Subject: Taxation

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Page 1 of 34
 NAVOTAS POLYTECHNIC COLLEGE
Bachelor of Science in Business Administration
Taxation
Atty. Christian Wilfred D. Morales, CPA1

Module 1: General Principles of Taxation and Income Tax

Intended Learning Outcomes (ILO)

At the end of this topic, the student must have learned the fundamental principles
of taxation, understand the theoretical and basis of taxation, know the inherent
and constitutional limitations of taxation and the aspects, situs, nature and
characteristics of Taxation.

Lecture Proper and Discussion

DEFINITION AND CONCEPT OF TAXATION

Introduction

Taxation is the inherent power of the state or sovereign to impose burden upon
persons, property or rights within its jurisdiction for the purpose of raising
revenues in order to defray the legitimate expenditures of the government.

The power of taxation, being an essential and inherent attribute of sovereignty,

belongs, as a matter of right, to every independent government and needs no
express conferment by the people before it can be exercised. It is purely
legislative and, thus, cannot be delegated to the executive and judicial branches of
government without running afoul to the doctrine of separation of powers.2

Nature of Taxation

By nature, taxation is an attribute of sovereignty and is legislative in character.

The power of taxation is an inherent attribute of sovereignty; the government
chiefly relies on taxation to obtain the means necessary to carry on its operation.
Taxes are essential to its very existence; hence, the dictum that “taxes are the
lifeblood of the government”.3

1
Member of the Integrated Bar of the Philippines, Member of the Philippine Institute of Certified
Public Accountant, former Associate of Maceda, Valencia and Co., Maceda Valencia & Co. (MVCo.),
a member firm of Nexia International, former Senior Financial Specialist of Financial Management
Division (FMD), former Senior Internal Control Officer and Head of Financial Audit Section (FAS) of
Internal Audit Services, National Irrigation Adminstration (NIA), former Professor of Law and
Accounting at College of Business Administration, City of Malabon University (CMU), Attorney II at
BIR Legal Division, Law Practitioner
2
Film Development Council of the Philippines v. Colon Heritage Realty Corporation, G.R. No.
203754, June 16, 2015
3
Commissioner of Internal Revenue v. Eastern Telecommunications Philippines, Inc., G.R. No.
163835, July 7, 2010

Page 2 of 34
With the power of taxation being legislative, all the incidents are within the
control of the Legislative. The people of a state give to their government a right of
taxing themselves and their property, and as the exigencies of the Government
cannot be limited, they prescribe no limit to the exercise of this right, resting
confidently on the interest of the legislator and on the influence of the
constituents over their representatives, to guard themselves against its abuse.4

Taxation is a power that is purely legislative. Essentially, this means that in the
legislative primarily lies in the discretion to determine the nature (kind), object
(purpose), extent (rate), coverage (subjects), and situs (place) of taxation. It has
the authority to prescribe a certain tax at a specific rate for a particular public
purpose on persons or things within its jurisdiction. In other words, the legislature
wields the power to define what tax shall be imposed, why it should be imposed,
how much tax shall be imposed, against whom (or what) it shall be imposed.5

Characteristics of Taxation

As a general rule, the power to tax is plenary and unlimited in its range,
acknowledging in its very nature no limits, so that the principal check against its
abuse is to be found only in the responsibility of the legislature (which imposes
tax) to its constituencies who are to pay it.6

Belonging as a matter of incident to sovereignty, the power of taxation does not

need constitutional conferment. Constitutional provisions do not give rise to the
power to tax but merely impose limitations on that would be an invincible power.
Since the power of taxation is prerogative of sovereignty, relinquishment is never
presumed and any reduction or diminution must be strictly construed and must
be coached in clear and unmistakable terms.7

The power of taxation is sometimes called the power to destroy.8 Therefore, it

should be exercised with caution to minimize injury to the proprietary rights and
in order to maintain public trusts and confidence in the Government.

Taxation as an Inherent Power

At the outset, it must be emphasized that although the power to tax is inherent in
the State, the same is not true for local government units (LGU) because although
the mandate to impose taxes granted to LGU is categorical and long established,
the same is not encompassing as it is subject to limitations in Sec. 5, Art. X of the
1987 Constitution, viz.:

Section 5. Each local government unit shall have the power to create its own
sources of revenues and to levy taxes, fees, and charges subject to such guidelines
and limitations as the Congress may provide, consistent with the basic policy of

4
Sarasola v. Trinidad, G.R. No. L-14595, October 11, 1919
5
Chamber of Real Estate and Builders’ Association v. Romulo, G.R. No. 160756, March 9, 2010
6
MCAA v. Marcos, G.R. No. 120082, September 11, 1996
7
Churchull and Tait v. Concepcion, 34 Phil. 969, September 22, 1916
8
Roxas v. CTA, 23 SCRA 276, April 26, 1968

Page 3 of 34
local autonomy. Such taxes, fees, and charges shall accrue exclusively to the local
governments.

The power to tax is an attribute of sovereignty and thus, inherent in the State.
Such, however, is not true for provinces, cities, municipalities, and barangays as
they are not sovereign; rather, they are mere territorial and political subdivisions
of the Republic.9

It is settled that a municipal corporation unlike a sovereign state is clothed with

no inherent power of taxation. The charter or statute must plainly show an intent
to confer that power or the municipality cannot assume it. The power, when
granted, is to be construed strictissimi juris. Any doubt or ambiguity arising out of
the term used in granting that power must be resolved against the municipality.
Therefore, the power of a province to tax is limited to the extent that such power
is delegated to it either by the Constitution or by statute.10

The power to tax is primarily vested in Congress, however it may be exercised by

local legislative bodies not by virtue of a valid delegation but by direct authority
conferred by the Constitution.11

Hence, the power to tax is inherent only with respect to the State. For the LGUs,
their power to tax is a direct grant of the Constitution.

Fundamental Powers of the State

The fundamental powers of the State are police power, eminent domain and
power of taxation. These powers are inherent in nature and do not need
constitutional grant or an enabling law before the State can exercise them. The
mere existence of the State allows it to exercise the powers.

Police power is the state authority to enact legislation that may interfere with
personal liberty or property in order to promote the general welfare. As defined, it
consists of imposition of restraint upon liberty or property in order to foster the
common good. It is incapable of exact definition.12

The power of eminent domain is the ultimate right of the sovereign power to
appropriate, not only the public, but the private property of all citizens within the
territorial sovereignty, to public purpose.13

The power of taxation is the power by which the sovereign, through its
lawmaking body, raises revenue to defray the necessary and legitimate expenses
of the government.

In summary, the three powers can be described as follows:

9
Peliloy Realty Corporation v. The Province of Benguet, G.R. No. 183137, April 10, 2013
10
Icard v. City Council of Baguio, G.R. No. L-1281, May 31, 1949
11
Id.
12
Philippine Association of Service Exporters, Inc. v. Drilon, G.R. No. 81958, June 30, 1988
13
Bernas, Constitutional Rights and Social Demands; Notes and Cases, Part II, 2010 Edition, p. 589

Page 4 of 34
 Taxation Police Power Eminent Domain
To raise revenue and To promote public
To take private
Purpose to defray government welfare through
property for public use
expenditures regulations
Affects all persons, Affects only the
Affects all persons,
Scope property, privileges particular property
property and rights
and even rights comprehended
Public necessity and
Public necessity and
right of the state to self-
Basis Public necessity private property is
protection and self-
taken for public use
preservation
Limited only to cost of
Amount of Exaction No limit No limit
regulation
No special or direct
No direct benefits but
benefits received but Direct benefit received
a healthy economic
Benefits derived the enjoyment of the is in the form of just
standard of society is
privileges of living in an compensation
attained
organized society
Non-impairment of Inferior to the non- Superior to the non- Superior to the non-
contract impairment clause impairment clause impairment clause
The State, its political
subidivisions, and may
The State and its The State and its
Execising Authority be granted to public
political subidivisions political subidivisions
service companies or
public utilities

Purposes of Taxation

The primary purpose of taxation is to raise revenue to defray the legitimate

business expenses of the government to promote the general welfare and to
protect its citizens. The imposition, however, need not solely be for the purpose of
raising revenue in order to be classified as tax.

