Pxopy, Well Organized Comprehensive Perse Teale) Pata ae WAU ta Self-taught NVicphOletLicdeclenccloh Optional Tax Eckel INCOME Laws Principles and Applications REX B. BANGGAWAN, CPA, MBAINCOME TAXATION LAWS, PRINCIPLES AND APPLICATIONS Well Organized Comprehensive Illustrative Simplified CREATE Law Updated Self-taught Designed for OBE An Integrated Principle-based Approach A Guide to Understanding and Mastering Income Tax Principles and Applications For Accountancy students CPA Board Exam candidates Finance & Business students, Law students Taxpayers and Tax practitioners By REX B, BANGGAWAN, CPA, MBA.INCOME TAXATION 2021 EDITION OVERVIEW OF CONTENTS Introductory concepts to taxation The concept of tax, tax laws and tax administration The concept of gross income under taxation Taxation schemes, accounting period, methods and income reporting Final income taxes Capital gains taxes Overview of the regular income tax Exclusions and exempt income Income subject to regular income tax Compensation income Fringe benefits and the fringe benefits tax Dealings in properties subject to regular tax Allowable deductions from gross income Specific regular tax rules applicable individuals Specific regular tax rules applicable to corporations"THE CONCE MAP OF INCOME TAXATION Introductory concepts (Chapters 1-2) Capital Gains Taxation Regular Income Taxation Fringe benefits Gains on dealings in properties r Gross income Less: Deductions from gross income XXX Taxable income P_XXX J J Individual Taxpayers (Progressive Income Tax) Corporate Income Taxpayers (Corporate Income Tax) Chapter 154-15B Special individual tax rules: Taxable estates Taxable trusts Special corporate tax rules: Gross income tax McIT Branch profit remittance taxTABLE OF CONTENTS PARTI INTRODUCTORY CONCEPTS CHAPTER 1 Introduction to Taxation 1-34 Definition of taxation : Theories of cost allocation The Lifeblood Doctrine ‘The inherent powers of the State The scope of taxation Inherent limitations Constitutional limitations Stages of taxation Situs of taxation Other fundamental doctrines in taxation Double taxation Escape from taxation Tax amnesty and tax condonation Exercise Drills 6 BSIkada 1 i 1 ©: CHAPTER 2 Taxes, Tax Laws, and Tax Administration 35+ Taxation laws and tax exemption laws Sources of laws and administrative issuances Nature of Philippine tax laws Elements of tax Classification of taxes Tax distinguished with similar items Tax system Tax collection system 2 Principles of a sound tax system Tax administration Powers of the BIR and the CIR Other agencies with tax related functions Taxpayer classification for purposes of tax administration Exercise Drills ww ww wd rs SEGURA as PARTI INCOME RECOGNITION, MEASUREMENT AND REPORTING, AND TAXPAYER CLASSIFICATIONS CHAPTER 3 Introduction to Income Taxation 63-99 The concept of income 63 Elements of gross income 63 Capital items deemed with infinite value 64 Recovery of loss capital vs. recovery of loss profits 65 The concept of realized benefit 66 Complex transactions 67er Mode of realization of benefits ‘Types of income taxpayers Individual income taxpayers Classification rule for individual taxpayers Taxable estates and trusts Corporate taxpayers ‘The general rules in income taxation Situs of income Exercise Drills CHAPTER 4 Tax Schemes, Periods, and Methods and Reporting CHAPTER Income taxation schemes Classification of gross income Accounting period Short accounting period Accounting methods ‘Tax reporting ‘Types of tax returns Mode of filing income tax returns ‘Taxpayers mandated to use the eFPS Groupings of eFPS taxpayers Payment of taxes Penalties for filing of returns and late payment of taxes Exercise Drills PART IL SPECIAL INCOME TAXATION 5 Final Income Taxation Features of final income taxation ‘The final withholding system ‘Taxpayers subject to final income tax Items of passive income subject to final tax Final tax to individuals and corporations Final tax on interest from banks Final tax on dividends Final tax on royalties Final tax on prizes Final tax on winnings Final tax on informer’s reward Final tax on “tax free” covenant bonds Exceptions to the final taxation of certain taxpayers ‘The tax sparing rule Other applications of the final income tax Final withholding tax return: Entities exempt from final tax Exercise Drills a 69 70 7 72 74 74 77 78 83-99 100-135 100 101 102 103 105 118 118 118 119 119 121 121-124 125-135 136-171 136 136 137= CHAPTER 6 Capital Gains Taxation 172-227 Classification of taxpayer's properties 172 Analysis of taxpayer's properties 173 Asset classification rules 174 ‘Types of gains on dealings in properties 176 Scope of the capital gains taxation 176 Capital gains on the sale of stocks directly to buyer 176 Meaning of domestie stocks 176 Meaning of “other disposition” 477 Tax on sale of stacks through the PSE 178 Tax basis of stocks 180 Costing procedures for stocks 180 Capital gains tax rates for domestic stocks 183 Transactional compliance 184 Annualized capital gains tax 184 Installment payment of the two-tiered capital gains tax 187 Special rules on wash sales and tax-free exchanges 189 Tax free exchanges of property 193 Corporate reorganization 193 Initial acquisition of control 197 Capital gains tax on the sale of real property 201 Nature and scope of the 6% capital gains tax 203 Exceptions to the 6% capital gains tax 204 Installment payment of the 6% capital gains tax 207 Documentary stamp tax on the sale of capital 209 Exercise Drills 211-227 PART IV REGULAR INCOME TAXATION CHAPTER 7 Introduction to Regular Income Taxation ‘The regular income tax model and its characteristics Determination of taxable income of individual taxpay ‘The classification and globalization rule Determination of taxable income of corporations Income tax reporting format for individual taxpayers, Sales, revenue, receipts or fees Non-operating income Income tax reporting format for corporate taxpayers ‘Types of regular income tax Scope of the progressive income tax of individuals Computation of progressive income tax for individuals Determination of the corporate income tax Income tax forms Required attachments in the annual income tax returns Determination of tax due during transition of tax rates Quarterly filing of income tax returns Exercise DrillsUNIT 1- GENERAL RULES ON GROSS INCOME, CHAPTER 8 CHAPTER 9 Regular Income ation ~ Exclusions in Gross Income 259-288 List of exclusions from gross income 259 Proceeds of life insurance and return of premium 260 Gitts, bequests, and devises or descent 261 Compensation for injuries and sickness 262 Income exempt under treaty 263 Retirement benefits and termination benefits 263-265 Miscellaneous exempt benefits 266 Investment income of the government & foreign government 267 Prizes and awards 267 Mandatory contributions to SSS, GSIS, PhilHealth and HDMF 267 Contribution to Personal Equity Retirement Account (PERA) — 268 Gain on sale of bonds with more than 5 year maturity 269 Gains on redemption of shares in mutual funds. 