GENERAL PRINCIPLES OF TAXATION

A. TAXATION: ITS GENERAL CONCEPTS1) Taxation as a power

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

i. Nature of the power of taxation 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.”

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

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 there from 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. For example the power to tax may not be delegated except when provided for by the constitution.

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

1

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

2

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)

Cases: o Sison vs. Ancheta, 130 SCRA 654o Municipality of Makati vs. Court of Appeals, 190 SCRA

206

ii. Importance of Taxation and the Lifeblood Doctrine

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)

“The areas which used to be left to private enterprise and initiative and which the government was called upon to enter optionally, and only because it was better equipped to administer for the public welfare than is any private individual or group of individuals, continue to lose their well-defined boundaries and to be absorbed within activities that the government must undertake in its sovereign capacity it is to meet the increasing social challenges of the times. Hence, the need for more revenues.” (Justice Makalintal in Sison vs. Ancheta, July 25, 1984)

iii. Justifications for the exercise of the taxing power1.The Benefits-Protection Theory/Benefit-Received Theory

The 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.

3

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)

2.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).

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.

iv. Purposes and Objectives of Taxation1. 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

4

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. (Re Special Duties under the Tariff and Customs Code; See also RA 8800 re Safeguard Measures Act)

2) Taxation as a processAs 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.

i. Stages in the tax process1. Levy/Imposition- the act of imposition by the legislature such as by

its enactment of the law.- 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. Assessment and Collection- the act of administration and implementation of the

tax law by the executive through its administrative agencies.

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

The two processes together constitute the “taxation system”.

ii. Principles of a sound tax system1. 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.

- The principle of fiscal adequacy as a characteristic of a sound tax system was originally stated by Adam Smith in his Canons of Taxation (1776), as: “Every tax ought to be so contrived as both to take out and to keep out of the pockets of the people as little as possible over and above what it brings into the public

5

treasury of the state.” It simply means that sources of revenues must be adequate to meet government expenditures and their variations. (ABAKADA vs. Ermita, G.R. 168056, Sept. 1, 2005)

2. Administrative Feasibility- tax system should be capable of being properly and

efficiently administered by the government and enforced with the least inconveniences to the taxpayer.

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.

** The non-observance of these canons, which are merely intended to make the tax system sound, will not render the tax impositions by the taxing authority invalid, except to the extent that specific constitutional or statutory limitations are impaired.

B. THE CONCEPT AND CHARACTERISTICS OF TAXES (LEMP3S)1. It is an enforced contribution2. It is proportionate in character - It is ordinarily based on the

taxpayer’s ability to pay.3. It is levied by the law-making body of the State4. The 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.

5. 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.

6. It is generally payable in money7. Tax 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.

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

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

10. 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.

Scope of Legislative Taxing Power [S2 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

C. LIMITATIONS ON THE EXERCISE OF THE TAXING POWER

6

1) Inherent Limitationsi. Public Purpose 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 ora.2) for some recognized objects of governments ora.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.

Test in determining Public Purposes in taxa. 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.

Cases:a. Pascual vs. Secretary of Public Works, 110 Phil 331

The Court allowed petitioner to maintain a taxpayer’s suit assailing the constitutional soundness of Republic Act No. 920 appropriating P85,000 for the construction, repair and improvement of feeder roads within private property. All these cases involved the disbursement of public funds by means of a law.

b. Lutz vs. Araneta, 98 Phil 148The basic defect in the plaintiff's position is his

assumption that the tax provided for in Commonwealth Act No. 567 is a pure exercise of the taxing power. Analysis of the Act, and particularly of section 6 will show that the tax is levied with a regulatory purpose, to provide means for the rehabilitation and stabilization of the threatened sugar industry. In other words, the act is primarily an exercise of the police power.

c. Gomez vs. Palomar, 25 SCRA 827

7

The eradication of a dreaded disease is a public purpose, but if by public purpose the petitioner means benefit to a taxpayer as a return for what he pays, then it is sufficient answer to say that the only benefit to which the taxpayer is constitutionally 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. Any other view would preclude the levying of taxes except as they are used to compensate for the burden on those who pay them and would involve the abandonment of the most fundamental principle of government that it exists primarily to provide for the common good.

ii. Inherently Legislative Rationale: Doctrine of Separation of Powers.

Taxation is purely legislative hence, Congress cannot delegate the power to others.

Coverage, Object, Nature, Extent, Situs Cases:

o Pepsi vs. Municipality of Tanauan, 69 SCRA 460o Pepsi vs. City of Butuan, 24 SCRA 789o

Exceptions to non-delegation: 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)

Flexible Tariff Clause: Section 401 – Modification of Duty, Tariff and Customs Code of the Philippines (TCCP)

Provide the legal basis by which the President may: (1) change the level and form of import duties, (2) impose an import quota or ban imports, and (3) levy an additional duty on all imports.

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 matters 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,

8

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

Limitations on Delegationa. 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; andc. 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.

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; andb. 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.

iii. Territoriality Important Points to Consider:1) Territoriality or Situs of Taxation means “place of

taxation” depending on the nature of taxes being imposed.

2) 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.

3) 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.

Factors to Consider in determining Situs of Taxation1) kind and Classification of the Tax2) location of the subject matter of the tax3) domicile or residence of the person4) citizenship of the person5) source of income6) place where the privilege, business or occupation is

being exercised

iv. International Comity

9

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 latterb.3) foreign government may not be sued without its consent so that it is useless to assess the tax since it cannot be collectedb.4) reciprocity among states

v. Tax Exemption of the Government 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 its operations.

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)

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

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.

2) Constitutional Limitationsi. Due Process Clause 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.

10

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.

Cases: Villegas vs. Hiu Chiong Tsau Pao Ho, November 10,

1978Requiring a person before he can be employed

to get a permit from the City Mayor of Manila who may withhold or refuse it at will is tantamount to denying him the basic right of the people in the Philippines to engage in a means of livelihood. While it is true that the Philippines as a State is not obliged to admit aliens within its territory, once an alien is admitted, he cannot be deprived of life without due process of law which includes the means of livelihood. The shelter of protection under the due process and equal protection clause is given to all persons, both aliens and citizens.

City of Baguio vs. De Leon, 25 SCRA 938At any rate, it has been expressly affirmed by

us that such an "argument against double taxation may not be invoked where one tax is imposed by the state and the other is imposed by the city ..., it being widely recognized that there is nothing inherently obnoxious in the requirement that license fees or taxes be exacted with respect to the same occupation, calling or activity by both the state and the political subdivisions thereof.

Sison vs. Ancheta, GR L-59431, 25 July 1984Equality and uniformity in taxation means that

all taxable articles or kinds of property of the same class shall be taxed at the same rate. The taxing power has the authority to make reasonable and natural classifications for purposes of taxation. Where the differentiation conforms to the practical dictates of justice and equity, similar to the standards of equal protection, it is not discriminatory within the meaning of the clause and is therefore uniform.

CIR vs. CA and Fortune, G.R. No. 119761, August 29, 1996

Unless there is due notice to the taxpaying public, due compliance with Internal Revenue Tax rules and regulations may not be reasonably expected. And most importantly, their strict enforcement could possibly suffer from legal infirmity in the light of the constitutional provision on `due process of law' and the essence of the Civil Code provision concerning effectivity of laws, whereby due notice is a basic requirement.

ii. Equal Protection Clause and the Rule on Uniformity of Taxation

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

11

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.

Cases: Association of Customs Brokers vs. Manila, 93 Phil

107While the tax in the Ordinance refers to

property tax and it is fixed ad valorem, it is merely levied on all motor vehicles operating within Manila with the main purpose of raising funds to be expended exclusively for the repair, maintenance and improvement of the streets and bridges in said city. The ordinance imposes a license fee although under the cloak of an ad valorem tax to circumvent the prohibition in the Motor Vehicle Law. Further, it does not distinguish between a motor vehicle for hire and one which is purely for private use. Neither does it distinguish between a motor vehicle registered in Manila and one registered in another place but occasionally comes to Manila and uses its streets and public highways. The distinction is necessary if the ordinance intends to burden with tax only those registered in Manila as may be inferred from the word “operating” used therein. There is an inequality in the ordinance which renders it offensive to the Constitution.

Ormoc Sugar Central vs. Ormoc Treasurer, 17 February 1968

The taxing ordinance should not be singular and exclusive as to exclude any subsequently established sugar central, of the same class as plaintiff, for the coverage of the tax. As it is now, even if later a similar company is set up, it cannot be subject to the tax because the ordinance expressly points only to Ormoc City Sugar Company, Inc. as the entity to be levied upon.

Philreca vs. DILG. 10 June 2003Supreme Court held that there is reasonable classification under the Local Government Code to justify the different tax treatment between electric cooperatives covered by P.D. No. 269, as amended, and electric cooperatives under R.A. No. 6938. First, substantial distinctions exist between cooperatives under P.D. No. 269, as amended, and cooperatives under R.A. No. 6938. Second, the classification of tax-exempt entities in the Local Government Code is germane to the purpose of the law. Finally, Sections 193 and 234 of the Local Government Code permit reasonable classification as these exemptions are not limited to existing conditions and apply equally to all members of the same class.

NOTE: see also Tio vs. Videogram, 151 SCRA 208.

12

Requisites for a Valid Classification 1. Must not be arbitrary2. Must not be based upon substantial distinctions3. Must be germane to the purpose of law.4. Must not be limited to existing conditions only; and5. Must apply equally to all members of a class.

iii. Freedom of Religion 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”

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)

Cases: Free Exercise Clause

o American Bible Society vs. City of Manila, 101 Phil 386

In the case at bar the license fee herein involved is imposed upon appellant for its distribution and sale of bibles and other religious literature. It may be true that in the case at bar the price asked for the bibles and other religious pamphlets was in some instances a little bit higher than the actual cost of the same but this cannot mean that appellant was engaged in the business or occupation of selling said "merchandise" for profit. SC believes that the provisions of City of Manila Ordinance No. 2529, as amended, cannot be applied to appellant, for in doing so it would impair its free exercise and enjoyment of its religious profession and worship as well as its rights of dissemination of religious beliefs.

With respect to Ordinance No. 3000, as amended, which requires the obtention the Mayor's permit before any person can engage in any of the businesses, trades or occupations enumerated therein, SC do not find that it imposes any charge upon the enjoyment of a right granted by the Constitution, nor tax the exercise of religious practices.

Tolentino vs. Secretary of Finance, 25 August 1994

The registration requirement is a central feature of the VAT system, designed to provide a record of tax credits because any person who is subject to the payment of the VAT pays an input tax, even as he collects an output tax on sales made or services

13

rendered. The registration fee is thus a mere administrative fee, one not imposed on the exercise of a privilege, much less a constitutional right.

iv. Freedom of Speech and of the Press Basis: Sec. 4 Art. III. No law shall be passed abridging the

freedom of speech, of expression or of the press xxx “

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.

v. Uniformity, Equitability and Progressivity of Taxation

Basis: Sec. 28(1) Art. VI. The rule of taxation shall be uniform and equitable. The Congress shall evolve a progressive system of taxation.

