D. DIVIDEND INCOME

SEC. 73. Distribution of dividends or Assets by Corporations. -(A) Definition of Dividends. - The term 'dividends' when used in this Title means any distribution made by a corporation to its shareholders out of its earnings or profits and payable to its shareholders, whether in money or in other property.Where a corporation distributes all of its assets in complete liquidation or dissolution, the gain realized or loss sustained by the stockholder, whether individual or corporate, is a taxable income or a deductible loss, as the case may be.(B) Stock Dividend. - A stock dividend representing the transfer of surplus to capital account shall not be subject to tax. However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent that it represents a distribution of earnings or profits.(C) Dividends Distributed are Deemed Made from Most Recently Accumulated Profits. - Any distribution made to the shareholders or members of a corporation shall be deemed to have been made form the most recently accumulated profits or surplus, and shall constitute a part of the annual income of the distributee for the year in which received.(D) Net Income of a Partnership Deemed Constructively Received by Partners. - The taxable income declared by a partnership for a taxable year which is subject to tax under Section 27 (A) of this Code, after deducting the corporate income tax imposed therein, shall be deemed to have been actually or constructively received by the partners in the same taxable year and shall be taxed to them in their individual capacity, whether actually distributed or not.

Section 250. Dividends. Dividends, for the purpose of the law, comprise any distribution whether in cash or other property, in the ordinary course of business, even though extraordinary in amount made by a domestic or resident foreign corporation, joint-stock company, partnership, joint account, association, or insurance company to the shareholders or members out of its earnings or profits accumulated since March 1, 1913.Although interest on certain Government bonds and other similar obligations is not taxable when received by a corporation, upon amalgamation with the other funds of the corporation, such income loses its identity and when distributed to shareholders, is taxable, the same extent as other dividends.A taxable distribution made by a corporation to individual stockholders or members shall be included in the gross income of the distributees when the cash or other property is unqualifiedly made subject to their demand. Dividends, in cash or other property received by an individual, are subject to tax in his hands in the same manner as other income.Dividends, whether in cash or other property received by a domestic or resident foreign corporation from a domestic corporation are taxable only to the extent of 25 per cent thereof in accordance with Section 24 of the Code. Dividends received by a domestic corporation from a foreign corporation, whether resident or nonresident, are taxable to the extent that they constitute income from sources within the Philippines, as provided in section 37 (a) (2) (b) of the Code. Dividends paid by the domestic corporation to a nonresident foreign corporation are taxable in full.

Section 251. Dividends paid in property. - Dividends paid in securities or other property (other than its own stock), in which the earnings of a corporation have been invested, are income to the recipients to the amount of the all market value of such property when receivable by individual stockholders. When receivable by corporations, the amount of such dividends includible for purposes of the tax on corporations are specified in section 24 of the Code. (See also section 250 of these regulations). A dividend paid in stock of another corporation is not a stock dividend. even though the stock distributed was acquired through the transfer by the corporation declaring the dividends of property to the corporation the stock of which is distributed as a dividend. Where a corporation declares a dividend payable in a stock of another corporation, setting aside the stock to be so distributed and notifying the stockholders of its action, the income arising to the recipient of such stock is its market value at the time the dividend becomes payable. Scrip dividends are subject to tax in the year in which the warrants are issued.

Section 252. Stock dividends. - A stock dividend which represents the transfer of surplus to capital account is not subject to income tax. However, a dividend in stock may constitute taxable income to the recipient thereof notwithstanding the fact that the officers or director of the corporation (as defined in section 84) choose to call such distribution as a stock dividend. The distinction between a stock dividend which does not, and one which does, constitute income taxable to the shareholder is the distinction between a stock dividend which works no change in the corporate entity, the same interest In the same corporation being represented after the distribution by more shares of precisely the same character and a stock dividend where there either has been a Change of corporate identity or a change in the nature of the shares issued as dividends whereby the proportional interest of the shareholders after the distribution is essentially different from his former interest. A stock dividend constitutes income if it gives the shareholder an interest different from that which his former stock holdings represented. A stock dividend does not constitute income if the new shares confer no different rights or interest than did the old - the new certificates plus the old representing the same proportionate interest in the net asset of the corporation as did the old.

Section 253. Sale of stock received as dividends. - Stock issued by a corporation, as a dividend, does not constitute taxable income to a stockholder in such corporation, but gain may be derived or loss sustained by the stockholder, whether individual or corporate, from the sale of such stock, which gain or loss will be treated as arising from the sale or exchange of a capital asset. (See section 34 of the Code.) The amount of gain derived or loss sustained from the sale of such stock, or from the sale of the stock with respect to which it is issued, shall be determined in accordance with the following rules:(a) Where the stock issued as dividend is as or substantially the same character or preference as the stock upon which the stock dividend is paid, the cost of each share (or when acquired prior to March, 1, 1913, the fair market value as of such date) will be the quotient of the cost (or such fair market value) of the old shares of stock divided by the total number of the old and new shares.(b) Where the stock issued as a dividend is in whole or in part of a character or preference materially different from the stock upon which the stock dividend is paid, the cost (and when acquired prior to March 1,1913, the fair market value as of such date) of the old shares of stock shall be divided between such old stock and the new stock, in proportion, as nearly as may be, to the respective value of each class of stock old and new at the time the new shares of stock are issued, and the cost (or when acquired prior to March 1, 1913, the fair market value as of such date) of each share of stock will be the quotient of the cost (or such fair market value as of March 1, 1913) of the class to which such share belongs divided by the number of shares in that class.(c) Where the stock with respect to which a stock dividend is issued was purchased at different times and at different prices and the identity of the lots cannot be determined, any sale of the original stock, will be charged to the earliest purchases, of such stock, and any sale of dividend stock issued with respect to such stock will be presumed to have been made from the stock issued with respect to the earliest purchased stock, to the amount of the dividend chargeable to such stock.(d) Where the stock with respect to which a stock dividend is declared was purchased at different times and at different prices, and the dividend stock issued with respect to such stock cannot be identified as having been issued with respect to any particular lot of such stock, then any sale of such dividend stock will be presumed to have been made from the stock issued with respect to the earliest purchased stock, to the amount of the stock dividend chargeable to such stock.

Section 254. Declaration and subsequent redemption of a stock dividend. - A true stock dividend is not subject to tax on its receipt in the hands of the recipient. Nevertheless, if a corporation, after the distribution of a stock dividend, proceeds to cancel or redeem its stock at such time and in such manner as to make the distribution and cancellation or redemption essentially equivalent to the distribution of a taxable dividend, the amount received in redemption or cancellation of the stock shall be treated as a taxable dividend to the extent of the earnings or profits accumulated by such corporation since March 1, 1913

Section 255. Sources of distribution. For the purpose of income taxation every distribution made by a corporation is made out of earnings or profits to the extent thereof and from the most recently accumulated earnings or profits. In determining the source of a distribution, consideration should be given first, to the earnings or profits of the taxable year; second, to the earnings or profits, accumulated since February 28, 1913, only in the case where, and to the extent that, the distribution made during the taxable year are not regarded as out of the earnings or profits of the taxable year and all the earnings or profits accumulated since February 28, 1913, have been distributed; and, fourth, to sources other than earnings or profits only after the earnings or profits have been distributed.

Section 256. Distribution in liquidation. - In all case's where a corporation (as defined in section 84) distributes all of its property or assets in complete liquidation or dissolution, the gain realized from the transaction by the stockholder, whether individual or corporate, is taxable to the extent recognized in section 34 (b) of the Code. For this purpose, the term complete liquidation includes anyone of a series of distributions made by a corporation in complete cancellation or redemption of an of its stocks in accordance with a bona fide plan of liquidation under which the transfer of all the assets under liquidation is to be completed within a reasonable time from the date of the first distribution, usually not to exceed one year from the time of such first distribution. If the amount received by the stockholder in liquidation is less than the cost or other basis of the stock, the loss in the transaction is deductible to the extent allowed in section 34(c) of the Code.

Dividend represents a distribution of the profits by a corporations

1. Kinds of dividends recognized in law

a. Cash - when taxable, the measure of income is the amount of money received

b. Property - when taxable, the measure of income is the FMV of the property received. A dividend paid in shares of stocks of another corporation, or in treasury stocks, is a property dividend.

