BASIC APPROACH TO » INCOME TAXATION JAPAR B. DIMAAMPAO Associate Justice, Court of Appeals Professor of Law, Bar Reviewer 2018 EDITION 2 eee Published & Distibuted by REX Book Store ‘55 Ncanor Reyes, Se. St ‘Tel Hos, 7360587 “135.1964 1077 Cat Recto Arve Tel Nos, 735.5527 7355598 ll, Philppines wan cenpubshingcom phae Ly one and only wife Gina Whe ts far. mare previous than Anowledges Faw move fascinating than tasationPREFACE TO THE 2018 EDITION The passage of R.A. No. 10963 otherwise known as the “Tax Reform Act for Acceleration and Inclusion (TRAIN)* whistles for the publication of this 2018 edition to reflect the amendments to income tax law. By the same token, this new lexicon brings to light decisional rules on the withholding tax system, non-stock, non-profit charitable institutions, offiine international air cartier, Gross Philippine Billings, redemption of stock dividends, allowable deductions (statutory test), and gain on sale of equipment and machinery. True to form, this compendium explains these updates on Jurisprudence with edification, Rivetingly, the author propounds a simplified discussion on Revenue Memorandum Order No, 44-2016 particularly on non-stock, non-profit corporations and associations, tax benefits from sale-leaseback transactions, and minimum wage earner's exemption. May lawyers, law students, and bar examinees find this Jatest edition intellectually enriching and fulillingly useful Las Pifias City, 1 January 2018. JBD viPREFACE TO THE 2015 EDITION This edition features a comprehensive discourse on the exemption from taxation of charitable institutions and the application of the 10% preferential rate on non-profit hospitals. It accentuates most recent statute increasing the exemption of Christmas bonus and other benefits, BIR rulings and regulations relative to the new de minimis benefits as well as on the long-term deposit or investment cettificate The 2015 publication expounds on settled doctrines, particularly on the definition of gross income, improperly accumulated earnings tax, and the tests determinative or ordinary and capital assets. The 2014 bar examination questions were likewise incorporated in this edition The simplified approach appearing in past editions has been painstakingly adopted in this publication, The author ‘once again hopes that this humble endeavor would enlighten students, bar candidates, and lawyers as they unravel complex, yet interesting topics in the tield of taxation, Las Pifias, 1 January 2015. JBDPREFACE TO THE 2011 EDITION In the years that spanned from the last edition of this book, the field of income taxation was enriched by prodigious rulings of the Highest Court, enactments of Congress and opinions of foreign authorities. This publication elucidates the ebb and flow of the Boac doctrine, the requisites of the All-Events Test, and the factors determinative of the reasonableness of an advertising expense. Another significant addition to this edition is the compendious discussion of recent cases on Minimum Corporate Income Tax as well as the Theory of Favorable Business Climate. The author likewise integrated a discourse on the peculiarities of Republic Act No, 9504 which increased personal exemptions and relieved minimum, wage eamers of their duty to file income tax returns. ‘American jurisprudence and notations and distinguished foreign authorities were cited to supplement crucial topics. Once more, the author reiterates his relentless desire to help students and reviewees successfully hurdle the bar examinations. May this book help lawyers and future lawyers in their pursuit for knowledge. Las Pifias, 3 January 2011. JBDPREFACE TO THE 2008 EDITION The munificent acceptance of the Basic Approach fo Income Taxation inspired this third publication. The simplified yet comprehensive approach of the book's first two editions had been conscientiously maintained. Jurisprudential principles on taxable income, personal exemptions, retirement benefits and bad debts that may be claimed by banks, insurance and surety companies were imperative additions to this edition. Recent rules on Minimum Corporate Income Tax (MCIT) under Revenue Regulations No. 12-2007 were given emphasis. Likewise, the 20% discount given to senior citizens which can now be claimed as tax deduction, no longer as tax credit, as envisaged under Republic Act No. 9257, was discussed. May this book guide lawyers, bar reviewees and law students in their journey towards the advancement of the legal profession. Las Pifias, 28 February 2008, JBDPREFACE TO THE SECOND EDITION This 2005 edition of Basic Approach to Income Taxation includes updates on jurisprudence concerning the various subdivisions originally presented in the first edition Refinements on presentation were also made for reading efficacy. A substantial addition, however, is the discussion on Capital Gains Tax in Escrow Agreements as well as the amendments introduced by Republic Act 9337 or the Expanded Value-Added Tax Law which took effect on 4 July 2005. May lawyers, law students and bar reviewees find this edition more comprehensive and comprehensible. Manila, 14 July 2005, JBDPREFACE TO THE FIRST EDITION Asin the United States, the income tax is the backbone of our national tax system. Aside from its revenue raising function, the significance of income taxation may be drawn directly from express constitutional provisions as when the fundamental law mandates, for instance, that the rule of taxation shall be uniform and equitable and that Congress shall evolve a system of progressive taxation. In laying down the principles with which it is to be enforced, the fundamental law in effect recognizes that income taxation is a necessary means to mitigate economic disparities among different income groups, The complexity of income taxation, however, has generated considerable difficulty even in the determination of the different forms of income and the laws and statutes applicable to each of these forms. This may be attributed to special treatment accorded to various political, economic and social interests and to special rules governing particular relationships, such as between shareholders and their corporations, between partners, and between grantors and their trusts and beneficiaries. Perhaps the most significant of these causes is an economic system of millions of taxpayers who conduct their affairs in diverse ways. ‘Ten essential topics subdivide this book entitled “Basic Approach to Income Taxation.” As can be gleaned from the title, the principles, rules and implications relating to income taxation have all been simplified, explained, exemplified and illustrated for efficient comprehension. wiMay this book widen the knowledge of law students, lawyers, professionals and taxpayers and may this be instrumental in preparing reviewees for the bar examina- tions. JBD vil ACKNOWLEDGMENT By a familiar gesture of kindness, the Honorable Chief Justice, Hilario G. Davide, Jr., has once again agreed to Jend his juristic thoughts on this humble endeavor. Although referred to asa fine legal treatise, this small work undoubtedly wither in comparison to the multitude of accomplishments the Chief Justice has purposely invested for the Judiciary. For their significant influence, | am thankful to: Justice Dante O. Tinga for being a true mentor of the pith and marrow of the practice of law; Former Justice Secretary now Dean of the College of Law of MLQU, Dean Artemio Tuquero, for reposing in me such trust and confidence and for sharing in my belief that the task of conferring knowledge is sacred, Thank you too, Sir, for all the years of guidance and friendship; Dean Ed Vincent Albano for inspiring me to put my knowledge of taxation into writing; Dean Antonio R. Tupaz for his brilliant methods in uplifting the quality of legal education. For their indispensable contributions, my sincere appreciation to: Atty, Maria Ella Cecilia D. Dumlao Wendell lan C. Perez Cecille Bulaong xbFor their valuable support and inspiration, | am grateful to: Aly. Emer Francia; My staff at the Court of Appeals; All my students whom I had the pr teaching; ilege of Rex Book Store, Inc., its Chairman Juanito F. Fontelera; Atty, Ernesto C. Salao and Fritzie J, Espanola; and finally to Almighty God who is the ultimate source of knowledge JBD This modest book was written under the aacpices of the Professorial Chair Program of Supreme Cocot Senior fustice Renate S. Puna Library, Cnltege of Law, University of, the East. The Funds for Research and Syllabus of this book were provided. by the UE Foundation for Research and Advanced Studies, Tue. (UHE-FRASI.CONTENTS Preface to the 2015 Editior Preface to the 2011 Edition Preface to the 2008 Editi Preface to the Second E Preface to the First Edition Acknowledgment. I. tion Chapter 1 SALIENT FEATURES OF THE PRESENT INCOME TAX SYSTEM Individual Income Taxation. Corporate Income Taxation. Common Features .. Chapter 2 INCOME AND REQUISITES; INCOME TAX; NATURE AND FUNCTIONS Definitions. Judicial definitions. Economist's definition ae Income, Capital, Revenue, Receipts Distinctions. Sources of Incom Income Tax; Basis, Nature, Functions >a nee ES NaaE. Requisites for Income to Be Taxable... Doctrine of Constructive Receipt of Income. F. Doctrines on Determination of Taxable Income .... (1) Claim of Right Doctrine... (2) Severance Test Theory... (8) Control Test... cee (4) Doctrine of Propriety Interest... (6) Realization Test.... Chapter 3 GROSS INCOME General Statutory Definition Broad Definition... Jurisprudential Definition. Formula: Gross Income; Net Income; Taxable ‘Compensation Income; Income Tax Due; Income Tax Payable Gross Income Taxation and Net income ‘Taxation; Distinctions; Advantages and Disadvantages EXCLUSIONS FROM GROSS INCOME A. Reasons for Exclusion B. Exclusions from Gross income.. (1) Proceeds of life insurance ... (2) Amount received as retum of premium Pease (3) Gifts, bequests and devises... (4) Compensation for injuries or sickness .... (5) Income exempt under treaty... (6) Retirement benefits, pensions, gratuities, etc. .. (7) Miscellaneous items... OD> ov "1 1" 1 n " n 12 13 13 13 14 18 15 15 16 47 17 18 18 22 A. Classification of Individual Taxpayers B. General Principles: Sources of income; C. Applicable Rates D. Categories of Income. COMPENSATION INCOME Chapter 4 INDIVIDUAL INCOME TAXATION (1) Resident Citizen (2) Non-Resident Citizen (3) Resident Alien. (4) Non-Resident Alien (5) Non-Resident Alien Not Engaged in Trade or Business Tax Base . A. Definition . B. Basis/Test.. CC. Requisites for Taxabilty. D. Forms of Compensation + Other tax implications of condonation of indebtedness + Other tax implications of premiums paid by employer... a) Convenience of the Employer Rule. b) De minimis Benefits. E. Special Rules on Fringe Benefits .. F. Doctrine of Cash Equivalent... BUSINESS/TRADE/PROFESSIONAL INCOME A. Income Covered... (1). Income derived by self-employed from trade or business (trading, manufacturing, merchandising, farming, and others). 26 26 26 27 28 28 29 29 30 30 31 31 32 32 33 33 36 40 Mt amoo (2) Income derived by professionals from the practice of professions... (3) Gross income of farmers .....ec00. Interest Income .... Rental Income Dividend income. Passive Investment Income (4) Other Sources. Chapter 5 CORPORATE INCOME TAXATION Definition under the NIRC...... Major Groups of Corporations for Income Tax PUNPOSES oo. rnees (1) Domestic Corporations... (2) Resident Foreign Corporations. (3) Non-Resident Foreign Corporations. Minimum Corporate Income Tax Improperly Accumulated Eamings Tax Other Corporate Tax Rates (1) Common Tax Rates (2) Domestic Corporations (3) Resident Foreign Corporations... (4) Non-Resident Foreign Corporations ‘Tax Exempt Corporations under the NIRC (1) Labor, Agriculture, or Horticultural ‘Organization Not Organized Principally for Profit. 7 (2) Mutual Savings Banks and Cooperative Banks.. : @) Fraternal Beneficiary Society, Order or Association .. (4) Cemetery Companies (5) Religious, Charitable, Scientific, Athletic or Cultural Corporations .. 42 43 43 45 46 50 51 53 57 87 59 63 64 73 7 7 7 78 at 81 82 82 83 84 (6) Business, Chamber of Commerce, or Board of Trade. (7) Civic League... (8) Non-Stock, Non-Profit Educational Institutions. (9) Government Educational institution... (10) Mutual Fire Insurance Companies and Like Organizations. (11) Farmers, Fruit Growers or Like Association... Tax-Exempt Corporations under Special LAWS. .eeseo Chapter 6 ALLOWABLE DEDUCTIONS FROM GROSS INCOME A, Basic Principles... B. The Cohan Rule Principle.. C. Statuiory Test Principle Kinds of Allowable Deductions 1. Itemized Deductions... 2. Optional Standard Deduction. Kinds of itemized Deductions ae D. Business Expenses........ vs Kinds of Business Expenses... E. Interest Expenses Definition F. Taxes. i Nature and Scope GB. LOSSES rerseecee (1) Definition (2) Kinds of Losses (3) Special Kinds of Losses . a) Wagering losses ... avi 86 87 89 92 92 93 97 98 98 99 99 99 100 100 400 105 13 113 118 118 4124 424 122 123 123|. Employer's Contribution to Pens b) Losses due to voluntary removal of building incident to renewal or replacement......... ©) Loss of useful value of capital asset due to changes in business condition... (4) Casualty Losses.. (5) Non-deductible Losses Bad Debts... (1). Definition... (2) Requisites for Deductibilty (3) Measure of Bad Debts Deduciible Deprociation.... (1). Definition... (2) Requisites for Deductibility Depletion «nin (1). Definition nen (2) Theory and Purpose of Depletion AlOWENCE..eroeneeecee (3) Who Are Entitled Essential Factors ......... _ Charitable and Other Contributions (1) Kinds. (2) Entitled (3) Requisites | for Deductibility {4) Contribution Deductible in Full (5) Contribution Subject to Limitation (6) Deductible under Special Laws .. Research and Development Expenditure (1) In Goneral (2) Limitations on Deduction (1) Nature , (2) Requisites for Deductibilty (3) There is no need of special permit from the BIR to put up a pension plan for the benefit of employees... 