GENERAL PRINCIPLES

I. Concepts, Nature and Characteristics of Taxation and Taxes.

Taxation Defined:

As a process, it is a means by which the sovereign, through its law-making body, raises revenue to defray the necessary expenses of the government. It is merely a way of apportioning the costs of government among those who in some measures are privileged to enjoy its benefits and must bear its burdens.

As a power, taxation refers to the inherent power of the state to demand enforced contributions for public purpose or purposes.

Rationale of Taxation - The Supreme Court held:“It is said that taxes are what we pay for civilized society.

Without taxes, the government would be paralyzed for lack of the motive power to activate and operate it. Hence, despite the natural reluctance to surrender part of one’s hard-earned income to the taxing authorities, every person who is able must contribute his share in the running of the government. The government for its part is expected to respond in the form of tangible and intangible benefits intended to improve the lives of the people and enhance their moral and material values. The symbiotic relationship is the rationale of taxation and should dispel the erroneous notion that it is an arbitrary method of exaction by those in the seat of power.

Taxation is a symbiotic relationship, whereby in exchange for the protection that the citizens get from the government, taxes are paid.” (Commissioner of Internal Revenue vs Algue, Inc.,et al., L-28896, Feb. 17, 1988)

Purposes and Objectives of Taxation

1. Revenue – to provide funds or property with which the State promotes the general welfare and protection of its citizens.

2. Non-Revenue [PR2EP]

a. Promotion of General Welfare – Taxation may be used as an implement of police power in order to promote the general welfare of the people. [see Lutz vs Araneta (98 Phil 148) and Osmeňa vs Orbos (G.R. No. 99886, Mar. 31, 1993)]

b. Regulation – As in the case of taxes levied on excises and privileges like those imposed in tobacco or alcoholic products or amusement places like night clubs, cabarets, cockpits, etc.

In the case of Caltex Phils. Inc. vs COA (G.R. No. 92585, May 8, 1992), it was held that taxes may also be imposed for a regulatory purpose as, for instance, in the rehabilitation and stabilization of a threatened industry which is affected with public industry like the oil industry.

c. Reduction of Social Inequality – this is made possible through

the progressive system of taxation where the objective is to prevent the under-concentration of wealth in the hands of few individuals.

d. Encourage Economic Growth – in the realm of tax exemptions and tax reliefs, for instance, the purpose is to grant incentives or exemptions in order to encourage investments and thereby promote the country’s economic growth.

e. Protectionism – in some important sectors of the economy, as in the case of foreign importations, taxes sometimes provide protection to local industries like protective tariffs and customs duties.

Taxes Defined

Taxes are the enforced proportional contributions from persons and property levied by the law-making body of the State by virtue of its sovereignty for the support of government and for public needs.

Essential Characteristic of Taxes [LEMP3S]

1. It is levied by the law-making body of the StateThe power to tax is a legislative power which under the

Constitution only Congress can exercise through the enactment of laws. Accordingly, the obligation to pay taxes is a statutory liability.

2. It is an enforced contribution

A tax is not a voluntary payment or donation. It is not dependent on the will or contractual assent, express or implied, of the person taxed. Taxes are not contracts but positive acts of the government.

3. It is generally payable in moneyTax is a pecuniary burden – an exaction to be discharged

alone in the form of money which must be in legal tender, unless qualified by law, such as RA 304 which allows backpay certificates as payment of taxes.

4. It is proportionate in character - It is ordinarily based on the taxpayer’s ability to pay.

5. It is levied on persons or property - A tax may also be imposed on acts, transactions, rights or privileges.

6. It is levied for public purpose or purposes - Taxation involves, and a tax constitutes, a burden to provide income for public purposes.

7. It is levied by the State which has jurisdiction over the persons or property. - The persons, property or service to be taxed must be subject to the jurisdiction of the taxing state.

Theory and Basis of Taxation

1. Necessity TheoryTaxes proceed upon the theory that the existence of the

government is a necessity; that it cannot continue without the means to pay its expenses; and that for those means, it has the right to compel all citizens and properties within its limits to contribute.

In a case, the Supreme Court held that:Taxation is a power emanating from necessity. It is a

necessary burden to preserve the State’s sovereignty and a means to give the citizenry an army to resist aggression, a navy to defend its shores from invasion, a corps of civil servants to serve, public improvements designed for the enjoyment of the citizenry and those which come with the State’s territory and facilities, and protection which a government is supposed to provide. (Phil. Guaranty Co., Inc. vs Commissioner of Internal Revenue, 13 SCRA 775).

2. The Benefits-Protection Theory/Benefit-Received TheoryThe basis of taxation is the reciprocal duty of protection

between the state and its inhabitants. In return for the contributions, the taxpayer receives the general advantages and protection which the government affords the taxpayer and his property.

Qualifications of the Benefit-Protection Theory:

a. It does not mean that only those who are able to pay and do pay taxes can enjoy the privileges and protection given to a citizen by the government.

b. From the contributions received, the government renders no special or commensurate benefit to any particular property or person.

c. The only benefit to which the taxpayer is entitled is that derived from his enjoyment of the privileges of living in an organized society established and safeguarded by the devotion of taxes to public purposes. (Gomez vs Palomar, 25 SCRA 829)

d. A taxpayer cannot object to or resist the payment of taxes solely because no personal benefit to him can be pointed out as arising from the tax. (Lorenzo vs Posadas, 64 Phil 353)

3. Lifeblood Theory Taxes are the lifeblood of the government, being such, their

prompt and certain availability is an imperious need. (Collector of Internal Revenue vs. Goodrich International Rubber Co., Sept. 6, 1965) Without taxes, the government would be paralyzed for lack of motive power to activate and operate it.

Nature of Taxing Power

1. Inherent in sovereignty – The power of taxation is inherent in sovereignty as an incident or attribute thereof, being essential to the existence of every government. It can be exercised by the government even if the Constitution is entirely silent on the subject.

a. Constitutional provisions relating to the power of taxation do not operate as grants of the power to the government. They merely

constitute limitations upon a power which would otherwise be practically without limit.

b. While the power to tax is not expressly provided for in our constitutions, its existence is recognized by the provisions relating to taxation.

In the case of Mactan Cebu International Airport Authority vs Marcos, Sept. 11, 1996, as an incident of sovereignty, the power to tax has been described as “unlimited in its range, acknowledging in its very nature no limits, so that security against its abuse is to be found only in the responsibility of the legislative which imposes the tax on the constituency who are to pay it.”

2. Legislative in character – The power to tax is exclusively legislative and cannot be exercised by the executive or judicial branch of the government.

3. Subject to constitutional and inherent limitations – Although in one decided case the Supreme Court called it an awesome power, the power of taxation is subject to certain limitations. Most of these limitations are specifically provided in the Constitution or implied therefrom while the rest are inherent and they are those which spring from the nature of the taxing power itself although, they may or may not be provided in the Constitution.

Scope of Legislative Taxing Power [S 2 A P K A M]

1. subjects of Taxation (the persons, property or occupation etc. to be taxed)2. amount or rate of the tax3. purposes for which taxes shall be levied provided they are public purposes4. apportionment of the tax5. situs of taxation6. method of collection

Is the Power to Tax the Power to Destroy?

In the case of Churchill, et al. vs Concepcion (34 Phil 969) it has been ruled that:

The power to impose taxes is one so unlimited in force and so searching in extent so that the courts scarcely venture to declare that it is subject to any restriction whatever, except such as rest in the discretion of the authority which exercise it. No attribute of sovereignty is more pervading, and at no point does the power of government affect more constantly and intimately all the relations of life than through the exaction made under it.

And in the notable case of McCulloch vs Maryland, Chief Justice Marshall laid down the rule that the power to tax involves the power to destroy.

According to an authority, the above principle is pertinent only when there is no power to tax a particular subject and has no relation to a case where such right to tax exists. This opt-quoted maxim instead of being regarded as a blanket authorization of the unrestrained use of the taxing power for any and all purposes, irrespective of revenue, is more reasonably construed as an epigrammatic statement of the political and economic axiom that since the financial needs of a state or nation may outrun any human calculation, so the power to meet those needs by taxation must not be limited even though the taxes become burdensome or confiscatory. To say that “the power to tax is the power to destroy” is to describe not the purposes for which the taxing power may be used but the degree of vigor with which the taxing power may be employed in order to raise revenue (I Cooley 179-181)

Constitutional Restraints Re: Taxation is the Power to Destroy

While taxation is said to be the power to destroy, it is by no means unlimited. It is equally correct to postulate that the “power to tax is not the power to destroy while the Supreme Court sits,” because of the constitutional restraints placed on a taxing power that violated fundamental rights.

In the case of Roxas, et al vs CTA (April 26, 1968), the SC reminds us that although the power of taxation is sometimes called the power to destroy, in order to maintain the general public’s trust and confidence in the Government, this power must be used justly and not treacherously. The Supreme Court held:

“The power of taxation is sometimes called also the power to destroy. Therefore it should be exercised with caution to minimize injury to the proprietary rights of a taxpayer. It must be exercised fairly,

equally and uniformly, lest the tax collector kill the ‘hen that lays the golden egg’. And, in order to maintain the general public’ trust and confidence in the Government this power must be used justly and not treacherously.”

The doctrine seeks to describe, in an extreme, the consequential nature of taxation and its resulting implications, to wit:

a. The power to tax must be exercised with caution to minimize injury to proprietary rights of a taxpayer;

b. If the tax is lawful and not violative of any of the inherent and constitutional limitations, the fact alone that it may destroy an activity or object of taxation will not entirely permit the courts to afford any relief; and

c. A subject or object that may not be destroyed by the taxing authority may not likewise be taxed. (e.g. exercise of a constitutional right)

Power of Judicial Review in Taxation/Doctrine of Judicial Non-Interference

The courts cannot review the wisdom or advisability or expediency of a tax. The court’s power is limited only to the application and interpretation of the law.

Judicial action is limited only to review where involves:1. The determination of validity on the tax in relation to constitutional precepts or provisions.2. The determination, in an appropriate case, of the application of the law.

Aspects of Taxation1. Levy – determination of the persons, property or excises to be taxed, the sum or sums to be raised, the due date thereof and the time and manner of levying and collecting taxes (strictly speaking, such refers to taxation)

2. Collection – consists of the manner of enforcement of the obligation on the part of those who are taxed. (this includes payment by the taxpayer and is referred to as tax administration)

The two processes together constitute the “taxation system”.

Basic Principles of a Sound Tax System [FAT] 1. Fiscal Adequacy – the sources of tax revenue should coincide with, and approximate the needs of government expenditure. Neither an excess nor a deficiency of revenue vis-à-vis the needs of government would be in keeping with the principle.

2. Administrative Feasibility – tax laws should be capable of convenient, just and effective administration.

3. Theoretical Justice – the tax burden should be in proportion to the taxpayer’s ability to pay (ability-to-pay principle). The 1987 Constitution requires taxation to be equitable and uniform.

II. Classifications and Distinction

Classification of Taxes

A. As to Subject matter

1. Personal, capitation or poll taxes – taxes of fixed amount upon all persons of a certain class within the jurisdiction of the taxing power without regard to the amount of their property or occupations or businesses in which they may be engaged in.

example: community tax

2. Property Taxes – taxes on things or property of a certain class within the jurisdiction of the taxing power.

example: real estate tax

3. Excise Taxes – charges imposed upon the performance of an act, the enjoyment of a privilege, or the engaging in an occupation.

examples: income tax, estate tax or donor’s tax

B. As to Burden

1. Direct Taxes – taxes wherein both the “incidence” as well as the “impact” or burden of the tax faces on one person.

examples: income tax, community tax, donor’s tax, estate tax

2. Indirect Taxes – taxes wherein the incidence of or the liability for the payment of the tax falls on one person, but the burden thereof can be shifted or passed to another person.

examples: VAT, percentage taxes, customs duties excise taxes on certain specific goods

Important Points to Consider regarding Indirect Taxes:1. When the consumer or end-user of a manufacturer product is tax-exempt, such exemption covers only those taxes for which such consumer or end-user is directly liable. Indirect taxes are not included. Hence, the manufacturer cannot claim exemption from the payment of sales tax, neither can the consumer or buyer of the product demand the refund of the tax that the manufacturer might have passed on to him. (Phil. Acetylene Co. inc. vs Commissioner of Internal Revenue et. al., L-19707, Aug.17, 1987)

2. When the transaction itself is the one that is tax-exempt but through error the seller pays the tax and shifts the same to the buyer, the seller gets the refund, but must hold it in trust for buyer. (American Rubber Co. case, L-10963, April 30, 1963)

3. Where the exemption from indirect tax is given to the contractee, but the evident intention is to exempt the contractor so that such contractor may no longer shift or pass on any tax to the contractee, the contractor may claim tax exemption on the transaction (Commissioner of Internal Revenue vs John Gotamco and Sons, Inc., et.al., L-31092, Feb. 27, 1987)

4. When the law granting tax exemption specifically includes indirect taxes or when it is clearly manifest therein that legislative intention to exempt embraces indirect taxes, then the buyer of the product or service sold has a right to be reimbursed the amount of the taxes that the sellers passed on to him. (Maceda vs Macaraig,supra)

NOTE: In Contex Corp. vs. CIR, (G.R. No. 111535. July 2, 2004), the Court held that while, RA 7227 does not grant tax exemptions, such grant is not all encompassing but is limited only to those taxes for which an SMBA registered business may directly liable. Hence, Subic Bay Freefort Zone and Enterprise (SBFZ) locators are not relieved from indirect axes that may be shifted to them by a VAT registered seller.

In an indirect tax, which also includes VAT, the amount of tax paid on the goods, properties or services bought, transferred, or leased may be shifted or passed on by the seller, transferor, or lessor to the buyer, transferee or leasee.

C. As to Purpose1. General/Fiscal/Revenue – tax imposed for the general purposes of the government, i.e., to raise revenues for governmental needs.

Examples: income taxes, VAT, and almost all taxes

2. Special/Regulatory – tax imposed for special purposes, i.e., to achieve some social or economic needs.

Examples: educational fund tax under Real Property Taxation

D. As to Measure of Application

1. Specific Tax – tax imposed per head, unit or number, or by some standard of weight or measurement and which requires no assessment beyond a listing and classification of the subjects to be taxed.

Examples: taxes on distilled spirits, wines, and fermented liquors

2. Ad Valorem Tax – tax based on the value of the article or thing subject to tax.

example: real property taxes

E. As to Date

1. Progressive Tax – the rate or the amount of the tax increases as the amount of the income or earning (tax base) to be taxed increases.

examples: income tax, estate tax, donor’s tax

2. Regressive Tax – the tax rate decreases as the amount of income or earning (tax base) to be taxed increases.

Note: We have no regressive taxes (this is according to De Leon)

3. Mixed Tax – tax rates are partly progressive and partly regressive.

4. Proportionate Tax – tax rates are fixed on a flat tax base.examples: real estate tax, VAT, and other percentage taxes

F. As to Scope or authority imposing the tax

1. National Tax – tax imposed by the National Government.examples: national internal revenue taxes, customs duties

2. Municipal/Local Tax – tax imposed by Local Government units.examples: real estate tax, professional tax

Regressive System of Taxation vis-à-vis Regressive TaxA regressive tax, must not be confused with regressive

system of taxation.Regressive Tax: tax the rate of which decreases as the tax

base increases.Regressive System of Taxation: focuses on indirect taxes,

it exists when there are more indirect taxes imposed than direct taxes.

Taxes distinguished from other Impositions

a. Toll vs TaxToll – sum of money for the use of something, generally

applied to the consideration which is paid for the use of a road, bridge of the like, of a public nature.

Distinctions between Tax and Toll

Tax vs Toll1. demand of sovereignty 1. demand of proprietorship2. paid for the support of the government

2. paid for the use of another’s property

3. generally, no limit as to amount imposed

3. amount depends on the cost of construction or maintenance of the public improvement used

4. imposed only by the government

4. imposed by the government or private individuals or entities

b. Penalty vs TaxPenalty – any sanctions imposed as a punishment for

violations of law or acts deemed injurious.

Tax vs Penalty1. generally intended to raise revenue

1. designed to regulate conduct

2. imposed only by the government

2. imposed by the government or private individuals or entities

c. Special Assessment vs TaxSpecial Assessment – an enforced proportional

contribution from owners of lands especially or particularly benefited by public improvements.

Tax vs Special Assessment1. imposed on persons, property and excise

1. levied only on land

2. personal liability of the person assessed

2. not a personal liability of the person assessed, i.e. his liability is limited only to the land involved

3. based on necessity as well as on benefits received

3. based wholly on benefits

4. general application (see Apostolic Prefect vs Treas. Of Baguio, 71 Phil 547)

4. exceptional both as time and place

Important Points to Consider Regarding Special Assessments:1. Since special assessments are not taxes within the constitutional or statutory provisions on tax exemptions, it follows that the exemption under Sec. 28(3), Art. VI of the Constitution does not apply to special assessments.2. However, in view of the exempting proviso in Sec. 234 of the Local Government Code, properties which are actually, directly and exclusively used for religious, charitable and educational purposes are not exactly exempt from real property taxes but are exempt from the imposition of special assessments as well.( see Aban)3 .The general rule is that an exemption from taxation does not include exemption from special assessment.

d. License or Permit Fee vs TaxLicense or Permit fee – is a charge imposed under the

police power for the purposes of regulation.

Tax vs License/Permit Fee1. enforced contribution assessed by sovereign authority to defray public expenses

1. legal compensation or reward of an officer for specific purposes

2. for revenue purposes 2. for regulation purposes3. an exercise of the taxing power

3. an exercise of the police power

4. generally no limit in the amount of tax to be paid

4. amount is limited to the necessary expenses of inspection and regulation

5. imposed also on persons and property

5. imposed on the right to exercise privilege

6. non-payment does not necessarily make the act or business illegal

6. non-payment makes the act or business illegal

Three kinds of licenses are recognized in the law:1. Licenses for the regulation of useful occupations.2. Licenses for the regulation or restriction of non-useful occupations or enterprises3. Licenses for revenue only

Importance of the distinctions between tax and license fee:1. Some limitations apply only to one and not to the other, and that exemption from taxes may not include exemption from license fees.2. The power to regulate as an exercise of police power does not include the power to impose fees for revenue purposes. (see American Mail Line vs City of Butuan, L-12647, May 31, 1967 and related cases)3. An extraction, however, maybe considered both a tax and a license fee.4. But a tax may have only a regulatory purpose.5. The general rule is that the imposition is a tax if its primary purpose is to generate revenue and regulation is merely incidental; but if regulation is the primary purpose, the fact that incidentally revenue is also obtained does not make the imposition of a tax. (see Progressive Development Corp. vs Quezon City, 172 SCRA 629)

e. Debt vs TaxDebt is based upon juridical tie, created by law, contracts,

delicts or quasi-delicts between parties for their private interest or resulting from their own acts or omissions.

Tax vs Debt1. based on law 1. based on contracts,

express or implied2. generally, cannot be assigned

2. assignable

3. generally payable in money 3. may be paid in kind4. generally not subject to set-off or compensation

4. may be subject to set-off or compensation

5. imprisonment is a sanction for non-payment of tax except poll tax

5. no imprisonment for non-payment of debt

6. governed by special prescriptive periods provided for in the Tax Code

6. governed by the ordinary periods of prescriptions

7. does not draw interest except only when delinquent

7. draws interest when so stipulated, or in case of default

General Rule: Taxes are not subject to set-off or legal compensation. The government and the taxpayer are not creditors and debtors or each other. Obligations in the nature of debts are due to the government in its corporate capacity, while taxes are due to the government in its sovereign capacity (Philex Mining Corp. vs CIR, 294 SCRA 687; Republic vs Mambulao Lumber Co., 6 SCRA 622)Exception: Where both the claims of the government and the taxpayer against each other have already become due and demandable as well as fully liquated. (see Domingo vs Garlitos, L-18904, June 29, 1963)

Pertinent Case:

Philex Mining Corp. vs Commissioner of Internal Revenue

G.R. No. 125704, Aug. 28, 1998The Supreme Court held that: “We have consistently ruled

that there can be no offsetting of taxes against the claims that the taxpayer may have against the government. A person cannot refuse to pay a tax on the ground that the government owes him an amount equal to or greater than the tax being collected. The collection of a tax cannot await the results of a lawsuit against the government.”

f. Tax Distinguished from other Terms.

1. Subsidy – a pecuniary aid directly granted by the government to an individual or private commercial enterprise deemed beneficial to the public.2. Revenue – refers to all the funds or income derived by the government, whether from tax or from whatever source and whatever manner.3. Customs Duties – taxes imposed on goods exported from or imported into a country. The term taxes is broader in scope as it includes customs duties.4. Tariff – it may be used in 3 senses:

As a book of rates drawn usually in alphabetical order containing the names of several kinds of merchandise with the corresponding duties to be paid for the same.

As duties payable on goods imported or exported (PD No. 230)

As the system or principle of imposing duties on the importation/exportation of goods.

5. Internal Revenue – refers to taxes imposed by the legislative other than duties or imports and exports.6. Margin Fee – a currency measure designed to stabilize the currency.7. Tribute – synonymous with tax; taxation implies tribute from the governed to some form of sovereignty.8. Impost – in its general sense, it signifies any tax, tribute or duty. In its limited sense, it means a duty on imported goods and merchandise.

Inherent Powers of the State1. Police Power2. Power of Eminent Domain3. Power of Taxation

Distinctions among the Three Powers

Taxation Police Power Eminent DomainPURPOSE- levied for the purpose of raising revenue

- exercised to promote public welfare thru regulations

- taking of property for public use

AMOUNT OF EXACTION- no limit

- limited to the cost of regulations, issuance of the license or surveillance

- no exaction, compensation paid by the government

BENEFITS RECEIVED- no special or direct benefits received but the enjoyment of the privileges of living in an organized society

- no direct benefits but a healthy economic standard of society or “damnum absque injuria” is attained

- direct benefit results in the form of just compensation

NON-IMPAIRMENT OF CONTRACTS-the impairment rule subsist

- contract may be impaired - contracts may be impaired

TRANSFER OF PROPERTY RIGHTS- taxes paid become part of public funds

- no transfer but only restraint on the exercise of property right exists

- property is taken by the gov’t upon payment of just compensation

SCOPE- affects all persons, property and excise

- affects all persons, property, privileges, and even rights

- affects only the particular property comprehended

BASIS

- public necessity

- public necessity and the right of the state and the public to self-protection and self-preservation

-public necessity, private property is taken for public use

AUTHORITY WHICH EXERCISES THE POWER- only by the government or its political subdivisions

- only by the government or its political subdivisions

- may be granted to public service, companies, or public utilities

III. Limitations on the Power of Taxation

Limitations, Classified

a. Inherent Limitations or those which restrict the power although they are not embodied in the Constitution [P N I T E]

1. Public Purpose of Taxes2. Non-delegability of the Taxing Power3. Territoriality or the Situs of Taxation4. Exemption of the Government from taxes5. International Comity

b. Constitutional Limitations or those expressly found in the constitution or implied from its provision

1. Due process of law2. Equal protection of law3. Freedom of Speech and of the press4. Non-infringement of religious freedom5. Non-impairment of contracts6. Non-imprisonment for debt or non-payment of poll tax7. Origin of Appropriation, Revenue and Tariff Bills8. Uniformity, Equitability and Progressitivity of Taxation9. Delegation of Legislative Authority to Fx Tariff Rates, Import and Export Quotas10. Tax Exemption of Properties Actually, Directly, and Exclusively used for Religious Charitable11. Voting requirements in connection with the Legislative Grant of Tax Exemption12. Non-impairment of the Supreme Courts’ jurisdiction in Tax Cases13. Tax exemption of Revenues and Assets, including Grants, Endowments, Donations or Contributions to Education Institutions

c. Other Constitutional Provisions related to Taxation

1. Subject and Title of Bills 2. Power of the President to Veto an items in an Appropriation, Revenue or Tariff Bill3. Necessity of an Appropriation made before money4. Appropriation of Public Money5. Taxes Levied for Special Purposes6. Allotment to LGC

Inherent Limitations

A. Public Purpose of Taxes1. Important Points to Consider:

a. If taxation is for a public purpose, the tax must be used: a.1) for the support of the state or

a.2) for some recognized objects of governments or a.3) directly to promote the welfare of the community (taxation as an implement of police power)

b. The term “public purpose” is synonymous with “governmental purpose”; a purpose affecting the inhabitants of the state or taxing district as a community and not merely as individuals.

c. A tax levied for a private purpose constitutes a taking of property without due process of law.

d. The purposes to be accomplished by taxation need not be exclusively public. Although private individuals are directly benefited, the tax would still be valid provided such benefit is only incidental.

e. The test is not as to who receives the money, but the character of the purpose for which it is expended; not the immediate result of the expenditure but rather the ultimate.

f. In the imposition of taxes, public purpose is presumed.

2. Test in determining Public Purposes in tax

a. Duty Test – whether the thing to be threatened by the appropriation of public revenue is something which is the duty of the State, as a government.

b. Promotion of General Welfare Test – whether the law providing the tax directly promotes the welfare of the community in equal measure.

B. Non-delegability of Taxing Power

1. Rationale: Doctrine of Separation of Powers. Taxation is purely legislative hence, Congress

cannot delegate the power to others.

2. Exceptions: a. Delegation to the President (Art.VI. Sec. 28(2) 1987

Constitution)/Flexible Tariff ClauseThe power granted to Congress under this constitutional

provision to authorize the President to fix within specified limits and subject to such limitations and restrictions as it may impose, tariff rates and other duties and imposts include tariffs rates even for revenue purposes only. Customs duties which are assessed at the prescribed tariff rates are very much like taxes which are frequently imposed for both revenue-raising and regulatory purposes (Garcia vs Executive Secretary, et. al., G.R. No. 101273, July 3, 1992)

b. Delegations to the Local Government (Art. X. Sec. 5, 1987 Constitution)

It has been held that the general principle against the delegation of legislative powers as a consequence of the theory of separation of powers is subject to one well-established exception, namely, that legislative power may be delegated to local governments. The theory of non-delegation of legislative powers does not apply in maters of local concern. (Pepsi-Cola Bottling Co. of the Phil, Inc. vs City of Butuan, et . al., L-22814, Aug. 28, 1968)

NOTE: In MCIAA vs. Marcos, the Supreme Court ruled that considering the present provisions of the Constitution, Local Government Units’ power to tax is no longer just a delegated power but a power granted by the Constitution.

c. Delegation to Administrative Agencies with respect to aspects of Taxation not legislative in character.

Examples: assessment and collection

3. Limitations on Delegation

a. It shall not contravene any Constitutional provisions or inherent limitations of taxation;

b. The delegation is effected either by the Constitution or by validly enacted legislative measures or statute; and

c. The delegated levy power, except when the delegation is by an express provision of Constitution itself, should only be in favor of the local legislative body of the local or municipal government concerned.

4. Tax Legislation vis-à-vis Tax Administration - Every system of taxation consists of two parts:

a. the elements that enter into the imposition of the tax [S2 A P K A M], or tax regulation; and

b. the steps taken for its assessment and collection or tax administration

If what is delegated is tax legislation, the delegation is invalid; but if what is involved is only tax administration, the non-delegability rule is not violated.

C. Territoriality or Situs of Taxation

1. Important Points to Consider:a. Territoriality or Situs of Taxation means “place of taxation”

depending on the nature of taxes being imposed.b. It is an inherent mandate that taxation shall only be exercised

on persons, properties, and excise within the territory of the taxing power because:

b.1) Tax laws do not operate beyond a country’s territorial limit.

b.2) Property which is wholly and exclusively within the jurisdiction of another state receives none of the protection for which a tax is supposed to be compensation.

c. However, the fundamental basis of the right to tax is the capacity of the government to provide benefits and protection to the object of the tax. A person may be taxed, even if he is outside the taxing state, where there is between him and the taxing state, a privity of relationship justifying the levy.

2. Factors to Consider in determining Situs of Taxationa. kind and Classification of the Taxb. location of the subject matter of the taxc. domicile or residence of the persond. citizenship of the persone. source of incomef. place where the privilege, business or occupation is being exercised

D. Exemption of the Government from Taxes

1. Important Points to Consider:Reasons for Exemptions:a.1) To levy tax upon public property would render necessary new taxes on other public property for the payment of the tax so laid and thus, the government would be taxing itself to raise money to pay over to itself;a.2) In order that the functions of the government shall not be unduly impede; anda.3) To reduce the amount of money that has to be handed by the government in the course of itsoperations.

2. Unless otherwise provided by law, the exemption applies only to government entities through which the government immediately and directly exercises its sovereign powers (Infantry Post Exchange vs Posadas, 54 Phil 866)

3. Notwithstanding the immunity, the government may tax itself in the absence of constitutional limitations.

4. Government-owned or controlled corporations, when performing proprietary functions are generally subject to tax in the absence of tax exemption provisions in their charters or law creating them.

