UP 2008 Taxation Law (Taxation 1)

NIVERSITY OF THE PHILIPPINES

COLLEGE OF LAW

Bar Operations 2008

TAXATION LAW

Bar Operations Head � Arianne Reyes

Academics Head � Henry Aguda

Ryan Balisacan

Subject Head � Erwin Matib

Subject Committee � Ryan Romero, Diane Rosacia, Aimee Salamat, Maricon

Maralit, Kate Modesto

Information Management �

Committee

Chino Baybay [Head] * Simoun Salinas [Deputy] * Rania Joya

[Design & Lay-out] * Ludee Pulido [Documentations] * Linus

Madamba * Des Mayoralgo * Jillian De Dumo * Mike

Ocampo * Abel Maglanque * Edan Marri R. Cañete

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BASIC CONCEPTS TAXATION

Taxation Law 1Taxation Law 1Taxation Law 1Taxation Law 1

TABLE OF CONTENTSTABLE OF CONTENTSTABLE OF CONTENTSTABLE OF CONTENTS

I.I.I.I. Basic Concepts in Income Taxation 3

II.II.II.II. General Classification of TaxpayersGeneral Classification of TaxpayersGeneral Classification of TaxpayersGeneral Classification of Taxpayers 4444

III.III.III.III. Tax on IndividualsTax on IndividualsTax on IndividualsTax on Individuals 5555

IV.IV.IV.IV. Tax on CorporationsTax on CorporationsTax on CorporationsTax on Corporations 11111111

V.V.V.V. Taxation of Fringe BenefitsTaxation of Fringe BenefitsTaxation of Fringe BenefitsTaxation of Fringe Benefits 22221111

VI.VI.VI.VI. TTTTaxation on Partnershipsaxation on Partnershipsaxation on Partnershipsaxation on Partnerships 22223333

VII.VII.VII.VII. Taxation on Estates and TrustsTaxation on Estates and TrustsTaxation on Estates and TrustsTaxation on Estates and Trusts 22224444

VIII.VIII.VIII.VIII. Source of IncomeSource of IncomeSource of IncomeSource of Income 22225555

IX.IX.IX.IX. Gross IncomeGross IncomeGross IncomeGross Income 22228888

X.X.X.X. Exclusions from Gross IncomeExclusions from Gross IncomeExclusions from Gross IncomeExclusions from Gross Income 33330000

XI.XI.XI.XI. Allowable deductions from Gross IncomeAllowable deductions from Gross IncomeAllowable deductions from Gross IncomeAllowable deductions from Gross Income 33332222

XII.XII.XII.XII. NonNonNonNon----deductible expensesdeductible expensesdeductible expensesdeductible expenses 55552222

XIII.XIII.XIII.XIII. Capital GainCapital GainCapital GainCapital Gains and Lossess and Lossess and Lossess and Losses 55552222

XIV.XIV.XIV.XIV. Situs of TaxationSitus of TaxationSitus of TaxationSitus of Taxation 55555555

XV.XV.XV.XV. Installment BasisInstallment BasisInstallment BasisInstallment Basis 55556666

XVI.XVI.XVI.XVI. Returns and Payments of Tax/Withholding TaxesReturns and Payments of Tax/Withholding TaxesReturns and Payments of Tax/Withholding TaxesReturns and Payments of Tax/Withholding Taxes 55557777


TAXATION LAW 1

I.I.I.I. BASIC CONCEPTS IN INCOME BASIC CONCEPTS IN INCOME BASIC CONCEPTS IN INCOME BASIC CONCEPTS IN INCOME

TAXATIONTAXATIONTAXATIONTAXATION Income Tax – defined as a tax on all yearly

profits arising from property, professions, trades or offices.

– a tax on the net income or the entire income realized in one taxable year.

Nature of income tax (PED) • DIRECT TAX – the tax burden is borne by

the income recipient upon whom the tax is imposed.

• PROGRESSIVE TAX – the tax base increases as the tax rate increases.

• EXCISE TAX (privilege tax) – a tax on the right to earn income

Purpose(s) of Income Tax: Fiscal/Non-Fiscal (ROM) § raise revenue to defray the expenses of the

government; § offset regressive sales and consumption

taxes; and § together with estate tax, mitigate the evils

arising from the inequalities of wealth by a progressive scheme of taxation which places the burden on those best able to pay.

Income – all wealth which flows to the taxpayer other than a mere return of capital • It is an amount of money coming to a

person/corporation within a specified time, whether as payment for services, interest or profit from investment. Unless otherwise specified, it means cash or its equivalent. Income can also be thought of as a flow of the fruits of one's labor. (Conwi v. Court of Tax Appeals)

• Income includes earnings, lawfully or unlawfully acquired, without consensual recognition, express or implied, of an obligation to repay and without restriction as their disposition.

Differentiated from Capital o Capital is a fund; income is a flow. A fund of

property existing at an instant of time is called capital. A flow of services rendered by that capital by the payment of money from it or any other benefit rendered by a fund of capital in relation to such fund through a period of time is called income.

o Capital is wealth, while income is the service of wealth. The Supreme Court of Georgia expresses the thought in the following figurative language: "The fact is that property is a tree, income is the fruit; labor is a tree, income the fruit; capital is a tree, income the fruit." A tax on income is not a tax on property. "Income," as here used, can be defined as "profits or gains." (Madrigal v. Rafferty)

è Increase in Property Value – A mere

increase in the value of property is NOT INCOME, but merely unrealized increase in capital. The increase in the value of

property is also known as appraisal surplus or revaluation increment.

Classification of Income According to Source 1. Income from sources within the Philippines 2. Income from sources without the Philippines 3. Income from sources partly within and

partly without the Philippines Taxability of Income, Requisites

a. there is income, gain or profit b. the income, gain or profit is received or

realized during the taxable year c. the income gain or profit is not exempt from

income tax

Tests to Determine Realization of Income for Tax Purposes • Realization Test – no taxable income until

there is a separation from capital of something of exchangeable value, thereby supplying the realization or transmutation which would result in the receipt of income.

• Claim of right doctrine – a taxable gain is conditioned upon the presence of a claim of right to the alleged gain and the absence of a definite unconditional obligation to return or repay that which would otherwise constitute a gain. § Principle of Constructive Receipt of Income àààà Income which is credited to the account of or set apart for a taxpayer and which may be drawn upon by him at any time is subject to tax for the year during which so credited or set apart, although not then actually reduced to possession. The income must be credited to the taxpayer without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made.

• Economic benefit test – any economic benefit to the employee that increases his net worth is taxable.

Classifications of Income Subject to Philippine Income Tax 1. Compensation Income –derived from

rendering of services under an employer-employee relationship.

2. Professional Income – fees derived from engaging in an endeavor requiring special training as professional as a means of livelihood (e.g. the fees of CPAs, doctors, lawyers, engineers)

3. Business Income – gains or profits derived from rendering services, selling merchandise, manufacturing products, farming and long-term construction contracts

4. Passive Income – income in which the taxpayer merely waits for the amount to come in (e.g. interest income, royalty income, dividend income, winnings and prizes)

5. Capital Gain – gain from dealings in capital assets


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II. GENERAL CLASSIFICATION OF TAXPAYERSII. GENERAL CLASSIFICATION OF TAXPAYERSII. GENERAL CLASSIFICATION OF TAXPAYERSII. GENERAL CLASSIFICATION OF TAXPAYERS

Who is a taxpayer? Under Sec 22(N), a taxpayer is any person subject to [income] tax. Income taxpayers, with distinction based on the amount of income subject to tax, or the applicable tax rates, or both, are classified as follows:

Primary

Classification Sub-Classification(s)

Individuals

Citizens of the Philippines

Residents of the Philippines

Not Residents of the Philippines

Aliens

Residents of the Philippines

Not Residents of the Philippines

Engaged in Trade or Business in the Philippines

Not Engaged in Trade or Business in the Philippines

Special Classes of Individuals

Individual Employed by Regional or Area Headquarters and Regional Operating Headquarters of Multinational Companies

Individual Employed by Offshore Banking Units

Individual Employed by a foreign service contractor or by a foreign service subcontractor engaged in petroleum operations in the Philippines

Estates and Trusts

Corporations

Domestic Corporations

Foreign Corporations

Resident Corporations

Non-resident Corporations

Special Classes of Corporations

Proprietary educational institutions and non-profit hospitals

Domestic Depositary Bank (Foreign Currency Deposit Units)

Resident international carriers

Offshore Banking Units

Resident Depositary Bank (Foreign Currency Deposit Units)

Regional or Area Headquarters and Regional Operating Headquarters of Multinational Companies

Non-resident cinematographic film owners, lessors or distributors

Non-resident owners or lessors of vessels chartered by Philippine nationals

Non-resident lessors of aircraft, machinery and other equipment


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III. TAX ON INDIVIDUALSIII. TAX ON INDIVIDUALSIII. TAX ON INDIVIDUALSIII. TAX ON INDIVIDUALS A. Classifications of Individual Taxpayers

1. Citizens RESIDENT – a citizen is deemed as a resident of the Philippines unless he qualifies as a non-resident under Sec. 22E of the NIRC; -taxable for income derived from all sources based on taxable (i.e., net) income

NON-RESIDENT – a citizen of the Philippines who: (1) establishes to the satisfaction of the

Commissioner the fact of his physical

presence abroad with a definite intention to

reside therein. (2) Leaves the Philippines during the taxable

year to reside abroad, either as an immigrant or for employment on a

permanent basis. (3) Works and derives income from abroad and

whose employment thereat requires him to

be physically present abroad most of the

time during the taxable year. (4) Has been previously considered as

nonresident citizen and who arrives in the

Philippines at any time during the taxable

year to reside permanently in the Philippines shall likewise be treated as a non-resident citizen for the taxable year in which he arrives in the Philippines with respect to his income derived from sources abroad UNTIL the date of his arrival in the Philippines.

– taxable for income derived within the Philippines based on taxable (i.e., net) income

NOTES: An OVERSEAS CONTRACT WORKER is taxable only on income from sources within the Philippines. (Sec. 23 (c)) o NOTE FURTHER: A seaman who is a

Filipino citizen and who receives compensation for services rendered abroad as member of the complement of a vessel engaged exclusively in international trade is treated as an overseas contract worker.

• Length of stay is indicative of intention. A citizen of the Philippines who shall have stayed outside the Philippines for 183 days or more by the end of the year is a non-resident citizen. His presence abroad, however, need not be continuous. [RR1-79]

2. Alien RESIDENT – residence is within the Philippines and who is not a citizen thereof. An alien actually present in the Philippines who is not a mere transient or sojourner is a resident of the Philippines for income tax purposes. A mere floating intention, indefinite as to time, to return to another country is not sufficient to constitute him a transient. – taxable for income derived within the Philippines based on taxable (i.e., net)

income NON-RESIDENT – residence is NOT in the Philippines and who is not a citizen thereof.

§ Engaged in trade or business in the Philippines (NRAETB) - is taxable for income derived within the Philippines based on taxable (i.e., net) income

§ Engaged in trade or business in the Philippines (NRANETB) - is taxable for income derived within the Philippines based on gross income1

NOTES: What makes an alien a resident or non-resident alien is his intention with regard to the length and nature of his stay. Thus: a. One who comes to the Philippines for a

definite purpose which in its very nature may be promptly accomplished is not a resident citizen.

b. One who comes to the Philippines for a definite purpose which in its very nature would require an extended stay, and to that end, makes his home temporarily in the Philippines, becomes a resident, though it may be his intention at all times to return to his domicile abroad when the purpose for which he came has been consummated or abandoned. (Sec. 5, RR 2)

• Length of stay is indicative of intention. An alien who shall have stayed in the Philippines for more than one year by the end of the taxable year is a resident alien. NOTE FURTHER: An alien who shall come to the Philippines and stay for an aggregate period of more than one hundred eighty days during a calendar year shall be considered a non-resident alien in

business, or in the practice of profession, in the Philippines. [Sec. 25(A)(1)] Thus, if an alien stays in the Philippines for 180 days or less during the calendar year, he shall be deemed a non-resident alien not doing business in the Philippines, regardless of whether he owns 1. Stock in trade of the taxpayer, or other

property of a kind which would properly be included in an inventory of a taxpayer if on hand at the end of the taxable year (example: Raw Materials Inventory, Work in Process Inventory, Office Supplies Inventory)

2. Property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business (example: Merchandise Inventory)

3. Property used in the trade or business which is subject to the allowance for depreciation (example: Office Equipment) § actually engages in trade or business

therein. (Mamalateo) B. Three Kinds of Income

Capital Gains subject to Capital Gains Tax When the asset sold was held as a capital asset, the gain or loss is called a capital gain or loss. When the asset sold was not held as a capital

1 Notwithstanding the general classification of aliens into resident and non-resident for income tax purposes, note that there is a special classification of aliens who are taxed differently. See subsection D.