125 126 130 131 134 134 134 138 139 139 140 143 143 143 143 144 144 144 145 145 146 147 147 148 148 149 149 149 149 150 (4) Treatment of Income from Pension Plan i (8) Deductible Payments to Pension Trusts ... i Optional Standard Deduction Special Deductions Allowed to Insurance ‘Companies... Items Not Deductible .. Chapter 7 ESTATES AND TRUSTS Estate Trust... (1) Taxable Trusts... (2) Rules on Taxability. ©. Computation of Tax on Estate and Trust p> Chapter 8 SPECIAL TOPICS IN INCOME TAXATION A, Determination of Source According to Kinds of Income. Tax Situs of Three Possible Sources of Income .. : Settled Case on the Tax Silus of Interest Income . B. Capital Transactions... Chapter 9 INCOME TAX RULES ON DEALINGS IN PROPERTY CAPITAL GAINS FROM SALE OR OTHER DISPOSITION OF REAL PROPERTY Transaction Covered..... vai 150 150 150 151 182 155 156 156 156 187 158 159 159 162 475(1) Individual Taxpayers (2) Corporate Taxpayers... (3) Payment of Capital Gains Tax on Extra. judicial Foreclosure Sale of Capital Assets GAINS AND LOSSES FROM DEALINGS IN PROPERTY A. Concept. B. Measure of Income.or Loss... C. Adjusted Basis or Cost of the Property Sold. Settled Rules on ‘Sale or Exchange Tax-exempt Sales or Exchanges "No Gain, No Loss Recognized”. F. “Gain Recognized, Loss Not Recognized Rule”... f mo Chapter 10 ‘TAXPAYERS REQUIRED TO FILE INCOME TAX RETURNS A. Individuals B. Corporations No Matter How Created or Organized including General Professional Partnerships C. Estates and Trusts Engaged in Trade OF BUSINESS esc ceeseceseeetnei APPENDICES Appendix A ~ Revenue Regulations No. 9-98 Appendix B - Revenue Regulations No. 5-99. Appendix C — Revenue Regulations No. 13-2000 Appendix D ~ Revenue Regulations No. 2-201 ... 175 177 477 178 179 179 181 182 184 185 187 187 188 198 203 209 Appendix E - Revenue Regulations No. 25-2002... Appendix F — Revenue Regulations No. 76-2003 Appendix G — Revenue Regulations No. 12-2007 .. Appendix H ~ Revenue Memorandum Circular No. 18-2011...... Appendix | - Revenue Memorandum Order No. 44-2016 Appendix J - 2018 Bar Examinations Taxation Law... Appendix K - 2017 Bar Examinations Questions on Taxation. sesnanenes ene 216 219 223 233 236 239 259Chapter 1 SALIENT FEATURES OF THE PRESENT INCOME TAX SYSTEM 1 INDIVIDUAL INCOME TAXATION A B. D. ‘Schedular Tax Treatment 1. Itclassifies income. 2. It provides for different tax rules. 3. Itimposes different tax rates. Net Income Taxation 1. Resident citizen (RC) 2. Non-resident citizen (NRC) 3. Resident alien (RA) 4. Non-resident alien engaged in trade or business (NRA-ETB) Gross Income Taxation Non-resident alien not engaged in trade or business (NRA-NETB) Income Tax Situs 1. Residence — RA,RC 2. Place — NRA, NRC 3. Citizenship ~— RC2 BASIC APPROACH TO INCOME TAXATION CHAPTER t 3 SALIENT FEATURES OF THE PRESENT INCOME TAX SYSTEM Il. CORPORATE INCOME TAXATION C. Final Withholding Tax System A. Global Tax Treatment 4, Withholding agent (source) — withholds the 1. It generally provides for uniform rules. tax and remits the same to the BIR Fm tax rate. 2. Tax withheld — final settlement of the tax liability on the income covered D. Operational Rules of the Withholding Tax System 4. Withholding agent — the payor, agent of the 1, Domestic Corporation (DC) government for the collection of the tax in order 2. Resident Foreign Corporation (RFC to ensure Its payments. Its a payee by fiction peeroenaet of law; a mere tax collector. The liability is direct and independent from the taxpayer, because 1. Non-resident Foreign Corporation (NRFC) the income fax.is stil imposed on and due from the latter. As agent, itis personally liable for the tax arising from the breach of its legal duty to 2. It-generally imposes ur 3. It does not generally classify income. B. Net Income Taxation C. Gross Income Taxation D. Income Tax Situs 41, Residence = — RFC withhold. Ergo, the agent is not liable for the 2. Place — NRFC tax as no wealth flowed into him — he eared ° no income. Sree 2. Taxpayer ~ the person subject to tax imposed Ml, COMMON FEATURES by law. He should not answer for the non- performance by the withholding agent of its A. Pay as You Tile System legal duty. 1. Individuals — upon filing of their income tax returns 2. Corporations — upon filing of their quarterly corporate income tax returns and final adjustment corporate returns B. Creditable Withholding Tax System 1. Withholding agent (source) — withholds the tax and remits the same to the BIR 2, Tax withheld — creditable against income tax dueChapter 2 INCOME AND REQUISITES; INCOME TAX; NATURE AND FUNCTIONS A. DEFINITIONS (1969 Bar) In a broad sense, income means all wealth that flows into the taxpayer other than as @ mere return of capital. It includes the forms of income specifically described as gains and profits including gains derived from the sale or other disposition of capital assets, Judicial definitions + gain derived from capital, or from labor, or from both capital and labor, including the gain derived from the sale or exchange of capital assets. (Fisher v, Trinidad, 43 Phil. 973; Eisner v. Macomber, 252 U.S. 189, 40 8. Ct. 189, 64 L. Ed. 527 1920) + amountof money corning to a person or corporation within a specified time, whether as payment for services, interest, or profit from investment. (CONWIv. CTA, 213 SCRA 83) Economist's definition + money value of the net accretion to one’s economic power between two points of time. (R.M. Haig, The Federal Income Tax, Columbia University; Anderson, Taxation and the American Economy) 4 CHAPTER 2 5 INCOME AND REQUISITES; INCOME TAX; NATURE AND FUNCTIONS + cannot be determined by reckoning cash receipts; other income determining factors: inventories, accounts receivable, property acquisition, and accounts payable for expenses incurred, B. INCOME, CAPITAL, REVENUE, RECEIPTS; DISTINCTIONS (1995 Bar) Capital vw Income Fund Flow Wealth Service of wealth Tree (property) Fruit (metaphorical language) Gross receiptincludes receipts which may constitute capital as well as income; therefore, broader in scope. Income connotes a narrower concept limited only to gain derived from labor, capital or property, excluding non- income items such as the capit ested, cost of goods sold or those excluded by law from income tax: Revenue refers to all funds or income derived by the government whether from tax or other sources, Revenue is to the government as income is to private persons or corporations. C. SOURCES OF INCOME + Property (capital) + Labor (service) + Sale/Exchange of capital asset and activity ‘Source of income is any property, activity or service that produced the income. (COM v. BOAC, 149 SCRA 395) It may also be in the form of proceeds from sales of transport documents.BASIC APPROACH TO INCOME TAXATION Under the Tax Code, however, income derived from whatever source forms part of the taxpayer's income. This includes the following: (1) (2) (3) @) (5) (6) Treasure found or punitive damages representing profits lost; Amount received by mistake (Javier v. CA, 199 SCRA 824; Javier v. Com, CTA Case No. 3393, July 27, 1983) (2013 Bar); If a foreign bank erroneously remitted U.S.$1 millon instead of U.S.$1,000 and it appears subsequently that the recipients spent the difference of U.S.$999,000 on various purchases of property both here and abroad of their own material benefit, the said sum constitutes taxable income. It has been held that if a taxpayer receives ‘earnings under a claim of right without restrictions as to its disposition, he has received income even though it may still be claimed that he is not entitled to retain the money and even though he may stillbe adjudged liable to restore its equivalent. This is an exception to the rule that Income received through mistake is not taxable as its receipt is offset by liability to the party making the excessive payment. (North American Consolidated v. Burnet, 286 U.S. 417) Cancellation of the taxpayer's indebledness; Payment of usurious interest; legal gains —~ gambling, theft, embezzlement, extortion, fraud — income to embezzler if forgiven by the owner; Tax refund — must be claimed as deduction from gross income in the preceding year. It means that CHAPTER 2 1 | INCOME AND REQUISITES; INCOME TAX: NATURE AND FUNCTIONS Dd. the tax must be a deductible one (2003, 2005, 2014 Bar); (7) Bad debt recovery — must be claimed as deduction from gross income in the preceding year. Itassumes that the taxpayer has a net income, not a net loss. (2003, 2005 Bar) + Recovery of bad debt and tax refund finds a jurisprudential hook in Tax Benefit Rule. It is a tule which limits the recognition of income from the recovery of an expense or loss properly deducted in a prior taxable year to the amount of the deduction that generated a tax savings. Under this rule, if an amount deducted from gross income in a prior taxable year is recovered in a later year, the recovery is income in the last year. (Tennessee Carolina Transp., Inc. v. C.LR., 6, 582 F 2nd 378, 379) INCOME TAX; BASIS, NATURE, FUNCTIONS (1) itis a tax on all yearly profits arising from property, profession, trades or offices or as a tax on a person's income, emoluments, profits and the like. (2) Itis based on income, either gross or net, realized in one taxable year. (3) Excise tax — it is not levied upon the person or property but upon the right of a person to receive income or profits. (4) Functions of income tax: a) to provide large amounts of revenues; b) to offset regressive sales and consumption taxes:6) BASIC APPROACH TO INCOME TAXATION ©) to mitigate the evils arising from the inequalities in the distribution of income and wealth which are considered deterrents to social progress, by a progressive scheme of taxation. (Report of the Tax Commission of the Phil., Vol. Il; Madrigal v. Rafferty, 38 Phil, 414) The basis of the right of the 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. (Com. v. Lednicky, 11 SCRA 603) This is called the Partnership Theory which has spawned the following principles: a) Protection theory. Itdictates that when the flow cofwealth proceeded from, and occurred within, Philippine territory, enjoying the protection accorded by the Philippine government, the same, in consideration of such protection should share the burden of supporting the government. (CIR v. BOAC, 149 SCRA 395) (2009 Bar) b) Theory of favorabie business climate, Domestic corporations owe their corporate existence and 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. (CREBA v. Romulo, 614 SCRA 605) REQUISITES FOR INCOME TO BE TAXABLE a) There must be gain or profit, whether in cash or its equivalent CHAPTER 2 9 INCOME AND REQUISITES; INCOME TAX; NATURE AND FUNCTIONS (2). The gain must be realized or received. This implies that not all economic gains constitute taxable income. a) Mere increase in the value of property is not income (unrealized increase in capital). b) Increases in the taxpayer's net worth are not taxable increases in net worth if they are not the result of the receipt by it of unreported or unexplained taxable income, but are 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. (Femandoz v. Commissioner of Internal Revenue, 29 SCRA 553) c) _Butifthe increase in the net worth of a taxpayer is the result of the receipt by it of unreported or unexplained taxable income, the correction is taxable income. d) Receipt includes constructive recelpt. Doctrine of Constructive Receipt of Income — Income which is credited to the account of and set apart for a taxpayer and which may be drawn by him at any time is subject to tax for the year during which it was so credited or set apart although not yet then actually received or reduced to his possession, To constitute receipt in such case, the income must be credited to the taxpayer without any substantial imitation or condition upon which payment is to be made.10 BASIC APPROACH TO INCOME TAXATION Examples of Constructive Receipt: i. Matured interest coupons due and de- mandable (convertible into cash); ji, Share in the profits of a partner in a part- nership (2013, 2014 Bar); iii, Interest credited on savings bank deposit (Section 53, Rev. Regs. No. 2); iv. Dividends applied by the corporation against the indebtedness of a stockholder (Section 50, Rev. Regs. No, 2); v. Rental payments refused by the lessor when the lessee tendered payment and the latter made a judicial deposit of the rental (Limpan Investment Corporation v. CIR, 17 SCRA 703); vi, Amount credited to shareholders of a building and loan association when such credit passes without restriction to the shareholder. The Doctrine of Constructive Receipt is designed to prevent the taxpayer using 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 the income. In Filipinas Synthetic Corporation v. CA, 316 SCRA 480, the Supreme Court ruled that itis the right to receive income, and not the actual receipt, that determines when to include the amount in gross income. @) CHAPTER 2 1 INCOME AND REQUISITES; INCOME TAX; NATURE AND FUNCTIONS 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? The accrual of income is permitted when the all-events test has been met. This test requires: (1) fixing of a right fo income to pay; and (2) the availability of the reasonable accurate determination of such income. (CIR v. Isabela Cultural Corporation, 515 SCRA 556) (2010 Bar) The gain must not be excluded by law or treaty from taxation. This means that not all income is required to be included in computing the taxable income. F, DOCTRINES ON DETERMINATION OF TAXABLE INCOME (1) (2) (3) @) 6) Claim of Right Doctrine — illegally acquired income constitutes realized gain. (Rutkin v. U.S., 343 U.S. 130) (2001 Bar) Severance Test Theory — separation from capital of something which is of exchangeable value. (Eisner v. Macomber, 252 U.S. 189) Control Test — power to procure the payment of income and enjoy the benefit thereof. (Helvering . Horst, 311 U.S. 112) Doctrine of Propriety Interest — treats stock options, shares of stock or other assets transferred by an employer to an employee to secure better services as taxable. Realization Test — revenue is generally recognized when the earning process is complete or virtually complete and an exchange has taken place,Chapter 3 GROSS INCOME A. GENERAL STATUTORY DEFINITION (1995 Bar) In a narrow sense, gross income means all income derived from whatever source, including but not limited to the following: (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 profession; (3) Gains derived from dealings in property; (4) Interests; (6) Rents; (6) Royalties; (7) Dividends; (8) Annuities; (9) Prizes and winnings; (10) Pensions; and (11) Pariner’s distributive share from the net income of the general professional partnership. 