Special or Regulatory

Taxation is no longer envisioned as a measure merely to raise revenue to support

the existence of the government; taxes may be levied with a regulatory purpose to
provide means for the rehabilitation and stabilization of a threatened industry
which is affected with public interest as to be within the police power of the state.

Promotion of General Welfare

Taxation may be used as an implement of police power in order to promote the

general welfare of the people. In the case of Caltex v. COA, it was held that
taxation may be used to regulate oil industry because it is imbued with public
interest as it vitally affects the general welfare. Any unregulated increase in oil
prices could hurt the lives of a majority of the people and cause economic crisis of
untold proportions. The stabilization of oil prices is of prima concern, which the
state, via its police power, may be properly address.

Reduction of Social Inequity

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The Philippines adopts the progressive system of taxation which means that the
higher the tax base, the higher the tax one must pay. This system aims to reduce
social inequity by preventing concentration of wealth in the hands of few
individuals, the government will have more funds to provide for the social
amelioration programs and better infrastructure, health, education, and jobs for
the people.

Encourage Economic Growth

Taxation may also grant exemptions and reliefs in order to encourage

investments. With more investments coming in because attractive tax incentive
package, jobs are created and this increases the purchasing power of workers,
resulting to economic growth. Foreign corporations availing tax packages and
incentives creates business for local suppliers and service providers.

Protectionism

Taxation also serves a toll by providing structure and, mechanics for the
imposition of emergency measures, including tariffs, to protect domestic
industries and producers from increased imports which inflict or could inflict
serious injury.14

Principles of Sound Tax System

Fiscal Adequacy

The taxes collected by the government must be sufficient, adequate or at least

approximate, to government expenditures. Fiscal adequacy requires that sources
of revenues must be adequate to meet government expenditures and their
variations.15

Administrative Feasibility

The tax system should be capable of being effectively administered and enforced
with the least inconvenience to the taxpayer. However, non-observance of this
cannon will not render tax imposition invalid except to the extent that specific
constitutional and statutory limitations are impaired.16 Thus, even if a particular
tax may seem burdensome to implement, it is not necessarily invalid unless some
aspect of the tax is violative of any law or Constitution.

Theoretical Justice

The tax burden should be proportional to the taxpayer’s ability to pay. The
Constitution requires that taxation should be uniform and equitable. Uniformity
requires that all subjects or objects of taxation similarly situated are to be treated

14
Southern Cross Cement Corporation v. Secretary of Finance, G.R. No. 158540, July 8, 2004
15
Chavez v. Ongpin, G.R. No. 76778, June 6, 1990
16
Diaz v. Secretary of Finance, G.R. No. 193007, July 19, 2011

Page 6 of 34
alike both in privileges and liabilities. Violation of this canon renders the tax law
unconstitutional.17

Theories and Basis of Taxation

Lifeblood Theory

Taxes are the lifeblood of the government and so should be collected without
unnecessary hindrance. Without taxes, the government would be paralyzed for
lack of the motive power to activate and operate. The exercise of taxing power
derives its source from the very existence of the State whose social contract with
its citizens obliges it to promote public interest and common good.18

Necessity Theory

The power to tax is an attribute of sovereignty. It is a power emanating from

necessity. It is a necessary burden to preserve the State’s sovereignty and a means
to protect the citizenry and promotes their social and general welfare. The
existence of power to tax rest from the government mandate to oversee the
welfare of the people.19

Benefits-Protection Theory (Doctrine of Symbiotic Relationship)

Despite the reluctance to surrender part of one’s hard-earned income to the taxing
authorities, every person who is able must contribute his share in the running of
the government. The government, in turn, is expected to respond in the form of
tangible and intangible benefits intended to improve the lives of the people and
enhance their moral and material values. This symbiotic relationship is the
rationale of taxation.20

Favorable Business Climate Theory

Corporations owe their corporate existence and their privilege to do business to

the government. They also benefit from the effort of the government to improve
financial market and ensure a favorable business climate. It is therefore fair for
the government to require them to make a reasonable contribution to the public
expenses.21

DOCTRINE AND PRINCIPLES OF TAXATION

Prospectivity of Tax Laws

17
Commissioner of Internal Revenue v. Fortune Tobacco Corporation, G.R. No.180006, September 28,
2011
18
National Power Corporation v. City of Cabanatuan, G.R. No. L-22074, April 30, 1965
19
Commissioner of Internal Revenue v. Bank of the Philippine Islands, G.R. No.134062, April 17,
2007
20
Commissioner of Internal Revenue v. Algue, Inc., G.R. No. L-28896, February 17, 1988
21
Id.

Page 7 of 34
As a rule, laws have no retroactive effect, unless the contrary is provided.22 Tax
laws operate prospectively, irrespective of whether it enacts, amends, repeals or
modify existing tax laws, unless the purpose of legislature to give retroactive effect
is expressly stated in the law or implied from the language used. Thus, taxes must
only be imposed prospectively, as a general rule.

With respect to the Bureau of Internal Revenue (BIR) rulings, regulations, or

circulars, the Tax Code23 provides that any revocation, modification or reversal of
any of the rules and regulations promulgated by the Commissioner shall not be
given retroactive application if the revocation, modification or reversal will be
prejudicial to the taxpayers, except in the following cases:

(a) Where the taxpayer deliberately misstates or omits material facts from his
return or any document required of him by the Bureau of Internal Revenue;

(b) Where the facts subsequently gathered by the Bureau of Internal Revenue are
materially different from the facts on which the ruling is based; or

(c) Where the taxpayer acted in bad faith.

Thus, rulings or circulars promulgated by the Commissioner of Internal Revenue

(CIR) have no retroactive application where to so apply them would be
prejudicial to the taxpayer.

Estoppel

The doctrine of estoppel is based upon the grounds of public policy, fair dealing,
good faith and justice, and its purpose is to forbid one to speak against his own
act, representations or commitments to the injury of one to whom they were
directed and who reasonable relied thereon. This doctrine arises from equity
designed to aid the law in the administration of justice.24

Government is never estopped from collecting taxes because of mistakes or errors

on the part of its agents.25

Imprescriptibility of Taxes

Taxes are imprescriptible except when provided otherwise by the tax law itself.
For the purpose of safeguarding the taxpayers from any unreasonable
examination, investigation or assessment, our tax law provides a statute
limitation in the collection of taxes. Thus, the law on prescription, being a
remedial measure should be construed in order to afford such protection. As a
corollary, the exceptions to the law on prescription should be perforce be strictly
construed.26

22
Manila trading and Supply Co. v. Santos, 66 Phil. 237, September 26, 1938
23
Sec. 246 of the NIRC
24
Philippine National Bank v. Court of Appeals, 94 SCRA 357, November 21, 1979
25
Commissioner of Internal Revenue v. Benguet Corporation, G.R. No. 134588, July 8, 2005
26
Commissioner of Internal Revenue v. B.F. Goodrich Phil., Inc., G.R. No. 104171, February 24, 1999

Page 8 of 34
Double Taxation

Double taxation means taxing the same property twice when it should be taxed
only once; that is, taxing the same person twice by the same jurisdiction for the
same thing. It is obnoxious when the taxpayer is taxed twice, when it should be
but once. Otherwise described as direct duplicate taxation, the two taxes must be
imposed on the same subject matter, for the same purpose, by the same taxing
authority, within the same jurisdiction, during the same taxing period; and the
taxes must be of the same kind or character.27

In order to constitute double taxation in the objectionable or prohibited sense, the

same property must be taxed twice when it should be taxed once; both taxes must
be imposed on the same property or subject matter, for the same purpose, by the
same taxing authority, within the same jurisdiction, during the same taxing
period, and they must be the same kind or character of tax.28

Double taxation in the strict sense pertains to direct duplicate taxation. Double
taxation in the broad sense pertains to indirect double taxation, a case in which
there is burden of two or more impositions. Hence, there is no double taxation
when a taxpayer is simultaneously imposed of tax by the national government
and by the local government because there are two taxing authorities.