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asset (in other words, as an ordinary asset), the gain or loss is called an ordinary gain or loss. What are capital assets? àààà those not

considered as ordinary assets! What are ordinary assets? àààà FOUR

CATEGORIES OF ORDINARY ASSETS are as follows [Sec. 39]: (RIDS)Real property used in trade or business of the taxpayer (example: Building used as a factory) -Are all sales / dispositions of capital assets subject to capital gains tax? à NO! Only two kinds of things held as capital assets are subject to the capital gains tax, as follows: 1. On sale, barter, exchange or other

disposition of shares of stock of a domestic corporation not listed and traded through a local stock exchange, held as a capital asset:

On the net capital gain: Not over P100,000 = Final Tax of 5% On any amount in excess of P100,000 = plus Final Tax of 10% on the excess Key definitions

Net capital gain à selling price less cost Selling price à consideration on the sale OR

fair market value of the shares of stock at the time of the sale, whichever is HIGHER

Cost à original purchase price

2. On sale, exchange, or other disposition of real property in the Philippines, held as a capital asset à On the gross selling price, or the current fair market value at the time of the sale, whichever is higher, a final tax of 6%

-The capital gains tax is applied on the gross

selling price, or the current fair market value at the time of the sale, whichever is higher. Any gain or loss on the sale is immaterial because there is a conclusive presumption by law that the sale resulted in a gain.

EXCEPTION: When sale of residence is not liable for capital gains tax?

a. There is a sale or disposition of their

principal residence by natural persons. b. The proceeds of the sale are fully

utilized in acquiring or constructing a new principal residence within 18 calendar months from the date of sale or disposition.

The Commissioner shall have been duly notified by the taxpayer within 30 days from the date of sale or disposition through a prescribed return of his intention to avail of the tax exemption.

A deposit is made of the 6% capital gain tax otherwise due, in cash or manager’s check, in an interest-bearing account with an Authorized Agent Bank (AAB), under an Escrow Agreement between the taxpayer and the Bureau of Internal Revenue that the same shall be released to the taxpayer when the proceeds of the sale shall have been utilized as intended. The tax exemption can only be availed of once every 10 years

è If there is no full utilization of the proceeds of 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 (CGT). The GSP or FMV at the time of sale, whichever is higher, shall be multiplied by a fraction which the unutilized amount bears to the gross selling price in order to determine the taxable portion.

i.e., Unutilized amount x (higher of ) = Taxable GSP GSP or FMV portion

ALTERNATIVE TAXATION: In case of a sale or other disposition of real property to the government or any of its political subdivisions or agencies or to government-owned or controlled corporations, the tax shall be EITHER the year-end tax of the individual (i.e., capital gain to be included in the computation of income subject to schedular rates),

OR the capital gain tax of 6%, at the option of the taxpayer

• What is the tax implication of a sale

/ disposition of a capital asset NOT subject to capital gains tax? àààà The net capital gain or loss is included in the computation of net income subject to schedular rates (5% to 32%).

3. Passive Income subject to Final Tax

“Final tax” means tax withheld from source, and the amount received by the income earner is net of the tax already. The tax withheld by the income payor is remitted by him to the BIR. The income having been tax-paid already, it need not be included in the income tax return at the end of the year. These passive income items are as follows:

Interest Income: o on any currency bank deposit, yield or

any other monetary benefit from deposit substitutes, trust funds and similar arrangements - 20% final tax

o under the expanded foreign currency deposit system (EFCDS) - 7.5% final tax for residents, exempt if non-residents

o on long-term deposit or investment certificates (LTDIC) in banks (e.g., savings, common or individual trust funds, deposit substitutes, investment


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management accounts and other investments, which have maturity of 5 years or more) – exempt Ø Should LTDIC holder pre-terminate

LTDIC before the 5th year, a final tax shall be imposed on the entire income based on the remaining maturity:

4 years to less than 5 years 5%

3 years to less than 4 years 12%

less than 3 years 20%

Dividends

o cash and/or property dividends2 actually or constructively received by an individual from

§ a domestic corporation § a joint stock company § insurance or mutual fund

companies § regional operating headquarters

of multinational companies o share of an individual in the

distributable net income after tax of a partnership (except a general professional partnership) of which he is a partner

o share of an individual member or co-venturer in the net income after tax of an association, a joint account, or a joint venture or consortium taxable as a corporation

è Rate – 10% for residents (RC, RA) and non-resident citizens (NRC),

20% for NRAETB (non-resident aliens engaged in trade or business)

Royalties o From books, literary works, and

musical compositions – 10% o Other royalties – 20%

Winnings, except Philippine Charity sweepstakes / lotto winnings – 20%

Prizes exceeding P10,000 – 20%

o Prize, differentiated from winnings à A prize is the result of an effort made (e.g., prize in a beauty contest), while winnings are the result of a transaction where the outcome depends upon chance (e.g., betting).

2 A stock dividend representing the transfer of surplus to capital account shall not be subject to tax. However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent that it represents a distribution of earnings or profits. (Sec. 73B, NIRC) [In other words, stock dividends are generally not subject to tax as long as there are no options in lieu of the shares of stock. On the other hand, a stock dividend constitutes income if it gives the shareholder an interest different from that which his former stockholdings represented.]

4. “Other Income” subject to Schedular Tax Rates3 Income which is neither capital gain with capital gain tax, nor passive income with final tax, is “other income” or residual income. It may be derived from:

1. Employer-employee relationship, which is called compensation income

2. Business or profession 3. Sale or exchange of property which

is not subject to the capital gain tax 4. Incidental sources, such as interest

or dividend, which is not subject to final tax (i.e., dividend from a foreign corporation in case of resident citizens, rent income). Ø The tax rates on NET ordinary

or other income (schedular rates)4 are as follows:

Income over

But less than

Tax Plus of Excess over

10,000 5%

10,000 30,000 500 10% 10,000

30,000 70,000 2,500 15% 30,000

70,000 140,000 8,500 20% 70,000

140,000 250,000 22,500 25% 140,000

250,000 500,000 50,000 30% 250,000

500,000 125,000 32% 500,000

Rule for Married Individuals àààà Married individuals, whether citizens, resident or nonresident aliens, who do not derive income purely from compensation, shall file a return for the taxable year to include the income of both spouses. [Sec 51(D)]

1. Compute the income tax separately on their respective incomes.

2. Add the two taxes to arrive at a single income tax still due and refundable.

3. Income which is clearly joint, or which cannot be identified as exclusively of one spouse, will be divided equally. [Sec 24(A)] o EXCEPTION to the one-return rule:

Where it is impracticable for the spouses to file one return, each spouse may file a separate return of income but the returns so filed shall be consolidated by the Bureau for purposes of verification for the taxable year. [Sec 51(D)]

3 Schedular tax rates apply to all classes of individuals, with the exception of non-resident aliens not engaged in trade or business. Should NRANETB earn “other income,” such is subject to a 25% final tax. 4 Pro-forma computation of income subject to schedular tax rates: Gross Compensation Income P xxx Less: Personal Exemptions (xxx) Health Insurance (xxx) Net Compensation Income P xxx Add: Net Business Income xxx Net Professional Income xxx Other Income (capital gains, rent, etc.) xxx Net Income subject to schedular tax rates P xxx where Net Business Income and Net Professional Income are computed as follows:

Gross Business / Professional Income P xxx Less: Itemized Deductions [OR] Optional Standard Deduction (xxx) Net Business / Professional Income P xxx


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B. Deductions [from Income Subject to Schedular Tax Rates], In General

The allowable deductions from the gross income of an individual taxpayer5 are as follows:

Business Expenses and Expenses from Practice of Profession – deductible only from business gross income and professional income, respectively but not from compensation income.6 The expenses to be deducted may either be itemized deductions OR the optional standard deduction.7

Special deduction for actual premium payments for health and/or

hospitalization insurance taken by an individual taxpayer provided that the following requisites are met:

a. The taxpayer’s family gross income does not exceed P250,000 in a taxable year.

b. The amount deductible should only be limited to P2,400 per family or P200 per month.

è In the case of married taxpayers, only the spouse claiming the additional exemption for dependents shall be entitled to this deduction.

Personal Exemptions – are arbitrary amounts allowed by law to be deducted from income to cover personal, living, or family expenses of the taxpayer. These deductions are allowed on the theory that the minimum requirements of subsistence of a taxpayer should be free from tax.

Kinds: 1. Basic Personal Exemptions

Kind of Taxpayer Basic Personal Exemption (BPE)

Single individuals (includes widow/er)

P20,000

Married individual who are § judicially decreed as

legally separated, and

§ with no qualified dependents

P20,000

Head of Family P25,000

Each married individual * P32,000

* BUT note Sec 35(A) - In the case of married individuals where only one of the spouses is deriving gross income, only such spouse shall be allowed the personal exemption.

5 Remember that non-resident aliens not engaged in trade or business are taxed on gross income. They may not, therefore, avail of these deductions. 6 Thus, the only deductions that may be claimed by individuals with compensation income only are personal exemptions and premium payments on health and/or hospitalization insurance. 7 See Allowable Deductions from Gross Income for the detailed discussion on itemized deductions and the optional standard deduction.

Who is a Head of the Family? [Sec 35(A), NIRC]

1. An unmarried or legally separated man or woman with dependents who may be

- one or both parents - one or more brothers or sisters, or

- one or more legitimate, illegitimate or legally adopted children

Note: Senior Citizen Law (RA 7434 as amended by 9257) provides in section 4 that senior citizens shall be treated as dependents provided for in the NIRC, as amended and as such, individual taxpayers caring for them, be they be relatives or not shall be accorded the privileges granted by the Code insofar as having dependents are concerned.

2. Such dependent must be living with AND

dependent upon him for chief support

- Chief support – principal or main support given regularly such that withdrawal will result in destitute life for dependent; includes situations where taxpayer is away from home on business, or dependent is away at school

→ more than one-half of the

requirements for support. Hence, if two children contribute equal amounts to the support of a parent, neither of them qualify as head of the family.

3. Such brothers or sisters or children are

→ not more than 21 years old → unmarried and → not gainfully employed

OR → regardless of age, are incapable of

self-support because of mental or physical defect.

2. Additional Exemptions (AE) – depends on the number of qualified dependent children - Amount allowed as a deduction àààà P8,000 per dependent child, but not to exceed four children - Who may claim additional exemptions?

Married Individuals à Additional exemptions are claimed by only one spouse. Generally, the spouse who is the gross compensation earner is the claimant of the additional exemptions. Where the husband and wife are both compensation income earners, the husband is the proper claimant of the additional exemptions EXCEPT if there is an express waiver by the husband in favor of his wife, as embodied in the withholding exemption certificate. When the spouses have business and/or professional income only, either may claim the additional exemptions at the end of the year. The wife claims the additional exemptions in the following instances: i. husband has no income ii. husband works abroad iii. Legally separated spouses à Additional exemptions can be claimed by the spouse with custody of the child or children (but the total amount for the spouses shall not exceed the maximum of four). [Sec 35(B), NIRC]


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Who is a dependent for purposes of additional exemptions? àààà A legitimate, illegitimate or legally adopted child chiefly dependent upon and living with the taxpayer:

1. not more than 21 years old, unmarried and not gainfully employed OR 2. regardless of age, is incapable of self-support because of mental or physical defect NOTE: Only children may be considered “dependent” for purposes of additional exemptions.

Who may claim personal exemptions? à Citizens (whether resident or non-resident) and resident aliens are allowed to avail of basic personal and additional exemptions. Non-resident aliens engaged in trade or business are entitled to basic personal exemptions only by way of reciprocity, but not to additional exemptions. [Sec. 35, NIRC] • Limit of BPE Allowed to NRAETB: An

amount equal to the exemptions allowed by the non-resident alien’s country to Filipino citizens not residing therein but deriving income therefrom, but not to exceed the amount fixed by NIRC.[In other words, whichever is LOWER]

Change of Status [Sec 35(C), NIRC]

1. If taxpayer marries during taxable year, taxpayer may claim the corresponding BPE in full for such year (i.e., no need to pro-rate the exemption).

2. If taxpayer should have additional dependent(s) during taxable year, taxpayer may claim corresponding AE in full for such year.

3. If taxpayer dies during taxable year, his estate may still claim BPE and AE for himself and his dependent(s) as if he died

at the close of such year.

4. If during the taxable year a. spouse dies or b. any of the dependents dies or marries,

turns 21 years old or becomes gainfully employed, taxpayer may still claim same exemptions as if the spouse or any of the dependents died, or married, turned 21 years old or became gainfully employed at the close of such year.

TIP: When it comes to change of status, the status beneficial to the taxpayer is used for purposes of claiming deductions as long as the taxpayer achieved such status at any time during the taxable period.