269 Income from sale of gold to the BSP 270 Other exempt income under the NIRC and special laws 272 Barangay Micro-business Enterprises (BMBEs) 272 Covid-19 benefits 272 Qualification of exemption on exempt entities 276 Exercise Drills 277-288 Regular Income Taxation - Inclusions in Gross Income 289-331. List of inclusions in gross income subject to regular tax Interest income Rent and royalty income Dividends Conditional exemption of foreign-source dividends Annuities Prizes and winnings Partner's distributive share in GPP net income General criteria for inclusion in gross income Other sources of gross income subject to regular tax ‘Tax benefit on recoveries of past deductions Refund of non-deductible taxes Special considerations in reporting gross income The effect of accounting methods and situs The effect of VAT The effect of creditable withholding tax The power of the CIR to redistribute income and expense The transfer pricing regulation 289 291 292 293 294 296 297 298 299 299 300 303 304 304 307 308 309 310 Exercise Drills 315-331UNIT 2 - SPECIAL RULES ON GROSS INCOME CHAPTER 10 Compensation income CHAPTER 11 CHAPTER 12 Eniployer-employce relationship Elements of an employer employee relationship Types of employees as to function and taxability he tax model on compensation income Non-taxable compensation income De minimis benefits empt benefits under treaty Necessity or convenience of the employer rule Components of taxable compensation income Regular compensation Non-compensation items Supplemental compensation 13! month pay and other benefits Ilustrations: Compensation income ‘Taxability of minimum woge earners Rules of change in minimum wage status The withholding tax on compensation Benefits not subject to withholding tax on compensation Deadline of the withholding tax on compensation Treatment of the withholding tax on compensation Exercise Drills Fringe Benefits Taxation Tax treatments of fringe benefits Scope of the fringe benefit tax Exempt fringe benefits to the fringe benefits tax The fringe benefits tax and its characteristics Procedural computations of the fringe benefits tax Rules on valuation of fringe benefits Special guidelines on monetary value determination Fringe benefits tax rates, Grossed-up rates Computation of the fringe benefits tax Accounting entries Exercise Drills Dealings in Properties Dealings in properties subject to regular income tax Determination and treatment of gain or loss The holding period rule Presentation of gains or losses in the income tax return ‘The effect of situs rules on dealings in properties Net capital loss carry-over Special rules in tax basis determination ‘Tax free exchanges Merger or consolidation 332-378 332 333 333 334 334 335 338 340 341 342 342 344 347 352 356 359 360 363 363 364 365-378 379-409 379 380 382 383 384 385 386 394 394 395 396 399-409 410-449 410 410 412 413 415 416 418 421 422Initial acquisition of control 422 Exchanges not plainly for stocks 423 Wash sales 430 ‘Transactions considered exchanges 434 ercise Drills 436-449 UNIT 3 — DEDUCTIONS ON GROSS INCOME CHAPTER 13 Principles of Deductions 450-493 Business expense vs. personal expel 450 Allocation of common expenses 451 Business expense vs. capital expenditures 451 Rules on deducting capital expenditures 453 Depreciation methods 453 Special considerations with deductions 457 Asset related acquisition costs 459 he effects of accounting methods on deductions 462 The effect of VAT on deductions 463 ‘The general principles of deductions 463 ‘The LOAN Principle 464 ‘The Matching Rule 466 The Related Party Rule 467 ‘The Withholding Rule and rules of withholding 469 Summary of expanded withholding tax rates 470 Penalties for late withholding and remittances 472 Periods in which deductions or credits are taken 473 Non-deductible expenses 43 ‘Tax reporting classification of deductions 473 Modes of claiming deductions 474 Exercise Drills 476-493 CHAPTER 13-A Regular Allowable Itemized Deductions 494-536 List of itemized deductions 494 Interest expense 494 Taxes 500 Foreign income tax credit 501 Losses 504 Bad debts 507 Depreciation expense 509 Amortization expense on intangible assets 511 Depletion expense 511 Charitable contributions 515 Contributions to pension 519 Research and Development and general expenses 521 Entertainment and amusement expenses 522 Exercise Drills 525-536i CE a _ ~——etFs CHAPTER 13-B Special Allowable Itemized Deductions and 537-572 Net Operating Loss Carry-over 537 List of special deductions 538 Special expenses under the NIRC and special laws a Deduction incentives under special laws 356 Net Operating Loss Carry-over eo7 NOL vs. NOLCO 559 Requisites for the deductibility of NOLCO sé Rules in carry-over of NOLCO be NOLCO for individual taxpayers 564 NOLCO and merger and consolidation 7 Exercise Drills 565-5 CHAPTER 13-C Optional Standard Deduction 573-5" The Optional Standard Deduction (OSD) ‘Taxpayers mandatorily required to use itemized deductions 573 OSD percentages and bases 574 Rules on determination of OSD for individuals 576 Other taxable income from operations 576 Non-operating income 877 OSD for corporate taxpayers pe Cost of services OSD for general professional partnership including partners 585 Exercise Drills 590-598 UNIT 4— SPECIFIC REGULAR TAX RULES PER TAXPAYER CLASS Sub-Unit 1 Special Regular Tax Rules for Individual taxpayers CHAPTER 14 Individual Income Taxation 599-637 Income tax tables for individual taxpayers 599 Taxpayers subject to percentage tax 600 Pure compensation income earners 600 Conditions for substituted filing system 601 Pure business and or professional income earner 604 Mixed income earner 606 The 8% optional income tax 607 Interim transition to the Value Added Tax 613 Taxable estates and trusts 616 Consolidation of two or more trusts 618 Employee trust fund 619 Return of married taxpayers 620 Individuals with PERA accounts 621 Where to file Income Tax Returns 622 Installment payment of regular income tax 623 Amendment of income tax return 625 Exercise Drills 626-637Sub-Unit 2 Special Regular Tax Rules for Corporate taxpayers CHAPTER 15-A Corporate Income Taxation - Special Corporations General classification and tax rules for corporations Domestic MSME corporations Sub-classification of corporate taxpayers Exempt corporations The classification rule Requisites of exemption of non-profit corporations Exception to the classification rule Taxation of cooperatives Allocation of common expenses of exempt corporations Reporting requirements for exempt corporations Special domestic corporations ‘The Pre-dominance test ‘Taxation of FCDUs, EFCDUs Special resident foreign corporations Tax on OBUs ‘Taxation of RHQs and ROHQs of multinational companies ‘Tax on international carriers BO! or PEZA-registered enterprises ecial non-resident foreign corporations CHAPTER 15-B Corporate Income Taxation ~ Regular Corporations Appendix 1 Appendix 2 Appendix 3 Appendix 4 The repular corporate income tax The minimum corporate income tax ‘Timing of MCIT imposition ‘The MCIT concept of “Gross income” MCIT basic application MCIT Integr plication Excess MCIT carry-ove Corporate tax transition schedule Quarterly MCIT Relief from the imposition of the MCIT ‘The branch profit remittance tax xercise Drills Appendices Table summary for final income tax rates Withholding tax tables on compensation Income tax table for individual taxpayers List of compromise penalties relevant to income tax 638-682 638 639 641 642 642 644 645, 648 650 651 651 651 653 658 659 660 660 666 666 669-682 683-721 683 683 684 685 one 689 691 694 699 700 701 706-721- Introduction to Taxation cuAPTER 1 INTRODUCTION To Taxation Chapter Overview and Objectives This chapter discusses the fundamental principles of uation this chapter, readers bah following: must be able to comprehend and demonstrate mastery Concept of taxation and its necessity Lifeblood doctrine and its implestonto neat Theories of government cost allocation Inherent power of the State Scope of the taxation power Limitations of the taxation power Stages of taxation Concept of situs in taxation . Fundamental principles surrounding taxation 10. Various escapes from taxation 11, Concept of tax amnesty and condonation ~PErnauneenr WHAT IS TAXATION? Taxation may be defined as a State power, a legislative process, and a mode of government cost distribution. a 1. Asa state power Taxation is an inherent power of the State to enforce a proportional contribution from its subjects for public purpose. 