There is no constitutional prohibition against double taxation in the Philippines.

It is something not favored, but is permissible, provided some other constitutional
is not violated.29

International Juridical Double Taxation

International Juridical Double Taxation means the imposition of comparable

taxes in two or more states on the same taxpayer in respect of the same subject
matter and for identical period. The apparent rationale for doing away with
double taxation is to encourage free flow of goods, services and movement of
capital, technology, and persons between countries, conditions deemed vital in
creating robust and dynamic economies.30

Double taxation usually arises when a person is a resident of a contracting states

and derives income from, or owns capital, in, the other contracting state and both
states impose tax on that income or capital.

Double taxation may be prevented or at least be minimized by the following

method:

(a) Exemption Method, the income or capital which is taxable at the state of
source or situs is exempted at the state of residence, although in some instances it
27
Commissioner of Internal Revenue v. Bank of Commerce, G.R. No. 149636, June 8, 2005
28
Villanueva v. City of Iloilo, G.R. No. L-26521, December 28, 1968
29
Id.
30
Commissioner of Internal Revenue v. S.C. Johnson and Sons, Inc., 309 SCRA 87, June 25, 1999

Page 9 of 34
may be considered in determining the rate of tax applicable to the taxpayer’s
remaining income or capital.

(b) Credit Method, although the income or capital which us taxed in the state of
source is still applicable in the state of residence, the tax paid in the former is
credited against the tax levied in the latter. The basic difference between the two
methods is that in the exemption method, the focus is on the income or capital,
whereas the credit method focuses upon the tax.

(c) Tax Treaty, this is entered in sovereign capacity of the State with another State
which among others grants tax exemption or preferential rates on certain taxes.

Impact and Incidence of Taxation

The impact and incidence are material when understanding the distinction
between an indirect tax, a tax in which the liability for the payment of tax may be
shift to another, and direct tax, a tax in in which the liability cannot be shifted.

Impact of taxation means the point at which a tax is originally imposed. In so far
as the law is concerned, the taxpayer is the person who must pay the tax to the
government. The taxpayer is referred to as the statutory taxpayer, the one whom
the tax is formally assessed. Incidence of taxation means the point at which the
tax burden finally rests or settles down. It takes place when shifting has been
effected from the statutory taxpayer to another.

In relation thereto, direct taxes are those that are exacted from the very person to
whom it is intended and who should pay them; they are impositions for which a
taxpayer is directly liable on the transaction or business he is engaged in.

In contrast, indirect taxes are those demanded, in the first instance, from, or are
paid by, one person in the expectation and intention that he can shift the burden
to someone else. They are taxes wherein the liability for the payment of the tax
falls on one person but the burden thereof can be shifted to another.

To illustrate, in case a seller sold a merchandise to a buyer and such merchandise

is subject to Value-Added Tax (VAT), the selling price of such merchandise and
the amount paid for by the buyer includes the VAT. The seller, in effect, shifts the
tax burden, not the liability to pay the tax before the BIR, to the buyer as part of
the selling price. In this illustration, the seller is the statutory taxpayer, the one
whom the VAT is formally assessed (impact of taxation), but the seller may shift
the burden of the VAT to the buyer as part of purchase price (incidence of
taxation).31

Simply stated, a direct tax is a tax where the impact and incidence of taxation
falls to one person because the burden of payment cannot be shifted to another
person. An indirect tax, on the other hand, is a tax where the impact of taxation is

31
Commissioner of Internal Revenue v. PLDT, G.R. No. 140230, December 15, 2005

Page 10 of 34
on one person (statutory taxpayer) and the incidence is on another person
because the burden to pay the tax is shifted to him.

Thus, in cases of refund involving indirect taxes, it is the statutory taxpayer that
may claim the refund because the tax was formally assessed to him and not to the
other person to whom the burden of taxation settled.

Tax Avoidance and Tax Evasion

These methods are the most common ways used by the taxpayers in escaping
from taxation. Tax avoidance is the tax-saving device within the means
sanctioned by law. This method should be used in good faith and at arm’s length.
Tax Evasion, on the other hand, is a scheme used outside of those lawful means
and when availed of, usually subjects the taxpayer to civil and/or criminal
liabilities.

Tax evasion connoted the integration of three factors:

(a) The end to be achieved, that is the non-payment of tax due or payment of less
than that known by the taxpayer to be legally due;

(b) Accompanying state of mind which is evil, bad faith, willful or deliberate; and

(c) Course of action which is unlawful.32

The Tax Code imposes a penalty if imprisonment and fine to any person who
willfully attempts in any manner to evade or defeat any tax imposed or the
payment thereof. The conviction or acquittal for this violation does not prevent
the filing of a suit for the collection of taxes.

Tax Exemption

Exemption is an immunity or privilege; it is freedom from a charge or burden to

which others are subjected.33

Tax exemption is a mere personal privilege of the grantee. It implies a waiver on

the part of the government of its right to collect what otherwise would be due to
it. Exemptions are not discriminatory in character as long as the same is founded
on reason or rational basis.

Tax exemptions should be granted only by clear and unequivocal provision of law
on the basis of language too plain to be mistaken. They cannot be extended by
mere implication or inference.34 The burden of proof rests upon the party claiming
the exemption to prove that it is in fact covered by the exemption so claimed.

32
Commissioner of Internal Revenue v. Toda, G.R. No. 14718, September 14, 2004
33
PLDT v. City of Davao, G.R. No. 143867, March 25, 2003
34
National Power Corporation v. Province of Isabela, G.R. No. 165827, June 16, 2006

Page 11 of 34
The basis for the strict interpretation or construction of provisions granting tax
exemptions or deductions is to minimize differential treatment and foster
impartiality, fairness and equality of treatment among taxpayers. For exemptions
from taxation are not favored nor they are presumed in law.

Considering that taxation is the general rules, tax exemption may be withdrawn
at the pleasure of the taxing authority except when the exemption was granted to
private parties based on material consideration of mutual nature. In which case,
the exemption granted then becomes contractual in character and is thus covered
by the non-impairment clause of the Constitution.35

As taxation is legislative in character, the taxing authority is Congress itself,

hence, the grant of exemption and the removal thereof is within the power and
prerogative of Congress.

Tax Amnesty

A tax amnesty operates as a general pardon or intentional overlooking by the

State of its authority to impose penalties on persons otherwise guilty of evasion or
violation of a revenue or tax law. It is an absolute forgiveness or waiver of the
government of its right to collect what is due and to give tax evaders to start with
a clean slate.36

A tax amnesty, much like a tax exemption, is never favored nor presumed in law.
The grant of a tax amnesty is akin to tax exemption; thus, it must be construed
strictly against the taxpayer and in favor of the government.

Doctrine of Equitable Recoupment

This doctrine refers to a case where a taxpayer has a claim for refund but was not
able to file a written claim due to the lapse of the prescriptive period within which
to make a refund is allowed. Under this doctrine, the taxpayer is allowed to
credit such refund to his existing tax liability.37

Under our jurisdiction, failure of the taxpayer to claim a refund within the period
provided by the Tax Code shall bar any future claim due to prescription. Such
foregone claim for refund is not allowed to be credited to future tax liabilities.