2 CHAPTERS 13 GROSS INCOME, B, BROAD DEFINITION Ina broad sense, gross income means income less income which by statutory definition or otherwise, is exempt from the tax imposed by law. Stated otherwise, gross income means all items of income less exclusions. C, JURISPRUDENTIAL DEFINITION Gross income means total income from all sources, before deductions, exemptions or other tax reductions. (Black's Law Dictionary, 2009 Edition, p. 831) FORMULA: GROSS INCOME; NET INCOME; TAXABLE COMPENSATION INCOME; INCOME TAX DUE; INCOME TAX PAYABLE Gross Income = Allincome less exclu- sions (1980, 1983 Bar) Net or Taxable income = Gross income less allowable deductions (1977, 2000 Bar) Taxable Compensation Income = Gross compensa- tion less personal and additional ex- emptions (Individual Taxpayers) Income Tax Due = Taxable ornetincome multiplied by income tax rate Income Tax Payable = Income Tax due less creditable withhold- ing tax or tax credit4 BASIC APPROACH TO INCOME TAXATION GROSS INCOME TAXATION AND NET INCOME ‘TAXATION; DISTINCTIONS; ADVANTAGES AND DISADVANTAGES Gross Income Taxation | Net income Taxation Allows no deductions Deductions are allowed Grants no exemptions _| Exemptions are granted Tax base: Gross income __ | Tax base: Net income ‘Advantages of Gross ‘Advantages of Net Income Taxation Income Taxation Simplifies the income tax| Fair and just due to grant of system deductions Does away with wastage of | Tax audit minimizes fraud manpower and supplies Substantial reduction in| Provides equitable reliefs corruption and tax evasion|in the form of deductions, — exercise of discretion to| exemptions and tax credits allow or disallow deductions dispensed with Disadvantages of Gross isadvantages of Net Income Taxation __|__Income Taxation No deductions and Vulnerable to corruption on ‘exemptions allowed account of margin of discre- tion in the grant of deduc- tions ‘Susceptible of fraud in the | Confusing and camplex pro- absence of general audit | cess of filing income tax retum Taxpayers lose interest to| Difficult/costly to administer earn more thereby lessening their purchasing capacity CHAPTER 3 18 GROSS INCOME EXCLUSIONS FROM GROSS INCOME A. REASONS FOR EXCLUSION (1). The item of receipt does not fall within the definition of income for income tax purposes. + Damages recovered in libel and stander suits + Damages recovered for alienation of affection + Damages recovered for breach of promise to marry (2013 Bar) + Damages recovered for loss of life of spouse + Damages recovered in annulment of marriage (2) Aprovision of the Tax Code or special law exempts it from income tax. B. EXCLUSIONS FROM GROSS INCOME (1) Proceeds of life insurance (2003, 2005, 2007 Bar) — received in a single sum or installments — not taxable — Reason: indemnity rather than as gain or profit. Insurance contract is a contract of indemnity. Exception — interest payments shall be included in gross income if such amount is held by the insurer under the agreement to pay interest thereon, However, proceeds of life insurance where the beneficiary is revocable is subject to estate tax. The exclusion from income taxation applies regardless of who the beneficiary is, whether a family member, or other individual, corporation, or partnership. Exclusion applies to group insurance, death benefits under the Workmen's Compensation Insurance or under health or accident insurance contract having the characteristics of life insurance16 (2) BASIC APPROACH TO INCOME TAXATION proceeds by reason of death. (EI Oriente v. Posa- das, 56 Phil. 147) Transfer of insurance contract -— amount excludible should only be the amount or value of actual consideration paid and the premiums paid later by the transferee. Where the consideration and premiums paid exceed the proceeds, no amount is includible in the gross income of the transferee. + Other tax implications of life insurance proceeds (2003 Bar) a) Included in the gross estate. + Third person is revocably designated as beneficiary; + Estate, executor or administrator is designated as beneficiary, revocable or irrevocable. b) Excluded from the gross estate: (2007 Bar) + Third person as beneficiary; irrevocably designated + Proceeds of group insurance. ‘Amount received as retum of premium ~ under life insurance, endowment or annuity contracts, either during the term or at the maturity of the contract. Cash surrender value of the policy is also non- taxable, Return of premium means a repayment of a part or the whole of the premiums paid. (Com. v. Winslow, 113F Ed.) 418) (3) (4) CHAPTER 3 7 GROSS INCOME, Reason for the exclusion: Return of capital Amount other than amount paid by reason of death, Excess of the amounts. received over the aggregate premiums or consideration paid is taxable. Hence, ifa taxpayer took out a P100,000.00 endowment policy in which he paid P80,000.00 as aggregale premiums and upon maturity he received 100,000.00, only P20,000.00 is taxable, Gifts, bequests and devises Reason: Not a product of capital nor industry. + Gifts are subject to donor's tax, whereas be- quests and devises are subject to estate tax (1994 Bar) + But the income from such property is taxable. If the taxpayer inherits securities, the value of such securities does not constitute income but the dividends and interest paid on such securities are taxable. + Principal paid under a marriage settlement and alimony or allowance based on eeparation agreement are considered as gifts + Remuneratory donations are subject to income tax. (See Pirovano v. CIR, 14 SCRA 832) Compensation for injuries or sickness (1964, 1967, 1986, 1995, 2001 Bar) Reason: Compensatory; not gain/profit; adds nothing to the individual. (Lawkins v. Com., 6B.T.A 1032) + Through accident or health insurance; + Workmen's Compensation;18 6) @) BASICAPPROACH TO INCOME TAXATION + Damages received whether by suit or agreement ‘on account of such injuries or sickness; + Damages recovered are taxable if the amount represents loss of anticipated profits; not taxable if it represents a retum of capital or investment. (BIR Ruling, September 8, 1954) + Ifthe recovery represents damages for lost profits, it is taxable as ordinary income. (36 TC. 1173 [1961], Federal Income Taxation, Third Edition, Rose and homie, p. 24) (2008 Bar) + Disability benefits paid under life insurance are also excluded although the law refers to accidents and health insurance. (Wong v. Wing Non, 18TC 205, December 18, 1949) Income exempt under treaty. This is premised on our adherence to the generally accepted principies of international law. in this category, the following items of income are tax-exempt: + Income derived by the US Consular officiaie in the Philippines in connection with such consular service (USPI Consular Convention). + Income exempt under tax treaty with foreign countries, Retirement benefits, pensions, gratuities, etc, (1999, 2000 Bar) a) Retirement benefits received by officials and employees of private firms, individuals or corporations. Requisites for exclusions: i, Reasonable private plan maintained by the employer duly approved by the BIR b) CHAPTER 3 19 GROSS INCOME for exclusive benefit of the members- employees; ii. Retiring official or employee who has rendered at least 10 years of service; Atleast 50 years of age atthe time of the retirement; iv. The benefit of exclusion shall be availed of only once. (Santos v. Servier Philippines, Inc., 572 SCRA 487) +. Even if the member has attained 50 years of age with at least 10 years of service, if the employee-member is still on active employment with the company, any and all amounts distributed from the fund to the private member over and above his personal contributions shall be taxable to the said employee recipient as wages were received before his retirement from the service of his employer. (BIR Ruling 97-86, April 4, 1986) + An agreement to pay the taxes on the retirement benefits as an incen- tive to prospective retirees and for them to avail of the optional retire- ment scheme is not contrary to law ‘or public morals, (Intemational Broad- casting Corporation v. Amarilla, 505 SCRA 687) Retirement benefits paid to employees who have reached the age of 60 or more but not beyond 65 years with at least five years of credited service. (R.A. No. 7641)20 BASIC APPROACH TO INCOME TAXATION + The age and service requirements imposed under the Tax Code are deemed as minimum requirements for retirement benefits to qualify forincome taxexemption (BIR Ruling No. 52-2000 dated October 30, 2000; BIR Ruling [DA-151-04)) Separation benefits due to death, sickness or other physical disability or for any cause beyond the control of the said official or employee. + Any amount received from an employer as a result of separation from service due to sickness is exempt from all taxes. (B/R Ruling 1-87, January 9, 1987; Ruling 39- 87, February 10, 1987) + Separation benefits paid to retrenched employees as a consequence of either the sale of the entire business to another corporation or the cessation of the employer's business are exempt from income tax. (BIR Ruling 130-87, May 14, 1987) (2017 Bar) + Benefits received as a result of voluntary resignation are taxable. (1984 Bar) Reason: It is a cause within the control of the said! official or employee. + The exemplion holds regardless of the employee's age and length of service. (1999 Bar) + The law does not require that the exclu- sion be enjoyed once. + Separation of employee due to dissolution ofa law firm is a cause beyond the control D CHAPTERS at GROSS INCOME of said employee. (BIR Ruling No. 73-85, May 20, 1985) + Compulsory retirement — cause beyond the control of the employee. (Request for reconsideration of Atty. Zialcita, 190 SCRA 851) + Terminal leave pay is excluded from gross income. Compulsory retirement may be considered as a cause beyond the control of the said official or employee. Consequently, the amount received by way of commutation of his accumulated leave credits asa result thereof falls within the enumerated exclusion from gross income. Itis not considered compensation for services rendered. Reason: It is paid when the employer has already severed his connection with his employees and who is no longer working. (Ibid,) (1991, 1996 Bar) Social Security benefits, retirement gratuities received by resident or non-resident citizens or resident aliens from foreign government agencies and other private or public institutions. (2007 Bar) Pensions received by retirees from foreign sources. (BIR Ruling 72-87, March 12, 1987) Benefits received from US Veterans Adminis- tration (R.A. No. 360) by veterans residing in the Philippines. Payment of benefits under the Social Security ‘System in accordance with the provisions of RA. No. 8282.9) BASICAPPROACH TO INCOME TAXATION Bonefits received from the GSIS under R.A. No, 8291 including retirement gratuity. (7) Miscellaneous items a) Income received by foreign governments from their investments in the Philippines. Reason: To lessen the burden of foreign loans inasmuch as the interest of these loans are, by contractual arrangement, borne by the domestic borrowers. Foreign governments include financing institutions owned, controlled and financed by them and international or regional financing institutions established by governments. + To be exempt, the creditor must be the foreign government or financing institu- tions owned, controlled, and established by it. + Mitsubishi Metal Corporation, a Japa- nese Corporation, borrowed $20 million from the Import-Export Bank of Japan (Eximbank), owned, controlled and financed by the Japanese government through a consortium of Japanese banks. Mitsubishi used the same amount in extending loan to Atlas which agreed to sell copper concentrates to the former. RULING: Mitsubishi, not Eximbank, is the sole creditor of Atlas in the contract of loan, hence, the interest income of. Mitsubishi is subject to income tax. Eximbank (not party in interest) had nothing to do with the sale of the copper concentrates. When Mitsubishi obtained the loan of $20 milion from Eximbank b) c) CHAPTER 3 23 GROSS INCOME of Japan, said amount ceased to be the property of the bank and became the property of Mitsubishi, Tax exemptions are construed STRICTISSIMI JURIS. (Com. Mitsubishi Metal Corp., 181 SCRA 214) + Income of foreign government from operation in the Philippines of vessels owned or chartered by it is taxable. (Opinion of the Secretary of Justice, 40 0.G. 785) Income derived by the Government of the Philippines or any political subdivision from any public utility or from the exercise of any ‘essential governmental function (e.g., income derived by a municipality from the operation of a market or an electric power plant) — This is in recognition of the principle of exemption from taxation of government agencies or entities. Prizes and awards under the following conditions (2000, 2015 Bar): i, Received in recognition of religious, charitable, scientific, educational, artistic, literary or civic achievement; ii, Recipient was selected without any action on his part to enter the contest or proceeding; iii, Recipient is not required to render substantial future services as a condition to receiving the prize or award. Prizes and awards in sports competition granted to athletes whether held in the Philippines or abroad and sanctioned by their national sports associations (1996, 2011 Bar);4 BASIC APPROACH TO INCOME TAXATION + National sports associations must be accredited by the Philippine Olympic Committee (POC), (Section 13, R.A. No. 6847) 13th-month pay and other benefits: i. Other benefits cover productivity incentives and Christmas bonus; ii, Total exclusion shall not exceed P90,000 (R.A. No. 10963) GSIS, SSS, Medicare and other contributions; Gains from the sale or exchange of retirement of bonds, debentures, or other certificate of indebtedness with a maturity of more than five years; Gains from redemption of shares in Mutual Fund Company, + Tax-exempt income under special laws/ agreements |. Prizes received in charity, horse rac- ing, sweepstakes from the Philippine Charity Sweepstakes Office. (R.A. No. 1169) i. Salaries and stipend in dollars received by non-Filipino citizens serving as staff of + International Rice Research Institute (R.A. No, 2707); + Ford Foundation Grants (R.A. No. 3538); + Agricultural Department of the Southeast Asian Fisheries De- vi vil CHAPTERS 2 GROSS INCOME velopment Center (SEAFDEC) (PD. No. 246); + Population Council of New York (PD. No, 246). Income from bonds and securities: + For sale in the international market (RD. No. 81); + Issued by EPZA (PD. No. 66). Income derived from the installment sales of houses to their employees and workers or to low-income groups in housing projects or income derived from rentals thereof (P.D. Nos. 745 and 1217 — Housing Program of the Government) Officers and staff of Asian Deve- lopment Bank (ADB), experts and consultants performing missions for the Bank shall be exempt from Philippine income tax. (Article XII, Section 45, Govemment Agreement with ADB) Awards given by the Ramon Magsay- say Award Foundation (RMAF) are ‘exempt from the payment of income tax. (R.A. No. 2062) Holiday pay, overtime pay, night shitt differential pay and hazard pay received by minimum wage earners shall be exempt from income tax (Section 2, RR 10-2008; R.A. No. 9504)A Chapter 4 INDIVIDUAL INCOME TAXATION CLASSIFICATION OF INDIVIDUAL TAXPAYERS (1) (2) Resident Citizen (RC) (2015 Bar) —- citizens of the Philippines who are residing therein, (Article IV, Constitution) Non-Resident Citizen (NRC) —~ citizens of the Philippines who are physically present abroad for an uninterrupted period covering an entire taxable year (2015 Bar). NRC means one who establishes to the satisfaction of the BIR Commissioner the fact of his physical presence abroad with definite intention to reside therein, elther as: a) Immigrant; b) Employee on a more or less permanent basis; ©) Contract workers whose contracts of employ ment are renewed from time to time within or during the taxable year. NRC may be considered RC or NRC depend- ing upon his departure and arrival. In this regard, NRC shall submit proof to the BIR to show his intention of leaving the Philippines to reside permanently abroad or to return to and reside in the Philippines for this purpose. 