E. International Comity

1. Important Points to Consider:a. The property of a foreign state or government may not be taxed by another.

b. The grounds for the above rule are:b.1) sovereign equality among statesb.2) usage among states that when one enter into the

territory of another, there is an implied understanding that the power does not intend to degrade its dignity by placing itself under the jurisdiction of the latter

b.3) foreign government may not be sued without its consent so that it is useless to assess the tax since it cannot be collected

b.4) reciprocity among states

Constitutional Limitations

1. Due Process of Law

a. Basis: Sec. 1 Art. 3 “No person shall be deprived of life, liberty or property without due process of law x x x.”

Requisites:1. The interest of the public generally as

distinguished from those of a particular class require the intervention of the state;

2. The means employed must be reasonably necessary to the accomplishment for the purpose and not unduly oppressive;

3. The deprivation was done under the authority of a valid law or of the constitution; and

4. The deprivation was done after compliance with fair and reasonable method of procedure prescribed by law.

In a string of cases, the Supreme Court held that in order that due process of law must not be done

in an arbitrary, despotic, capricious, or whimsical manner.

2. Equal Protection of the Law

a. Basis: Sec.1 Art. 3 “ xxx Nor shall any person be denied the equal protection of the laws.

Important Points to Consider:1. Equal protection of the laws signifies that all

persons subject to legislation shall be treated under circumstances and conditions both in the privileges conferred and liabilities imposed

2. This doctrine prohibits class legislation which discriminates against some and favors others.NOTE: see Tio vs. Videogram, 151 SCRA 208.

b. Requisites for a Valid Classification1. Must not be arbitrary

2. Must not be based upon substantial distinctions 3. Must be germane to the purpose of law. 4. Must not be limited to exiting conditions only; and 5. Must apply equally to all members of a class.

3. Uniformity, Equitability and Progressivity of Taxation

a. Basis: Sec. 28(1) Art. VI. The rule of taxation shall be uniform and equitable. The Congress shall evolve a progressive system of taxation. b. Important Points to Consider:1. Uniformity (equality or equal protection of the laws)

means all taxable articles or kinds or property of the same class shall be taxed at the same rate. A tax is uniform when the same force and effect in every place where the subject of it is found.

2. Equitable means fair, just, reasonable and proportionate to one’s ability to pay.

3. Progressive system of Taxation places stress on direct rather than indirect taxes, or on the taxpayers’ ability to pay

4. Inequality which results in singling out one particular class for taxation or exemption infringes no constitutional limitation. (see Commissioner vs. Lingayen Gulf Electric, 164 SCRA 27)

5. The rule of uniformity does not call for perfect uniformity or perfect equality, because this is hardly attainable.

4. Freedom of Speech and of the Press

a. Basis: Sec. 4 Art. III. No law shall be passed abridging the freedom of speech, of expression or of the press xxx “b. Important Points to Consider:

1. There is curtailment of press freedom and freedom of thought if a tax is levied in order to suppress the basic right of the people under the Constitution.2. A business license may not be required for the sale or contribution of printed materials like newspaper for such would be imposing a prior restraint on press freedom3. However, an annual registration fee on all persons subject to the value-added tax does not constitute a restraint on press freedom since it is not imposed for the exercise of a privilege but only for the purpose of defraying part of cost of registration.

5. Non-infringement of Religious Freedom

a. Basis: Sec. 5 Art. III. “No law shall be made respecting an establishment of religion or prohibiting the free exercise thereof. The free exercise and enjoyment of religious profession and worship, without discrimination or preference, shall forever be allowed. x x x” b. Important Points to Consider:

1. License fees/taxes would constitute a restraint on the freedom of worship as they are actually in the nature of a condition or permit of the exercise of the right.

2. However, the Constitution or the Free Exercise of Religion clause does not prohibit imposing a generally applicable sales and use tax on the sale of religious materials by a religious organization. (see Tolentino vs Secretary of Finance, 235 SCRA 630)

6. Non-impairment of Contracts

a. Basis: Sec. 10 Art. III. “No law impairing the obligation of contract shall be passed.” b. Important Points to Consider:1. A law which changes the terms of the contract by making new

conditions, or changing those in the contract, or dispenses with those expressed, impairs the obligation.

2.The non-impairment rule, however, does not apply to public utility franchise since a franchise is subject to amendment, alteration or repeal by the Congress when the public interest so requires.

7. Non-imprisonment for non-payment of poll tax

a. Basis: Sec. 20 Art. III. “No person shall be imprisoned for debt or non-payment of poll tax.”b. Important Points to Consider:1.The only penalty for delinquency in payment is the payment of

surcharge in the form of interest at the rate of 24% per annum which shall be added to the unpaid amount from due date until it is paid. (Sec. 161, LGC)

2.The prohibition is against “imprisonment” for “non-payment of poll tax”. Thus, a person is subject to imprisonment for violation of the community tax law other than for non-payment of the tax and for non-payment of other taxes as prescribed by law.

8. Origin or Revenue, Appropriation and Tariff Bills

a. Basis: Sec. 24 Art. VI. “All appropriation, revenue or tariff bills, bill authorizing increase of the public debt, bills of local application, and private bills shall originate exclusively in the House of Representatives, but the Senate may propose or concur with amendments.”b. Under the above provision, the Senator’s power is notonly to

“only concur with amendments” but also “to propose amendments”. (Tolentino vs Sec. of Finance, supra)

9. Delegation of Legislative Authority to Fix Tariff Rates, Imports and Export Quotas

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

10. Tax Exemption of Properties Actually, Directly and Exclusively used for Religious, Charitable and Educational Purposes

a. Basis: Sec. 28(3) Art. VI. “Charitable institutions, churches and parsonages or convents appurtenant thereto, mosques, non-profit cemeteries, and all lands, building, and improvements actually, directly and exclusively used for religious, charitable or educational purposes shall be exempt from taxation.”b. Important Points to Consider:

1. Test of the tax exemption: the use and not ownership of the property

2. To be tax-exempt, the property must be actually, directly and exclusively used for the purposes mentioned.

3. The word “exclusively” means “primarily’.NOTE: But see Lung Center vs. QC, 29 June 2004 stating that “exclusively” means “solely”.

4. The exemption is not limited to property actually indispensable but extends to facilities which are incidental to and reasonably necessary for the accomplishment of said purposes.

5. The constitutional exemption applies only to property tax.

6. However, it would seem that under existing law, gifts made in favor or religious charitable and educational organizations would nevertheless qualify for donor’s gift tax exemption. (Sec. 101(9)(3), NIRC)

11. Voting Requirements in connection with the Legislative Grant for tax exemption

a. Basis: Sec. 28(4) Art. VI. “No law granting any tax exemption shall be passed without the concurrence of a majority of all the members of the Congress.”b. The above provision requires the concurrence of a majority not of attendees constituting a quorum but of all members of the Congress.

12. Non-impairment of the Supreme Courts’ jurisdiction in Tax Cases

a. Basis: Sec. 5 (2) Art. VIII. “The Congress shall have the power to define, prescribe, and apportion the jurisdiction of the various courts but may not deprive the Supreme Court of its jurisdiction over cases enumerated in Sec. 5 hereof.”

Sec. 5 (2b) Art. VIII. “The Supreme Court shall have the following powers: x x x(2) Review, revise, modify or affirm on appeal or certiorari x x x final judgments and orders of lower courts in x x x all cases involving the legality of any tax, impost, assessment, or toll or any penalty imposed in relation thereto.”

13. Tax Exemptions of Revenues and Assets, including grants, endowments, donations or contributions to Educational Institutions

a. Basis: Sec. 4(4) Art. XIV. “Subject to the conditions prescribed by law, all grants, endowments, donations or contributions used actually, directly and exclusively for educational purposes shall be exempt from tax.”b. Important Points to Consider:

1. The exemption granted to non-stock, non-profit educational institution covers income, property, and donor’s taxes, and custom duties.

2. To be exempt from tax or duty, the revenue, assets, property or donation must be used actually, directly and exclusively for educational purpose.

3. In the case or religious and charitable entities and non-profit cemeteries, the exemption is limited to property tax.

4. The said constitutional provision granting tax exemption to non-stock, non-profit educational institution is self-executing.

5. Tax exemptions, however, of proprietary (for profit) educational institutions require prior legislative implementation. Their tax exemption is not self-executing.

6. Lands, Buildings, and improvements actually, directly, and exclusively used for educational purposed are exempt from property tax, whether the educational institution is proprietary or non-profit.

c. Department of Finance Order No. 137-87, dated Dec. 16, 1987

The following are some of the highlights of the DOF order governing the tax exemption of non-stock, non-profit educational institutions:

1. The tax exemption is not only limited to revenues and assets derived strictly from school operations like income from tuition and other miscellaneous fees such as matriculation, library, ROTC, etc. fees, but it also extends to incidental income derived from canteen, bookstore and dormitory facilities.

2. In the case, however, of incidental income, the facilities mentioned must not only be owned and operated by the school itself but such facilities must be located inside the school campus. Canteens operated by mere concessionaires are taxable.

3. Income which is unrelated to school operations like income from bank deposits, trust fund and similar arrangements, royalties, dividends and rental income are taxable.

4. The use of the school’s income or assets must be in consonance with the purposes for which the school is created; in short, use must be school-related, like the grant of scholarships, faculty development, and establishment of professional chairs, school building expansion, library and school facilities.

Other Constitutional Provisions related to Taxation

1. Subject and Title of Bills (Sec. 26(1) 1987 Constitution)

“Every Bill passed by Congress shall embrace only one subject which shall be expressed in the title thereof.”

NOTE: In the Tolentino E-VAT case, supra, the E-vat, or the Expanded Value Added Tax Law (RA 7716) was also questioned

on the ground that the constitutional requirement on the title of a bill was not followed.

2. Power of the President to Veto items in an Appropriation, Revenue or Tariff Bill (Sec. 27(2), Art. VI of the 1987 Constitution)

“The President shall have the power to veto any particular item or items in an Appropriation, Revenue or Tariff bill but the veto shall not affect the item or items to which he does not object.”

3. Necessity of an Appropriation made before money may be paid out of the Treasury (Sec. 29(1), Art. VI of the 1987 Constitution)

“No money shall be paid out of the Treasury except in pursuance of an appropriation made by law.”

4. Appropriation of Public Money for the benefit of any Church, Sect, or System of Religion (Sec. 29(2), Art. VI of the 1987 Constitution)

”No public money or property shall be appropriated, applied, paid or employed, directly or indirectly for the use, benefit, support of any sect, church, denomination, sectarian institution, or system of religion or of any priest, preacher, minister, or other religious teacher or dignitary as such except when such priest, preacher, minister or dignitary is assigned to the armed forces or to any penal institution, or government orphanage or leprosarium.”

5. Taxes levied for Special Purpose (Sec. 29(3), Art. VI of the 1987 Constitution)

“All money collected or any tax levied for a special purpose shall be treated as a special fund and paid out for such purpose only. It the purpose for which a special fund was created has been fulfilled or abandoned the balance, if any, shall be transferred to the general funds of the government.”

An example is the Oil Price Stabilization Fund created under P.D. 1956 to stabilize the prices of imported crude oil. In a decided case, it was held that where under an executive order of the President, this special fund is transferred from the general fund to a “trust liability account,” the constitutional mandate is not violated. The OPSF, according to the court, remains as a special fund subject to COA audit (Osmeňa vs Orbos, et al., G.R. No. 99886, Mar. 31, 1993)

6. Allotment to Local GovernmentsBasis: Sec. 6, Art. X of the 1987 Constitution

“Local Government units shall have a just share, as determined by law, in the national taxes which shall be automatically released to them.”

IV. Situs of Taxation and Double Taxation

Situs of Taxation

1. Situs of Taxation literally means the Place of Taxation.2. Basic Rule – state where the subject to be taxed has a situs

may rightfully levy and collect the tax

Some Basic Considerations Affecting Situs of Taxation1. Protection

A legal situs cannot be given to property for the purpose of taxation where neither the property nor the person is within the protection of the taxing state

In the case of Manila Electric Co. vs Yatco (69 Phil 89), the Supreme Court ruled that insurance premium paid on a fire insurance policy covering property situated in the Phils. are taxable in the Phils. Even though the fire insurance contract was executed outside the Phils. and the insurance policy is delivered to the insured therein. This is because the Philippine Government must get something in return for the protection it gives to the insured property in the Phils. and by reason of such protection, the insurer is benefited thereby.

2. The maxim of Mobilia Sequuntur Personam and Situs of Taxation

According to this maxim, which means ”movable follow the person,” the situs of personal property is the domicile of the owner.

This is merely a fiction of law and is not allowed to stand in the way of taxation of personalty in the place where it has its actual situs and the requisite legislative jurisdiction exists.

Example: shares of stock may have situs for purposes of taxation in a state in which they are permanently kept regardless of the domicile of the owner, or the state in which he corporation is organized.

3. Legislative Power to Fix SitusIf no constitutional provisions are violated, the power of the

legislative to fix situs is undoubted.

Example: our law fixes the situs of intangible personal property for purposes of the estate and gift taxes. (see Sec. 104, 1997 NIRC)

NOTE: In those cases where the situs for certain intangibles are not categorically spelled out, there is room for applying the mobilia rule.

4. Double Taxation and the Situs Limitation (see later topic)

Criteria in Fixing Tax Situs of Subject of Taxation

a. Persons – Poll tax may be levied upon persons who are residents of the State.

b. Real Property – is subject to taxation in the State in which it is located whether the owner is a resident or non-resident, and is taxable only there.

Rule of Lex Rei Sitaec. Tangible Personal property – taxable in the state where it

has actual situs – where it is physically located. Although the owner resides in another jurisdiction.

Rule of Lex Rei Sitaed. Intangible Personal Property – situs or personal property is

the domicile of the owner, in accordance with the principle “MOBILIA SEQUUNTUR PERSONAM”, said principle, however, is not controlling when it is inconsistent with express provisions of statute or when justice demands that it should be, as where the property has in fact a situs elsewhere. (see Wells Fargo Bank v. Collector 70 PHIL 325; Collector v. Fisher L-11622, January, 1961)

e. Income – properly exacted from persons who are residents or citizens in the taxing jurisdiction and even those who are neither residents nor citizens provided the income is derived from sources within the taxing state.

f. Business, Occupation, and Transaction – power to levy an excise tax depends upon the place where the business is done, of the occupation is engaged in of the transaction not place.

g. Gratuitous Transfer of Property – transmission of property from donor to donee, or from a decedent to his heirs may be subject to taxation in the state where the transferor was a citizen or resident, or where the property is located.

V. Multiplicity of Situs

There is multiplicity of situs when the same subject of taxation, like income or intangible, is subject to taxation in several taxing jurisdictions. This happens due to:

a. Variance in the concept of “domicile” for tax purposes;b. Multiple distinct relationship that may arise with respect to

intangible personality; andc. The use to which the property may have been devoted, all of

which may receive the protection of the laws of jurisdiction other than the domicile of the owner

Remedy – taxation jurisdiction may provide:a. Exemption or allowance of deductions or tax credit for foreign

taxesb. Enter into treaties with other states

Double Taxation

Two (2) Kinds of Double Taxation1. Obnoxious or Direct Duplicate Taxation (Double taxation in

its strict sense) - In the objectionable or prohibited sense means that the same property is taxed twice when it should be taxed only once.

Requisites:

1. Same property is taxed twice2. Same purpose3. Same taxing authority4. Within the same jurisdiction5. During the same taxing period6. Same kind or character of tax

2. Permissive or Indirect Duplicate Taxation (Double taxation in its broad sense) – This is the opposite of direct double taxation and is not legally objectionable. The absence of one or more of the foregoing requisites of the obnoxious direct tax makes it indirect.

Instances of Double Taxation in its Broad Sense1. A tax on the mortgage as personal property when the

mortgaged property is also taxed at its full value as real estate;2. A tax upon a corporation for its capital stock as a whole and

upon the shareholders for their shares;3. A tax upon a corporation for its capital stock as a whole and

upon the shareholders for their shares;4. A tax upon depositions in the bank for their deposits and a tax

upon the bank for their property in which such deposits are invested5. An excise tax upon certain use of property and a property tax

upon the same property; and 6. A tax upon the same property imposed by two different states.

Means to Reduce the Harsh Effect of Taxation1. Tax Deduction – subtraction from gross income in arriving a

taxable income2. Tax Credit – an amount subtracted from an individual’s or

entity’s tax liability to arrive at the total tax liability

A deduction differ from a tax credit in that a deduction reduces taxable income while credit reduces tax liability

3. Exemptions4. Treaties with other States5. Principle of Reciprocity

ConstitutionalityDouble Taxation in its stricter sense is undoubtedly

unconstitutional but that in the broader sense is not necessarily so.General Rule: Our Constitution does not prohibit double taxation; hence, it may not be invoked as a defense against the validity of tax laws.

a. Where a tax is imposed by the National Government and another by the city for the exercise of occupation or business as the taxes are not imposed by the same public authority (City of Baguio vs De Leon, Oct. 31, 1968)

b. When a Real Estate dealer’s tax is imposed for engaging in the business of leasing real estate in addition to Real Estate Tax on the property leased and the tax on the income desired as they are different kinds of tax

c. Tax on manufacturer’s products and another tax on the privilege of storing exportable copra in warehouses within a municipality are imposed as first tax is different from the second

d. Where, aside from the tax, a license fee is imposed in the exercise of police power.

Exception: Double Taxation while not forbidden, is something not favored. Such taxation, it has been held, should, whenever possible, be avoided and prevented.

a. Doubts as to whether double taxation has been imposed should be resolved in favor of the taxpayer. The reason is to avoid injustice and unfairness.

b. The taxpayer may seek relief under the Uniformity Rule or the Equal Protection guarantee.

Forms of Escape from Taxation

Six Basic Forms of Escape from Taxation1. Shifting2. Capitalization3. Transformation4. Evasion5. Avoidance6. Exemption

1. Shifting – Transfer of the burden of a tax by the original payer or the one on whom the tax was assessed or imposed to another or someone else

Impact of taxation – is the point at which a tax is originally imposed.

Incidence of Taxation – is the point on which a tax burden finally rests or settles down.

Relations among Shifting, Impact and Incidence of Taxation – the impact is the initial phenomenon, the shifting is the intermediate process, and the incidence is the result.

Kinds of Shifting:a. Forward Shifting – the burden of tax is transferred

from a factor of production through the factors of distribution until it finally settles on the ultimate purchaser or consumer

b. Backward Shifting – effected when the burden of tax is transferred from the consumer or purchaser through the factors of distribution to the factor of production

c. Onward Shifting – this occurs when the tax is shifted two or more times either forward or backward

2. Capitalization, defined – the reduction in the price of the taxed object equal to the capitalized value of future taxes which the purchaser expects to be called upon to pay

3. Transformation – The method whereby the manufacturer or producer upon whom the tax has been imposed, fearing the loss of his market if he should add the tax to the price, pays the tax and endeavors to recoup himself by improving his process of production thereby turning out his units of products at a lower cost.

4. Tax Evasion – is the use of the taxpayer of illegal or fraudulent means to defeat or lessen the payment of a tax.

Indicia of Fraud in Taxationa. Failure to declare for taxation purposes true and actual

income derived from business for two consecutive years, and b. Substantial underdeclaration of income tax returns of the

taxpayer for four consecutive years coupled with overstatement of deduction.

Evasion of the tax takes place only when there are no proceeds. Evasion of Taxation is tantamount, fiscally speaking, to the absence of taxation.

5. Tax Avoidance – is the use by the taxpayer of legally permissible alternative tax rates or method of assessing taxable property or income in order to avoid or reduce tax liability.

Tax Avoidance is not punishable by law, a taxpayer has the legal right to decrease the amount of what otherwise would be his taxes or altogether avoid by means which the law permits.

Distinction between Tax Evasion and Avoidance

Tax Evasion vs Tax Avoidanceaccomplished by breaking the letter of the law

accomplished by legal procedures or means which maybe contrary to the intent of the sponsors of the tax law but nevertheless do not violate the letter of the law

VI. Exemption from Taxation

A. Tax Exemption – is a grant of immunity, express or implied, to particular persons or corporations from the obligations to pay taxes.

B. Nature of Tax Exemption1. It is merely a personal privilege of the grantee2. It is generally revocable by the government unless the

exemption is founded on a contract which is protected from impairment, but the contract must contain the other essential elements of contracts, such as, for example, a valid cause or consideration.

3. It implies a waiver on the part of the government of its right to collect what otherwise would be due to it, and in this sense is prejudicial thereto.

4. It is not necessarily discriminatory so long as the exemption has a reasonable foundation or rational basis.

C. Rationale of tax ExemptionPublic interest would be subserved by the exemption

allowed which the law-making body considers sufficient to offset monetary loss entailed in the grant of the exemption. (CIR vs Bothelo Shipping Corp., L-21633, June 29, 1967; CIR vs PAL, L-20960, Oct. 31, 1968)

Grounds for Tax Exemptions1. May be based on a contract in which case, the public

represented by the Government is supposed to receive a full equivalent therefore

2. May be based on some ground of public policy, such as, for example, to encourage new and necessary industries.

3. May be created in a treaty on grounds of reciprocity or to lessen the rigors of international double or multiple taxation which occur where there are many taxing jurisdictions, as in the taxation of income and intangible personal property

D. Equity, not a ground for Tax ExemptionThere is no tax exemption solely on the ground of equity, but

equity can be used as a basis for statutory exemption. At times the law authorizes condonation of taxes on equitable considerations. (Sec 276, 277, Local Government Code)

E. Kinds of Tax Exemptions1. As to basis

a. Constitutional Exemptions – Immunities from taxation which originate from the Constitution

b. Statutory Exemptions – Those which emanate from Legislation

2. As to forma. Express Exemption – Whenever expressly granted by

organic or statute of lawb. Implied Exemption – Exist whenever particular persons,

properties or excises are deemed exempt as they fall outside the scope of the taxing provision itself

3. As to extenta. Total Exemption – Connotes absolute immunityb. Partial Exemption – One where collection of a part of the

tax is dispensed with

F. Principles Governing the Tax Exemption1. Exemptions from taxation are highly disfavored by law, and

he who claims an exemption must be able to justify by the clearest grant of organic or statute of law. (Asiatic Petroleum vs Llanes, 49 PHIL 466; Collector of Internal Revenue vs. Manila Jockey Club, 98 PHIL 670)

2. He who claims an exemption must justify that the legislative intended to exempt him by words too plain to be mistaken. (Visayan Cebu Terminal vs CIR, L-19530, Feb. 27, 1965)

3. He who claims exemptions should convincingly prove that he is exempt

4. Tax exemptions must be strictly construed (Phil. Acetylene vs CIR, L-19707, Aug. 17, 1967)

5. Tax Exemptions are not presumed. (Lealda Electric Co. vs CIR, L-16428, Apr. 30, 1963)

6. Constitutional grants of tax exemptions are self-executing (Opinion No. 130, 1987, Sec. Of Justice)

7. Tax exemption are personal. 8. Deductions for income tax purposes partake of the nature of

tax exemptions, hence, they are strictly construed against the tax payer

9. A tax amnesty, much like a tax exemption is never favored or presumed by law (CIR vs CA, G.R. No. 108576, Jan. 20, 1999)

10. The rule of strict construction of tax exemption should not be applied to organizations performing strictly religious, charitable, and educational functionsVII. Other Doctrines in Taxation

Prospectivity of Tax Laws

General Rule: Taxes must only be imposed prospectively

Exception: The language of the statute clearly demands or express that it shall have a retroactive effect.

Important Points to Consider1. In order to declare a tax transgressing the due process clause

of the Constitution it must be so harsh and oppressive in its retroactive application (Fernandez vs Fernandez, 99 PHIL934)

2. Tax laws are neither political nor penal in nature they are deemed laws of the occupied territory rather than the occupying enemy. (Hilado vs Collector, 100 PHIL 288)

3. Tax laws not being penal in character, the rule in the Constitution against the passage of the ex post facto laws cannot be invoked, except for the penalty imposed.

Imprescriptibility of Taxes

General Rule: Taxes are imprescriptible

Exception: When provided otherwise by the tax law itself. Example: NIRC provides for statutes of limitation in the assessment and collection of taxes therein imposed

Important Point to Consider1. The law on prescription, being a remedial measure, should be

liberally construed to afford protection as a corollary, the exceptions to the law on prescription be strictly construed. (CIR vs CA. G.R. No. 104171, Feb. 24, 1999)

Doctrine of Equitable RecoupmentIt provides that a claim for refund barred by prescription may

be allowed to offset unsettled tax liabilities should be pertinent only to taxes arising from the same transaction on which an overpayment is made and underpayment is due.

This doctrine, however, was rejected by the Supreme Court, saying that it was not convinced of the wisdom and proprietary thereof, and that it may work to tempt both the collecting agency and the taxpayer to delay and neglect their respective pursuits of legal action within the period set by law. (Collector vs UST, 104 PHIL 1062) Taxpayer’s Suit - It is only when an act complained of, which may include legislative enactment, directly involves the illegal disbursement of public funds derived from taxation that the taxpayer’s suit may be allowed.

VIII. Interpretation and Construction of Tax Statutes Important Points to Consider:1. On the interpretation and construction of tax statutes,

legislative intention must be considered.

2. In case of doubt, tax statutes are construed strictly against the government and liberally construed in favor of the taxpayer.

3. The rule of strict construction against the government is not applicable where the language of the tax law is plain and there is no doubt as to the legislative intent.

4. The exemptions (or equivalent provisions, such as tax amnesty and tax condonation) are not presumed and when granted are strictly construed against the grantee.

5. The exemptions, however, are construed liberally in favor of the grantee in the following:

a. When the law so provides for such liberal construction;b. Exemptions from certain taxes granted under special

circumstances to special classes of persons;c. Exemptions in favor of the Government, its political

subdivisions;d. Exemptions to traditional exemptees, such as, those in

favor of charitable institutions.

6. The tax laws are presumed valid.

7. The power to tax is presumed to exist.

TAX ADMINISTRATION AND ENFORCEMENT

Agencies Involved in Tax Administration

1. Bureau of Internal Revenue and the Bureau of Customs for internal revenue and customs law enforcement, respectively. It is noteworthy that the BIR is largely decentralized in that a great extent of tax enforcement duties are delegated to the Regional Directors and Revenue District Officers.

2. Provincial, City and Municipal assessors and treasures for local and real property taxes.

Agents and Deputies for Collection of National Internal Revenue Taxes

Under Sec. 12 of the 1997 NIRC, the following are constituted as agents of the Commissioner:

a. The Commissioner of Customs and his subordinates with respect to the collection of national internal revenue taxes on imported goods;

b. The head of the appropriate government office and his subordinates with respect to the collection of energy tax; and

c. Banks duly accredited by the Commissioner with respect to receipt of payments of internal revenue taxes authorized to be made through banks.

Bureau of Internal Revenue

Powers and Duties

a. Exclusive and original power to interpret provisions of the NIRC and other tax laws, subject to review by the Secretary of Finance;

b. Assessment and Collection of all national internal revenue taxes, fees and charges;

c. Enforcement of all forfeitures, penalties and fines connected therewith;

d. Execution of judgment in all cases decided in its favor by the Court of Tax Appeals and the ordinary courts.

e. Effecting and administering the supervisory and police powers conferred to it by the Tax Code or other laws.

f. Obtaining information, summoning, examining and taking testimony of persons for purposes of ascertaining the correctness of any return or in determining the liability of any person for any internal revenue tax, or in collecting any such liability.

Rule of “ No Estoppel Against the Government”

It is a settled rule of law that in the performance of its governmental functions, the state cannot be estopped by the neglect of its agents and officers. Nowhere is it more true than in the field of taxation (CIR vs. Abad, et. al., L-19627, June 27, 1968). Estoppel does not apply to preclude the subsequent findings on taxability (Ibid.)

The principle of tax law enforcement is: The Government is not estopped by the mistakes or errors of its agents; erroneous application and enforcement of law by public officers do not block the subsequent correct application of statutes (E. Rodriguez, Inc. vs. Collector of Internal Revenue, L-23041, July 31, 1969.)

Similarly, estoppel does not apply to deprive the government of its right to raise defenses even if those defenses are being raised only for the first time on appeal (CIR vs Procter & Gamble Phil. G.R. No. 66838, 15 April 1988.)

Exceptions:

The Court ruled in Commissioner of Internal Revenue vs. C.A., et. al. G.R. No. 117982, 6 Feb 1997 that like other principles of law, the non-application of estoppel to the government admits of exceptions in the interest of justice and fair play, as where injustice will result to the taxpayer.