D. Special Classification of Individuals and Corresponding Tax Treatment [Sec 25(C), (D), (E)]

1. Alien individuals employed by: a. Regional or Area Headquarters

(RAHQ) and Regional Operating Headquarters (ROHQ) established in the Philippines by multinational companies o Multinational company, defined

à a foreign firm or entity engaged in international trade with affiliates or subsidiaries or branch offices in the Asia-Pacific Region and other foreign markets

b. Offshore Banking Units established in the Philippines

2. Alien individuals who are permanent

residents of a foreign country but who are employed and assigned in the

Philippines by a foreign service contractor

or by a foreign service subcontractor

engaged in petroleum operations in the Philippines

Ø Tax Rate and Base - 15% of gross

income received as salaries, wages, annuities, compensation, remuneration and other emoluments, such as honoraria and allowances o The same tax treatment shall apply

to Filipinos employed and occupying the same positions as those of aliens employed by these multinational companies, offshore banking units and petroleum service contractors and subcontractors.

Ø Note that the coverage of the special

classification (and the corresponding tax rate) is limited to income received as wages. Hence, any

income earned from all other sources

within the Philippines by the alien employees shall be subject to the

pertinent income tax (example: sale of real property in the Philippines is subject to 6% capital gain tax, imposed on the gross selling price or fair market value of the property at the time of the sale, whichever is higher).


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E. Summary of Tax Bases and Tax Rates QUICK GLANCE

CATEGORY OF INCOME

RESIDENT NON-RESIDENT

CITIZEN ALIEN CITIZEN NRAETB NRANET

B

All sources Within the Philippines

Within the Philippines



1. Compensation / Business / Profession

2. Prizes of P10,000 or less 3. Proprietary, Educational /

Hospital 4. Cinematographic Film and the

like

Based on Taxable (i.e, Net) Income

Schedular Income Tax Rates (Sec. 24, NIRC) (i.e, 5% to 32%)

GIW – 25%

Not Applicable

GIW - 25%

GIW – 25%

5. Interest from any currency bank deposit , etc., Royalties (other than from books, literary works and musical compositions), Winnings / Prizes (except prizes P10,000 and below)

GIW – 20% Final Withholding Tax

6. Royalties from books, literary works, musical compositions

GIW – 10% Final Withholding Tax

7. Interest from long-term deposit or investment certificates, which have a maturity of 5 years or more

EXEMPT; However: In case of pre-termination, with remaining

maturity of: 4 years to less than 5 years – 5% on entire

income 3 years to less than 4 years – 12% on entire

income less than 3 years – 20% on entire income

8. Cash / Property Dividends from a domestic corporation, etc., OR share in the distributable net income after tax of a partnership (except a general professional partnership), etc.

GIW – 10% Final Withholding Tax GIW – 20%

9. Interest (Expanded Foreign Currency Deposit System)

GIW – 7.5% Final Withholding Tax

EXEMPT

10. Winnings on Philippine Sweepstakes / Lotto

EXEMPT

11. Capital Gains on Sale of Shares (not traded in a domestic stock exchange)

Net Capital Gains within: Not Over P100,000 – 5% Final Tax

Amount in Excess of P100,000 – plus 10% Final Tax on the excess

12. Capital Gains on Sale of Real Property in the Philippines

Gross Selling Price or FMV, whichever is higher – 6% Final Tax

13. Sale of Shares (traded in a domestic stock exchange)

½ of 1% of the Selling Price (Stock Transaction Tax) Note: Stock Transaction Tax is not an income tax, but a

business (percentage) tax

Legend:

GIW – Gross Income within the Philippines FMV – Fair Market Value

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TAXATION LAW 1

IV. TAX ON CORPORATIONSIV. TAX ON CORPORATIONSIV. TAX ON CORPORATIONSIV. TAX ON CORPORATIONS

A. Coverage of the term “Corporation” [Sec 22(B)] àààà The term “corporation” includes partnerships, no matter how created or organized, joint-stock companies, joint accounts (cuentas en participacion), associations, or insurance companies It does NOT include:

1. general professional partnerships (partnerships formed by persons for the sole purpose of exercising their common profession, no part of the income of which is derived from engaging in any trade or business)

2. joint venture or consortium formed for the purpose of undertaking construction projects or engaging in petroleum, coal, geothermal and other energy operations pursuant to an operating consortium agreement under a service contract with the Government.8

B. Classification of Corporations General Types

1. Domestic Corporation (DC) - one created or organized in the Philippines or under its laws [Sec 22(C)]

2. Foreign Corporation (FC) – one that is not domestic [Sec 22(D)] • Resident Foreign Corporation (RFC)

- a foreign corporation engaged in trade or business within the Philippines [Sec 22(H)]9

• Non-resident foreign corporation (NRFC) - a foreign corporation not engaged in trade or business within the Philippines [Sec 22(I)]

Special Types

1. Proprietary educational institutions and non-profit hospitals

2. Domestic Depository Bank (Foreign Currency Deposit Units)

3. Offshore Banking Units 4. Resident Depository Bank (Foreign

Currency Deposit Units) 5. Resident international carrier 6. Non-resident owner or lessor of vessel 7. Non-resident cinematographic film owner,

lessor or distributor 8. Non-resident lessor of aircraft, machinery

and other equipment 9. Regional/Area Headquarters & Regional

Operating Headquarters of Multinational companies

8 In this case, the joint venture [as an entity] is not subject to income tax, but each member of the joint venture shall be taxable on his/its share in the net income of the corporation. On the other hand, a joint venture constituted for purposes other than (2) above is treated as a corporation and taxable as such. 9 The qualifier “resident” in the term “resident foreign corporation” should not be equated with the nationality of the corporation. In determining nationality, the “control test” is often invoked and applied, which considers corporate nationality by the nationality of its controlling shareholders or members. (Mamalateo, citing Winship v. Philippine Trust Co., 90 Phil 744) Thus, for income tax purposes, a domestic corporation may be formed or organized by foreigners (as long as three of them are residents of the Philippines as per the Corporation Code),provided that it is organized under the laws of the Philippines.

C. Scope of Taxation

QUICK GLANCE

Type of Corporation

Sources of Taxable Income

Allowed Business

Deductions?

Domestic Corporation (DC)

Within and without the Philippines

Yes

Resident Foreign Corporation (RFC)


Yes

Non-resident Foreign Corporation (NRFC)


No*

* - Ergo, non-resident foreign corporations are taxed on GROSS INCOME.

NOTE: A good example of a resident foreign

corporation is the Philippine branch of a foreign corporation duly licensed by the Securities and Exchange Commission. The Philippine branch is merely an extension of the foreign head office (i.e., non-resident foreign corporation); hence it does not have nor issue Philippine shares of stock. There is only one single entity to speak of. However, for income tax purposes, only the

income of the Philippine branch from sources

within the Philippines is subject to income tax, and the income of the Philippine branch as well as that of the foreign head office from sources outside the Philippines are exempt from Philippine income tax. - NOTE FURTHER: Marubeni Corporation v.

Commissioner (177 SCRA 500) clarified the single entity concept. à As a GENERAL RULE, the head office of a foreign corporation is the same juridical entity as its branch in the Philippines following the “single entity concept”. The income from sources within the Philippines of the foreign head office shall thus be taxable to the

Philippine branch. BUT when the head office of a foreign corporation independently and directly invested in a domestic corporation without the funds passing through its Philippine branch, the taxpayer with respect to the tax on the dividend income would be the non-resident foreign corporation itself and the dividend income shall be subject to the tax similarly imposed on non-resident foreign corporations.

D. Tax on Domestic Corporations

Domestic corporations are subject to any or some of the following: • Capital Gain Tax • Final Tax on Passive Income • Normal Tax [OR] Minimum Corporate

Income Tax (MCIT) [OR] Gross Income Tax (GIT)

• Improperly Accumulated Earnings Tax (IAET)

1. Capital Gains subject to Capital Gains Tax

a. On sale, barter, exchange or other disposition of shares of stock of a

domestic corporation not listed and


TAXATION LAW 1

traded through a local stock exchange, held as a capital asset:

On the net capital gain: Not over P100,000 Final Tax of 5%

On any amount in excess of P100,000 plus 10% Final tax on the excess

b. On the sale, exchange or disposition of

lands and/or buildings which are not actually used in the business of a corporation and are treated as capital assets à On the gross selling price, or the current fair market value at the time of the sale, whichever is higher, a final tax of 6%

Ø NOTE: Tax treatment is the same as that of individuals.

Ø The capital gains tax is applied on the gross selling price, or the current fair market value at the time of the sale, whichever is higher. Any gain or loss on the sale is immaterial because there is a conclusive presumption by law that the sale resulted in a gain.

2. Passive Income Subject to Final Tax

Interest Income: o on any currency bank deposit, yield or

any other monetary benefit from deposit substitutes, trust funds and similar arrangements - 20%

o under the expanded foreign currency deposit system (EFCDS) - 7.5%

Dividends received from another domestic corporation (Intercompany Dividend) - EXEMPT

Royalties (any kind) – 20%

3. Income subject to Normal Tax [OR] Minimum Corporate Income Tax (MCIT) [OR] Gross Income Tax (GIT) NORMAL CORPORATE INCOME TAX RATE àààà 35% of net taxable income

Gross Income – Allowable Deductions = Taxable Income

MINIMUM CORPORATE INCOME TAX (MCIT) àààà 2% of MCIT Gross Income

Gross Sales – Sales Returns – Sales Returns & Allowances – Cost of Goods Sold = MCIT GI

What is cost of goods sold? It includes all business expenses DIRECTLY incurred to produce the merchandise to bring them to their present location and use. [Sec. 27(E)(4)]

è MCIT gross income differentiated from the

normal tax gross income à the latter would include other incidental income items, such as rent income, interest, gain on sale of assets, certain tax refunds, etc.

When is the MCIT computed? à beginning of the fourth taxable year immediately

following the year in which such corporation commenced its business operations

What amount of income tax is paid by the corporation to the BIR? à Whichever is HIGHER between the normal tax and the minimum corporate income tax.

ILLUSTRATION: E Co., a domestic trading corporation, in its fourth year of operations had a gross profit from sales of P300,000 and net taxable income of P100,000. How much was the income tax paid by the corporation for the year?

MCIT (P300,000 x 2%) P6,000

Normal income tax

(P100,000 x 35%) P35,000

Income Tax to be paid for the year

(whichever is higher) P35,000

Excess MCIT carry-forward

Any excess of the minimum corporate income tax over the normal income tax shall be carried forward and credited against the NORMAL TAX for the three (3) immediately succeeding taxable years. [Sec. 27(E)(2)] In the year to which carried forward, the normal tax should be higher than the MCIT.

ILLUSTRATION: A domestic corporation had the following data on computations of the normal tax (NT) and the minimum corporate income tax (MCIT) for five years.

Yr 4 Yr 5 Yr 6 Yr 7 Yr 8

MCIT 80,000 50,000 30,000 40,000 35,000

NT 20,000 30,000 40,000 20,000 70,000

The excess MCIT over NT carry-forward is shown below:

Year 4 Year 5 Year 6 Year 7 Year 8

MCIT 80,000 50,000 30,000 40,000 35,000

NT 20,000 30,000 40,000 20,000 70,000

↓ ↓

NT is higher

40,000 70,000

Less: MCIT carry-fwd

(40,000)

(20,000)

(20,000)

From Year 4

From Year 5

From Year 7

Tax Due

80,000 50,000 - 40,000 30,000

-Arrow pointing downward means that the normal tax is higher so that there can be an excess MCIT carry-forward against it.

> >

>


TAXATION LAW 1

-While only P40,000 out of P60,000 excess MCIT in Year 4 was used in Year 6, the unused P20,000 cannot be used in Year 8 because Year 8 was beyond three years from Year 4.

Relief from MCIT (LLBM) à The Secretary of Finance is authorized to suspend the imposition of the minimum corporate income tax on any corporation which suffers LOSSES:

-on account of prolonged labor dispute (losses from a strike staged by employees that lasts for more than 6 months and caused the temporary shutdown of operations), or -because of force majeure (acts of God and other calamity; includes armed conflicts like war or insurgency), or -because of legitimate business reverses (substantial losses due to fire, robbery, theft or other economic reasons).

GROSS INCOME TAX (GIT) àààà The President, upon the recommendation of the Secretary of Finance, may allow domestic corporations the option to be taxed at fifteen percent (15%) of gross income, after the following conditions have been satisfied:

Tax effort ratio 20% of GNP

Ratio of IT collection to total tax revenue

40%

VAT tax effort 4% of GNP

Ratio of Consolidated Public Sector Financial Position (CPSFP) to GNP

0.90%

Ratio of the Corporation’s Cost of Sales to Gross Sales

Does not exceed 55%

Gross Sales – Sales Returns – Sales Returns &

Allowances – Cost of Goods Sold = GI

The election of the gross income tax option by the corporation shall be irrevocable for three (3) consecutive taxable years during which the corporation is qualified under the scheme.