26 CHAPTER 4 a INDIVIDUAL INCOME TAXATION (8) Resident Alien (RA) — non-citizens who reside in the Philippines: a) b) °) He must be a resident not mere transient or sojourner (whether he is a transient or not is determined by his intention with regard to the length and nature of bis stay). Alien living in the Philippines and has no defi- nite intention (floating intention) as to the time of return to his country or his stay in the Philip- pines. Those who come to the Philippines and whose extended stay may be necessary to accomplish the purpose and to that end they may have the intention at any time to return home, when their purpose of stay is accomplished/completed. + BIR regulation provides no fixed or definite criterion of determining residency beyond stating that NRA must have no residence in the Philippines. The difficulty, however, arises where an alien lives in the Philip- pines, though he does not maintain resi- dence therein. Maintenance of residence is the test but actual stay is a basic factor in determining residency. Therefore, the following must be considered: i. Maintenance of residence in the Philippines; Actual physical residence in the Philippines; lil, His temporary stay (with intention to return) is on an extended stay:28 BASIC APPROACH TO INCOME TAXATION. iv, Considered resident alien if he re- sides for more than one year, v. Loses his residence if he stays out- side the Philippines for @ continuous period exceeding three months as of and including December 31 (4) Non-Resident Alien (NRA) — neither citizen nor (8) resident of the Philippines a) NRA-ETB — comes and stays in the Philip- pines for an aggregate period of more than 180 days during the calendar year; (Section 25A[1], NIRC, as amended) (2000 Bar) ) ETB— includes the performance of personal services within the Philippines; ©) Foreign technician on a job contract for one year, Non-Resident Alien Not Engaged in Trade or Busi- ness (2016 Bar) —- NRA-NETB. In general, his income is taxed at 25% final tax based on gross or entire income. However, NRA-NETB is taxed at a special rate of 15% if employed by the following: a) Regional or area headquarters of multi-national corporations (RHQs, RAQs) 5) Offshore banking units established in the Phil- ippines (OBUs); ©) Petroleum service contractors or sub-contrac- tors. The preferential rate does not apply to em- ployees of RHQs, RAQs, OBUs and petroleum contractors and subcontractors registered with the SEC after January 1, 2018 (R.A. No. 10963) CHAPTER 4 29 INDIVIDUAL INCOME: TAXATION B. GENERAL PRINCIPLES: SOURCES OF INCOME; ‘TAX BASE Sources of Income Tax Base RC within and without taxable income NRC within taxable income RA within taxable income NRA-ETB within taxable income NRA-NETB within gross income C. APPLICABLE RATES Self-employed individuals and/or professionals whose ‘gross sales or gross receipts and other non-operating income do not exceed the Value Added Tax (VAT) Threshoid (P3M) shall have the option to avail of an eight percent (8%) tax on. gross sales or receipts and other non-operating income in ‘excess of Two Hundred Fifty Thousand Pesos (P250,000) in liew of graduated income tax rates (0% to 35%) and the percentage tax under Section 116 of the Tax Code. (R.A. No. 10963) Tax schedule effective January 1, 2018 until December 31, 2022: Not over P250,000 ~ 0% Over P250,000 but not = 20% of the excess of cover 400,000 250,000 ‘Over P400,000 but not ~ P30,000 + 25% of the over P800,000 excess over P400,000 Over P600,000 but not - P130,000 + 30% of the over P2,000,000 ‘excess over P800,00030 BASIC APPROACH TO INCOME TAXATION Over P2,000,000 but not — P490,000 + 32% ‘over P8,000,000 of the excess over P 2,000,000 — P2,410,000 + 35% Of the excess over P8,000,000 Over P 8,000,000 D. CATEGORIES OF INCOME (7967, 1969, 1970 Bar) CATEGORIES OF INCOME Compensation income Business income derived by self-employed Professional income derived by professionals Passive investment income Gains derived from dealings in property COMPENSATION INCOME A. DEFINITION All remuneration for services rendered by an employee for his employer unless specifically excluded under the Tax Code, (RR 2-98) It includes salaries, wages, emoluments, honoraria, bonuses, allowances. (transportation, representation, entertainment and the like), fringe benefits (monetary and non-monetary fees) including director's fee, taxable pensions and retirement Pay and other income of similar nature including compensation paid in kind. CHAPTER 4 at INDIVIDUAL INCOME TAXATION Income of similar nature — proceeds from property sharing; COLA, PERA, housing allowance, overlime pay, emergency pay, hazard pay, rice and clothing allowance, medical allowance, grocery allowance. BASIS/TEST: Designation/name of the remuneration upon which it is paid and the manner of payment is IMMATERIAL. What is important is that it is derived from employer-empioyee relationship. + However, not every compensation income is includ- ible under the term gross compensation income. Compensation for services rendered by an inde- pendent contractor does not fall under the legal category of “gross compensation income.” + Amounts paid either as advances or reimburse- ment for transportation, representation, and other bona fide ordinary and necessary expenses in- curred in the performance of his duties — not tax- able compensation income, Only the excess, if any, over actual expenses is taxable. + Three years backwages shall be taxable to an illegally separated employec but not attorney's fees. which are not subject to tax. (BIR Ruling, July 13, 1992) + Income derived by partner from professional part- nership does not form part of the gross compensa- tion income. REQUISITES FOR TAXABILITY (1) Personal services actually rendered; (2) Payment is for such services rendered; (3) Payment is reasonable.2 BASIC APPROACH TO INCOME TAXATION D, FORMS OF COMPENSATION Form/Kind — Measure of income: a) (2) (3) (4) Cash or in money —- Amount of money received. Property or in kind (Doctrine of Cash Equivalent) ~- FMV, Price is stipulated —- FMV of the compensation in the absence of contrary evidence. Promissory notes or other evidence of indebted- ness (noi mere security) — Not Discounted: Face Value; Discounted: 1) Year of receipt — Discount ed value; 2) Maturity Date — Difference between Face Value and Fair Market Value Cancellation or forgiveness of indebtedness made in consideration of debtor's services rendered — amount of debt cancelled, (2014 Bar) + Other tax implications of condonation of indebtedness: i. Ino consiceration is given, il arnounts to taxable donation and therefore subject to donor's tax as far ae the creditor (donor) is concerned (1997 Bar); ii, Itamounts to taxable indirect dividend if the creditor is @ corporation and the debtor is the stockholder. Premiums paid by employer on the life insurance policy of employee whose family, executor, admin- istrator or his estate is the beneficiary — amount of the premium paici + Conversely, premiums are not taxable if the beneficiary is the employer whether directly or indirectly designated. m CHAPTER 4 33 INDIVIDUAL INCOME TAXATION + Other tax implications of premiums paid by employer: i. Employer may claim the premiums as deductible from gross income if the ben- sficiary designated is the family, executor, administrator or the estate of the em- ployee (2004, 2007 Bar); ii. Employer is not allowed to claim premiums. paid as deductible if he is directly or indi- rectly designated as beneficiary, (Section 36/AII4)) (1978 Bar) Income tax paid by employer in consideration of the employee's services rendered — amount of such tax paid. Personal services performed partly within and partly without — apportion on the time basis. Tax exempt compensation income (benefits, privi- leges, facilities, etc.) a) Convenience of the Employer Rule. (1996, 2013 Bar) Itgrants exemption to benefits which are given for the exclusive benefit or conveni- ence of the employer. + Ifsuch quarters and other facilities exceed the employee's needs, only a ratable part of the value thereof as employee would have spent therefor constitutes taxable income. The remainder is considered expense of the employer. (Collector v. Henderson, 1 SCRA 649) + Lodging quarters furnished to an employ- ee by or on behalf of the employer shall be excluded from employee's gross incomeBASIC APPROACH TO INCOME TAXATION if the living quarter is situated within the business premises of the employer and the employes is required to accept such lodging facility as a condition of his em- ployment. (Revenue Audit Memo. Order No. 1-87, April 23, 1987) * The value of meal furnished to an em- ployee by of on behalf of his employer shalt be excluded from the employee's gross income if the meals are furnished in the business premises of tha employer, and the meals are for the convenience of the employer. (Ibid.) + Under Revenue Regulations 3-98, the monetary value of housing unit or the rental value thereof is tax exempt if the housing unit is situated within the busi- hess premises of the employer. In this case, the recipient must be a managerial or supervisory employee. De minimis Benefits. These tefer to facilities or privileges furnished or offered by an em- ployer to his employees that are of relatively small value and are offered or furnished by the employer merely as a means of promoting health, goodwill, contentment or efficiency of his employees (2016 Bar). These include ONLY, pursuant fo RR 5-201, the following: i, Monetized unused vacation leave credits of private employees not exceeding ten (10) days during the year; li, Monetized value of leave credits paid to government officials and employees; vi vil vii. CHAPTER 4 35 INDIVIDUAL INCOME TAXATION Medical cash allowance to dependents of employees not exceeding P750.00 per employee pér semester or P125.00 per month; Rice subsidy of P1,500.00 or one (1) sack of 50-kg. rice per month amounting to not more than P1,500.00; (2007 Bar; RR -2008) Uniform and clothing allowance not ‘exceeding P5,000.00 per annum; (RR 8-2012) Actual medical assistance, e.g., medical allowance to cover medical and health care needs, annual medical/executive check-up, maternity assistance, and routine consultations, not exceeding 10,000.00 per annum; Laundry allowance not exceeding P300.00 per month; Employee achievement awards, e.g., for 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 P10,000.00 received by the employee under an established written plan which does not discriminate in favor of highly paid employees; Gifts given during Christmas and mejor anniversary celebrations not exceeding 5,000.00 per employee per annum; Daily meal allowance for overtime and night/graveyard shift work not exceedingBASIC APPROACH TO INCOME TAXATION twenty-five percent (25%) of the basic minimum wage; xi, Collective bargaining agreement ben- efits and benefits derived from produc- tivity incentive schemes not exceeding P 10,000.00 per annum. (RR 1-2015) CHAPTER 4 a INDIVIDUAL INCOME TAXATION Life or health insurance and other non-life insurance premiums or similar amounts in excess of what the law allows. (2) Not all benefits given by an employer to his employees are subject to FBT. The following benefits are not subject to FBT: a) Fringe benefits which are authorized and E. SPECIAL RULES ON FRINGE BENEFITS ‘exempted from income tax under the Code (1) What is a fringe benefit? Fringe benefits refer to goods, services, or other benefits furnished or granted by an employer, in cash or in kind, in addition to basic salaries, to or under special law. For instance, separa- tion benefits which are given to employees who are involuntarily separated from work are not subject to FBT, managerial or supervisory employees such as, but b) Contributions of the employer for the ben- Not limited to the following: efit of the employee to retirement, insur- + Housing; ance and hospitalization benefit plans; + Expense account; : ) Benefits given to the rank and file, whether + Vehicle of any kind ; granted under a collective bargaining : agreement or not; + Household personnel, such as maid, driver, i ‘ and others; | d) De minimis benefits (refer to Tax Exempt ' ti . - 9b): + Interest on loan at lose than market rate ! Compensation Income, item no. S{b) (benchmark rate of 12%) to the extent of the i 2) Benefits