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 cons938titutional 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.

Cases:o Tolentino vs. Secretary of Finance

c. Indeed, regressivity is not a negative standard for courts to enforce. What Congress is required by the Constitution to do is to "evolve a progressive system of taxation." This is a directive to Congress, just like the directive to it to give priority to the enactment of laws for the enhancement of human dignity and the reduction of social, economic and political inequalities (Art. XIII, Sec. 1), or for the promotion of the right to "quality education" (Art. XIV, Sec. 1). These provisions are put in the Constitution as moral incentives to legislation, not as judicially enforceable rights.

o City of Baguio vs. De Leon, 25 SCRA

14

vi. Non-imprisonment for non-payment of poll tax Basis: Sec. 20 Art. III. “No person shall be imprisoned for

debt or non-payment of poll tax.”

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.

vii. Non-impairment Clause Basis: Sec. 10 Art. III. “No law impairing the obligation of

contract shall be passed.”

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. (See MERALCO vs. Province of Laguna, G.R. No. 131359, May 5, 1999)

Cases:o Cagayan Power and Light Co. vs. CIR, G.R. No.

60126, September 25, 1985SC held that Congress could impair petitioner's

legislative franchise by making it liable for income tax from which heretofore it was exempted by virtue of the exemption provided for in its franchise. Republic Act No. 5431, in amending section 24 of the Tax Code by subjecting to income tax all corporate taxpayers not expressly exempted therein and in section 27 of the Code, had the effect of withdrawing petitioner's exemption from income tax.

o Casanova s. Hord, 8 Phil 125o RCPI vs. Provincial Assessor of South Cotabato, G.R.

131359, May 5, 1999o City Government of Quezon City vs. Bayantel, G.R.

No. 162015, March 6, 2006

viii. Tax Exemption of Traditional Exemptees- Taxation of Properties Actually, Directly and

Exclusively used for Religious, Charitable and Educational Purposes

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

15

for religious, charitable or educational purposes shall be exempt from taxation.”

Important Points to Consider:a. Test of the tax exemption: the use and not ownership of

the propertyb. To be tax-exempt, the property must be actually, directly

and exclusively used for the purposes mentioned.c. The word “exclusively” means “primarily’.

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

d. 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.

e. The constitutional exemption applies only to property tax.

f. 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)

Cases: Lladoc vs. CIR, 14 Phil 292

Manifestly, gift tax is not within the exempting provisions (Art VI, Sec. 28 (3)). A gift tax is not a property tax, but an excise tax imposed on the transfer of property by way of gift inter vivos, the imposition of which on property used exclusively for religious purposes, does not constitute an impairment of the Constitution.

Abra Valley College vs. Aquino, 15 June 1988The test of exemption from taxation is the use of the

property for purposes mentioned in the Constitution. Under the 1935 Constitution, the trial court correctly arrived at the conclusion that the school building as well as the lot where it is built should be taxed, not because the second floor of the same is being used by the Director and his family for residential purposes, but because the first floor thereof is being used for commercial purposes. However, since only a portion is used for purposes of commerce, it is only fair that half of the assessed tax be returned to the school involved.

Bishop of Nueva Segovia vs. Provincial Board of Ilocos Norte, 51 Phil 352

The Supreme Court included in the exemption a vegetable garden in an adjacent lot and another lot formerly used as a cemetery. It was clarified that the term "used exclusively" considers incidental use also. Thus, the exemption from payment of land tax in favor of the convent includes, not only the land actually occupied by the building but also the adjacent garden devoted to the incidental use of the parish priest. The lot which is not used for commercial purposes but serves solely as a sort of lodging place also qualifies for exemption because this constitutes incidental use in religious functions.

16

Herrera vs. QC Board of Assessment Appeals, 30 September 1961

Within the purview of the Constitutional exemption from taxation, the St. Catherine's Hospital is a charitable institution, and the fact that it admits pay-patients does not bar it from claiming that it is devoted exclusively to benevolent purposes, it being admitted that the income derived from pay-patients is devoted to the improvement of the charity wards. The existence of "St. Catherine's School of Midwifery" does not, and cannot, affect the exemption to which St. Catherine's Hospital is entitled under our fundamental law. On the contrary, it furnishes another ground for exemption.

Similarly, the garage in the building above referred to which was obviously essential to the operation of the school of midwifery and were entitled to transportation thereto for Mrs. Herrera received no compensation as directress of St. Catherine's Hospital were incidental to the operation of the latter and of said school, and, accordingly, did not affect the charitable character of said hospital and the educational nature of said school.

Lung Center of the Philippines vs. QC, 29 June 2004The portions of the land leased to private entities as

well as those parts of the hospital leased to private individuals are not exempt from such taxes. On the other hand, the portions of the land occupied by the hospital and portions of the hospital used for its patients, whether paying or non-paying, are exempt from real property taxes.

ix. Tax Exemption of Non-stock, non-profit educational institutions

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

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

17

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.

Case: CIR vs. CA, 14 October 1998 (YMCA)o YMCA is not an educational institution within the

purview of Article XIV, Section 4, paragraph 3 of the Constitution. The term “educational institution” or “institution of learning” has acquired a well-known technical meaning, of which the members of the Constitutional Commission are deemed cognizant. Under the Education Act of 1982, such term refers to schools. The school system is synonymous with formal education, which “refers to the hierarchically structured and chronological graded learnings organized and provided by the formal school system and for which certification is required in order for the learner to progress through the grades or move to the higher levels.” The Court has examined the “Amended Articles of Incorporation” and “By-Laws” of the YMCA, but found nothing in them that even hints that it is a school or an educational institution.

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

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.”

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

18

exempt from property tax, whether the educational institution is proprietary or non-profit.

xi. Origin or Revenue, Appropriation and Tariff Bills 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.”

Under the above provision, the Senator’s power is not only to “only concur with amendments” but also “to propose amendments”. (Tolentino vs. Sec. of Finance, supra)

xii. Flexible Tariff Clause- Delegation of Legislative Authority to Fix Tariff Rates,

Imports and Export Quotas

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.

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

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.”

The above provision requires the concurrence of a majority not of attendees constituting a quorum but of all members of the Congress.

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

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.”

xv. Taxation by Local Government Units

3) The Doctrine of Judicial Non-Interference / Power of Judicial Review in Taxation

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:

19

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.

4) Taxpayer’s SuitIt 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.

D. FORMS OF ESCAPE FROM TAXATION1) Resulting to Losses to Government’s Revenue

i. Tax Evasion the use of the taxpayer of illegal or fraudulent means

to defeat or lessen the payment of a tax. an illegal practice where a person, organization or

corporation intentionally avoids paying his/her/its true tax liability. Those caught evading taxes are generally subject to criminal charges and substantial penalties.

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

ii. 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.

is the legal utilization of the tax regime to one's own advantage, in order to reduce the amount of tax that is payable by means that are within the law.

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 AvoidanceTax Evasion vs. Tax Avoidance

accomplished 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

iii. Tax Exemption is a grant of immunity, express or implied, to

particular persons or corporations from the obligations to pay taxes.

20

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.

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.

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)

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 immunity

21

b. Partial Exemption – One where collection of a part of the tax is dispensed with

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 is 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 functions

2) Not Resulting to Lossesi. 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:1. 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

2. 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

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

ii. Capitalization

22

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

iii. 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 endeavours to recoup himself by improving his process of production thereby turning out his units of products at a lower cost.

3) Illustrative Casesi. Republic vs. Heirs of Cesar Jalandoni, 20 Sept 1965

Record shows that the three lots alleged to have been excluded in the return were already declared in the earlier return submitted by Bernardino Jalandoni as part of his property and his wife for purposes of income tax, there is reason to believe that their omission from the return submitted by Cesar Jalandoni was merely due to an honest mistake or inadvertence as properly explained by appellants. We can hardly dispute this conclusion as it would be stretching too much the imagination if we would find that, because of such inadvertence, which appears to be inconsequential, the heirs of the deceased deliberately omitted from the return the three lots with the only purpose of defrauding the government after declaring therein as asset of the estate property worth P1,324,555.80.

The same thing may be said with regard to the alleged undervaluation of certain sugar and rice lands reported by Cesar Jalandoni for the same can at most be considered as the result of an honest difference of opinion and not necessarily an intention to commit fraud.

Finally, SC finds it unreasonable to impute with regard to the appraisal made by appellants of the shares of stock of the deceased simply because Cesar Jalandoni placed in his return an aggregate market value instead of mentioning the book value declared by said corporations in the returns filed by them with the Bureau of Internal Revenue. The fact that the value given in the returns did not tally with the book value appearing in the corporate books is not in itself indicative of fraud especially when it is taken into consideration the circumstance that said book value only became known several months after the death of the deceased. Moreover, it is a known fact that stock securities frequently fluctuate in value and a mere difference of opinion in relation thereto cannot serve as proper basis for assessing an intention to defraud the government.

ii. CIR vs. Norton and Harrisson, 31 August 1964Based on an over-all appraisal of the circumstances

presented by the facts of the case, it yields to the conclusion that the Jackbilt is merely an adjunct, business conduit or alter ego, of Norton and Harrison and that the fiction of corporate entities, separate and distinct from each, should be disregarded. This is a case where the doctrine of piercing the veil of corporate fiction, should be made to apply.

23

It may not be amiss to state in this connection, the advantages to Norton in maintaining a semblance of separate entities. If the income of Norton should be considered separate from the income of Jackbilt, then each would declare such earning separately for income tax purposes and thus pay lesser income tax. The combined taxable Norton-Jackbilt income would subject Norton to a higher tax.