Compensation and Set-Off

Compensation is a concept which takes place when two persons, in their own
right, are creditors and debtors of each other. It is a mode of extinguishing an
obligation.38

35
Id.
36
Commissioner of Internal Revenue v. Marubeni Corporation, 423 Phil. 862, December 18, 2001
37
Taxation Law Review, Francis J. Sababan, 2008 Edition, p. 14-5
38
Art. 1278, New Civil Code

Page 12 of 34
As a general rule, taxes cannot be the subject of compensation for the reason that
the government and the taxpayer are not creditors and debtors of each other.
There is a material distinction between a debt and a tax. The former is due to the
government in its corporate capacity and the latter is due to the government in its
sovereign capacity.39

By way of exception, compensation of debts and taxes is allowed when both of

the claims of the government and the taxpayer have already become due and
demandable as well as fully liquidated, that is an appropriation has already been
made.40

Compromise

A compromise is a contract where the parties, by making reciprocal concessions,

avoid litigation or put an end to one already commenced. Compromise of tax
cases is allowed.41 Under the Tax Code, the CIR is authorized to enter into
compromise of the civil and criminal aspect of taxes

CONSTRUCTION AND INTERPRETATION OF TAX LAWS

Nature of Tax Laws

Tax laws are civil and not penal in nature, although there are penalties provided
for their violation. The purpose of tax laws in imposing penalties for
delinquencies is to compel the timely payment of taxes or to punish evasion or
neglect of duty.42

Tax Laws

Tax laws should be interpreted in favor of the taxpayer and strictly against the
government, except in matters relating to tax exemptions and tax amnesty.43
Simply speaking, an income item is considered not taxable unless the tax law
clearly states because tax burdens are not to be presumed to be imposed.

In case of tax exemptions, tax laws should be interpreted in favor of the

government and strictly against the taxpayer. This is the doctrine of strictissimi
juris. Meaning, in the absence of clear import whether an income should be
exempt, the said income is within the purview of taxation because an exemption
to a common burden cannot be presumed. A person must be able to justify his
claim of exemption by words too plain to be mistaken and too categorical to be
misinterpreted.

INHERENT LIMITATIONS OF TAXATION

39
Philex Mining Corp. v. Commissioner of Internal Revenue, 294 SCRA 687, August 28, 1998
40
Domingo v. Garlitos, 8 SCRA 443, June 29, 1963
41
Art. 2028, New Civil Code
42
Lorenzo v. Posadas, Jr., G.R. No. L-43082, June 18, 1937
43
The Collector of Internal Revenue v. Suyoc Consolidated Mining Company, et. al., G.R. No. L-
11527, November 25, 1958

Page 13 of 34
Public Purpose

Taxes are exacted only for public purpose. They cannot be used for purely private
purpose or for the benefit of private persons for the reason that the power to tax
exist for the general welfare. It would be a plain robbery for a State to tax its
citizens and use the funds for private purpose.

The term “public purpose” does not only pertain to those which are traditionally
viewed as governmental function, like building roads, bridges and schools. The
term also includes those purpose designed to promote social justice. Thus, public
money may be use for low-cost housing, relocation of illegal settlers and social
reforms.44

It is a general rule that legislature, Congress, is without power to appropriate

public revenue for anything other than a public purpose. It is essential that the
character of the expenditures which must determine its validity as justifying a tax,
and not the magnitude of interest to be affected nor the degree to which the
general advantage of the community be ultimately be benefitted.45

Test in Determining Public Purpose

(a) Whether the thing threatened by the appropriation of public funds is

something which is the duty of the State as a government. This test is called Duty
Test.

(b) Whether the law providing the tax directly promotes the welfare of the
community in equal measure. This test is called Promotion of General Welfare
Test.

Inherently Legislative

Taxation is purely legislative, and Congress cannot delegate the power to others.
This limitation arises from the doctrine of separation of powers among the
Executive, Legislative and Judicial branches of the government. However, the
general rule prohibiting delegation of Congress of its power to tax is subject to the
following exceptions:

Delegation to LGUs

At present, the power to tax of LGUs is directly conferred by the Constitution

subject only to guidelines and limitations set by Congress consistent with the
policy of local autonomy. This can be found under Sec. 5, Art. X of the 1987
Constitution, viz.:

44
Planters Products, Inc., v. Fertiphil Corporation, G.R. No. 166006, March 14, 2008
45
Pascual v. The Secretary of Public Works and Communications, G.R. No. L-10405, December 29,
1960

Page 14 of 34
Section 5. Each local government unit shall have the power to create its own
sources of revenues and to levy taxes, fees, and charges subject to such guidelines
and limitations as the Congress may provide, consistent with the basic policy of
local autonomy. Such taxes, fees, and charges shall accrue exclusively to the local
governments.

Delegation to the President

Under Sec. 28(2), Art. VI of the 1987 Constitution provides that Congress may,
by law, authorize the President to fix within the specified limits, and subject to
limitations and restrictions it may impose, tariff rates, import and export quotas,
tonnage and wharfage dues, and other duties or impost within the framework of
national development program of the Government.

This delegation exists from the premised that custom duties may be reduced or
removed for the purpose of protecting consumers from high prices or maybe
increased for the protection of local industries.46

Delegation to Administrative Agencies

Some aspects of the taxing process that are not legislative in character may be
delegated to administrative agencies. In these cases, there really is no delegation
of power to tax, what is merely being delegated is the aspect of collection of taxes
under the Tax Code. The BIR is the primary government agency in charge in the
collection of taxes imposed. Collection of tax is not legislative in nature and thus,
can be properly delegated to an administrative agency.

Territoriality

Tax laws cannot operate beyond the State’s territorial limits. Persons, property,
right, or activity outside one’s jurisdiction does not receive any protection of the
State. Thus, if a law is passed by Congress, it must ensure that the object or
subject of taxation is within the territorial jurisdiction of the taxing authority.

Situs of Taxation

Situs of taxation means the “place of taxation” or the place or the authority that
has the right to impose and collect taxes.47 The following are the situs of different
taxes:

(a) With respect to income tax, the situs is determined by the nationality,
residence and source of income.

(b) With respect to property taxes involving real property, the situs is the place
where the real property is located.

46
Garcia v. The Executive Secretary, G.R. No. 101273, July 3, 1992
47
Id.

Page 15 of 34
(c) With respect to property taxes involving tangible personal property, the situs is
the place where the personal property is located.

(d) With respect to property taxes involving intangible personal property, the situs
is the place where the owner of the said intangible personal property resides.

(e) With respect to Estate and Donor’s tax, the situs is determined by the
nationality and residence of the donor, or in case of estate, the decedent, and the
location of the property.

(f) In case of Business Taxes, the situs is the place where the business is performed
or the occupation is engaged in.

(g) For the Sale of Real Property, the situs is the place or location of the real
property.

(h) For the Sale of Personal Property, the situs is the place of sale.

(i) For Value Added Tax (VAT), the situs where the goods, property or services
are destined, used, or consumed.

International Comity

In this limitation, the property or income of a state or foreign government may

not be taxed by another state or government where the said income is derived or
sourced or the property located.

Exemption of Government Entities, Agencies, and Instrumentalities

In our jurisdiction, there are two (2) different taxing authorities, namely, the
national government and the local government.

National Government

The taxing power of the State, or the national government, is comprehensive,

unlimited, plenary, and supreme. The State can impose tax in almost everything
within its jurisdiction and the State can even tax itself, its political subdivisions,
government agencies and instrumentalities. There is no prohibition on the
Constitution of such act. However, the legislature, Congress, chooses not to
impose tax on those performing governmental functions.

As such, a distinction can be made between those agencies performing

governmental functions and those performing proprietary or business functions.
With respect to the former, those agencies are exempt from taxation because they
are exercising functions which are sovereign in character or relating to
governance, on the other hand, the latter is subject to taxation because they are
functioning as an entity in their private capacity.48

48
Tax Principles and Remedies, Japar B. Dimaampao, 5th Edition, 2018, p. 66

Page 16 of 34
Local Government

The local government cannot impose tax to the national government and its
properties.49 This doctrine emanates from the “supremacy” of the national
government over the local government. Local governments have no power to tax
instrumentalities of the national government.

CONSTITUTIONAL LIMITATIONS OF TAXATION

Section 1, Article III. No person shall be deprived of life, liberty, or property

without due process of law, nor shall any person be denied the equal protection
of the laws.

Due Process Clause

The constitutional safeguard of due process is embodied in the “no person shall
be deprived of life, liberty, or property without due process of law.” Due process
has a dual aspect: the substantive due process, which requires the validity of the
law, and the procedural due process, which requires an opportunity to be heard
before an impartial and competent tribunal.50

Substantive due process, in taxation, requires that the enactment of tax laws must
be within the power of the Congress and within the limitations provided for. The
tax law must be valid before any right or liability may arise.