• [Sec. 27(A)] 4. Improperly Accumulated Earnings Tax (IAET) [Sec. 29, as implemented by RR 2-2001 which prescribes rules governing the imposition of IAET]

a) Rule àààà There is imposed for each taxable

year, in addition to other taxes, a tax equal to 10% of the improperly accumulated taxable income of domestic and closely-held corporations formed or availed of for the purpose of avoiding the income tax with respect to its shareholders or the shareholders of any other corporation, by

permitting the earnings and profits of the

corporation to accumulate instead of dividing

them among or distributing them to the shareholders.

b) Rationale à It is a tax in the nature of a

PENALTY to the corporation for the improper accumulation of its earnings, and a DETERRENT to the avoidance of tax upon shareholders who are supposed to pay dividends tax on the earnings distributed to them.

c) Exception àààà The use of undistributed earnings and profits for the reasonable needs of the business would not generally make the accumulated or undistributed earnings subject to the tax. What is meant by “reasonable needs of the business” is determined by the IMMEDIACY TEST. Ø Immediacy Test - It states that the

“reasonable needs of the business” are the 1) immediate needs of the business;

and 2) reasonably anticipated needs.

Ø How to prove the “reasonable needs

of the business” à The corporation should prove that there is 1) an immediate need for the

accumulation of the earnings and profits; or

2) a direct correlation of anticipated needs to such accumulation of profits.

d) Composition: The following constitute accumulation of earnings for the reasonable needs of the business: (ILL ABE)

1) ALLOWANCE for the increase in the

accumulation of earnings up to 100% of

the paid-up capital of the corporation as of Balance Sheet date, inclusive of accumulations taken from other years;

2) Earnings reserved for definite corporate EXPANSION projects or programs requiring considerable capital expenditure as approved by the Board of Directors or equivalent body;

3) Earnings reserved for BUILDING, PLANT or EQUIPMENT ACQUISITION as approved by the Board of Directors or equivalent body;

4) Earnings reserved for compliance with any LOAN COVENANT or pre-existing obligation established under a legitimate business agreement;

5) Earnings required by LAW or applicable

regulations to be retained by the corporation or in respect of which there is legal prohibition against its distribution;

6) In the case of subsidiaries of foreign

corporations in the Philippines, all undistributed earnings intended or reserved for INVESTMENTS WITHIN THE PHILIPPINES as can be proven by corporate records and/or relevant documentary evidence.

e) Covered Corporations àààà Only domestic

and closely-held corporations are liable for IAET.


TAXATION LAW 1

Closely-held corporations are those: a) at least 50% in value of the outstanding capital stock; or b) at least 50% of the total combined voting power of all classes of stock entitled to vote

è is owned directly or indirectly by or for not more than 20 individuals. Domestic corporations not falling under the aforesaid definition are, therefore, publicly-held corporations.

To determine whether the corporation is

closely held corporation, insofar as such determination is based on stock ownership, the following RULES shall be applied: a. Stock Not Owned by Individuals. - Stock owned directly or indirectly by or for a corporation, partnership, estate or trust shall be considered as being owned proportionately by its shareholders, partners or beneficiaries. b. Family and Partnership Ownership. - An individual shall be considered as owning the stock owned, directly or indirectly, by or for his family, or by or for his partner. For purposes of this paragraph, the ‘family of an individual’ includes his brothers or sisters (whether by whole or half-blood), spouse, ancestors and lineal descendants. c. Option to Acquire Stocks. - If any person has an option to acquire stock, such stock shall

be considered as owned by such person. For purposes of this paragraph, an option to acquire such an option and each one of a series of option shall be considered as an option to acquire such stock. d. Constructive Ownership as Actual Ownership. - Stock constructively owned by reason of the application of (a) or (c) shall, for purposes of applying (a) or (b), be treated as

actually owned by such person; but stock constructively owned by the individual by reason of the application of (b) shall NOT be

treated as owned by him for purposes of again applying such paragraph in order to make another the constructive owner of such stock.

èèèè BIR Ruling 025-02 àààà The ownership of a domestic corporation for purposes of determining whether it is a closely held corporation or a publicly held corporation is ultimately traced to the individual shareholders of the parent company. Where at least 50% of the outstanding capital stock or at least 50% of the total combined voting power of all classes of stock entitled to vote in a corporation is owned directly or indirectly by at least 21 or more individuals, the corporation is considered as publicly held corporation. f) Exempt Corporations: (BIG-PEN-T)

1. Banks and other non-bank financial intermediaries;

2. Insurance companies; 3. Publicly-held corporations; 4. Taxable partnerships; 5. General professional partnerships;

6. Non- taxable joint ventures; and

7. Enterprises that are registered:

a. with the Philippine Economic Zone

Authority (PEZA) under R.A. 7916;

b. pursuant to the Bases Conversion and

Development Act of 1992 under R.A.

7227; and

c. under special economic zones declared by

law which enjoy payment of special tax

rate on their registered operations or

activities in lieu of other taxes, national

or local.

Words in regular letters are found in Sec. 29(B)(2) of the NIRC. Words in italics are additions made by the revenue regulation to consolidate Sec. 29 with other pertinent laws.

g) Computation: TI + (ET + EG + FT +

NOLCOD) – (TP + D + RN) = IATI

Year's taxable income P xx

Add: Income exempt from tax xx

Income excluded from gross income xx

Income subject to final tax xx

Amount of NOLCO deducted xx

Total P xx Less: Income tax paid/payable for the

taxable year xx

Dividends actually or constructively paid from the applicable year's taxable income xx

Amount reserved for the reasonable needs of the business emanating from the covered year's taxable income xx

Improperly accumulated taxable income P xx

Multiplied by IAET rate 10% Improperly accumulated earnings(IAET) tax P xx

è Words in regular letters are in the statutory formula. Words in italics are additions made by the revenue regulation. h) Limitation àààà The profit that has been

subjected to IAET shall no longer be subjected to IAET in later years even if not declared as dividend. However, profits which have been subjected to IAET, when declared as dividends, shall be subject to tax on dividends except in those instances where the recipient is not subject thereto.

i) Declaration of Dividends from earnings àààà

For purposes of determining the source of earnings or profits declared or distributed from accumulated income, the dividends shall be deemed to have been paid out of the most recently accumulated profits or surplus and shall constitute a part of the annual income of the distributee for the year in which received pursuant to Section 73(C) of the Code. But, where the dividends or portion of the said dividends declared forms part of the accumulated earnings as of December 31, 1997, or emanates from the accumulated income of a particular year and is therefore an exemption to the


TAXATION LAW 1

proceeding statement, such fact must be supported by a duly executed Board Resolution to that effect.

j) Period for Payment of Dividend/IAET àààà

The dividends must be declared and paid or issued not later than one year following the close of the taxable year, otherwise, the IAET, if any, should be paid within fifteen (15) days thereafter.

k) Determination of Purpose to Avoid Income Tax

1) The fact that a corporation is a mere holding company or investment company shall be prima facie evidence

of a purpose to avoid the tax upon its shareholders or members Ø A "holding or investment company" is

a corporation having practically no activities except holding property, and collecting the income therefrom or investing the same; and

2) where the earnings or profits of a

corporation are permitted to accumulate beyond the reasonable needs of the business. PRIMA FACIE INSTANCES of accumulation of profits beyond the reasonable needs of a business (UBE) 1) Investment of substantial earnings and

profits of the corporation in UNRELATED BUSINESS or in stock or securities of unrelated business;

2) Investment in BONDS and other

long-term securities; and 3) Accumulation of earnings IN EXCESS

OF 100% OF PAID-UP CAPITAL, not otherwise intended for the reasonable needs of the business.

-The controlling intention of the taxpayer is that which is manifested at the time of accumulation. A speculative and indefinite purpose will not suffice. The mere recognition of a future problem or the discussion of possible and alternative solutions is not sufficient. Definiteness of plan/s coupled with action/s taken towards its consummation is essential.

ONE LAST NOTE ON THE APPLICABILITY

OF TAX RATES OF DOMESTIC

CORPORATIONS: All corporations, agencies, or instrumentalities owned or controlled by the GOVERNMENT are taxable and shall pay such rate of tax upon their taxable income as are imposed on domestic corporations

engaged in a similar business, industry, or activity. EXCEPTIONS (i.e, not taxable): o Government Service Insurance

System (GSIS), o Social Security System (SSS), o Philippine Health Insurance

Corporation (PHIC), o Philippine Charity Sweepstakes Office

(PCSO) Note: Exemption for PAGCOR was withdrawn by RA 9337

E. Tax on Resident Foreign Corporations

Resident foreign corporations are subject to any or some of the following: • Capital Gain Tax • Final Tax on Passive Income • Normal Tax [OR] Minimum Corporate

Income Tax (MCIT) [OR] Gross Income Tax (GIT)

• Branch Profit Remittance Tax

1. Capital Gains subject to Capital Gains Tax à On sale, barter, exchange or other disposition of shares of stock of a domestic corporation not listed and traded through a local stock exchange, held as a capital asset: On the net capital gain: Not over P100,000 Final Tax of 5% On any amount in excess of P100,000 plus Final Tax of 10% on the excess

NOTE: Tax treatment is the same as that of individuals and domestic corporations. The net taxable income from the sale of real property realized by the resident foreign corporation shall be subject to the normal corporate income tax.

2. Passive Income Subject to Final Tax Interest Income: o on any currency bank deposit, yield or

any other monetary benefit from deposit substitutes, trust funds and similar arrangements - 20%

o under the expanded foreign currency deposit system (EFCDS) - 7.5%

Dividends received from a domestic corporation (Intercompany Dividend) - EXEMPT

Royalties (any kind) – 20%

3. Income subject to Normal Tax [OR] Minimum Corporate Income Tax (MCIT) [OR] Gross Income Tax (GIT) à The discussion with respect to this topic (income subject to normal tax, MCIT, or GIT) under the subheading of domestic corporations is equally applicable to resident foreign corporations, both as to concepts and computations, except that RFCs are taxed only on income from sources within the Philippines.

NORMAL CORPORATE INCOME TAX RATE àààà 35% of net taxable income from sources

within the Philippines

MINIMUM CORPORATE INCOME TAX (MCIT) àààà 2% of MCIT Gross Income from sources within the Philippines. The MCIT is imposed on RFCs under the same conditions as domestic corporations. [Sec. 28(A)(2)]

GROSS INCOME TAX (GIT) àààà The President, upon the recommendation of the Secretary of Finance, may allow resident foreign corporations the option to be taxed at fifteen percent (15%) of gross income within


TAXATION LAW 1

the Philippines, under the same conditions as domestic corporations. [Sec. 28(A)(1)]

Branch Profit Remittance Tax [Sec. 28(A)(5)] Ø Taxable transaction – any profit remitted

by a branch to its head office Ø Tax Rate and Base – 15% based on the

total profits applied or earmarked for remittance without any deduction for the tax component

Ø Non-taxable activities –activities which are registered with the Philippine Economic Zone Authority

Ø Income NOT TREATED AS BRANCH

PROFITS unless effectively connected with the conduct of trade or business in the Philippines:

i. Interests, dividends, rents, royalties, including remuneration for technical services

ii. salaries, wages premiums, annuities, emoluments

iii. other fixed or determinable annual, periodic or casual gains, profits, income

iv. capital gains received during each taxable year from all sources within the Philippines

NOTES:

- imposed whether the head office of the foreign corporation is located in a tax treaty country, in a tax haven or other non-treaty country. - imposed only on the profits remitted by a Philippine branch to the head office of a foreign corporation. Should the branch of a domestic corporation remit profits to its head office, the transaction is not subject to the branch profit remittance tax.

F. Tax on Nonresident Foreign Corporations

Non-resident foreign corporations are subject to any or some of the following: • Capital Gain Tax • Final Tax on Passive Income • Final Tax on [Other] Gross Income

from sources within the Philippines

1. Capital Gains subject to Capital Gains Tax à On sale, barter, exchange or other disposition of shares of stock of a domestic corporation not listed and traded through a local stock exchange, held as a capital asset:

On the net capital gain: Not over P100,000 Final Tax of 5% On any amount in excess of P100,000 plus Final Tax of 10% on the excess

NOTE: The gross income from the sale of real property realized by the non-resident foreign corporation shall be subject to a 35% final tax imposed on gross income from sources within the Philippines.

2. Passive Income Subject to Final Tax

Interest o on foreign loans contracted on or after

August 1, 1986 – 20%

o under the expanded foreign currency deposit system (EFCDS) - EXEMPT

Dividends (cash and/or property) received from a domestic corporation (Intercorporate Dividend) – 15%, AS LONG AS the country in which the nonresident foreign corporation is domiciled allows a tax credit for taxes “deemed paid” in the Philippines equivalent to 20%

20% represents the difference between the regular income tax of 35% on corporations and the 15% tax on dividends If the country within which the NRFC is domiciled does NOT allow a tax credit, a final withholding tax at the rate of 35% is imposed on the dividends received from a domestic corporation. [In other words, the dividends are subject to the third kind of tax: Final Tax on [Other] Gross Income from sources within the Philippines.]

Final Tax on [Other] Gross Income from sources within the Philippines à 35% of the gross income received from all sources within the Philippines, such as interests, dividends, rents, royalties, salaries, premiums (except reinsurance premiums), annuities, emoluments or other fixed or determinable annual, periodic or casual gains, profits and income, and capital gains EXCEPT capital gains resulting from the sale of shares of stock of a domestic corporation not listed and traded through a local stock exchange, held as a capital asset.