Thus the SC held that Norton & Harrison is liable for the deficiency sales taxes assessed against it by the appellant Commissioner of Internal Revenue

iii. Philippine Acetylene vs. CIR, 17 August 1967Sales tax are paid by the manufacturer or producer who

must make a true and complete return of the amount of his, her or its gross monthly sales, receipts or earnings or gross value of  output actually removed from the factory or mill, warehouse and to pay the tax due thereon. The tax imposed by Section 186 of the Tax Code is a tax on the manufacturer or producer and not a tax on the purchaser except probably in a very remote and inconsequential sense. Accordingly, its levy on the sales made to tax-exempt entities like the Napocor is permissible. On the other hand, there is nothing in the language of the Military Bases Agreement to warrant the general exemption granted by General Circular V-41 (1947). Thus, the expansive construction of the tax exemption is void; and the sales to the VOA are subject to the payment of percentage taxes under Section 186 of the Tax Code. Therefore, tax exemption is strictly construed and exemption will not be held to be conferred unless the terms under which it is granted clearly and distinctly show that such was the intention.

iv. CIR vs. American Rubber, 29 November 1966In Philippine Packing Corporation vs. Collector of Internal

Revenue (100 Phil. 545 et seq.), it was ruled that the exemption from sales tax established in Section 188(b) of the Internal Revenue Tax Code in favor of sales of agricultural products, whether in their original form or not, made by the producer or owner of the land where produced is not taken away merely because the produce undergoes processing at the hand of said producer or owner for the purpose of working his product into a more convenient and valuable form suited to meet the demand of an expanded market; that the exemption was not designed in favor of the small agricultural producer, already exempted by the subsequent paragraphs of the same Section 188, but that said exemption is not incompatible with large scale agricultural production that incidentally required resort to preservative processes designed to increase or prolong marketability of the product.

v. CIR vs. John Gotamco and Sons, 27 February 1987Direct taxes are those that are demanded from the very

person who, it is intended or desired, should pay them; while indirect taxes are those that are demanded in the first instance from one person in the expectation and intention that he can shift the burden to someone else. Herein, the contractor’s tax is payable by the contractor but it is the

24

owner of the building that shoulders the burden of the tax because the same is shifted by the contractor to the owner as a matter of self-preservation. Such tax is an “indirect tax” on the organization, as the payment thereof or its inclusion in the bid price would have meant an increase in the construction cost of the building.

Hence, the Contractee’s (WHO) exemption from “indirect taxes” implies that contractor (Gotamco) is exempt from contractor’s tax.

vi. Maceda vs. Macaraig, 31 May 1991, 8 June 1993NAPOCOR is a non-profit public corporation created for the

general good and welfare, and wholly owned by the government of the Republic of the Philippines.  From the very beginning of the corporation’s existence, NAPOCOR enjoyed preferential tax treatment “to enable the corporation to pay the indebtness and obligation” and effective implementation of the policy enunciated in Section 1 of RA 6395.  From the preamble of PD 938, it is evident that the provisions of PD 938 were not intended to be strictly construed against NAPOCOR.  On the contrary, the law mandates that it should be interpreted liberally so as to enhance the tax exempt status of NAPOCOR.  It is recognized principle that the rule on strict interpretation does not apply in the case of exemptions in favor of government political subdivision or instrumentality.  In the case of property owned by the state or a city or other public corporations, the express exception should not be construed with the same degree of strictness that applies to exemptions contrary to the policy of the state, since as to such property “exception is the rule and taxation the exception.”

vii. Contex vs. CIR, G.R. No. 151135, July 2, 2004Exemptions from VAT are granted by express provision of

the Tax Code or special laws. Under Zero-rating, all VAT is removed from the zero-rated goods, activity or firm. In contrast, exemption only removes the VAT at the exempt stage, and it will actually increase, rather than reduce the total taxes paid by the exempt firm’s business or non-retail customers. It is for this reason that a sharp distinction must be made between zero-rating and exemption in designating a value-added tax.

Apropos, the petitioner’s claim to VAT exemption in the instant case for its purchases of supplies and raw materials is founded mainly on Section 12 (b) and (c) of Rep. Act No. 7227, which basically exempts them from all national and local internal revenue taxes, including VAT and Section 4 (A)(a) of BIR Revenue Regulations No. 1-95.

On this point, petitioner rightly claims that it is indeed VAT-Exempt and this fact is not controverted by the respondent. In fact, petitioner is registered as a NON-VAT taxpayer per Certificate of Registration issued by the BIR. As such, it is exempt from VAT on all its sales and importations of goods and services.

25

viii. CIR vs. Estate of Benigno Toda, Jr., G.R. No. 147188, September 14, 2004Tax evasion connotes the integration of three factors: (1)

the end to be achieved, i.e., the payment of less than that known by the taxpayer to be legally due, or the non-payment of tax when it is shown that a tax is due; (2) an accompanying state of mind which is described as being “evil,” in “bad faith,” “willful,” or “deliberate and not accidental”; and (3) a course of action or failure of action which is unlawful. All these factors are present in the instant case. 

The scheme resorted to by CIC in making it appear that there were two sales of the subject properties, i.e., from CIC to Altonaga, and then from Altonaga to RMI cannot be considered a legitimate tax planning.  Such scheme is tainted with fraud.

Here, it is obvious that the objective of the sale to Altonaga was to reduce the amount of tax to be paid especially that the transfer from him to RMI would then subject the income to only 5% individual capital gains tax, and not the 35% corporate income tax.  Altonaga’s sole purpose of acquiring and transferring title of the subject properties on the same day was to create a tax shelter.  Altonaga never controlled the property and did not enjoy the normal benefits and burdens of ownership.  The sale to him was merely a tax ploy, a sham, and without business purpose and economic substance.  Doubtless, the execution of the two sales was calculated to mislead the BIR with the end in view of reducing the consequent income tax liability.

ix. John Hay Peoples Alternative Coalition vs. Lim, et.al., G.R. No. 119775, October 24, 2003It is clear that under Section 12 of R.A. No. 7227 it is only

the Subic SEZ which was granted by Congress with tax exemption, investment incentives and the like.  There is no express extension of the aforesaid benefits to other SEZs still to be created at the time via presidential proclamation.

While the grant of economic incentives may be essential to the creation and success of SEZs, free trade zones and the like, the grant thereof to the John Hay SEZ cannot be sustained.  The incentives under R.A. No. 7227 are exclusive only to the Subic SEZ, hence, the extension of the same to the John Hay SEZ finds no support therein.

More importantly, the nature of most of the assailed privileges is one of tax exemption.  It is the legislature, unless limited by a provision of the state constitution that has full power to exempt any person or corporation or class of property from taxation, its power to exempt being as broad as its power to tax.

The challenged grant of tax exemption would circumvent the Constitution’s imposition that a law granting any tax exemption must have the concurrence of a majority of all the members of Congress.

26

x. See also: CIR vs. Yutivo and Sons (1961) and CIR vs. Seagate Technology (Phils.), G.R. No. 153866, 11 February 2005.

E. RULES OF CONSTRUCTION OF TAX LAWS1) 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:i. When the law so provides for such liberal construction;ii. Exemptions from certain taxes granted under special circumstances

to special classes of persons;iii. Exemptions in favor of the Government, its political subdivisions;iv. 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.

Case: CIR vs. CA and Ateneo, 18 April 1997The doctrine in the interpretation of tax laws is that “(a) statute will not be construed as imposing a tax unless it does so clearly, expressly, and unambiguously. . . . (A) tax cannot be imposed without clear and express words for that purpose. Accordingly, the general rule of requiring adherence to the letter in construing statutes applies with peculiar strictness to tax laws and the provisions of a taxing act are not to be extended by implication.”  In case of doubt, such statutes are to be construed most strongly against the government and in favor of the subjects or citizens because burdens are not to be imposed nor presumed to be imposed beyond what statutes expressly and clearly import.

Ateneo’s Institute of Philippine Culture never sold its services for a fee to anyone or was ever engaged in a business apart from and independently of the academic purposes of the university. Funds received by the Ateneo de Manila University are technically not a fee. They may however fall as gifts or donations which are “tax-exempt” as shown by private respondent’s compliance with the requirement of Section 123 of the National Internal Revenue Code providing for the exemption of such gifts to an educational institution.

F. THE CONCEPT OF TAX LAWS1) Nature Prospectivity of Tax Laws

General Rule: Taxes must only be imposed prospectively

27

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.

2) Sourcesi. Constitution

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. 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.”

4. 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

28

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)

5. 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.”

ii. Statutesiii. Issuances by the Secretary of Financeiv. Administrative Issuance by the BIR

Cases: CIR vs. CA and Fortune, G.R. No. 119761, 29 August

1996Prior to the issuance of RMC 37-93, the brands

were in the category of locally manufactured cigarettes not bearing foreign brands, subject to 45% ad valorem tax.  Without RMC 37-93, the enactment of RA7654 would not have new tax rate consequences on the company’s products.  In issuing RMC 37-93, the BIR legislated under its quasi-legislative authority and not simply interpreted the law.  When an administrative rule goes beyond merely providing for the means that can facilitate or render least cumbersome the implementation of the law but substantially adds to or increases the burden of those governed.  It behooves the agency to accord at least to those directly affected a chance to be heard, and thereby be duly informed, before that new issuance is given the force and effect of law.

PB Com vs. CIR, 28 January 1999When the Acting Commissioner of Internal

Revenue issued RMC 7-85, changing the prescriptive period of two years to ten years on claims of excess quarterly income tax payments, such circular created a clear inconsistency with the provision of Section 230 of 1977 NIRC. In so doing, the BIR did not simply interpret the law; rather it legislated guidelines contrary to the statute passed by Congress.

v. Tax Ordinancesvi. Tax Treaties

exist between many countries on a bilateral basis to prevent double taxation

29

See CIR vs. SC Johnson and Son, 26 June 1999

G. OTHER DOCTRINES IN TAXATION Imprescriptibility of TaxesGeneral Rule: Taxes are imprescriptibleException: 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 Consider 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)

INCOME TAXATION

BASIC CONCEPT OF PHILIPPINE INCOME TAXATION

A. CONCEPT OF INCOME1. INCOME , defined;

It is understood as follows:a. Income is all wealth that flows into the taxpayer other than

a mere return of capital;b. It includes all gains or profit as well as gains from sale or

transfer of property whether real or personal, ordinary or capital asset;

c. The gains derived from capital, from labor, or both combined, provided it is understood to include profit gained through a sale or conversion of capital assets( Black Law Dictionary);

d. The amount of money coming to a person or corporation within specified time, whether as payment for services, interest or profit from investment. ( Fisher Vs. Trinidad 43 Phil 973, Conwi vs. CTA 213 SCRA 83)

2. CAPITAL, defined Accumulated goods, possessions and assets used for the production of profits and wealth.

- Owner’s equity in the business.

3. INCOME vs. CAPITALIncome as contrasted with the capital1. The essential difference between capital and income is that

capital is a fund while, income is a flow;

30

2. Capital is wealth while, income is the service of wealth;3. The fact is that property is the tree, income is the fruit; labor

is the tree, income is the fruit; capital is the tree, income is the fruit. (Madrigal vs. Rafferty 38 Phil 414)

B. Forms of IncomeIncome 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.

C. Classification of Income1. 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

B. TEST APPLIED IN DETERMINING THE EXISTENCE OF INCOME

1. Severance test/ realization test- as a capital or investment is not income subject to tax, the

gain or profit derived from the exchange or transaction of said capital by the taxpayer for his separate used benefit and disposal is income subject to tax.