2. Asaprocess Taxation is a process of levying taxes by the legislature of the State to enforce proportional contributions from its subjects for public purpose. 3. Asa mode of cost distribution Taxation is a mode by which the State allocates its costs or burden to its subjects who are benefited by its spending, The Theory of Taxation Every government provides a vast array of public services including defense, Public order and safety, health, education, and social protection among others.Chapter 1 - Introduction to Taxation Assystem of government is indispensable to every society. Without i, the peop, will not relish the benefits of a civilized and orderly society. However, a government cannot exist without a system of funding. The government's neces, for funding is the theory of taxation. The Basis of Taxation The government provides benefits to the people in the form of public services. the people provide the funds that finance the government. This mutual, support between the people and the government is referred to as the bas, taxation, This mutuality is illustrated as follows: Public services Government People ti taxes Receipt of benefits is conclusively presumed Every citizen and resident of the State directly or indirectly benefits from: public services rendered by the government. These benefits can be in the fore daily free usage of public infrastructures, access to public health or educatio. services, the protection and security of person and property, or simply comfort of living in a civilized and peaceful society which is maintained by! government. While most public services are received indirectly, their realization by e citizen and resident is undeniable. In taxation, the receipt of these benefits by people is conclusively presumed. Thus, taxpayers cannot avoid payment of under the defense of absence of benefit received. The direct receipt or at availment of government services is not a precondition to taxation. THEORIES OF COST ALLOCATION Taxation is a mode of allocating government costs or burden to the people distributing the costs or burden, the government regards the following ge" considerations in the exercise of its taxation power: 1. Benefit received theory 2. Ability to pay theoryChapter 1 - Introduction to Benefit received theory The benefit received theory presupposes that the more bencfit one receives fr the government, the more taxes he should pay. Ability to pay theory The ability to pay theory presupposes that taxpayer's ability to pay. their relative capacity te tion should also consider the xpayers should be required to contribute based or sacrifice for the support of the government. In short, those who have more should be taxed more even if they benefit less from the government. Those who have less shall contribute less even if they receive more of the benefits from the government. Aspects of the Ability to Pay Theory 1. Vertical equity 1 4 Vertical equity proposes that the extent of one’s ability to pay is directly proportional to the level of his tax base. For example, A has P200,000 income while B has P400,000. In taxing income. th government should tax B more than A because B has greater income; hence, a grea capacity to contribute. 2. Horizontal equity Horizontal equity requires consideration of the particular circumstance of the taxpayer. For example, Businessmen A and B both have P300,000 income. & incurred P200,000 in business expenses while B incurred only P50,000 business expenses. The government should tax B more than A because he has lesser expenses and thus greater capacity to contribute taxes. Vertical equity is a gross concept while horizontal equity is a net concept. The Lifeblood Doctrine Taxes are essential and indispensable to the continued subsistence of the government. Without taxes, the government would be paralyzed for lack of motive power to activate or operate it. (CIR vs, Algue) Taxes are the lifeblood of the government, and their prompt and certain availability are an impcrious need. Upon taxation depends the government's ability to serve the people for whose benefit taxes are collected. (Vera vs Fernandez)Chapter 1 - Introduction to Taxatior Implication of the lifeblood doctrine in ta ation Tax is imposed even in the absence of a Constitutional gra Claims for tax exemption are construed against taxpayers The government reserves the right to choose the objects of taxation The courts are not allowed to interfere with the collection of taxes In income taxation: a. Income received in advance is taxable upon receipt b. Deduction for capital expenditures and prepayments is not allo effectively defers the collection of income tax A lower amount of deduction is preferred when a claimable ex subject to limit. d. Ahigher tax base is preferred when the tax object has multiple ta INHERENT POWERS OF THE STATE A government has its basic needs and rights which co-exist with its creation. It: rights to sustenance, protection, and properties. The government sustains itself the power of taxation, secures itself and the well-being of its peoplebs power, and secures its own properties to carty out its public services by : power of eminent domain. These rights, dubbed as “powers” are natural, inseparable, and inherent to ee government. No government can sustain or eliectively operate without th powers. Therefore, the exercise of these powers by the government is presur understood and acknowledged by the people from the very moment they estab their government. These powers are naturally exercisable by the governn: even in the absence of an express grant of power in the Constitution. The Inherent Powers of the State 4. Taxation power is the power of the State to enforce proportional contri from its subjects to sustain itself. 2. Police power is the general power of the State to enact laws to protect! well-being of the people. 