Special Types of Corporations A. Special Type of Domestic Corporations

1. Proprietary Educational Institutions and Hospitals (Non-profit)

Tax Rate and Base – 10% on net income (except on income subject to capital gains tax and passive income subject to final tax) within and without the Philippines CAVEAT: If gross income from unrelated

trade or business or other activity exceeds 50% of total gross income derived from all sources, the tax rate of 35% shall be imposed on the entire taxable income. - Unrelated trade, business or other activity à 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. - Proprietary educational institution à any private school maintained and administered by private individuals or groups with an issued permit to operate from the DECS, CHED or TESDA.

2. Depository Banks (Foreign Currency Deposit Units) [Sec. 27(D)(3) as amended by RA 9294 (2004)] Ø Coverage of the Rule – ONLY income derived by a depository bank under the expanded foreign currency deposit system from foreign currency transactions with: - nonresidents, - offshore banking units in the Philippines, - local commercial banks including branches

of foreign banks that may be authorized


TAXATION LAW 1

by the Bangko Sentral ng Pilipinas (BSP) to transact business with foreign currency deposit system units and

- other depository banks under the expanded foreign currency deposit system

Ø Tax Rate: Exempt from all taxes, except net income from such transactions as may be specified by the Secretary of Finance, upon recommendation by the Monetary Board to be subject to the regular income tax payable by banks

EXCEPTION: Interest income from foreign currency loans granted by such depository banks under said expanded system to residents other than offshore units in the Philippines or other depository banks under the expanded system shall be subject to a final tax at the rate of 10%.

B. Special Types of Resident Foreign Corporations

1. International Carriers -Tax Rate and Base – 2.5% on Gross Philippine Billings (GPB) What is GPB?

In the case of International Air Carriers, GPB refers to the amount of: -gross revenue derived from carriage of persons, excess baggage, cargo and mail originating from the Philippines in a continuous and uninterrupted flight, irrespective of the place of sale or issue and the place of payment of the ticket or passage document =gross revenue from tickets revalidated, exchanged and/or indorsed to another international airline if the passenger boards a plane in a port or point in the Philippines

-for flights which originate from the Philippines, but transshipment of passenger takes place at any port outside the Philippines on another airline, the gross revenue consisting of only the aliquot portion of the cost of the ticket corresponding to the leg flown from the Philippines to the point of transshipment [RR 15-2002] -Air Canada vs. CIR (CTA Case No. 6572) – A foreign airline company selling tickets in the Philippines through their local agents shall be considered as resident foreign corporation engaged in trade or business in the country. The absence of flight operations within the Philippine territory cannot alter the fact that the income received was derived from activities within the Philippines. The test of taxability is the source, and the source is that activity which produced the income. In the case of International Shipping, GPB means: -gross revenue whether for passenger, cargo or mail originating from the Philippines up to final destination, regardless of the place of sale or payments of the passage or freight documents.

2. Offshore Banking Units authorized by the Bangko Sentral ng Pilipinas (BSP) [Sec. 28(A)(4) as amended by RA 9294 (2004)]

Coverage of the Rule ONLY income derived by offshore banking units from foreign currency transactions with: -nonresidents, -other offshore banking units -local commercial banks including branches of foreign banks that may be authorized by the Bangko Sentral ng Pilipinas (BSP) to transact business with offshore banking units -Tax Rate: Exempt from all taxes, except net income from such transactions as may be specified by the Secretary of Finance, upon recommendation by the Monetary Board to be subject to the regular income tax payable by

banks -EXCEPTION: Interest income derived from foreign currency loans granted to residents other than offshore banking units or local commercial banks, including local branches of foreign banks that may be authorized by the BSP to transact business with offshore banking units, shall be subject only to a final tax at the rate of 10%.

3. Resident Depository Bank (Foreign Currency Deposit Units) [Sec. 28(D)(7)(b) as amended by RA 9294 (2004)] -Coverage of the Rule – ONLY income derived by a depository bank under the expanded foreign currency deposit system from foreign currency transactions with:

-nonresidents, -offshore banking units in the Philippines, -local commercial banks including branches of foreign banks that may be authorized by the Bangko Sentral ng Pilipinas (BSP) to transact business with foreign currency deposit system units and -other depository banks under the expanded foreign currency deposit system -Tax Rate: Exempt from all taxes, except net income from such transactions as may be specified by the Secretary of Finance, upon recommendation by the Monetary Board to be subject to the regular income tax payable by banks -EXCEPTION: Interest income from foreign currency loans granted by such depository banks under said expanded system to residents other than offshore units in the Philippines or other depository banks under the expanded system shall be subject to a final tax at the rate of 10%.

4. Regional or Area Headquarters and Regional Operating Headquarters of multinational Companies

Regional or area headquarters – not subject to income tax Regional or area headquarters à a branch established in the Philippines by multinational companies and which headquarters do not earn or derive income from the Philippines and which act as supervisory, communications and coordinating center for their affiliates,


TAXATION LAW 1

subsidiaries, or branches in the Asia-Pacific Region and other foreign markets.

Regional operating headquarters – 10% of their taxable income -a branch established in the Philippines by multinational companies which are engaged in any of the following services:

(SMART - BAD – PPL)

1. general Administration and planning 2. business Planning and coordination 3. sourcing and Procurement of raw materials and components 4. corporate finance Advisory services 5. Marketing control and sales promotion 6. Training and personnel management 7. Logistic services 8. Research and development services and product development 9. technical Support and maintenance

10. Data processing and communications, and 11. Business development.

C. Special Types of Non-resident Foreign Corporations 1. Non-resident cinematographic film owners,

lessors or distributors – 25% of gross income from all sources within the Philippines

2. Nonresident Owner or Lessor of Vessels

Chartered by Philippine Nationals – 4.5% of gross rentals, lease or charter fees from leases or charters to Filipino citizens or corporations, as approved by the Maritime Authority

3. Nonresident Owner or Lessor of Aircraft,

Machineries and Other Equipment – 7.5% of gross rentals or fees .

Summary of Tax Bases and Rates of Special Corporations QUICK GLANCE

Type of Corporation Tax Base Tax Rate

Domestic Corporations

Proprietary Educational Institutions and Hospitals (Non-profit) Taxable Income from all sources 10%

Depository Banks (Foreign Currency Deposit Units) v With respect to income derived under the expanded

foreign currency deposit system from certain foreign currency transactions

v With respect to interest income from foreign currency loans to residents other than offshore units in the Philippines or other depository banks under the expanded system

Exempt (except that net income from such transactions is subject to the regular income tax payable by banks)

-

Amount of interest income 10%

Resident Foreign Corporations

International Carriers Gross Philippine Billings 2.5%

Offshore Banking Units v With respect to income derived by offshore banking

units from certain foreign currency transactions v With respect to interest income derived from foreign

currency loans granted to residents other than offshore banking units or local commercial banks


-


Resident Depository Bank (Foreign Currency Deposit Units) v With respect to income derived under the expanded

foreign currency deposit system from certain foreign currency transactions

v With respect to interest income from foreign currency loans to residents other than offshore units in the Philippines or other depository banks under the expanded system


-


Regional or Area Headquarters Exempt -

Regional Operating Headquarters of Multinational Companies Taxable Income from within the Philippines

10%

Non-resident Foreign Corporations

Non-resident cinematographic film owners, lessors or distributors

Gross Income from the Philippines 25%

Nonresident Owner or Lessor of Vessels Chartered by Philippine Nationals

Gross Rentals, Lease and Charter Fees from the Philippines

4.5%

Nonresident Owner or Lessor of Aircraft, Machineries and Other Equipment

Gross Rentals, Charges and Fees from the Philippines

7.5%


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Exempt Corporations [Sec. 30] (CREB-CLEF-SMB)

The following organizations shall not be taxed in respect to income received by them as such (e.g. membership fees): 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 bank without capital stock organized and operated for mutual purposes and without profit

3. A BENEFICIARY society, order or association, operating for the exclusive

benefit of the members such as a fraternal organization operating under the lodge system, or mutual aid association or a non-stock corporation organized by employees providing for the payment of life, sickness,

accident, or other benefits exclusively to the

members of such society, order, or association, or non-stock corporation or their dependents

4. CEMETERY company owned and operated exclusively for the benefit of its members

5. Non-stock corporation or association organized and operated exclusively for RELIGIOUS, charitable, scientific, athletic, or cultural purposes, or for the

rehabilitation of veterans, no part of its net

income or asset shall belong to or inures to

the benefit of any member, organizer, 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 stock-holder, or individual

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

8. A non-stock and nonprofit EDUCATIONAL institution

9. Government EDUCATIONAL institution 10. FARMERS' or other mutual typhoon or fire

insurance company, mutual ditch or irrigation

company, mutual or cooperative telephone

company, or like organization of a purely

local character, the income of which consists solely of assessments, dues, and fees collected from members for the sole purpose of meeting its expenses and

11. Farmers', fruit growers', or like association

organized and operated as a SALES agent for the purpose of marketing the products of its members and turning back to them the proceeds of sales, less the necessary selling expenses on the basis of the quantity of produce finished by them;

è Notwithstanding the exemptions, income of whatever kind and character of the enumerated 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.

Note: RA 9178 Barangay Micro Business Enterprises (BMBEs) implemented by DO 17-04, April 20, 2004

• BMBEs shall be exempt from income tax for income arising from the operations of the enterprise.

• BMBE is any business entity or enterprise engaged in the production, processing or manufacturing of products or commodities, including agro-processing trading and services, whose total assets including those arising from loans but exclusive of land on which the particular business entity’s office, plant and equipment are situated, shall not be more that P3M.


TAXATION LAW 1

Summary of Tax Bases, Tax Rates and Applicable Tax Regimes for Corporations

CATEGORY OF INCOME

DOMESTIC RESIDENT NON-RESIDENT

All sources Within the Philippines


1. Taxable Income (i.e., income other than #s 2 to 9)

35% Normal Tax

35% Normal Tax

35% of Gross Income

2. Interest from any currency bank deposit , etc.

GIW - 20% Final Tax

3. Royalties

GIW - 20% Final Tax

4. Interest (Expanded Foreign Currency Deposit System)

GIW - 7.5% Final Tax EXEMPT

5. Cash / Property Dividends from a domestic corporation

EXEMPT

15% or 35%, whichever is applicable

6. Capital Gains on Sale of Shares (not traded in a domestic stock exchange)

Net Capital Gains within: Not Over P100,000 – 5% Final Tax

Amount in Excess of P100,000 – plus 10% Final Tax on the excess

7. Capital Gains on Sale of Land and/or Building

GSP or FMV, whichever is higher – 6% Final Tax

35% Normal Tax

35% of Gross Income

8. Sale of Shares (traded in a domestic stock exchange)

½ of 1% of the Selling Price (Stock Transaction Tax) Note: Stock Transaction Tax is not an income tax,

but a business (percentage) tax

TAX REGIMES APPLICABLE

Normal Tax YES YES

YES, but based on Gross Income

Minimum Corporate Income Tax YES YES NO

Gross Income Tax YES YES NO

Improperly Accumulated Earnings Tax YES, if closely- held

corporation NO NO

Branch Profit Remittance Tax NO YES Not Applicable

Legend:

GIW - Gross Income within the Philippines

GSP – Gross Selling Price

FMV – Fair Market Value


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V. TAXATION OF FRINGE BENEFITS V. TAXATION OF FRINGE BENEFITS V. TAXATION OF FRINGE BENEFITS V. TAXATION OF FRINGE BENEFITS [Sec. 33 of the NIRC]

A. Definition of Fringe Benefit àààà 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 (The fringe benefit covered by Sec 33 refers to those enjoyed by managerial and supervisory employees.)

Key definitions: Managerial employee à one who is vested with the powers or prerogatives to lay down and execute management policies and/or to hire, transfer, suspend, lay-off, recall, discharge, assign or discipline employees. Supervisory employees à those who, in the interest of the employer, effectively recommend such managerial actions if the exercise of such authority is not merely routinary or clerical in nature but requires the use of independent judgment. All employees not falling within any of the above definitions are considered rank-and-file

employees.

Examples of fringe benefits:

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

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

B. Tax Rate and Tax Base – [Generally] 32% of the grossed-up monetary value (GMV) GMV represents the whole amount of income realized by the employee.

How GMV is determined à GMV is determined by dividing the actual monetary value of the fringe benefit by 68% [100% - tax rate of 32%]. For example, the actual monetary value of the fringe benefit is P1,000. The GMV is equal to P1,470.59 [P1,000 / 0.68]. The fringe benefit tax, therefore, is P470.59 [P1470.59 x 32%].

Special Cases: § For fringe benefits received by non-resident

alien not engaged in trade of business (NRANETB), the tax rate is 25% of the grossed-up monetary value (GMV). The GMV is determined by dividing the actual monetary value of the fringe benefit by 75% [100% - 25%].