- There is no taxable income until there is separation from capital of something of exchangeable value, thereby supplying the realization or transmutation that would result in the receipt of income.

- Under this doctrine, in order that income may exist, it is necessary that there be a separation from capital of something of exchangeable value.

2. TAX benefit rule Economic benefit rule -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.:

o Interest credited on savings bank deposits dividends applied by the corporation against the indebtedness of stockholder

31

o Share in the profit of a partner in General Professional Partnership

3. Claim of right doctrine applicable only in those instances where money is taken, it

does not involve the money or other proceeds from embezzled or stolen personal or other property. Thus, proceeds of stolen or embezzled property are taxable income, because even income from illegal sources is taxable. Ownership thereof is not in issue; the culprit has an obligation to return the same.

4. Income from whatever sources All income not expressly excluded or exempted from the class

of taxable income, irrespective of the voluntary or involuntary action of the taxpayer in producing the income.

C. REQUISITES FOR THE TAXABILITY OF AN INCOME

1. Existence of a gain - Gain is a sine qua non or an indispensable requisite to the existence of taxable income. If a taxpayer receives no profit from his labor or transaction, then such condition will not give rise to taxability of income.

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. Realization of a gaina. Actual gain – gain must be realized and receive.b. Constructive receipt – profit is set aside, declared- When an income is credited to the account of or set aside for,

a taxpayer and which may be drawn by him at any time, without any substantial limitation or condition upon which payment is to be made.

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.

32

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 indebtedness of

stockholder Share in the profit of a partner in General Professional Partnership

3. Gains must not be excluded (sec 32b)- any amount receive by an officer or employee or by his heirs from the employer as a consequence of separation from service because of death, sickness or other physical disability or for any other cause beyond his control.

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.

D. THE PHILIPPINE INCOME TAX SYSTEM

1. Type of income tax systemsa. Schedular system vs. Global systemSchedular system- a system employed where the income tax treatment varies

and is made to depend on the kind or category of taxable income of the taxpayer.

- the system that itemizes the different oncom and provide for varied percentages of tax, to be applied thereto. It has different rates.

* individual taxpayer fallows the scheduler tax system because their income from different sources are classified into compensation income, business income, passive income, capital gain derived from sale of shares of stock or sale of real property. These incomes are categorized and treated differently.

Global income tax system- it is a tax system whereby gross compensation income is

aggregated (globalized) with the net income from business, trade or profession to arrive at the global taxable income ( after allowable exemption) which taxable aggregate income is then subjected to a unitary progressive graduated rates of 0% to 32%.

corporate taxpayer adopts the global system of taxation. There is no classification of income from different sources with certain exceptions. All income of corporate taxpayer are globalized and tax at 32%.

Distinctions between schedular and global treatment in income tax

1. Under the scheduler treatment there are different tax rates while under the global treatment there is a unitary or single tax rate;

2. Under the shedular treatment there are different categories of taxable income while under the global treatment there is no need for classification as all taxpayer are subjected to single rate;

33

3. Shedular is usually used in the income of individual taxpayer while global is usually applied to corporation.

b. Schedular rates of taxes vs. Schedular system

2. Philippine income tax system as a semi global/ mixed system.

E. CRITERIA IN IMPOSING PHILIPPINE INCOME TAXES

1. Place where income was earned- income is taxable depending on the nature of taxpayer. Citizens of the Philippines and domestic corporation are taxable on income from all sources whether earned within or without; non residents citizen, resident alien, non resident alien and foreign corporation are taxable on income only from sources realized within the Philippines.

2. Residency- test of residency- maintenance of residence here in the Philippines.- Actual physical presence in the Philippines- Though there is an intention to return, if the Taxpayer

temporarily resides in the Philippines on an extended stay.

3. Citizenship

F. THE INCOME TAXPAYER AND THE GENERAL PRINCIPLE OF THEIR TAXABILITY (Tax Situs for Income Purposes)

1. General principle of income taxation (sec 23 NIRC)Except when otherwise provided by NIRC: a. A citizen of the Philippines residing therein is taxable on all income

derived from sources within and without the Philippines; b. A nonresident citizen is taxable only on income derived from

sources within the Philippines; c. An individual citizen of the Philippines who is working and deriving

income from abroad as an overseas contract worker is taxable only on income derived from sources within the Philippines: Provided, That a seaman who is a citizen of the Philippines and who receives compensation for services rendered abroad as a member of the complement of a vessel engaged exclusively in international trade shall be treated as an overseas contract worker;

d. An alien individual, whether a resident or not of the Philippines, is taxable only on income derived from sources within the Philippines;

e. A domestic corporation is taxable on all income derived from sources within and without the Philippines; and

f. A foreign corporation, whether engaged or not in trade or business in the Philippines, is taxable only on income derived from sources within the Philippines.

2. Individual Taxpayer

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):

34

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.

Residence does not mean mere physical presence. What makes an alien resident or a non-resident alien is his intention with regard to the length and nature of his stay.

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.

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.

35

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).

Personal Exemptions for RC, NRC, and RA

Taxpayer Exemption (amount)

1. Single person including a married person judicially decreed as legally separated

P 20k

2. Each married person P 32k3. Head of family P 25k

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.

(2) 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.(b)living with the Taxpayer(c) dependent upon the Taxpayer for chief support(d)not more than 21 yrs. of age(e)not married(f) not 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

36

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 ExemptionRule: 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; oriii. the wife is the one 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 cannot 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.

37

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:

Salaries, 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.

3. Tax on corporations (Corporate Taxpayers)

a.) 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-resident = 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)

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

38

(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.

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 GNPb. a ratio of 40% of income tax collection to total tax revenuesc. a VAT effort of 4% of GNP andd. 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 Termsa. “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.

39

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)

40

(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

(a.) Int’l carrier -> 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 transhipment 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 transhipment shall form part of the GPB.

In International shipping, “Gross Phil. Billing” means gross revenue whether for passenger, cargo or mail originating from the Philippines 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)

41

(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

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 andb. Income tax paid for the Taxable year.

Formula: Taxable incomeadd: Income exempt from tax

Income subject to final taxIncome excluded from gross incomeAmount of NOLCO deducted

Less: Dividends actually or constructively 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

42

(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.

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.

43

(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.

C. 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.

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.

Partnership not subject to income tax, which include the following;

a. General Professional partnershipb. Joint venture or consortium agreement formed for the purpose of

undertaking construction projects or engaging in petroleum, coal, geothermal and other energy

operations pursuant to an operating or consortium agreement

44

under a service contract with the government. 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.

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 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.

4. 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.

45

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

46

The deductions mentioned are not available to TRUSTS administered in foreign country.

G. SOURCES OF INCOME

1. Services / compensation- all kind of compensation for services rendered as a result of

employer-employee relationship. - It includes;a. salaries, wages, fees, allowances;b. commissions paid to salesperson or those paid in insurance

premium;c. compensation paid for services on the basis of percentage on

profits;d. honoraria, director’s fee;e. bonuses, tips;f. allowance for transportation, representation or entertainment;g. pensions or retiring allowance paid by private persons or by the

government;h. amount receive from refraining from rendering servicesi. Christmas gift based upon fixed percentile of salaries given to

employees during holidaysj. Amount receive as an special award for special servicesk. Prize won in competitive contest conducted for non commercial or

commercial purposesl. Proceeds from profit sharing and other benefit received in cash or in

kind.To be taxable the requisites are:

1. it must arise from personal service under an employee-employer relationship

2. it is in the nature of income to the recipient.

Tips or gratuities paid directly to an employee by a customer of the employer which is not accounted for by the employee to the employer are considered taxable income.

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 a 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).

47

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. Interest income- refers to the compensation for the use of money or forbearance for its

used or arising from indebtedness.- An 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.- Central bank circular No. 416, dated July 29 1974, increased and

fixed the legal rate of interest at 12% per annum applicable to loans or forbearance of money, goods or credit and court judgment thereon pursuant to the Usury law. Later on December 10, 1982, it amended its previous Circular and directed that rate of interest including commissions, premiums, fees and other charges, on loan or forbearance of money, goods or credit Regardless of their maturity and whether secured or unsecured that may be collected by any person, whether natural or juridical shall not be subject to any ceiling prescribed under the Usury Law, as amended. However, the 6% legal rate of interest under the Civil Code remained valid and still applies to other kind of monetary judgment which has nothing to do with loans or forbearance of money, goods or credits.

- Interest may refer, also to interest income from peso bank deposit which is subject to final tax of 20%. However, this interest income is

48

not included to the gross income but, together with other withholding taxes, it is deductible form the tax due to arrive at the amount still payable or refundable, as the case may be. ( NDC vs. CIR 151 SCRA 472)

Contractor’s tax is a tax imposed upon the privilege of engaging business - it is generally in the nature of excise tax on the exercise of privilege of selling services or labor rather than a sale of products and is directly collectible form the person exercising the privilege.- being an excise tax it cannot be levied by levying authority where the said privilege or business is done outside its jurisdiction. Like property tax, it cannot be imposed on a disposition outside the levying district. (CIR vs. Marubeni Corp. GR. No. 137377, Dec. 18, 2001)

3. 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.

- a corporate profit set aside, declared and ordered by the Board of Directors to be paid to the Stockholders on demand or at a fixed time. It may be classified into:

1. Cash dividend2. property dividend3. stock dividend4. liquidating dividend5. script dividend6. other dividend indirectly paid

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 earnings 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.

49

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.) The 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)

4. 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.

Note: (Gross Income from sources within the Philippines)* Gains, profits, and income from the sale of real property located in the Phils. and

50

* 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.

5. Royalty Income – these are the compensations or payments for the use of property and are

paid to the owner of a right.

6. 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 improvements 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

51

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.

Rent and royalties- rent is the consideration for the use of property, real or personal paid

by the lessee to a lessor through a contract of lease by which the latter temporarily grants the enjoyment of certain property to the former who undertakes to pay rent or a price certain thereof, for which contract to last for a definite on indefinite period, but in no case to exceed 99 years.

- Royalties on the other hand, are payment for the use of property which includes earning from copy right, trademarks, patents, and natural resources under a lease. Royalties are subject to final tax as follows:

a. 10% for books, literary works and musical composition;b. 20% for the use of other property.

DETERMINATION OF GROSS INCOME AND THE RULES ON INCLUSIONAND EXCLUSION FROM GROSS INCOME

A. The Concept of Gross Income

a. Gross Income, definition- 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. Gross Income v. Gross Sales/ Receipts

Where gross income pertains to all income during a taxable year derived from whatever source, gross sales or gross receipts, however, refers to the total invoice value of sales, before deducting for customer discounts, allowances, or returns. Gross Income derived from business shall be equivalent to gross sales returns, discounts and allowance and cost of goods.