3. Eminent domain is the power of the State to take private property for p use after paying just compensation.Chapter 1 - Introduction to Taxation Comparison of the three powers of the State Point of Eminent Difference Taxation Police Power Domain Exercising Government Government Government and Authority _| private utilities Purpose For the support of | To protect the For public use the government | general welfare of the people Persons Community or | Community or Owner of the affected class of class of property individuals individuals Amount of Unlimited Limited No amount Imposition (Tax is based on (Imposition is imposed. government limited to cover | (The government needs.) cost of regulation.) pays just compensation.) Importance Most important_| Most superior Important Relationship Inferior tothe | Superior tothe | Superior to the with the “Non-impairment | “Non-impairment | “Non-impairment Constitution Clause” of the Clause” of the Clause” of the Constitution Constitution Constitution Limitation Constitutional Publicinterest | Public purpose andinherent | and due process and just limitations compensation Similarities of the three powers of the State 1. They are all necessary attributes of sovereignty. 2. They are all inherent to the State. 3. They are all legislative in nature. 4. They are all ways in which the State interferes with private rights and properties. 5. They all exist independently of the Constitution and are exercisable by the government even without a Constitutional grant. However, the Constitution may impose conditions or limits for their exercise. 6. They all presuppose an equivalent form of compensation received by the persons affected by the exercise of the power. 7. The exercise of these powers by the local government units may be limited by the national legislature.Chapter 1 - Introduction to Taxation OPE OF THE TAXATION POWER the scope of taxation is widely regarded as comprehensive, plenary, unlinite and supreme. However, despite the seemingly unlimited nature of taxation, it is not absolute unlimited. Taxation has its own inherent limitations and limitations imposed 5 the Constitution. ‘THE LIMITATIONS OF THE TAXATION POWER AY Inherent limitations Territoriality of taxation International comity Public purpose Exemption of the government Non-delegation of the taxing power 1 2. 3. 4. 5. Constitutional Limitations 1. Due process of law 2. Equal protection of the law 3. Uniformity rule in taxation 4. Progressive system of taxation 5. Non-imprisonment for non-payment of debt or poll tax 6. Non-impairment of obligation and contract 7. Free worship rule 8. Exemption of religious or charitable entities, non-profit cemeterie churches and mosque from property taxes 9. Non-appropriation of public funds or property for the benefit of at church, sect or system of religion 10, Exemption from taxes of the revenues and assets of non-profit, non-sto educational institutions Concurrence of a majority of all members of Congress for the passage of law granting tax exemption 12. Non-diversification of tax collections 13. Non-delegation of the power of taxation 14, 11. Non-impairment of the jurisdiction of the Supreme Court to review t cases 15. The requirement that appropriations, revenue, or tariff bills sh originate exclusively in the House of Representatives 16. The delegation of taxing power to local government unitsChapter 1 - Introduction to Taxation INHERENT LIMITATION OF TAXATION Territoriality of taxation Public services are normally provided within the boundaries of the State. Thus, the government can only demand tax obligations upon its subjects or residents within its territorial jurisdiction. There is no basis in taxing foreign subjects abroad since they do not derive benefits from our government. Furthermore, extraterritorial taxation will amount to encroachment of foreign sovereignty. Two-fold obligations of taxpayers: 1. Filing of returns and payment of taxes 2. Withholding of taxes on expenses and its remittance to the government These obligations can only be demanded and enforced by the Philippine government upon its citizens and residents, It cannot enforce these upon subjects outside its territorial jurisdiction as this would result in encroachment of foreign sovereignty. af Exception to the territoriality principle 1, Inincome taxation, resident citizens and domestic corporations are taxable on income derived both within and outside the Philippines. 2, In transfer taxation, residents or citizens such as resident citizens, non- resident citizens and resident aliens are taxable on transfers of properties located within or outside the Philippines. International comity In the United Nations Convention, countries of the world agreed to one fundamental concept of co-equal sovereignty wherein all nations are deemed equal with one another regardless of race, religion, culture, economic condition or military power. No country is powerful than the other. It is by this principle that each country observes international comity or mutual courtesy or reciprocity between them. Hence, 7 1. Governments do not tax the income and properties of other governments. 2. Governments give primacy to their treaty obligations over their own domestic tax laws, Embassies or consular offices of foreign governments in the Philippines including international organizations and their non-Filipino staff are not subject to income taxes or property taxes. Under the National Internal Revenue Code (NIRC), theChapter 1 - Introduction to Taxation income of foreign government and foreign government-owned and controle, corporations are not subject to income tax. a When a state enters into treaties with other states, it is bound to honor th agreements as a matter of mutual courtesy with the treaty partners © the same conflicts with its local tax laws. Public purpose / ely Tax is intended for the common good. Taxation must be exercised absolutely for public purpose. It cannot be exercised to further any private interest. Exemption of the government : The taxation power is broad, The government can exercise the power upor anything including itself. However, the government normally does not tax itself a this will not raise additional funds but will only impute additional costs. Under the NIRC, government properties and income from essential_public functions are not subject to taxation. However, the income of the governmen from its properties and activities conducted for profit, including income fron government-owned and controlled corporations is subject to tax. Non-delegation of the taxing power The legislative taxing power is vested exclusively in Congress and is non delegable, pursuant to the doctrine of separation of the branches of th government to ensure a system of checks and balances. The power of lawmaking, including taxation, is delegated by the people to th legislature. So as not to spoil the purpose of delegation, it is held that what ha been delegated cannot be further delegated. Exceptions to the rule of non-delegation 1. Under the Constitution, local government units are allowed to exercise th power to tax to enable them to exercise their fiscal autonomy. 2. Under the Tariff and Customs Code, the President is empowered to fix th amount of tariffs to be flexible to trade conditions. —_ Other cases that require expedient and effective administration an implementation of assessment and collection of taxes. CONSTITUTIONAL LIMITATIONS OF TAXATION Observance of due process of law No one should be deprived of hi law. Tax laws should neither be fy life, liberty, or property without due process ¢ harsh nor oppressive, 8Chapter 1 - Introduction to Taxation Aspects of Due Process 4. Substantive due process Tax must be imposed only for public purpose, collected only under authority of a valid law and only by the taxing power having jurisdiction. An assessment without a legal basis violates the requirement of due process. 