TAXATION
Notes2 - Principles of Taxation
PRINCIPLES OF A SOUND TAX SYSTEM
Basic Principles of sound tax system
Taxation is very important in each and every country.
Without taxes, a country would not be able to carry out its
day to day operations. To further expedite a country’s
progress, proper administration and management of the tax
system is needed. There is proper administration if a
country is able to follow the principles of a sound tax
system.
1) THEORETICAL JUSTICE - This principle states that
taxation should consider the taxpayer’s ability to pay.
Taxes should not be oppressive, unjust or confiscatory.
As the old saying goes, you should not kill the hen that
lays the golden egg. Using the progressive tax system is
a way of following theoretical justice.
This principle mandates that taxes must be just,
reasonable and fair.
The tax burden should be in proportion to the taxpayer’s
ability to pay.
“Taxes must be based on the taxpayer’s ability to pay.”
2) FISCAL ADEQUACY - This requires that sources of
government funds must be sufficient to cover
government cost. Taxes should increase in response to
increase in government spending. In other words, the
government should collect the right amount of taxes to
be used in its day to day operations.
Ex: The Government should not incur and deficit but
should have enough funds to fund all its programs,
projects and activities.
The sources of revenue should be sufficient to meet the
demands of public (expenditures)
expenditure
3) ADMINISTRATIVE FEASIBILITY - Tax laws should be
capable of efficient and effective administration to
encourage compliance. Easy for taxpayers to comply,
avoids administrative bottlenecks and reducing
compliance cost. Using the EFPS provided by the BIR is
a way of further improving administrative feasibility.
The tax law must be capable of effective or efficient
enforcement
Tax laws should be capable of convenient, just and effective
administration
Tax laws should close-up the loopholes for tax evasion and
deter unscrupulous officials from committing fraud.
There is no law that requires compliance with this principle,
so even if the tax law violates this principle; such tax law is
valid.
LIMITATIONS ON THE POWER OF TAXATION
The power of taxation, is however, subject to constitutional
and inherent limitations.
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Constitutional limitations are those provided for in the
constitution or implied from its provisions, while inherent
limitations are restrictions to the power to tax attached to
its nature.
1) Observance of due process of law and equal protection
of the laws. (sec, 1, Art. 3) - Any deprivation of life,
liberty or property is with due process if it is done under
the authority of a valid law and after compliance with fair
and reasonable methods or procedure prescribed.
The power to tax, can be exercised only for a
constitutionally valid public purpose and the subject of
taxation must be within the taxing jurisdiction of the
state.
The government may not utilize any form of assessment
or review which is arbitrary, unjust and which denies the
taxpayer a fair opportunity to assert his rights before a
competent tribunal. All person subject to legislation shall
be treated alike under like circumstances and conditions,
both in the privileges conferred in liabilities imposed.
Persons and properties to be taxed shall be group, and
all the same class shall be subject to the same rate and
the tax shall be administered impartially upon them.
2) Rule of uniformity and equity in taxation (sec. 28(1) Art.
VI) All taxable articles or properties of the same class
shall be taxed at the same rate. Uniformity implies
equality in burden not in amount. Equity requires that
the apportionment of the tax burden be more or less just
in the light of the taxpayer’s ability to bear the tax
burden.
3) No imprisonment for non-payment of poll tax (sec. 20,
Art III) A person cannot be imprisoned for non-payment
of community tax, but may be imprisoned for other
violations of the community tax law, such as falsification
of the community tax certificate, or for failure to pay
other taxes.
4) Non-impairment of obligations and contracts, sec 10, Art
III. The obligation of a contract is impaired when its
terms and conditions are changed by law or by a party
without the consent of the other, thereby weakening the
position or the rights of the latter. IF a tax exemption
granted by law and of the nature of a contract between
the taxpayer and the government is revoked by a later
taxing law, the said law shall not be valid, because it will
impair the obligation of contract.
5) Prohibition against infringement of religious freedom
(Sec 5, Art III, it has been said that the constitutional
guarantee of the free exercise and enjoyment of religious
profession and worship, which carries the right to
disseminate religious belief and information, is violated
by the imposition of a license fee on the distribution and
sale of bibles and other religious literatures not for profit
by a non-stock, non-profit religious corporation.