BIR Ruling No. 108-93Facts: SEA COMMERCIAL COMPANY, INC. (SEACOM), is a domestic corporation with an authorized capital stock of Thirty Million Pesos (P30,000,000.00), divided into Thirty Thousand (30,000) Preferred shares of stock and Two Hundred Seventy Thousand (270,000) Common shares of stock, all with a par value of One Hundred Pesos (P100.00) per share, of which One Hundred Fifty Five Thousand Three Hundred Two (150,302) Common shares of stock are issued and outstanding as of 31 December 1991; and that as of 31 December 1991, it had a total stockholder's equity in the amount of Thirty Four Million Seven Hundred Nine Thousand Five Hundred Five Pesos (P34,709,505.00), which include unrestricted retained earnings in the amount of Nineteen Million Four Hundred Sixty Nine Thousand Four Hundred Forty One Pesos (P19,469,441.00); that on 15 June 1992, the Corporation declared all of its unrestricted retained earnings as of 31 December 1991 as dividends in favor of stockholders of record as of 15 June 1992, payable on or before 15 April 1993, that said dividends shall be distributed in the form of cash in the amount of Seven Million Five Hundred Twenty Thousand Three and 08/100 Pesos (P7,520,003.08), and the following properties with a total book value of Eleven Million Nine Hundred Forty Nine Thousand Four Hundred Thirty Seven and 92/100 Pesos (P11,949,437.92). The aforementioned real and personal properties are capital assets of the Corporation, which are not used and not intended to be used by the Corporation in its ordinary course of business; that the properties declared as dividends were recorded in the books of the Corporation at their book values; that the total book value of the property dividends is equivalent only to Twenty-Five and 80/100 percent (25.8%) of SEACOM'S assets for the year ended 31 December 1991; and that the Corporation continues to do business and its stockholders have no intention of liquidating the corporation after the declaration of property dividends.

Ruling: The property dividend shall be recorded at the book value in the books of both the issuing corporation and the recipient stockholder. The BIR Ruling No. 21(c)(2)-028-89-130-89 applying Sections 250 and 251 of Revenue Regulations No. 2 stating that dividends paid in securities or other property (other than its own stock) in which the earnings of a corporation have been invested are income to the recipient to the amount of the full market value of such property when receivable by individual stockholders has already been modified having been rendered obsolete by Executive Order No. 37 (effective August 1, 1986) subjecting to income tax at 0% effective January 1, 1989, dividends received from a domestic corporation and the share of an individual partner in a partnership subject to tax under Section 24(a) of the Tax Code (BIR Ruling No. 276-91 December 26, 1991)The proposed property dividend which shall be received by the stockholders of SEACOM shall be subject to a final withholding tax of zero (0%) percent, and the receiving stockholders shall not be subject to any income or capital gains tax arising from their receipt of these properties as property dividend. (Section 21(c)(2) of the Tax Code, as amended by Executive Order No. 37). However, certificates authorizing transfer of real estate properties without payment of the capital gains tax shall be secured from the Revenue District Officer of the Revenue District where the property is located before said properties are transferred in the name of the recipient stockholders (BIR Ruling No. 028-89 dated February 22, 1989). Similarly, certificates authorizing transfer of shares of stock without payment of the capital gains tax shall be secured from the Revenue District Officer of the Revenue District where the principal place of office of the corporation declaring the dividends is located. It shall be the ministerial duty of the Revenue District Officer to issue said certificates.SEACOM shall not be subject to any income or capital gains tax on the difference between the fair market value and the book value of the real estate properties declared and distributed as property dividends. This is because there is no realized gain considering the fact that the value used at the time of distribution is the book value.Upon subsequent sale or other disposition of the property received as dividends by the stockholders, the basis of such shall also be its book value at the time of the dividend distribution.The amount of the documentary stamp tax on the Deeds of Conveyance to be executed between SEACOM and the recipient stockholders covering the real estate properties declared as property dividends shall be based on the book value of said real estate properties. The documentary stamp tax that shall be collected shall be at the rate of ten (10) pesos for every one thousand pesos (P1,000.00), or fractional part thereof, of the book value of the real properties declared as dividends (Section 196, Tax Code). On the other hand, the documentary stamp tax on the Deeds of Conveyance to be executed between SEACOM and the recipient stockholders covering the shares of stock to be declared as property dividends shall be based on the par value of the shares of stocks, at the rate of fifty centavos (P0.50) for each two hundred pesos (P200.00), or fractional part thereof, of the value of the shares of stock declared as property dividends (Section 176, Tax Code). In both cases, the documentary stamp tax shall be due and payable on the day of execution of the Deeds of Conveyance (Section 173, Tax Code).

c. Stock

Comm. v. Manning, 66 SCRA 14

Under a trust agreement, Julius Reese who owned 24,700 shares of the 25,000 common shares of MANTRASCO, and the three private respondents who owned the rest, at 100 shares each, deposited all their shares with the Trustees. The trust agreement provided that upon Reese's death MANTRASCO shall purchase Reese's shares. The trust agreement was executed in view of Reese's desire that upon his death the Company would continue under the management of respondents. Upon Reese's death and partial payment by the company of Reeses's share, a new certificate was issued in the name of MANTRASCO, and the certificate indorsed to the Trustees. Subsequently, the stockholders reverted the 24,700 shares in the Treasury to the capital account of the company as stock dividends to be distributed to the stockholders. When the entire purchase price of Reese's interest in the company was paid in full by the latter, the trust agreement was terminated, and the shares held in trust were delivered to the company.The Bureau of Internal Revenue concluded that the distribution of the 24,700 shares of Reese as stock dividends was in effect a distribution of the "assets or property of the corporation." It therefore assessed respondents for deficiency income taxes as well as for fraud penalty and interest charges.On a petition for review, the Supreme Court held that the newly acquired shares were not treasury shares; their declaration as treasury stock dividends was a complete nullity and that the assessment by the Commissioner of fraud penalty and the imposition of interest charges pursuant to the provision of the Tax Code were made in accordance with law.Where by the use of a trust instrument as a convenient technical device, respondents bestowed unto themselves the full worth and value of a deceased stockholder's corporate holding acquired with the very earnings of the companies, such package device which obviously is not designed to carry out the usual stock dividend purpose of corporate expansion reinvestment, e.g., the acquisition of additional facilities and other capital budget items, but exclusively for expanding the capital base of the surviving stockholders in the company, cannot be allowed to deflect the latter's responsibilities toward our income tax laws. The conclusion is ineluctable that whenever the company parted with a portion of its earnings "to buy" the corporate holdings of the deceased stockholders, it was in ultimate effect and result making a distribution of such earnings to the surviving stockholders. All these amounts are consequently subject to income tax as being, in truth and in fact, a flow of cash benefits to the surviving stockholders.Where the surviving stockholders, by resolution, partitioned among themselves, as treasury stock dividends, the deceased stockholder's interest, and earnings of the corporation over a period of years were used to gradually wipe out the holdings therein of said deceased stockholder, the earnings (which in effect have been distributed to the surviving stockholders when they appropriated among themselves the deceased stockholder's interest), should be taxed for each of the corresponding years when payments were made to the deceased's estate on account of his shares. In other words, the Tax Commissioner may not asses the surviving stockholders, for income tax purposes, the total acquisition cost of the alleged treasury stock dividends in one lump sum. However, with regard to payment made with the corporation's earnings before the passage of the resolution declaring as stock dividends the deceased stockholder's interest (while indeed those earnings were utilized in those years to gradually pay off the value of the deceased stockholder's holdings), the surviving stockholders should be liable (in the absence of evidence that prior to the passage of the stockholder's resolution the contributed of each of the surviving stockholder rose corresponding), for income tax purposes, to the extent of the aggregate amount paid by the corporation (prior to such resolution) to buy off the deceased stockholder's shares. The reason is that it was only by virtue of the authority contained in said resolution that the surviving stockholders actually, albeit illegally, appropriated and petitioned among themselves the stockholders equity representing the deceased stockholder's interest.