§ For fringe benefits received by alien individuals and Filipino citizens employed by

regional or area headquarters, regional operating headquarters, offshore banking units (OBUs), or foreign service contractor, the tax rate is 15% of the grossed-up monetary value (GMV). The GMV is determined by dividing the actual monetary value of the fringe benefit by 85% [100% - 15%]. What is the tax implication if the employer gives ‘fringe benefits’ to rank-and-file employees? Fringe benefits given to a rank-and-file employee are treated as part of his

compensation income subject to income tax

and withholding tax on compensation income.

Payor of Fringe Benefit Tax (FBT) – the employer [but the law allows the employer to deduct such tax as a business expense, in determining his taxable income] Fringe Benefits which are not taxable [Sec. 33 of the NIRC, consolidated with Sec. 2.33(C) of RR 03-98] [RED CNC] 1. Fringe benefits which are authorized and

EXEMPTED from tax under special laws 2. CONTRIBUTIONS of the employer for the

benefit of the employee to retirement, insurance and hospitalization benefit plans

3. Benefits given to the RANK AND FILE employees, whether granted under a collective bargaining agreement or not

4. DE MINIMIS benefits 5. If the grant of fringe benefits to the employee

is required by the nature of, or NECESSARY to the trade, business, or profession of the employer

6. If the grant of fringe benefits is for the CONVENIENCE of the employer [Convenience of the Employer Rule]

NOTES:

De minimis benefits – those which are of relatively small value are offered by the employer as a means of promoting health, goodwill, contentment, or efficiency of his employees, such as the following: (CLAMMP – RUST)

1. Monetized unused vacation leave credits of private employees not exceeding ten (10)

days during the year and the monetized value of leave credits paid to government

officials and employees; 2. Medical cash allowance to dependents

of employees not exceeding P750 per

semester or P125 per month;

BIR Ruling 019-02: To be considered “de minimis” medical allowance, the following conditions must concur:

1. The amount given to the EE shall be for his own medical expense; 2. The amount actually given and actually spent shall not exceed P10, 000 in any given calendar year; 3. The EE must fully substantiate with or in his name the medical allowance to be granted.

3. Rice subsidy of P350 per month granted

by an employer to his employees;


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4. Uniforms given to employees by the employer;

5. Medical benefits given to the employees by the employer;

6. Laundry allowance of P150 per month; 7. Employee achievement awards, e.g. for

length of service or safety achievement, which must be in the form of a tangible personal property other than cash or gift certificate, with an annual monetary value

not exceeding one-half (½) month of the

basic salary of the employee receiving the award under an established written plan

which does not discriminate in favor of highly paid employees;

8. Christmas and major anniversary

celebrations for employees and their guests;

9. Company picnics and sports tournaments in the Philippines and are participated exclusively by employees; and

10. Flowers, fruits, books or similar items given to employees under special

circumstances, e.g. on account of illness, marriage, birth of a baby, etc. [as enumerated in RR 03-98, as amended by RR 10-00]

Tax implication of de minimis benefits: EXEMPTED from tax. However, should the amount of the benefits given be in EXCESS of the ceilings prescribed, the following rules apply:

-If given to managerial / supervisory employees à The amount in excess of the ceiling prescribed is taxable as a fringe benefit (i.e., there will be a 32% tax imposed on the grossed-up monetary value of the residual amount). -If given to rank-and-file employees à The amount in excess of the ceiling prescribed is taxable as salary or compensation income.

BIR Ruling 023-02: Meal and food allowance, although not for overtime work, is considered de minimis if it does not exceed 25% of the basic wage. The rules and regulations on de minimis benefits do not allow aggregation of the amounts set for each type of benefit.

BIR Ruling 034-02 (Aug 16, 2002): Representation and Transportation Allowance (RATA) and Personnel Economic Relief Allowance (PERA) are not subject to Income Tax and Withholding Tax. Additional Compensation Allowance (ACA) is part of “other benefits” under Sec. 32(b)(7)(e) of the Tax Code of 1997 which are excluded from gross compensation income provided the total amount of such benefits does not exceed P30,000. It is also not subject to withholding tax pending its formal integration into basic pay.

Example of Benefits Necessary to the Trade / Business of the Employer: BIR Ruling 013-02: Outstation Allowance given by the Philippine Gaming Management Corporation to its managerial and supervisory employees (who will be away from the office site for at least 8 hours to visit the lotto franchise holders for repair and/or inspection of equipment) intended to cover meals and trip related expenses is clearly required by the nature of or necessary to the trade or business of the employer and hence, not subject to the fringe benefits tax. It is also not subject to withholding tax.

Examples of Convenience of the Employer Rule: 1. The value of the meals given to the employee

is not taxable, if the employer provides the meals for a substantial non-compensatory business purpose (generally, when employee is required to be on duty during the meal period).

2. Lodging is not taxable if the employee must accept the lodging on the employer’s business premises as a condition of his employment.


TAXATION LAW 1

VI. TAXATION OF PARTNERSHIPSVI. TAXATION OF PARTNERSHIPSVI. TAXATION OF PARTNERSHIPSVI. TAXATION OF PARTNERSHIPS

A. Classification of Partnerships for Tax Purposes 1. General Professional Partnerships (GPP) –

partnerships formed by persons for the sole purpose of exercising their common profession, no part of the income of which is derived from engaging in any trade or business

2. Other Partnerships (or General Co-

partnerships) – partnerships wherein all or part of their income is derived from the conduct of trade or business

B. General Professional Partnerships [Sec 26] Rules: 1. A GPP as such shall not be subject to

the income tax. 2. The partners shall only be liable for

income tax only in their separate and

individual capacities. 3. For purposes of computing the

distributive share of the partners, the net income of the GPP shall be computed in the same manner as a corporation.

4. Each partner shall report as gross income his distributive share, actually or

constructively received, in the net income of the partnership.

5. The share of a partner shall be subject to a creditable withholding income tax of 15%. (RR 2- 1998)

NOTES: • GPP is not a taxable entity àààà The partnership is a mere mechanism or a flow-through entity in the generation of income by, and the ultimate mechanism distribution of such income to the individual partners. (Tan v.

Commissioner [Oct. 3, 1994]) But, the partnership itself is required to file income tax returns for the purpose of furnishing information as to the share in the gains or profits which each partner shall include in his individual return. (RR 2- 1998) • The share of an individual partner in the net profit of a general professional partnership is deemed to have been actually or constructively received by the partner in the same taxable

year in which such partnership net income was earned, and shall be taxed to them in their individual capacities, whether actually distributed or not, at the graduated income tax ranging from 5% to 32%. Thus, the principle of constructive receipt of income or profit is being applied to undistributed profits of GPPs. The payment [to the partners] of such tax-paid profits in another year should no longer be liable to income tax. (Mamalateo)

C. Other Partnerships (or General Co-

partnerships) Rules:

1. The partnership is subject to the same rules on corporations (capital gains tax, final tax on passive income, normal tax, minimum corporate income tax [MCIT] and gross income tax [GIT]), but is not subject to the improperly accumulated earnings tax [IAET]. The partnership must file quarterly and year-end income tax returns.

2. The taxable income of the partnership, less the normal corporate income tax

thereon, is the distributable net income of the partnership.

3. The share of a partner in the partnership’s distributable net income of a year shall be deemed to have been actually or constructively received by the partners in the same taxable year and shall be taxed to them in their individual capacity, whether actually distributed or not. [Sec. 73(D)] Such share will be subjected to a final tax of 10% to be withheld by the partnership. [Sec. 24(B)(2)]

Ø Co-ownership - There is co-ownership: 1. When two or more heirs inherit and

undivided property from a decedent. 2. When a donor makes a gift of an

undivided property in favor of two or more donees.

- When Co-ownership is not subject to tax à When the co-ownership’s activities are limited merely to the preservation of the co-owned property. The co-owners are only liable for income tax in their separate and individual capacities.

- When Co-ownership is subject to tax à

When the income of the co-ownership is invested by the co-

owners in business, the co-owners have in effect constituted themselves into a partnership. In such a case, the co-ownership shall be subject to tax as a corporation. à automatically converted into an unregistered partnership the moment the said common properties and/or the incomes derived from them are used as a common fund with intent to produce profits for the heirs in proportion to their respective shares in the inheritance as determined in a project partition either duly executed in an extrajudicial settlement or approved by the court in the corresponding testate or intestate proceeding. [Ona v. CIR, May, 25 1972]


TAXATION LAW 1

VII. TAX ON ESTATES AND TRUSTSVII. TAX ON ESTATES AND TRUSTSVII. TAX ON ESTATES AND TRUSTSVII. TAX ON ESTATES AND TRUSTS

A. Application of Income Tax à The tax imposed upon individuals shall apply

to the income of estates or of any kind of property held in trust, including: 1. Income accumulated in trust for the

benefit of unborn or unascertained

person or persons with contingent

interests, and income accumulated or held for future distribution under the terms of the will or trust;

2. Income which is to be distributed

currently by the fiduciary to the

beneficiaries, and income collected by a

guardian of an infant which is to be held or distributed as the court may direct;

3. Income received by estates of deceased

persons during the period of

administration or settlement of the estate; and

4. Income which, in the discretion of the

fiduciary, may be either distributed to the beneficiaries or accumulated.

EXCEPTION àààà The tax shall not apply to employee's trust which forms part of a pension,

stock bonus or profit-sharing plan of an employer for the benefit of some or all of his employees i. if 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 fund accumulated by the trust in accordance with such plan, and

ii. if under the trust instrument it is impossible, at any time prior to the satisfaction of all liabilities with respect to employees under the trust, for any part of the corpus or income to be (within the taxable year or thereafter) used for, or diverted to, purposes other than for the exclusive benefit of his employees. - NOTE HOWEVER: Any amount

actually distributed to any employee or distributee shall be taxable to him in the year in which so distributed to the extent that it exceeds the amount contributed by such employee or distributee.

B. Computation and Payment of the Tax

àààà The tax shall be computed upon the taxable income of the estate or trust and shall be paid by the fiduciary. (GENERAL RULE)

EXCEPTIONS:

1. Revocable Trusts. - Where at any time the power to revest in the grantor title to any part of the corpus of the trust is vested

1. in the grantor 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

2. in any person not having a substantial adverse interest in the disposition of such part of the corpus or the income therefrom,

the income of such part of the trust shall

be included in computing the taxable

income of the grantor.

2. Income for Benefit of Grantor - Where any part of the income of a trust i. is, or in the discretion of the

grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be held or accumulated for future distribution to the grantor, or

ii. may, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income, be distributed to the grantor, or

iii. is, or in the discretion of the grantor or of any person not having a substantial adverse interest in the disposition of such part of the income may be applied to the payment of premiums upon policies of insurance on the life of the grantor,

such part of the income of the trust shall

be included in computing the taxable

income of the grantor.

NOTE: 'In the discretion of the grantor' means in the discretion of the grantor, either alone or in conjunction with any person not having a substantial adverse interest in the disposition of the part of the income in question.

Consolidation of Income of Two or More Trusts

- Where, in the case of two or more trusts, the creator of the trust in each instance is the same person, and the beneficiary in each instance is the same, the taxable income of all the trusts shall be consolidated and the tax computed on such consolidated income, and such proportion of said tax shall be assessed and collected from each trustee which the taxable income of the trust administered by him bears to the consolidated income of the several trusts.

C. How Taxable Income of the Estate or Trust is Computed

àààà [Sec. 61] The taxable income of the estate or trust shall be computed in the same manner and on the same basis as in the case of an individual, EXCEPT that: (A) There shall be ALLOWED AS A

DEDUCTION in computing the taxable income of the estate or trust the amount of the income of the estate or trust for the taxable year which is to be distributed currently by the fiduciary to the beneficiaries, and the amount of the income collected by a guardian of an infant which is to be held or distributed as the court may direct, BUT the amount so allowed as a deduction shall be included in


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computing the taxable income of the beneficiaries, whether distributed to

them or not. Any amount allowed as a deduction under this Subsection shall not be allowed as a deduction under Subsection (B) of this Section in the same or any succeeding taxable year.

(B) In the case of income received by

estates of deceased persons during

the period of administration or

settlement of the estate, and in the case of income which, in the discretion

of the fiduciary, may be either

distributed to the beneficiary or

accumulated, there shall be allowed as an ADDITIONAL DEDUCTION the amount of the income of the estate or trust for its taxable year, which is properly paid or credited during such year to any legatee, heir or beneficiary but the amount so allowed as a deduction shall be included in computing the taxable income of the legatee, heir or beneficiary.

(C) In the case of a trust administered in a

foreign country, the deductions mentioned in Subsections (A) and (B) of this Section shall not be allowed: Provided, That the amount of any income included in the return of said trust shall not be included in computing the income of the beneficiaries.

B. Exemption Allowed to Estates and Trusts

àààà P20,000 from the income of the estate or trust.