Estoppel Against the Taxpayer

While the principle of estoppel may not be invoked against the government, this is not necessarily true in case of the taxpayer. In CIR vs. Suyac, 104 Phil 819, the taxpayer made several requests for the reinvestigation of its tax liabilities such that the government, acceding to the taxpayers request, postponed the collection of its liability. The taxpayer cannot later on be permitted to raise the defense of prescription inasmuch as his previous requests for reinvestigation have the effect of placing him in estoppel.

Nature and Kinds of Assessments

An assessment is the official action of an administrative officer determining the amount of tax due from a taxpayer, or it may be the notice to the effect that the amount therein stated is due from the taxpayer that the payment of the tax or deficiency stated therein. (Bisaya Land Transportation Co. vs CIR, 105 Phil 1338)

Classifications:

a. Self-assessment- Tax is assessed by the taxpayer himself. The amount is reflected in the tax return that is filed by him and the tax is paid at the time he files his return. (Sec. 56 [A] {1], 1997 NIRC)

b. Deficiency Assessment- This is an assessment made by the tax assessor whereby the correct amount of the tax is determined after an examination or investigation is conducted. The liability is determined and is; therefore, assessed for the following reasons:

1. The amount ascertained exceeds that which is shown as tax by the taxpayer in his return;

2. No amount is shown in the return or;3. The taxpayer did not file any return at all.

(Sec. 56 [B] ]1] and [2] 1997 NIRC)

c. Illegal and Void Assessments- This is an assessment wherein the tax assessor has no power to act at all (Victorias Milling vs. CTA, L-24213, 13 Mar 1968)

d. Erroneous Assessment – This is an assessment wherein the assessor has the power to assess but errs in the exercise of that power (Ibid.)

Principles Governing Tax Assessments

1. Assessments are prima facie presumed correct and made in good faith.

The taxpayer has the duty of proving otherwise (Interprovincial Autobus vs. CIR, 98 Phil 290)

In the absence of any proof of any irregularities in the performance of official duties, an assessment will not be disturbed. (Sy Po. Vs. CTA, G.R. No 81446, 8 Aug 1988

All presumptions are in favor of tax assessments (Dayrit vs. Cruz, L-39910, 26 Sept. 1988)

Failure to present proof of error in the assessment will justify judicial affirmation of said assessments. (CIR vs C.C. G.R. No. 104151 and 105563, 10 Mar 1995)

A party challenging an appraiser’s finding of value is required to prove not only that the appraised value is erroneous but also what the proper value is (Caltex vs. C.C. G.R. No. 104781, 10 July 1998)

2. Assessments should not be based on presumptions no matter how logical the presumption might be. In order to stand the test of judicial scrutiny it must be based on actual facts.

3. Assessment is discretionary on the part of the Commissioner. Mandamus will not lie to compel him to assess a tax after investigation if he finds no ground to assess. Mandamus to compel the Commissioner to assess will result in the encroachment on executive functions (Meralco Secuirities Corp. vs. Savellano, L-36181 and L-36748, 23 Oct 1992).

Except:

The BIR Commissioner may be compelled to assess by mandamus if in the exercise of his discretion there is evidence of arbitrariness and grave abuse of discretion as to go beyond statutory authority (Maceda vs. Macaraig, G.R. No. 8829, 8 June 1993).

4. The authority vested in the Commissioner to assess taxes may be delegated. An assessment signed by an employee for and in behalf of the Commissioner of Internal Revenue is valid. However, it is settled that the power to make final assessments cannot be delegated. The person to whom a duty is delegated cannot lawfully delegate that duty to another. (City Lumber vs. Domingo, L-18611, 30 Jan 1964).

5. Assessments must be directed to the right party. Hence, if for example, the taxpayer being assessed is an estate of a decedent, the administrator should be the party to whom the assessment should be sent (Republic vs. dela Rama, L-21108, 29 Nov. 1966), and not the heirs of the decedent.

Means Employed in the Assessment of Taxes

A. Examination of Returns: Confidentiality Rule

The Tax Code requires that after the return is filed, the Commissioner or his duly authorized representative shall examine the same and assess the correct amount of tax. The tax or the deficiency of the tax so assessed shall be paid upon notice and demand from the Commissioner or from his duly authorized representative. Any return, statement or declaration filed in any office authorized to receive the same shall not be withdrawn. However, within three (3) days from the date of such filing, the same may be modified, changed or amended, provided that no notice for audit or investigation of such return, statement or declaration has in the meantime been actually served upon the taxpayer. (Sec 6[A], 1997 NIRC)

Although Sec. 71 of the 1997 NIRC provides that tax returns shall constitute public records, it is necessary to know that these are confidential in nature and may not be inquired into in unauthorized cases under pain of penalty of law provided for in Sec 270 of the 1997 NIRC.

The aforesaid rule, however, is subject to certain exceptions. In the following cases, inquiry into the income tax returns of taxpayers may be authorized:

1. When the inspection of the return is authorized upon the written order of the President of the Philippines.

2. When inspection is authorized under the Finance Regulation No. 33 of the Secretary of Finance.

3. When the production of the tax return is material evidence in a criminal case wherein the Government is interested in the result. (Cu Unjieng, et. al. vs. Posadas, etc, 58 Phil 360)

4. When the production or inspection thereof is authorized by the taxpayer himself (Vera vs Cusi L-33115, 29 June 1979).

B. Assessment Based on the Best Evidence Obtainable

The law authorizes the Commissioner to assess taxes on the basis of the best evidence obtainable in the following cases:

1. if a person fails to file a return or other document at the time prescribed by law; or

2. he willfully or otherwise files a false or fraudulent return or other document.

When the method is used, the Commissioner makes or amends the return from his knowledge and from such information as he can obtain through testimony or otherwise. Assessments made as such are deemed prima facie correct and sufficient for all legal purposes. (Sec. 6 [B], 1997 NIRC)

Best Evidence Obtainable refers to any data, record, papers, documents, or any evidence gathered by internal revenue officers from government offices or agencies, corporations, employers, clients or patients, tenants, lessees, vendees and from all other sources, with whom the taxpayer had previous transactions or from whom he received any income, after ascertaining that a report required by law as basis for the assessment of any internal revenue tax has not been filed or when there is reason to believe that any such report is false, incomplete or erroneous.

A case in point on the use of the best evidence obtainable is Sy Po vs CTA. In that case, there was a demand made by the Commissioner on the Silver Cup Wine Company owned by petitioner’s deceased husband Po Bien Seng. The demand was for the taxpayer to submit to the BIR for examination the factory’s books of accounts and records, so BIR investigators raided the factory and seized different brands of alcoholic beverages.

The investigators, on the basis of the wines seized and the sworn statements of the factory’s employees on the quantity of raw

materials consumed in the manufacture of liquor, assessed the corresponding deficiency income and specific taxes. The Supreme Court, on appeal, upheld the legality of the assessment.

C. Inventory Taking, Surveillance and Presumptive Gross Sales and Receipts

The Commissioner is authorized at any time during the taxable year to order the inventory-taking of goods of any taxpayer as a basis for assessment.

If there is reason to believe that a person is not declaring his correct income, sales or receipts for internal revenue tax purposes, his business operation may be placed under observation or surveillance. The finding made in the surveillance may be used as a basis for assessing the taxes for the other months or quarters of the same or different taxable years. (Sec. 6 [C], 1997 NIRC)

D. Termination of Taxable Period

The Commissioner shall declare the tax period of a taxpayer terminated at any time when it shall come to his knowledge:

a. That the taxpayer is retiring from business subject to tax;

b. That he intends to leave the Philippines or remove his property therefrom;

c. That the taxpayer hides or conceals his property; ord. That he performs any act tending to obstruct the

proceedings for the collection of the tax for the past or current quarter or year or to render the same totally or partly ineffective unless such proceedings are begun immediately.

The written decision to terminate the tax period shall be accompanied with a request for the immediate payment of the tax for the period so declared terminated and the tax for the preceding year or quarter, or such portion thereof as may be unpaid. Said taxes shall be due and payable immediately and shall be subject to all the penalties prescribed unless paid within the time fixed in the demand made by the Commissioner (Sec. 6 [d], 1997 NIRC)

E. Fixing of Real Property Values

For purposes of computing any internal revenue tax, the value of the property shall be whichever is the higher of : (1) the fair market value as determined by the Commissioner; or (2) the fair market value as shown in the schedule of values of the Provincial and City Assessors for real tax purposes (Sec 6 [E], 1997 NIRC).

F. Inquiry into Bank Deposits

Examination of bank deposits enables the Commissioner to assess the correct tax liabilities of taxpayers. However, bank deposits are confidential under R.A. 1405. Notwithstanding any contrary provisions of R.A. 1405 and other general or special laws, the Commissioner is authorized to inquire into the bank deposits of;

1. a decedent to determine his gross estate; and

2. any taxpayer who has filed an application for compromise of his tax liability under Sec. 204 (A) (@) of the Tax Code by reason of his financial incapacity to pay his tax liability. In this case, the application for compromise shall not be considered unless and until he waives in writing his privilege under R.A. 1405, or under other general or special laws, and such waiver shall constitute the authority of the Commissioner to inquire into bank deposits of the taxpayer (Sec. 6[F], 1997 NIRC).

Net Worth Method in Investigation

The basis of using the Net Worth Method of investigation is Revenue Memorandum Circular No. 43-72. This method of investigation, otherwise known as “inventory method of income tax verification” is a very effective method of determining taxable income and deficiency income tax due from a taxpayer.

Basic Concept and TheoryThe method is an extension of the basic accounting

principle: assets minus liabilities equals net worth. The taxpayer’s net worth is determined both at the beginning and at the end of the same taxable year. The increase or decrease in net worth is adjusted by adding all non-deductible items and subtracting therefrom non-taxable receipts. The theory is that the unexplained increase in net worth of a taxpayer is presumed to be derived from taxable sources.

Legal Source of authority for use of the MethodThe Commissioner’s authority to use the net worth method

and other indirect methods of establishing taxable income is found in Sec. 43, 1997 NIRC. This authority has been upheld by the courts in a long line of cases, notable among which is the leading case of Perez vs. CTA, 103 Phil 1167. The method is a practical necessity if a fair and efficient system of collecting revenue is to be maintained.

Moreover, Sec. 6[B], 1997 NIRC, provides for a broad and general investigatory power to assess the proper tax on the best evidence obtainable whenever a report required by law as basis for the assessment of any national internal revenue tax shall not be forthcoming within the time fixed by law or regulation, or when there is reason to believe that any such report is false, incomplete or erroneous.Conditions for the use of the method

(a) That the taxpayer's books of accounts do not clearly reflect his income, or the taxpayer has no books, or if he has books, he refuses to produce them (Inadequate Records).

The Government may be forced to resort to the net worth method of proof where the few records of the taxpayer were destroyed; for, to require more would be tantamount to holding that skillful concealment is an inevitable barrier to proof.

(b) That there is evidence of a possible source or sources of income to account for the increase in net worth or the expenditures (Need for evidence of the sources of income).

In all leading cases on this matter, courts are unanimous in holding that when the tax case is civil in nature, direct proof of sources of income is not essential-that the government is not required to negate all possible non-taxable sources of the alleged net worth increases. The burden of proof is upon the taxpayer to show that his net worth increase was derived from non-taxable sources.

As stated by the Supreme Court, in civil cases, the assessor need not prove the specific source of income. This reasonable on the basic assumption that most assets are derived from a taxable source and that when this is not true, the taxpayer is in a position to explain the discrepancy. (Perez vs. CTA, supra)

However, when the taxpayer is criminally prosecuted for tax evasion, the need for evidence of a likely source of income becomes a prerequisite for a successful prosecution. The burden of proof is always with the Government. Conviction in such cases, as in any criminal case, rests on proof beyond reasonable doubt.

(c) That there is a fixed starting point or opening net

worth, i.e., a date beginning with a taxable year or prior to it, at which time the taxpayer’s financial condition can be affirmatively established with some definiteness.

This is an essential condition, considered to be the cornerstone of a net worth case. If the starting point or opening net worth is proven to be wrong, the whole superstructure usually fails. The courts have uniformly stressed that the validity of the result of any investigation under this method will depend entirely upon a correct opening net worth.

(d) That the circumstances are such that the method does not reflect the taxpayer’s income with reasonable accuracy and certainty and proper and just additions of personal expenses and other non-deductible expenditures were made and correct, fair and equitable credit adjustments were given by way of eliminating non-taxable items. (Proper adjustments to conform to the income tax laws)

Proper adjustments for non-deductible items must be made. The following non-deductibles, as the case may be, must be added to the increase or decrease in the net worth:

1. personal, living or family expenses;2. premiums paid on any life insurance policy;3. losses from sales or exchanges of property

between members of the family;4. income taxes paid;5. estate, inheritance and gift taxes;6. other non-deductible taxes;7. election expenses and other expenses

against public policy;8. non-deductible contributions;9. gifts to others;10. net capital loss, and the like

On the other hand, non-taxable items should be deducted therefrom. These items are necessary adjustments to avoid the inclusion of what otherwise are non-taxable receipts. They are:

1. inheritance, gifts and bequests received;2. non-taxable capital gains;3. compensation for injuries or sickness;4. proceeds of life insurance policies;5. sweepstakes winnings;6. interest on government securities and the like

Increase in net worth are not taxable if they are shown not to be the result of unreported income but to be the result of the correction of errors in the taxpayer’s entries in the books relating to indebtedness to certain creditors, erroneously listed although already paid. (Fernandez Hermanos Inc. vs. CIR, L-21551, 30 Sept. 1969)

Enforcement of Forfeitures and Penalties

Statutory Offenses and Penalties

1. Additions to the Tax

Additions to the tax are increments to the basic tax incident due to the taxpayer’s non-compliance with certain legal requirements, like the taxpayer’s refusal or failure to pay taxes and/or other violations of taxing provisions.

Additions to the tax consist of the:(1) civil penalty, otherwise known as surcharge,

which may either be 25% or 50 % of the tax depending upon the nature of the violation;

(2) interest either for a deficiency tax or delinquency as to payment;

(3) other civil penalties or administrative fines such as for failure to file certain information returns and violations committed by withholding agents. (Secs. 247 to 252, 1997 NIRC)

General Considerations on the Addition to taxa. Additions to the tax or deficiency tax apply to all

taxes, fees, and charges imposed in the Tax Code.

b. The amount so added to the tax shall be collected at the same time, in the same manner, and as part of the tax.

c. If the withholding agent is the government or any of its agencies, political subdivisions or instrumentalities, or a government owned or controlled corporation, the employee thereof responsible for the withholding and remittance of the tax shall be personally liable for the additions to the tax prescribed (Sec. 247[b], 1997 NIRC) such as the 25% surcharge and the 20% interest per annum on the delinquency (Secs. 248 and 249 [C], 1997 NIRC)

SurchargeThe payment of the surcharge is mandatory and

the Commissioner of Internal Revenue is not vested with any authority to waive or dispense with the collection thereof. In one case, the Supreme Court held that the fact that on account of riots directed against the Chinese on certain dates, they were prevented from paying their internal revenue taxes on time, does not authorize the Commissioner to extend the time prescribed for the payment of taxes or to accept them without the additional penalty (Lim Co Chui vs. Posadas, 47 Phil 460)

The Commissioner is not vested with any authority to waive or dispense with the collection therof. (CIR vs. CA, supra). The penalty and interest are not penal but compensatory for the concomitant use of the funds by the taxpayer beyond the date when he is supposed to have paid them to the Government.(Philippine Refining Company vs. C.A., G.R. No. 1188794, 8 May 1996).

An extension of time to pay taxes granted by the Commissioner does not excuse payment of the surcharge (CIR vs. Cu Unjieng, L-26869, 6 Aug. 1975)

The following cases, however, show the instances when the imposition of the 25% surcharge had been waived:1. Where the taxpayer in good faith made a mistake in the

interpretation of the applicable regulations thereby resulting in delay in the payment of taxes. (Connel Bros. Co. vs. CIR, L-15470, 26 Dec. 1963)

2. A Subsequent reversal by the BIR of a prior ruling relied upon by the taxpayer may also be a ground for dispensing with the 25% surcharge. (CIR vs. Republic Cement Corp., L-35677, 10 Aug. 1983)

3. Where a doubt existed on the part of the Bureau as to whether or not R.A. 5431 abolished the income tax exemptions of corporations (including electric power franchise grantees) except those exempt under Sec. 27 (now, Sec. 30, 1997 NIRC), the imposition of the surcharge may be dispensed with (Cagayan Electreic Power & Light Co. vs CIR, G.R. No. 60126, 25 Sept. 1985)

4. In the case of failure to make and file a return or list within the time prescribed by law, not due to willful neglect, where such return or list is voluntarily filed by the taxpayer without notice from the CIR or other officers, and it is shown that the failure to file it in due time was due to a reasonable cause, no surcharge will be added to the amount of tax due on the return. In such case, in order to avoid the imposition of the surcharge, the taxpayer must make a statement showing all the facts alleged as reasonable causes for failure to file the return on time in the form of an affidavit, which should be attached to the return.

Interest This is an increment on any unpaid amount of tax,

assessed at the rate of twenty percent (20%) per annum, or such higher rate as may be prescribed y rules and regulations, from the date prescribed for payment until the amount is fully paid. (Sec. 249 [A], 1997 NIRC)

Interest is classified into:1. Deficiency interest

Any deficiency in the tax due, as the term is defined in this code, shall be subject to the interest of 20% per annum, or such higher rate as may be prescribed by rules and regulations, which shall be assessed and collected from the date prescribed for its payment until the full payment thereof (Sec. 249 [B], 1997 NIRC)

2. Delinquency interest

This kind of interest is imposed in case of failure to pay:

(1) The amount of the tax due on any return required to be filed, or

(2) The amount of the tax due for which no return is required, or

(3) A deficiency tax, or any surcharge or interest thereon on the due date appearing in the notice and demand of the Commissioner.

3. Interest on Extended Payment Imposed when a person required to pay the tax is qualified

and elects to pay the tax on installment under the provisions of the Code, but fails to pay the tax or any installment thereof, or any part of such amount or installment on or before the date prescribed for its payment, or where the Commissioner has authorized an extension of time within which to pay a tax or a deficiency tax or any part thereof. (Sec. 249[d], 1997 NIRC)

Administrative Offenses1. Failure to File Certain Information Returns2. Failure of a Withholding Agent to Collect and Remit Taxes3. Failure of a Withholding Agent to Refund Excess Withholding Tax

GENERAL CONCEPT AND ITEMS OF INCOME

I. Income in General

A. Income means all wealth which flows into the taxpayer other than as a mere return on capital.

It denotes the amount of money or property received by a person or corporation within a specified time, whether as payment for services, interests, or profits from investments.(Fisher vs. Trinidad, 43 Phil 973)

“A mere return of capital”e.g. Payments of loans

vs.“Other than a mere return of capital”

e. g. interest paid on such loans

Income is not merely increase in value of property; but a gain, a profit in excess of capital as a result of exchange transactions.

B. Basic Feature of our Present Income Tax System1. The law has adopted the most comprehensive tax situs by using all possible legal criteria in the determination of its tax base as well as the source of the taxable income. 2. The individual income tax system, in the main, is progressive in nature, i. e. the tax rates increase as the tax base increases. In certain cases, however, final taxes are imposed on passive income.3. The present income tax law is now more schedular than global in the case of individual income taxpayers, but it has maintained much of its global treatment on corporation. C. Forms of Income

Income may either be received in the form of:

1. Cash – income pertains to money or money substitutes derived as compensation or earning derived from labor, practice of profession and conduct of business.

2. Property – income denotes the earned right of ownership over tangible or intangible thing as a result of labor, business or practice of profession.

3. Services – income based on the performance received in payment for the work previously rendered by one person to another.

4. Combination of cash, services or property.

D. Classification of Income

1. Compensation Income –the gain derived from labor

especially employment such as salaries and commission.2. Profession or Business

Income – the value derived from an exercise of profession, business or utilization of capital assets. e.g. income derived from sale of assets used in trade or business

3. Passive Income – income in which the taxpayer merely waits for the amount to come in. e. g. interest derived from bank accounts

4. Capital Gain – an income derived from the sale of assets not used in trade or business. e.g. income from sale of personal property

E. Distinction between Other Terms and Income

Income Capital-- Flow of wealth -- Original investment or fund

used in order to generate earnings

-- Service of wealth -- wealth

-- Fruit -- Tree

Income Revenue-- Refers to the earnings of individual person, partnership, corporation or estate and trust.

-- Refers to all funds occurring to the treasury of the gov’t.

Income Receipts-- Refers to the amount after excluding capital invested, cost of goods, and other allowable deductions.

-- Refer to all wealth collected over a certain period. It may include capital as well as income.

F. Income may be classified as Non – taxable or Taxable;

1. Non – Taxable Income – income received but not included in determination of taxable income, nor as part of the gross income.

E.xamples: 13th month pay not exceeding P30k Winnings from lotto or sweepstakes

2. Taxable Income – it is the amount of the income upon which the tax rate prescribed by law is applied to obtain the amount of Income Tax.

Taxable Income may be grouped into three (3) categories: Passive investment income subject to final tax = eg.

Royalties, interest from Phil. Bank deposit. Compensation income – refers to all income payments,

in money or in kind, “arising from personal” services under an employer – employee relationship.

Non – compensation income or Business / Professional Income – any other income that is not derived from personal services or not related to an ER – EE (employer – employee) relationship and is generally subject to tax on net income basis.

G. Requisites for income to be taxable.1. There must be gain – there must be a value received in the form

of cash or its equivalent as a result of rendition of service or earnings in excess of capital invested.

A mere expectation of profits is not an income A transaction where- by nothing of exchangeable value

comes to or is received by the taxpayer does not give rise to or create taxable income.

Items or amounts received which do not add to the taxpayer’s net worth or redound to his benefits such as amounts merely deposited or entrusted to him are not considered as gains (CIR vs. Tours specialist, 183 SCRA 402).

Gain need not be necessarily in cash. It may be in form of payment, reduction or cancellation of T’s indebtedness, or gain from exchange of property.

2. The gain must actually be or constructively realized or received.

GENERAL RULE: A mere increase in the value of property without actual realization, either through sale or other disposition, is not taxable. The increase in value is a mere unrealized increase in capital.

EXCEPT: ECONOMIC BENEFIT PRINCIPLE (BIR RULING NO. 029 – 98, MARCH 19, 1998)

-That even without the sale or other disposition if by reason of appraisal, the cost basis is used as the new tax base for purposes of computing the allowable depreciation expense, the net difference between the original cost basis and new basis due to appraisal is taxable.

An income is constructively received by a person when - it is credited to the amount of or segregated in his favor and which maybe drawn by him at any time without any limitations e. g.:

Interest credited on savings bank deposits Dividends applied by the corporation against the

indebted- ness of stockholder Share in the profit of a partner in General Professional

Partnership

3. The gain must not be excluded by the law or treaty from the taxation.

The gain must not be exempted. Property or money received by a taxpayer in which he

has “no business transaction right to retain, but a duty to return “To the one person from whom it was received is not considered as income (e. g. payment by mistake). Reason: The receipt is offset by a liability to the party making the excess payment. However, where the duty to return is unclear, the recipient may be required to pay the tax.

II. GROSS INCOME

A. Gross Income – means all income derived during a taxable year by a taxpayer from whatever source, whether legal or illegal.

The term “derived from whatever source “implies the inclusion of all income under the law, irrespective of the voluntary or involuntary action of the taxpayer in producing the gains.

It includes illegal gains arising from – gambling, betting, lotteries extortion and fraud.

B. Items included in the determination of Gross Income, but not limited to the following; (C - G2IR2P3AD)

1. Compensation for services in whatever form paid, including but not limited to;

a. Salaries – refer to earnings received periodically for regular work other than manual labor.

b. Wages – are earnings received usually according to specified intervals of work, as by the hour, day or week.

c. Fees - amount received by an employee for the services rendered to the employer.

d. Commission – refers to percentage of total or an certain quota of sales volume attained as part of incentives, such a sales commission.

e. Similar items – like pension or retiring allowance.

A pension awarded to a person where no services have been rendered are mere gifts or gratuities and not taxable as income. They are subject to donor’s tax payable by the donee.

Compensation for personal services is taxable when:

a. Income for services rendered is taxable in the year of receipt.(cash basis)b. Cash, property or services earned during the taxable year though not actually received are deemed to have accrued to the taxpayer and are classified as income (accrual basis).

Forms of Compensationa. moneyb. in kind

Compensation paid to an employee of a corporation in its stock is to be treated as if the corporation sold the stock for its market value and paid to the employee in cash.

Living quarters furnished to the employee in addition to cash salary. The rental value should be reported as income.

Meals given to employee, the value thereof substitutes income.

CONVENIENCE OF THE EMPLOYER RULE The allowances furnished to the employee which are for the

convenience and advantage of the employer or for proper performance of the employees’ duty, shall not be taxable on the part of the employee receiving the same.REQUISITES:

a. They must be furnished within the employer business premises.

b. The employer accepts the same as a condition of his employment

--- Promissory notes or other evidence of indebtedness received in payment of services are considered as income to the extent of their fair market value.

--- An individual who performs services for a creditor, who in consideration thereof cancels his debt, income to that amount is realized by the debtor as compensation for his services. However, if the creditor condones /cancels the debt without any service rendered by the debtor, the amount of such debt is a gift and need not be included in the gross income of the debtor. The amount is subjects to donor’s tax.

c. Both in money and in kind.

2. Gross income derived from the conduct of trade, business or the exercise of a profession.

(a). Determination of gross income in case of manufacturing, merchandising or mining business.

Formula: Gross Income = (Gross Sales – cost of goods sold) + other income

(b). Income from a long term contract – long term contract means building, installation and construction contract covering a period in excess of one year.

NOTE: any income derived from these contracts shall be reported upon the basis of Percentage of Completion.

(c). Income from farming may be reported in any of the following methods:

(1). Cash basis – no inventory is used in determining profits.(2). Accrual basis – an inventory is used in determining profits.(3). Crop basis – it is generally used when the farmer is engaged in producing crops which take more than a year to gather and dispose of from the time of planting.

3. Gains derived from dealings in property – refers to the income derived from the sale and or exchange of assets, which result in gain because of the excess of the amount of value received by the taxpayer.

GENERAL RULE: The entire amount of the gain or loss arising from the transaction shall be taxable or deductible, or the case may be.

4. Royalty Income – these are the compensations or payments for the use of property and are paid to the owner of a right.

5. Rental Income – refers to earning derived from leasing real estate as well as personal property. It includes all other obligations assumed to be paid by the lessee to the third party in behalf of the lessor.

Taxes paid by the tenant (lessee) to or for a lessor for a business property are additional rent and constitute income taxable to the lessor.

Advanced rentals:(a). if the advanced rental is a Security Deposit which restricts the lessor as to its use -- such amount shall be “excluded” in the determination of rental income.

(b). If the advance rental is Prepaid Rental received without restriction as to its use – the entire amount is “taxable” in the year it is received.

Permanent improvements made by the lessee on leased property.

When the lessee makes improve – ments on the leased property and the said improvements will belong to the lessor upon the expiration of the lease contract, the lessor may report the income there from upon either by the following methods:

(a). Outright method – the lessor will report as income the FMV (fair market value) of the improvements on the year of completion.

(b). Spread out method – the lessor may spread over the life of the lease the estimated depreciated value of such improvements at the termination of the lease and report as income of each year of the lease an aliquot part theory.

Income resulting from pre – mature termination of the lease contract.

RULES:

1. If the improvement is destroyed before the termination of the lease contract -- the lessor is entitled to “deduct” as a loss for the year when such destruction takes place the amount previously reported as income.

2. If the lease is terminated prior to the expiration of the lease contract for any reason, other than a bonafide sale to the lessor – the lessor received “additional income” for the year the value of the improvements exceed the amount of income already reported.

Income of corporation from leased property. Where the property of a corporation is leased to the lessee in consideration that the latter shall pay in lieu of rental an amount equivalent to a certain rate of dividend on the lessor’s capital stock; it shall be considered as;

(a). Rentals (income) – to lessee and lessor (income to the corp.)

(b). Dividend from the lessor corporation – as far as the shareholders are concerned.

6. Interest IncomeAn earning derived from depositing or lending of money,

goods or credits.

GENERAL RULE: Interest received by a taxpayer, whether usurious or not, is subject to income tax.

EXCEPT: When interest income is exempted by law from income tax.

7. Prizes and winningsGENERAL RULE: Prizes and winnings whether in cash or in kind are taxable.

Prizes and winnings are subject to 20% final tax.

Where the amount of prizes or winning is P10k or less – subject to schedular rate.

8. Pension Refers to allowance paid regularly to a person on his

retirement or to his dependents on his death, in consideration of past services, meritorious work, age, loss or injury.

9. Partner’s distributive profits from the net income of a General Professional Partnership.

NOTE: Gen. Professional Partnership -- is created by a group of individuals for the purpose of exercising their common professionE. g. Law firm

10. Annuities Amount payable yearly or at other regular intervals for a

certain or uncertain period They also represent as installment payments for life

insurance sold by insurance companies.