granted to employee as required difference between the market rate and actual | by the nature of, or necessary to the trade, rate granted; business or profession of the employer, + Membership fees, dues and other expenses f) Benefits granted for the convenience of bore by the employer for the employee in social and athletic clubs or other similar organizations; Expenses for foreign travel; Holiday and vacation expenses; Educational assistance to the employee or his dependents; and the employer. (3) Benefits which are considered necessary to the business of the employer, or are granted for the convenience of the employer. The following fringe benefits are not subject to FBT because they are given primarily for the convenience of the employer:38 (4) BASIC APPROACH TO INCOME TAXATION @) Housing privilege of military officials of the AFP located inside or near military camps (1994 Bar); b) Anhousing unit which is situated inside or at most 50 meters from the perimeter of the busi- ness premises; c) Temporary housing for an employze for 3 months or less; d) Expenses of the employee which are reim- bursed by the employer if they are supported by receipts in the name of the employer and do not partake the nature of a personal expense of the employee; ) Motor vehicles used for sales, freight, delivery service and other non-personal uses; f) The use of alveraft (including helicopters) ‘owned and maintained by the employer; 9) Business expenses which are paid by the em- ployer for the foreign travel of his employees in connection with business meetings or con- ventions. The expenses should be supported by documents proving the actual occurrences, of the meetings/conventions, or official com- munications from business associates. Nature of Fringe Benefits Tax. The Fringe Benefits Tax is a tax imposed on fringe benefits which are granted or are paid by an employer to an employee occupying a managerial ‘or supervisory position. A final tax of 35% based on the grossed-up Monetary value (R.A. No. 10963) (5) (6) @ CHAPTER 4 39 INDIVIDUAL INCOME TAXATION Purpose of the FBT. The FBT isa measure to ensure that an income tax is paid on fringe benefits (FBs). If they were given in cash, an income is automatically with- held and collected by government. An additional compensation which is given in non-cash form is virtually untaxed, This situation has caused inequity in the distribution of the tax burden. The FBT can, enhance the progressiveness and fairness of the tax system. Who should pay the FBT? (2003 Bar) ‘The FBTis a tax on the income of an employee which is paid by the employer on behalf of the em- ployee. ‘The FBT is collected from the employer even if the employer is a tax-exempt corporation, or an instrumentality of the Philippine government, Why is the FBT collected from the. employer? (2003 Bar) Valuation of benefits is easier at the level of the firm. The problem of allocating the benefits among idual employees is avoided. Collection of the FBT is also ensured because the FBT is withheld at source and does not depend on the self-declaration of the individual. FBT is not an adi ional tax on the employer. The FBT is not an additional tax on the em- ployer. He can claim the fringe benefit and the FBT as a deductible expense from his gross income, Benefits subject to the FBT. ‘The FBT is imposed on fringe benefits given or furnished to managerial or supervisory employees40 (10) (1) BASIC APPROACH TO INCOME TAXATION on or after January 1, 1998. Fringe benefits granted to rank and file employees are not subject to FT. Who are considered as managers? supervi- sors? rank-and-file? “Managerial employees” refer to those who are given powers or prerogatives to lay down and execute management policies and/or to hire, trans- fer, suspend, lay-off, recall, discharge, assign or discipline employees. “Supervisory employees” are those who effectively recommend such managerial actions if the exercise of such authority is not merely rou- tinary or clerical in nature but requires the use of independent judgment. “Rank-and-file employees” mean all em- ployees who are holding neither managerial nor supervisory position. Decision rules The car plan extended by PAGCOR to its qualified employees is considered a fringe benefit. Thus, PAGCOR should withhold the tinal fringe ben- efit tax thereon, Payment of the membership dues and fees cannot be considered as fringe benefits because they are not borne by PAGCOR for its employees. Hence, they are not subject to fringe benefit tax. (CIR v. PAGCOR, G.R. No. 177387, 9 November 2016) DOCTRINE OF CASH EQUIVALENT It provides that any economic benefit to the em- ployee whatever may have been the mode by which it is effected is compensation income. In stock option, for CHAPTER 4 4 INDIVIDUAL. INCOME TAXATION instance, the difference between the FMV of the shares al the time the option is exercised and the option price constitutes additional compensation income to the em- ployee. (Com. v. Smith, 324 U.S. 177; Com. v. Le Bue, 351 U.S. 243) BUSINESS/TRADE/PROFESSIONAL INCOME INCOME COVERED (1) Income derived by self-employed from trade or business (trading, manufacturing, merchandis- ing, farming, and others). + Self-employment income consists of the ean- ings derived by the individual from the practice of profession or conduct of trade or business carried on by him as a sole proprietor or by a partnership of which he is a member. Self-employed — means a person engaged in trade or business or performs services for others for a fee and who derived personal income from such trade or business or from the performance of such services. The term includes but is not limited to single pro- pristorships engaged in trade or business as manufacturers, traders, market vendors, own- ers of eateries and farmers as well as owner of service shops, brokers, agents and others similarly situated. + Business is any activity that entails the time, attention and effort of an individual or group of individuals for livelihood or profit. + Inthe case of manufacturing, merchandising, or mining business, how is the gross income computed?42 BASIC APPROACH TO INCOME TAXATION Answer: Gross income means the total sales, less the cost of goods sold plus any income from investments and inci- dental operations. (Section 4B, Rev, Regs. No, 2) + Hows income from long-term contracts (build- ing installations or construction contracts covering a period of more than one [1] year) treated for income tax purposes? (2012 Bar) Answer: + Percentage of completion basis -~ gross income already earned though not yet received, based on estimates of architects or engineers duly certified by them is reported in a taxable year and all deductions relating to such for the taxable year, even ifnot yet paid, are taken into account, + Completed contract basis — taxpayer reports his income and deductions in the year the contract is finally completed (Section 44, Rov. Regs. No. 2) (2) Income derived by professionals from the prac- tice of professions. Professionals — refer to persons who derive their income from the practice of their profession The term includes lawyers and other persons who are registered with the PRC such as doctors, den- tists, CPAs and othars similarly situated. It may also refer to one who pursues an arl and makes living therefrom such as artists, athletes, and others similarly situated, CHAPTERS 8 INDIVIDUAL INCOME TAXATION (3) Gross income of farmers include: a) Sale of livelihood and farm products received from the farm; b) Value of merchandise and other property re- ceived from such sales; ©) _Profitfrom the sale of livestock and other items purchased; d) Gross income from all other sources, rent re- ceived on crop shares, proceeds of income of growing crops, INTEREST INCOME a) Definition — amount of compensation paid for the use of money or forbearance from such use. b) Includes such interest arising from indebted- ness — business or non-business, legal or illegal, usurious or not: i, _ Interest on government securities — tax- able effective January 1, 1998; ii, Interest on savings deposit, time deposits and deposit substitutes subject to 20% final tax (2017 Bar); Interest income from long-term deposit or investment certificate is exempt under the following conditions: iii: The depositor or investor is an individ- ual citizen (resident or non-resident) or resident alien or non-resident alien ‘engaged in trade or business in the Philippines and not a corporation;44 BASICAPPROAGH TO INCOME TAXATION 2 The long-term deposits or invest- ments certificates should be under the name of the individual and not under the name of the corporation or the bank or the trust department/unit of the bank; ii.3 The long-term deposits or invest- Ments must be in the form of savings, common or individual trust funds, deposit substitutes, investment man- agement accounts and other invest- ments evidenced by certificates in such form prescribed by the Bangko Sentral ng Pilipinas (BSP); il.4 The long-term deposits or invest- ments must be issued by banks only and not by other financial institutions; ii.5 The long-term deposits or invest- ments must have a maturity period of not less than five years; iiL6 The long-term deposits or invest- ments must be in denominations of Ten Thousand Pesos (P10,000,00) and other denominations as may be prescribed by the BSP; ii.7 Only the interest income from long- term deposits or investments cer- tificates are covered by income tax exemption; ji.8 Income tax exemption does not cover any other income such as gains from trading, foreign exchange gain; CHAPTER 4 45 INDIVIDUAL INCOME TAXATION ii The long-term deposits or invest- ments should not be terminated by the investor before the fifth year, otherwise it shall be subjected to the graduated rates of 5%, 12% or 20% on interest income earnings. (Rev- enue Memo. Circular No, 18-2011) RENTAL INCOME a) Definition — fixed sum either in cash or prop- erty equivalent, to be paid at a definite period for the use or enjoyment of a thing or right. b) Scope — all rentals (including royalties) derived from lease of property, whether used in business or not, from real estate or personal property; earings from copyrights, trademarks, patents and natural resources under lease. ¢) Items considered likewise as rental income + Obligations of lessor to third parties as- sumed by the lessee: |. Real estate taxes on leased prem- ises; ii, Insurance premiums paid by lessee on property; lll, Dividends paid by lessee to stock- holders of lessor-corporation; iv. Interest paid by lessee to holder of bonds issued by lessor-corporation + Value of permanent improvements made by lessee on leased property that will be- come the property of the lessor upon the6 BASIC APPROACH TO INCOME TAXATION expiration of the lease. The lessor shall report such an income under any of the following methods (1995 Bar): i Outright method — Fair Market Value of the completed building or improvement shall be reported as additional rent income; i, Spread out method — Allocate the depreciated value over the remaining term of the lease contract. d) Are advance rentals taxable? i, Prepaid rentals — taxable if so received under a claim of right and without restric- tion as to its use. ii, Security deposit—not taxable. However, itis taxable ifthe lessee violates any provi- sion of the contract. iil, Loan — not taxable. DIVIDEND INCOME a) Definition — corporate profit set aside, de- clared and distributed by the director of a corporation to be paid to stockholders on de- mand or at a fixed time. Under the Tax Code, any distribution made by a corporation to its ‘stockholders, whether in money or property out of its earnings and profit accrued since March 1, 1913. b) Kinds of Dividend i, Cash dividend — paid in given sum of money. CHAPTER 4 a INDIVIDUAL INCOME TAXATION i, Property dividend — one paid by corpo- ration in securities (not its own stock) or other property. ili, Stock dividend — one paid by a corpo- ration with its own stock. It represents transfer of surplus to capital account. It may be of the same kind or different from that on which it is issued. A dividend paid in stock of another corporation is not a stock dividend. This is technically known as “dividend in stock’, (Section 251, Rev. Regs, No, 2) Asa general rule, stock dividends are not taxable. (2003 Bar) Reason: They are considered unre- alized gain, and cannot be subjected to income tax until that gain has been realized, Mere issuance thereof is not yet subject to income tax as they are nothing but an en- richment through increase in value of capital investment. (Commissioner v, CA, 301 SCRA 152) Exceptions, however, are as follows: + Change in the stockholder's equity, right/nterest in the net assets of the corporation; + © Recipient is other than shareholder, Stock dividend is taxable to usufructu- ary (Bachrach v. Siefert, 87 Phil, 483);48 BASICAPPROAGH TO INCOME TAXATION + Cancellation or redemption of shares of stock (Ibid); + Distribution of treasury stocks; + Dividends declared in the guise of treasury stock dividend to avoid the effects of income taxation (Com- missioner v. Manning, 66 SCRA 14) (1994 Bar); + Different classes of stock were issued. Ilustration of taxability/non-taxability of stock dividend lssued and | Stock | TaxableiNot Caso | Authorized CIS | Outstanding | Dividend | Taxable 1 | common |" Common | Common | Not Taxable 1 | Coma Pret | Gammon | Proferred | Not Taxable lt [Coma Pret. | Coma Pret, [Gammon | Taxable WV [Coma Pret | Coma Prot_| Profored | Taxable iv. Scrip Diviclend — one that is paid in the vi. form of promissory notes. Indirect Dividend — one made through the exercise of right or other means of pay- ment, @.g., cancellation or condonation of indebtedness. Liquidating Dividend — one resulting from the distribution by a corporation of all its property or assets in complete liquidation or dissolution. It is generally a return of capital, and hence, itis not income. (2013 Giver Domestic Domestic Domestic Domestic Domestic ©) CHAPTER 4 49 INDIVIDUAL INCOME TAXATION. Bar) However, it is taxable income with respect to the excess of amount received over cost of the share surrendered. Recipient Taxable (taxrateVExempt DomestiRFC tax exempt (2005 Bar) RC,NRC,RA 10% ~ effective taxable year 2000 NRA~ETB 20% NRA-NETB. 25% NREC 15% subject to allow- ance