Procedural due process, on the other hand, requires that the taxpayer must be
informed of the nature and basis of the tax liability and must be given opportunity
to challenge or respond to such tax liability.

Equal Protection Clause

Equal protection means that no person or class of persons shall be deprived of the
same protection of laws which is enjoyed by other persons or other classes in the
same place and in like circumstances.51 This simply means that persons similarly
situated should be treated alike as to rights and obligations. The equal protection
clause does not guarantee absolute equality, but only equality among equals.
Hence, laws must not be discriminatory.

Section 10, Article III. No law impairing the obligation of contracts shall be
passed.

An impairment of an obligation of contract is a change is the terms of the

contracts between parties, either in the time or mode of performance, or imposes

49
Basco v. PAGCOR, 197 SCRA 52, May 14, 1991
50
Secretary of Justice v. Lantion, G.R. No. 139465, January 18, 2000
51
Philippine Rural Electric Cooperatives Association, Inc. v. DILG, G.R. No. 143076, June 10, 2003

Page 17 of 34
new conditions, or dispenses with those express or authorizes something different
from that provided in the terms.52

The purpose of this non-impairment clause is to safeguard the integrity of

contracts, the agreement between parties, against unwarranted intrusion of the
State. There is an impairment if an enacted law diminishes a contract.53

Section 20, Article III. No person shall be imprisoned for debt or non-payment
of a poll tax.

Poll tax is a fixed amount imposed on persons residing within a specified

territory, whether citizens or not, without regard to their property, occupation or
business in which they are engaged. A community tax is a common example of
poll tax.

Section 24, Article VI. All appropriation, revenue or tariff bills, bills
authorizing increase of the public debt, bills of local application, and private
bills, shall originate exclusively in the House of Representatives, but the
Senate may propose or concur with amendments.

At this juncture, it must be emphasized that Congress is composed of two houses.

The Senate, which is the Upper House, and the House of Representative, the
Lower House. In passing a law, both the Senate and the House must agree to the
bill.

Under this limitation, the Constitution simply means that the initiative for filing a
revenue, tariff, or tax bills, bills authorizing increase of the public debt, private
bills or bills of local application must come from the House of Representative.

Hence, it is enough that the initiative to file a revenue bill should originate from
the House of Representatives. The Senate only needs to wait for the revenue bill
to be passed by the House of Representatives, so it can later on propose or concur
with amendments.54

Section 28(1), Article VI. The rule of taxation shall be uniform and equitable.
The Congress shall evolve a progressive system of taxation.

Equality and uniformity of taxation means that all taxable articles or kinds of
property of the same class be taxed at the same rate. The taxing power has the
authority to make a reasonable and natural classification for purposes of
taxation.55

With respect to progressive system, a tax is progressive when the rate increase as
the tax base increases. With this in mind, the Constitution does not prohibit the
52
Clemons v. Nolting, 42 Phil. 702, January 24, 1992
53
Goldenway Merchandising Corporation v. Equitable PCI Bank, G.R. No. 195540, March 13, 2013
54
Tolentino v. Secretary of Finance and Commissioner of Internal Revenue, G.R. 115455, August 25,
1994
55
Churchill v. Concepcion, G.R. No. 11572, September 22, 1916

Page 18 of 34
imposition of indirect taxes, like VAT, which are regressive. It simply provides
that direct taxes are to be preferred and indirect taxes should be minimized. The
mandate is not to prescribe, but to evolve.56

Section 28(2), Article VI. The Congress may, by law, authorize the President
to fix within specified limits, and subject to such limitations and restrictions as
it may impose, tariff rates, import and export quotas, tonnage and wharfage
dues, and other duties or imposts within the framework of the national
development program of the Government.

This delegation exists from the premised that custom duties may be reduced or
removed for the purpose of protecting consumers from high prices or maybe
increased for the protection of local industries.57

Section 28(3), Article VI. Charitable institutions, churches and personages or

convents appurtenant thereto, mosques, non-profit cemeteries, and all lands,
buildings, and improvements, actually, directly, and exclusively used for
religious, charitable, or educational purposes shall be exempt from taxation.

This limitation applies only to Real Property Tax. In this, there must be specific
identification of real property based on its actual, direct and exclusive use to
determine whether it is exempted from real property tax.58

Section 28(4), Article VI. No law granting any tax exemption shall be passed
without the concurrence of a majority of all the Members of the Congress.

The requirement of majority concurrence pertains to the total membership of

Congress and not simply the majority of the quorum in a given day.

Section 5, Article X. Each local government unit shall have the power to
create its own sources of revenues and to levy taxes, fees and charges subject to
such guidelines and limitations as the Congress may provide, consistent with
the basic policy of local autonomy. Such taxes, fees, and charges shall accrue
exclusively to the local governments.

The power to tax of LGUs is made by direct authority as conferred in this

Section. This power, however is still subject to guidelines and limitations which
Congress may provide consistent with the policy of local autonomy.59

Section 4(3), Article XIV. All revenues and assets of non-stock, non-profit
educational institutions used actually, directly, and exclusively for educational
purposes shall be exempt from taxes and duties. Upon the dissolution or
cessation of the corporate existence of such institutions, their assets shall be
disposed of in the manner provided by law.

56
Philippine Airlines, Inc. v. Secretary of Justice, G.R. No. 115852, October 30, 1995
57
Id.
58
Lung Center of the Philippines v. Quezon City, G.R. No. 144104, June 29, 2004
59
Id.

Page 19 of 34
Proprietary educational institutions, including those cooperatively owned,
may likewise be entitled to such exemptions, subject to the limitations
provided by law, including restrictions on dividends and provisions for
reinvestment.

The revenues and assets of non-stock non-profit educational institution proved to

have been used actually, directly, and exclusively used for educational purposes
are exempt from duties and taxes. The tax exemption granted is conditioned only
on the actual, direct, and exclusive use of their assets, revenues, and income for
educational purposes.

Income and revenues of non-stock non-profit educational institution not used

actually, directly, and exclusively used for educational purposes are not exempt
from duties and taxes. To avail of the exemption, the taxpayer must factually
prove that it used actually, directly, and exclusively for educational purposes the
revenues or income sought to be exempted.

The tax exemption granted to proprietary educational institution is subject to

limitations provided for by law. The Tax Code60 provides that proprietary
educational institution shall pay a tax of 10% based on their taxable income
provided that their gross income from unrelated trade, business, or activity shall
not exceed 50% of their total gross income. This limitation does not apply to a
non-stock non-profit educational institution.61

Stages of Taxation

Levy

The stage in which there is a determination of the persons, property or excises to

be taxed, the sum or sums to be raised, the due date thereof and the time and
manner of levying and collecting taxes.

Assessment and Collection

The manner of enforcement of the obligation on the part of those who are taxed.

Payment

It is the act of compliance by the taxpayer, including such options, schemes, or

remedies as may be legally available.

Refund

60
Sec. 27(B) of the NIRC
61
Commissioner of Internal Revenue v. DLSU, G.R. No. 196596, November 9, 2016

Page 20 of 34
The recovery of tax alleged to have been erroneously or illegally collected, or of
any penalty claimed to have been collected without authority, or of any sum
alleged to have been excessively, or in any manner wrongfully collected.

Tax Nature and Characteristic

Taxes are the enforced proportional contributions exacted by the State from
persons and properties pursuant to its sovereignty in order to support the
Government ad to defray all the public needs. Every tax has three elements:

(a) It is an enforced proportional contribution from persons and properties;

(b) It is imposed by the State by virtue of its sovereignty; and

(c) It is levied for the support of the Government.62

Requisites of a Valid Tax

Taxes are the lifeblood of the government and should be collected without
unnecessary delay, but their collection should not be tainted with arbitrariness.
The following are the requisites of a valid tax;

(a) It should be for a public purpose.

(b) The rule of taxation should be uniform

(c) Either the person or property taxed be within the jurisdiction of the taxing
authority.