If the part of annuity payments represent “interest” = taxable income.

If the annuity is a mere return of premium = not taxable.

11. Dividends -- Means any distributions made by a stock corporation to

its stockholders out of its earnings or profits and payable to its stockholders in money or other property.

NON – TAXABLE INTER – CORPORATE PRINCIPLE Dividends from the domestic/resident corporations and

shares in profits of taxable partnerships received by domestic/resident corp. are exempt from income tax.

Sources of dividends payment: Every dividend declared by a corporation is presumed to come from the “most recently accumulated profit”.

Taxable dividends include the following:(a) Cash Dividend – a dividend paid in cash and

is taxable to the extent of the cash received.

(b) Liquidating dividend – a dividend distributed to the SHs upon dissolution of the corporation.

(c) Scrip Dividend – issued in a form of promissory note and it is taxable in its Fair Market Value.

(d) Indirect dividend – when a corporation forgives the indebtedness of its stockholders, the transaction has the effect of payment of dividend to the extent of the amount of the debt.

(e) Property dividend—a dividend paid in property of a corporation such as stock investment, bands or securities held by the corporation and to the extent of the FMV of the property received at the time of the distribution.

(f) Stock Dividend -- Involves the transfer of a portion of retained earning to capital stock by action of stockholders. it simply means the capitalization of retained earnings.

GENERAL RULE: A mere issuance of stock dividends is not subject to income tax, because it merely represents capital and it does not constitute income to its recipient. Before disposition thereof, stock dividends are nothing but a representation of interest in the corporate entity.

EXCEPTIONS: When stock dividends are subject to tax:

a.) These shares are later redeemed for a consideration by the corporation or otherwise conveyed by the stockholder to the extent of such contribution. Under the NIRC, if a corporation, after the distribution of a non-taxable 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 tax of a taxable dividend, the amount received in redemption or cancellation of the stock shall be treated as a taxable dividend to the extent that it represents a distribution of earnings or profits. (Sec.73 (B), NIRC). Depending on the circumstances, corporate earnings may be distributed under the guise of initial capitalization by declaring the stock dividends previously issued and later redeem or cancel said dividends by paying cash to the stockholder. This process amounts to distribution of taxable dividends which is just delayed so as to escape the tax. (CIR vs. CA, 301 SCRA 152)

b.) he recipient is other than the stockholder. (Bachrach vs. Seifert, 57 PHIL 483)

c.) A change in the stockholder’s equity results by virtue of the stock dividend issuance.

Stock dividend is classified into:

(1). Non – taxable – is one where the new shares confer the same rights and interest as the old share. There is no change in the corporate identity. After the distribution thereof, there is no change in the proportionate interest of SHs.

(2). Taxable Stock dividend – is one where there either has been a change of corporate identity or a change in the nature of the shares, where the proportionate interest of the SHs changes.

Under the corp. code, stock dividend being one payable in capital stock, cannot be declared out of outstanding capital stock but from retained earnings of the corporation.

Where corporate earnings are used to purchase outstanding stocks treated as treasury stock (stocks issued and fully paid for and subsequently reacquired by the corporation of purchase, redemption or through same other means) as a technical but prohibited device, to avoid the effects of income taxation, distribution of said corporate earnings in the form of stock dividend will subject SHs receiving them to income tax. The corporation parting with a portion of its earnings “to buy” the outstanding stock is in ultimate effect and result making a distribution of such earnings to the stockholders. (Commissioner vs. Manning, 66 SCRA 14)

III. EXCLUSION FROM INCOMEA. Exclusion – refers to income received or earned but is not taxable as income because it is exempted by law or by treaty. Receipts which are not in fact income are also excluded from Gross Income.

Exclusion Deductions

-- not taken into account in determining gross income

they are subtracted from gross income

Exclusions are in the nature of tax exemptions, thus the claimant must establish them convincingly.

B. Exclusion under the Code. (LAGI C MR G2)1). Life Insurance Proceed The proceeds of life insurance policies paid to the heirs or beneficiaries upon the death of the insured, whether in a single sum or otherwise.

Note: Reason for exclusion: The contract of insurance is

a contract of indemnity hence, the proceeds thereof are considered indemnity rather than a gain or profits.

Instances when proceeds from insurance are taxable:a.) Where proceeds are held by the insurer under

an agreement to pay interest. The interest is included in determination of gross income.

b.) Where the transfer is for valuable consideration.

2.) Amount Received by Insured as Return of Premium The amount received by the insured as a return of premiums paid by him under life insurance, endowment, or annuity contracts, either during the term or at the maturity of the term of the contract of upon surrender.

Reason for the exclusion: The return of premium is a mere return of capital. However, where the included in the gross amount received exceed the aggregate premiums paid, the excess shall be income.

3.) Gift, Bequests, and Devises

The value the property acquired by gift, devise, or descent shall be excluded. However, the income from such property, as well as gift, bequest, devise, or descent of income from property, in cases of transfers of divided interest, shall be included in gross income.

4). Income Exempt under TreatyIncome of any kind, to the extent required by any treaty obligation

binding upon the Government of the Philippines.

5.) Compensation for Injuries or Sickness Amounts received, through Accident or Health Insurance or

under Workmen’s Compensation Acts, as compensation for personal injuries or sickness, plus the amounts of any damages received, whether by suit or agreement, on the account of such injuries or sickness.

Example of damages recovered from personal injuries: Moral damages for personal injuries.

If the award of damages is to compensate loss of property or an award of damages to compensate loss of income / profits, such is subject to tax.

6.) Miscellaneous Items

a.) Income derived by Foreign Government – Income derived from investments in the Philippines in loans, stocks, bonds or other domestic securities or from interest on deposits in banks in the Philippines by:

(i) Foreign governments, (ii) Financing institutions owned, controlled or enjoying

refinancing from foreign governments, and (iii) International or regional financial institutions

established by foreign governments. b.) Income derived by the Government or its Political

Subdivision – Income derived from any public utility or from the exercise of any essential governmental function accruing to the Government of the Philippines or to any political subdivision thereof.

c.) Prizes and Award - Prizes and award to be excluded, the following conditions must concur;

(1) Prizes and award made primarily in recognition of religious, charitable,

scientific, educational, artistic, literary, or civic achievement.

(2) The recipient was selected without any action on his part to enter the contest or proceeding.

(3) The recipient is not required to render substantial future services as a condition in receiving the award.

d.) Prizes and Award in Sports Competition - All prizes and award granted to athletes in local and international sports competitions and tournaments whether held in the Phils. Or abroad and sanctioned by sports associations.

e.) 13th Month Pay and Other Benefits - The total exclusion shall not exceed P30k.

f.) GSIS, SSS, Medicare and Other Contributions

7.) Retirement Benefits, Pension, Gratuities, etc.

The following items are exempt from taxation:(a). Retirements benefits received under RA 7641 and those received by officials and employees of private firms in accordance with reasonable PRIVATE BENEFIT PLAN.

Requisites:(1.) The retiring official or employee has been in service of the same employer for at least ten years.(2.) Is not less than 50 yrs. of age at the time of his retirement.(3.) And is available to official or employee only once.

Private retirement benefit plan A “reasonable private benefit plan” means a pension; gratuity, stock bonus or profit sharing plan maintained by an employer for the benefit of some or all of his employees – a.) wherein contributions are made by such employer or

employees, or both, for the purpose of distributing to such employer the earnings and principal of the fund thus accumulated; and

b.) wherein said plan provides that at no time shall any part of the principal or income of the fund be used for, or be diverted to, any purpose other than for the exclusive benefit of said employee

(b). Any amount received by an official or employees or by his heirs from the employer as a “consequence of separation from service due to death, sickness or other physical disability beyond the control of the said official or employer.

(c). Terminal leave and other social security benefits. The terminal leave pay of government employees whose

employment is co-terminous is exempt since it falls within the meaning of the phrase “for any cause beyond the control of the said official or employees” (BIR Ruling 143-98)

(d). Benefits received under the US veterans Administration.

(e). Benefits received from SSS

(f) Benefits received from GSIS

8.) Gains from the Sale of Bonds, Debentures or other Certificates of Indebtedness with maturity of more than five (5) years.

9.) Gains from Redemption of Shares in Mutual Fund.

C. Exclusion from income under Special Laws

1. Prizes received by winners in charity horse race sweepstakes from PCSO.

2. Back pay benefits

3. Income of cooperative marketing association

4. Salaries and stipends in dollars received by non – Filipino citizens on the technical staff of IRRI (International Rice Research Institutes).

5. Supplemental allowances per diem, benefits received by officer or employees of the Foreign Service.

6. Income from bonds and securities for sale in the international market.

IV. FRINGE BENEFITS

A. FRINGE BENEFITS – mean any good, service or other benefit furnished or granted in cash or in kind by an employer to an individual employee, except rank and file employee.

Pursuant to Revenue Regulations No. 3 – 98 (dated May 21, 1998) implementing section 33 of the Tax Code, the special treatment of fringe benefits shall be applied to fringe benefits given or furnished to managerial or supervising employees and not to the rank and file.

Rank and file – means all employees who are holding neither managerial nor

Managerial Employee – is one who is vested with powers or prerogatives to lay down and execute management policies and/or to hire, transfer, lay – off, recall, discharge, assign, or discipline employees.

Supervisory Employees – are those who, in the interest of the employer, effectively recommend such managerial actions if the exercise of such authority is not merely routinely or clerical in nature but requires the use of independent judgment.

The regulation does not cover those benefits properly forming part of compensation income subject to withholding tax.

Fringe Benefit Tax (FBT) – refers to monetary burden imposed on any good, services or other benefits furnished or granted by an employer, in cash or in kind, in addition to basic salaries, to an individual employee, except rank and file employee.

Formula: GMV = MV divided 68% (as of Jan. 1, 2000)

FBT = (fb) GMV x 32% (as of Jan 1, 2000)

B. VALUATION OF THE FRINGE BENEFITS

Fringe Benefit (forms) Value of Fringe Benefits1). Money The value is the amount

received2). Property with owner ship transferred to the employee.

Fair market value of the property

3). Property w/o transfer of ownership

Depreciation value of the property

C. ITEMS WHICH ARE CONSIDERED AS FRINGE BENEFITS (H2 IT – FIV2E2)

1). HousingHousing Privilege FB tax base

(a) Lease of residential property for the use of the employee as his usual place of residence.

MV = 50% x rental payments

(b) Residential Property owned by ER and Assigned to employee as his usual place of residence.

MV = [5% (FMV or Zonal Value whichever is higher)] x 50%

(c) Residential property purchased by ER on installment basis for the use of ER as his usual place of residence.

MV = [5% x AC (Acquisition)] x 50%

(d) Residential property purchased by MV = FMV or 2V W/ever

ER and ownership is transferred to EE as his usual place of residence.

is increase

(e) Residential property transferred to employee at less than employer’s acquisition cost.

MV = FMV or Zonal Value (whichever is higher) – Acquisition Cost

Non – taxable Housing Fringe Benefits(a) Housing privilege of military officials of AFP(b) Housing unit, which is situated inside or adjacent to

the premise of a business or factory. A housing unit is considered adjacent if it is located within the maximum 50 meters from the perimeter of the business premises.

(c) Housing benefit granted to employees on a temporary basis not exceeding three (3) months.

2). Household Expenses – Refer to expenses of the employee paid by the employer for household personnel or other personal expenses. Household expenses shall include:

(a) salaries of household helper(b) personal driver of the EE (employee)(c) Payment for homeowner assoc., etc.

3). Interest on loan at less than market rate if the ER (employer) lends money to his employee

-- free of interest or at a rate lower than 12% (or prevailing market rate) the interest foregone by the ER or the difference of the interest assumed by the ER and the 12% rate shall be treated as taxable fringe benefit.

Applicable to installment payment or loan with interest rate lower than 12 % starting January 1, 1998.

4). Expenses for Foreign TravelGENERAL RULE: Expenses for foreign travel insured by the

employee and/or family members of the employee borne by the employer shall be treated as taxable fringe benefits of the EE.

EXCEPT: Where the expenses for foreign travel paid by the

employer for the employee are for the purpose of attending business meeting or convention. The exemption covers only the following expenses:

1. Inland travel expenses except lodging cost in hotel averaging US$ 300 or less per day; and

2. Cost of economy or business class airline ticket [*However, if the ticket is a first class one, 30% of the cost of the ticket shall be subject to a fringe benefit tax].

Travel expenses should be supported by documents proving the actual occurrences of the meetings or conventions. Likewise, documents and evidence showing the business purpose of the employees’ travel must be presented otherwise, the entire cost will be considered taxable fringe benefit.

5). Membership fees, dues and other expenses borne by the ER for his EE, in social or athletic clubs or other similar organizations – These are treated as taxable Fringe Benefits of the EE in full.

6). Life or Health Insurance -

GENERAL RULE: The cost of life or health insurance and other non – life insurance premiums or similar amounts in excess of what the law allows borne by the ER for his EE shall be treated as taxable fringe benefits.

EXCEPT:

(a.) Contribution of the ER for the benefits of the EE pursuant to existing laws such as RA 8287 (SSS) or RA 8291 (GSIS).(b.) The cost of premium borne by the ER for the group insurance of his EE.

7). Holidays and Vacation Expense

8). Motor Vehicle Valuation of Motor Vehicle of any kind

(a.) Motor vehicle purchased by ER in name of EE

MV = AC (acquisition Cost)

(b.) “cash for the purchased provided by the ER, the ownership is placed in the name of the EE

MV = cash received by the EE

(c.) Purchase on “Installment” basis, the ownership is placed in the name of the EE

MV = AC (exclusive of interest)/ 5 years

(d.) “Portion” of purchased price shouldered by ER

MV = amount shouldered by the ER

(e.) Fleet of motor vehicle “leased” by the ER

MV = 50% x rental payment

(f) Fleet of Motor vehicles owned and maintained by the ER

MV = [AC/5] x 50%

Note: In case of letters a, b, c and d, regardless of whether the motor vehicle is used for the personal purpose of the EE and partly for the benefit of his ER, the monetary value shall be the entire value of the benefit.

Under letters e and f, the fleet of motor vehicles is for the use of the business and the EEs. The value of the benefit shall be the rental payments (e) or the acquisition cost (f) of all motor vehicles not normally used for sales, freight, delivery service and non-personal use.

The use of YACHT whether owned and maintained or leased by the ER shall be treated as taxable fringe benefit – the value of the benefit shall be measured based on the depreciation of the Yacht at an estimated useful life of 20 yrs.

The use of AIRCRAFT (including helicopters) owned and maintained by the ER shall be treated as “business use” and not subject to FBT.

9). Expense Account

NOTE: Expense Account subject to Fringe Benefit Tax(a.) Expenses incurred by the EE but paid by his ER.(b.) Expenses paid by the EE but reimbursed by his

ER.

Expense account not subject to FBT.(a.) expenses duly receipted for in the name of the

ER and(b.) The expenditures do not partake the nature

of personal expenses attributable to the EE. Personal expenses of the EE (like groceries) paid

for or reimbursed by the ER are taxable fringe benefits, whether or not duly receipted for in the name of the EE.

Representation and Transportation Allowances (RATA)--- refers to fixed amounts which are regularly received by the EEs as part of their monthly compensation income.--- they are not treated as Taxable Fringe Benefits but the same are treated as Taxable Compensation Income.

10). Educational Assistance

NOTE:GENERAL RULE: The cost of the educational assistance to the EE or his dependents which are borne by the ER shall be treated as Taxable Fringe Benefits.

EXCEPTION: Educational assistance not treated as Taxable

Fringe Benefits

a) Education granted to EERequisites:(1.) Educational grant whereby the study is directly connected with the trade, business or profession of the ER.(2.) And there is a written contract obligating the EE to remain under the employment for a certain period.

(b.) Educational Assistance granted to the dependents of the employee in the nature of educational assistance to the dependents of the EE through a competitive scheme under a scholarship program of the company.

D. FRINGE BENEFITS NOT SUBJECT TO THE FRINGE BENEFIT TAX

1). Contributions of ER for the benefits of EE to retirement, insurance, and hospitalization benefits plans.

2). Benefits given to rank and file EEs whether granted under CBA or not.

3). Fringe Benefits which are exempted from income tax under the tax code or other special laws.

4). Fringe Benefits which are required by the nature of, or necessary to the trade, business or profession of the ER.

5). Fringe Benefits granted for the convenience or advantage of the ER.

6). De minimis benefits as may be define by the Secretary of Finance.

NOTE: DE MINIMIS Benefits – are privileges granted by the ER to the EEs which are relatively of small value for the purpose of the promoting the health, goodwill, contentment and efficiency of the EEs.

Examples of De Minimis benefits are the following:(1.) Monetized unused vacation leave credits of not more than ten (10) days during the year.(2.) Medical cash allowance to dependent of the EES not more than P750 per employee per semester or P125 per month.

(3.) Rice Subsidy – worth P1000 or one (1) sack of 50 kg. rice per month

(4.) Uniform and clothing allowances – not more than P3k per annum.

(5.) Medical Benefit yearly – not more than P10k per annum.

V. DEDUCTIONS FROM GROSS INCOME

A. Deductions -- these are items or amounts authorized by the law to be subtracted from the pertinent items of the gross income to arrive at the taxable income.

Basic Principle governing deductions:(1.) The taxpayer seeking a deduction must point out some specific provisions of the statue authorizing the deduction; and

(2.) He must be able to prove that he is entitled to the deduction authorized or allowed.

Time of availing deductions: a taxpayer has the right to deduct all authorized allowances for the taxable year. He cannot deduct them from the income of the next or any succeeding year.

B. Kinds of Deductions

1). Deductions from compensation income of individual taxpayers – taxpayers whose income is derived purely from compensation income (one that arises from an ER – EE relationship).

An individual taxpayer whose income is derived from ER-EE relationship is also not allowed to deduct itemized deductions (Sec. 34 NIRC), except Premium

Payments on Health and/or Hospitalization Insurance, if applicable.

An individual taxpayer whose income derived from ER – EE relationship is not allowed to elect an optional standard deduction (OSD) of 10% of his income.

2). Deduction for self – employed and Professionals – individual taxpayer who are self employed and /or professionals engaged in the practice of their profession may deduct the following items from their gross income:

(a.) itemized deductions or the optional deduction (OSD).

(b.) Premium payments on health or hospitalization insurance.

3). Deductions from corporate income.

NOTE: Corporations include “partnership” other than general

professional partnership engaged in trade or business in the Phils.

They are entitled to claim the itemized deductions.

4). Special Deduction-- Deductions allowed to be subtracted in addition to the

itemized deductions allowable to corporations.

NOTE: These deductions may be availed of by:(a.) Insurance companies(b.) Estate and Trust(c.) Private educational Institutions.

C. The following are the taxpayers who are entitled to avail of deduction.1). Citizens of the Philippines

2). Resident aliens

3). Non – resident aliens engaged in trade or business in the Phils

4). Domestic corporation

5). Resident foreign corporation/ engaged in trade or business in the Philippines

6). Taxable co – partnership and General Professional Partnership

7). Estates and Trusts

Taxpayers who are taxed only on the basis of their gross income received from within the Phils.

(a.) NRA (ETB) – non – resident aliens not engaged in trade or business in the Phils.(b.) NRFC – non resident foreign corp. those not engaged in trade or business in the Phils.

VI. ALLOWABLE ITEMIZED DEDUCTIONS

Available only to taxpayers :(a.) self – employed/ those in the exercise of

their profession(b.) Corporations

A. Business Expenses

General Requisites for Deductibility:

(1.) The expenses must be ordinary and necessary Ordinary – expenses which are commonly incurred in

the trade or business of the taxpayers as distinguished from capital expenditures. An expense is ordinary if it is normal or usual to the line of business.

2 kinds of expenditures

(a.) capital expenditure (b.) ordinary expenditure-- not deductible from the gross income

-- deductible from the gross income in the year it was incurred

-- has the effect of prolonging the life of an asset

-- does not prolong the life of an asset for more than a year

-- if the property acquired has a useful life of more than 1 yr. the expenses thereof are considered capital expenditure

--The acquired property has a useful life of not more than 1 yr.

-- expenditure for extra ordinary/major repairs

-- expenditure for minor/ordinary repair

Necessary expenses – expenses which are appropriate and helpful to the taxpayer’s business or if it is intended to realized profit or to minimize a loss.

Extraordinary repairs - those in the nature of replacements, alteration, and expansion to the extent that they arrest deterioration and prolong the life of the property.

Ordinary repairs – those made to keep the property ordinarily efficient working condition and do not materially add to the value of the property.

(2.) It must be paid or incurred during the taxable year.

NOTE: Paid – the payment is on cash receipt basis, expenses

are deductible in the year they are incurred. Incurred – the payment thereof is on accrual basis,

expenses are deductible in the year they are incurred, whether paid or not.

(3.) It must be directly connected with trade or business or profession of the taxpayer.

(4.) it must be substantiated by adequate proof

NOTE: The claimed deduction must be evidenced by

official receipts or other adequate records. The evidence must establish the following:

(a.) the amount of expenses being deducted; and

(b.) the direct relation of such to the development, management, operation, and/or conduct of the trade, business or profession of the taxpayer.

(5.) It must not be against the law, morals, public policy or public order.

Examples of illegitimate business expenses: (not deductible) (a.) Bribe given to obtain protection from

arrest and prosecution (b.) Kickback(c.) Payments to secure political influence to

obtain favorable public contracts.(d.) Protection payments

- The legitimate expenses of an illegitimate business however, are deductible on the theory that income tax is not a tax on gross income even if such income is earned as an illegal business.

Specific expenses that are part of expense in general.

(1) Compensation for personal services. (Including Grossed Up monetary value of fringe benefit)

NOTE: Requisites for deductibility; (In addition to the

general requisites for deductibility)(a.) They are reasonable (b.) Payments for personal service

actually rendered.(c.) Withholding tax imposed has been

paid.

Some factors in determining reasonableness of compensation.

(a.) Payment must be made in good faith(b.) Character of taxpayer’s business(c.) Volume and amount of its net earning(d.) Locality in which the business is in(e.) General and economic conditions, etc.

There is no fixed test for determining the reasonableness of a given compensation. It is just to assume that a reasonable compensation is only such amount as would be ordinarily be paid for like services by like enterprises in like circumstances.

Bonuses to be deductible must be:(a.) made in good faith(b.) for service actually rendered(c.) must be reasonable* If the bonuses were granted without any service rendered, they are not considered as deductible from gross income.

Premiums paid on life insurance of an officer, employee, or business associate, where the taxpayer is directly or indirectly a beneficiary under the policy is not deductible.

Pension and compensation for injuries are also deductible limited to the amount not compensated for by insurance or otherwise.

(2.) Travel Expenses Travel expenses include – transportation expenses and

meals and lodging, here and/or abroad. Requisites for deductibility: (In addition to the

general requisites)(a.) reasonable and necessary

(b.) incurred or paid “while away from home” – it means away from principal place of business

Note: If the trip is undertaken for purposes other than business or exercise of profession, the transportation expenses are personal expenses and the meals and lodging are living expenses and are not deductible.

Transportation expenses of an employee from his residence to his office and back are not deductible. They are personal expenses. However, transportation expenses from his office to his customer’s place of business and back are deductible. They are business expenses.

(c) Paid or incurred in the conduct of trade or business.

(3.) Rentals Requisites for deductibility (In addition to the

general requisites)(a.) Must be made on condition to the continued use

or possession of the property.(b.) The taxpayer has not taken or is not taking title

to the rented property.(c.) Rented property is used in conduct of the

business, trade, or profession of the employer.(d.) Must be paid or incurred within the taxable year.

(4.) Entertainment, Amusement and Recreation expenses. Requisites for Deductibility (In addition to the

general requisites)(a.) The expenses are directly related to or in furtherance of the trade, business or profession of the taxpayer

(b.) The same must be directly connected in the development, management and operation of the trade, business or profession of the Taxpayer

(c.) The expenses must be reasonable and not contrary to the law, morals, public policy or public order

(d.) Substantiated by adequate receipts and/or records.

(e.) Must be paid or incurred during the taxable year.

(f.) Must not exceed the ceiling provided by the Sec. of Finance

COHAN RULEWhere it is certain from the evidence adduced that the

taxpayer did incur expenses but that the actual amount thereof has not been established, the commissioner should make a close “approximate” thereof and his determination thereof shall bear heavily on the taxpayer for his inexactitude. (Visayas Cebu Terminal v. Collector 108 PHIL 320).

OPTION GRANTED TO PRIVATE EDUCATIONAL INSTITUTIONS.

- Private educational institution may, at its option, elect either: (a.) To deduct expenditure otherwise considered as capital outlays of depreciable assets incurred during the taxable year, for the expansion of school facilities or

(b.) to deduct an allowance for depreciation thereof.B. Interest Expenses

Interest – refers to the compensation allowed by the law fixed by the parties for the loan or forbearance of money, goods or credits.

Requisites for Deductibility:

(a.) there must be indebtedness.(b.) the indebtedness must be that of the taxpayer(c.) the indebtedness must be connected with the trade, business or profession of the taxpayer(d.) the interest must have been paid or incurred during the taxable year(e.) the interest must have been stipulated in writing(f.) the deduction for interest expense shall be reduced by an amount equal to 38% of the interest income subject to final tax (beginning Jan. 1, 2000).

Interest expenses that cannot be deducted from gross income:

(1.) Interest paid in advance by a taxpayer reporting income on cash basis provided:

(a.) Such interest may be allowed as deduction in the year the indebtedness is paid: and

(b.) If the indebtedness is payable in periodic amortization -- the interest corresponding to the amortized principal may be deducted during the taxable year.

(2.) If the indebtedness is incurred to finance petroleum exploration.

(3.) Interest on loans between related taxpayer:(a) between members of a family

- Brothers and sisters (whether by whole or by half blood).- Spouse- Ancestors- Lineal descendants

(b.) between an individual and a corporation --- where more than 50 % in the value of outstanding capital stock is owned by such individual except in the case of distribution in liquidation.(c.) between two corporations – where more than 50% of the OCS of which is owned directly or indirectly by or for the same individual except distribution in liquidation.(d.) between the Grantor and the fiduciary in Trust(e.) between the fiduciary of a trust and a fiduciary of another trust if the same person is a grantor with respect to each trust.(f.)The interest should not be given to related taxpayers

The taxpayer has the option of either treating the interest incurred to acquired property used in trade, business or exercise of a profession as a:

(a.) as deductions or (b.) as capital expenditures

Rule: -- but the election of one excludes the other.

Other deductible interest(a.) interest paid on account of delinquency in the payment of tax because a tax obligation is considered indebtedness to the government for purpose of income tax.Except: fines and penalties

(b.) Interest on scrip dividend given by a corporation to a SH in the form of a promissory note.--- It is deductible expense on the part of the corporation

Except: Interest in preferred stock is not deductible because it is not interest expense incurred in indebtedness but actually a dividend on shares of stocks.

(c) In the case of banks and loan or trust companies, interest paid within the year on deposits or on savings received for investment and secured by interest-bearing certificates of indebtedness issued by such bank or company.

C. Taxes The deduction is allowed to taxes proper only and not allowed in

amounts representing;(a.) surcharge(b.) penalties(c.) Fines incident to delinquency

Taxes that are deductible [BILDAP]1. business taxes2. import duties3. license taxes4. documentary stamp taxes5. any other taxes paid directly to the government,

national or local, paid or accrued within the taxable year, in connection with taxpayer’s trade, business or profession.

6. privilege taxes

Taxes that are not deductible [F2ESTIVE]1. Foreign income tax, if claimed as tax credit

Income tax imposed by a foreign country are deductible only if:(a.) the taxpayer is qualified to avail of tax credit;(b.) He does not signify in the return his desire to avail of the same as a tax credit.

GENRULE: Taxes allowed as deduction, when refundable or credited shall be included as part of gross income in the year of receipt to the extent of the income tax benefit of said deduction.

The right to deduct income taxes paid to a foreign government is given only as an “alternative or substitute “to his right to claim a tax credit for such foreign income taxes.

Limitation on deduction(a.) non – resident alien engaged in trade or business in the Phils.

(b.) resident foreign corporation --- the deductions for taxes shall be allowed only if and to the extent that they are connected with income from “sources within” the Phils.

2. Final Taxes

3. Estate and donor’s taxes

4. Stock transaction tax on the sale, barter or exchange of s/s listed and traded through the local stock exchange.

5. Taxes assessed against local benefits tending to increase the value of the property (special assessment or levies).

6. Taxes which are not in connection with the trade, business or profession of Taxpayer.

7. Income tax imposed by the Philippine gov’t.

8. Value – added Tax (VAT)

9. Energy Taxes

Note: To be deductible, the taxes must be imposed by law and payable by the taxpayer. Thus, a value- added tax is not deductible by the customer upon whom the burden of the tax is shifted by the seller. However, the customer may consider the tax burden as part of his cost as an ordinary or capital expenditure if incurred in business or trade.