for tax credit + Dividend received from foreign corporation is subject to Philippine income tax if at least 50% of the world (total) income of the foreign corporation must be derived from the Philippines for three years preceding the declaration of such dividend Decisional rules on redemption of shares of stock 1. Not taxable + Shares are redeemed in the absence of the availability of unrestricted earn- ings. (CIR v. Goodyear Phils., Inc., 799 SCRA 489) + Notin the nature of a recurring return fon stock. (Wise & Co,, Inc. v. Meer, 78 Phil, 655) + The source of redemption is the original capital subscription uponBASIC APPROACH TO INCOME TAXATION establishment of the corporation or initial capital investment in an exist- ing enterprise. (CIR v. CA, 301 SCRA 152) fi, Taxable + The redeemed shares are from stock dividend declarations other than as initial capital investment. + There is redemption or cancellation; the transaction involves stock divi- dends; and the “time and manner* of the transaction makes it essentially equivalent to a distribution of taxable dividends. PASSIVE INVESTMENT INCOME a) ILis an income subject to final withholding tax (2001 Bar). b) The withholding agent withholds the tax and remits the same to the BIR. c) The recipient is not required to include the income in his gross income. Neither is the taxpayer required to include it in the taxable income. (CIR v. PAL, 504 SCRA 90) d} Taxpayer is not required to file ITR if his or her income consists solely of income subject to final tax, e) The tax withheld constitutes final settlement of the tax liability on the income. f) Examples of income subject to final tax (2007 Bat) a) b) dy CHAPTER 4 st INDIVIDUAL INCOME TAXATION + Interest income from bank deposit; + Royalties; + Dividend received from domestic corpora- tion by individual or non-resident foreign corporation (NRFC); + Prizes amounting tomore than P10,000.00; + Winnings (except sweepstakes and lotto); + Partner's share from the net income after tax of business partnership, joint acoount, Joint venture or consortium. (4) Other Sources Capital Gain from Sale of Shares of Stock (2008, 2011 Bar) i. If not listed and traded through stock ‘exchange — 15% of the net capital gain (R.A. No. 10963) ji. if fisted and traded through local stock exchange — 6/10 of 1% of Gross Selling Price. (R.A, No. 10963) The tax is in the nature of percentage tax, not an income tax. Interest income received by a resident indi- vidual taxpayer from a depository bank under the expanded foreign currency deposit system — Final tax of 15% (R.A. No, 10963) Acquisition and disposition of capital stock which include sales and retirement of bonds. illegal gains — gambiing, betting, lotteries, extortion or fraud82 e) 9) BASIC APPROACH TO INCOME TAXATION Recovery of damages — taxable — it repre- sents lost profitfincome. Bad Debts recovery — taxable if it results in reduction of the taxpayer's tax liability in the previous year. "Tax benefit rule” or the "Doc- {rine of equitable benefit” applies in this case. (2005 Bar) + it must be claimed as a deduction from the gross income in the preceding year. + The reduction results in a tax benefit, Tax refund — taxable if it results in reduction of the taxpayer's liability in the preceding year. This means that the lax refunded must be previously claimed as deduction from gross in- come. Tax benefit rule likewise applies. (2005, 2014 Bar) Chapter 5 CORPORATE INCOME TAXATION DEFINITION UNDER THE NIRC Corporation includes partnerships, no matter how created or organized, joint stock companies, joint accounts, associations or insurance companies except: a) Joint construction venture (2007 Bar); General professional partnership; Joint venture for engaging in petroleum, coal, ge0- thermal and other energy operations pursuant to a consortium agreement with the government. Unregistered or registered partnership — taxable provided that the following requisites concur: a) Agreement, oral or writing, to contribute money, property or industry to a common fund; b) Intention to divide the profits. i. Two sisters purposely created a com- mon fund without being registered for the purpose of engaging in a series of trans- actions for profit — taxable unregistered partnership is created. The qualifying expression —- no matter how created or organized — clearly indicates that a joint venture need not be undertaken in any of the standard forms, or in conformity 5354 BASIC APPROACH TO INCOME TAXATION with the usual requirements of the law on partnership, in order that one could be deemed constituted for purposes of the tax on corporations. (Evangelista v, Collector, 102 Phil. 140) Taxable partnership is formed where 15 persons contributed money to purchase sweepstakes tickets for the sole purpose of dividing among themselves the prize. Two persons entered into agreement to operate a cockpit under which one was ‘0 contribute his services and the other to provide the capital — taxable partnership is formed. (Rallos v. Rallos, 2 Phil. 509) As a rule, co-ownership is tax-exempt. It becomes taxable if it is converted into an unregistered partnership. Converted into partnership if the properties and income are used as common fund with intention to produce profits. If after partition, the shares of the heirs are held under a single management for profil making, unregis- tered partnership is formed (1997 Bar) (Ona, et al. v. Commissioner, 45 SCRA 74), Pascual and Dragon bought two (2) parcels of land from Bernardino and three (3) from Roque. Thereafter, the first two (2) were sold to Meirenir Development Corporation at a profit of P165,224.70 and the three (3) to Reyes and Samson ‘or a profit of P60,000.00. They divided the profits between the two (2) of them. RULING: There was no partnership vi vii. CHAPTER 5 55 (CORPORATE INCOME TAXATION formed. 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. (Article 1769, NCC) (Pascual and Dragon v. Commissioner, 166 SCRA 560) On March 2, 1973, Joe Obillos, Sr. trans- ferred his rights under contract with Orti- gas Co, to this four (4) children to enable them to build residences on the lots. TCTs were issued. Instead of building houses, the Obillos children sold them after one (1) year to Walled City Securities Corpora- tion and Olga Cruz Canda. The Supreme Court held that the Obillos children are co-owners. It is an isolated act which shows no intention fo form a partnership. !tappears that they decided to sell it after they found it expensive to build houses, (Obillos, Sr. v. Commissioner, 139 SCRA 436) Pool of insurers is taxable as unregistered partnership. The ceding companies entered into a Pool Agreement or an association that would handle all the insurance businesses covered under their quota-share reinsur- ance treaty and surplus reinsurance treaty. The following unmistakably indicate a partnership or an association under the NIRC: vii.1 The pool has a common fund, consist- ing of money and other valuables thatBASIC APPROACH TO INCOME TAXATION are deposited in the name and credit of the pool, This common fund pays for the administration and operation expenses of the pool. vil2 The pool functions through an ex- ecutive board, which resembles the board of directors af a corporation, ‘composed of one representative for each of the ceding companies. Vil3 True, the pool itself is not a rein- surer and does not issue any insurance policy; however, its work is indispensable, beneficial, and economically useful to the business of the ceding companies and Munich, because without it they would not have received their premiums. The ceding companies share “in the business ceded to the pool” and in the “expenses” according to a “Rules of Distribution" annexed to the Pool Agreement. Profit motive or business is, therefore, the primordial reason for the pool's formation. (Afisco Insurance Corporation v. Court of Appeals, 302 SCRA 1) (2) Joint accounts or joint ventures formed for profits Joint Emergency Operation — (no legal per- sonality) operates the business affairs of the two companies as though they constitute a single entity thereby obtaining substantial economy and profit in operation — taxable. (Collector v. Batangas Co., 54 OG 6724) CHAPTER 5 81 CORPORATE INCOME TAXATION (3) Joint Stock Companies — generally classified as a partnership possessing some of the characteristics ofa corporation. They appear to be like corporations to the extent that they have capital stock but when capital is divided or made transferable even without the consent of the co-partner, they partake of the nature of partnership. (Brocki v. American Express Company, CA Michigan, 279F 2d 785, 787) B. MAJOR GROUPS OF CORPORATIONS FOR INCOME TAX PURPOSES (Sources, tax base, tax rate) (1) DOMESTIC CORPORATIONS (2016 Bar) Source: Within and without Tax base: Taxable income Tax rate: Tax rate: 30% effective January 1, 2009 (R.A. No. 9337) Special domestic corporations: nal insti a) Private Educ ition — + Subject to ten’percent (10%) on their tax- able income provided that its gross income from unrelated trade, business or other activity does not exceed fifty percent (50%) of the total income, Conversely, it is subject to thirty-five percent (35%) if its income from unrelated trade or business exceeds fifty percent (50%) of the total (gross) income. + Private educational Institution — is any “private school” maintained and admin- istered by private individuals or groups issued a permit to operate by Secretary58 BASIC APPROACH TO INCOME TAXATION ‘of DECS in accordance with existing laws and regulations. + Unrelated trade, business, or other activity — the conduct of which is not substantially related to the exercise or performance by such educational institution of its educa- tional purpose or function, + Related activities include income derived from auxiliary activities — school owned canteen, cafeteria, dormitory and book- store within the school premises. (B/R Ruling 237-87, 16 December 1987) b) Non-profit hospital + Same rules as private educational institu- tion, + Unrelated trade, business, or other activity — the conduct of which is not substantially related to the exercise or performance by such hospital of its primary purpose or function + St. Luke's Medical Center, Inc., as. propri- elary non-profit hospital, is entitled to the preferential rate of 10% on its net income from its for-profit activities. tt remains as @ proprietary non-profit hospital under Section 27(B) of the NIRC as long as it does not distribute any of its profits to its members and such profits are reinvested pursuant to its corporate purposes. (CIR v. Si. Luke's Medical Center, Inc., 682 SCRA 66) CHAPTER 5 89 (CORPORATE INCOME TAXATION ¢) Government-owned and controlled corpo- ration i. Philippine Amusement and Gaming Cor- poration (PAGCOR) Tax exempt — income from gaming operations, such as casino, dollar pit, regular bingo and mobile bingo operations. Contractees and licensees of PAG- COR are likewise exempt from the payment of corporate Income tax and other taxes since Section 13(b) of P.D. No. 1869 is clear and unequivo- cal that said exemption inures to their benefit. (Bloomberry Resorts and Hotels, Inc. v. BIR, 800 SCRA 123) Taxable — income from other related ‘operations which include income from casinos, traditional bingo, electronic bingo, internet casino poker and betting operated by licensed private operators, junket operations, SM demo units, and other necessary and related services, shows and en- tertainment. (PAGCOR v. BIR, 744 SCRA 712) (2) RESIDENT FOREIGN CORPORATIONS Source: Tax base: Tax rate; Within Taxable income 30% effective January 1, 2009 (R.A. No. 9337}60 BASIC APPROACH TO INCOME TAXATION ‘Special Resident Foreign Corporations: a) International Carriers — within — Gross Phil Billings — 2.5%; b) Offshore banking unit — within — Gross on- shore income —~ 10%; ©) Foreign currency deposit unit —within — Gross onshore income — 10%. Transacting business — means continuity of commercial dealings and arrangements. (Far East Int! Import and Export Corp. v. Nankai Kogyo Co., Ltd., 6 SCRA 725) Gross Philippine Billings ~~ refers to the amount of gross revenue realized from carriage of persons, excess baggage, cargo and mail originat- ing from the Philippines in a continuous and uninter- rupted flight, irrespective of the place of sale or issue and the place of payment of the ticket or passage document. (2005 Bar) FOREIGN AIRLINE COMPANIES WITH- OUT FLIGHTS STARTING FROM OR PASSING THROUGH ANY POINT IN THE PHILIPPINES — An offline airline having a branch office or a sales agent in the Philippines which sells passage docu- ments for compensation or commission to cover off- line flights of its principal or head office, or for other airlines covering flights originating from Philippine ports or offine flights, is not considered engaged in business as an international air carrier in the Philippines and is, therefore, not subject to Gross Philippine Billings Tax provided for in Section 28(A)[3][a] of the Code nor to the three percent (3%) common carrier's tax under Sec- tion 118(A) of the same Code (2005 Bar). This CHAPTER 5: ot CORPORATE INCOME TAXATION provision is without prejudice to classifying such taxpayer under a different category pursuant to a separate provision of the same Code. (Rev. Regs. No. 15-2002) International Air Carrier and International Shipping — shall be taxed on the basis of their Gross Philippine Billings. ‘The 2.5% tax attaches only when the carriage of persons, excess baggage, cargo and mails tatad from the Philippines in a continuous and uninterrupted flight, regardless of where the pas- sage documents were sold. An offline international air carrier having no flights to and from the Philippines is clearly not liable for the Gross Philippine Billings tax. (Air Canada v. CIR, 778 SCRA 131) Offline international airline is subject to corporate income tax Section 28(AX3)(a) of the 1997 NIRC does not, in any categorical term, exempt alll international air carriers from the coverage of Section 28(A)(1) of the 1997 NIRC. Certainly, had legislature's inten- tions been to completely exclude all international air carriers from the application of the general rule under Section 28(A)(1), it would have used the appropriate language to do so; but the legislature did not. Thus, the logical interpretation of such