B. The General Rules on Inclusion and Exclusion of Income Items

52

a. Taxable Income, Definition (sec 31) – means the pertinent items of gross income less the deductions

and/or personal and additional exemptions, if any, authorized for such types of income by the NIRC or other special laws

b. Inclusions (sec 32A)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 a certain quota of sales volume attained as part of incentives, such a sales commission.

e. Similar items – like pension or retiring allowance.

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

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.

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.

6. Interest Income - an earning derived from depositing or lending of money, goods or credits.

GENRULE: 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 winnings

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 profession.E. g. Law firm

53

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 SH’s (stockholders) out of its earnings or profits and payable to its SH’s in money or other property.

c. Exclusion under the Code. (LAGI C MR G2) (sec32 B)

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. 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 PremiumThe 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 or 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 of 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.

54

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.) Retirement Benefits, Pension, Gratuities, etc.

7.) Miscellaneous Itemsa.) 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

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

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

C. The Rules as Applied to Compensation Income and Other Benefits

1) Taxability of Compensation Income and the Application of the Employer’s Convenience Rule

Compensation Income, defined- all kinds of compensation for services rendered as a result of an employer-employee relationship. They include:

a. salaries, wages, fees, allowances;b. commissions paid to salespersons or those paid on

insurance premiums;

55

c. compensation for services on the basis of a percentage of profits;

d. honoraria, director’s fees;e. bonuses, tips;f. allowances for transportation, representation and

entertainment;g. pensions or retiring allowances paid by private persons or

by the government (excepts pensions exempt by law from tax)

h. amounts received for refraining from rendering services (also constitute taxable income)

i. Christmas gifts based upon fixed percentile of salaries given to employees during the holidays;

j. amounts received as award for special services or for suggestions to employer or for the prevention of theft/robbery

k. prizes won in competitive contests conducted for commercial or non-commercial purposes

l. proceeds from profit sharing and other benefits paid in cash or in kind.

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.

EMPLOYER’S CONVENIENCE RULEThe 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 permit.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) Retirement Payments, Pensions and Gratuities

56

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 employees 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; andb.) 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

3) Separation Payments 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.

4) Leave BenefitsThe terminal leave pay of government employees whose

employment is co-terminus 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)

5) 13th Month Pay and other Bonuses13th month pay equivalent to the mandatory one (1) month basic

salary of officials and employees (national or local), including GOCC, and of private offices received after the 12th month ay beginning 1994 and similar benefits, provided the total amount is P30k and below, likewise exempt from withholding tax but any amount in excess thereto shall be taxable and also subject to withholding tax

6) SSS/GSIS/other contributions (Phil-Health/Pag-ibig) and Union Dues

7) Fringe Benefits (Sec 33) Fringe benefit, defined

means 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 employees) such as but not limited to the following:

1. housing;2. expense account;3. vehicle of any kind;4. household personnel, such as maid, driver and

others;5. interest on loan at less than market rate to the

extent of the difference between the market rate and actual rate granted;

57

6. membership fees, dues and other expenses borne by the employer for the employee in social and athletic clubs or other similar organizations;

7. expenses for foreign travel;8. holiday and vacation expenses;9. educational assistance to the employee or his

dependents;10. life or health insurance and other non-life

insurance premiums or similar amounts in excess of what the law allows.

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 supervisory.

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.

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

D. The Rules as Applied to Trade/Business or Professional Income (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:

58

(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.

E. The Rules as Applied to Passive Income

a.Royalties, Prizes and WinningsRoyalties Royalties are subject to 20% final withholding tax Royalties on publication of books, literary works, musical

composition are subject to 10% final withholding tax

Prizes and winningsGEN RULE: Prizes and winnings whether in cash or in kind are

taxable. Prizes and winnings are subject to 20% final tax.

Provided; 1. more than P10k 2.won in the Philippines

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

b.Interest Income from Bank Deposits and Deposit Substitutes

Savings deposits- subject to 20% final withholding tax

Time deposits - longer than 5 years exempt from final withholding tax - if pre-terminate, subject to final withholding tax

4 years – less than 5 years 5%3 years – less than 4 years 12%Less than 3 years 20%

Foreign currency deposits- subject to 7.5% final withholding tax- except: OCW/Seamen opening foreign currency deposits

c.Dividends Cash dividends are subject to 10% final withholding tax other kinds of dividends are not subject to final withholding

tax

NON – TAXABLE INTER – CORPORATE PRINCIPLE Dividends from the domestic corporation and shares in

profits of taxable partnerships received by domestic 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:i) Cash Dividend – a dividend paid in cash and is taxable to the extent of the cash received.ii) Liquidating dividend – a dividend distributed to the SHs upon dissolution of the corporation.iii) Scrip Dividend – issued in a form of promissory note and it is taxable in its FMViv) Indirect dividend – when a corporation forgives the indebtedness of its stockholders, the transaction has the

59

effect of payment of dividend to the extent of the amount of the debt.v) 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. vi) Stock Dividend -- Involves the transfer of a portion of retained earnings to capital stock by action of stockholders. It simply means the capitalization of retained earnings.

GENRULE: 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;

1. 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)

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

3. 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

60

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)

4. Sale of Real Property Classified as Capital Asset- subject to 6% final withholding tax

5. Sale of Shares of Stocks Not Listed nor Traded in the Stock Exchange (based on gain)

P100k and below 5% More than P100k 10%

F. The Rules as Applied to Other Sources of Income (a)Cancellation of Indebtedness(b)Income from Lease and Leasehold Improvements(c) Income from Installment Transactions

As a general rule, the whole profit accruing from a sale of property is taxable as income in the year the sale is made. But, if not all of the sale price is received during such year, and a statute provides that income shall be taxable in the year in which it is "received," the profit from an installment sale is to be apportioned between or among the years in which such instalments are paid and received. (Banas vs. CA, G.R. No. 102967, February 10, 2000)

(d)Income from Long-Term Construction Projects

G. Exclusions by Reason of Special Laws

a. Prizes received by winners in charity horse race sweepstakes from PCSO.b. Back pay benefits c. Income of cooperative marketing association d. Salaries and stipends in dollars received by non – Filipino citizens on the technical staff of IRRI (International Rice Research Institutes).e. Supplemental allowances per diem, benefits received by officer or employees of the Foreign Service.f. Income from bonds and securities for sale in the international market.

DEDUCTIONS FROM GROSS INCOME

A. The Concept of Allowable Deductionsa. DEDUCTIONS, defined

These are items that are originally part and must be included in the taxpayer’s gross income but are allowed to be subtracted therefrom to determine the net income.

b. DEDUCTIONS vs. EXCLUSIONS

DEDUCTIONS EXCLUSIONS (Non-taxable items)1. Deductions are disbursements, 1. These are certain items which

61

expenses or losses that the law allows to reduce gross income. They represent generally, though not exclusively expenditures, other than the capital expenditures, connected with the production of income.

could be properly taxed as income yet the law specifically exclude then from taxation either on the basis of public consideration or from the fact that the transmutation of economic gain is not essentially the result of labor and efforts of the taxpayer.

2. The allowable deductions from gross income are limited to those that are related to the taxpayer’s business or profession; the only exceptions are a.) charitable contributions and b.) some kinds of losses.

2. They are not included in the income tax return unless information regarding them is specifically called for.

3. Taxpayers who are taxed only for net income within the Philippines (NRAEBI and RFC) can only claim deductions incurred in carrying on such business in the Philippines.

3. It may be availed of by all kinds of taxpayers.

c. DEDUCTIONS WHEN ALLOWED Deductions are matters of legislative grace. A taxpayer can

only deduct an item or amount from gross income if there is a law authorizing such a deduction. The taxpayer must be able to point to the specific provision of the statute authorizing such deduction and that he must be able to prove that he is entitled to it.

These allowable deductions can be availed of only if it is shown that the tax required to be deducted and withheld therefrom has been paid to the BIR (Rev. Reg. No. 2, April 17, 1998)

d. DEDUCTIONS vs. TAX CREDIT1. Tax credit – it is the right of an income taxpayer to

deduct from income tax payable the foreign income tax he has paid to his foreign country subject t limitations.

- Subtracted from the tax itself- It reduces the taxpayer’s liability dollar for dollar.

Deductions – subtracted from the gross income before the tax is computed

- It reduces the taxable income upon which the tax liability is calculated.

CASES: i. CIR vs. Central Luzon Drug Corp., April 15, 2005

A tax credit differs from a tax deduction. On the one hand, a tax credit reduces the tax due, including – whenever applicable – the income tax that is determined after applying the corresponding tax rates to taxable income. A tax deduction, on the other, reduces the income that is subject to tax in order to arrive at taxable income. To think of the former as the latter is to avoid, if not entirely confuse the use. A tax credit is used only after the tax has been computed, a tax deduction, before.

62

ii. CIR vs. Central Luzon Drug Corp., June 26, 2006The 20% discount required by RA 7432 to be given to

senior citizens is a tax credit, not a deduction from the gross sales of the establishment concerned. The definition of tax credit found in Sec. 2(1) of Rev. Reg. No. 2-94 is erroneous as it refers to a tax credit as the amount representing the 20% discount that “shall be deducted by the said establishment from their gross sales for VAT and other percentage tax purposes.”

iii. Bicolandia Drug Corp. vs. CIR, June 22, 2006The term “cost” in Sec. 4(a) of RA No. 7432 (Senior

Citizens Act) refers to the amount of the 20% discount extended by a private establishment to senior citizens in their purchase of medicines. This amount shall be applied as a tax credit and may be deducted from the tax liability of the entity concerned, if there is no current tax due or the establishment reports a net loss for the period, the period may be carried over to the succeeding taxable year.

B. KINDS OF ALLOWABLE DEDUCTIONS1. Itemized or Actual Deductions – items or amounts, which the law

allows to be deducted from gross income in order to arrive at taxable income.

2. Optional Stand Deductions – These are deductions in lieu of the itemized deductions. It us 10% of the gross income of the taxpayer from business or profession.

3. Special Deductions – these are deductions allowed to be deducted in addition to the itemized deductions allowable to corporations which may be availed of by insurance companies, mutual insurance companies, mutual marine insurance companies, assessment insurance companies, estates and trusts and private educational institutions.

C. THE OPTIONAL STANDARD DEDUCTION (OSD) These are deductions in lieu of the itemize deductions. It is 10%

of the gross income of the taxpayer from business or profession.o Only citizens and resident aliens in business, trade or

profession may elect the OSD.o Corporations are not allowed to choose OSD.o The choice must be signified in the income tax return of

the taxpayer and once chosen, it is irrevocable for the taxable year for which the return is made.

o No need to include financial statements in the return of OSD was claimed.

o It cannot be used as a deduction from compensation income.