D. Tax Credit--- refers to the taxpayer’s right to deduct from the income

tax due, the amount of tax he has paid to foreign country.NOTE:

Tax Credit Tax deduction-- deducted from Phil income tax

-- deducted from the gross income

-- all taxes are allowed to be deducted with the exception of the taxes expressly excluded

-- only foreign income taxes may be claimed as credits

Persons entitled to tax credit

1. Resident Citizen of the Philippines2. Domestic Corp. except General Professional

Partnership 3. Members of the GPP4. Beneficiaries of Estates and Trusts.

Persons not entitled to Tax credit1. Non Resident Citizen2. Aliens, whether residents or non – residents3. Foreign Corporation, whether residents or non -

residents

Conditions for allowance of tax credit:(a.) The taxpayer must signify in his income tax

return his desire to claim tax credit(b.) The return must be accompanied by

appropriate form prescribed by CIR(c.) The form must be carefully filed with all the

informations required. (d.) Additional information must be furnished(e.) If the credit is sought for taxpayer already paid,

the form must have attached to it the receipt for tax payment. Limitations on Tax Credit

(a.) For taxes paid to one foreign country- The amount of tax credit in respect of the tax paid or incurred to any country shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer’s net income from sources within such country taxable under the tax code bears to his entire taxable income for the same year. Formula: Net Income from Foreign country x Phil. Income Tax = Limit on the amount of credit.

(b.) For taxes paid to two or more foreign countries. The total amount of the credit shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer’s net income from sources outside the Phils. taxable under the tax code.Formula:Net Income from sources outside the Phils x Phil. Income Tax = Limit on the amount of credit.

Net income from all sources

E. Losses - implies an unintentional parting with something of value

Requisites for Deductibility:(a.) The loss must be that of the taxpayer.

(b.) There must be an actual loss suffered in a closed and completed transaction.

--- “closed transaction “means that taxable year when the amount of loss was finally ascertained.

(c.) The loss must be connected with the taxpayer’s trade, business or profession.

(d.) The loss must not be compensated for by insurance or otherwise.

(e.) The loss must be liquidated and charge – off during the taxable year.

-- The deduction shall be in full or not at all.

(f.) The loss must be reported to BIR within 45 days from date of loss.

(g.) The loss must not be claimed as deduction for estate tax purposes in the estate tax return.

Classifications of Losses:1). Ordinary Losses

(a.) Losses incurred in trade, business or profession.

(b.) Losses incurred of property connected with the trade, business or profession, if due to casualty or from robbery, theft or embezzlement.

2). Capital Losses(a.) Losses from sale or exchange of capital

assets.

(b.) Losses resulting from securities becoming worthless and which are capital assets.

A mere loss on account of the shrinkage in value of securities or shares of stock is not deductible. The loss to be deducted must be actually suffered when the stock is disposed.

(c) Losses from short sales of property.

(d) Losses due to failure to exercise privilege or options to buy or sell.

3). Special Kinds of Losses(a.) Losses from wash sale of stock or securities

Loss on wash sales not deductible when;

(1.) A taxpayer who is not a dealer of stocks in trade has disposed shares and

(2.) Within the period of 60(sixty) days beginning 30 days before the date of such sale and ending 30 days after such date.

(3.) The taxpayer has acquired substantially identical stocks or securities.

However, if losses from wash sales are claimed by a “dealer” in securities in the ordinary course of business, such losses are deductible.

(b.) Losses of the useful value of capital assets due to same change in business conditions.

E. g. Where a new law is passed directly or indirectly making the continued profitable use of the property impossible.

(c.) Abandonment losses in petroleum operations.

NOTE: In case of petroleum operations which are

abandoned in whole or in part, all accumulated exploration and development expenditures to a certain extent may be allowed as deduction.

In case of producing well subsequently abandoned, the amortized cost therof as well as the undepreciated cost of equipment directly used therein shall be allowed as a deduction in the year of abandonment.

(d.) Losses due to voluntary removal of building, machinery, etc., If the demolition is incident to renewal and

replacement = deductible If the demolition or removal of building is for

the purpose of erecting a new one = not deductible expense.

(e.) Wagering Losses (gambling)

Wagering losses are deductible only to the extent of the gains from such wagering transaction. If there is no gain from the wagering transaction, the loss therefrom cannot be deducted from gross income.

Wagering transactions - are those in which the outcome is uncertain or those that involve games of chance.

NET OPERATING LOSS CARRY – OVER (NOLCO)

NOTE: Net Operating Loss – denotes the excess of allowable

deductions over gross income.

Net Operating loss Carry – over (NOLCO)– it means that the net operating loss for the taxable year immediately preceding the current taxable year shall be carried over as a deduction from gross income for the next three (3) consecutive taxable yrs. immediately following the year of such loss in an amount not to exceed the taxable income during the year the loss was sustained.

Limitations of availability of NOLCO(a.) There must be no substantial change in ownership of the business or enterprise in that:

1. Not less than 75% in nominal value of the outstanding issued shares, if the business is on the name of the corporation, is held by or on behalf of the same persons; or2. Not less than 75% of the paid up capital of the corporation, if the business is in the name of the corporation, is held by or on behalf of the same persons.

(b.) Where one business operation is income tax – exempt and the other is not, the losses in the latter operations are not deductible from the profits in the taxable operation.

(c.) Any net loss incurred in a taxable year during which the taxpayer was exempt from income tax shall not be allowed to be carried over to the next three years.

NOLCO For mines other than oil and gas wells.--- the net operating loss of mines incurred in the first 10 yrs.

of operation shall be carried over to the next five (5) yrs following the loss.

F. Bad Debts

Definitions1. Bad debts are debts due to the taxpayer when actually

ascertained to be worthless and charged-off within the taxable year. (Sec.34 [E1], NIRC).

2. They refer to those debts resulting from the worthlessness or uncollectibility, in whole or in part, of amounts due to the taxpayer by others, arising from money lent or from uncollectible amounts of income from goods sold or services rendered. (Sec.2 [a], Rev. Regs. No.5-99)

Requisites for deductibility of bad debts1. There must be a valid and subsisting debt.

A valid and subsisting debt is one the collection of which may be enforced in a court of law. A debt which had prescribed is no longer valid and subsisting.

2. The same must be connected with the taxpayer’s trade, business or practice of profession.

3. The same must not be sustained in a transaction entered into between related parties enumerated under Sec. 36 (B) of the NIRC. The said section provides:

In computing net income, no deduction shall in any case be allowed in respect of losses from sales or exchange of property directly or indirectly.

i. Between members of a family. For the purpose of this paragraph, the family of an individual shall include only his brothers and sisters (whether by the whole half-blood), spouse, ancestors, and lineal descendants; or

ii. Except in the case of distributions in liquidation, between an individual and a corporation more than fifty percent (50%) in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual; oriii. Except in the case of distributions in liquidation, between two corporations more than fifty percent (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;

iv. Between the grantor and a fiduciary of any trust; or

v. Between the fiduciary of a trust and the fiduciary of another trust if the same person is a grantor with respect to each trust; or

vi. Between a fiduciary of a trust and a beneficiary of such trust.

4. The same must be actually charged-off the books of accounts of the taxpayer as of the end of the taxable year;

A partial writing-off of a bad debt is not allowed; it must be charged-off in full or not at all (Fernandez Hermanos, Inc. vs. Commissioner, 29 SCRA 552; Philippine Refining Co. vs. Court of appeals, 70 SCAD 544, 256 SCRA 667).

5. The same must be actually ascertained to be worthless and uncollectible as of the end of the taxable year.

In general, a debt is not worthless simply because it is of doubtful value or difficult to collect. Worthlessness is determined upon the exercise of a sound business judgment. The determination of worthlessness in a given case must depend upon the particular facts and circumstances of the case.

The following, coupled with the creditor’s reasonable efforts to collect, may justify an ascertainment of the worthlessness of a debt.

i. The flight or disappearance of the debtor (Connel Bros. Co. [Phil.] vs. Comm., CTA Case Nos. 411 and 610, April 20, 1966);ii. Insufficiency of collateral (par. 1, Sec. 102, Regs.; Phil. Trust Co. vs. Coll., CTA Case No. 367, January 30, 1961);iii. Bankruptcy or insolvency;iv. Loss of evidence of indebtedness (Western Pacific Corp. vs. Coll., CTA Case No. 720);v. Death of debtor leaving no assets;vi. Injury to debtor incapacitating him from workvii. Absence of visible properties of the debtor (Esso Standard Eastern, Inc. vs. Comm., CTA Case No. 1530, Nov. 11, 1968); andviii. Fruitless efforts to collect small amounts from debtors scattered all over the country. (El Powenir Rubber Products, Inc. vs. Vera, CTA Cases Nos. 1702 and 1705, July 26, 1969.)

In the case of banks, in lieu of requisite No. (5), the Bangko Sentral ng Pilipinas (BSP), thru its Monetary Board, shall ascertain the worthlessness and uncollectibility of the bad debts and it shall approve the

writing off of the said indebtedness from the banks’ books of accounts at the end of the taxable year.

In no case may a receivable from an insurance or surety company be written-off from the taxpayers’ books and claimed as bad debts deduction unless such company has been declared closed due to insolvency or for any such similar reason by the Insurance Commission. (Sec. 3, Rev. Regs. No. 5-99)

In order that bad debts may be deducted from gross income it must be “actually ascertained to be worthless and charge-off within the taxable year.“ The law does not permit the charging off and the deduction of a bad debt in year other than in the year in which it is determined to be worthless. (Phil. Trust Co. vs. Collector.)

Where under a foreclosure of a mortgage, the mortgagee buys the mortgaged property and credits the indebtedness with the purchase price, the difference between the purchase price and the indebtedness will not be allowed as a deduction for bad debts. The determination of loss is deferred until the disposal of the property.

Securities becoming worthless

If any securities which are capital assets, are ascertained to be worthless and charged-off within the taxable year, the loss resulting therefrom to the taxpayer (other than a bank or trust company incorporated under the laws of the Phil.) is not considered as a bad debt but as a capital loss.

Losses from theft or embezzlement The bad debt theory holds that since the embezzlement of funds creates a debtor-creditor relationship; the loss is deductible as bad debt in the year when the right of recovery becomes worthless.

Tax Benefit Rule

The rule provides that the recovery of bad debts previously allowed as deduction in the preceding years shall be included as part of the gross income in the year of recovery to the extent of the Income Tax Benefit of said deduction. (Sec. 34 [E, 1] NIRC)

If a taxpayer realized a reduction of income tax from him on account of his bad debt deduction, his subsequent recovery thereof shall be treated as a receipt of realized taxable income.

If a taxpayer did not benefit from the deduction of the bad debt because it did not result to any reduction of his income tax in the year of such deduction (i.e. where the result of his business operation was a net loss even without deduction of the bad debts written-off); then his subsequent recovery shall be treated as a mere recovery or a return of capital. (Sec. 4, Rev. Regs. No. 5-99), hence not taxable.

Where the bad debt expense was disallowed by the BIR as a deduction, the subsequent collection of the debt is not taxable.

Recoveries of bad debts previously deducted from gross income do not constitute taxable income unless the deduction in prior years resulted in a reduction of income tax liability. This has given rise to the “equitable doctrine of tax benefit.”

G. Depreciation

Definition1. Depreciation is the gradual diminution in the useful

value of tangible property used in trade or business resulting from exhaustion, wear and tear, and normal obsolescence.

2. The term is also applied to amortization of value of intangible assets the use of which in trade or business is definitely limited in duration. (Basilan Estates, Inc. vs. Comm., 21 SCRA 17).

Rationale The taxpayer is entitled to see that from earnings the value of the property invested is kept unimpaired, so that at the end of any given term of years, the original investment remains as it was in the beginning. Accordingly, the law permits the taxpayer to recover gradually his capital investment in wasting assets free from tax. (Basilan Estate, Inc. vs. Comm., supra).

The necessity for depreciation allowance arises from the fact that certain property used in business gradually approaches a point where its usefulness is exhausted.

Persons Entitled to claim depreciation allowance1. Resident citizens and resident aliens (Sec. 34 [F, 1],

NIRC)a.) In general

i. A taxpayer who owns property and has a capital investment in the property may claim depreciation.

ii. In the case of property held by one person for life with remainder to another person (e.g. usufruct or fideicommissary substitution), the deduction shall be computed as if the life tenant were the absolute owner of the property and shall be allowed to the life tenant.

iii. In the case of property held in trust, the allowable deduction shall be apportioned between the income beneficiaries and the trustee in accordance with the pertinent provisions of the instrument creating the trust, or, in the absence of such provisions, on the basis of the trust income allowable to each.

iv. If the remainder of the terms of lease is greater than the probable life of the building erected or of the improvements made by the lessee in pursuance of an agreement with the lessee, an annual deduction in the form of an allowance for depreciation may be made (Sec. 49, 74, regulations).

b.) Depreciation of properties used in petroleum operations

The service contractor at his option may use the declining method or the straight-line method of depreciation. However, if the service contractor initially elects the declining balance method, it may, at any subsequent date, shift to the straight-line method.

The useful life of properties directly related to production of petroleum shall be ten (10) years of such shorter life as may be permitted by the Commissioner of Internal Revenue

Properties not used directly in production of petroleum shall be depreciated under the straight

line method on the basis of an estimated useful life of five (5) years (Sec. 34 [F, 4], NIRC).

c.) Depreciation of properties used in mining operationsi. It shall be computed at the normal rate of

depreciation if the expected life is ten (10) years or less; or

ii. Depreciated over any number of years between five (5) years and the expected life is more than ten (10) years (Sec. 34 [F, 5], NIRC).

2. Non-resident aliens engaged in trade or business and resident foreign corporations

A reasonable allowance for the deterioration of property arising out of its use or employment or its non-use in the business, trade or profession conducted by them in the Phils. shall be permitted only when such property is located within the Phils. (Sec. 34 [F, 6], NIRC).

Requisites for deductibility1. The allowance for depreciation must be reasonable

(Bacolod-Murcia Milling Co. Inc. vs. Comm., CTA Case No. 1402, Oct. 31, 1969).

2. It must be for property arising out of its use or employment in the business or trade, or out of its not being used temporarily during the year (Connel Bros. Co. vs. Collector, CTA Cases No. 411 & 610, April 30, 1966).

3. It must be charged-off during the taxable year; The deduction must be made in the year in which the wear & tear occurs. Depreciation may not be accumulated.

4. A statement on the allowance must be attached to the return.

5. The property must have a limited useful life.

The following property may not be depreciated:2. Inventories or stock in trade;3. Land, apart from improvements or physical

development added to it;4. Bodies of minerals which through the process

of removal suffer depletion5. Automobiles or other transportation

equipment used solely by the taxpayer for pleasure;

6. Building used solely by the taxpayer as his residence;

7. Furniture or furnishing used in the said building;

8. Personal effects or clothing except properties or costumes used exclusively in a business such as theatrical business

9. Intangibles, the use of which in business or trade is not of limited duration; and

10. Incidental repairs which neither materially add to the value of property nor prolong the life, but keep it in an ordinary efficient operating condition.

Limitation of Deduction The law allows a deduction from gross income of depreciation but limits the recovery to the capital invested in the assets being appreciated. It does not authorize depreciation of assets beyond its acquisition cost.

Reason: Deductions are mere privileges. Moreover, it will transgress the underlying purpose of depreciation allowance.

Methods of computing depreciation allowance Some of the common methods are:

1.) Straight-line method/ Fixed Percentage Method - This method spreads the total depreciation over the useful life of the asset and generally results in

an equal depreciation per unit of time regardless of the use to which the properties are put.

2.) Declining Balance Method - This method uses a rate (usually 1.5 or 2 times the straight-line rate) to the declining book value of the asset. Depreciation is largest in amount the first year and declines in the years thereafter.

3.) Working-Hours Method –The total working hours of the machine until its retirement is estimated and a charge per hour is determined using the following formulas:

4.) Unit of production method – This is similar to the working-hours method with the difference that the estimated service life is stated in units of products instead of working hours.

5.) The sum of the Years – Digits Method – This method requires the application of a changing fraction to the cost basis of the property, reduced by the estimated residual salvage value.

Agreement as to useful life on which depreciation rate is based The taxpayer and the Commissioner of Internal Revenue may enter into agreement in writing specifically dealing with the useful life and rate depreciation of any property. I In case of modification in the agreed rate and useful life of depreciation, the taxpayer must notify the Commissioner in writing.

H. Depletion

Definitions1. Depletion is the exhaustion of natural resources like mines

and oil or gas wells as a result of production or severance from such mines or wells.

2. It also refers to the periodic allocation of the cost of a wasting asset over the period the natural resources is extracted or produced.

Wasting assets refer to natural resources, which are physically consumed and once consumed, are irreplaceable. Examples include coal, oil, ore, precious metals like gold and silver, and timber.

Rationale As the product of the mine is sold, a gradual sale is being made of the taxpayer’s capital interest in the property. Depletion allowance enables the taxpayer to recover that capital interest free of income tax.

When the allowance shall equal the capital invested, no further allowance shall be granted.

Personal entitled to claim depletion allowance Annual depletion deduction are allowed only to mining entities which own an economic interest in mineral deposit or those which have capital investment in the mineral deposit. (Sec. 3, Rev. Regulation No. 5-76).

In the case of a resident foreign corporation or an alien individual engaged in trade or business in the Phils. allowance for depreciation of oil and gas wells or mines shall be authorized only in respect to oil and gas wells or mines located within the Phils. (Sec. 34 [G, 3], NIRC).

I. Charitable and other Contributions

Kinds of contributions allowed as deduction:

1. Ordinary or contributions with limit or subject to limitation

2. Special or contributions deductible in full

Requisites for deductibility1.) The contribution must actually be paid or made to the

Phil. Government or any of its agencies or political subdivision or to any domestic corporations or associations specified by the Tax Code or other entities as allowed by the Tax Code and existing special laws.

2.) It must be made within the taxable year;

3.) It must not exceed 10% of the individual’s taxable income and 5% of the corporation’s taxable income before deducting the contribution (applicable only to contributions with limit); and

4.) It must be evidenced by adequate records or receipts (Sec. 34 [H], NIRC).

Contributions with limit The following are subject to limit (5%\10% limit):

1.) Donations to the Philippine government or any of its agencies or any political subdivision thereof exclusively for public purposes;

2.) Donations to accredited domestic corporations or associations organized and operated exclusively for:

a.) Religions;b.) Charitable;c.) Scientific;d.) Youth and sports development;e.) Cultural; orf.) Educational purposes; or for theg.) Rehabilitations of veterans; and

3.) Donations to social welfare institutions or to non-government organizations in accordance with rules and regulations promulgated by the Secretary of Finance, provided no part of the net income of which inures to the benefit of any private stockholders or individual. (Sec. 34 [H,1], NIRC).

Contributions deductible in full under the Tax Code:1.) Donations to the government of the Philippines or to

any of its agencies or political subdivisions including fully-owned government corporations exclusively to finance, to provide for, or to be used in undertaking priority activities in:

a.) Education;b.) Health;c.) Youth and sports development;d.) Human settlements;e.) Science and culture; andf.) Economic development

According to the national priority plan determined by NEDA provided, that donations not in accordance with the said annual priority plan shall be with limit;

2.) Donations to foreign institutions or international organizations in pursuance or compliance with agreements, treaties, or commitments entered into by the government of the and the foreign laws or international organizations or in pursuance of special laws, and

3.) Donations to certain accredited non-government organization (see Sec. 34, [H, 2]).

Under P.D. No. 507: Contributions, donations, gifts and bequests to social welfare, cultural and charitable Institutions, no part of the net income of which inures to the benefit of any individual, are deductible in full in computing the donor’s taxable

income and are also exempt from donor’s and estate tax.

Valuation of Contributions The amount of any charitable contribution of property

other than money shall be based on the acquisition cost of said property.

J. Research and Development

A taxpayer may treat research or development expenditures which are paid or incurred by him during the taxable year in connection with his trade, business or profession as ordinary and necessary expenses which are not chargeable to capital account. The expenditures so treated shall be allowed as deduction during the taxable year when paid or incurred. (Sec. 34, [I, 1], NIRC).

Two ways of treating Research and Development Cost1.) As an outright expense, in which case it may be

deducted during the taxable year when paid or incurred; or (Sec.34, [I, 1], NIRC).

2.) As a deferred expense, in which case it is to be amortized over a period of not less than 60 months. (Sec 34, [I, 2], NIRC).The following research and development expenditures at the option of the taxpayer may be treated as deferred expenses:1.) paid or incurred by the taxpayer in connection with his trade, business or profession;2.) not treated as expenses;3.) the expenditure must not be chargeable to capital account

Limitations on Deductions

The following are not deductible as research and development costs:1.) Any expenditures for the acquisition or improvement of

land, or for the improvement of property to be used in connection with research and development of a character which is subject to depreciation and depletion; and

2.) Any expenditures paid or incurred for the purpose of ascertaining the existence, location, extent, or quality of any deposit of ore or other mineral, including oil or gas. (exploration expenditures subject to depletion) [Sec. 34, [I, 3], NIRC].

K. Pension Trusts

Requisites for deductibility of payments to pension trust (under Sec. 34, [J], NIRC)1.) The employer must have established a pension or

retirement plan to provide for the payment of reasonable pensions to its employees;

2.) The pension plan is reasonable and actuarially sound (Sec. 118, Regs.);

3.) It must be funded by the employer; i.e., the employer contributes cash to the plan;

4.) The amount contributed must no longer be subject to its control or disposition; and

5.) The payment has not therefore been allowed as a deduction.

Allowable deductions in relation to pension trusts1.) Contributions to such trusts during the taxable year to

cover the pension liability accruing during the year. These are considered as ordinary and necessary business expenses allowed as a deduction under Sec. 34, [A, 1], of the NIRC.

2.) A reasonable amount transferred or paid into such trust during the taxable year in excess of the contributions but only if such amount:a.) has not therefore been allowed as a deduction;

andb.) is apportioned in equal parts over a period of ten

(10) consecutive years beginning with the year in which the transfer or payment is made

these are those referred to as payments to the pensions trust deductible pursuant to Section 34 (J) of the NIRC.

L. Optional Standard Deduction Elements of Optional Standard Deduction:

1.) It is in lieu of itemized deductions allowed under Section 34 (A to J), NIRC. 2.) It is available only to individual taxpayers other

than one with pure compensation income and a nonresident alien,

3.) The amount deductible should not exceed 10% of the taxpayer’s gross income.

2.) The taxpayer must signify in his return his intention to avail of the OSD, otherwise he shall be considered as having availed himself of the itemized deductions.

3.) Once elected, it is irrevocable for the taxable year for which the return is made

4.) The taxpayer need not submit with his return, financial statements, however, he must keep such records pertaining to his gross income during the taxable year.

M. Premium Payments The premiums payments or health and/ or hospitalization insurance of an individual taxpayer including his family are deductible regardless of whether the taxpayer is engaged in trade, business, or profession, or deriving compensation income out of an employer-employee relationship.

An individual taxpayer who elects the OSD may still deduct the premium payments when applicable.

Requisites for allowance as deduction1.) The amount of premiums that may be deducted shall

not exceed P2,400 per family or P200 a month during the taxable year;

2.) The health and/ or hospitalization insurance is taken by the taxpayer for himself or for any member or members of his family;

3.) The family of the taxpayer has a gross income of not more than P250,000 for the taxable year; and

4.) In case the taxpayer is married, only the spouse claiming the additional exemption for dependents shall be entitled to the deduction.

VII. Special Deductions

The NIRC provides special rules for deductible from gross income for the following:

1.) Insurance companies;2.) Mutual Insurance companies;3.) Mutual marine insurance companies;4.) Assessment insurance companies;5.) Estates and trusts; and6.) Private educational institutions

Insurance companies Whether domestic or foreign, doing business in the Phils., they are allowed to deduct, in addition to the itemized deductions under Section 34 of the Tax Code, the following:1.) Net additions, if any, required by law to be made

within the year to reserve funds, and

2.) Sums other than dividends paid within the year on policy and annuity contracts. The released reserve

shall be treated as income for the year of release. (Sec. 37, [A], NIRC, Sec. 126, Regs.)

Mutual insurance companies These companies (other than mutual life & mutual marine) are allowed to deduct from gross income the following:1.) Any portion of the premium deposits returned to

the policy holders

2.) Such portion of the premium deposits as are retained for the payment of losses, expenses and reinsurance reserves. (Sec. 37, B, NIRC; Sec. 127, Regs.)

Mutual marine insurance companies They are entitled to deduct from gross income the following:1.) Amounts repaid to policy holders on account of

premium previously paid by them; and

2.) Interest paid upon those amounts between the ascertainment date and the date of its payment. (Sec. 37, [C], NIRC, Sec. 128, Regs.)

Assessment insurance companies Whether domestic or foreign, they may deduct in a taxable year the sum actually deposited with the officers of the govt. of the Phils., pursuant to law as additions to guarantee or reserve funds. (Sec. 37 [D], NIRC).

VIII. Items not Deductible

In computing taxable net income, the following are not deductible:

1.) Personal living or family expenses; These are not deductible from compensation and business/professional income under Section 24, (A), NIRC.

2.) Any amounts paid for new buildings or for permanent improvements, or betterments made to increase the value of any property or estate; No.2 does not apply to intangible drilling and development cost incurred in petroleum operations which are deductible under Sec.34 (G,1) of the NIRC.(Depletion) EXCEPT: Proprietary Educational Institutions for the capital expenditures for school expansion purposes.

3.) Any amount expended in restoring property or in making good the exhaustion thereof for which as allowance is or has been made; Items in nos. 2 and 3 are capital expenditures or those expenditures that result in obtaining benefits of a permanent nature such as lands, buildings and machineries

4.) 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 A person is said to be financially interested in the taxpayer’s business, if he is a stockholders thereof or he is to receive as his compensation a share of the property of the business.

5.) Losses from sales or exchange of property between related taxpayers (Sec. 36, NIRC).

Income Tax Treatment on the Sale or Exchange of Property

Categories of Sale or Exchange Transactions

1.) SALE OR EXCHANGE OF ORDINARY ASSETS

Definitionsa.) Ordinary Assets – refer to properties held by the

taxpayer in the pursuit of his profession, trade or business, they are:

i. Stock in Trade;ii. Property of a kind which would properly be

included in the inventory if on hand at the close of the taxable year;

iii. Property held by the taxpayer primarily for sale to customers in the ordinary course of trade or business;

iv. Property used in trade or business which is subject to the allowance for depreciation; and

v. Real property used in trade or business. (Sec. 39, [A], NIRC)

b.) Ordinary income (ordinary gain) – includes any gain from the sale or exchange of property which is not a capital asset (Sec. 22, [Z], NIRC)

c.) Ordinary Loss – includes any loss from the sale or exchange of property which is not a capital asset. (Sec. 22, [Z], NIRC)

Income Tax Treatment on the Sale or Exchange of Ordinary Assets The general rule in income taxation apply both as to the gain and as to the loss, any gain shall be reported as ordinary income and any loss may be allowed as a deduction in gross income.

Exemplification of Rules1.) If an individual taxpayer is engaged in real estate

business or is a real estate dealer, the gains he may derive from the said activity will be considered as ordinary income and the losses he may incur is deductible from his gross income. The 6% tax imposed on the sale of real property which is a capital asset is inapplicable to him.

2.) If a domestic corporation is engaged in real estate business, the gains it may derive from said activity is considered as ordinary income and any loss incurred is considered as an ordinary loss. The loss is deductible from the corporation’s ordinary income and from its income from any other source whether ordinary or capital. Ordinary losses (whether the taxpayer is an individual or a corporation) are deductible either from ordinary gains or capital gains.

2.) SALE OR EXCHANGE OF CAPITAL ASSETS

Definitionsa.) Capital Asset means property held by the taxpayer

(whether or not connected with his trade or business) but does not include:

i. Stock in trade;ii. Property of a kind which would properly be

included in the inventory if on hand at the close of the taxable year;

iii. Property held by the taxpayer primarily for sale to customers in the ordinary course of trade or business;

iv. Property used in trade or business which in subject to the allowance for depreciation; and

v. Real property used in trade or business. (Sec. 39, [A], NIRC)

This is an enumeration by exclusion, all others not enumerated are capital assets.

b.) Capital gain is the gain from the sale or exchange of capital assets.

c.) Capital loss is the loss incurred from the sale or exchange of capital assets.

d.) Net Capital gain is the excess of the gains from sales or exchange of capital assets over the losses from such sales or exchanges (Sec. 39, [A, 2], NIRC).

e.) Net capital Loss is the excess of the losses from sales or exchanges of capital assets over the gains from such sales or exchanges. (Sec. 39, [A, 3], NIRC).

f.) Net Capital Loss Carry Over (NCLCO) means that:i. If any taxpayer, other than a corporation, sustains

in any taxable year a net capital loss;ii. Such net capital loss cannot be deducted from

ordinary income due to the loss limitation rule;iii. Such loss could be carried over to the next taxable

year (not thereafter) as a deduction against net capital gain in an amount not in excess of the taxable income (i.e. net income before exemptions) in the year the loss was sustained; and

iv. Such loss shall be treated as a loss from the sale or exchange of capital assets held for not more than twelve (12) months. (Sec. 39, [D], NIRC)

g.) Holding period refers to the percentages of the gain or loss taken into account in computing the net capital gain net capital loss and net income. The percentages are:100% - if the capital asset has been held for not more

than twelve (12) months (short-term); and50% - if the capital asset has been held for more than

twelve (12) months (long-term) The holding period of capital assets is only

applicable to individual taxpayer and not to corporations.

h.) Loss Limitation Rule provides that Capital losses are deductible only to the extent of capital gains.