2, Procedural due process There should be no arbitrariness in assessment and collection of taxes, and the government shall observe the taxpayer's right to notice and hearing. The law established procedures which must be adhered to in making assessments and in enforcing collections. Under the NIRC, assessments shall be made within three years from the due date of filing of the return or from the date of actual filing, whichever is later. Collection shall be made within five years from the date of assessment. The failure of the government to observe these rules violates the requirement of due process. Equal protection of the law No person shall be denied the equal protection of the law. Taxpayers should be treated equally both in terms of rights conferred and obligations imposed. This rule applies where taxpayers are under the same_circumstances and conditions. This requirement would mean Congress cannot exempt sellers of “palot” while subjecting sellers of “penoy” to tax since they are essentially the same goods. Uniformity rule in taxation ‘The rule of taxation shall be uniform and equitable. Taxpayers under dissimilar circumstances should not be taxed the same. Taxpayers should be classified according to commonality in attributes, and the tax classification to be adopted should be based on substantial distinction. Each class is taxed differently, but taxpayers falling under the same class are taxed the same. Hence, uniformity is relative equality. Progressive system of taxation Congress shall evolve a progressive system of taxation. Under the progressive system, tax rates increase as the tax base increases. The Constitution favors progressi x as it is consistent with the taxpayer's ability to pay. Moreover, the progressive system aids in an equitable distribution of wealth to society by taxing the rich more than the poor.— — 1 - Introduction to Taxation Non-imprisonment for non-payment of debt or poll tax Asa policy, no one shall be imprisoned because of his poverty, and no one shall j, imprisoned for mere inability to pay debt. However, this Constitutional guarantee applies only when the debt is acquired by the debtor in good faith. Debt acquired in bad faith constitutes estafa, a crimiyg, offense punishable by imprisonment. Is non-payment of tax equivalent to non-payment of debt? Tax arises from law and is a demand of sovereignty. It is distinguished from deby which arises from private contracts. Non-payment of tax compromises public interest while the non-payment of debt compromises private interest. The non. payment of tax is similar to a crime. The Constitutional guarantee on nop. imprisonment for non-payment of debt does not extend to non-payment of tay, except poll tax. Poll, personal, community or residency tax Poll tax has two components: a. Basic community tax b. Additional community tax The constitutional guarantee of non-imprisonment for non-payment of poll tay applies only to the basic community tax. Non-payment of the additional community tax is an act of tax evasion punishable by imprisonment. Non-impairment of obligation and contract The State should set an example of good faith among its constituents. It should not set aside its obligations from contracts by the exercise of its taxation power. Tax exemptions granted under contract should be honored and should not be cancelled by a unilateral government action. Free worship rule The Philippine government adopts free exercise of religion and does not subject its exercise to taxation. Consequently, the properties and revenues of religious institutions such as tithes or offerings are not subject to tax. This exemption, however, does not extend to income from properties or activities of religious institutions that are proprietary or commercial in nature. Exemption of religious, charitable or educational entities, non-profit cemeteries, churches and mosques, lands, buildings, and from property taxes provements 10Chapter 1 - Introduction to Taxation The Constitutional exemption from roperty tax applies fc rties actually, directly, and exclusive Property tax applies for: prope (ie. pr pela educational purposes, primarily) used for charitable, religious, In observing this Constitutional limitation, the Philippines follows the doctrine of use. wherein only properties actually devoted for religious, charitable, or educational activities are exempt from real property tax. Under the doctrine of ownership, the properties of religious, charitable, or educational entities whether or not used in their primary operations are exempt from real property tax. This, however, is not applied in the Philippines. Non-appropriation of public funds or property for the benefit of any church, sect, or system of religion This constitutional limitation is intended to highlight the separation of religion and the State. To support freedom of religion, the government should not favor any particular system of religion by appropriating public funds or property in support thereof. It should be noted, however, that compensation to priests, imams, or religious ministers working with the military, penal institutions, orphanages, or leprosarium is not considered religious appropriation. Exemption from taxes of the revenues and assets of non-profit, non-stock educational institutions including grants, endowments, donations, or contributions for educational purposes The Constitution recognizes the necessity of education in state building by granting tax exemption on revenues and assets of non-profit educational institutions. This exemption, however, applies only on revenues and assets that are actually, directly, and exclusively devoted for educational purposes. Consistent with this constitutional recognition of education as a necessity, the NIRC also exempts_government educational institutions from income tax and subjects private educational institutions to a minimal income tax. Concurrence of a majority of all members of Congress for the passage of a law granting tax exemption Tax exemption law counters against the lifeblood doctrine as it deprives the government of revenues. Hence, the grant of tax exemption must proceed only upon a valid basis. As a safety net, the Constitution requires the vote of the majority of all members of Congress in the grant of tax exemption. In the approval of an exemption law, an absolute majority or the majority of all members of Congress, not a relative majority or quorum majority, is required. However, in the withdrawal of tax exemption, only a relative majority is required. ~ coyNon-diversification of tax collections : Tax collections should be used only for public purpose. It should never by diversified or used for private purpose. Non-delegation of the power of taxation / The principle of checks and balances in a republican state requires that taxation power as part of lawmaking be vested exclusively in Congress. However, delegation may be made on matters involving the expedient