provi- sions is that, if Section 28(A)(3)(a) is applicable toa taxpayer, then the general rule under Section 28(A) (1) would not apply. If, however, Section 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 Section 28(A)(1).62 BASIC APPROACH TO INCOME TAXATION Cleariy, no difference exists between British Overseas Airways and South African Airways. The findings therein that an offline carrier is doing business in the Philippines and that income from the sale of passage documents here is Philippine- source income must be upheld. ‘The general rule is that resident foreign corpo- rations shall be liable for a 32% (now 30%) income tax on th: icome from within the Philippines, except for resident foreign corporations that are international carriers that derive income “from car- riage of persons, excess baggage, cargo and mail originating from the Philippines" which shall be taxed at 2 1/2% of their Gross Philippine Billings. South African Airways, 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 embod- ied 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 car- rier maintains flights to and from the Philippines, it shall be taxed at the rate of 2 1/2% of its Gross Philippines 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% (now 30%) of such income. (South African Airways v. CIR, 612 SCRA 665) An offline international air carrier selling passage tickets in the Philippines, through a (3) CHAPTER 5: 63 CORPORATE INCOME TAXATION general sales agent, is a resident foreign cor- poration doing business in the Philippines Doing business includes appointing represent- atives or distributors operating under full control of the foreign corporation, domiciled in the Philippines or who in any calendar year stay in the country for a period totalling one hundred eighty (180) days or more. Upon this point, an offline carrier, a foreign air cartier not certified by the Civil Aeronautics Board, that maintains office or has designated or appointed agents or employees in the Philippines, through whom, it sells or offers for sale any air transportation, or negotiates for, or holds itself out by solicitation, advertisement, or otherwise sells, provides, furnishes, contracts, or arranges for such transportation, is undoubtedly “doing sings or “engaged in trade or business in the Phil As such, it is taxable under Section 28(A)(1), ‘and not Section (A)(3) of the 1997 National Internal Revere Code, subject o any applicable tax treaty to which the Philippines is a signatory, Pursuant to Article 8 of the RP-Canada Tax Treaty, Air Canada may only be imposed a maximum tax of 1 1/2% of its gross revenues earned from the sale of its tickets in the Philippines. (Air Canada v. CIR, 778 SCRA 131) NON-RESIDENT FOREIGN CORPORATIONS (2014, 2016 Bar) Source: Within Tax base: Tax rate: Gross income 30% effective January 1, 2009 (R.A. No. 9337)64 c. BASIC APPROAGH TO INCOME TAXATION ‘Special Non-Resident Foreign Corporations: a) NR—lessor of cinematographic film — within — Gross income — 25% final tax; b) NR — owner or lessor of vessels chartered by Phil. Nationals — within — Gross rental — 4.5% final tax; c) NR — owner or lessor of aircraft, machinery and equipment — within — Gross rental — 7.5% final tax. Two vessels of V. Reederij Amsterdam called on Philippine ports twice to unload car- goes for foreign destination. It has no office in the Philippines. The fees were collected by its husbanding agent, Royal Intemational Ooean Lines. The Supreme Court held that the corporation is considered non-resident foreign corporation. Casual activity as in this case, does nat amount to engaging in trade or business in the Philippines. (NV. V. Reederij “Amsterdam” v. CIR, 162 SCRA 487) MINIMUM CORPORATE INCOME TAX (Sections 27{E], 28A[2], implemented by Revenue Regulations No, 9-98 as amended by Revenue Regulations No. 12-2007) (2016 Bar) (1) Concept and Rationale of the MCIT The MCIT on domestic corporations is a new concept introduced by R.A. No. 8424 fo the Philip- pine taxation system. It came about as a result of the perceived inadequacy of the self-assessment system in capturing the true income of corporations. twas devised as a relatively simple and effective revenue-raising instrument compared to the normal CHAPTER 5, 65 CORPORATE INCOME TAXATION income tax which is more difficult to control and enforce. Itis a means to ensure that everyone will make some minimum contribution to the support of, the public sector, x x x 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. Congress intended to put a stop to the practice of corporations which, while having large turn-overs, report minimal or negative net income resulting in minimal or zero income taxes year in ‘and year out, through under-deciaration of income or over-deduction of expenses otherwise called tax shelters. x x x The primary purpose of any legitimate busi- ness is to earn a profit. Continued and repeated losses after operations of a corporation or con- sistent reports of minimal net income render its financial statements and its tax payments suspect. For sure, certain tax avoidance schemes resorted to by corporations are allowed in our jurisdiction. ‘The MCIT serves to put a cap on such tax shelters. As a tax on gross income, it prevents tax evasion and minimizes tax avoidance schemes achieved through sophisticated and artful manipulations of deductions and other stratagems. Since the tax base was broader, the tax rate was lowered To further emphasize the corrective nature of the MCIT, the following safeguards were incorpo- rated into the law.(2) (3) BASIC APPROACH TO INCOME TAXATION First, recognizing the birth pangs of businesses and the reality of the need to recoup initial major capital expenditures, the imposition of the MCIT commences only on the fourth taxable year immediately following the year in which the corporation commenced its operations. This grace period allows a new business to stabilize first and make its ventures viable before it is subjected to the MCIT. ‘Second, the law allows the carrying forward of any excess of the MCIT paid over the normal income tax which shall be credited against the normal income tax for the three immediately succeeding years. Third, since certain businesses may be incur- ring genuine repeated losses, the law authorizes the Secretary of Finance to suspend the imposition of MCIT ifa corporation suffers losses due to pro- longed labor dispute, force majeure and legitimate business reverses. (CREBA v. Romulo, 614 SCRA 605) Purpose of MCIT (2001 Bar) The imposition of the MCIT is designed to forestall the prevailing practice of corporations of over claiming deductions in order to reduce their income tax payments. Nature of minimum corporate income tax (MCIT) The MCIT is an estimate of the income tax that is due froma firm. It is equal to two percent (2%) of the gross income of a corporation at the close of each taxable quarter. Being a minimum income tax, a corporation should pay the MCIT whenever its regular (normal) @) CHAPTER °r CORPORATE INCOME TAXATION income tax is lower than the MCIT, or when the firm reports a net loss in its tax return, Conversely, the reguiar income tax is paid when itis higher than the MCIT. MCIT is not an additional tax to the regular or normal income tax At the end of the taxable quarter, the MCIT is compared with the regular income tax which is due from a corporation. If the regular income is higher than the MCIT, then the corporation does not pay the MCIT, Newly established firms, or those which are on their first three years of operations are not covered by the MCIT. Coverage of the MCIT (2001 Bar) The MCIT covers domestic and resident for- eign corporations which are subject to the regular income tax. The term “regular income tax’ refers to the regular income tax rates under the Tax Code. The tax rate is 33% for 1999, 32% for 2000, 36% effective July 1, 2005 and 30% effective January 4, 2009, Thus, corporations which are subject to a special corporate tax system do not fall within the coverage of the MCIT. These are as follows: + Schools, hospitals, and income of Offshore Banking Units (OBUs), and Foreign Currency Deposit Unit (FCDU) from foreign currency transactions; + Regional operating headquarters — The incomes of these corporations are subject to a ten percent (10%) preferential tax rate;68 (6) BASIC APPROACH TO INCOME TAXATION Firms under a special income tax regime such as those under the PEZA law and the Bases Conversion Development Act; * International carriers subject to tax at 2 1/2% of their Gross Philippine Billings For corporations whose operations or activi- ties are partly covered by the regular income tax system and partly covered under a special income tax system, the MCIT shall apply on operations covered by the regular income tax system. For example, the MCIT does not cover an activ- ity of a firm which is registered with the Board of Investments (BO!) and is granted an income tax holiday. The MCIT shall cover its othor activities which are not covered by the BO! tax incentives. When does a corporation start to be covered by the MCIT? Acorporation starts to be covered by the MCIT on the fourth (4th) year of its business operations. The period of reckoning the start of its business operations is the year when the corporation was registered with the BIR. This rule will apply regard- less of whether the corporation is using the calen- dar year or fiscal year as ils taxable year. (Manila Banking Corporation v. CIR, 499 SCRA 782) + Firms that were registered in 1994 and earlier yearsare covered by the MCIT beginning Janu- ary 1, 1998, Firms which were registered with the BIR in any month in 1998 will be covered by the MCIT afler the lapse of three calendar years, i.e., 2002. (7) (8) CHAPTER 5. 88 ‘CORPORATE INCOME TAXATION ‘Suspension of the payment of MCIT The Secretary of Finance, upon the recom- mendation of the BIR Commissioner, may suspend the imposition of the MCIT on a corporation in any of the following cases + Sustained losses from prolonged labor dispute; + Force majeure; + Legitimate business reverses. "Sustained losses from a prolonged labor dispute” means losses arising from a strike staged by employees which lasted for more than six (6) months within a taxable period and which has caused the temporary shutdown of business opera- tions. “Force majeure” means a cause due to an irresistible force as by “Act of God" like lightning, earthquake, storm, flood and other natural calami- ties. This term would also include armed confcts like war or insurgency. “Legitimate business reverses” shail include substantial losses due to fire, robbery, theft or embezzlement, or for other economic reason as determined by the Secretary of Finance. How Is the MCIT computed? The MCIT is equal to two percent (2%) of the gross income of the corporation at the end of the taxable quarter. “Gross income” means gross sales less sales retums, discounts and allowances and cost of goods sold. It will also include all items of gross income enumerated under Section 32(A) of the Tax7 BASIC APPROACH TO INCOME TAXATION Code, as amended, except income exempt from income tax and income subject to final withholding tax. Cost of goods sold include ail business expens- 8s directly incurred to produce the merchandise to bring them to their present location and use, For attrading or merchandising concern, cost of goods sold means the invoice cost of goods sold, plus import duties, freight in transporting the goods to the place where the goods are actually sold, including insurance while the goods are in transit. For a manufacturing concern, cost of goods manufactured and sold means all costs of produc- tion of finished goods such as raw materials used, direct labor and manufacturing overhead, freight cost, insurance premiums and other costs incurred to bring the raw materials to the factory or ware- house. For sale of services, gross income means gross receipts less sales retums, allowances, discounts and cost of services which cover all direct costs and expenses riecessarily incurred to provide the services required by the customers and clients including: + Salaries and employee benefits of personnel, consultants and specialists directly rendering the service; + Cost of facilities directly utiized in providing the service such as depreciation or rental of equipment used; + Cost of supplies. Interest expense is not included as part of cost of service, except in the case of banks and other financial institutions (9) (10) CHAPTER 5 m (CORPORATE INCOME TAXATION The term “gross receipts” means amounts actually or constructively received during the taxable year. However, for taxpayers employing the accrual basis of accounting, it means amounts earned as gross income. When is the MCIT reported and paid? ‘The MCIT shall be paid in the same manner prescribed for the payment of the normal corporate income tax which Is on a quarterly and on a yearly basis, The taxpayer shall pay the MCIT whenever it is greater than the regular or normal corporate income tax which is imposed under Section 27(A) and Section 28(A)(1) of the Code. Thus, in the computation of the tax due for the taxable quarter, if the computed quarterly MCIT is higher than the quarterly normal income tax, the tax due to be paid for such taxable quarter and the time of filing the quarterly corporate income tax return shall be the MCIT which is two percent (2%) of the gross income as of the end of the taxable quarter. The final comparison between the normal income tax payable by the corporation and the MCIT shall be made at the end of the taxable year and the payable or excess payment in the Annual Income Tax Return shall be computed taking into consideration corporate income tax payment made at the time of filing of quarterly corporate income tax return whether this be MCIT of normal income tax. Can the company claim the MCIT it paid as a deduction from gross income? Since the MCIT is an estimate of the normal income tax, it cannot be claimed as deduction.nR BASIC APPROACH TO INCOME TAXATION (11) What is the carry-forward provision under the mcit? Any excess of the MCIT over the normal in- come tax may be carried forward on an annual basis and be credited against the normal income tax for the three immediately succeeding taxable years. Mlustration: Normal income tax cit Amount of tax to be