Specific Examples of Properties classified as capital assets Capital assets include personal property (not used in trade or business) such as movables in one’s residence, personal vehicles, appliances and furniture for personal use, jewelries etc. as well as real property (not used in trade or business) such as residential land, idle land not used in business operations and residential house.

Tax Treatment of Capital gains and Capital losses

a.) As to Individual Taxpayers1) On personal property classified as capital asset

(other than shares of stock) The following are the applicable rules:

a. The percentages of gain or loss to be taken into account shall be -

a.1) 100% if the capital asset has been held for 12 months or less; and

a.2) 50% if the capital asset has been held for more than 12 months (holding period rule)

b. Capital losses shall be deducted only to the extent of the capital gains (loss limitation rule)

c. Net Capital Loss Carry Over Rule is applicable.

2) On real property classified as capital assets The following are the applicable rules;

a. A final capital gains tax is imposed on individuals including estates and trusts computed as follows:

tax base: gross selling price or fair market value, whichever is higher

tax rate: 6%

b. The tax is imposed on capital gains presumed to have been realized from the sale, exchange or disposition of real property located in the Phils. classified as capital assets including pacto de retro

sales and other forms of conditional sales (such as mortgage foreclosure sale)

c. The tax shall be in lieu of the income tax imposed on individuals under graduated rates in Sec. 24, [A].Capital gains from sale of real property shall not be included in the gross income of the individual taxpayer.

d. There are two situations wherein the 6% final tax rate may not be applied, to wit:A. If the real property classified as

capital asset is sold to the government or any of its political subdivisions or to gov’t. owned or controlled corporations, the 6% final tax rate or the graduated income tax rates may be used on the actual gain of the taxpayer, at the option of the taxpayer; and

B. If the principal residence of the individual taxpayer is sold and the proceeds of the sale is used to acquire or construct a new residence within 18 months from the date of the sale, the sale is exempt from income tax provided:B.1) That the Commissioner is notified by the taxpayer within thirty (30) days from the date of the sale or disposition through a prescribed return of his intention to avail of tax exemption;B.2) The tax exemption can only be availed of once every ten (10) years; andB.3) If there is no full utilization of the proceeds of the sale or disposition, the portion of the gain presumed to have been realized from the sale or disposition shall be subject to capital gains tax.

e. The sale of rights over realty, although classified as real property under the Civil Code, is not subject to capital gains tax because the situs of these rights follow their owner who may not be located in the Phils. Only real property located in the Phils. is subject to capital gains tax. (Sec. 24 [b, 1], NIRC; BIR Ruling No. 083-99, June 22, 1999).

3) On shares of stock not held by dealers in securities The following are the applicable rules:

a. A final capital gains tax is imposed on capital gain from sale of shares of stock, computed as follows:1. On non-listed stocks or on sales of

shares (listed or unlisted with stock exchanges): not effected through the stock exchanges: 5% on net capital gains not over P100, 000

10% on net capital gains in excess of P100, 000 (Sec. 24, [C], 25 [B], 27 [D, 2], 28 [A, 7, C], [B, 5, C])

2. For sale of shares listed and traded in the stock exchange the same shall be exempt from income tax but it shall be subject to a Stock Transfer Tax of ½ of 1% of the Gross Selling Price.

b. The final capital gains tax is in lieu of the ordinary income tax on individuals, corporations and other taxpayers (estates & trusts).

c. The net capital gains on stock transactions shall not be included in the gross income of the seller or transferor in computing his income tax liability.

d. It is a final tax, which shall in no case, be allowed as a deduction against income or credited against income tax or any other tax

e. Also subject to a stock transfer tax at a different rate are shares of stock sold or exchanged through initial public offering.

b.) As to Corporations The following rules apply whether the capital asset is personal or real property:b.1) Capital gains and losses are recognized to the

extent of 100% regardless of the holding period (holding period is not applicable);

b.2) The net capital loss carry-over is not applicable;

b.3) Capital losses are deductible only to the extent of capital gains; and

b.4)Ordinary losses are deductible from capital gains but net capital loss cannot be deducted from ordinary gain or income.

1. On personal property classified as capital asset (other than shares of stock)]

- Only the Loss Limitation Rule applies.

2. On real property classified as capital assets- The following are the additional rules applicable:

i. A final tax of six percent (6%) is imposed on the gain based on the gross selling price or fair market value, whichever is higher, of such lands and/or buildings. (Sec. 27, [A, 5], NIRC)

ii. The tax shall be in lieu of the income tax imposed on corporations under the graduated rates in Sec. 27 (A) of the Tax Code.

3. On shares of stock not held by dealers in securities- The rules applicable to individual taxpayer are also applicable.

Requisites for recognition of capital gain or loss They are:

1.) The transaction must involve property classified as capital asset; and

1.) The transaction must arise from sale or exchange.

Limitation on Capital losses General Rule: Capital losses are allowed only to the extent of capital gains.

Exception: Any loss sustained by a domestic bank or trust company from the sale of bonds, debentures, notes or certificates or other evidences of indebtedness issued by any corporation including those issued by the government is considered as an ordinary loss and deductible from ordinary income.

Reason: Banks and trust companies are considered as dealers in securities, hence, these securities are considered as property primarily held for sale to customers in the ordinary course of business.

Other Capital Asset Transactions

The following are considered as sales or exchanges of capital assets:1. Retirement of bonds with interest coupons or in registered form

Amounts received by the holder upon the retirement of bonds, debentures, notes or certificates or other services of indebtedness issued by any corporation (including those issued by a gov’t. or political subdivision thereof) with the interest coupons or in registered forms, shall be considered as amounts received in exchange thereof. (Sec. 39, [E], NIRC)

2. Short sales of property A short sale takes place when a seller first make a sale of stock or security which he does not own (he merely borrows the stock certificate through or from his stock broker) and subsequently buys or covers the stock to complete the transaction.

The seller sells the shares short in the expectation of a decrease in value thereof within a reasonably short period of time. He covers his short sale when the expected decrease in the value materializes or when the time for the return of the borrowed shares comes.

2.) Failure to exercise privilege or option to buy or sell property Gains or losses attributable to the failure to exercise privileges or options to buy and sell property shall be considered as capital gains or losses, such as the option given to a taxpayer to buy an agricultural land is a capital asset and the gain or the loss that may be incurred by him from the disposition of said option is either a capital gain or a capital loss.

3.) Securities becoming worthless If any securities which are capital assets are ascertained to be worthless and written off during the taxable year, the loss resulting therefrom in the case of a taxpayer other than a bank or a trust company incorporated under the laws of the Phils. a substantial part of whose business is the receipt of deposits, is considered a capital loss.

4.) Distribution in liquidation If, in liquidation or dissolution, the corporation acquires its own stock and exchanges its assets (land) for the shares, the shareholders who surrendered their shares for land shall likewise be subject to the capital gains tax prescribed under Section 24 (C) of the Tax Code.

Gains or losses from liquidating dividends are considered as capital gains or losses inasmuch as liquidating dividends are considered as full payment from the corporation in exchange for stocks held by the stockholders.

5.) Readjustment of interest in a general professional partnership When a partner retires from a general professional partnership or the partnership is dissolved, he realizes a gain or loss measured by the difference between the price he received for his interest and cost to him of his interest in the partnership.

3.) SALES OR EXCHANGES RESULTING IN NON-RECOGNITION OF GAINS OR LOSSES

a.) Exchange solely in kind (exchange of property solely for stocks) in legitimate mergers or consolidations.1) A corporation which is a party to a merger or consolidation exchanges property solely for stock in a corporation which is a party to the merger or consolidation;

2) A corporation which is a party to a merger or consolidation receives in exchange for property not only stock of another corporation but also money and/or other property and distributes it in pursuance of the plan of merger or consolidation. [Section 40(c)(3)(6)(i)]

3) A shareholder exchanges stock in a corporation which is a party to the merger or consolidation solely for the stock of another corporation, also a party to the merger or consolidation.

4) A security holder of a corporation which is a party to the merger or consolidation exchanges his securities in such corporation solely for stock or securities in another corporation, a party to the merger or consolidation.

b.) Transfer or exchange of property for stock resulting in acquisition of corporate control A person exchanges his property for stock or unit of participation in a corporation of which as a result of such exchange said person, alone or together with others, not exceeding four persons, gains control of said corporation “Control” means ownership of stocks in a corporation possessing at least 51% of the total voting power of all classes of stock entitled to vote. The items enumerated above are also called “tax-exempt exchanges.”

4,) TRANSACTIONS RESULTING IN TAXABLE GAINS BUT NON-RECOGNITION OF LOSSES

a.) Transactions between related taxpayers (Sec, 36, NIRC)

b.) Illegal transactions

c.) Wash sales (except those made by dealers in securities)

Wash sale is a sale of securities where substantially identical securities are acquired or purchased within a 61-day period beginning 30 days before the sale and ending 30 days after the sale. (Sec. 38, [A], NIRC).

Requisites for non-deductibility:

1) The sale or other disposition of stocks or securities resulted in a loss;

2) There was an acquisition, or contract or option for acquisition of stock or securities within thirty (30) days before the sale or thirty (30) days after the sale; and

3) The stock or securities sold where substantially the same as those acquired within the 61-day period. The word “acquired” means acquired by purchase or by an exchange, and comprehends cases where the taxpayer has entered into a contract or option within the sixty-one-day period to acquire by a purchase or by such an exchange (Sec. 131, [f], Regs.)

“Substantially identical” means that the stock must be of the same class, or in the case of bonds, the terms thereof must be the same.

The following are not substantially identical:

i. The common stock and the preferred stock of the same corporation;

ii. A non-voting stock and a stock with voting power;

iii. The stock of the corporation and the stock of another corporation; and

iv. Two series of bonds where one is secured by a mortgage and the other is not; or which differ as to interest rates.

d.) Exchanges not solely in kind in mergers and consolidations

1) If in connection with an exchange described earlier resulting in non-recognition of gains or losses, an individual, a shareholder, a security holder or a corporation receives not only stock or securities permitted to be received without the recognition of gain or loss, but also money and/or property, the gain, if any, but not the loss, shall be recognized but in an amount not in excess of the sum of the money and the fair market value of such other property received.

Provided, that as to the shareholder, if the money and/or property received has the effect of a distribution of a taxable dividend, there shall be taxed as dividend to the shareholder an amount of the gain recognized not in excess of his proportionate share of the undistributed earnings and profits of the corporation, the remainder if any, of the gain recognized shall be treated as a capital gain. (Sec. 40, [3, a])

2) If a corporation which is a party to the merger or consolidation receives not only stock permitted to be received without the recognition of gain or loss, but also money and/or property, and does not distribute it in pursuance of the plan of merger or consolidation, the gain, if any, shall be recognized in an amount not in excess of the sum of such money and the fair market value of such other property so received, which is not distributed. (Sec. 40, C,[3, b])

3) If a taxpayer receives stock or securities which would be permitted to be received without the recognition of the gain if it were the sole consideration, and as part of consideration, another party to the exchange assumes a liability of the taxpayer, or acquires from the taxpayer property subject to a liability, then such assumption or acquisition shall not be treated as money and/or other property, and, therefore any gain or loss would still not be recognized if no money and/or property was involved in the exchange.

4) If the amount of the liabilities assumed plus the amount of the liabilities to which the property is subject, exceed the total of the adjusted basis of the property transferred pursuant to such exchange, then such shall be considered as a gain from the sale or exchange of a capital asset or of property, which is not a capital asset, as the case may be. (Sec. 40, [C, 4], NIRC)

e.) Sales or exchanges which are not at arms length

Determination of Gain or Loss

Computation of Gain or Loss The gain from the sale or other disposition of property shall be the excess of the amount realized over the basis or adjusted basis for determining gain. The loss shall be the excess of the basis or adjusted basis for determining loss over the amount realized. The amount realized from the sale or other disposition of property shall be the sum of money received plus the fair market value of the property (other than money) received.

Basis of Property In case the property was acquired before March 1, 1913: fair market value as of said date

In case the property was acquired on or after March 1, 1913:a.) By purchase – the costb.) By gratuitous title –

b.1) Inheritance – the fair market price or value at the date of acquisition

b.2) Gift – the same as it would be in the hands of the donor or the last preceding owner by whom it was not acquired by gift

c.) For less than an adequate consideration in money or money’s worth: amount paid by the transferee for the property

d.) In a transaction where gain or loss is not recognized in pursuance of a plan of merger or consolidation: the basis of the stock or securities received by the transferor – same as the basis of the property, stock or securities exchanged decreased by:

1) the money received and2) fair market value of the other property

receivedincreased by:

1) the amount treated as dividend of the shareholder and

2) the amount of any gain recognized on the exchange

e.) If as a part of the consideration, the transferee assumes liability of the transferor or acquires from the latter property subject to a liability such assumption or acquisition shall be treated as money received by the transferor.f.) For the “boot” received: its fair market value. (Sec. 40, [C, 5])

Sources of Income

Sources of Income in General

The source of an income is the property, activity or services that produce the income. (Commissioner vs. British Overseas Airways Corp., 149 SCRA 395)

The term “source” is not a place but an activity or property and as such, it has a situs or location.

The ascertainment of the sources of income becomes important when it is considered that not all taxpayers, whether natural or juridical, pay income taxes on all their income.

1) Resident citizens of the Phils. – taxable upon income derived from all sources (from sources within and without the Phils.)

2) Domestic corporations – taxable income derived from all sources (from sources within and without the Phils.)

3) Nonresident citizens of the Phils. – taxable upon income derived from Phil. sources only (only from sources within the Phils.)

4) Resident aliens – taxable upon income derived from Phil. sources only (only from sources within the Phils.)

5) Non-resident aliensa.) Engaged in trade or business in the Phils. – taxable upon income derived from Phil. sources only (only from sources within the Phils.)

b.) Not engaged in trade or business in the Phils. – taxable upon income derived from Phil. sources only (only from sources within the Phils.)

6) Foreigna.) Resident (engaged in trade or business in the Phils.) – taxable upon income derived from Phil. sources only (only from sources within the Phils.)

b.) Non-resident (not engaged in trade or business in the Phils.) – taxable upon income derived from Phil. sources only (only from sources within the Phils.)

Classification of income as to source

1) Income which is derived in full from source within the Phils.

2) Income which is derived in full from source outside the Phils.

3) Income which is derived partly from sources within and partly from sources outside the Phils. (Sec. 42, NIRC)

Gross income from sources within the Phils.

1) Interests:a.) Interests derived from sources within the Phils.b.) Interests on bonds, notes or other interest-bearing obligations of residents, corporate or otherwise. (Sec. 42, [A, 1], NIRC)

2) Dividends:a.) From a domestic corporation, andb.) From a foreign corporation 50% or more of the gross income of which for the 3-year period ending with the close of the taxable year preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence) was derived from sources within the Philippines. (Sec. 42, [A, 2], NIRC)It must be only in an amount which bears the same ratio to such dividends as the gross income of the corporation for such period derived from sources within the Philippines bears to its gross income from all sources.

3) Compensation for labor or personal services performed in the Phils. (Sec. 42, [A, 3], NIRC)

4) Rentals and Royalties from property located in the Phils. or from any interest in such property, including rentals or royalties for – a.) The use of, or the right or privilege to use in the

Phils. any copyright, patent, design or model, plan, secret formula or process, goodwill, trademark, trade brand or other like property or night;

b.) The use of, or the right to use in the Phils. any industrial, commercial or scientific equipment;

c.) The supply of scientific, technical, industrial or commercial knowledge or information;

d.) The supply of any assistance that is ancillary and subsidiary to, and is furnished as a means of enabling the application or enjoyment of, any such property or right as is mentioned in paragraph (a), any such equipment as is mentioned in paragraph (b) or any such knowledge or information as is mentioned in paragraph (c);

e.) The supply of services by a nonresident person or his employee in connection with the use of property or rights belonging to, or the installation or operation of any brand, machinery or other apparatus purchased from such nonresident person;

f.) Technical advice, assistance or services rendered in connection with technical management or administration of any scientific, industrial or commercial undertaking, venture, project or scheme; and

g.) The use of, or the right to use:1. Motion picture films;2. films or video tapes for use in connection with

television; and3. tapes for use in connection with radio

broadcasting

5) Gains, profits, and income from the sale of real property located in the Phils. and

6) Gains, profits, and income from sale of personal property, treated as derived entirely from the country where it is sold.

Exception to the rule: gain from the sale of shares of stock in a domestic corporation which is treated as derived entirely from sources within the Phils. regardless of where the shares are sold.

Passage of title test: it is the prevailing view that in ascertaining the place of sale, the determination of where and when the title to the goods passes from the seller to the buyer is decisive.

Enumeration in Section 42 not all-inclusive

In the case of Commissioner vs. British Overseas Airways Corporation (BOAC) [149 SCRA 395], the Supreme Court held:

“xxx Section 37 (now Section 42) by its language, does not intend the enumeration to be exclusive. It merely directs that the types of income listed therein be treated as income from sources within the Phils. a cursory reading of the section will show that it does not state that it is an all-inclusive enumeration, and that no other kind of income may be so considered.xxx”

. The Supreme Court further held:

“xxxThe absence of flight operations to and from the Phils. is not determination of the source of income on the situs of income taxation. Admittedly, BOAC was an off-line international airline at the time pertinent to this case. The test of taxability is the source, and the source of an income is that activity xxx which produced the income. Unquestionably the passage documentations in these cases were sold in the Phils. and the revenue therefrom was derived from a business activity regularly pursued within the Phils.xxx”

Gross Income from sources outside the PhilippinesInterest other than that derived from sources within the Phils.

1. Dividends other than those derived from sources within the Phils.

a. Dividends from foreign corporations in general; and

b. Dividends derived from foreign corporations, 50% or more of the gross income of which for the 3-year period preceding the declaration of dividends (or for such part of such period as the corporation has been in existence was derived from foreign sources

2. Compensation for labor or personal services performed outside the Phils.

3. Rentals or royalties from property located outside the Phils. or from any interest in such property including rentals or royalties for the use of or for the privilege of using outside the Phils., patents, etc.

4. Gains, profits and income from the sale of real property located outside the Phils.

5. Gains, profits and income from the sale of personal property located outside the Phils., and

6. Income derived from the purchase of personal property within and its sale outside the Phils. (Sec. 42, NIRC)

Gross Income from sources partly within and partly outside the Phils.

Special rules are provided by the Regulations on the following classes of income which are treated as derived from sources partly within and partly outside the Phils.

1) Income from transportation such as foreign steamship companies whose vessel touch the Phil. ports (Sec. 163, Regulations) and other services rendered partly within and partly outside the Phils. such as foreign corporations carrying on the business of transmission of telegraph and cable messages between points outside the Phils. (Sec. 164, Regulations)

2) Income from the sale of personal property produced in whole or in part by the taxpayer within and sold outside the Phils.; or produced in whole or in part by the taxpayer outside and sold within the Phils.

GENERAL PRINCIPLES OF PHILIPPINE INCOME

TAXATION

I. CLASSIFICATION OF TAXPAYERS

Table 1. General View

Sources of

Taxable Income

A.) Individuals(1) CITIZEN a. Resident Citizen

(RC)Within and without

net incomeif engaged in trade, business or profession

b. Non-Resident citizen (NRC)

Within net income

c. OCW / Seamen Within net income(2) ALIEN / FOREIGNERSa. Resident aliens (RA)

Within net income if engaged in trade, business or profession

b. Non-Resident alien (NRA)1. Non Resident Alien Engaged in Trade or Business (NRAETB)

Within net income

2. Non Resident Alien Not Engaged in Trade or Business (NRANETB)

within gross income

(3) SPECIAL ALIENSa. Employed by Regional / area headquarters (RAHQ)

within gross income

b. Employed by Regional Operating Headquarters (ROHQ)

within gross income

c. Employed by Offshore Banking Units (OBUs)

within gross income

d. Employed by petroleum service contractors and subcontractors

within gross income

B.) Corporations(1) DOMESTIC within

and without

net income

a. Proprietary Educational Institution & Hospital

within and without

net income

b. GOCC except GSIS, SSS, PHIC, PCSO and PAGCOR

within and without

net income

(2) FOREIGN(a) Resident (engaged in trade or business)

Within gross income

1. International. carrier

Within gross Phil. billing

2.Remittance Branch Office

Within Amount applied for to be remitted

3. OBU Within gross income

4. RAHQ5. ROHQ within(b) Non-resident within gross income

1. Cinematographic Film owner, lessor or Distributor

within gross income

2. Owner /Lessor of aircraft, machineries and other equipment

within gross rentals/ fees

3. Owner / lessor of vessels chartered by Phil. nationals.

within gross rentals

(3) ESTATE UNDER JUDICIAL SETTLEMENT

within & without

net income

(4) IRREVOCABLE TRUST

within and without

net income

II. TAX ON INDIVIDUALS

A.) Classification of Individual Taxpayer

1. Citizens of the Philippines may be classified into;

(a) Resident Citizens (RC) -> those residing in the Phils.

(b) Non-resident Citizens -> those not residing in the Phils.

A “non-resident citizens” means (sec. 22 (E) National Internal Revenue Code (NIRC)

1. One who establishes to the satisfaction of the Commissioner of Internal Revenue (CIR) the fact of his physical presence abroad with a definite intention to reside therein.

2. A citizen of the Phils. who leaves the country during the taxable year to reside abroad, either as immigrant or for employment

or on permanent basis.

3. A citizen of the Phils. who works and derive from abroad and whose employment thereat requires him to be physically present abroad most of the time during the taxable year.

4. A citizen who has been previously considered as non-resident citizen and who arrives in the Phils. at any time during the taxable year to reside permanently in the country. (He shall be considered a NRC for the taxable year in which he arrives in the Phils. with respect to his income derived from sources abroad until the date of his arrival in the Phils.)

Rev. Regulations. No. 9-73, November 26, 1973 - The continuity of residence abroad is not essential. If physical presence is established, such physical presence for the calendar year is not interrupted by reasons of travels to the Phils.

2. Aliens / Foreigners

(a.)Resident aliens (RA) -> those residing in the Philippines though not a citizen thereof.

(b.) Non resident aliens (NRA) -> those not residing in the Phils.

1.) Those engaged in trade or business in the Phils. (NRAETB)

2.) Those not engaged in trade / business in the Phils. (NRANETB).

A “non-resident alien” individual who came to the Phils. and stayed therein for an aggregate period of more than 180 days during

any calendar year shall be deemed a NRA doing business in the Phils.

The term “engaged in trade / business” denotes habitually or sustained activity.

“Resident aliens” are those who are actually present in the Phils. and who are not mere transients or sojourners. For tax purposes a resident alien is;

1.) An alien who lives in the Phils. with no definite intention to stay as a resident.

2.) One who comes in the Phils. for definite purposes which in its very nature would require on extended stay and to that end, makes his home temporarily in the Phils.

3.) An alien who stay within the Phils. for more than 12 months from the date of his arrival in the Phils.

B.) Personal and Additional Exemptions

Nature & Purpose: Personal and additional exemptions are fixed amounts which are in the nature of deduction and are intended to substitute for the disallowance of personal or living expenses as deductible items.

Table 2: Persons entitled to personal and additional exemption

Taxpayer P E A E

1.Resident citizen

√

2.Non- resident (NRC)

√ (for income derived w/in)

√ (income from w/in)

3. Resident alien (RA)

√ (w/in)√ (income from w/in)

4. NRAETB √ (by way of

reciprocity)5. NRANEBT X6. Estate √ (only up

to P20k)7. Trust √ (only up

to P20k)

Reciprocity means that the foreign country where the nonresident alien is a citizen or subject grants exemption to Filipinos not residing there but doing trade or business, or exercising profession therein.

The extent of personal exemptions allowed to such non-resident alien shall be in the amount equal to the exemptions allowed in the income tax law in the country of which he is a subject or citizen, to citizens of the Phils. not resident in such country not to exceed the amount fixed under our laws. (Sec. 36 [D], NIRC).

Table 3 : Basic Personal Exemptions for RC, NRC, and RATaxpayer Exemption (amount)1. Single person

including a married person judicially decreed as legally separated

2. Each married person3. Head of family

HEAD OF FAMILY > is one who is unmarried or legally separated man or woman with;

(1) One or both parents –(a) Living with the taxpayer. (b) Dependent upon the

taxpayer for their chief support.

one or more brothers - (a) Living with the taxpayer

(b) Dependent upon the T for chief support(c) Not more than 21 yrs. of

age(d) Not married

(e) Not gainfully employed

(3) one or more legitimate recognized natural / legally adopted children.

living with the Taxpayerdependent upon the Taxpayer for chief supportnot more than 21 yrs. of agenot marriednot gainfully employed

Regardless of age, such children, brothers or sisters qualify a Taxpayer as head of family is they are incapable of self-support because of mental or physical defect.

“CHIEF SUPPORT” -> means principal or main support. More than fifty percent (50%) being provided to certain dependents is enough. This phrase does not necessarily mean that the dependent derives no name at all, he may still derive income but the same is insufficient to support him.

“LIVING WITH” -> requires the Taxpayer and his dependent to actually be residing together but temporary absence from their common residence brought by face of circumstances such as:(a) The Taxpayer is away on business (b) The dependent who

may be boarding elsewhere is in pursuit of education.

“GAINFULLY EMPLOYED” means that the dependent will only qualify as such if he derives no income for himself, or he is employed but his income is not sufficient to support him independently outside of the principal/chief support afforded to him by the taxpayer.

RA 7432 in relation to exemptions RA 7432 (approved April 23, 1992) expressly allows a qualified senior citizens to be claimed as dependents by those who care for them whether a relative or not.

Additional Exemption

Rule: An additional exemption of P8,000 is granted to Taxpayer for each, but not exceeding four (4) of his :(a) Legitimate,

illegitimate and/or legally adopted children

(b) Living with the Taxpayer

(c) Chiefly dependent upon him for support

(d) Not more than 21 yrs. old

(e) Unmarried(f) Not gainfully

employed.

Take note of the following rules:

1. Personal exemption of married persons:

a. If not legally separated, each spouse is entitled to P32k as personal exemption.

b. If legally separated, each is entitled to P20k as a single individual unless qualifies as head of family.

c. Where only one (1) of the spouses is deriving income, only such spouse shall be allowed the personal exemption.

2. For additional exemptiona. For married

individuals can be claimed by only 1 of the spouses.

b. For legally separated spouses, it can be claimed only by the spouse who has custody of the children; but the amount claimed by both shall not exceed the maximum allowed.

c. Additional exemption can be claimed only by the “husband” unless:

i. he waives his right in favor of his wife

ii. the husband is working abroad

iii. the wife is the on deriving income.

3. The law requires that married individuals, the husband and wife although required to file one (1) income tax return, should nevertheless compute their individual income

separately. If any income of the spouses can not be definitely attributable to or identifiable as income exclusively earned as realized by either of the spouses, the same shall be divided equally between the spouses.

Rules on change of Status These are:

1.) If the taxpayer marries or should have additional dependent(s) during the taxable year, the taxpayer may claim the corresponding additional exemption, as the case may be, in full for such year.

2.) If the taxpayer dies during the taxable year, his estate may still claim the personal and additional exemption for himself and his dependents as if he died at the close of such year.

3.) If the spouse or any of the dependents dies or if any of such dependents marries, becomes twenty-one (21) years old or becomes gainfully employed during the taxable year, the taxpayer may still claim the same exemptions as if the spouse or

any of the dependents died, or as if such dependents married, became twenty-one (21) years old or become gainfully employed at the close of such year.

Table 4. Rates of Tax on Certain Passive Income of Individual Taxpayer

Passive Income (Subject to Final Tax)

CITIZEN & RA

1. Royaltiesexcept:

(a) Books, literacy works

(b) musical compositions

20%

10%

10%

2. Prizes (exceeding P10k) & other winnings (except: PCSO & LOTTO winnings)

20%

3. Interest on bank deposits

20%

4. Interest under Expanded foreign currency deposit system

7.5%

5. Interest on long-term deposits> 5 yrs.< 3 yrs.3 to < 4 yrs.

exempt20%12%

6. Dividend from Domestic corporation, joint stock company insurance or mutual fund comp. and ROHQs of Multinational comp.