ang effective administration and implementation of assessment and collection of taxes, Also, certain aspects of the taxing process that are non-legislative in character are delegated. Hence, implementing administrative agencies such as the Department of Finance and the Bureau of Internal Revenue (BIR) issues revenue regulations, rulings, orders, or circulars to interpret and clarify the application of the law. But even so, their functions are merely intended to interpret or clarify the proper application of the law. They are not allowed to introduce new legislations within their quasi- legislative authority. Non-impairment of the jurisdiction of the Supreme Court to review tax cases Notwithstanding the existence of the Court of Tax Appeals, which is a special court, all cases involving taxes can be raised to and be finally decided by the Supreme Court of the Philippines. Appropriations, revenue, or tariff bills shall originate exclusively in the House of Representatives, but the Senate may propose or concur with amendments. Laws that add income to the national treasury and those that allows spending therein must originate from the House of Representatives while Senate may concur with amendments. The origination of a bill by Congress does not necessarily mean that the House bill must become the final law. constitutional by the Supreme Court wher version of a tax bill. It was held n Senate changed the entire house Each local government unit shall exercise the power to create its own sources of revenue and shall have a just share in the national taxes This is a constitutional recognition of the local g autonomy of local governments and an express delegation of the taxing power. 12Chapter 1 - Introduction to Taxation STAGES OF THE EXERCISE OF TAXATION POWER 1. Levy or imposition 2, Assessment and collection (D Levy or imposition This process involves the enactment of a tax law by Congress and is called impact of taxation. It is also referred to as the legislative act in taxation. Congress is composed of two bodies: 1. The House of Representatives, and 2. The Senate As mandated by the Constitution, tax bills must originate from the House of Representatives. Each may, however, have their own versions of a proposed law which is approved by both bodies, but tax bills cannot originate exclusively from the Senate. Matters of legislative discretion in the exercise of taxation 1. Determining the object of taxation 2. Setting the tax rate or amount to be collected 3. Determining the purpose for the levy which must be public use 4. Kind of tax to be imposed 5. Apportionment of the tax between the national and local government 6. Situs of taxation 7, Method of collection (2-) Assessment and Collection \ The tax law is implemented by the administrative branch of the government. Implementation involves assessment or the determination of the tax liabilities of taxpay and collection, This stage is referred to as incidence of taxation or the administrative act of taxation. SITUS OF TAXATION Situs is the place of taxation. It is the tax jurisdiction that has the power to levy -faxes upon the tax object. Situs rules, serve as frames of reference in gauging whether the tax object is within or outside the tax jurisdiction of the taxing authority, Examples of Situs Rules: 1. Business tax situs: Businesses are subject to tax in the place where the business is conducted. Illustration A taxpayer is involved in car dealership abroad and restaurant operation in the Philippines. 13- | | Chapter 1 - Introduction to Taxation ‘The restaurant business will be subject to business tax in the Philippines since the business is conducted herein, but the car dealing business is exempt because the business is conducted abroad. 2. Income tax situs on services: Service fees are subject to tax where they are rendered. Illustration A foreign corporation leases a residential space to a non-resident Filipino citizen abroad. ‘The rent income will be exempt from Philippine taxation as the leasing service is rendered abroad. 3. Income tax situs on sale of goods: The gain on sale is subject to tax in the place of sale. Mlustration ; While in China, a non-resident OFW citizen agreed with a Chinese friend to sell his diamond necklace to the latter. They stipulated that the delivery of the item and the payment will be made a week later in the Philippines. The sale was consummated as agreed. The contract of sale is consensual and is perfected by the meeting of the minds of L the contracting parties. The perfection of the contract of sale is in China. The situs of taxation is China. The gain on the sale of the necklace will be taxable abroad and exempt in the Philippines. 4. Property tax situs: Properties are taxable in their location. Mlustration 4 An overseas Filipino worker has a residential lot in the Philippines. He will still pay real property tax despite his absence in the Philippines because his property is located herein, 5. Personal tax situs: Persons are taxable in their place of residence. Illustration Ahmed Lofti is a Sudanese studying medicine in the Philippines. Ahmed will pay personal tax in the Philippines even if he is an alien because he is residing in the Philippines. OTHER FUNDAMENTAL DOCTRINES IN TAXATION 1, Marshall Doctrine - “The power to tax involves the power to destroy.” Taxation power can be used as an instrument of police Power. It can be used to discourage or prohibit undesirable activities or occu power carries with it the power to destroy. 14 pation. As such, taxationChapter 1 - Introduction to Taxation However, the taxation power does not include the power to destroy if it is used solely for the purpose of raising revenue. (Roxas vs. CTA) 2, Holme’s Doctrine - “Taxation power is not the power to destroy while the court sits.” Taxation power may be used to build or encourage beneficial activities or industries by the grant of tax incentives. While the Marshall Doctrine and the Holme’s Doctrine appear to contradict each other, both are actually employed in practice. A good manifestation of the Marshall Doctrine is the imposition of excessive tax on cigarettes while applications of the Holme’s Doctrine include the creation of Ecozones with tax holidays and provision of incentives, such as the Omnibus Investment Code (E.0. 226) and the Barangay Micro-Business Enterprise (BMBE) Law. 3. Prospectivity of tax laws Tax laws are generally prospective in operation. An ex post facto law or a law that retroacts is prohibited by the Constitution. Exceptionally, income tax laws may operate retrospectively if so intended by Congress under certain justifiable conditions. For example, Congress can levy tax on income earned during periods of foreign occupation even after the war. 4. Non-compensation or set-off Taxes are not subject to automatic set-off or compensation. The_taxpayer cannot delay payment of tax to wait for the resolution of a lawsuit involving “his pending claim against the government. Tax is not a debt; hence, it is not subject to set-off. This rule is important to allow the government sufficient period to evaluate the validity of the claim. (See Philex Mining Corporation vs. CIR, G.R. 125704) Exceptions: a. Where the taxpayer's claim has already become due and demandable such as when the government already recognized the same and an appropriation for refund was made b. Cases of obvious overpayment of taxes c. Local taxes 5. Non-assignment of taxes Tax obligations cannot be assigned or transferred to another entity by contract. Contracts executed by the taxpayer to such effect shall not prejudice the right of the government to collect. 