D. ITEMIZED DEDUCTIONS: Concepts, Kinds, Rules and Requisites Who can claim the itemized deductions?

1. Corporations2. General Professional Partnership3. Individuals engaged in trade, business or profession4. Estate and Trust engaged in trade or business

63

If the taxpayer failed to elect the kind if deduction in his income tax, he shall be considered as having availed himself of the itemized deduction.

a) General Business Expenses- Capital Expenditure vs. Ordinary Expenditure

Property Acquired must have a useful life of not more than one year to qualify as an ORDINARY EXPENDITURE.

o Deductible in full if many receipt If it has a useful life of more than one year, then the

expenditure is CAPITAL EXPENDITURE.o Gradual deduction only.

- Rule Re: Proprietary Education InstitutionsExpenses to Private Educational Institutions – those

undertaken to achieve improvements in education activities and expansion of school facilities.

- The taxpayer has the option:i. To deduct expenditures otherwise considered as

capital outlays of depreciable assets incurred for the expansion of school facilities; or

ii. To deduct allowance for depreciation thereof.

- Where the expansion has been claimed as a deduction, no further claims for yearly depreciation of the school facilities are allowed.

- Reasonableness Test a. CIR vs. Gen. Foods, Inc. April 24, 2003

- There is yet to be clear-cut criteria or fixed test for determining the reasonableness of an advertising expense. There being no hard and fast rule on the matter, the right to a deduction depends n a no. of factors such as but not limited to: the type and size of business in which the taxpayer is engaged; the volume and amount of its net earnings; the nature of the expenditure itself; the intention of the taxpayer and the general economic conditions. It is the interplay of these, among other factors and properly weighed, that will yield a proper evaluation.

b. CM Hoskins vs. CIR, Nov. 28, 19691. Other tests suggested are: a.) payment must be

made in good faith; b.) the character of the taxpayer’s business; c.) the volume and amount of its net earnings; d.) the size of a particular business; e.) the employees’ qualifications and contributions to the business venture; and f.) general economic conditions.

- Representation ExpenseRequisites:- It must be ordinary, reasonable and necessary;- It must be directly connected or related to or in

furtherance of the conduct of his trade, business or exercise of a profession;

64

- It must not be contrary to law, morals, public policy or public order;

- It must not exceed the ceiling that may be prescribed by the Sec. of Finance; and

- It must be supported by official receipts or adequate records.

- Substantiation Rule and the Cohan Doctrine Substantiation Doctrine1. All business expense deductions must be

substantiated with:a. Receipts or adequate records;b. Amount of expense;c. Date and place of expense;d. Purpose of expense; ande. Professional or business relationship of

expense.

COHAN Doctrine- Authority of the BIR to allow a taxpayer to deduct a

certain percentage even without receipt provided the surrounding circumstances will show that the expense is incurred.

- Case: a. Gancayco vs. Collector, 1 SCRA 980

- Representation expenses cannot be allowed as an income tax deduction in the absence of receipts, invoices or vouchers supporting said expenses and in case the taxpayer cannot specify the items constituting said expenses.

b) Bad DebtsRequisites for Deductibility of Bad Debts:i. There must be a valid and subsisting debt;ii. The debt must be actually ascertained to be worthless

and uncollectible during the taxable year;iii. The obligation is not between related parties;iv. The debt is charged off within the year; andv. The debt must be connected with the trade, business

or profession of the taxpayer.

Tax Benefit Rule This doctrine holds that a recovery of bad debts

previously deducted from gross income constitutes taxable income if in the year the account was written off, the deduction resulted in a tax benefit, e.g., in the reduction of taxable income of the taxpayer.

This doctrine can only be availed of by a Creditor and never by a Debtor.

c) Interests

i. Requisites for Deductibility1. There is an indebtedness;2. The indebtedness must be that of the taxpayer;

65

3. In connection with taxpayer’s profession, trade or business;

4. There is liability to pay interest on the debt;5. The interest must have been paid or incurred within

the year;6. It must be legally due and stipulated in writing;7. It must not be expressly disallowed by law to be

deducted from taxpayer’s gross income; 8. It must be within the limit set by law; and9. It must not be in favor of a relative.

ii. On Capital Expenditure

Whenever a taxpayer opts to claim interest expense as a capital expenditure, he can validly claim deduction out of the annual depreciation of the property and not the amount of interest paid.

iii. Rules Re: Deductibility Interest payment to be deductible must be incurred

within the taxable year on indebtedness connected with the taxpayer’s profession, trade or business. However, if the interest was paid on indebtedness incurred or continued to purchase or carry obligations the interest upon which is exempt from taxation as income, then the interest payment shall be deductible.

iv. Tax Arbitrage Scheme (Rev. Regs. 13-2000)

v. Interest on Tax DelinquenciesCase: CIR vs. Itogon Suyoc Mines, July 29, 1969

The NIRC provides that interest upon the amount determined as a deficiency shall be assessed and shall be paid upon notice and demand from the CIR at the rate therein specified (Sec. 51(d), NIRC). The imposition of the monthly interest to the State for the delay in paying the tax and for the concomitant use by the taxpayer of the funds that rightfully should be in the government’s hands.

d) Taxesi. Requisites for Deductibility

Paid or incurred within the taxable year; Must not be specifically excluded by law

from being deducted from taxpayer’s gross income; and

Deductible only by the person(s) upon whom the tax is imposed by law.

ii. Deductible Taxes Import duties Business taxes – VAT, other percentage

taxes and excise taxes Privilege or occupation taxes, licenses Documentary stamp taxes Income war-profits and excess-profits

taxes imposed by the authority of any foreign country only if the taxpayer does not signify in his return his desire to have any extent the benefits of the provisions of law allowing credits against the tax for taxes of foreign countries

66

Any other taxes of every amount and nature paid directly to the government or any political subdivision.

iii. Non-deductible Taxes Income Tax Estate and gift taxes

Special assessment or levies on properties Energy Tax Taxes not related with the trade, business or

profession of the taxpayer Taxes which are final Income taxes imposed by authority of any foreign

country if the taxpayer signifies in his return, his intention to avail of tax credit for the said taxes.

e) Depreciationi. Properties subject to depreciation

Tangible property susceptible to wear and tear, to decay or decline from natural causes, to exhaustion and to obsolescence due to the normal process of the art or due to inadequacy of the property to meet growing needs of the business.Ex. Machines and equipment that must be replaced by new invention.

Intangible property, the use of which in trade or business is of limited duration like patents, copyrights, royalties and franchises.

ii. Allowable modes of depreciation Straight-line method – this method spreads the total

depreciation over the useful life of the assets. Declining-balance method – this method uses a rate

to the declining book value of the assets. Working-hours method – the total working hours of

the machine until its retirement is estimated and a charge per hour is determined.

Unit of production method – the estimated service life is stated in units of products instead of working hours.

Sum-of-the-years digit method – this is a method of depreciation where bigger depreciation expenses are provided during the early years of the fixed assets which gradually diminish until the total depreciation is equal the cost of the assets.

Any other method which may be prescribed by the Dept. of Finance upon recommendation of the CIR.\

f) Depletioni. This is the removal, extraction or exhaustion of a

natural resource such as mines and gas wells as a result of production or severance from such mines or walls.

g) Losses Requisites:

a. The loss must be that of the taxpayer;b. Actually sustained during the taxable year;c. Not compensated by insurance or other form of

indemnity;

67

d. Evidenced by a closed and completed transaction;e. Not claimed as a deduction for estate tax purposes; andf. If it is a casualty loss, must be reported to the

concerned authorities within prescribed time (45 days).

Types of Losses:

ORDINARY LOSSES CAPITAL LOSSES SPECIAL LOSSES Occurs when the

expenses are more than gross income or sale of ordinary asset

Can be deductible only from capital gains

Kinds:g. Wagering losses –

deductible only to the extent of gain or winnings.

h. Losses on wash sales of stocks – not deductible because these are considered as artificial loss.

i. Abandonment losses in petroleum operation and producing well.

j. Losses due to voluntary removal of building incident to renewal or replacements – deductible expense from gross income.

k. Loss of useful value of assets due to changes in business conditions.

l. Losses from sales or exchanges of property between related taxpayers.

m. Loss of farmers.

To a domestic corporation – all losses actually sustained and charged off within the taxable year and not compensated for by insurance or other form of indemnity.

Subject to the Loss Limitation Rule

To RC or a NRAETB – losses actually sustained during the year in trade, business or profession conducted within the Phils. and not compensated by insurance or other form of indemnity.

Kinds of capital losses:

a. Losses from sale or exchange of capital assets

b. Losses resulting from securities becoming worthless and which are capital assets

c. Losses due to failure to exercise privilege or option to buy or sell property

Net Operating Loss Carry Over (NOLCO)o Case: PICOP vs. CIR, Dec. 01, 1995

It is thus clear that under our law, and outside the special realm of BOI-registered enterprises, there is no such thing as a carry-over of net operating loss. To the contrary, losses must be deducted against current income in the taxable year when such losses were incurred. Moreover, such losses may be charged off only against income earned in the same taxable year when the losses were incurred.

o NOLCO – This refers to the excess of allowable deduction over gross income. It can be carried over as a deduction from gross income for the

68

next 3 consecutive years immediately following the year of such loss.

o 75% Interest Retention Rule NOLCO should be allowed only if there has

been no substantial change in the ownership of the business or enterprise in that

Not less than 75% in nominal value of outstanding issued shares if the business is in the name of a corporation, is held by or on behalf of the same persons; or

Not less than 75% of the paid up capital of the corporation, if the business is in the name of a corporation, is held by or on behalf of the same persons.

h) Charitable Contributionsi. With Limitation

1. Donations to the government of the Phils. or any of its agencies or political subdivisions for exclusively public purposes.

2. Donations to accredited domestic corp. or associations organized and operated exclusively for religious, charitable, scientific, youth and sports development, cultural, educational, rehabilitation of veterans, social welfare institution and NGO.

ii. Deduction in full1. Donations to the government or political subdivisions

including fully owner GOCCs to be used exclusively in undertaking priority activities in – educational, health, youth and sport devt. provided however, that any donation to the government NOT in accordance with the priority plan shall be the subject to the limitation of 5% or 10%.

2. Donations to foreign institutions or international organizations in compliance with agreements, treaties or commitments.

3. Donations to accredited NGO’s.4. Donations to traditional exemptees.

i) Pension Trusts An employer establishing or maintaining a pension trust to

provide for the payment of reasonable amount transferred or paid into such trust during the taxable year in excess of such contributions, but only if such amount:i. Has not theretofore been allowed as a deduction;ii. Is apportioned in equal parts over a period of 10

consecutive years in which the transfer or payment is made.

j) Research and Development Costsi. Amount Deductible – amount rateably distributed over

a period of 60 months beginning the month, taxpayer realized benefits from such expenditures.

k) Other Forms of Deductions (Sec. 37 NIRC)a. Special Deductions Allowed to Insurance Companies;b. Mutual Insurance Companies;

69

c. Mutual Marine Insurance Companies;d. Assessment Insurance Companies;e. Estates and Trusts; andf. 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, and2.) 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

holders2.) 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; and2.) 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).