Fisher v. Trinidad, 43 Phil 973

Are the "stock dividends" in the present case "income" and taxable?A dividend is defined as a corporate profit set aside, declared, and ordered by the directors to be paid to the stockholders on demand or at a fixed time. Until the dividend is declared, the corporate profits belong to the corporation and not to the stockholders, and are liable for the payment of the debts of the corporation.A stock dividend, when declared, is merely a certificate of stock which evidences the interest of the stockholder in the increased capital of the corporation. There is a clear distinction between a cash dividend and a stock dividend. The one is a disbursement to the stockholder of accumulated earnings, and the corporation parts irrevocably with all interest therein; the other involves no disbursement by the corporation; the corporation parts with nothing to its stockholder. When a cash dividend is declared and paid to stockholders, such cash becomes the absolute property of the stockholders and cannot be reached by the creditors of corporation in the absence of fraud. The property represented by a stock dividend, however, still being the property of corporation, and not of the stockholder, it may be reached by an execution against the corporation, and sold as a part of the property of the corporation. In such a case, if all of the property of the corporation is sold under execution, then the stockholders certainly could not be charged with having received an income by virtue of the issuance of the stock dividend. If the ownership of the property represented by a stock dividend is still in the corporation and not in the holder of such stock, certainly such stock cannot be regarded as income to the stockholder. The stockholder has received nothing but a representation of an interest in the property of the corporation and, as a matter of fact, he may never receive anything, depending upon the final outcome of the business of the corporation.

Held: "Stock dividends" are not "income," the same cannot be taxed under that provision of Act No. 2833 which provides for a tax upon income. Under the guise of an income tax, property which is not an income cannot be taxed.

2. Measure of income in cash and property dividend

3. stock dividend

a. When taxable - if it gives the shareholder an interest different from that which his former stock represented

i) Measure of Income - FMV of the shares of stocks received

b. When not taxable - if the new shares confer no different interest or rights than the old

i) Adjusted cost per share where the stock received as dividend is all of substantially the same character or preference as the stock upon which the stock dividend is paid, the cost of each share shall be equal to the cost of the old shares divided by the total number of the old and new shares. The new basis per share is used in computing any gain or loss upon any subsequent sale of the shares.

4. Liquidated Dividend

BIR Ruling 322-87Facts: The Company is a trading concern and at present is in the process of liquidation; and that individual stockholders will receive their liquidating dividends in excess of their investment.Ruling: Since the individual stockholders of the Company will receive upon its complete liquidation all its assets as liquidating dividends, they will thereby realize capital gain or loss. The gain, if any, derived by the individual stockholders consisting of the difference between the fair market value of the liquidating dividends and the adjusted cost to the stockholders of their respective shareholdings in the said corporation (Sec. 83 (a), Sec. 256, Income Tax Regulations) shall be subject to income tax at the rates prescribed under Section 21(a) of the Tax Code, as amended by Executive Order No. 37.Moreover, pursuant to Section 34(b) of the Tax Code, as amended by Executive Order No. 37, only 50% of the aforementioned capital gain is reportable for income tax purposes if the shares were held by the individual stockholders for more than twelve months and 100% of the capital gains if the shares were held for less than twelve months.

Wise & Co. Inc., v. Meer, GR. L-48231

A distribution does not necessarily become a dividend by reason of the fact that it is called a dividend by the distributing corporation. "The ordinary connotation of liquidating dividend involves the distribution of assets by a corporation to its stockholders upon dissolution." The determining element therefore is whether the distribution was in the ordinary course of business and with intent to maintain the corporation as a going concern, or after deciding to quit with intent to liquidate the business. Proceedings actually begun to dissolve the corporation or formal action taken to liquidate it are but evidentiary and not indispensable."The distinction between a distribution in liquidation and an ordinary dividend is factual; the result in each case depending on the particular circumstances of the case and the intent of the parties. If the distribution is in the nature of a recurring return on stock it is an ordinary dividend. However, if the corporation is really winding up its business or recapitalizing and narrowing its activities, the distribution may properly be treated as in complete or partial liquidation and as payment by the corporation to the stockholder for his stock. The corporation is, in the latter instances, wiping out all or Part of the stockholders' interest in the company . . ."Gains resulting from distributions made in complete liquidation or dissolution of a corporation as specifically contemplated in section 25 (a) of the former Income Tax Law, are taxable as income, whether the stockholder happens to be an individual or a corporation. Section 25 (a) of the law, far from limiting the taxability, provides that the gain thus realized is a "taxable income" under the law so long as a gain is realized, it will be a taxable income whether the distribution comes from the earnings or profits of the corporation or from the sale of all of its assets in general, so long as the distribution is made "in complete liquidation or dissolution."

5. Essentially Equivalent to distribution of taxable dividends

CIR v. CTA & Anscor, GR. No. 108576

Sometime in the 1930s, Don Andres Soriano, a citizen and resident of the United States, formed the corporation A. Soriano Y Cia, predecessor of ANSCOR, with a P1,000,000.00 capitalization divided into 10,000 common shares at a par value of P100/share. ANSCOR is wholly owned and controlled by the family of Don Andres, who are all non-resident aliens. In 1937, Don Andres subscribed to 4,963 shares of the 5,000 shares originally issued. The authorized capital stock was increased to P2,500,000.00 divided into 25,000 common shares with the same par value with only 10,000 issued and all subscribed by Don Andres. Don Andres transferred 1,250 shares each to his two sons, Jose and Andres, Jr., as their initial investments in ANSCOR. Both sons are foreigners.Stock dividends were declared on 1947, 1949 and 1963.On December 30, 1964 Don Andres died. As of that date, he has a total shareholdings of 185,154 shares - 50,495 of which are original issues and the balance of 134,659 shares as stock dividend declarations. One-half of that shareholdings were transferred to his wife, Doa Carmen Soriano, as her conjugal share. The other half formed part of his estate.ANSCOR increased its capital stock to P20M and in 1966 to P30M. In the same year, stock dividends worth 46,290 and 46,287 shares were respectively received by the Don Andres estate and Doa Carmen from ANSCOR. Hence, increasing their accumulated shareholdings to 138,867 and 138,864 common shares each.On December 28, 1967, Doa Carmen requested a ruling from the United States Internal Revenue Service (IRS), inquiring if an exchange of common with preferred shares may be considered as a tax avoidance scheme under Section 367 of the 1954 U.S. Revenue Act. By January 2, 1968, ANSCOR reclassified its existing 300,000 common shares into 150,000 common and 150,000 preferred shares. The IRS opined that the exchange is only a recapitalization scheme and not tax avoidance. Consequently, Doa Carmen exchanged her whole 138,864 common shares for 138,860 of the newly reclassified preferred shares. The estate of Don Andres in turn, exchanged 11,140 of its common shares for the remaining 11,140 preferred shares, thus reducing its (the estate) common shares to 127,727.

ANSCOR redeemed 28,000 common shares from the Don Andres estate. By November 1968, the Board further increased ANSCORs capital stock to P75M divided into 150,000 preferred shares and 600,000 common shares. About a year later, ANSCOR again redeemed 80,000 common shares from the Don Andres estate further reducing the latters common shareholdings to 19,727.In 1973, after examining ANSCORs books of account and records, Revenue examiners issued a report proposing that ANSCOR be assessed for deficiency withholding tax-at-source, pursuant to Sections 53 and 54 of the 1939 Revenue Code, for the year 1968 and the second quarter of 1969 based on the transactions of exchange and redemption of stocks.Subsequently, ANSCOR filed a petition for review with the CTA assailing the tax assessments on the redemptions and exchange of stocks.The bone of contention is the interpretation and application of Section 83(b) of the 1939 Revenue Act which provides:Sec. 83. Distribution of dividends or assets by corporations. -(b) Stock dividends - A stock dividend representing the transfer of surplus to capital account shall not be subject to tax. However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent it represents a distribution of earnings or profits accumulated after March first, nineteen hundred and thirteen. (Italics supplied).Specifically, the issue is whether ANSCORs redemption of stocks from its stockholder as well as the exchange of common with preferred shares can be considered as essentially equivalent to the distribution of taxable dividend, making the proceeds thereof taxable under the provisions of the above-quoted law.

General RuleSection 83(b) of the 1939 NIRC was taken from Section 115(g)(1) of the U.S. Revenue Code of 1928. It laid down the general rule known as the proportionate test wherein stock dividends once issued form part of the capital and, thus, subject to income tax. Specifically, the general rule states that:A stock dividend representing the transfer of surplus to capital account shall not be subject to tax.Having been derived from a foreign law, resort to the jurisprudence of its origin may shed light. Under the US Revenue Code, this provision originally referred to stock dividends only, without any exception. Stock dividends, strictly speaking, represent capital and do not constitute income to its recipient. So that the mere issuance thereof is not yet subject to income tax as they are nothing but an enrichment through increase in value of capital investment. As capital, the stock dividends postpone the realization of profits because the fund represented by the new stock has been transferred from surplus to capital and no longer available for actual distribution. Income in tax law is an amount of money coming to a person within a specified time, whether as payment for services, interest, or profit from investment. It means cash or its equivalent. It is gain derived and severed from capital, from labor or from both combined - so that to tax a stock dividend would be to tax a capital increase rather than the income. In a loose sense, stock dividends issued by the corporation, are considered unrealized gain, and cannot be subjected to income tax until that gain has been realized. Before the realization, stock dividends are nothing but a representation of an interest in the corporate properties. As capital, it is not yet subject to income tax. It should be noted that capital and income are different. Capital is wealth or fund; whereas income is profit or gain or the flow of wealth. The determining factor for the imposition of income tax is whether any gain or profit was derived from a transaction.