(d) The assessment and collection be in consonance with the due process clause.

(e) The tax must not infringe on the inherent and constitutional limitations of the
power of taxation.

Kinds of Taxes

As to Object

(a) Personal, Capitation, or Poll Tax, a tax of fixed amount imposed on persons
residing within a specified territory, whether citizens or not, without regard to
their property of the occupation or business in which they may be engaged.

(b) Property tax, a tax imposed on property, real or personal, in proportion to its
value or in accordance with some other reasonable method of apportionment.

(c) Excise Tax, a tax imposed upon the performance of an act, enjoyment of
privilege, or the engagement in an occupation.

62
Mandanas v. Executive Secretary, G.R. No.199802, July 3, 2018

Page 21 of 34
As to Graduation

(a) Progressive, a tax rate or amount of tax increases as the amount of income or
earning to be taxed increases.

(b) Regressive, a tax rate or amount of tax decreases as the amount of income or
earning to be taxed increases.

(c) Proportionate, a tax rate based on fixed percentage of the amount of the
property receipts or other basis to be taxed.

As to Tax Rates

(a) Specific Tax, the computation of the tax or the rates of the tax is already
provided for by law.

(b) Ad Valorem, the tax upon the value of the article or thing subject of taxation.

(c) Mixed, the tax rates are partly specific and partly ad valorem.

As to Burden or Incidence

(a) Direct Tax, a tax demanded from the person who also shoulders the burden of
the tax. It is a tax which the taxpayer is directly or primarily liable and which he
or she cannot shift to another.

(b) Indirect tax, a tax demanded from a person in the expectation and intention
that he or she shall indemnify himself or herself at the expense of another, falling
finally upon the ultimate purchaser or consumer.

As to Purpose

(a) General, tax imposed for the purpose of raising public funds for the service of
the government.

(b) Special, tax imposed primarily for the regulation of useful or non-useful
occupation or enterprises and secondarily only for the purpose of raising public
funds.

As to scope

(a) National Tax, tax imposed by the national government.

(b) Local Tax, tax imposed by the local government units.

INCOME TAXATION

Preliminaries

Page 22 of 34
Section 21 of the Tax Code enumerates the national internal revenue taxes;

(a) Income Tax;

(b) Estate and Donor’s Tax;

(c) Value-added Tax;

(d) Other Percentage Taxes;

(e) Excise Taxes;

(f) Documentary Stamp Taxes;

(g) Such other taxes that may be imposed and collected by the BIR.

These national internal revenue taxes are the only taxes that the BIR may collect,
including the fees and charges related thereto such as interest and penalties. Local
taxes, real property taxes, and customs duties are not national internal revenue
taxes and thus, not collectible by the BIR.

Thus, all national internal revenue taxes are national taxes but not all national
taxes are national internal revenue taxes.

By nature, income tax is a privilege or excise tax. Estate tax and donor’s tax are
transfer taxes while VAT, excise tax, and other percentage taxes are business
taxes. Documentary stamp tax is a tax on certain types of documents specifically
provided under the Tax Code.

Income Tax System

There are three (3) types of systems, namely;

(a) Global Tax System, under this system, all income received by the taxpayer are
grouped together, without any distinction as to the type or nature of this income,
and after deducting expenses and other allowable deductions, are subject to tax
using a common rate.63

(b) Schedular Tax System, under this system, various types of income are
classified accordingly and are accorded different tax treatments, in accordance
with schedules characterized by graduated tax rates. Since these types of income
are treated separately, the allowable deduction shall likewise vary from each type
of income.64

63
Tan v. Del Rosario, G.R. No. 109289, October 3, 1994
64
Id.

Page 23 of 34
(c) Semi-Schedular or Semi-Global Tax System, a system where income not
subject to final tax are grouped together and after deducting allowable deductions,
a single tax rate is used in determining the tax liability.

Criteria in Imposing Income Tax

The Tax Code adopts comprehensive criteria in the imposition of income tax:

(a) Citizenship Principle, a citizen of the Philippines residing therein is taxable on

all income derived from whatever sources whether within or without the
Philippines, while citizen of the Philippines not residing there is taxable only on
income derived from sources within the Philippines.

(b) Residence Principle, all income derived from sources within the Philippines by
persons not residing in the Philippines whether citizen or nor, or domestic or
foreign, are subject to income tax.

(c) Source Principle, all income derived from sources within the Philippines are
subject to income tax.

Definition and Nature of Income Tax

An income tax is a national tax imposed on the net or the gross income realized
in a taxable year.65 Income tax is a tax on all yearly profits arising from property,
trade, profession or business, or a tax imposed upon person’s income,
emoluments, profits and the like.66

Income tax is an excise tax. It is not levied upon persons, property, funds, or
profits but on the privilege of receiving said income or profit. Without income,
there is no imposition of income tax. Further, if an inflow is not income, it cannot
be subject to income tax.

Distinction between Capital and Income

Before one may be subject to income tax, there must first and foremost be an
income. Without an income, whether actual or presumed, there is no income tax.
Further, one must distinguish an income from capital because it is the income
that is subject to income tax.

The State cannot impose a tax on capital as it constitutes an unconstitutional

confiscation of property.67

The essential difference between capital and income is that capital is a fund;
income is a flow. A fund or property existing at an instant time is called capital. A
flow of services rendered by that capital by the payment of money from it or any

65
Commissioner of Internal Revenue v. Solidbank Corporation, G.R. No. 148191, November 25, 2003
66
Fischer v. Trinidad, G.R. No. L-17518, October 20, 1922
67
Id.

Page 24 of 34
other benefit rendered by a fund of capital in relation to such fund through period
of time is called an income. Capital is wealth, while income is the service of
wealth. A tax on income is not a tax on property. Income can also be thought as a
flow of fruit from one’s labor.68

Membership fees, assessment dues and other fees of similar nature are considered
only as contributions, to and/or replenishment of the funds for the maintenance
and operations of the facilities offered by recreational clubs to their exclusive
members. They represent “held in trust” by these clubs to defray their operating
and general cost and hence, only constitute infusion of capital. 69

Taxability of Income

Existence of Income

For an income tax to exist, there must be a gain, a value received in the form of
cash or equivalent as a result of rendition of service or earnings in excess of
capital invested. A mere expectation of profit in not an income.

A transaction whereby nothing of exchangeable value comes to or is received by

the taxpayer does not give rise to or create taxable income. Items or amounts
received which do not add to the taxpayer’s net worth or redound to his benefits
such as amounts merely deposited or entrusted to him are not considered gains.70

Realization of Income

An income is realized or recognized when it is actually or constructively received.

Actual receipt of income means income is actually or physically received by the
income earner. Constructive receipt, on the other hand, is when the income is
placed at the control of the income payee without physically receiving the same.

Requisites for Income to be Taxable

An income is taxable when all of the following requirements or circumstances are

present:

(a) The is a gain;

(b) The gain is realized during the taxable year; and

(c) The gain is not exempt from income tax by law or treaty.

Test to Determine Income for Tax Purposes

Realization Test

68
Madrigal v. Rafferty, G.R. No. L-12287, August 7, 1918
69
ANPC v. Commissioner of Internal Revenue, G.R. No. 228539, June 26, 2019
70
Commissioner of Internal Revenue v. Tours Specialist, Inc., G.R. No. L-66416, March 21, 1990

Page 25 of 34
Under this test, there is no income until there is a separation from capital of
something of exchangeable value, thereby supplying the realization or
transmutation which would result in the receipt of income

Claim of Right Doctrine (Doctrine of Ownership, Command or Control)

Under this doctrine, a taxable gain is conditioned upon the presence of a claim of
right to the alleged gain and the absence of a definite unconditional obligation to
return or pay.

Doctrine of Proprietary Interest

Under this, an income is taxable inly to the extent that the taxpayer is
economically benefitted.

Severance Test

Under this test, there is no taxable income until there is a separation from capital
of something which is of exchangeable value thereby supplying the realization
which would result in the receipt of income.