E. Fiduciary Returns

àààà Guardians, trustees, executors, administrators, receivers, conservators and all persons or corporations, acting in any fiduciary capacity, shall: - render, in duplicate, a return of the

income of the person, trust or estate for whom or which they act, and

- be subject to all the provisions which

apply to individuals in case such person, estate or trust has a gross income of P20,000 or over during the taxable year.

Such fiduciary or person filing the return for him or it, shall: - take OATH that

§ he has sufficient knowledge of

the affairs of such person, trust or estate to enable him to make such return and

§ that the same is, to the best of

his knowledge and belief, true

and correct, and - be subject to all the provisions of this

Title which apply to individuals. A return made by or for one or two or more joint fiduciaries filed in the province where such fiduciaries reside, under such rules and regulations as the Secretary of Finance shall prescribe, shall be sufficient compliance.

F. Fiduciaries Indemnified Against Claims for Taxes Paid

àààà Trustees, executors, administrators and other fiduciaries are INDEMNIFIED against the claims or demands of every beneficiary for all payments of taxes which they shall be required to make, and they shall have CREDIT for the amount of such payments against the beneficiary or principal in any accounting which they make as such trustees or other fiduciaries.

VIII. SOURCE OFVIII. SOURCE OFVIII. SOURCE OFVIII. SOURCE OF INCOMEINCOMEINCOMEINCOME [Sec. 42]

A. Classification of Income according to

Source 1. Income derived from sources within the

Philippine 2. Income derived from sources without the

Philippine 3. Income derived from sources partly within

and partly without the Philippines B. Basic Principles

1. Resident Citizens (RC) and Domestic Corporations (DC) are taxable on income derived from within and without the Philippines

2. Non-resident Citizens (NRC), Non-resident Aliens (NRA), Resident Foreign Corporations (RFC) and Non-resident Foreign Corporations (NRFC) are taxable only on income derived from within the Philippines.

C. Gross Income From Sources Within the Philippines (RIDIC - within) àààà The following items of gross income shall

be treated as gross income from sources WITHIN the Philippines:

1. Interests derived from sources within the Philippines, and interests on bonds, notes or other interest-bearing obligation of residents

2. Dividends received: a. from a domestic corporation; and b. from a foreign corporation, UNLESS less

than 50% of its gross income for the previous 3-year period was derived from sources within the Philippines [in which case it will be treated as income partly from within and partly from without]. The income which is considered as derived from within the Philippines is obtained by using the following formula:

NOTE: * of the corporation giving the

dividend

3. Compensation for labor or personal services performed in the Philippines

4. Rentals and royalties from property located in the Philippines or from any interest in such property, including rentals or royalties for – (stackem) a. The use of or the right or privilege to

use in the Philippines any copyright, patent, design or model, plan, secret

formula or process, goodwill,

Philippine Gross Income* x Dividend = Income Within Worldwide Gross Income*


TAXATION LAW 1

trademark, trade brand or other like

property or right; b. The use of, or the right to use in the

Philippines any industrial, commercial

or scientific equipment; c. The supply of scientific, technical,

industrial or commercial knowledge or information;

d. The supply of any assistance that is ancillary and subsidiary to, and is furnished as a means of enabling the

application or enjoyment of, any such property or right as is mentioned in (a), any such equipment as is mentioned in (b) or any such knowledge or information as is mentioned in (c);

e. The supply of services by a nonresident person or his employee in connection with the use of property or rights belonging to, or the installation

or operation of any brand, machinery or

other apparatus purchased from such nonresident person;

f. Technical advice, assistance or

services rendered in connection with technical management or administration of any scientific,

industrial or commercial undertaking, venture, project or scheme; and

g. The use of or the right to use: (i) Motion picture films; (ii) Films or video tapes for use in

connection with television; and (iii) Tapes for use in connection with

radio broadcasting.

5. Gains, profits and Income from the sale of real property located in the Philippines

6. GENERAL RULE: Gains, profits and

income from the sale of personal property, subject to the following rules:

Place of PURCHASE

Place of SALE

Treatment**

Philippines Abroad Income from Without

Abroad Philippines Income from Within

** in other words, treated as income from the country in which sold

EXCEPTIONS:

1. Gain from the sale of shares of stock in a domestic corporation à

treated as derived entirely from sources within the Philippines regardless of where the said shares

are sold. 2. Gains from the sale of

(manufactured) personal property: a. produced (in whole or in part)

by the taxpayer within and sold without the Philippines, or

b. produced (in whole or in part) by the taxpayer without and sold within the Philippines

à treated as derived partly from sources within and partly from sources without the Philippines.

Place of

PRODUCTION Place of SALE

Treatment

Philippines Abroad Partly within, partly without

Abroad Philippines Partly within, partly without

Ø Allowable Deductions from Gross

Income From Sources Within the Philippines GENERAL RULE:

From the items of gross income above, the following are allowed as deductions: a. expenses, losses and other

deductions properly allocated to items of gross income

b. ratable part of expenses, interests, losses and other deductions effectively connected with the business or trade conducted exclusively within the Philippines which cannot definitely be allocated to some items of gross income

Formula for (b):

EXCEPTION:

No DEDUCTIONS FOR INTEREST paid or incurred abroad shall be allowed from the item of gross income unless indebtedness was actually incurred to provide funds for use in connection with the conduct or operation of trade or business in the Philippines.

D. Gross Income From Sources Without the

Philippines (RIDIC - without) àààà The following items of gross income shall

be treated as income from sources without the Philippines:

1. Interests other than those derived from sources within the Philippines

2. Dividends other than those derived from sources within the Philippines

3. Compensation for labor or personal services performed without the Philippines

4. Rentals or royalties from property located without the Philippines or from any interest in such property

5. Gains, profits and Income from the sale of real property located without the Philippines

Ø Allowable Deductions to Gross Income

From Sources Without the Philippines

1. expenses, losses, and other deductions properly apportioned to items of gross income

2. ratable part of any expense, loss or other deduction which cannot definitely be allocated to some items or classes of gross income

e.g.:

Gross Income from Expenses Without the Philippines x Unallocated = allocated Worldwide Gross Income Expenses to income

from without

Expenses

Philippine Gross Income x Unallocated = allocated

Worldwide Gross Income Expenses to income from within


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C. QUICK GLANCE

Item of Income Test of Source of Income

Interest Residence of the debtor

Income from Services Place of performance10

Rental Location of the property

Royalty Place of use of the intangible

Gain on Sale of Real Property Location of the property sold

Gain on Sale of Personal Property (EXCEPT: - Shares of a domestic corporation - Personal property produced (in whole or in

part) by the taxpayer within and sold without the Philippines [or vice versa])

Place of sale

Gain on Sale of Domestic Shares Always income from within

Gain on sale of personal property produced (in whole or in part) by the taxpayer within and sold without the Philippines [or vice versa]

Partly from without and partly from within

Dividends a. From Domestic Corporation

Income from within

b. From Foreign Corporation Income from WITHIN, IF at least 50% of its gross income for the previous 3-year period was derived from sources within the Philippines. [entire income considered as income from within]

HOWEVER, if less than 50% of its gross income for the previous 3-year period was derived from sources within the Philippines, considered as partly within and partly without. Income within computed using this formula: Philippine Gross Income* x Dividend= Income Within Worldwide Gross Income* NOTE: * àààà of the corporation giving the dividend

10 Regardless of the residence of the payor, of the place in which the contract for service was made, or of the place of payment.


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Taxable = Ordinary + net capital net income net income gains

IX. GROSS INCOMEIX. GROSS INCOMEIX. GROSS INCOMEIX. GROSS INCOME A. Basic Principles

Gross Income à means all income derived from whatever source11, including (but not limited to) the following items: (TRIP CARD GPP)

1. Gross income derived from the conduct of TRADE or business or the exercise of a profession

2. RENTS 3. INTERESTS 4. PRIZES and winnings 5. COMPENSATION for services in

whatever form paid, including, but not limited to fees, salaries, wages, commissions, and similar items

6. ANNUITIES 7. ROYALTIES 8. DIVIDENDS 9. GAINS derived from dealings in property 10. PENSIONS 11. PARTNER'S distributive share from the

net income of the general professional partnership (GPP)

Ø The term “gross income” whenever used

without qualification, is comprehensive, as defined above, and is different from the limited meaning of gross income for purposes of minimum corporate income tax or the gross income tax of corporations.

B. Supplementary Discussion on Some Items Included in Gross Income

1. Compensation Income a. income arising from an ER-EE relationship.

It means all remuneration for services performed by an EE for his ER, including the cash value of all remuneration paid in any medium other than cash. [Sec. 78(A)] It includes: 1. Salaries and wages 2. Commissions 3. Tips 4. Allowances 5. Bonuses 6. Fringe Benefits of rank and file EEs

b. It does NOT include remuneration paid:

§ For agricultural labor paid entirely in

products of the farm where the labor is performed, or

§ For domestic service in a private home, or

§ For casual labor not in the course of the

employer's trade or business, or § For services by a citizen or resident of the

Philippines for a foreign gov’t or an int’l

organization. [Sec. 78(A)]

Withholding Tax on Compensation Income à The income recipient (i.e., EE) is the

person liable to pay the tax income, yet to improve the collection of compensation income of EEs, the State requires the ER to withhold the tax upon payment of the compensation income.

11 It does not include income excluded or exempted by law.

Fringe Benefits of Rank and File EEs Basic Rule: Convenience of the ER Rule If meals, living quarters, and other facilities and privileges are furnished to an employee for the convenience of the employer, and incidental to the requirement of the employee’s work or position, the value of that privilege need not be included as compensation.

2. Gains Derived From Dealings In

Property – Dealings in property such as sales or exchanges may result in gain or loss. The kind of property involved (i.e., whether the property is a capital asset or an ordinary asset) determines the tax

implication and income tax treatment, as follows:

ORDINARY ASSET

CAPITAL ASSET***

Gain from sale or exchange

Ordinary Gain Capital Gain

Loss from sale or exchange

Ordinary Loss Capital Loss

Excess of Gains over the Losses

[goes into computation

of] Ordinary Net

Income

Net Capital Gain

*** à (except shares of stock not listed nor traded in a local stock exchange and real property subject to capital gains tax)

• If the asset involved is classified as ordinary, the entire amount of the gain from the transaction shall be included in the computation of gross income [Sec 32(A)], and the entire amount of the loss shall be deductible from gross income. [Sec 34(D)]. (See XI. Allowable Deductions from Gross Income - Losses)

• If the property sold is a capital asset (except shares of stock not listed nor traded in a local stock exchange and real property subject to capital gains tax), the rules on capital gains and

losses apply in the determination of the amount to be included in gross income. (See XIII Capital Gains and Losses)

• Computation of Gain or Loss [Sec.

40(A)]:

Note: Amount realized from sale or other disposition of property = sum of money received + fair market value of the property (other than money) received

Amount realized from sale or other disposition of property

Less: basis or adjusted basis_____ ____ GAIN (LOSS)


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§ In computing the gain or loss from the sale or other disposition of property, the BASIS shall be as follows: 1. Property acquired by purchase –

its cost, i.e., the purchase price plus expenses of acquisition.

2. Property which should be included

in the inventory – its latest inventory value [RR-2 sec 136]

3. Property acquired by devise,

bequest or inheritance – its fair market price or value as of the date of acquisition

4. Property acquired by gift or

donation – the same as if it would be in the hands of the donor or at last preceding owner by whom it was not acquired by gift, EXCEPT that if such basis is greater than the FMV of the property at the time of the gift then, for the purpose of determining loss, the basis shall be such FMV

5. Property (other than capital asset)

acquired for less than an adequate

consideration in money’s worth – a) the amount paid by the transferee for the property; or b) the transferor’s adjusted basis at the time of the transfer whichever is greater

6. Property acquired in a transaction

where gain or loss not recognized – The basis shall be the same as it would have been in the hands of the transferor increased by the amount of gain recognized by the transferor on the transfer.

3. Interest Income – e.g., Interest income

from government securities such as Treasury Bills

4. Rental Income – • Actual rent itself àààà included in gross

income (taxable) • Payments by lessee of obligations

of lessor to third persons àààà

considered as additional rent income of the lessor, and therefore included in gross income (taxable).

• Advance Rentals àààà Receipt of advance rentals by the lessor may or may not constitute taxable income to him depending on the true nature of the so-called advance rentals. o If the advance rental is in the

nature of prepaid rent (for the lessee), received by the lessor under a claim of right and without restriction as to use, the entire amount is taxable income of the lessor in the year received.

o If the amount received is in the nature of a security deposit for the faithful compliance by the lessee of the terms of the contract, there is no income to the lessor unless the conditions which make the security deposit the property of the lessor occur (i.e., the lessee violates the terms of the lease agreement)

5. Dividends – Any dividend which is not exempt from income tax, or which is not subject to final tax, is taxable dividend included in the computation of the taxable income (gross income) in the income tax return at the end of the year.

NOTE: Liquidating Dividend – distribution of all the property of a corporation. It is strictly not dividend income, but rather a sale of shares of stock resulting in capital gain or loss.

6. Annuities – income derived from a capital

amount paid to an insurance company.