The ExceptionHowever, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent it represents a distribution of earnings or profits accumulated after March first, nineteen hundred and thirteen. (Emphasis supplied).Although redemption and cancellation are generally considered capital transactions, as such, they are not subject to tax. However, it does not necessarily mean that a shareholder may not realize a taxable gain from such transactions. Simply put, depending on the circumstances, the proceeds of redemption of stock dividends are essentially distribution of cash dividends, which when paid becomes the absolute property of the stockholder. Thereafter, the latter becomes the exclusive owner thereof and can exercise the freedom of choice. Having realized gain from that redemption, the income earner cannot escape income tax.As qualified by the phrase such time and in such manner, the exception was not intended to characterize as taxable dividend every distribution of earnings arising from the redemption of stock dividends. So that, whether the amount distributed in the redemption should be treated as the equivalent of a taxable dividend is a question of fact, which is determinable on the basis of the particular facts of the transaction in question. No decisive test can be used to determine the application of the exemption under Section 83(b) The use of the words such manner and essentially equivalent negative any idea that a weighted formula can resolve a crucial issue - Should the distribution be treated as taxable dividend. On this aspect, American courts developed certain recognized criteria, which includes the following:1) the presence or absence of real business purpose,2) the amount of earnings and profits available for the declaration of a regular dividend and the corporations past record with respect to the declaration of dividends,3) the effect of the distribution as compared with the declaration of regular dividend,4) the lapse of time between issuance and redemption,5) the presence of a substantial surplus and a generous supply of cash which invites suspicion as does a meager policy in relation both to current earnings and accumulated surplus.

REDEMPTION AND CANCELLATIONFor the exempting clause of Section 83(b) to apply, it is indispensable that: (a) there is redemption or cancellation; (b) the transaction involves stock dividends and (c) the time and manner of the transaction makes it essentially equivalent to a distribution of taxable dividends. Of these, the most important is the third.Redemption is repurchase, a reacquisition of stock by a corporation which issued the stock in exchange for property, whether or not the acquired stock is cancelled, retired or held in the treasury. Essentially, the corporation gets back some of its stock, distributes cash or property to the shareholder in payment for the stock, and continues in business as before. The redemption of stock dividends previously issued is used as a veil for the constructive distribution of cash dividends. In the instant case, there is no dispute that ANSCOR redeemed shares of stocks from a stockholder (Don Andres) twice (28,000 and 80,000 common shares). But where did the shares redeemed come from? If its source is the original capital subscriptions upon establishment of the corporation or from initial capital investment in an existing enterprise, its redemption to the concurrent value of acquisition may not invite the application of Sec. 83(b) under the 1939 Tax Code, as it is not income but a mere return of capital. On the contrary, if the redeemed shares are from stock dividend declarations other than as initial capital investment, the proceeds of the redemption is additional wealth, for it is not merely a return of capital but a gain thereon.It is not the stock dividends but the proceeds of its redemption that may be deemed as taxable dividends. Here, it is undisputed that at the time of the last redemption, the original common shares owned by the estate were only 25,247.5. This means that from the total of 108,000 shares redeemed from the estate, the balance of 82,752.5 (108,000 less 25,247.5) must have come from stock dividends. Besides, in the absence of evidence to the contrary, the Tax Code presumes that every distribution of corporate property, in whole or in part, is made out of corporate profits, such as stock dividends. The capital cannot be distributed in the form of redemption of stock dividends without violating the trust fund doctrine - wherein the capital stock, property and other assets of the corporation are regarded as equity in trust for the payment of the corporate creditors. Once capital, it is always capital. That doctrine was intended for the protection of corporate creditorsWith respect to the third requisite, ANSCOR redeemed stock dividends issued just 2 to 3 years earlier. The time alone that lapsed from the issuance to the redemption is not a sufficient indicator to determine taxability. It is a must to consider the factual circumstances as to the manner of both the issuance and the redemption. The time element is a factor to show a device to evade tax and the scheme of cancelling or redeeming the same shares is a method usually adopted to accomplish the end sought. Was this transaction used as a continuing plan, device or artifice to evade payment of tax? It is necessary to determine the net effect of the transaction between the shareholder-income taxpayer and the acquiring (redeeming) corporation. The net effect test is not evidence or testimony to be considered; it is rather an inference to be drawn or a conclusion to be reached. It is also important to know whether the issuance of stock dividends was dictated by legitimate business reasons, the presence of which might negate a tax evasion plan.The issuance of stock dividends and its subsequent redemption must be separate, distinct, and not related, for the redemption to be considered a legitimate tax scheme. Redemption cannot be used as a cloak to distribute corporate earnings. Otherwise, the apparent intention to avoid tax becomes doubtful as the intention to evade becomes manifest.Depending on each case, the exempting provision of Sec. 83(b) of the 1939 Code may not be applicable if the redeemed shares were issued with bona fide business purpose, which is judged after each and every step of the transaction have been considered and the whole transaction does not amount to a tax evasion scheme.It is the net effect rather than the motives and plans of the taxpayer or his corporation that is the fundamental guide in administering Sec. 83(b). This tax provision is aimed at the result. It also applies even if at the time of the issuance of the stock dividend, there was no intention to redeem it as a means of distributing profit or avoiding tax on dividends. The existence of legitimate business purposes in support of the redemption of stock dividends is immaterial in income taxation. It has no relevance in determining dividend equivalence. Such purposes may be material only upon the issuance of the stock dividends. The test of taxability under the exempting clause, when it provides such time and manner as would make the redemption essentially equivalent to the distribution of a taxable dividend, is whether the redemption resulted into a flow of wealth. If no wealth is realized from the redemption, there may not be a dividend equivalence treatment.The three elements in the imposition of income tax are: (1) there must be gain or profit, (2) that the gain or profit is realized or received, actually or constructively,and (3) it is not exempted by law or treaty from income tax. Any business purpose as to why or how the income was earned by the taxpayer is not a requirement. Income tax is assessed on income received from any property, activity or service that produces the income because the Tax Code stands as an indifferent neutral party on the matter of where income comes from.As stated above, the test of taxability under the exempting clause of Section 83(b) is, whether income was realized through the redemption of stock dividends. The redemption converts into money the stock dividends which become a realized profit or gain and consequently, the stockholders separate property.Profits derived from the capital invested cannot escape income tax. As realized income, the proceeds of the redeemed stock dividends can be reached by income taxation regardless of the existence of any business purpose for the redemption.A review of the cited American cases shows that the presence or absence of genuine business purposes may be material with respect to the issuance or declaration of stock dividends but not on its subsequent redemption. The issuance and the redemption of stocks are two different transactions. Although the existence of legitimate corporate purposes may justify a corporations acquisition of its own shares under Section 41 of the Corporation Code, such purposes cannot excuse the stockholder from the effects of taxation arising from the redemption. If the issuance of stock dividends is part of a tax evasion plan and thus, without legitimate business reasons the redemption becomes suspicious which may call for the application of the exempting clause. The substance of the whole transaction, not its form, usually controls the tax consequences.After considering the manner and the circumstances by which the issuance and redemption of stock dividends were made, there is no other conclusion but that the proceeds thereof are essentially considered equivalent to a distribution of taxable dividends. As taxable dividend under Section 83(b), it is part of the entire income subject to tax under Section 22 in relation to Section 21of the 1939 Code. Moreover, under Section 29(a) of said Code, dividends are included in gross income. As income, it is subject to income tax which is required to be withheld at source. The 1997 Tax Code may have altered the situation but it does not change this disposition.