10%

7. Capital gains from the sale of real property located in the Phils.

6% (GSP/ FMV, whichever is higher)

8. Sales of Shares of Stocks not traded in local exchange

5% - not exceeding P100k10% - amount in excess of P100k

9. Cash and/ or property dividends

beginning Jan. 1998

beginning Jan. 1999

beginning Jan. 2000

6%

8%

10%

Any income or gain derived in which a final tax is imposed shall no longer be included in the taxable net income of the taxpayer (applicable only to citizens and aliens)

Final tax is imposed without deduction. Neither is the provision on personal additional applicable.

Aliens employed by RAHQs & ROHQs, OBUs, Petroleum service contractor & subcontractor of a multinational corporations are entitled to 15% tax, only on those:

Salari

es, wages, annuities, honoraria and the like as received from such RAHQs or ROHQs.

Provided that the same tax treatment is extended to Filipino employees having the same position in such entities.

III. TAX ON CORPORATIONS (CORPORATE TAXPAYERS)

CORPORATION DEFINED (Sec. 24(b) Tax Code) - The term shall include partnership, no matter how created or organized, joint stock companies, joint accounts, or insurance companies, but does not include general professional partnerships and a joint venture or consortium formed for the purpose of undertaking construction projects or engaging in petroleum, coal, geothermal and other energy operations pursuant to operating or consortium agreement under a service contract with the government.

GENERAL PROFESSIONAL PARTNERSHIP (GPP) - are formed by persons for the role purpose of exercising their common profession, no part of the income of which is derived from engaging in any trade & business.

CORPORATIONS ARE CLASSIFIED INTO TWO CLASSES NAMELY:

(1) Domestic -> those created or organized in the Phils. or under its laws.

(2) Foreign -> those created organized or existing under any laws other than those of the Phils. and they are either;

Resident foreign = those foreign corporation engaged in trade or business within the Phils.

Non-resid

ent = those foreign corporation not engaged in trade or business within the Phils.

“DOING OR ENGAGING IN” or “TRANSACTING BUSINESS”-> The term implies a continuity of commercial dealings and arrangements and contemplates to that extent, the performance of acts or works or the exercise of some of the functions normally insistent to and in the progressive prosecution of commercial gain or for the purpose and the object of the business organization (Comm. vs. British Overseas Airways Corporation – BOAC case 149 S 395)

Table 5 Rates and Tax base on Corporate Taxpayers in General Taxpayers

Taxes Imposed (Tax Rates and Tax Base)

Taxes Imposed Domestic Corp.

Net income

1.) Normal Corporate Income Tax (NCIT)

32% (Jan. 1, 2000)

2.) Minimum Corporate Income Tax (MCIT)

2%

3.) Branch Remittance Tax

4.) Improperly Accumulated Earning Tax (IAET)

10%

5.) Passive Incomes (Final tax)

a. Interest Peso bank

deposits - Foreign

Currency Deposit Units

b. Royaltiesc. Capital gains from

sales of share of stock not traded in the stock

< P100k > P 100kd. Income of a

depository bank under Foreign Currency Deposit Units

e. Capital gains from sale of real property situated in the Phils. (capital assets)

20%

7.5%

20%

5%Exempt

(RA 9294)

10%

6%f. Interest on foreign

loan 10%

g. Intercorporate dividends exempt

A. Tax On Domestic

Corporation (Sec. 27

of NIRC)

Except as otherwise provided in the Tax Code, Domestic corporations duly organized and existing under the Philippine laws shall be subject to the following tax rates based on their gross income derived from sources within or without the Phils.

35% - for 1997 and prior years34% - effective January 01, 199833% - effective January 01, 199932% - effective January 01, 2000

(1) Proprietary Educational Institutions / non-profit hospitals - Except those

income subject to final tax, proprietary educational institutions/ non-profit are taxable with the tax rate of 10% on their gross income.

Proprietary Educational Institution means any private school maintained and administered by private individuals or groups within an issued permit from the DECS, CHED or TESDA.

Predominance Test / Preponderance Test means that if the gross income from unrelated trade, business or other activity exceeds 50% of the total gross income derived by any educational institution or hospital from all sources the normal tax shall be imposed on the entire taxable income.

“Unrelated trade, business or other activity” means any trade business or other activity, the conduct of which is not substantially related to the exercise or performance by such educational institution or hospital of its primary purpose or function.

Article XIV Sec. 4 (3) of the Constitution provides that “all revenues and assets of non-stock and non-profit educational institution used actually, directly and exclusively for educational purposes are exempt from taxes and duties.

(2) Government owned or controlled corporations (GOCCs) – GOCCs, agencies or its instrumentality shall pay applicable corporate income tax rates except: GSIS, SSS, PHIC, PCSO and PAGCOR.

B. Tax Imposed on Domestic corporations

(1.) Normal Corporate Income Tax (NCIT) -> the tax rate of 32% (as of Jan. 1, 2000) is imposed on any income derived, within and without the Phils. Except on those passive income (Section 27 (A) NIRC)

(2.) Gross Income Tax Option -> The President upon the recommendation of the Secretary of Finance may, effective January 1, 2000, allow corporations the option to be taxed at fifteen percent (15%) of gross income provided that the following conditions are met therein:

a. a tax effort ratio of 20% of GNP

b. a ratio of 40% of income tax collection to total tax revenues

c. a VAT effort of 4% of GNP and

d. a 0.9% ratio of the Consolidated Public Sector Final Position (CPSFP) to Gross National Product (GNP)

The option to be taxed based on gross income shall be available only to firms whose ratio of cost of sales to gross sales or receipts from all sources does not exceed fifty-five percent (55%).

The election of the gross income tax option shall be irrevocable for three (3) consecutive taxable years during which the corporation is qualified under the scheme.

Definition of Terms

a. “Gross Income” derived from business shall be equivalent to gross sales returns, discounts and allowance and cost of goods.

b. “Cost of goods sold” shall include all business expenses directly incurred to produce

the merchandize to bring them to their present location and use.

c. For trading and merchandising concern, “Cost of goods sold” shall include the invoice cost of the goods sold, plus import duties freight in transporting the goods to the place where the goods are actually sold, including insurance while the goods are in transit.

d. For manufacturing concern, “Cost of goods manufactured and sold” shall include all costs of production of finished goods, such as raw materials used, direct labor and manufacturing overhead, freight cost, insurance premiums and other costs incurred to bring the raw materials to the factory or warehouse.

e. In sale of service, “gross income” means gross receipt less sales returns, allowance and discounts.

(3.) Minimum Corporate Income Tax (MCIT) -> a tax rate of 2% is imposed on the gross income of domestic corporations and resident foreign corporations.

Rationale: MCIT is designed to forestall the prevailing practice of corporation or over-claiming deductions in order to reduce their income tax payments.

Requisites:a. It is imposed

beginning the fourth (4th) taxable year immediately following the taxable yr. in which such corporation starts its

business operation.

b. It is imposable only if such corporation has zero or negative taxable income or whenever the amount of MCIT is greater than the Normal Corporate Income Tax (NCIT) due from such corporation.

Carry Forward of Excess Minimum Tax-> any excess of the minimum corporate income tax (MCIT) over the normal income tax shall be carried forward on an annual basis and credited against the normal income tax for the three (3) immediately succeeding taxable yrs.

Instances when MCIT may be suspended by the Secretary of Finance

-> The Sec. of Finance, upon recommendation of the Commissioner may suspend the imposition of MCIT, upon showing that the corporation suffers losses due to any of the following causes:a. Prolonged

labor dispute (e.g. strikes for more than 6 months)

b. Legitimate business reverses (e.g. theft)

c. Force majeure (e.g. war)

(4.) Final tax on certain Passive Income-> refer to previous note

The following corporations are not subject to MCIT

(1.) Proprietary Educational Institution if enjoys preferential tax rate

(2.) Non-profit hospitals

(3.) Depository banks under expended FCDU

(4.) International carriers

(5.) Offshore Banking Units

(6.) ROHQs of resident foreign corp.

(7.) Other corporations not subject to the normal tax rate

B. TAX ON FOREIGN CORPORATIONS (Sec. 28 of NIRC)

(1.) Resident Foreign Corporation Engaged in Trade or business in the Phils. (RFC) - Foreign Corporation shall be taxed on income derived from sources “within” the Philippines.

Tax Imposed on Resident

Foreign Corporation (RFC)

(1.) NCIT -> 32% effective Jan. 01, 2000 and thereafter

(2.) Gross Income Tax Option -> 15% tax rate on gross income of RFC is also applicable.

(3.) Minimum Corporate Income Tax (MCIT) -> 2% based on gross income is also applicable

(4.) Tax on Branch Profits Remittances -> subject to 15% based on the “total profits” applied or earmarked for remittance w/o any deduction for the tax component thereof:

except : Those activities registered w/ the PEZA; interests dividends, rents and

royalties; remuneration for technical services, salaries, and wages; premiums, annuities, emoluments; capital gains, profit and income.

(5.) Final tax on certain Passive Income - the same tax rates as imposed to domestic corporation = is also applicable to RFC except: the imposition of capital gain tax (6%) on sale of real property (capital asset) located in the Phils.

A different tax rate is

imposed on the following RFCs

-> 2 ½% on Gross Philippine Billing Int’l air carrier =

“Gross Philippine Billings” refer to the amount of gross revenue from (a) carriage of persons, excess baggage cargo and mail originating from the Phils. in a (b) continuous and uninterrupted flight, irrespective of the place of sale or issue and the place of payment of the ticket or passage document.

Take note: For a flight w/c originates from the Phils. but transshipment of passenger takes place at any port outside the Phils., only the aliquot portion of the cost of the ticket corresponding to the leg flow from the Phils. to the point of transshipment shall form part of the GPB.

In International shipping, “Gross Phil. Billing” means gross revenue whether for passenger, cargo or mail originating from the Phils. up to the final destination, regardless of the place of sale or payments of the passage or freight documents.

(b) Regional / Area Headquarters (RAHQs) -> tax exempt

-> These are branches established in the Phils. by a multinational companies but they do not earn or derive income here and their functions are limited to being a supervisory communication and coordinating center for their affiliates.

(c.) Regional Operating Headquarters (ROHQs) -> subject to 10% tax.-> these are branches established in the country by multinational companies which are engaged in any of the following:

general administration & planning;

business planning

business development (and the like)

(d.) Offshore Banking Units authorized by Bangko Sentral ng Pilipinas EXCEPT: RA 9294.

(2.) Non-Resident Foreign Corporations (NRFCNETB) - are subject to 32% tax rate (effective Jan. 1, 2000 and thereafter) on all income derived from sources within the Phils. except on certain passive income (refer to Table #1).

NRFCs are not entitled to deduction as well as exemption (personal and additional exemption)

TAX SPARING RULE / CREDIT

-> provides that a final withholding tax at the rate of 15% shall be imposed for the amount of cash and /or property dividends received from a domestic corporation by non-resident Foreign corporation subject to the condition that the country in which the NRFC is domiciled shall allow a credit against the tax due from NRFC taxes deemed to have been paid in the Phils. equivalent to 17% which represents the difference

between the regular income tax rate of 32% and the usual corporate rate of 15%.

Take note: Tax sparing credit

applies only when the conditions for its availment are clearly established by the taxpayer. Since the concession is in the nature of a tax exemption.

The 15% reduced tax must actually be paid and the 17% must be deemed paid tax.

The 15% tax on dividends is applicable if the country where the recipient NREC is domiciled does not imposed any tax on dividend received by said recipient foreign corporation (BIR Ruling, March 30, 1977)

IMPROPERLY ACCUMULATED EARNINGS TAX (IAET) (Sec. 29 NIRC)

Nature and Purpose: The improperly accumulated earning tax of 10% in addition to the regular corporate income tax shall apply to every corporation formed or availed for the purpose of avoiding of any other corporation by permitting earnings and profit to accumulate instead of being divided or distributed.

The term “Improperly accumulated taxable income” means taxable income adjusted by:

(1) Income exempt from tax

(2) Income excluded from gross income

(3) Income subject to final tax

(4) The amount of NOLCO deducted and reduced by the sum of:a. Dividends

actually or constructively paid and

b. Income tax paid for the

Taxable year.

Formula:Taxable incomeadd: Income

exempt from taxIncome

subject to final taxIncome

excluded from gross income

Amount of NOLCO deducted

Less: Dividends

actually or

constructiv

ely paid

Income tax paid for the yr.

Improperly accumulated Taxable

Income

Improperly Accumulated Earnings Tax does not apply to the following:

(1.) Banks and other non-banks financial intermediaries

(2.) Publicly held corporations

(3.) Insurance companies

Presumptions of Improper accumulations - There is a “prima facie” evidence of a purpose by a corporation to avoid the tax upon its shareholders or members:

(1) Where the corporation is a mere holding company.

(2) Where the corporation is an investment company where more than 50% of its outstanding stock is owned directly/ indirectly by one person during the taxable year.

(3) Where the corporation permits its earnings or profits to be accumulated “beyond the reasonable needs of the business”.

“Reasonable needs of the business” includes the reasonably anticipated needs of the business e.g.

investment of corporation’s profits in a business related to taxpayer’s business.

Purpose: To compel the corporations to distribute dividends to the stockholders (subject to dividend tax)

Instances of Reasonable Accumulations:

(1) It is retained for working capital needed by the business

(2) It is invested in addition to plant property and equipment reasonably by the business

(3) In accordance with contract obligations, it is placed to the credit of a sinking fund for the purposes of retiring bonds issued by the corporation.

EXEMPTIONS FROM TAXES ON CORPORATIONS (Sec. 30 of NIRC): The following shall not be taxed in respect to income received by them:

(a.) Labor, agricultural or horticultural organization not organized principally for profit.

(b.) Mutual savings bank not having a capital stock represented by shares and cooperative banks w/o capital stock organized and operated for mutual purposes and without profit.

(c.) A beneficiary society or association operating for exclusive benefit of the members or a mutual aid association or non-stock corporation organized by employees providing benefits exclusively to its members or their dependents.

(d.) Cemetery company owned and operated for the exclusive benefits of its member

(e.) Non-stock corporation or association organized and operated

exclusively for religious, scientific, athletic, or cultural purposes, or for the rehabilitation of veterans, no part of it net income or asset shall belong to or inure to the benefit of any member, organizer, or officer or any specific person

(f.) Business league chamber of commerce, or board of trade not organized for profit and no part of the net income of which inures to the benefit of any private stockholder or individual

(g.) Civic league or association not organized for profit but operated exclusively for the promotion of social welfare

(h.) A non-stock and non-profit educational institution.NOTE: Refer to Article XIV Section 4(3), 1987 Constitution.

(i.) Farmers’ fruit growers or like organization organized and operated as sales agent for the purpose of marketing the products of its member.

(j.) Farmers’ or other mutual typhoon or fire insurance company or like organization of a purely local character, the income of which consists solely of assessment, dues and fees collected from members for the sole purpose of meeting its expenses.

(k.) Government educational institution

Income of whatever kind and character of the foregoing organizations from any of their properties, real or personal or from any of their activities “conducted for profit” regardless of the disposition made of such income shall be subject to tax.

IV. TAX ON PARTNERSHIP AND CO-OWNERSHIP

PARTNERSHIP is a contract whereby two or more persons bind themselves to contribute money, property, or industry to a common fund with the intention of dividing the profits among themselves.

For income tax purposes, partnership may be classified as follows:

(1.) Partnership not subject to income tax, which include the following;

a. General Professional partnership

b. Joint venture or consortium agreement formed for the purpose of undertaking constr

uction projects or

engaging in petroleum, coal, geothermal and other energy operations pursuant to an operating or consortium agreement under a service contract with the government.

(2.) Partnership subject to income tax / Business Partnership-> All other partnership except GPP and

Joint Venture, no matter how created or organized are considered corporation subject to corporate income tax.

Table 6. Tax liability of Partnerships and the Partners Taxpayers.

Tax Liability GPP (Partnership not subject to tax)

Partnership itself - The entity itself is not taxable

Partners - The partners share in the net income of the partnership shall be taxable to the partners whether distributed or not.

Partners share in the net loss of the partnership

- may be claimed by the partner as a deductible expense in his personal income tax retain

Payment made by a partner to a partner for services rendered

- considered as additional share in the net income of the partner – (ordinary business income)

Filing of return - Partnership should file an “annual information return”

Reason: To furnish the BIR of information as to the share of each partner shall be part and include in his personal income tax return

Partner’s distributive share in the net income of the partnership

- subject to graduated income tax rates

BIR RULING No. 162 June 11, 1987 A partner’s

contribution of real property to the partnership fund is not subject to income tax.

CO-OWNERSHIP -> it is created whenever the ownership of an undivided thing or right belongs to different persons.GEN. RULE: Co-ownership is exempt from income tax because the activities of the co-

owners are usually limited to the “preservation” of the properties owned in common and the collection of the income therefrom.

EXCEPTIONS: (When co-ownership is subject to tax).

(1) When the income of the co-ownership is invested by the co-owners in other income-producing properties or income-producing activities, and

(2) When there is no attempt to divide inherited property for more than ten (10) years and the said property was not under any administration proceedings nor held in trust, an unregistered partnership is deemed to exist.

Tax liability of co-owners -> The co-owners in exempt co-ownership shall be viable for income tax only in their separate and individual capacity.

Filing of return -> The owners shall report and include in their respective personal income tax returns their shares of the net income of the co-ownership.

V. TAX ON ESTATES AND TRUSTS (Sec. 60. NIRC)

Estate is the mass of property, rights and obligations left behind by the decedent upon his death.

Estates may be classified as follows:1. Estates not under judicial settlement - are subject to income tax generally as mere co-ownership.- The tax liability on income of the co-ownership levied directly on the co-owners. Thus, the heirs shall include in their respective returns their distributive shares of the net income of the estate.

2. Estates under judicial settlement - are subject to income tax in the same manner as individual.

- Income received during the settlement of the estate is taxable to

the fiduciary (guardian, executor, trustee, and administrator).

- The return should be filed by executor or administrator of the trust.

Trust is an arrangement created by will or co-agreement under which title to property is passed to another for conservation or investment with the income therefrom and ultimately the corpus (principal) to be distributed in accordance with the directions of the creator as expressed in the governing instrument.

2 Kinds of Trust :

1. Irrevocable Trust -> is considered as a separate taxpayer.

2. Revocable Trust -> is one where at anytime the power to revest the title to any part of the corpus of the trust is vested:

(a.) in the grantor (creator of the trust) either alone or in conjunction with any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom; or

(b.) in any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom.

NOTE: The tax shall be imposed on taxable income of the grantor.

Various trusts subject to income tax.

(1.) Trust where income is accumulated for the benefit of certain or uncertain persons or persons with contingent interest.

(2.) Trust where income is accumulated or held for future distribution under the terms of the will or trust.

(3.) Trust where income is to be distributed currently by the fiduciary to the beneficiaries.

(4.) Trust where income collected by a

guardian of an infant is held or distributed as the court may direct.

(5.) Trust where income in the discretion of the fiduciary may be either distributed to the beneficiaries or accumulated.

Exempt Trust -The tax imposed on estate and trust does not apply to EMPLOYER’S TRUST provided that the following conditions are satisfied:

(1.) The employee’s trust forms part of a pensions, stocks, bonus or profit sharing plan of an employer for the benefit of some or all of its employees.

(2.) Contributions are made to the trust by such employer, or employees, or both for the purpose of distributing to such employees the earnings and principal of the trust and accumulated by the trust in accordance with such plan.

(3.) No part of the corpus or income shall be used for or diverted to, purpose other than for the exclusive benefit of his employees.

Consolidation of income in trusts

(1.) If there are two or more trusts created

(2.) The same are created by the same person (grantor)

(3.) and the beneficiary of such is the same person in each instance.

Take note: Rules applicable in the computation of the tax on estates and trusts:

(1.) The same rules in the determination of gross income for individuals are applicable.

(2.) The same deductions allowed to an individual taxpayer

are also allowed, in addition of the following deductions:

(a.) amount of its income which is to be distributed currently to the beneficiaries, and

(b.) Amounts of its income for the taxable year which is properly paid or credited during such year to any heir, legatee, or beneficiary, but the amount so allowed as a deduction shall be included in computing the taxable income of the heir, legatee, or beneficiary.

(3.) Personal Exemption of P20k is also applicable

(4.) The graduated rates of tax used for individuals taxpayers are also applicable

The deductions mentioned are not available to TRUSTS administered in foreign country.

TRANSFER TAXES

Transfer Taxes Defined

Are those imposed upon the gratuitous disposition of private property.

Under our law, they are taxes levied on the transmission of private properties from a prior decedent to his heirs in the case of estate tax, or from a donor to a donee in the case of donor’s tax.

Kinds of Transfer Taxes

1. Death taxes or duties Are those levied on

the gratuitous transfers of property upon one’s death, formerly comprised of the estate and inheritance taxes: Both taxes are now integrated into one estate tax.

2. Gift Taxes Are imposed on the

gratuitous transfers of property during one’s lifetime, formerly comprised of the donor’s and donee’s gift taxes; both taxes are now integrated into a donor’s tax.

Estate Tax

Estate tax defined Is a graduated tax

imposed on the privilege of the decedent to transmit property at death and is based on the entire net estate, regardless of the number of heirs and relations to the decedent.

It is a “transfer” tax not a property tax.

The tax on the right to transmit property at death and on certain transfers which are made by the statute the equivalent of testamentary dispositions.

Nature of Estate Tax It is not a direct tax

on property nor is it a capitation tax, that is, the tax is laid neither on the property, nor on the transferee or transferor, but on the right of the decedent to transmit his estate.

It is not a property tax but an excise tax.

Purpose and justification of estate tax:

The following theories have been advanced to justify death taxation: (BRAP)

a.) Benefit-Received Theory

For the performance of services rendered by the government in the distribution of the estate of the decedent and other benefits that accrue to the estate and the heirs, the state collects the tax.

b.) Redistribution of Wealth Theory

Is a contributing factor to the inequalities in wealth and income. The imposition of death tax reduces the property received by the successor bringing about a more equitable distribution of wealth in society.

c.) Ability-to pay- theoryThe receipt of inheritance places assets in the hands of the heirs and beneficiaries thereby creating an ability to pay the tax and thus to contribute to governmental income; and

d.) Privilege theory or State Partnership theory

Inheritance is not a right but a privilege granted by the state and large estates have been acquired only with the protection of the state. The State, as a “passive and silent partner” in the accumulation of property has the right to collect the share which is properly due to it.

Incidence or burden of estate of tax

Three views on who is the taxpayer in estate taxation:

1. PREDECESSOR – the object of the tax is the property which has been held or accumulated by the deceased and the tax has fallen upon him in the sense it has affected the amount of the property which he could dispose.

2. SUCCESSOR – the tax is not paid by the predecessor who has no liability till he dies and who is free to ignore the duty if he wishes, while the successor comes into less than he would have, and has no kind of redress.

3. NO PERSONAL INCIDENCE-

4. the estate tax has no personal incidence at all, merely falling upon the estate as such.

Law applicable:Estate taxation is

governed by the statute in force at the time of the death of the decedent.

Meaning of Gross Estate:

Gross estate Is the total value of all

property, whether real or personal, tangible or intangible belonging to the decedent at the time of his death, situated within or outside the Philippines, where such decedent was a resident or citizen of the Philippines. In the case of a nonresident alien decedent, it shall include only property situated in the Philippines.

Property Included in the Gross

Estate:

In case of resident citizens, nonresident citizens and resident aliens:

1. Real Property within and without the Philippines;

2. Tangible personal property within and without the Philippines; and

3. Intangible personal property within and without the Philippines.

In cases of nonresident aliens:1. Real property within

the Philippines;2. Tangible personal

property within the Philippines and;

3. Intangible personal property within the Philippines, unless there is reciprocity in which case, it is not taxable.

Meaning of RECIPROCITY;There is reciprocity if

the foreign country of which the decedent was a citizen or resident at the time of his death:

1.) Did not impose an estate tax; or

2.) allowed a similar exemption from estate tax with respect to intangible personal property owned by Filipino citizens not residing in that foreign country.

Note: 1. Reciprocity applies only when:

A.) The property is an intangible; and

B.) The decedent is a nonresident alien

2. The following intangibles are deemed located in the Philippines:

1.) Franchises which must be exercised in the Philippines;

2.) Shares, obligations or bonds issued by any corporation or sociedad anonima organized or constituted in the Philippines in accordance with its laws; 3.) Shares, obligations or bonds issued by any foreign corporation 85% of the business of which is located in the Philippines;4.) Shares, obligations or bonds issued by any foreign corporation if such shares obligations or bonds have acquired a business situs in the Philippines; and5.) Shares or rights in any partnership, business, or industry established in the Philippines.

Inter Vivos Transfers Subject to Estate Tax

The gross estate extends to gratuitous transfers made by the decedent during his lifetime which are treated

by the law as substitutes for testamentary dispositions. They are transfers inter vivos in form but mortis causa in substance.

Rationale for taxability:

To reach such transfers which are really substitutes for testamentary dispositions and thus to prevent the evasion of the estate tax.

These transfers are:a.) transfers in

contemplation of death (sec.85 b);

b.) transfers with retention or reservation of certain rights (sec.85 b);

c.) revocable transfers (sec.85 c)

d.) transfers of property arising under a general power of appointment ( sec.85 d); and

e.) transfers for insufficient consideration (sec.85 g)

Note: Transfers by virtue of

a bonafide sale of property for an adequate and full consideration in money or money’s worth are excluded and not taxable.

Inclusions in the Gross

Estate (CR2IG DIP)

1) Transfer in contemplation of death

A transfer with the thought of death. The term “in contemplation of death” means that the impelling or controlling motive is the thought of death, regardless of whether the transferor is near the possibility of death or not, which induces the disposition of the property for the purpose of avoiding the tax. Example: donation was made concurrently with the execution of a will (Vidal de Roces vs.Posadas, 58 Phil 108)

The following circumstances are

taken into account in determining in whether the transfer was made in contemplation of death:

A.) Age and state of health of the decedent at the time of the gift;B.) Length of time between the gift and the date of death; andC.) Concurrent making of a will or making a will within a short time after the transfer.

The following are examples of motives precluding the category of a transfer in contemplation of death:

a.) To relieve the donor from the burden of management;

b.) To save income or property taxes;

c.) To settle family litigated and unlitigated disputes;

d.) To provide independent income for dependents;

e.) To see the children enjoy the property while the donor is alive.

f.) To protect the family from hazards of business operations; and

g.) To reward services rendered.

Note:

The THREE (3) YEAR PRESUMPTION provides that any transfer of a material part of his property in the nature of a final disposition or distribution thereof made by the decedent within three years prior to his

death without such adequate and full consideration shall , unless shown to the contrary, be deemed to be have been made in contemplation of death.

This provision, however, has been already deleted in Sec. 100 (b) now sec. 85 (B) of the Tax Code by PD No. 1705.

Under BIR Ruling No. 261 September 2, 1987, the law does not specify the number of years prior to a decedent’s death within which a transfer can be considered in contemplation of death.

2.) Transfer with retention or reservation of certain rights This contemplates

the instances where the owner transfers his property during life but still retains economic benefits (the possession or enjoyment of the property or the power to designate the person who may exercise such rights).

It includes:A. Transfer without retention of interest but intended to take effect at or after the decedents death.Example: donations mortis causa.B. Transfer with retention of interest in respect to:

The possession or enjoyment of or the right to the income from the property; or

The right either alone or in conjunction with any person, to designate the person who shall possess or enjoy the property or the income therefrom. And such interest is retained by the decedent for his life or for any period which does not in fact end before his death.C. Transfer with reversionary interest, wherein there is a possibility that the transferred property may return to the decedent or his estate or that it may become subject to a power of disposition by the decedent. Illustration:

A transfers his property to B in naked ownership and to C in usufruct throughout C’s lifetime subject to the

condition that if C predeceases A, the property shall return to A. If A dies during C’s lifetime, the value of the reversionary interest of A at death is included in his gross estate.

3.) Revocable transfer A transfer where:a.) The decedent or in

conjunction with any other person has reserved the right to alter, amend, revoke, or terminate; or

b.) Any such power is relinquished in contemplation of the decedent’s death.

The power to alter, amend or revoke shall be considered to exist on the date of the decedent’s death even though:

a.) the exercise of the power is subject to a precedent giving of notice; or

b.) The alteration, amendment or revocation takes effect only upon the expiration of a stated period after the exercise of the power.

If the notice has not been given or the power has not been exercised on or before the decedent’s death, such notice or the power shall be considered to have been given or exercised on the date of the decedent’s death.(sec.85 C.2) NIRC

4.) Transfer of property under a general power of appointment

A transfer where the donor of the power of appointment authorizes the donee of such power to designate any person he chooses to be given the right over the appointed property.