paid 2000 2001 += - 2002 50,000 60,000 100,000 75,000 700,000 60,000 76,000 100,000 100,000 Less: Excess MCIT 2000 — 25,000 = i 2001 — 40,000 ~ — 65,000 Net amount of tax payable 75,000 100,000 38,000 ‘The taxpayer is required to pay the MCIT whenever itis greater than the regular income tax. Thus, in 2000, the taxpayer will pay MCIT oF P75,000 since this is greater than the normal income tax of P50,000. In 2001, the taxpayer will pay MCIT of 100,000 because its MCIT in 2001 is stil higher than the regular income tax. The excess MCIT of P25,000 in 2000 (or the difference between the MCIT and the regular income tax in 2000) cannot be used in this instance. In 2002, when the regular income tax of 100,000 is higher than the MCIT of P60,000, the taxpayer is allowed to claim as credit the CHAPTER 5: 3 CORPORATE INCOME TAXATION excess MCIT of P25,000 and P40,000 for 2000 and 2001 respectively, or a total credit of P65,000. Hence, the taxpayer will pay only 35,000 (P 100,000 - P65,000). D. IMPROPERLY ACCUMULATED EARNINGS TAX (Section 29 as Implemented by Revenue Regulations No, 2-200) a) 2) Rationale of improperly accumulated earnings tax of 10% Ifthe earnings and profits were distributed, the shareholders would then be liable to income tax thereon, whereas if the distribution were not made to them, they would incur no tax in respect to the undistributed earnings and profits of the corpora- tion. Thus, a tax is being imposed in the nature of ‘a penalty to the corporation for the improper accu- mulation of its earnings, and as a form of deterrent to the avoidance of tax on shareholders who are supposed to pay dividends tax on the earings distributed to them by the corporation. What is the touchstone of the liability? Itis the purpose behind the accumulation of the income and not the consequences of the accumula- tion, Thus, ifthe failure to pay dividends is due to some other causes, such as the use of undistributed earnings and profits for the reasonable needs of the business, such purpose would not generally make the accumulated or undistributed earnings subject to the tax. However, if there is a determination that a corporation has accumulated income beyond the reasonable needs of the business, 10% improperly accumulated earnings tax shall be imposed.™ BASIC APPROACH TO INCOME TAXATION (3) Determination of reasonable needs of the busi- (4) ness An accumulation of earnings or profits (includ- ing undistributed eamings or profits of prior years) is reasonable if itis necessary for the purpose of the business, considering all the circumstances of the case. The term ‘reasonable needs of the business" are hereby construed! to mean the immediate needs of the business, including reasonably anticipated needs. What constitute accumulation of earnings for the reasonable needs of the business? a) Allowance for the increase in the accumulation of eamings up to 100% of the paid-up capital of the corporation as of Balance Sheet date, inclusive of accumulations taken from other years; b) Earnings reserved for definite corporate expan- sion projects or programs requiring consider- able capital expenditure as approved by the Board of Directors or equivalent body; ©) Eamings reserved for building, plants or equip- ment acquisition as approved by the Board of Directors or equivalent body; d) Earnings reserved for compliance with any loan covenant or pre-existing obligation established under a legitimate business agreement; ©) Earnings required by law or applicable regu- lations to be retained by the corporation or in respect of which there is legal prohibition against its distribution; (5) CHAPTER 5 15 (CORPORATE INCOME TAXATION f) In the case of subsidiaries of foreign corpo- rations in the Philippines, all undistributed earnings intended or reserved for investments within the Philippines as can be proven by cor- porate records and/or relevant documentary evidence. + To determine the “reasonable needs" of the business in order to justify an accu- mulation of earnings, the Courts of the United States have invented the so-called “Immediacy Test” which construed the words “reasonable needs of the business” to mean the Immediate needs of the busi- ness, and it was generally held that if the corporation did not prove an immediate need for the accumulation of earnings and profits, the accumulation was not for the reasonable needs of the business, andthe penalty tax would apply. (Mertens, Law of Federal Income Taxation, Vol. 7, Chapter 39, p, 103) (2010 Bar) Coverage of IAET The 10% Improperly Accumulated Earnings Tax (IAET) is imposed on improperly accumulated taxable income earned starting January 1, 1998 by domestic corporation as defined under the Tax Code and which are classified as closely-held corpora- tions. What are closely-held corporations? Closely-held corporations are those corpora- tions at least ty percent (50%) in value of the out- standing capital stock or at least fifty percent (50%)76 (8) BASIC APPROACH TO INCOME TAXATION of the total combined voting power of all classes of stock entitled to vole is owned directly or indirectly by not more than twenty (20) individuals. Corporations not subject to |AET: * Banks and other non-bank financial interme- diaries; + Insurance companies; + Publicly-held corporations; + Taxable partnerships; + General professional partnerships; + Non-laxable joint ventures; + Enterprises duly registered with the Philippine Economic Zone Authority (PEZA) under RA. No. 7916, and enterprises registered pursuant to the Bases Conversion and Development Act of 1992 under R.A. No. 7227. Prima facie instances of accumulation of profits beyond the reasonable needs of a business are indicative of purpose to avoid income tax upon shareholders: + Investment of substantial earnings and profits of the corporation in unrelated business or in stock or securities of unrelated business; + Investment in bonds and other long-term se- curities; * Accumulation of earings in excess of 100% of paid-up capital, not atherwise intended for the reasonable needs of the business. CHAPTER 5 7 (CORPORATE INCOME TAXATION (9) IAET is not covered by the prescriptive period for assessment. It would not be proper for the law to compel a corporation to report improper accumu- lation of surplus. A tax imposed upon unreasonable accumulation of surplus is in the nature of a penalty. (Helvering v. National Grocery Co., 304 U.S. 282) E, OTHER CORPORATE TAX RATES (1) Common Tax Rates a) Capital gain from sale of share of stock, i If not listed and traded through stock ex- change — 15% of net capital gain (R.A. ‘No. 10963) ii, If listed and traded through local stock exchange — 6/10 of 1% of Gross Selling Price. (R.A. No. 10963). Itis in the nature of percentage tax. (2) Domestic Corporations a) Corporations have the option to be taxed at 15% of gross income. In this regard, the President may, upon the recommendation of the Secretary of Finance, effective 1 January 2000, allow corporations the option to be taxed at 15% of gross income, after the following conditions have been satisfied i. Atax effort ratio of 20% of Gross National Product (GNP); ji, Arratio of 40% of income tax collection to total tax revenues; iil, A VAT tax effort of 4% of GNP; and8 b) °) BASIC APPROACH TO INCOME TAXATION, iv. A 0.9% ratio of the Consolidated Public Sector Financial Position (CPSFP) to GNP. + The option to be taxed based on gross income shall be available only to firms whose ratio of cost of sales to gross sales or receipts from all sources does not exceed 55%, + The election of the gross income tax option by the corporation shall be irrevocable for three consecutive tax- able years during which the corpora- tion is qualified under the scheme, + The term “gross income” derived from business shall be equivalent to gross sales less sales returns, dis- counts and allowances and cost of goods sold. “Cost of goods sold” shall include all business expenses directly incurred to produce the merchandise to bring them to their present location and use. Interest on currency deposit and royalties derived from sources within the Philippines — 20% Final Tax Interest income from deposit under the ex- panded foreign currency system —~ 15% Final Tax. (RA. No. 10963) (3) Resident Foreign Corporations a) Branch Profit Remittance Tax + Tax base: Profits applied for or earmarked for remittance. This took effect on January 1, 1998. CHAPTER 5 7 CORPORATE INCOME TAXATION Tax rate: 15% final tax. Condition: Branch profits are effectively connected with the conduct of its trade or business in the Philippines. (1999 Bar) The dividend income remitted to Marubeni Corporation of Japan arising from its equity investments in Atlantic, Gulf and Pacific Company of Manila is considered separate and distinct income from the branch office in the Philippines, There ‘can be no other logical conclusion that the investment was made for purposes peculiarly germane to the conduct of the corporate affairs of Marubeni, Japan, but certainly not of the branch in the Philip- pines. (Commissioner v. Marubeni, 177 SCRA 500) Exempt profits remitted: Derived from activities registered with the Philippine Economic Zone Authority (PEZA). The branch office in the Philippines of a resident of the Federal Republic of Ger- many may be subjected to the branch profits remittance tax withhold at source in accordance with Philippine law but shall not exceed 10% of the gross amount of the profits remitted by that branch to the head office. This is pursuant to Paragraph 6, Article 10 of the RP-Germany Tax Treaty. (Deutsche Ban AG Manila Branch v. CIR, 704 SCRA 216) Purpose of Remittance Tax: The remit- tance tax was conceived in an attempt to(4) Non-Resident For a) b) BASIC APPROACH TO INCOME TAXATION equalize the iiicome tax burden on foreign corporations maintaining, on the one hand, local branch offices and organizing, on the other hand, subsidiary domestic corporations where at least a majority of all the latter’s shares of stock are owned by such foreign corporations. (Bank of America NT & SA v. Court of Appeals, 234 SCRA 302) ign Corporations Interest on foreign loan — 20% Final Tax. Dividend received from domestic corporation This is known as the tax sparing credit rule (Section 28 B 5[bj, NIRC). + Tax rate: 15% final tax. + Condition: foreign governrhent shall allow a credit against the tax due from the foreign corporation taxes deemed to have been paid, + Tax credit allowed: 15% effective Janu- ary 1, 2009 (R.A. No. 9337). Issues: + May a subsidiary corporation (withholding agent) file an action for refund? Answer: Procter and Gamble Philip- pines, subsidiary corporation of P & G-USA is properly re- garded as a “taxpayer” within the meaning of Section 309, NIRC (now Section 22{N}) and therefore, authorized to file re- CHAPTER 5. at ‘CORPORATE INCOME TAXATION fund. Withholding agent is tech- nically considered as taxpayer, Reason: It is also an agent of the taxpayer in reporting such an income. (Com. v. Procter, 204 SCRA 377) + Does the phrase “deemed paid” tax credit ‘mean tax credit actually granted by the foreign country? Answer; The Tax Code merely requires that the foreign country (USA) shall allow a credit against the tax due from Procter and Gamble-USA for taxes deemed to have been paid in the Phil- ippines. There is no statutory provision or revenue regula- tion requiring “Actual Grant.” Therefore, the phrase "deemed paid" “tax credit” does not imply tax credit actually granted by the foreign government. + Purpose of Tax Sparing Credit: To encourage foreign investments and to attract foreign investors. F, TAX EXEMPT CORPORATIONS UNDER THE NIRC (1) Labor, Agriculture, or Horticultural Organization Not Organized Principally for Profit a) Provincial fairs and like associations of a quasi- public character designed to encourage devel- opment of better agricultural and horticultural products through a system of awards, prizesBASIC APPROACH TO INCOME TAXATION or premiums and whose income derived from gate receipts, entry fees, donations, etc. is used exclusively to meet necessary expenses of upkeep and operation are thus exempt. b) On the other hand, the holding of periodical race meets by associations, the profits from which inure to the benefit of their stockholder are not tax-exempt. Similarly, corporations engaged in growing agricultural or horticultural products or raising livestock or similar products for profit are subject to tax. (Section 25, Rev. Regs, No. 2) (2) Mutual Savings Banks and Cooperative Banks a) Requisites for exemption: i. No capital stock represented by shares; ji, Earnings, less only the expenses of oper- ating are distributable wholly among the depositors (Section 26, Rev. Regs. No. 2 iii. Operated for mutual purposes and without profit } Exemption applies to foreign as well as domes- tic banks. ©) Notqualified as mutual savings bank if deposits are made compulsory under contracts between the bank and depositors and is operated for speculation rather than for savings. (C.C. 262; C.B. ill-2, 248; Mateus, ibid., Vol. 6, p. 7) (3) Fraternal Beneficiary Society, Order or Associa- tion a) Requisites for exemption: CHAPTER 5 83 CORPORATE INCOME TAXATION i. Operated under lodge system or for the exclusive benefit of the members of a society — they have parent and local organizations which are active (Western Funeral Benefit Association v. Helimich, 26, [2d] 367); ii, Established system of payment to its members or their dependents of life, sick, accident, or other benefits (Section 27, Rey. Regs. No. 2); ili, No part of the net income inures to the benefit of the stockholders or members. b) Agrand lodge established for the care of the members, their dependents, and members of an affliated lodge unable to earn a livelihood by reason of the infirmities of age was held tax exempt. c) Mutual protective societies not operating un- der the lodge system and traveler's associa- tion providing for fixed death benefits to the beneficiaries or members are not tax exeimpl. (Commercial Travelers Life and Accident As- sociation v. Rodway, 235 Fed. 370) (4) Cemetery Companies a) Requisites for exemption: i. Owned and operated exclusively for the benefit of its owners; ii, Not operated for profit, b) Any cemetery corporation chartered solely for burial purposes and not permitted by its charter to engage in any business not neces-