SPECIAL INCOME TAX TREATMENT OF GAINS AND LOSSES FROM DEALINGS IN PROPERTY

A. Background of the special rules

B. Ordinary Assets v. Capital AssetsOrdinary 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; andv. Real property used in trade or business. (Sec. 39, [A], NIRC)

70

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; andv. Real property used in trade or business. (Sec. 39, [A], NIRC)This is an enumeration by exclusion, all others not enumerated

are capital assets.

C. Rules on Ordinary Gains and LossesOrdinary income (ordinary gain) – includes any gain from the sale or exchange of property which is not a capital asset (Sec. 22, [Z], NIRC)

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 Rules 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.

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.

D. Special Rules on Capital Transactions (Capital Gains and Losses)

a. Rules on Real Property Classified as Capital Asset(1.) Definition of terms:

i. Capital gain is the gain from the sale or exchange of capital assets.

ii. Capital loss is the loss incurred from the sale or exchange of capital assets.

iii. 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).

iv. 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).

(2.) Tax Treatment of Capital gains and Capital losses

71

a.) As to Individual Taxpayers

a.1) 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 - 100% if the capital asset has been held for 12 months

or less; and 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.

a.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 highertax 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:

i. 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

ii. 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;

72

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).

b. Rules on Gains or Losses From Sale of Shares of Stocks Not Listed or Traded in the Stock Exchange by Non-dealers in Securities

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.

c. Rules Regarding Other Capital Assets

A. Loss Limitation Rule provides that Capital losses are deductible only to the extent of capital gains.

73

B. Holding Period Rule 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); and

- 50% - 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.

C. Net Capital Loss Carry Over (NCLCO) Rule 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)

Limitation on Capital lossesGeneral 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.

E. Special Capital 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

74

materializes or when the time for the return of the borrowed shares comes.

1.)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.

2.)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.

3.)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.

4.)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.

F. 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.

75

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; andiv. Two series of bonds where one is secured by a mortgage and

the other is not; or which differ as to interest rates.

G. Installment Sales v. Deferred Sales

Installment Sale is a sale in which proceeds are received over a period of time. Gain on an installment sale is recognized as the selling price received, not including interest. Proceeds are received in more than one tax year.

H. Instances When Gains are Taxable But Losses are Non-deductible

TRANSACTIONS RESULTING IN TAXABLE GAINS BUT NON-RECOGNITION OF LOSSES

a. Transactions between related taxpayers (Sec, 36, NIRC)b. Illegal transactionsc. Wash sales (except those made by dealers in securities) 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

76

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

I. Instances when Gains and Losses are Not Recognized for Tax purposes

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.

- 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;

- 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)]

- 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.

- 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.”

TAXATION OF INCOME OF INDIVIDUAL TAXPAYERS

A. Classification of Individual Taxpayers and the Factors affecting their Taxability

77

Citizens of the Philippines may be classified into:a.) Resident Citizens (RC)

Citizens of the Philippines who are taxed on their income within and without the country

Individual who is: engaged in trade or business In the exercise of his profession Employed, earning purely compensation income Not engaged in trade or business or in the exercise of his

profession nor employed but has some income Has mixed income

b.) Non-resident Citizens (NRC) Those not residing in the Philippines A Filipino citizen who: (sec. 22 (E) National Internal Revenue Code

(NIRC) 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.

A citizen of the Philippines who leaves the country during the taxable year to reside abroad, either as immigrant or for employment or on permanent basis.

A citizen of the Philippines 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.

A citizen who has been previously considered as non-resident citizen and who arrives in the Philippines 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 Philippines with respect to his income derived from sources abroad until the date of his arrival in the Philippines)

NOTE: 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 Philippines.

Three types of Non resident Citizena. Immigrantsb. Employees of a foreign entity on a permanent basisc. overseas contract workers

Immigrants and Employees of a foreign entity on a permanent basis are treated as NRC from the time they depart from the Philippines. However, overseas contract workers must be physically present abroad most of the time during the calendar year to qualify as NRC.

An overseas contract worker (OCW) is taxable only on income derived from sources within the Philippines. Sec 23(b) (c)

A seaman is considered as an OCW provided the following requirements are present:

a. receives compensation for services rendered abroad as a member of the complement of a vessel, andb. such vessel is engaged exclusively in international trade.

78

Aliens or foreignersa.) Resident aliens (RA)

Those residing in the Philippines though not a citizen thereof. RA is taxed only on income within the Philippines RA is one who comes to the Philippines for a definite purpose

which is in its nature would require an extended stay, and makes his home temporarily in the country

b.) Non resident aliens (NRA) Those not residing in the Philippines and not a citizen of the

PhilippinesThose engaged in trade or business in the Philippines (NRAETB)

This includes the performance of the functions of a public office. It shall not include performance off services as an employee

An alien whose aggregate period of stay in the Philippines is more than 180 days during any calendar year.Those not engaged in trade / business in the Philippines (NRANETB).

An alien whose aggregate period of stay in the Philippines does not exceed 180 days during any calendar year regardless of whether he actually engages himself in trade or business in the Philippines.

c.)Special Aliens Individuals employed by:

Regional or area headquarters and regional operating headquarters on multinational companies (MNC) in the Philippines

Offshore banking units (OBU) established in the Philippines

Foreign Service contractors or sub contractors engaged in petroleum operations in the Philippines.

They are taxed only at 15% preferential income tax rate on their gross compensation income from sources within the Philippines

B. Rules Applicable to Returnable Income

C. Rules Applicable to Passive Income

Rates of Tax on Certain Passive Income of Individual Taxpayer

Tax Rate & Tax Base

79

Passive Income (Subject to Final Tax)

CITIZEN & RA NRAETB NRANET

B1. Royaltiesexcept:

(a) Books, literacy works(b) musical compositions

20%

10%10%

20%

10%10%

-

2. Prizes (exceeding P10k) & other winnings (except: PCSO & LOTTO winnings)

20% 20% -

3. Interest on bank deposits 20% 20% -4. Interest under Expanded

foreign currency deposit system

7.5% exempt Exempt

5. Interest on long-term deposits> 5 yrs.< 3 yrs.3 to < 4 yrs.

exempt20%12%

exempt20%12%

exempt20%12%

6. Dividend from Domestic corporation, joint stock company insurance or mutual fund comp. and ROHQs of Multinational comp.

10% 10% 10%

7. Capital gains from the sale of real property located in the Phils.

6% (GSP/ FMV,

whichever is

higher)

6% 6%

8. Sales of Shares of Stocks not traded in local exchange

5% - not exceedi

ng P100k10% -

amount in

excess of P100k

5%

10%

5%

10%

9. Cash and/ or property dividends

beginning Jan. 1998

beginning Jan. 1999

beginning Jan. 2000

6%8%10%

20% 25%

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:

80

Salaries, 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.

D. Personal Exemptions Nature & Purpose: Personal 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.

Basic Personal ExemptionsIndividuals who are either earning compensation income, engaged

in business or deriving income from the practice of profession are entitled to personal exemptions as follows:

For single individual or married individual judicially decreed as legally separated with no qualified dependents………………………………...P 20,000.00For head of family…………………………………………………...….....P

25,000.00For each married individual *………………………………………........P

32,000.00

Note: In case of married individuals where only one of the spouses is deriving gross income, only such spouse will be allowed to claim the personal exemption.

Basic Personal Exemptions for RC, NRC, and RATaxpayer Exemption

(amount)1. Single person including a married person

judicially decreed as legally separated P 20k2. Head of family P 25k 3. Each married person P 32k

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.

(2) One or more brothers - (a)Living with the taxpayer(b)Dependent upon the taxpayer 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.(a) living with the Taxpayer(b)dependent upon the Taxpayer for chief support(c) not more than 21 yrs. of age(d)not married(e)not 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.

81

“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 citizen to be claimed as dependents by those who care for them whether a relative or not.

Additional ExemptionsAn 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.

The maximum amount of P 2,400 premium payments on health and/or hospitalization insurance can be claimed if:

Family gross income yearly should not be more than P 250,000 For married individuals, the spouse claiming the additional exemptions

for the qualified dependents shall be entitled to this deduction

Persons entitled to personal and additional exemptionTaxpayer P E A E HHIP1.Resident citizen √ √ √2.Non- resident (NRC)

√ (for income derived w/in)

√ (income from w/in) X

3. Resident alien (RA) √ (w/in) √ (income

from w/in) √

4. NRAETB √ (by way of reciprocity) X X

5. NRANEBT X X X6. Estate √ (only up to

P20k) X X

7. Trust √ (only up to P20k) X X

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.

82

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 Philippines not resident in such country not to exceed the amount fixed under our laws. (Sec. 36 [D], NIRC).

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.

E. Taxation of Married Individuals1. Personal exemption of married persons:

If not legally separated, each spouse is entitled to P32k as personal exemption.

If legally separated, each is entitled to P20k as a single individual unless qualifies as head of family.

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 wifeii. the husband is working abroadiii. the wife is the one 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 cannot 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.

F. Taxation of MinorsIncome of unmarried minors derived from property received by the living parent shall be included in the return of the parent except:

a. when donor’s tax has been paid on such property, or b. when transfer of such property is exempt from donor’s tax.

G. Tax Returns and Other Administrative Requirements

83

Tax Return - this is a report made by the taxpayer to the BIR of all gross income received during the taxable year, the allowable deductions including exemptions, the net taxable income, the income tax rate, the income tax due, the income tax withheld, if any, and the income tax still to be paid or refundable.

Individuals Required to File Income Tax Return1. Resident Citizen2. Non-Resident Citizen on income from within the Philippines3. Resident alien on income from within the Philippines4. NRAETB on income from within the Philippines5. an individual (citizen/aliens) engaged in business or practice of a

profession within the Philippines regardless of the amount of gross income

6. Individual deriving compensation income concurrently from two or more employers at any time during the taxable year and

7. Individual whose pure compensation income derived from sources within the Philippines exceed P60,000.

Individuals Exempt from Filing Income Tax Return1. individuals whose gross income does not exceed total personal and

additional exemptions2. individuals with respect to pure compensation income derived from

sources within the Philippines, the income tax on which has been correctly withheld

3. individuals whose sole income has been subjected to final withholding tax, and

4. individuals who are exempt from income tax

Where To File 1. legal residence- authorized agent bank; Revenue District Officer;

Collection agent or duly authorized treasurer2. Principal Place of business3. Office of the Commissioner

Time for FilingApril 15- for those earning sole compensation or solely business,

practice of profession or combination of business and compensation

Extension of Time to File ReturnThe Commissioner may on meritorious cases grant a reasonable

extension of time for filing income tax return and may subject the imposition of twenty percent (20%) interest per annum from the original due date.