EXCHANGE OF COMMON WITH PREFERRED SHARESExchange is an act of taking or giving one thing for another involving reciprocal transfer and is generally considered as a taxable transaction. The exchange of common stocks with preferred stocks, or preferred for common or a combination of either for both, may not produce a recognized gain or loss, so long as the provisions of Section 83(b) is not applicable. This is true in a trade between two (2) persons as well as a trade between a stockholder and a corporation. In general, this trade must be parts of merger, transfer to controlled corporation, corporate acquisitions or corporate reorganizations. No taxable gain or loss may be recognized on exchange of property, stock or securities related to reorganizations.Both the Tax Court and the Court of Appeals found that ANSCOR reclassified its shares into common and preferred, and that parts of the common shares of the Don Andres estate and all of Doa Carmens shares were exchanged for the whole 150, 000 preferred shares. Thereafter, both the Don Andres estate and Doa Carmen remained as corporate subscribers except that their subscriptions now include preferred shares. There was no change in their proportional interest after the exchange. There was no cash flow. Both stocks had the same par value. Under the facts herein, any difference in their market value would be immaterial at the time of exchange because no income is yet realized - it was a mere corporate paper transaction. It would have been different, if the exchange transaction resulted into a flow of wealth, in which case income tax may be imposed.Reclassification of shares does not always bring any substantial alteration in the subscribers proportional interest. But the exchange is different - there would be a shifting of the balance of stock features, like priority in dividend declarations or absence of voting rights. Yet neither the reclassification nor exchange per se, yields realize income for tax purposes.

E. INCOME FROM ANY SOURCE WHATEVER

1. Bad Debt Recovery

2. Forgiveness of indebtedness

RR-2, Section 50. Forgiveness of indebtedness The cancellation and forgiveness of indebtedness may amount to a payment of income, to a gift, or a capital transaction, dependent upon the circumstances. For example, an individual performs services for a creditor, who, in consideration thereof, cancels the debt, income to that amount is realized by the debtor as compensation for his service. If, however, a creditor merely desires to benefit a debtor without any consideration thereof cancels the debt, the amount of the debt is a gift from the creditor to the debtor and need not be included in the latters gross income. If a corporation to which a stockholder indebted forgives the debt, the transaction has the effect of the payment of the dividend.

3. Tax Refunds - for income tax purposes, as a general rule, tax refunds are taxable except: Philippine income tax (except fringe benefit tax); estate or donors tax; special assessments; income paid to a foreign country, if the taxpayer claimed a credit for such tax in the year it was paid; and stock transaction tax.

RMC. No. 13-80Refunds/Tax Credits under Section 295 of the Tax Code. Taxes previously claimed and allowed as deductions, but subsequently refunded or granted as tax credit pursuant to Section 295 of the Tax Code, should be declared as part of the gross income of the taxpayer in the year of receipt of the refund or tax credit. However, the following taxes, when refunded or credited, are not declarable for income tax purposes inasmuch as they are not allowable as deductions:Income tax imposed in Title III of the Tax Code;Income, war-profit and excess profits taxes imposed by authority of a foreign country; but this deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of paragraph (3) of this subsection (relating to credit for taxes of foreign countries); Estate and gift taxes;Taxes assessed against local benefits of a kind tending to increase the value of the property assessed;Stock transaction tax;Energy tax; andTaxes which are not allowable as deductions under the law.

Special Tax Credits granted under R.A. 5186; R.A. 6135 and P.D. 535. These tax credits and their tax consequences are as follows:Sales, compensating and specific taxes are paid on supplies and raw materials imported by a registered export producer. Said taxes are given as tax credit to be used in the payment of taxes, duties, charges and fees due to the national government in connection with its operations. (Sec. 7(a), R.A. No. 6135)The tax credits granted should form part of the gross income to the enterprise in the year of receipt of tax credit as said taxes paid are considered allowable deductions for income taxes purposes.In some cases, a registered BOI and tourism enterprise assumes payment of taxes withheld and due from the foreign lender-remittee on interest payments on foreign loans. In such cases, the enterprise is given a tax credit for taxes withheld subject to certain conditions. (Sec. 7(f), R.A. No. 5186; Sec. 8(c), P.D. No. 535)Said taxes assumed by the registered enterprise represent necessary and ordinary expenses incurred by the enterprise; hence, deductible from its gross income. Therefore, the tax credits granted necessarily constitute taxable income of the enterprise.

4. Damage Recovery - compensatory damages, as constituting returns of capital, are not taxable. Thus, amounts received as moral damages for personal actions, such as alienation of affections, libel, slander or breach of promise to marry, are not taxable.

5. Prizes and Winnings - generally taxable. Such payments constitute gains derived from labor.

Not taxable if recipient selected without any action on his part to enter the contest or proceedings; and the recipient is not required to render substantial future services as a condition for receiving the prize or award.

Those granted to athletes shall be exempt from income tax.

Prizes and awards in the nature of gifts are not taxable.

6. Income from any source whatever (income from illegal sources are taxable)

Gutierrez v. Collector, 101 Phil 743

The compensation or income derived from the expropriation of property located in the Philippines is an income from sources within the Philippines and subject to the taxing jurisdiction of the place.

DEDUCTIONS

A. Classes Of Deductions (Sec. 34)

Deductions from Gross Income. Except for taxpayers earning compensation income arising from personal services rendered under an employer-employee relationship where no deductions shall be allowed under this section other than Subsection M [Premium payments on Health and/or Hospitalization Insurance of an Individual Taxpayer] hereof, in computing taxable income, subject to income tax under sections

24(A)Individual resident alien25(A)Non-resident alien engaged in trade or business within the Philippines26members of general professional partnerships27(A)domestic corporations27(B)proprietary educational institutions and hospitals27(C)government-owned or controlled corporations, agencies, or instrumentalities28(A)(1)resident foreign corporations

there shall be allowed the following deductions from gross income:(a) Expenses(b) Interest(c) Taxes(d) Losses(e) Bad debts(f) Depreciation(g) Depletion of oil and gas wells and mines(h) Charitable and other contributions(i) Research and development(j) Pension trusts

The following are the deductions from the gross income to arrive at the taxable income.

Individuals:Gross compensation income from employer-employee relationship onlyGross income from business or practice of profession(a) premium payments on health and/or hospitalization insurance; and(b) personal exemptions(a) Optional Standard Deduction(b) Itemized Deductions(c) premium payments on health and/or hospitalization insurance; and(d) Personal exemptions

Corporations:Itemized deductions

Formula:IndividualCorporationsAll Income- Exclusions (Sec. 32[B])Gross Income- Allowable deductions (Sec. 34)Net Income- Personal Exemptions (Sec. 35)Taxable Net Incomex Tax RateIncome Tax Due- Creditable W/holding Tax- Tax creditIncome Tax Payable All Income- Exclusions (Sec. 32[B])Gross Income- Allowable deductions (Sec. 34)Taxable Net Incomex Tax RateIncome Tax Due- Creditable Withholding Tax- Tax creditIncome Tax Payable

1. Optional Standard Deduction for Individuals (OSD)

Sec. 34(L)In lieu of the deductions allowed, an individual subject to tax under Section 24, other than a nonresident alien, may elect a standard deduction in an amount not exceeding 10% of his gross income.

Discussion (V. D. Reyes):

The OSD is a deduction from gross income allowed to be taken in lieu of the itemized deductions. The OSD can be claimed only by an individual other than a nonresident alien. The taxpayer shall signify in the income tax return his intention to elect the OSD. Unless the taxpayer signifies in his return such intention, he shall be considered as having availed of the itemized deductions. The OSD is an amount equal to 10% of the gross income from business or practice of profession of the taxpayer. The deduction is not available against compensation income arising out of an employer-employee relationship. The election of the OSD is irrevocable for the taxable year for which the choice is made.

2. Itemized Deductions

A taxpayer may claim the following itemized deductions from gross income from business or practice of profession(a) Expenses(b) Interest(c) Taxes(d) Losses(e) Bad debts(f) Depreciation(g) Depletion of oil and gas wells and mines(h) Charitable and other contributions(i) Research and development(j) Pension trusts

The Sec. of Finance, upon the recommendation of the CIR may prescribe by regulation limitations or ceilings for any of the itemized deductions (a) to (j), subject to the following conditions:(a) only after public hearing shall have been held for such purposes;(b) considering the following factors:1. adequacy of the prescribed limits on the actual expenditure requirements of each particular industry2. effects of inflation on expenditure levels(c) no ceiling shall further be imposed on items of expenses already subject to ceilings under present law.

Any amount paid or payable which is otherwise deductible from, or taken into account in computing gross income, or for which depreciation or amortization is made, shall be allowed as a deduction only if it is shown that the tax required to be deducted and withheld therefrom has been paid to the BIR.

