10%
[Sec. 28(B)(5)(c)

However, if the stock is listed and traded through the local stock exchange, the tax of 6/10 of
1% of the gross selling price or gross value of stock sold, disposed, or exchanged.
(Sec. 127) (this is classified as Other Percentage Tax, rather than an income tax)

Notes: Stocks classified as capital asset mean all stocks and securities held by taxpayers
other than dealer in securities.

In case the gross selling price is lower than the FMV of the shares sold (not traded
through the local exchange), what is the tax effect?
The difference may be “deemed gift” and is subject to donor’s tax (See: Section 100, NIRC;
RMC No. 30-2019)
https://www.bir.gov.ph/images/bir_files/internal_communications_2/RMCs/RMC%20Full%20Te
xt%202019/RMC%20No%2030-2019.pdf

Note: The FMV of unlisted commons share is its Book Value, while the FMV of an
unlisted preferred shares is its Par Value.

For Further Readings:

RR No. 6-2008 https://www.bir.gov.ph/images/bir_files/old_files/pdf/39882rr%20no.%206-
2008.pdf
RR No. 6-2013 https://www.bir.gov.ph/images/bir_files/old_files/pdf/70201RR%206-2013.pdf

E. CAPITAL GAINS TAX ON DISPOSITION OF REAL PROPERTY

What is the tax treatment of the sale or exchange of real property located in the
Philippines?

If the real property is a capital asset, notwithstanding Section 39(B), it is generally subject to
capital gains tax, a final tax.

If the real property is an ordinary asset, then the ordinary gain is subject to income tax
(consequently, withholding tax), possibly VAT (depending on the gross selling price) and Donor’s
Tax (under Section 100).

How much is the capital gains tax on the sale or exchange of real property classified as
capital asset?

Seller/Taxypayer is: Capital Gains Tax is

 6% of the Gross Selling Price or FMV per
Citizen and Resident Aliens, including estates Tax Declaration or Zonal Value,
and trusts whichever is higher. [Sec. 24(D)]

Note: The law uses the term “gains presumed

Non-resident alien engaged in trade or
business in the Philippines
Individual who is a non-resident alien not
engaged in trade or business in the PH
Alien individuals employed in R/AHQ, ROHQ,
OBU, and Petroleum Service Contractor
Domestic Corporation
Resident Foreign Corporation
to have been realized from sale”; hence,
actual gains need not be computed.
Same, [Sec. 25(A)(3)]
Same [Sec. 25(B) last sentence)
Same [Sec. 25(E)]
Same [Sec. 27(D)(5)]
Real property located in the Philippines,
regardless of the classification, sold by a
resident FC shall be subject to creditable
withholding tax and income tax. [Sec.
28(A)(1)]

Note: actual gain be computed.

Non-Resident Foreign Corporation Real property located in the Philippines,
regardless of the classification, sold by a
resident FC shall be subject to final
withholding tax [Sec. 28(B)(1)]

Note: Actual gains need not be computed

since the taxes imposed on NRFC is based on
gross.

Sale of Real Properties Located Outside the Philippines, REGARDLESS OF

CLASSIFICATION: [SEC. 4(f), RR 7-2003]

a. Seller is resident citizen or domestic corporation – subject to normal/regular income tax

b. Seller is a non-resident citizen, alien, or foreign corporation - exempt

Sale or other disposition to the government, its political subdivision or agencies, or to GOCC
by Individual Taxpayer
The tax liability, if any, on gains thereon, shall be determined either:
a. Under Section 24(A) – schedular income tax for citizens/resident alien; or
b. Under Section 24(D) – capital gains tax
- At the option of the taxpayer.
Exemption from CGT – applicable only to natural persons, i.e. individual taxpayers
Individual taxpayer shall be exempt from CGT if the proceeds of the sale of his principal
residence shall be fully utilized in acquiring or constructing a new principal residence
within 18 months from the date of sale or disposition.

Requisites:
a. Seller is a natural person
b. Property sold is his principal residence
c. Proceeds of the sale is fully utilized to acquire or construct new principal residence
d. Full utilization is made within 18 months from date of sale or disposition
e. Notice to avail the tax exemption is given to the CIR within 30 days from the date of
sale
f. Tax exemption can be availed once every 10 years

Note: If there is no full utilization of the proceeds of the sale, the portion of the gain
presumed to have been realized (i.e. the unutilized portion) shall be subject to capital
gains tax.

Additional Reading:
Revenue Regulation No. 7-2003
https://www.bir.gov.ph/images/bir_files/old_files/pdf/1344rr07_03.pdf

-End-