TAXATION OF INCOME OF CORPORATE TAXPAYERS

A. Definition of a Corporation

CORPORATION (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.

84

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.

B. Tests In Determining The Existence Of A Corporation

C. Tests Applied To Partnerships, Co-Ownerships, And Estates1. Evangelista vs. CIR (102 Phil 140)

The term “partnerships” does not only refer to partnerships in its technical meaning.

The phrase “no matter how created or organized” includes that a joint venture need not be undertaken in any of the standard forms or in conformity with the usual requirements of the law on partnerships in order that one could be deemed to be so for tax purposes

Also included are joint accounts and associations, none of which have a legal personality of its own independent of that of its members

2. Ona vs. CIR (45 SCRA 74) co- ownerships become taxable in the event co-owners used the

properties as a common fund with intent to produce profits

3. Obillos vs. CIR (October 19, 1985) mere sharing of gross returns does not of itself establish or

constitute a taxable partnership, whether or not the persons sharing them have joint or common interest

there is no taxable partnership where the children of Obillos had no intention to divide profits among themselves

there must be an unmistakable intention to form a partnership or joint venture

a sale of co-ownership property does not necessarily establish that intention

4. Pascual and Dragon vs. CIR (October 18, 1988) mere sharing of gross returns does not of itself establish or

constitute a taxable partnership where two persons purchased two parcels of land in 1965 and

another three parcels in 1966, which they later sold at a profit the character of habituality peculiar to business transactions for

the purposes of gain must be present the sharing of returns is but a consequence of a joint or common

interest in the property there must be a clear intention to form a partnership

5. Afisco Insurance Corp. vs. CIR ( January 25, 1999) a pool of machinery insurers is a taxable association or

corporation as an unregistered partnership Reasons:

(1) The pool has a common fund, consisting of money and other valuables that are deposited in the name and credit of the pool. This common fund pays for the administration and operation expenses of the pool.

(2) The pool functions through an executive board which resembles the board of directors of a corporation, composed of one representative for each of the ceding companies.

(3) True, the pool itself is not a reinsurer and does not issue any insurance policy: however, its work is indispensable, beneficial

85

and economically useful to the business of the ceding companies and Munich, because without it they would not have received their premiums. The ceding companies share “in the business ceded to the pool” and in the “expenses” according to a “Rules of Distribution” annexed to the Pool Agreement. Profit motive or business is, therefore, the primordial reason for the pool’s formation.

D. Kinds of Corporations1. Domestic

those created or organized in the Philippines or under its laws.2. Foreign

those created organized or existing under any laws other than those of the Philippines, and they are either:

a. Resident those foreign corporation engaged in trade or business within the

Philippinesb. Non-resident

those foreign corporation not engaged in trade or business within the Philippines

“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)

E. Rules Applicable To Passive Income1. Tax Sparing Rule - 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%.

Note: 1. 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.

2. The 15% reduced tax must actually be paid and the 17% must be deemed paid tax.

3. 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)

a. CIR vs. Procter and Gamble PMC (160 SCRA 560 and 204 SCRA 377)

Procter and Gamble (Phil.) is a domestic corporation and a wholly-owned subsidiary of Procter and Gamble (USA), a non-resident foreign corporation. Over a number of years, PCMC-

86

Phil. had paid income tax on its net income, and from the remaining net profits, dividends were declared. An income tax of 35% on the dividends were withheld by it and paid to the BIR.

It invoked the tax-sparing credit provision of the NIRC, filed a claim for refund of the 20% point portion of the 35% point whole tax paid. The CTA ordered the refund. The SC ruled that the preferential 15% tax is inapplicable to the case because of the failure of the claimant to :

(1)show the actual amount credited by the US Government;

(2)present the US income tax returns of PCMC-USA, the parent company;

(3)submit a duly authenticated document evidencing the tax credit of the 20% differential.

However, this case was reversed by the Supreme Court in an en banc resolution (204 SCRA 377; Dec. 2, 1991) and ruled on the applicability of the preferential 15% tax because it was established that the NIRC does not require that the US tax law deems the parent company to have paid the 20% of tax waived by the Philippines. The NIRC only requires that the US shall allow PCMC-USA “deemed paid” tax credit equivalent to 20%.

F. Taxes on Corporations1) 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

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.

87

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.

Specific Taxes 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 GNPb. a ratio of 40% of income tax collection to total tax revenuesc. a VAT effort of 4% of GNP andd. a 0.9% ratio of the Consolidated Public Sector Final Position

(CPSFP) to Gross National Product (GNP)

Note: 1. 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%).

2. 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 “Gross Income” derived from business shall be equivalent to gross

sales returns, discounts and allowance and cost of goods. “Cost of goods sold” shall include all business expenses directly

incurred to produce the merchandize to bring them to their present location and use.

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.

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.

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:

88

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)

Corporations not subject to MCITi. Proprietary Educational Institution if enjoys preferential tax rateii. Non-profit hospitalsiii. Depository banks under expended FCDUiv. International carriersv. Offshore Banking Unitsvi. ROHQs of resident foreign corp.vii. Other corporations not subject to the normal tax rate

(4.) Final tax on certain Passive Income- refer to previous note

2) Tax on Foreign Corporations (sec. 28 of NIRC)(a.) Resident Foreign Corporation Engaged in Trade or

business in the Phils. (RFC) - Foreign Corporations 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.

Note: A different tax rate is imposed on the following RFCs(a.) Int’l carrier - 2 ½% on Gross Philippine Billing

89

o 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.

o Note: For a flight w/c originates from the Phils. but transhipment 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 transhipment shall form part of the GPB.

o 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.

British Overseas Airways Corp. vs. CIR (149 SCRA 395)- an international airline with no landing rights is

considered doing business in the Philippines- Reasons: a) Series of sale of transport documents (airline

tickets)b) Continuity of commercial transactionsc) Appointment of an agent is an indication that it is doing business in the Philippines- Note: This BOAC doctrine is modified by RR 15-2002 insofar as the Tax Situs of transport documents is concerned. RR 15-2002 provides that the sale of transport documents is the origin of the passenger, cargo, or excess baggage, irrespective of place of sale and place of payment thereof

(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.

(b.) 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).Note: NRFCs are not entitled to deduction as well as exemption (personal and additional exemption)

IMPROPERLY ACCUMULATED EARNINGS TAX (IAET) (Sec. 29 NIRC)

90

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 tax2) Income excluded from gross income3) Income subject to final tax4) The amount of NOLCO deducted and reduced by the sum of:

a) Dividends actually or constructively paid andb) Income tax paid for the Taxable year.

Formula: Taxable incomeAdd: Income exempt from tax

Income subject to final tax Income excluded from gross income

Amount of NOLCO deductedLess: Dividends actually or constructively 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 intermediaries2) Publicly held corporations3) 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 business2) It is invested in addition to plant property and equipment

reasonably by the business3) 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.

a. Cyanamid Phils. vs. CA (January 20, 2000)If the CIR determined that the Corporation avoided the tax

on shareholders by permitting earnings or profits to accumulate, and the taxpayers contested such a determination, the burden of

91

proving the determination wrong, together with the corresponding burden of first going forward with evidence, is on the taxpayer. This applies even if the corporation is not a mere holding or investment company and does not have an unreasonable accumulation of earnings or profits.

In order to determine whether profits are accumulated for the reasonable needs of the business to avoid the surtax upon shareholders, it must be shown that the controlling intention of the taxpayer is manifested at the time of accumulation, not intentions declared subsequently, which are mere afterthoughts. Also, the accumulated profits must be used within a reasonable time after the close of the taxable year. Petitioner did not establish, by clear and convincing evidence that such accumulation of profit was for the immediate needs of the business.

In 1981, the working capital of Cyanamid was more than twice its current liabilities, projecting adequacy in working capital. Available income covered expenses or indebtedness for that year, and there appeared no reason to expect an impending 'working capital deficit' which could have necessitated an increase in working capital, as rationalized by petitioner.

Furthermore, Under Section 25 of the 1977 NIRC, as amended, the following corporations exempt from the imposition of improperly accumulated tax: (a) banks; (b) non-bank financial intermediaries; (c) insurance companies; and (d) corporations organized primarily and authorized by the Central Bank of the Philippines to hold shares of stocks of banks. Petitioner does not fall among those exempt classes.

G. Exempt Organizations and Corporations (Sec. 30 of NIRC)The following shall not be taxed in respect to income received by them:

1. Labor, agricultural or horticultural organization not organized principally for profit.

2. 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.

3. 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.

4. Cemetery company owned and operated for the exclusive benefits of its member

5. 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

6. 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

7. Civic league or association not organized for profit but operated exclusively for the promotion of social welfare

8. A non-stock and non-profit educational institution. “All revenues and assets of non-stock, non-profit educational institutions used actually, directly, and exclusively for educational purposes shall be exempt taxes and duties.” [Article XIV Section 4(3), 1987 Constitution.]

9. Farmers’ fruit growers or like organization organized and operated as sales agent for the purpose of marketing the products of its member.

92

10. 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.

11. 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.

H. Tax Returns And Other Administrative Requirements

i. Who are required to filea. Corporation subject to tax having existed during the taxable

year, whether with income or not b. Corporation in the process of liquidation or receivershipc. Insurance company doing business in the Philippines or deriving

income thereind. Foreign corporation having income from within the Philippinese. Those exempt from income tax under Section 30 of the NIRC but

has not shown proof of exemption

ii. What and when to fileQuarterly returns on the first three quarters to be filed within 60

days after the close of the quarter basis and the final or adjusted return on the 15th day of the fourth month following g the close of the fiscal or calendar year.

iii. When to payPay as you file system. The tax subject of the return should be

paid within same time the return is filed.

93

94

Rates and Tax base on Corporate Taxpayers in General Taxpayers

95

Taxes Imposed (Tax Rates and Tax Base)Domestic Corp. RFC NRFC

Net income Net Income Gross Income

1.) Normal Corporate Income Tax (NCIT)

32% (Jan. 1, 2000) 32% 32%

2.) Minimum Corporate Income Tax (MCIT) 2% 2%

3.) Branch Remittance Tax 15%4.) Improperly Accumulated Earning

Tax (IAET) 10% 10% 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 Unitse. Capital gains from sale of real

property situated in the Phils. (capital assets)

20%7.5%20%

5%Exempt (RA 9294)

10%

6%

20%7.5%20%

5%Exempt (RA

9294)

10%

exempt

5%Exempt

(RA 9294)

f. Interest on foreign loan 10% 10% 20%g. Intercorporate dividends exempt exempt 15%