Items not deductible:

In computing taxable income, no deduction shall in any case be allowed for:(a) personal, living or family expenses;(b) any amount paid out for new buildings or for permanent improvements, or betterments made to increase the value of any property or estate;(c) any amount expended in restoring property or in making good the exhaustion thereof for which an allowance is or has been made;(d) premiums paid on any life insurance policy covering the life of any officer or employee, or of any person financially interested in any trade or business carried on by the taxpayer, individual or corporate, when the taxpayer is directly or indirectly a beneficiary under such policy.

And, no deduction shall be allowed for:(a) losses from sales or exchanges of property;(b) interest expense;(c) bad debtswhere the transaction is between related taxpayers, as follows:1) between members of a family. For purposes of this paragraph, the family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants;2) except in the case of distributions in liquidation, between an individual and a corporation more than 50% in value or the outstanding stock of which is owned, directly, or indirectly by or for such individual;3) except in the case of distribution in liquidation, between two corporations more than 50% in value of the outstanding stock of each of which is owned, directly or indirectly, by or for the same individual, if either one of such corporations, with respect to the taxable year of the corporation preceding the date of the sale or exchange was, under the law applicable to such taxable year a personal holding company or a foreign personal holding company. (There are no more personal holding companies or foreign personal holding companies under the NIRC).4) Between the grantor and a fiduciary of any trust;5) Between the fiduciary of a trust and the fiduciary of another trust if the same person is the grantor with respect to each trust;6) Between a fiduciary of a trust and a beneficiary of such trust.

B. Expenses In General

Sec. 34(A), NIRC(1) Ordinary and Necessary Trade, Business or Professional Expenses. (a) In General. There shall be allowed as deduction from gross income all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on or which are directly attributable to, the development, management, operation and/or conduct of the trade, business or exercise of a profession, including:(i) A reasonable allowance for salaries, wages, and other forms of compensation for personal services actually rendered, including the grossed-up monetary value of fringe benefit furnished or granted by the employer to the employee: Provided, That the final tax imposed under Section 33 hereof has been paid;(ii) A reasonable allowance for travel expenses, here and abroad, while away from home in the pursuit of trade, business or profession;(iii) A reasonable allowance for rentals and/or other payments which are required as a condition for the continued use or possession, for purposes of the trade, business or profession, of property to which the taxpayer has not taken or is not taking title or in which he has no equity other than that of a lessee, user or possessor;(iv) A reasonable allowance for entertainment, amusement and recreation expenses during the taxable year, that are directly connected to the development, management and operation of the trade, business or profession of the taxpayer, or that are directly related to or in furtherance of the conduct of his or its trade, business or exercise of a profession not to exceed such ceilings as the Secretary of Finance may, by rules and regulations prescribe, upon recommendation of the Commissioner, taking into account the needs as well as the special circumstances, nature and character of the industry, trade, business, or profession of the taxpayer: Provided, That any expense incurred for entertainment, amusement or recreation that is contrary to law, morals, public policy or public order shall in no case be allowed as a deduction.(b) Substantiation Requirements. No deduction from gross income shall be allowed under Subsection (A) hereof unless the taxpayer shall substantiate with sufficient evidence, such as official receipts or other adequate records: (i) the amount of the expense being deducted, and (ii) the direct connection or relation of the expense being deducted to the development, management, operation and/or conduct of the trade, business or profession of the taxpayer.(c) Bribes, Kickbacks and Other Similar Payments. No deduction from gross income shall be allowed under Subsection (A) hereof for any payment made, directly or indirectly, to an official or employee of the national government, or to an official or employee of any local government unit, or to an official or employee of a government-owned or -controlled corporation, or to an official or employee or representative of a foreign government, or to a private corporation, general professional partnership, or a similar entity, if the payment constitutes a bribe or kickback.(2) Expenses Allowable to Private Educational Institutions. In addition to the expenses allowable as deductions under this Chapter, a private educational institution, referred to under Section 27(B) of this Code, may at its option elect either: (a) to deduct expenditures otherwise considered as capital outlays of depreciable assets incurred during the taxable year for the expansion of school facilities, or (b) to deduct allowance for depreciation thereof under Subsection (F) hereof.

(Sec. 65-76, RR-2)Sec. 65. Business Expenses. Business expenses deductible from gross income include the ordinary and necessary expenditures directly connected with or pertaining to the taxpayers trade or business. The cost of goods purchased for resale, with proper adjustment for opening and closing inventories, is deducted from gross sales in computing gross income. Among the items included in business expenses are management expenses, commissions, labor, supplies, incidental repairs, operating expenses of transportation, equipment used in the trade or business, traveling expenses while away from home solely in the pursuit of a trade or business, advertising and other selling expenses, together with insurance premiums against fire, storm, theft, accident, or other similar losses in the case of a business, and rental for the use of business property. A taxpayer is entitled to deduct the necessary expenses paid in carrying on his business from his gross income from whatever source.

Sec. 66. Traveling Expenses. Traveling expenses as ordinarily understood, include transportation expenses and meals and lodging. If the trip is undertaken for other tan business purposes, the transportation expenses are personal expenses, and the meals and lodging are living expenses, and therefore, not deductible. If the trip is solely on business, the reasonable and necessary traveling expenses, including transportation expenses, meals, and lodging, become business instead of personal expenses.(a) If, then, an individual, whose business requires him to travel, receives a salary as full compensation for his services, without reimbursement for traveling expenses, or is employed on a commission basis with no expenses allowance, his traveling expenses, including the entire amount expended for meals and lodging, are deductible from gross income.(b) If an individual receives a salary and is also repaid his actual traveling expenses, he shall include in his gross income, the amount so repaid and may deduct such expenses.(c) If an individual receives a salary and also an allowance for meals and lodging, as for example, a per diem allowance in lieu of subsistence, the amount of the allowance should be included in gross income and the cost of such meals and lodging may be deducted therefrom.A payment for the use of a sample room at a hotel for the display of goods is a business expense. Only such expenses are reasonable and necessary in the conduct of the business and directly attributable to it may be deducted. A taxpayer claiming the benefit of the deductions referred to herein must attach to his return a statement showing (1) the nature of the business in which he engaged; (2) the number of days away from home during the taxable year on account of business; (3) the total amount of expenses incident to meals and lodging while absent from home and business during the taxable year; (4) the total amount of other expenses incident to travel and claimed as a deduction.Claim for the deductions referred to herein must be substantiated, when required by the CIR by record showing in detail the amount and nature of the expenses incurred.

Sec. 67. Cost of Materials. Taxpayers carrying materials and supplies on hand should include in expenses the charges of materials and supplies only to the amount that they are actually consumed and used in operation during the year for which the return is made, provided that the cost of such materials and supplies has not been deducted in determining the net income for any previous year. If a taxpayer carries incidental materials or supplies on hand for which no record of consumption is kept or of which physical inventories at the beginning and end of the year are not taken, it will be permissible for the taxpayer to include in his expenses and deduct from gross income the total cost of such supplies and materials as were purchased during the year for which the return is made, provided the net income is clearly reflected by this method.

Sec. 68. Repairs. The cost of incidental repairs which neither materially add to the value of the property nor appreciably prolong its life, but keep it in an ordinarily efficient operating condition, may be deducted as expense, provided the plant or property account is not increased by the amount of such expenditure. Repairs in the nature of replacement, to the extent that they arrest deterioration and appreciably prolong the life of the property should be charged against the depreciation reserves if such account is kept.

Sec. 69. Professional Expenses. A professional may claim as deductions the cost of supplies used by him in the practice of his profession, expenses paid in the operations and repair of transportation equipment used in making professional calls, dues to professional societies, and subscriptions to professional journals, the rent paid for office rooms, the expenses of the fuel, light, water, telephones, etc., used in such offices, and the hire of office assistants. Amounts currently expended for books, furniture, and professional instruments and equipment, the useful life of which is short, may be deducted. But amounts expended for books, furniture, and professional instruments and equipment of a permanent character are not allowable as deductions.