General power of appointment vs. special power of appointment:

A.) A power is general, when it authorizes the donee of the power to appoint any person he pleases including himself, thus having a full dominion over the property as if he owned it.

B.) It is special when, the donee can appoint only among a restricted or designated class of persons other than himself.

Note:If the power of

appointment is general, it makes the appointed property a part of the donee’s property.

Under a general power of appointment, title to the property is legally transferred to the donee. Therefore the property shall form part of the gross estate of the donee.

5.) Transfer for insufficient consideration

A transfer that is not a bona fide sale of property for an adequate and full consideration in money or money’s worth. The excess of the fair market value at the time of death over the value of the consideration received by the decedent shall form part of his gross estate. (Sec. 85, NIRC)

However, if the purported absolute sale inter vivos by the decedent is shown to be fictitious, then the total value of the property transferred

is subject to inclusion in the taxable estate.

6.) Proceeds of life insurance

Proceeds of life insurance taken by the decedent on his own life shall be included in the gross estate if the beneficiary:A.) Is the estate of

the decedent, his executor, or administrator (regardless whether the designation is revocable or irrevocable); or

B.) Third person other than the estate, executor, administrator but the designation of the beneficiary is revocable.

7.) Prior Interest

Except as otherwise specifically provided therein, subsections (B), (C), (E) of section 85 referring to transfer in contemplation of death, revocable transfer and proceeds of life insurance respectively shall apply to the transfers, trusts, estates, interests, rights, powers and relinquishment of powers as severally enumerated and described therein, whether made, created, arising, existing, exercised or relinquished before or after the effectivity of the CTRP.

NOTE:In most of these

transfers the property remains substantially that of the transferor during his lifetime notwithstanding the transfer since he still retain either the “beneficial ownership” or “naked title” to the property.

8.) Decedent’s Interest

To the extent of the interest therein of the decedent at the time of his death. (Sec. 85 A) NIRC

Exclusions from Gross Estate

The following properties are excluded from gross estate:

1) Amount receivable by any beneficiary irrevocably designated in the policy of insurance by the insured.

2) Proceeds of a group insurance policy taken out by a company for its employees.

3) Proceeds of insurance policies issued by the GSIS to government officials and employees.

4) Benefits accruing under the Social Security Act.

5) Proceeds of life insurance payable to the heirs of deceased members of the military personnel of the United States Army or Philippine Army under laws administered by the United State veterans Administration.

6) Accident insurance proceeds.

Note: Items 1 – 6 are proceeds of insurance not includible in the gross estate of the decedent.

7) Separate property of the surviving spouse.

Note:In the determination

of the gross estate, the nature of the property, whether common property of the spouses, separate or exclusive property either of the deceased or of the surviving spouse, becomes of vital importance. What regime of property relations shall govern the spouses?

Under the Civil Code, the husband and wife who got married before August 3, 1988 are governed by the Conjugal Partnership of Gains, while those who got married on or after August 3, 1988 are governed by the Absolute Community of Property, unless a different regime was agreed upon in the marriage settlement.

Exemption from Estate Tax

A. The first P200, 000.00 value of the estate (sec. 84 NIRC)B. The merger of the usufruct in the owner of the naked title.C. The transmission from the first heir, legatee, or donee in

favor of another beneficiary in accordance with the desire of the predecessor.D. All bequest, devises, legacies or transfers to social welfare, cultural and charitable institutions, no part of the net income of which inured to the benefit of any individual and provided that not more than 30% of the said bequest, etc shall be used by such institution for administration purposes.E. Intangible personal property of non-resident aliens under the principle of reciprocity.F. Retirement benefits of employees of private firms from private pension plans approved by the BIR.G. Amount received for war damages.H. Grants and donations to the Intramuros administration.

Allowable Deductions from the Gross Estate

The following are the expenses, losses, indebtedness and taxes that may be allowed as deductions from the gross estate:

A.) If decedent is a resident decedent:

ORDINARY DEDUCTIONS:

1) Funeral Expenses The amount

deductible is equal to 5% of the gross estate or the amount of the actual funeral expenses whichever is lower, but in no case to exceed P200, 000;

“Actual funeral expenses” are those which were actually incurred in connection with the interment or burial of the deceased and paid for from the estate of said deceased.

Funeral expenses include: a) Costs of coffin,

tombstone, mausoleum, and burial lot;

b) Funeral parlor fees;

c) Mourning clothing of the surviving spouse and the unmarried minor children;

d) Costs of obituary notices; and

e) Expenses during the wake.

The following cannot be deducted under funeral expenses:

a) Cash advances of the surviving spouse and the heirs;

b) Expenses paid by the relatives and friends; and

c) Expenses after the burial.

2) Medical expenses

Provided, that the following requisites are met:a. Must be incurred

by the decedent within one (1) year prior to his death

b. Must be duly substantiated by receipts; and

c. Must not exceed P500, 000.00.

3) Judicial expenses of the testamentary or intestate proceedings

Include “administration expenses” to those actually incurred in the administration of the estate.

Examples:a) fees of the

executor or administrator;

b) attorney’s fees;c) accountant’s

fees;d) court fees;e) salaries of

employees; andf) All other

expense related to the administration of the estate.

Note: Expenses not

essential to the proper settlement of the estate but incurred for the individual benefit of the heirs, legatees, or devisees are not allowed as deductions.

4) Claims against the decedent’s estate

Debts or obligations of the decedent that is enforceable against the estate provided that the following requisites are met:

a.) They were

contracted in good

faith and for an

adequate and full

consideration in

money or money’s

worth.

b.)They must be existing against the estate.c.) They must be legally enforceable obligations of the decedent and ought to be enforced by the claimants.d.)They must be reasonably certain in amount; and;e.)At the time the indebtedness was incurred, the debt instrument was duly notarized and if the loan was contracted within three (3) years before the death of the decedent, the administrator or executor shall submit a statement showing the disposition of the proceeds of the loan.

5) Claims against the insolvent persons

Requisites for deductibility:

A. The amount of said claims has been initially included as part of the gross estate; and

B. The incapacity of the debtors to pay their obligations is proven and not merely alleged.

6) Unpaid mortgages indebtedness

Requisites for deductibility:

A. The fair market value of the property mortgaged without deducting the mortgage indebtedness has been initially included as part of his gross estate; and

B. The mortgage indebtedness was

contracted in good faith and for an adequate and full consideration in money or money’s worth.

7) Casualty Losses

They include all losses incurred during the settlement of the estate arising from fires, storms, shipwreck or other casualties or from robbery, theft or embezzlement.

Provided, that the following requisites are met:

a.) Losses not compensated by an insurance or otherwise;

b.) Losses not have been claimed as a deduction for income tax purposes; and

c.) Losses incurred not later than the last day for payment of the estate tax (6 months from death).

8) Unpaid Taxes

Unpaid income tax on income due or received before death of the decedent, and real property taxes, which have accrued prior to the death of the decedent (real property taxes accrued at the beginning of the year but may be paid before or at the end of each quarter) are deductible.

Income taxes upon income received after the

death of the decedent, or property taxes not accrued before his death, or any estate tax cannot be deducted because they are chargeable to the income of the estate.

9) Vanishing deduction (property – previously taxed)

Is an amount allowed to reduce the taxable estate of a decedent where the property:

a. received by him from prior decedent by gift, bequest, devise or inheritance, orb. transferred to him by gift, has been the object of previous transfer deduction.

It is so-called a vanishing deduction because the rate of deduction gradually diminishes and entirely vanishes depending upon the time interval between the two (2) successive transfers.

There are two (2) factors necessary in vanishing deduction, these are;a. There are two

(2) deceased persons and the first is the transferor or there is donation and the donee subsequently dies;

b. The second decedent dies within five (5) years after the death of the prior decedent or in the case of gifts the decedent – donee dies within the same period after the date of the gift.

Rationale:The

deduction operates to

ease the harshness of successive taxation of the same property within a relatively short period of time.

Requisites for

deductibility:

1. The present decedent must have acquired the property by inheritance or by donation.

2. The property must have been acquired within five (5) years prior to the death of the present decedent3. The property must have formed part of the gross estate of the prior decedent if acquired by inheritance, or the taxable gift of the donor if acquired by donation.4. The estate tax or the donor’s tax, as the case may be, must have been paid on the previous transfer.5. The property must be identified as the one received from the prior decedent or from the donor, as the case may be; and6. The estate of the prior decedent must not have previously availed of the vanishing deduction on the subject property.

Procedure in computing vanishing deductions:1. Value taken of property previously taxed

Less:Mortgage paid by the present decedent on property previously mortgaged by prior decedent / donor, if any (Ist deduction)

= Initial basis

2. Initial basis X Expenses, etc and transfer for public purpose value of the gross estate of present decedent =2nddeduction

3. Initial Basis Less: 2 nd deduction Final Basis Multiplied by rate deduction (sec.86 (A.2), NIRC) VANISHING DEDUCTION

10) Transfer for public use

Requisites:1. The disposition must

be testamentary in character.2. To take effect after

death.3. In favor of the

government of the Philippines, or any political subdivision thereof.

1. Exclusively for public purpose.

11) Family home

Refers to the dwelling house, including the land on which it is situated, where the husband and wife, or an unmarried person who is the head of the family and members of their immediate family resides as certified by the Barangay Captain of the locality.

For the purpose of availing of a family home deduction to the extent provided by law, a person may constitute only one family home.

The amount deductible is equivalent to the current fair market value of the decedent’s family home if said current fair market value exceeds P1, 000,000.00., the excess shall be subject to estate tax.

Requisites to be

deductible:a. The family home

must be the actual residential home of the decedent and his family at the time of his death as certified by the barangay Captain of the locality where the family is situated.

b. The total value of the family home must be included in the gross estate of the decedent.

c. The allowable deduction must be in an amount equivalent to the current fair market value of the family home as declared or included in the gross estate not exceeding P1, 000,000.00.

12) Standard deduction equivalent to P1, 000,000.00 (does not include the P 200,000.00 exemption).

13) Amounts received by heirs under RA NO.4917 from the decedent’s employer as a consequence of the death of the decedent –employee provided that such amount is included in the gross estate of the decedent.

14) Net share of the surviving spouse in the conjugal / community property.

15) Tax credit for estate tax paid to a foreign country.

B.) If decedent is a non – resident alien.

The deductions allowed to citizens or residents of the Philippines are also extended to a non-resident alien decedent with respect to his estates situated in the Philippines at the time of his death.

In case of deductions for expenses, losses, indebtedness and taxes, the amount of the allowable deduction is limited only to the proportion of such deductions with the value of such part of his gross estate which at the time of his death, is situated in the Philippines, bears to the value of his entire gross estate wherever situated. (Sec. 86 (B))

Formula:

Philippine Gross Estate x Deductions Claimed Entire Gross estate

= allowable deduction of non-resident estate

As a prerequisite to the deduction, it must be included in the return required to be filed the value at the time of his death, of that part of the gross estate of the non-resident not situated in the Philippines, to determine the ratable portion of the deduction for expenses allowable.

Tax Credit

The estate tax imposed by the tax code shall be credited with the amount of any estate tax paid to a foreign country.

Limitations on credit:A.)The tax credit limit

for estate taxes paid to one foreign country is determined by the following:

Decedent’s Net Estate situated in a foreign country x Phil. Estate tax Entire net estate

= TAX CREDIT LIMIT

B.) The tax credit limit for estate taxes paid to two or more countries is determined as follows:

Decedent’s net estate situated outside of the Phil X Phil. Estate taxEntire net Estate

=Tax Credit limit

Note: 1.) Under limitation A the allowable tax credit is the lower amount between the tax credit limit and the estate tax paid to the foreign country.2.) under limitation B the allowable tax credit is the lower amount between the tax credit limit computed under (A) and that computed under (B)

Valuation of PropertyThe estate shall be

appraised at its FAIR MARKET VALUE AT THE TIME OF DEATH of the decedent (sec.88, NIRC)

This is regardless of any subsequent contingency affecting the estate. (Lorenzo vs. Posadas, 64 Phil. 353)

Transfers Exempt from Estate Tax

1.) The merger or usufruct in the owner of the naked title.

2.) The transmission or delivery of the inheritance or legacy of the fiduciary heir or legatee to the feideicomissary.

3.) The transmission from the first heir, legatee or donee in favor of another beneficiary, in accordance with the will of the predecessor.

4.) All bequests, devices, legacies or transfer to social welfare, cultural and charitable institutions no part of the net income pf which inures to the benefit of any individual.

Provided, that not more than 30% of the said bequests, legacies or transfers shall be used by such institutions for administration purposes.

Filing of Notice of Death Where the gross

value of the estate exceeds twenty thousand pesos (P 20,000.00) although exempt, the executor, administrator, or any of the legal heirs shall give,

within two (2) months after the decedent’s death or within like period after the executor or administrator qualifies as such, a written notice thereof, to the Commissioner of Internal Revenue.(sec. 89, NIRC) Filing of Return and Payment of Tax

1.) By whom? An estate tax return

under oath is required by law to be filed by the executor, administrator, or any of the legal heirs;

a.) Where the gross value of the estate exceeds p200, 000.00 though exempt from the estate tax; or

b.) Regardless of the gross value of the estate, where the said estate consists of registered or registrable real property, such as real property, motor vehicle, shares of stock or other similar property for which a clearance from the Bureau of Internal Revenue is required as a condition precedent for the transfer of ownership thereof in the name of the transferee.

2.) When to file? The return shall

be filed within six (6) months from the decedent’s death.

The Commissioner shall have the authority to grant, in meritorious cases, a

reasonable extension not exceeding thirty (30) days for filing the return.

The executor or the administrator, or any of the legal heirs, as the case may be, is required to give a written notice of death to the commissioner within two (2) months after the decedent’s death or after qualifying as such executor or administrator.

3.) Where to file? Except in cases

where the Commissioner of the Internal Revenue otherwise permits, the return shall be filed with an authorized agent bank or the Revenue District Officer, Revenue Collection Officer, or duly authorized treasurer of the city or municipality where the decedent was domiciled at the time of his death, or if there be no legal residence in the Philippines, with the Office of the Commissioner of Internal Revenue.

4.)Copies:The return shall be

filed in triplicate, two (2) for the BIR and one (1) copy for the taxpayer.

Liability for Payment of Estate Tax

The estate tax shall be paid by the executor or administrator who is primarily liable to pay it. (Commissioner vs. Gonzales, 18 SCRA 757) before delivery to any beneficiary of his distributive shares. (sec. 91 (c), NIRC).

After due payment, the executor or administrator shall be discharged from personal liability. (Collector vs. Mc Grath 1 SCRA 638)

The beneficiary shall, to the extent of his distributive

share, be subsidiarily liable for the portion of the estate tax as his distributive share bears to the value of the total net estate. (sec.91 (c), NIRC)

Measures to Insure Payment of Estate Tax

a. In judicial settlement of estates, the court is required to furnish the commissioner of Internal Revenue a certified copy of the schedule of participation and the court order approving the same within 30 days after its promulgation. (sec. 91(b));

b. The estate tax shall be paid by the executor or administrator before delivery to any beneficiary his distributive share of the estate (sec. 91 (c)). He may be discharged from personal liability for deficiency in the estate tax only after written application to the commissioner and upon determination that no such deficiency appears. (sec. 92)

c. No judge shall authorize the executor or judicial administrator to deliver a distributive share to any party interested in the estate unless a certification from the Commissioner that the estate tax has been paid as shown. (sec.94)

d. Registers of Deeds shall not register in the Registry of property any document transferring real property any document transferring real property or real right therein or any chattel mortgage, by way of gift inter vivos or mortis causa, legacy or inheritance, unless certification from the commissioner that the tax has been paid and the y shall immediately notify the Commissioner, Regional Director, Revenue District Officer, or Revenue collection Officer or treasurer of the city or municipality where their officer are located, of the non-payment of the tax discovered by them.

e. Any lawyer notary public, or any Government Officer who, by reason of his official duties, intervenes in the preparation or acknowledgement of documents regarding partition or disposal of donation inter vivos or mortis causa, legacy or inheritance, shall have the duty of furnishing the Commissioner,

etc., with copies of such documents and any information whatsoever, which may facilitate the collection of the aforementioned tax.

f .Neither shall a debtor of a deceased pay his debts to the heirs, legatees, executor or administrator of his creditor, unless a certification of the Commissioner that the tax fixed has been paid is shown; but he may pay the executor or judicial administrator without said certification if the credit is included in the inventory of the estate of the deceased.

g. Corporations, sociedad anonima, partnerships, business or industry organized in the Philippines shall not transfer in their books any shares obligations, bonds or rights by way of gift inter vivos or mortis causa, legacy or inheritance to the new owner unless a certification from the Commissioner that the taxes fixed and due thereon have been is shown; and

h. If a bank has knowledge of the death of a person who maintained a bank deposit account alone or jointly with another, it shall not allow any withdrawal from the said joint deposit account unless the Commissioner has certified that the estate taxes imposed thereon have been paid. However, the administrator of the estate or any of the heirs of the decedent may, upon authorization by the Commissioner of Internal Revenue withdraw an amount not exceeding twenty thousand pesos (P 20,00.00) without the said certification . For this purpose, all withdrawal slips shall contain a statement to the effect that all of the joint depositors are still living at the time of withdrawal by any on e of the joint depositors and such statement shall be under oath.

i. The estate tax together with interest, penalties, and costs that may accrue in addition thereto constitutes a lien upon all property and rights to property belonging to the taxpayer. The lien attaches when the taxpayer neglects or refuses to pay after demand. (sec. 219)

Procedure for Computing Net Estate and Estate Tax

FORMULA:

Gross Estate LESS: Allowable deductions Estate after allowable deductions

LESS: ½ net share of surviving spouse on conjugal or community property (if applicable)

Family home allowance (if applicable)

= Net estate of decedent LESS: P200, 000.00 exemptions

= Taxable net estate X Tax Rate in section 84

= Amount of estate tax due

WHEN THE GROSS ESTATEEXCEEDS P 2,000,000.00, THE ESTATE TAX RETURN SHALL BE ACCOMPANIED BY A STATEMENT, WHICH IS CERTIFIED BY AN INDEPENDENT PUBLIC ACCOUNTANT STATING:

1. The itemized assets of the decedent with its corresponding gross value at the time of his death or in the case of a non-resident, not citizen of the Philippines that part of his gross estate

situated in the Philippines.2. The itemized deductions from the gross estate.3. The amount of tax due, whether paid or still due and outstanding.

Payment of the Estate Tax:

The estate tax shall be paid at the time when the estate tax return is filed.

When the Commissioner finds that the payment of the estate tax on the due date would impose undue hardships upon the estate, or any heir;

A.)The payment of the estate tax may be extended for a period not to exceed five years, if there is a judicial settlement of the estate; or

b.) The payment of the estate tax may be extended for a period not to exceed two years if there is an extra-judicial settlement of the estate.

Conditions for Extension of Time Payment:

A.) The taxpayer is not guilty of negligence, intentional disregard of rules and regulations, or fraud; otherwise, no extension maybe granted; and

B.) The executor, administrator, or beneficiary may be required to furnish a performance bond in an amount not exceeding double the amount of the tax due.

DISTINCTION BETWEEN DONOR’S TAX AND ESTATE TAXDONOR’S TAX ESTATE TAXTax on the privilege to transmit property during the lifetime of the donor

Tax on the privilege to transmit property upon one’s death

Tax rates are lower Tax rates are higherExemption is only P 100,000.00 Tax exemption is P200,000.00Notice of donation is not required Notice of death is requiredExtension of payment is not provided

Extension of payment may be granted by the Commissioner of Internal Revenue

Payable within 30 days from the date of gift

Payable within 6 months from the date of death

Imposed on the net gift Imposed on the net estate

Meaning of donation or gift.

Is an act of liberality whereby a person disposes gratuitously of a thing or right in favor of another who accepts it.

For tax purposes, the term has a much wider meaning, it includes:

A. any transfer of property by gift, except in forced sales and in the sale of real property which is a capital asset, for less than and adequate and full consideration in money or money’s worth. (sec. 100)

B. Condonation or remission of debt, where the creditor merely desires to benefit a debtor and without any consideration therefore cancels the debt.

PARTIES TO A DONATION :

Donor The Person who disposes of his property or right.

Donee The Person who receives the property or right.

WHAT MAYBE DONATED?

THING or RIGHT

KINDS OF DONATIONS:

According to its date of effectivity:

1.) Donation Inter vivos If made between living persons to take effect during the

lifetime of the donor.

2.) Donation Mortis Causa If made in the nature of a testamentary disposition that is it

shall take effect at the time of death of the donor.

DONATIONS NOT SUBJECT TO DONOR’S TAX

Only donations inter vivos are subject to donor’s tax.

1. Donations mortis causa Is subject to estate tax. The laws on succession govern

them.

2. Donation Inter vivos Of the amount of P100, 000.00 or less and those declared

exempt by the tax code and special laws are also not subject to Donor’s tax.

Meaning of gift tax

Donor’s tax is a tax imposed on the transfer without the consideration of property between two or more persons who are living at the time the transfer is made.

KINDS OF GIFT TAXES:

They are:1.) Donor’s tax or tax levied on the act of giving; it supplements

the estate tax; and2.) Donee’s tax or tax levied on the act of receiving; it was

formerly the counterpart of the inheritance tax, which has been integrated into an estate tax.

Note: Both taxes have been integrated into a donor’s tax.

NATURE OF GIFT TAX

It is an excise (privilege) tax, imposed on the privilege of the donor to give or on the privilege of the donee to receive. It is not a tax on the property as such because its imposition does not rest upon general ownership.

The tax is imposed without reference to the death of the donor unlike in the case of estate tax.

PURPOSE OF GIFT TAX

1.) The gift tax was enacted originally to supplement the estate and inheritance taxes by preventing their avoidance through the taxation of gifts inter vivos.

2.) The donor’s tax is also intended to prevent the avoidance of income tax through the device of splitting income among numerous/different donees with the donor thereby escaping the effect of the progressive rates of income taxation.

PROPERTY INCLUDED IN THE TERM “GIFT”

(A). In the case of resident citizens, non-resident citizens and resident aliens:

1. Real property within and without the Philippines.2. Tangible personal property within and without the Philippines; and3. Intangible personal property within and without the Philippines.

(B.) In the case of non-resident aliens:1. Real property within the Philippines.2. Tangible personal property within the Philippines. 3. Intangible personal property within the Philippines, unless there is reciprocity in which case, it is not taxable:

Note: The specific items includible in the “gross estate” are

applicable to and are embraced by the term “gift”.

TRANSFERS SUBJECT TO DONOR’S TAX:

Donor’s tax shall apply:

A. whether the transfer is in trust or otherwise;B. whether the gift is direct or indirect (remission/condonation of debt)C. whether the property is real or personal, tangible or intangible.

Note:It includes not only the transfer of ownership in the fullest

sense but also the transfer of any right or interest in property but less than title.

REQUISITES OF A TAXABLE GIFT:

1.) CAPACITY of the donor to make the donation;2.) DONATIVE INTENT or INTENT on the part of the donor to

make a gift;3.) DELIVERY, whether actual or constructive, of the gift; and 4.) ACCEPTANCE of the gift by the donee.

Note: A. the donee, unlike the donor need not be capacitated.B. donor’s tax applies now to both natural and judicial

persons.

C. donative intent must be present in direct gift but with respect to indirect gift, e.g. transfer of property for less than an adequate and full consideration, donative intent is superfluous. Thus, donative intent is not always essential to constitute a gift.

LAW APPLICABLE:

The law in force at the time of the perfection / completion of the donation shall govern the imposition of donor’s tax.

STRANGER

A person who is not a brother, sister, spouse, ancestor and lineal descendant or of a relative by consanguinity in the collateral within the 4th civil degree.

TAX PAYABLE WHEN THE DONOR IS A STRANGER:

When the donee is a stranger, the tax payable by the donor shall be 30% of the net gifts.

Note:If the beneficiary is not a stranger, the applicable rate is that

provided in sec.99, NIRC.

POLITICAL CONTRIBUTIONS

Any contribution in cash or in kind to any candidate, political party, or coalition of parties for campaign purposes, shall be governed by the Election code.

MEANING OF NET GIFT

Net gift Means the total amount of gifts less the allowable deductions

and specific exemptions. The donor’s tax is computed on the basis of the total net gifts

made during the calendar year.

ALLOWABLE DEDUCTIONS:

Gifts Made by a Resident:

a.) Dowries or gifts made on account of marriage before its celebration or within one year thereafter by parents to each of their legitimate, illegitimate or adopted children to the extent of the first P10,000.00.

Requisites:1. The donation must be given on account of

marriage.2. The parent must give it to his child.3. The child must be either the legitimate, recognized

natural or legally adopted child of the donor, and;4. It must be given within one year before or after the

celebration of the marriage.

b.) Gifts made to or for the use of the National Government or any of its agencies which is not conducted for profit, or to any political subdivision of the said government.

c.) Gifts in favor of educational, charitable, religious, cultural or social welfare corporation, institutions, foundations, trust or philanthropic organization, research institution or organization, or accredited non-government organization. Provided, that no more than 30% of said gifts shall be used by such donee for administration purposes.

Note: For purposes of exemption, a non-profit educational and/or

charitable corporation, institution, accredited non-government organization, trust or philanthropic organization is defined as: school, trust or university and/ or charitable corporation,

foundation trust or philanthropic organization and/ or research institution or organization incorporated as a non-stock entity:

paying no dividends. governed by trustees who receives no compensation; and

devoting all its income to the accomplishment and promotion of the purposes enumerated in its articles of incorporation.

d.) Encumbrances on the property donated if assumed by the donee; and

e.) Those specifically provided by the donee as a diminution of the property donated.

f.) The first P100, 000.00 value of the gift (exemption).

g.) Tax credit for donor’s tax paid to a foreign country.

Gifts made by a Non-Resident not a Citizen of the Philippines

A.) Gifts made to or for the use of the National Government or any entity created by of its agencies which is not conducted for profit, or to any political subdivision of the said government.

B.) Gifts in favor of educational, charitable, religious, cultural or social welfare corporation, institution, foundations trust or philanthropic organization, research organization or institution or accredited NGO. Provided, that no more than 30% of said gifts shall be used by such donee for administration purposes.

C.) First P100, 000.00 of the gift. (Exemption)

Note:

1. Intangible personal property in the gross gift of a NON-RESIDENT ALIEN donor shall be taxable in the Philippines, if the PRINCIPLE OF RECIPROCITY is not cognizable.

2. Intangible personal properties considered situated in the Philippines.

Franchise which must be exercised in the Philippines

Shares of stocks issued by any corporation or sociedad anonima organized or constituted in the Philippines in accordance with its laws.

Shares of stocks issued by any foreign corporation 85% of the business of which is situated in the Philippines.

Shares of stock issued by a foreign corporation, if such shares, obligations, or bonds, have acquired a business situs in the Philippines; and

Shares or rights in any partnership, business or industry established in the Philippines.

3. VOID DONATIONS ARE NOT SUBJECT TO DONOR’S TAX

Such as:

Between husband and wife, even if the relationship has not been solemnized.

Between persons guilty of adultery or concubinage. Between those found guilty of the same criminal

offenses. Between those made to a public officer or his wife,

descendants, ascendants by reason of his office.

4. Renunciation of inheritance in favor of a co-heir is not subject to donor’s tax but, if it is renounced in favor of a third person it shall be subject to donor’s tax.

TAX CREDIT FOR DONOR’S TAXES PAID TO A FOREIGN

COUNTRY

1.) Donor was a Filipino citizen or resident alien, at the time of foreign donation

2.) Donor’s taxes of any character and description are imposed and paid by the authority of a foreign country.

Limitations:

A.) For donor’s tax paid to one foreign country;

The amount of tax credit in respect to the tax paid to any country shall not exceed the same proportion of the tax against which credit is taken which the net gifts situated within such country taxable under the National Internal Revenue Code bears to his entire net gift, and

B.) For donor’s tax paid to two or more foreign countries:

The total amount of the credit shall not exceed the same proportion of the tax against which such credit is taken, which the donor’s net gift situated outside the Philippines taxable under the National Internal Revenue Code bears to his entire net gift.

FORMULA:

1. Donor’s Tax Paid to 1 Foreign Country

Net gift situated in a foreign country X Phil. Donor’s Tax = Tax Credit Limit

Entire net gifts

2. Donor’s Taxes paid to 2 or more Foreign Countries

Net gifts outside the Philippines X Phil. Donor’s Tax = Tax Credit Limit

Entire net gifts

Note: Under limitation A the allowable tax credit limit is the

LOWER AMOUNT between the tax credit limit and the gift tax paid to the foreign country.

Under limitation B the allowable tax credit is the LOWER AMOUNT between the tax credits; limit computed under A and that computed Under B.