15I Chapter 1 - Introduction to Taxation Imprescr: in taxation Prescription is the lapsing of a right due to the passage of time. When one sleep on his right over an unreasonable period of time, he is presumed to hy waiving his right. The government's right to collect taxes does not prescrit. unless the law itself provides for such prescription. Under the NIRC, tax prescribes if not collected within 5 years from the date o its assessment. In the absence of an assessment, tax prescribes if not collecteg by judicial action within 3 years from the date the return is required to h. filed. However, taxes due from taxpayers who did not file a return or those who filed fraudulent returns do not prescribe. Doctrine of estoppel Under the doctrine of estoppel, any misrepresentation made by one party toward another who relied therein in good faith will be held true and binding against that person who made the misrepresentation. The government is not subject to estoppel. The error of any government employee does not bind the government. It is held that the neglect or omission of government officials entrusted with the collection of taxes should not be allowed to bring harm or detriment to the interest of the people. Also, erroneous applications of the law by public officers do not-block_the subsequent correct application of the same. 7 Judicial Non-interference Generally, courts are not allowed to issue injunction against the government's pursuit to collect tax as this would unnecessarily defer tax collection. This rule is anchored on the Lifeblood Doctrine. Strict Construction of Tax Laws When the law clearly provides for taxation, taxation is the general -rule-unless. there is a clear.exemption. Hence the maxim, “Taxation is the rule, exemption is the exception.” oo When the language of the law is clear and categorical, there is no room for interpretation. There is only room for application. However, when taxation Taws are vague, the doctrine of strict legal construction is observed, Vague tax laws Vague tax laws are construed against the government and in favor of the taxpayers. A vague tax law means no tax law. Obligation arising from law is not presumed. The Constitutional requirement of due process requires laws to be sufficiently clear and expressed in their provisions. 16Chapter 1 - Introduction to Taxation Vague exemption laws Vague tax exemption laws are construed against the taxpayer and in favor of the government. A vague tax exemption law means no exemption law. The claim for exemption is construed strictly against the taxpayer in accordance with the lifeblood doctrine, ‘The right of taxation is inherent to the State. It is a prerogative essential to the perpetuity of the government. He who claims exemption from the common burden must justify his claim by the clearest grant of organic or statute law. oe et al. vs, Smart Communications, Inc, G.R. No. 167260, February 27, When exemption is claimed, it must be shown indubitably to exist. At the outset, every presumption is against it. A well-founded doubt is fatal to the claim; it is only when the terms of the concession are too explicit to admit fairly of any other construction that the proposition can be supported. (Ibid) Tax exemption cannot arise from vague inference. Tax exemption must be clear and unequivocal. A taxpayer claiming a tax exemption must point to a specific provision of law conferring on the taxpayer, in clear and plain terms, exemption from a common burden. Any doubt whether a tax exemption exists is resolved against the taxpayer. (see Digital Telecommunications, Inc. vs. City Government of Batangas, et al) DOUBLE TAXATION Double taxation occurs when the same taxpayer is taxed twice by the same tax jurisdiction for the same thing. Elements of double taxation 1. Primary element: Same object 2. Secondary elements: a, Same type of tax b. Same purpose of tax cc. Same taxing jurisdiction d. Same tax period Types of Double Taxation 1. Direct double taxation This occurs when all the element of double taxation exists for both impositions. 17a Chapter 1 - Introduction to Taxation amples: a. An income tax of 10% on monthly sales and a 2% income tax on the annual sales (total of monthly sales) b. A 5% tax on bank reserve deficiency and another 1% penalty per day as a consequence of such reserve deficiency 2. Indirect double taxation ‘This occurs when at least one of the secondary elements of double taxation is not common for both impositions. Examples: | a. The national government levies business tax on the sales or gross receipts of business while the local government levies business tax upon the same sales or receipts. b. The national government collects income tax from a taxpayer on his income while the local government collects community tax upon the same income. c. The Philippine government taxes foreign income of domestic corporations and resident citizens while a foreign government also taxes the same income (international double taxation). Nothing in our law expressly prohibits double taxation. In fact, indirect double taxation is prevalent in practice. However, direct double taxation is discouraged because it is oppressive and burdensome to taxpayers. It is also believed to counter the rule of equal protection and uniformity in the Constitution. ized? The impact of double taxation can be minimized by any one or a combination of the following: How can double taxation be mini a. Provision of tax exemption only one tax law is allowed to apply to the tax object while the other tax law exempts the same tax object b, Allowing foreign tax credit - both tax laws of the domestic country and a foreign country tax the tax object, but the tax payments made in the foreign tax law are deductible against the tax due of the domestic tax law c. Allowing reciprocal tax treatment - provisions in tax laws imposing a reduced tax rates or even exemption if the country of the foreign taxpayer also gives the same treatment to Filipino non-residents therein d. Entering into treaties or bilateral agreements - countries may stipulate for a lower tax rates for their residents if they engage in transactions that are taxable by both of them 18Chapter 1 - Introduction to Taxation ESCAPES FROM TAXATION Escapes from taxation are the means available to the taxpayer to limit or even avoid the impact of taxation, Categories of Escapes from Taxation A, Those that result to loss of government revenue 1, Tax evasion, also known as tax dodging, refers to any act or trick that tends to illegally reduce or avoid the payment of tax. Examples: a. This can be achieved by gross understatement of income, non- declaration of income, overstatement of expenses or tax credit. b. Misrepresenting the nature or amount of transaction to take advantage of lower taxes. 