Sec. 70. Compensation for personal services. Among the ordinary and necessary expenses paid or incurred in carrying on any trade or business may be included a reasonable allowance for salaries or other compensation for personal services actually rendered. The test of deductibility in the case of compensation payments is whether they are reasonable and are, in fact, payments purely for service. This test and its practical application may be further stated and illustrated as follows:(1) Any amount paid in the form of compensation, but not in fact as the purchase price services, is not deductible. (a) an ostensible salary paid by a corporation may be a distribution of dividend on stock. This is likely to occur in the case of a corporation having few shareholders, practically all of whom draw salaries. If in such a case the salaries are in excess of those ordinarily paid for similar services, and the excessive payment correspond or bear a close relationship to the stockholder of the officers or employees, it would seem likely that the salaries are not paid wholly for services rendered, but that the excessive payments are a distribution of earnings upon the stock. (b) An ostensible salary may be in part payment for property. This may occur, for example, where a partnership sells out to a corporation, the former partners agreeing to continue in the service of the corporation. In such a case it may be found that the salaries of the former partners are not merely for services, but in part constitute payment for the transfer of their business.(2) The form or method of fixing compensation is not decisive as to the deductibility. While any form of contingent compensation invites scrutiny as a possible distribution of earnings of the enterprise, it does not follow that payments on a continent basis are to be treated fundamentally on any basis different from that applying to compensation at a flat rate. Generally speaking, if contingent compensation is paid pursuant to a free bargain between the employer and the individual made before the services are rendered, not influenced by any consideration on the part of the employer other than that of securing on fair and advantageous terms the services of the individual, it should be allowed as a deduction even though in the actual working out of the contract it may prove to be greater than the amount which would ordinarily be paid.(3) In any event the allowance for compensation paid may not exceed what is reasonable in all the circumstances. It is in general just to assume that reasonable and true compensation is only such amount as would ordinarily be paid for like services by like enterprises in like circumstances. The circumstances to be taken into consideration are those existing at the date when the contract for services was made, not those existing at the date when the contract is questioned.

Sec. 71. Treatment of excessive compensation. The income tax liability of the recipient in respect of an amount of ostensibly paid to him as compensation, but not allowed to be deducte4d as such by the payer, will depend upon the circumstances of each case. Thus, in the case of excessive payments by corporation, if such payments correspond or bear a close relationship to stockholdings, and are found to be distribution of earnings or profits, the excessive payments will be treated as dividend. If such payments constitute payment for property, they should be treated by the payer as a capital expenditure and by the recipient as part of the purchase price.

Sec. 72. Bonuses to employees. Bonuses to employees will constitute allowable deductions from gross income when such payments are made in good faith and as additional compensation for the services actually rendered by the employees, provided such payments, when added to the stipulated salaries do not exceed a reasonable compensation, for the services rendered. It is immaterial whether such bonuses are paid in cash or in kind or partly in cash and partly in kind. Donations made to employees and others, which do not have in them the element of compensation or are in excess of reasonable compensation for services, are not deductible from gross income.

Sec. 73. Pensions, compensation for injuries. Amounts paid for pensions to retired employees or to their families or other dependent upon them, or on account of injuries received by employees, and lump-sum amounts paid or accrued as compensation for injuries, are proper deductions as ordinary and necessary expenses. Such deductions are limited to the amount not compensated for by insurance or otherwise. When the amount of the salary of an officer or employee is paid for a limited period after his death to his widow or heirs, in recognition of the services rendered by the individual, such payments may be deducted. Salaries paid by employers to employees who are absent in the military, naval, or other service of the Government, but who intend to return at the conclusion of such service, are allowable deductions.

Sec. 74. Rentals. Where a leasehold is acquired for business purposes for a specified sum, the purchaser may take as a deduction in his return an adequate part of such sum each year, based on the number of years as the lease has to run. Taxes paid by a tenant to or for a landlord for business property are additional rent and constitute a deductible item to the tenant and taxable income to the landlord; the amount of the tax being deductible by the latter. The cost borne by lessee in erecting buildings or making permanent improvements on ground of which he is lessee is held to be a capital investment and not deductible as a business expense. In order to return to such taxpayer his investment of capital, an annual deduction may be made from gross income of an amount equal to the cost of such improvements divided by the number of years remaining of the term of the lease, and such deduction shall be in lieu of a deduction for depreciation. If the remainder of the term of lease is greater than the probable life of the building erected, or of the improvements made, this deduction shall take the form of an allowance for depreciation.

Sec. 75. Expenses of farmers. A farmer who operates a farm for profit is entitled to deduct from gross income as necessary expenses all amounts actually expended in the carryon on of the business of arming. The cost of ordinary tools of short life or small cost, such as hand tools, including shovels, rakes, etc., may be included. The cost of feeding and raising livestock may be treated as an expense deduction, in so far as such cost represents actual outlay, but not including the value of farm produce grown upon the far, or the laborer of the taxpayer. Where a farmer is engaged in producing crops which take more than a year from the time of planting to the process of gathering and disposal, expenses deducted may be determined upon the crop basis, and such deductions must be taken in the year in which the gross income from the crop has been realized. The cost of farm machinery, equipment, and farm buildings represents a capital investment and is not allowable deduction as an item of expense. Amounts expended in the development of farms, orchards, and ranches, prior to the time when the productive state is reached may be regarded as investments of capital. Amounts expended in purchasing work, breeding or dairy animals are regarded as investments of capital, and may be depreciated unless such animals are included in an inventory in accordance with section 149 of these regulations. The purchase price of transportation equipment if used wholly used in carrying on farm operations, is not deductible but is regarded as an investment of capital. The cost of gasoline or fuel, repairs, and upkeep of the transportation equipment if used wholly in the business of farming is deductible as an expense; if used partly for business purposes and partly for the pleasure or convenience of the taxpayer or his family, such cost may be apportioned according to the extent of the use for purposes of business and pleasure or convenience, and only the proportion of such cost justly attributable to business purposes is deductible as a necessary expense. If a farm is operated for recreation or pleasure and not on a commercial basis, and if the expenses incurred in connection with the farm are in excess of the receipt therefrom, the entire receipts from the sale of products may be ignored in rendering a return of income, and the expenses incurred, being regarded as personal expenses, will not constitute allowable deduction.

Sec. 76. When charges are deductible. Each years return, so far as practicable, both as to gross income and deductions therefrom, should be complete in itself, and taxpayers are expected to make every reasonable effort to ascertain the facts necessary to make a correct return. The expenses, liabilities, or deficit of one year cannot be used to reduce the income of a subsequent year. A taxpayer has the right to deduct all authorized allowances and it follows that if he does not within any year deduct certain of his expenses, losses, interests, taxes, or other charges, he cannot deduct them from the income of the next or any succeeding year. If it is recognized, however, that particularly in a going business of any magnitude there are certain overlapping items both of income and deduction, and so long as those overlapping items do not materially distort the income, they may be included in the year in which the taxpayer, pursuant to a consisting policy, takes them into his accounts. Judgments or other binding judicial adjudication, on account of damages for patent infringement, personal injuries, or other cause, are deductible from gross income when the claim is so adjudicated or paid, unless taken under other methods of accounting which clearly reflect the correct deduction, less any amount or such damages as may have been compensated for by insurance or otherwise. If subsequent to its occurrence, however, a taxpayer first ascertains the amount of a loss sustained during a prior taxable year which has not been deducted from gross income, he may render an amended return for such preceding taxable year including such amount of loss in the deduction from gross income and may in proper cases file a claim for refund of the excess tax paid by reason of the failure to deduct such loss in the original return. A loss from theft or embezzlement occurring in one year and discovered in another is ordinarily deductible for the year in which sustained.

1. Requisites For Deductibility

Visayan Cebu Terminal Co. v. Collector (108 Phil 320)

Doctrine: To be deductible, said business expenses must be ordinary and necessary expenses paid or incurred in carrying on any trade or business

Facts: Visayan Cebut Terminal (VCTC) is a corporation organized for the purpose of handling arrastre operations in the port of Cebu. It filed its ITR, certain entries therein were disallowed as expenses pertaining to the salaries of 2 officers, miscellaneous expenses, and representation expenses. VCTC questions the disallowance of deductions claimed for representation expenses.

Held: disallowance proper. To be deductible, said business expenses must be ordinary and necessary expenses paid or incurred in carrying on any trade or business; that those expenses must also meet the further test of reasonableness in amount, this test being inherent in the phase ordinary and necessary. The explanation to the effect that the supporting papers of some of the expenses had been destroyed when the house of appellants treasurer was burned, is not satisfactory, for appellants records were supposed to be kept in its offices, not in the residence of one of its officers.