All Events Test

This test requires that the right to income or liability be fixed, and the amount of
such income or liability be determined with reasonable accuracy. This test,
however, does not demand that the amount of income or liability be known
absolutely, only that a taxpayer has at his disposal the information necessary to
compute the amount with reasonable accuracy. The term “reasonable accuracy”
implies something less than an exact or completely accurate amount.71

Sources of Income

One of the criteria in imposing income tax is the Source Principle, place where
the income is derived. For income tax purposes, an income may be sources
within the Philippines, from sources without (outside) the Philippines, or from
sources partly within and partly without the Philippines.

The Tax Code, particularly Sec. 42, provides for the situs of income taxation or
place of income taxation. Specifically, the following items of gross income are
considered as income within or without the Philippines depending on the
circumstances that will be mentioned:

Interest Income

71
Commissioner of Internal Revenue v. Isabela Cultural Corporation, G.R. No.172231, February 12,
2007

Page 26 of 34
Interest may come from bank deposits or from interest-bearing obligations such as
bonds, promissory note and other debt instruments. Interest is derived from
sources within the Philippines if the obligor or debtor is a resident of the
Philippines.

For interest from bank deposits, note that deposits of money in bank are
considered as loan where the account holder is the creditor and the bank as the
debtor. In this case, interest from bank deposit is income within the Philippines if
the bank is situated in the Philippines. The physical location of the bank
determines whether the income is sources within the Philippines or without the
Philippines

In case of interest-bearing obligations, the income is considered as income from

within the Philippines if the obligor or the debtor is a resident of the Philippines.
The residency of the obligor determines the situs (place) of taxation and not the
citizenship of the obligor. Hence, the place where the contract is signed, the place
of payment or the place of performance are all immaterial. The Tax Code simply
provides residence of the debtor or obligor.

The residence of the obligor who pays the interest rather than the physical
location of the securities, bonds or notes, or the place of payment, is the
determining factor of the source of interest income. Accordingly, if the obligor is
a resident of the Philippines, the interest payment made by him can have no other
source other than within the Philippines.72

Dividend Income

Dividend is any distribution made by a corporation to its shareholders out of its

earnings or profits and payable to its shareholder, whether in the form of money
or property.

In determining whether dividend is an income from within or without the

Philippines, one must look in the corporation declaring dividends. Dividends may
come either from a domestic corporation, a corporation existing and incorporated
under the Philippine laws, or foreign corporation, a corporation existing and
incorporated under a foreign law. A corporation may either be a resident foreign
corporation, a corporation engaged in trade or business in the Philippines, or a
non-resident foreign corporation, a corporation not engaged in trade or business
in the Philippines.

Dividends declared by a domestic corporation is an income from within the

Philippines of its shareholders. The source of the income of the domestic
corporation is immaterial.

For dividends received from a resident foreign corporation, one must inquire into
the gross income of the foreign corporation for the last three (3) years before the
declaration of dividends. If at least fifty percent (50%) of the gross income of the

72
NDC v. Commissioner of Internal Revenue, G.R. No. L-53961, June 30, 1987

Page 27 of 34
foreign corporation for the last three (3) years before the declaration of dividends
was derived from sources within the Philippines, the dividends is considered as
income within the Philippines but only to the amount of the ratio between the
gross income derived from the Philippines and total gross income. The remaining
portion is dividend income without (outside) the Philippines.

If less than fifty percent (50%) of the gross income of the foreign corporation for
the last three (3) years before the declaration of dividends was derived from
sources within the Philippines, the dividends is considered as income without
(outside) the Philippines.

For dividends received from a resident foreign corporation, the dividends is

automatically considered as income without (outside) the Philippines.

Services

For compensation for labor or personal services, the determining factor is the
place of performance of services. If the service is performed in the Philippines,
compensation or payment for the service is income from within the Philippines. If
the service is performed outside the Philippines, the income payment is from
sources without the Philippines.

The existing rules does not take into consideration the place of execution of
contract or the place of payment of income.

If no accurate allocation or segregation of compensation for services performed

within the Philippines can be made, or when such labor or service is performed
partly within and partly without the Philippines, the amount to be included in the
gross income shall be determined on time basis. Thus, wages received for services
rendered inside the territorial limits of the Philippines and wages of an alien
seaman earned in a coastwise vessel is to be regarded as income earned within the
Philippines.

Rentals and Royalties

Payments for rentals and royalties on the use of properties or any interest on such
property is considered as income within the Philippines if the property or such
interest is located in the Philippines.

Sale of Real Property

Gains, profits, and income from the sale of real property is income from within
the Philippines if the property is located within the Philippines.

Sale of Personal Property

Gains, profits, and income from the purchase of personal property within the
Philippines and subsequent sale outside the Philippines is an income derived

Page 28 of 34
wholly from sources within the country in which it was sold. The “country in
which it was sold” means the place where the property is marketed.

Corollary, gains, profits, and income from the purchase of personal property
outside the Philippines and subsequent sale within the Philippines is an income
derived wholly from sources within the Philippines.

As an exception to this rules, sale of shares of stock of a domestic corporation is

an income derived entirely within the Philippines regardless of the place of sale.

Income from Sources Partly Within and Partly Without the Philippines

Where items of gross income are separately allocated to sources within the
Philippines, there shall be deducted (for purposes of computing the taxable
income) the expenses, losses or other deductions properly allocated and a ratable
part of other expenses, losses or other deductions which cannot definitely be
allocated to some items or classes of gross income. The remainder, if any, shall be
included in full as taxable income from sources within the Philippines.

In the case of gross income derived from sources partly within and outside the
Philippines, the taxable income may first be computed by deducting expenses and
a ratable part of any expense which cannot definitely be allocated to some items
or class of gross income.

Gains, profits, and income from sale of personal property produced (in whole or
in part) by the taxpayer within the Philippines and sold outside the Philippines, or
produced (in whole or in part) outside the Philippines and sold within the
Philippines shall be treated as derived from sources within and partly outside the
Philippines.

Kinds of Income Taxes

Normal / Net Income Tax (NIT)

A tax on citizen, resident individual and non-resident alien engaged in trade or

business on their taxable income using the graduated rates of 0% to 35%. This
type of income tax allows deductions from gross income to derive their taxable
income.

Eight Percent (8%) Income Tax

A type of income tax introduced by TRAIN Law. The eight percent (8%) income
tax is imposed on the total gross sales or gross receipts and other non-operating
income in excess of Php 250,000. In certain instances, such as those taxpayer who
are earning compensation income and business or professional income, the eight
percent (8%) income tax may be imposed even if the gross receipts or gross sales
does not exceed Php 250,000.

Gross Income Tax (GIT)

Page 29 of 34
A tax of twenty-five percent (25%) imposed on a non-resident alien not engaged
in trade or business in the Philippines or non-resident foreign corporation on their
entire income derived from sources within the Philippines. This type of income
tax does not allow deductions from gross income for the purpose of determining
their taxable income.

Final Income Tax (FIT)

This is a tax imposed on passive income derived from sourced within the
Philippines. The rate of Final Income Tax differs depending on the type of
income earned. This type of income tax does not allow deductions.

Regular Corporate Income Tax (RCIT)

This is a tax imposed on domestic corporation and resident foreign corporation at

the rate of twenty percent (20%) or twenty-five percent (25%). This type of
income tax does allow deductions from gross income for the purpose of
determining their taxable income.

Minimum Corporate Income Tax (MCIT)

A tax of one percent (1%) until June 30, 2023, and two percent (2%) afterwards,
imposed on the gross income of a domestic and resident foreign corporation on
the fourth year from commencement of operation. The tax is payable when
MCIT is higher than the RCIT.

Kinds of Taxpayers

The kind of income tax imposable is also dependent on the type of taxpayer or
income earner. In general, the taxpayer under the Tax Code is called “person”,
which means an individual, a trust, estate, or corporation.

An individual taxpayer is a natural person which may be a resident citizen, non-

resident citizen, resident alien, non-resident alien engaged in trade or business in
the Philippines and non-resident alien not engaged in trade or business in the
Philippines.