2, Tax avoidance, also known as tax minimization, refers to any act or trick that reduces or totally escapes taxes by any legally permissible means. Examples: a. Selection and execution of transaction that would expose taxpayer to lower taxes. b. Maximizing tax options, tax carry-overs or tax credits c. Careful tax planning 3. Tax exemption, also known as tax holiday, refers to the immunity, privilege or freedom from being subject to a tax which others are subject ‘to. Tax exemptions may be granted by the Constitution, law, or contract. All forms of tax exemptions can be revoked by Congress except. those granted by the Constitution and those granted under contracts. B. Those that do not result to loss of government revenue 1. Shifting — Thi taxpayers. Forms of shifting a. Forward shifting ~This is the shifting of tax which follows the normal flow of distribution (i.e. from manufacturer to wholesalers, retailers to consumers). Forward shifting is common with essential commodities and services such as food and fuel. 19Chapter 1 - Introduction to Taxation rd shifting. Backwar, here buyer vith numer, b. Backward shifting - This is the reverse of forw shifting is common with non-essential commoditi have considerable market power and commodities substitute products. Onward shifting - This refers to any tax shifting in the distributio, channel that exhibits forward shifting or backward shifting, Shifting is common with business taxes where taxes imposed on busines revenue can be shifted or passed-on to customers. 2. Capitalization - This pertains to the adjustment of the value of an ass caused by changes in tax rates. For instance, the value of a mining property will correspondingly decrea when mining output is subjected to higher taxes. This is a form o° backward shifting of tax. 3. Transformation - This pertains to the elimination of wastes or losses by the taxpayer to form savings to compensate for the tax imposition o; increase in taxes. Tax Amnesty Amnesty is a general pardon granted by the government for erring taxpayers to give them a chance to reform and enable them to have a fresh start to be part ofa society with a clean slate. It is an absolute forgiveness or waiver by the government on its right to collect and is retrospective in application. Tax Condonation Tax condonation is forgiveness of the tax obligation of a certain taxpayer under certain justifiable grounds. This is also referred to as tax remission. Because they deprive the government of revenues, tax exemption, tax refund, ta amnesty, and tax condonation are construed against the taxpayer and in favor of the government. Tax Amnesty vs. Tax Condonation Amnesty covers both civil and criminal liabilities, but condonation covers onl civil liabilities of the taxpayer. Amnesty ‘operates retrospectively by forgiving past violations. : Condonatior applies prospectively to any unpaid balance of the tax; hence, the portion alread! paid by the taxpayer will not be refunded. ‘Amnesty is also conditional upon the taxpayer paying the government a portion &! the tax whereas condonation requires no payment. 20Chapter 1 - Introduction to Taxation CHAPTER 1: SELF-TEST EXERCISES Discussion Questions 1. Define taxation. 2. Distinguish the theory and the basis of taxation. 3. Whatare the theories of government cost allocation? Explain each. 4, Differentiate vertical and horizontal equity. 5. Discuss the Lifeblood Doctrine. 6, Enumerate and explain the inherent powers of the State. 7. Distinguish the three powers of the State and enumerate their similarities. 8. Describe the scope of the power of taxation. . Distinguish substantive due process from procedural due process. 10. Distinguish the concept of equality from the concept of uniformity in taxation. 11. Distinguish non-payment of debt versus non-payment of tax in terms of consequences. 12, What institutions are exempt from real property tax in the Constitution? 13. Which of the constitutional limitations are also classified as inherent limitations? 14. Explain the stages of the exercise of taxation power. 15. Explain the concept of situs. 16. Distinguish the Marshall Doctrine from the Holme’s Doctrine. 17. Discuss the doctrine of strict construction of tax laws. 18, Explain double taxation, its elements, and its types. 19. What are the categories of escapes from taxation? Enumerate and explain each means of escape under each category. 20. Distinguish tax amnesty from tax condonation. Exercise Drills In the space provided for, indicate whether the statement relates to a Constitutional limitation (C) or inherent limitation (1). If it is not a limitation to the taxing power, indicate (N). 1.__ | Non-assignment of taxes c 2.__| Territoriality of taxation z 3.__ | Taxes must be for public use 53 4. Exemption of the property of religious institutions from t income tax 5. _ | Exemption of the revenues and assets of non-profit, non- F stock educational institutions 6.__ | Non-delegation of the taxing power. i 7. Non-appropriation for religious purpose c 8. | The requirement of absolute majority in the passage of a ; tax exemption law. 9.__| Non-imprisonment for non-payment of tax or debt c 21Chapter 1 - Introduction to Taxation Taxpayers under the same circumstance should be 10. treated equal both in terms of privileges and obligations. 11, | Exemption from property taxes of religious, educational, itable entities. 12. | Government income and properties are not objects of taxation. 13. | Each local government shall have the power to create its own sources of revenue. 14,__| Imprescriptibility in taxation | 15._| Non-impairment of obligation and contracts. - 16.__| Guarantee of proportional system of taxation. | 17.__[ International courtesy { _| 18. | Non-impairment of the jurisdiction of the Supreme Court to review tax cases. { T9._| The government is not subject to estoppel. 20._| Imprisonment for non-payment of poll tax. Vv ‘True or False 1 1 of benefit before one could be compelled to pay f 1. There should be direct receip taxes. 5.2. Eminent domain involves confiscation of prohibited commodities to protect the well-being of the people. * 3. Horizontal equity requires consideration of the circumstance of the taxpayer. ~ 4. Taxes are the lifeblood of the government. ~ 5. Taxation is a mode of apportionment of government costs to the people. © 6. The exercise of taxation power requires Constitutional grant. ~ 7. Taxation is inherent in sovereignty. F 8. Police power is the most superior power of the government. Its exercise needs to be sanctioned by the Consti T 9. Allinherent powers presuppose an equivalent form of compensation. 10. The reciprocal duty of support between the government and the people underscores the basis of taxation. True or False 2 i The scope of taxation is regarded as comprehensive, plenary, unlimited, and supreme. ‘The Constitutional exemption of religious, charitable, and non-profit cemeteries churches, and mosques refers to income tax and real property tax. Taxpayers under the same circumstance should be taxed differently. Taxation is subject to inherent and Constitutional limitations. International comity connotes courtesy between nations, Collection of taxes in the absence of a law is violative of the Constitution®! requirement for due process. No one shall be imprisoned for non-payment of tax. 22