Discussion:

An expense must satisfy the following conditions to be deductible from gross income under the category of expenses, in general:(a) it must be ordinary and necessary(b) it must be paid or incurred within the taxable year(c) it must be in carrying on, or directly attributable to, the development, management, operation and/or conduct of the trade, business or exercise of profession; and(d) Substantiated by official receipts or other adequate records.

An expense is considered ordinary, if it is normal in relation to the taxpayers business and the surrounding circumstances. The expense need not be recurring. The expense is necessary when it is intended to minimize losses or to maximize profits. The two conditions must be satisfied, such that an expense which is ordinary, but not necessary, or necessary, but not ordinary, is not deductible from gross income. A court may decide on when an expense is, or is not ordinary, but as much as possible, will refuse to substitute its judgment for that of the taxpayer on the necessity of the expense.

2. Compensation For Personal Services

Sec. 70-72, RR-2Sec. 70. Compensation for personal services. Among the ordinary and necessary expenses paid or incurred in carrying on any trade or business may be included a reasonable allowance for salaries or other compensation for personal services actually rendered. The test of deductibility in the case of compensation payments is whether they are reasonable and are, in fact, payments purely for service. This test and its practical application may be further stated and illustrated as follows:(1) Any amount paid in the form of compensation, but not in fact as the purchase price services, is not deductible. (a) an ostensible salary paid by a corporation may be a distribution of dividend on stock. This is likely to occur in the case of a corporation having few shareholders, practically all of whom draw salaries. If in such a case the salaries are in excess of those ordinarily paid for similar services, and the excessive payment correspond or bear a close relationship to the stockholder of the officers or employees, it would seem likely that the salaries are not paid wholly for services rendered, but that the excessive payments are a distribution of earnings upon the stock. (b) An ostensible salary may be in part payment for property. This may occur, for example, where a partnership sells out to a corporation, the former partners agreeing to continue in the service of the corporation. In such a case it may be found that the salaries of the former partners are not merely for services, but in part constitute payment for the transfer of their business.(2) The form or method of fixing compensation is not decisive as to the deductibility. While any form of contingent compensation invites scrutiny as a possible distribution of earnings of the enterprise, it does not follow that payments on a continent basis are to be treated fundamentally on any basis different from that applying to compensation at a flat rate. Generally speaking, if contingent compensation is paid pursuant to a free bargain between the employer and the individual made before the services are rendered, not influenced by any consideration on the part of the employer other than that of securing on fair and advantageous terms the services of the individual, it should be allowed as a deduction even though in the actual working out of the contract it may prove to be greater than the amount which would ordinarily be paid.(3) In any event the allowance for compensation paid may not exceed what is reasonable in all the circumstances. It is in general just to assume that reasonable and true compensation is only such amount as would ordinarily be paid for like services by like enterprises in like circumstances. The circumstances to be taken into consideration are those existing at the date when the contract for services was made, not those existing at the date when the contract is questioned.

Sec. 71. Treatment of excessive compensation. The income tax liability of the recipient in respect of an amount of ostensibly paid to him as compensation, but not allowed to be deducte4d as such by the payer, will depend upon the circumstances of each case. Thus, in the case of excessive payments by corporation, if such payments correspond or bear a close relationship to stockholdings, and are found to be distribution of earnings or profits, the excessive payments will be treated as dividend. If such payments constitute payment for property, they should be treated by the payer as a capital expenditure and by the recipient as part of the purchase price.

Sec. 72. Bonuses to employees. Bonuses to employees will constitute allowable deductions from gross income when such payments are made in good faith and as additional compensation for the services actually rendered by the employees, provided such payments, when added to the stipulated salaries do not exceed a reasonable compensation, for the services rendered. It is immaterial whether such bonuses are paid in cash or in kind or partly in cash and partly in kind. Donations made to employees and others, which do not have in them the element of compensation or are in excess of reasonable compensation for services, are not deductible from gross income.

Kuenzle & Streif, Inc. v. CIR (106 Phil 355)

Doctrine: Bonuses, when made in good faith and as additional compensation for services actually rendered, provided such payments when added to the stipulated salaries do not exceed a reasonable compensation for services, are deductible.

Facts: Petitioner filed its ITR and claimed deductions for certain items representing salaries, directors fees and bonuses of its non-resident president and VP, bonuses of some of its resident officers and employees, and interest on earned but unpaid salaries and bonuses of its officers and employees.

Held: Bonuses to employees made in good faith and as additional compensation for the services actually rendered by the employees are deductible, provided such payments, when added to the stipulated salaries, do not exceed a reasonable compensation for the services rendered. The conditions precedents to the deduction of bonuses to employees are: (1) the payment of the bonuses is in fact compensation; (2) it must be for personal services actually rendered and (3) the bonuses when added to the salaries, are reasonable when measured by the amount and quality of the services performed with relation to the business of the particular taxpayer.There is no fixed test for determining reasonableness of a given bonus as compensation. This depends upon many factors one of them being the amount and quality of the services performed with relation to the business. Other tests are: Payment must be made in good faith. The character of the taxpayers business, the value and amount of its net earnings, its locality, the type and extent of the services rendered, the salary policy of the corporation. The size of the particular business, the employees qualifications and contributions to the business venture and general economic conditions. However, in determining whether the particular salary or compensation payments is reasonable, the situation must be considered as a whole. Ordinarily, no single factor is decisive. It is important to keep in mind that it seldom happens that the application of one test can give a satisfactory answer, and that ordinarily, it is the interplay of several factors, properly weighed for the particular case, which must furnish the final answer.

Discussion:

Salaries, wages, fees, commissions, and similar compensation payments for services rendered to the taxpayer are deductible from gross income. The payment should be reasonable. Compensation paymentsReasonable amount: Deductible from gross income as compensation for personal services;Excess over reasonable amount: Not deductible. This should be treated as distributions of earnings on stock. Fringe benefits furnished or granted by the employed shall be deductible by the employer at the grossed-up monetary value of the fringe benefit, if the final tax imposed thereon on the employed has been paid.

3. Traveling/Transportation Expenses

Sec. 66, RR-2Traveling Expenses.Traveling expenses as ordinarily understood, include transportation expenses and meals and lodging. If the trip is undertaken for other tan business purposes, the transportation expenses are personal expenses, and the meals and lodging are living expenses, and therefore, not deductible. If the trip is solely on business, the reasonable and necessary traveling expenses, including transportation expenses, meals, and lodging, become business instead of personal expenses.(a) If, then, an individual, whose business requires him to travel, receives a salary as full compensation for his services, without reimbursement for traveling expenses, or is employed on a commission basis with no expenses allowance, his traveling expenses, including the entire amount expended for meals and lodging, are deductible from gross income.(b) If an individual receives a salary and is also repaid his actual traveling expenses, he shall include in his gross income, the amount so repaid and may deduct such expenses.(c) If an individual receives a salary and also an allowance for meals and lodging, as for example, a per diem allowance in lieu of subsistence, the amount of the allowance should be included in gross income and the cost of such meals and lodging may be deducted therefrom.A payment for the use of a sample room at a hotel for the display of goods is a business expense. Only such expenses are reasonable and necessary in the conduct of the business and directly attributable to it may be deducted. A taxpayer claiming the benefit of the deductions referred to herein must attach to his return a statement showing (1) the nature of the business in which he engaged; (2) the number of days away from home during the taxable year on account of business; (3) the total amount of expenses incident to meals and lodging while absent from home and business during the taxable year; (4) the total amount of other expenses incident to travel and claimed as a deduction.Claim for the deductions referred to herein must be substantiated, when required by the CIR by record showing in detail the amount and nature of the expenses incurred.

RR 3-98(B)(2)(d). Representation and transportation allowances which are fixed in amounts and are regularly received by the employees as part of their monthly compensation income shall not be treated as taxable fringe benefits but the same shall be considered as taxable compensation income subject to the tax imposed under Sec. 24 of the code (NIRC)

(B)(7) Expenses for Foreign Travel(a) Reasonable business expenses which are paid for by the employer for the foreign travel of his employee for the purpose of attending business meetings or conventions shall not be treated as taxable fringe benefits. In this instance, inland travel expenses (such as expenses for food, beverages and local transportation) except lodging cost in a hotel (or similar establishments) amounting to an average of US$300.00 or less per day, shall not be subject to a fringe benefit tax. The expense should be supported by documents proving the actual occurrences of the meetings or conventionsThe cost of economy and business class airplanes shall not be subject to a fringe benefit tax. However, 30% of the cost of first class airplane ticket shall be subject to a fringe