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TAXATION
Notes2 - Principles of Taxation
6) Prohibition against appropriations for religious purposes,
sec 29, (2) Art. VI, Congress cannot appropriate funds
for a private purpose, or for the benefit of any priest,
preacher or minister or for the support of any sect,
church except when such priest, preacher, is assigned to
the armed forces or to any penal institutions, orphanage
or leprosarium.
Case: A religious order, lessee of a piece of land,
constructed a seminary and a church on a portion of the
land, a one-story building that it sub-leased to private
individual.
The rent income is used for teaching at the seminary,
thus, subject to income tax;
The constitutional provision on exemption of the church,
parsonage or convent appurtenant thereto, is an
exemption of the church, from property tax. The income
tax is not a property tax. However, since the church is
also a non-profit-educational institution, its rent income,
since used actually, directly and exclusively (ADE) for
educational purposes, is exempt from the income tax
under the Constitution.
7) Exemption of all revenues and assets of non-stock, non-
profit educational institutions used actually, directly, and
exclusively for educational purposes from income,
property and donor’s taxes and custom duties (sec. 4 (3
and 4) art. XIV.
8) Concurrence by a majority of all members of Congress in
the passage of a law granting tax exemptions. Sec. 28
(4) Art. VI.
9) Congress may not deprive the Supreme Court of its
jurisdiction to review, revise, reverse, modify or affirm
on appeal or certiorari, final judgments and orders of
lower courts in all cases involving the legality of any tax,
impost, assessment or any penalty imposed in the
relation thereto.
Inherent limitations on Power of Taxation:
1) Non-Delegation of the power to Tax – the power to
tax is purely legislative and it cannot be delegated by
the legislature to the executive or judicial department
of the government. Separation of the three branches of
government. (The power to tax being legislative in
nature may not be delegated. (subject to exceptions)
2) Exemption from taxation of government entities.
Government agencies performing essential
government functions are exempt from tax unless
expressly taxed while those performing proprietary
functions are subject to tax unless expressly exempted.
Government cannot tax itself. (Government agencies
performing governmental functions are exempt from
taxation)
3) Public Purpose – purpose affecting the inhabitants of
the state as a community and not merely as individuals.
Financing educational activities, promotion of science,
maintenance of roads and bridges, aid for victims of
calamities. (Taxes may be levied only for public
purpose)
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4) Territorial Jurisdiction – the tax laws of the state are
enforceable only within its territorial limits. Tax laws do
not operate beyond the country’s territorial limits. (The
State may tax persons and properties under its
jurisdiction)
5) International comity – the property of a foreign State
or government may not be taxed by another. Courteous
and friendly agreement and interaction between
nations. (the property of a foreign State may not be
taxed by another)
TAX EVASION vs. TAX AVOIDANCE
TAX AVOIDANCE - Also known as “tax minimization”
➢ Tax avoidance is the exploitation of the taxpayer of
legally permissible alternative tax rates or methods of
assessing taxable property or income in order to avoid or
reduce tax liability. (It is not punished by law)
➢ DELPHERS TRADERS CORP vs. IAC (157 SCRA 349) - The
Supreme Court upheld the estate planning scheme
resorted to by the Pacheco family in converting their
property to shares of stock in a corporation which they
themselves owned and controlled. By virtue of the deed
of exchange, the Pacheco co-owners saved on
inheritance taxes. The Supreme Court said the records
do not point anything wrong and objectionable about this
estate planning scheme resorted to. The legal right of the
taxpayer to decrease the amount of what otherwise could
be his taxes or altogether avoid them by means which
the law permits cannot be doubted.
Example: Following the “holding period rule” in capital
gains transaction, by postponing the sale of the capital
asset until after twelve months from date of acquisition
you can reduce the tax on the capital gains by 50%.
Tax avoidance is the legitimate minimizing of taxes, using
methods included in the tax code. Businesses avoid taxes
by taking all legitimate deductions and by sheltering income
from taxes by setting up employee retirement plans and
other means, all legal and under the Internal Revenue Code
or state tax codes.
You may have heard of "tax shields" These shields are for
protection against higher taxes, and they are the strategies
of tax avoidance.
Some Examples of Tax Avoidance Strategies:
1) Taking legitimate tax deductions to minimize business
expenses and thus lower your business tax bill.