Individual Taxpayers

(a) Resident Citizen, a citizen of the Philippines residing therein. A citizen of the
Philippines residing abroad with no intention to reside thereat permanently is a
resident citizen. A resident citizen is taxable on all income derived from sources
within and without the Philippines

(b) Non-resident citizen, is a citizen of the Philippines who establishes to the

satisfaction of the Commissioner the fact of his physical presence abroad with a
definite intention to reside therein; a citizen of the Philippines who leaves the
Philippines during the taxable year to reside abroad, either as an immigrant or for

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employment on a permanent basis; a citizen of the Philippines who works and
derives income from abroad and whose employment thereat requires him to be
physically present abroad most of the time during the taxable year; or a citizen
who has been previously considered as nonresident citizen and who arrives in the
Philippines at any time during the taxable year to reside permanently in the
Philippines shall likewise be treated as a nonresident citizen for the taxable year
in which he arrives in the Philippines with respect to his income derived from
sources abroad until the date of his arrival in the Philippines.

The term “most of the time” is interpreted as an aggregate stay outside of the
Philippines of at least 183 days during the taxable year. The term “whose
employment thereat requires him” means that an individual must be employed in
a foreign country of the employer is in a foreign country.

A non-resident citizen is taxable only on his income derived from sources within
the Philippines.

(c) Resident alien, an individual whose residence is within the Philippines and
who is not a citizen thereof.

An alien is actually present in the Philippines who is not a mere transient or

sojourner is a resident of the Philippines for purposes of income tax. Whether the
alien is transient or not is determined by his intention with regard to the length
and nature of his stay. A mere floating intention indefinite as to time to return to
another country is not sufficient to constitute him a transient.

Thus, if the alien lives in the Philippines and has no definite intention as to his
stay, such alien is considered as resident. One who comes to the Philippines for a
definite purpose which in its nature may be promptly accomplished is a transient
and not a resident alien. But if his purpose is of such a nature that an extended
stay is necessary for its accomplishment, and to that end the alien makes his
home temporarily in the Philippines, he becomes a resident, though it may be his
intention at all time to return to his domicile abroad once the purpose for which
he came has been consummated or abandoned.

A resident alien is taxable only on his income derived from sources within the
Philippines.

(d) Non-resident Alien Engaged in Trade or Business in the Philippines, an

individual whose residence is outside the Philippines and who is not a citizen
thereof but is engaged in trade or business in the Philippines. A nonresident alien
individual who shall come to the Philippines and stay therein for an aggregate
period of more than one hundred eighty (180) days during any calendar year
shall be deemed a non-resident alien engaged in trade or business in the
Philippines.

A nonresident alien individual engaged in trade or business in the Philippines

shall be subject to an income tax in the same manner as a resident alien
individual, on taxable income received from all sources within the Philippines.

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(e) Non-resident Alien Not Engaged in Trade or Business in the Philippines, an
individual whose residence is outside the Philippines and who is not a citizen
thereof and is not engaged in trade or business in the Philippines but still has an
income from sources within the Philippines.

A nonresident alien individual not engaged in trade or business in the Philippines

shall be taxable on income received from all sources within the Philippines.

Corporations

For tax purposes, the term “corporation” shall include one person corporations,
partnerships, no matter how created or organized, joint-stock companies, joint
accounts (cuentas en participacion), associations, or insurance companies, but
does not include general professional partnerships and a joint venture or
consortium formed for the purpose of undertaking construction projects or
engaging in petroleum, coal, geothermal and other energy operations pursuant to
an operating consortium agreement under a service contract with the
Government.

General Professional Partnerships (GPP) are partnerships formed by persons for

the sole purpose of exercising their common profession, no part of the income of
which is derived from engaging in any trade or business.

Corporations may either be domestic corporation, resident foreign corporation or

non-resident foreign corporation, joint venture or partnership.

(a) Domestic Corporation, a corporation created or organized in the Philippines

or under its laws. Domestic corporations are taxable from all sources of income
within and without the Philippines.

(b) Resident Foreign Corporation, a corporation created or organized under

foreign laws which is engaged in trade or business within the Philippines.
Resident Foreign Corporations are taxable from all sources of income within the
Philippines.

(c) Non-Resident Foreign Corporation, a corporation created or organized under

foreign laws which is not engaged in trade or business within the Philippines.
Non-Resident Foreign Corporation Corporations are taxable from all sources of
income within the Philippines.

(d) Partnership, arises when two or more persons bind themselves to contribute
money, property, or industry to a common fund, with the intention of dividing
the profits among themselves. Two or more persons may also form a partnership
for the exercise of a profession. For tax purposes, a partnership may either be a
Trade Partnership (Ordinary Partnership) or General Professional Partnership.

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Trade Partnership (Ordinary Partnership) is a partnership engaged in trade or
business. This partnership falls within the definition of a corporation and thus, the
tax treatment is the same as that of a corporation.

General Professional Partnership is a partnership formed by persons for the sole

purpose of exercising their common profession, no part of income of which is
derived from engaging in any trade or business. A general professional
partnership not be subject to the income tax imposed. However, persons engaging
in business as partners in a general professional partnership shall be liable for
income tax only in their separate and individual capacities.

(e) Joint Venture, an association of persons or companies jointly undertaking

some commercial enterprise; generally, all contribute assets and share risks. It
requires a community of interest in the performance of the subject matter, a right
to direct and govern the policy in connection therewith, and duty, which may be
altered by agreement to share both in profit and losses. Joint venture is formed for
the execution of single transaction and is thus of a temporary nature.73

Estate and Trust

An estate is created by operation of law when an individual dies, leaving

properties to his compulsory or other heirs. Trust, on the other hand, is a legal
arrangement whereby the owner of property transfers ownership to a person who
is to hold and control the property belonging to the owner’s instruction, for the
benefit of a designated person.

The tax imposed upon individuals shall apply to the income of estates or of any
kind of property held in trust.

-o0o-

73
Aurbach v. Sanitary Wares Manufacturing Corporation, 180 SCRA 130, December 15, 1989

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Suggested Teaching Activities (TAs)

Refer to our Google Classroom for the Suggested Teaching Activities

Assessment Tasks / Output (ATOs)

Refer to our Google Classroom for the Assessment Task/Output

Readings and Other References

1. Taxation Law, Volume 1, Raegan L. Capuno (2020)

2. Taxation Law, Volume 2, Raegan L. Capuno (2020)
3. CPA Reviewer in Taxation, Enrico D. Tabag (2021)
4. CPA Reviewer in Taxation, Omar Erasmo G. Ampongan (2021)
5. Republic Act No. 8424 or the Tax Reform Act of 1997
6. Republic Act No. 10963 or the Tax Reform for Acceleration and Inclusion
Law
7. Republic Act No. 11534 or the Corporate Recovery and Tax Incentives for
Enterprises (CREATE) Act
8. Republic Act No. 11469 or the The Bayanihan to Heal as One Act
9. Republic Act No. 11494 or the The Bayanihan to Recover as One Act
10. RR No. 8-2018 - Implements the amended provisions on Income Tax
pursuant to RA No. 10963 (TRAIN Law)
11. RR No. 2-2021 - Amends certain provisions of RR No. 2-98, as amended,
to implement the amendments introduced by RA No. 11534 (Corporate
Recovery and Tax Incentives for Enterprises Act or CREATE Act) to the
NIRC of 1997, as amended, relative to the Final Tax on certain passive
income
12. RR No. 3-2021 - Prescribes the Rules and Regulations to implement
Section 3 of RA No. 11534 (Corporate Recovery and Tax Incentives for
Enterprises Act or CREATE Act), amending Section 20 of the NIRC of
1997
13. RR No. 5-2021 - Implements the new Income Tax rates on the regular
income of corporations, on certain passive incomes, including additional
allowable deductions from Gross Income of persons engaged in business
or practice of profession pursuant to RA No. 11534 (Corporate Recovery
and Tax Incentives for Enterprises Act or CREATE Act), which further
amended the NIRC of 1997.

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