2) Setting up a tax deferral plan to delay taxes until a later
date.
3) Taking tax credits for spending money for legitimate
purposes, like taking a Work Opportunity Tax Credit for
hiring workers in your business.
4) A tax loophole is tax avoidance. A loophole is a
"technicality that allows a person or business to avoid
the scope of a law or restriction without directly
violating the law."
RCD
TAXATION
Notes2 - Principles of Taxation
Since the tax code is so complex, savvy tax experts have
found ways to lower taxes for their clients without
breaking the law, taking advantage of parts of the law.
Some tax loopholes are deliberate on the part of
lawmakers; accelerated depreciation is one example.
Note the word "avoid" in the definition; finding a way to
avoid paying taxes by finding a hole in the tax code is
tax avoidance, not evasion. Just be aware that there are
some gray areas in the law. Getting a competent, honest
tax expert can save you from going over the line to tax
evasion.
TAX EVASION
TAX EVASION - is also known as “tax dodging”. It is
punishable by law.
It is the use by the taxpayer of illegal or fraudulent
means to defeat or lessen the payment of tax.
➢ Tax evasion is a term that connotes fraud through
the use of pretenses or forbidden devices to lessen
or defeat taxes.
ELEMENTS OF TAX EVASION - Tax evasion connotes the
integration of three (3) factors:
1) The end to be achieved, i.e. payment of less than that
known by the taxpayer to be legally due, or paying no
tax when it is shown that tax is due
2) An accompanying state of mind which is described as
being “evil”, “in bad faith”, “willful”, or “deliberate”
and not “accidental”.
3) A course of action (or failure of action) which is
unlawful.
INDICIA of FRAUD IN TAX EVASION
1) Failure to declare for taxation purposes true and
actual income derived from business for two (2)
consecutive years; or
2) Substantial under-declaration of income tax returns
of the taxpayer for four (4) consecutive years
coupled with unintentional overstatement of
deductions.
EVIDENCE TO PROVE TAX EVASION
➢ Since fraud is a state of mind, it need not be proved
by direct evidence but may be proved from the
circumstances of the case. REPUBLIC vs. GONZALES
(13 SCRA 638)
➢ Failure of the taxpayer to declare for taxation
purposes his true and actual income derived from
his business for two (2) consecutive years is an
indication of his fraudulent intent to cheat the
government of its due taxes.
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The terms "tax avoidance" and "tax evasion" are often used
interchangeably, but they are very different concepts.
Basically, tax avoidance is legal, while tax evasion is not.
Businesses get into trouble with the IRS when they
intentionally evade taxes. But your business can avoid
paying taxes, and your tax preparer can help you do that.
Tax evasion, is the illegal practice of not paying taxes, by
not reporting income, reporting expenses not legally
allowed, or by not paying taxes owed. In this situation, the
phrase "ignorance of the law excuses no one from
compliance therewith."
Tax evasion is part of an overall definition of tax fraud,
which is illegal intentional non-payment of taxes. It is most
commonly thought of in relation to income taxes, but tax
evasion can be practiced by businesses on state sales taxes
and on employment taxes. One common tax evasion
strategy is failing to pay turn over taxes you have collected
from others to the proper federal or state agency.
In fact, tax evasion can be practiced on all the taxes a
business owes.
Examples of Tax Evasion/Tax Fraud Practices - In
general, it's considered tax evasion if you knowingly fail to
report income or you don't file an income tax return. Some
practices considered tax evasion/tax fraud:
➢ Under-reporting income (claiming less income than you
actually received from a specific source
➢ Not reporting an income source
➢ Providing false information to the IRS about business
income or expenses
➢ Deliberately underpaying taxes owed
➢ Substantially understating your taxes (by stating a tax
amount on your return which is less than the amount
owed on the income you reported).
➢ Filing false payroll tax reports or failing to file these
returns.
➢ Deliberately underreporting or omitting income,
➢ Overstating the amount of deductions
➢ Keeping two sets of books
➢ Making false entries in books and records
➢ Claiming personal expenses as business expenses
➢ Claiming false deductions
➢ Hiding or transferring assets or income
Tax evasion isn't limited to income tax returns. Businesses
that have employees may be committing tax evasion in
several ways.
RCD