7. Pensions – paid for past employment services rendered.

8. Cancellation of debt – The cancellation or

forgiveness of indebtedness may have any of three possible consequences: 1. It may amount to payment of income.

If, for example, an individual performs services to or for a creditor, who, in consideration thereof, cancels the debt, income in that amount is realized by the debtor as compensation for personal services.

2. It may amount to a gift. If a creditor wishes merely to benefit the debtor, and without any consideration therefore, cancels the debt, the amount of the debt is a gift to the debtor and need not be included in the latter’s report of income.

3. It may amount to a capital transaction. If a corporation to which a stockholder is indebted forgives the debt, the transaction has the effect of a payment of dividend.

9. Prizes and Awards – Contest prizes and awards received are generally taxable. Such payment constitutes gain derived from labor. The EXCEPTIONS are as follows:

• Prizes and awards received in

recognition of religious, charitable, scientific, educational, artistic, literary or civic achievements are EXCLUSIONS from gross income if: a. The recipient was selected without

any action on his part to enter a contest or proceedings; and

b. The recipient is not required to render substantial future services as a condition to receiving the prize or award.

• Prizes and awards granted to athletes in local and int’l sports competitions and tournaments held in the Philippines and abroad and sanctioned by their national associations shall be EXEMPT from income tax.

10. Damage recovery –

• Compensatory damages, as constituting returns of capital, are not taxable. Thus, amounts received as moral damages for personal actions (such as alienation of affection, libel, slander or


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breach of promise to marry) are not taxable.

• Recovered damages representing recoveries of lost profits are taxable, just as profits are taxable in the regular course of business. Thus, damages recovered in patent infringement suits are taxable.

11. Bad Debt Recovery – Tax Benefit Rule – Bad debts claimed as a deduction in the preceding year(s) but subsequently recovered shall be included as part of the taxpayer’s gross income in the year of such recovery to the extent of

the income tax benefit of said deduction. There is an income tax benefit when the deduction of the bad debt in the prior year resulted in lesser income and hence tax

savings for the company. (Sec. 4, RR 5-99)

Illustration:

Case A Case B Case C

Year 1

Gross Income 500,000

400,000

500,000

Less: Allowable Deductions (before write-off of Uncollectible Accounts/Debts)

(200,000)

(480,000)

(495,000)

Taxable Income (Net Loss) before write-off

300,000

(60,000)

5,000

Deduction for Accounts Receivable written off

(2,000)

(2,000)

(6,000)

Taxable Income (Net Loss) after write-off

298,000

(62,000)

(1,000)

Year 2 Recovery of Amounts Written Off

2,000

2,000

6,000

Taxable Income on the Recovery

2,000 - 5,000

Explanation:

§ In Case A, the entire amount recovered (P2,000) is included in the computation of gross income in Year 2 because the taxpayer benefited by the same extent. Prior to the write-off, the taxable income was P300,000; after the write-off, the taxable income was reduced to P298,000.

§ In Case B, none of the P2,000 recovered would be recognized as gross income in Year 2. Note that even without the write-off, the taxpayer would not have paid any income tax anyway. The “taxable income” before the write-off was actually a net loss.

§ In Case C, only P5,000 of the P6,000 recovered would be recognized as gross income in Year 2. It was only to this extent that the taxpayer benefited from the write-off. The taxpayer did not benefit from the extra P1,000 because at this point, the P1,000 was already a net loss.

12. Tax Refund – As a general rule, a refund

of a tax related to the business or the practice of profession, is taxable income (e.g., refund of fringe benefit tax) in the year of receipt to the extent of the income tax benefit of said deduction (i.e., the tax benefit rule applies). However, the following tax refunds are not to be included in the computation of gross income: (EXCEPTIONS) (CAP–IF–FED–VAT) 1. Philippine income tax, except the

fringe benefit tax 2. Income tax imposed by authority of

any foreign country, if the taxpayer claimed a credit for such tax in the year it was paid or incurred.

3. Estate and donor’s taxes 4. Taxes assessed against local benefits

of a kind tending to increase the value of the property assessed (Special assessments)

5. Value Added Tax 6. Fines and penalties due to late

payment of tax 7. Final taxes 8. Capital Gains Tax

è The enumeration of tax refunds that are

not taxable (income) is derived from an

enumeration of tax payments that are not

deductible from gross income. If a tax is

not an allowable deduction from gross

income when paid (no reduction of taxable

income, hence no tax benefit), the refund

is not taxable.

X. EXCLUSIONS FROM GROSS X. EXCLUSIONS FROM GROSS X. EXCLUSIONS FROM GROSS X. EXCLUSIONS FROM GROSS

INCOMEINCOMEINCOMEINCOME [Sec. 32(B)]

The following are excluded from gross income: (GIRL CRM) 1. LIFE Insurance General rule: The proceeds of life

insurance policies paid to heirs or beneficiaries upon the death of the insured - Reason: Insurance is a contract of

indemnity; hence, the proceeds should be treated as indemnity and not as gain or income.

Exception: If such amounts are held by

the insurer under an agreement to pay interest thereon, the interest payments shall be included in gross income.

2. Amount Received by Insured as

RETURN of Premium General rule: The amount received by the

insured, as a return of premiums paid by him under life insurance, endowment, or annuity contracts, either during the term or at the maturity of the term mentioned in the contract or upon surrender of the contract - Reason: This is a return of capital and

not income.

Exception: If the amounts received by the insured (when added to the amounts already received before the taxable year under such contract) exceed the aggregate


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premiums or considerations paid (whether or not paid during the taxable year), then the excess shall be included in gross income. (source unknown)

3. GIFTS, Bequests, and Devises General rule: The value of property

acquired by gift, bequest, devise, or descent. - Reason: These transactions are

subject to transfer taxes – estate or donor’s taxes.

Exception: Income from such property, as

well as gift, bequest, devise or descent of income from any property, in cases of transfers of divided interest, shall be included in gross income.

4. COMPENSATION for Injuries or

Sickness The amounts received as compensation for

personal injuries or sickness, plus the amounts of any damages received, whether by suit or agreement, on account of such injuries or sickness.

5. INCOME Exempt under Treaty Income of any kind, to the extent required

by any treaty obligation binding upon the Government of the Philippines.

6. RETIREMENT Benefits, Pensions,

Gratuities, etc.- a. Retirement benefits received under

RA 7641 and those received by officials and employees of private firms in accordance with a reasonable private benefit plan maintained by the employer.

o REQUISITES:

i. The retiring employee has been in the service of the same employer for at least 10 years.

ii. The retiring employee is not less than 50 years of age at the time of his retirement

iii. The benefits shall be availed of by an employee only once.

iv. That there be a reasonable private benefit plan as defined below.

o 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

§ wherein contributions are made by such employer for the employees

§ for the purpose of distributing to such employees the earnings and principal of the fund thus accumulated and

§ wherein it is provided in the plan that at no time shall any part of the corpus or income of the fund be used for, or be diverted to, any purpose other than for the

exclusive benefit of the said officials and employees.

b. Any amount received by an employee

or by his heirs from the employer as a consequence of separation of such official or employee from the service of the employer because of o death o sickness o other physical disability or o for any cause beyond the

control of the employee (i.e., the separation of the employee must be involuntary and not initiated by him)

c. The social security benefits,

retirement gratuities, pensions and other similar benefits received by resident or nonresident citizens of the Philippines or aliens who come to reside permanently in the Philippines from foreign government agencies and other institutions

d. Payments of benefits due or to become

due to any person residing in the Philippines under the laws of the United States administered by the United

States Veterans Administration

e. Benefits received from or enjoyed under the Social Security System

f. Benefits received from the GSIS,

including retirement gratuity received by government officials and employees

è CASE LAW:

§ BIR Ruling 125-98: The phrase "shall not have availed of the privilege under a retirement benefit plan of the same or another employer" found in Sec. 32 (B) (6) (a) of the Tax Code means that the retiring official or employee must not have previously received retirement benefits from the same or another employer who

has a qualified retirement benefit plan.

§ BIR Ruling 143-98: The terminal leave pay of government employees whose employment is coterminous is

exempt since it falls within the meaning of the phrase "for any cause beyond the control of the said official or employee" found in Sec. 32(B).

7. MISCELLANEOUS Items a. Income Derived by Foreign

Government Income derived from (1) investments in

the Philippines in domestic securities (loans, stocks, bonds, etc.) or from (2) interest on deposits in banks in the Philippines by

i. foreign governments ii. financing institutions owned,

controlled, or enjoying refinancing from foreign governments, and


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iii. international or regional financial institutions established by foreign governments.

b. Income Derived by the Government

or its Political Subdivisions 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 Awards Prizes and awards made primarily in

recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement but only if:

i. recipient was selected without any action on his part to enter the contest or proceeding and

ii. recipient is not required to render substantial future services as a condition to receiving the prize or award

• d. Prizes and Awards in Sports

Competition • All prizes and awards granted to

athletes (1) in local and international sports competitions and (2) sanctioned by their national sports associations.

e. 13th Month Pay and Other Benefits Gross benefits received by employees

of public and private entities provided that the total exclusion shall not exceed P30,000 which shall cover:

i. Benefits received by government employees under RA 6686

ii. Benefits received by employees pursuant to PD 851 (13th Month Pay Decree)

iii. Benefits received by employees not covered by PD 851 as amended by Memorandum Order No. 28 and

iv. Other benefits such as productivity incentives and Christmas bonus

è What happens if the benefits exceed P30,000? à The amount in excess of P30,000 will be considered as compensation income.

f. GSIS, SSS, Medicare and Other

Contributions GSIS, SSS, Medicare and Pag-ibig

contributions, and union dues of individuals

g. Gains from the Sale of Bonds,

Debentures or other Certificate of Indebtedness

Gains realized from the sale or exchange or retirement of bonds, debentures or other certificate of indebtedness with a maturity of more than 5 years.

h. Gains from Redemption of Shares in Mutual Fund

Gains realized by the investor upon redemption of shares of stock in a mutual fund company

XI. ALLOWABLE DEDUCTIONS FROM XI. ALLOWABLE DEDUCTIONS FROM XI. ALLOWABLE DEDUCTIONS FROM XI. ALLOWABLE DEDUCTIONS FROM

GROSS INCOMEGROSS INCOMEGROSS INCOMEGROSS INCOME The term ‘taxable income’ means the pertinent items of gross income specified in the National Internal Revenue Code [Sec. 32], less the deductions [Sec. 34] and/or personal and additional exemptions [Sec. 35], if appropriate, authorized for such types of income by the Code or other special laws. [Sec. 31] A. Basic Principles Governing Tax

Deductions • He who claims it must point to the specific

provision of the statute authorizing it, and he must be able to prove that he is entitled to it.

• If the exemption is not expressly stated in the law, the taxpayer must at least be within the purview of the exemption by clear legislative intent. However, if there is an express mention in the law or if the taxpayer falls within the purview of the exemption by clear legislative intent, the rule on strict construction against the taxpayer-claimant will not apply.

• Unlike gross income, there is no catch-all provision for deductions.

• Deductions must comply with the substantiation requirement.

B. Kinds of Deductions

1. Itemized Deductions à business (or professional) expenses which are ordinary and necessary in the conduct of business (or in the exercise of profession)

2. Optional Standard Deduction (OSD) à

may be taken by an individual, in lieu of itemized deductions [Section 34(L)] REQUISITES: a. Available only to citizens and resident

aliens b. The standard deduction is optional;

i.e., unless the taxpayer signifies in his return his intention to elect this deduction, he is considered as having availed of the itemized deductions.

c. Such election, when made by the qualified taxpayer, is irrevocable for the year in which made; however, he can change to itemized deductions in succeeding years.

*Since an individual in business or in

the practice of profession is required

to file quarterly income tax returns,

can he choose the OSD in his quarterly

returns and then choose the itemized

deductions in his annual income tax

return, or vice versa? YES, the OSD or Itemized Deductions is against the gross income of the year. Quarterly income tax returns are only interim computations on the taxable income for the year.


TAXATION LAW 1

d. The amount of standard deduction is limited to ten percent (10%) of the taxpayer’s gross income. [However, OSD is not available against compensation income arising out of an employer-employee relationship. (Sec. 34, 1st par.)] *NOTE: The Gross Income base of OSD is – § For an individual in a

manufacturing or merchandising concern: gross income (or profit) from sales [i.e., sales less cost of sales], and incidental income, if any

§ For an individual whose income is from the sale of services: gross income (or profit) from sale of services [i.e., gross receipts less direct cost of services], and incidental income, if any

e. Proof of actual expenses is not

required, but the taxpayer should keep records pertaining to his gross income during the taxable year.

C. Who can avail of deductions? GENERAL RULE: All taxpayers EXCEPTION: Those earning compensation

income arising from personal services rendered under an employer-employee relationship

Rules: 1. Compensation income earners can avail

themselves only of the deduction in Sec. 34 (M), i.e., premium payments on health and/or hospitalization insurance (in addition to the appropriate personal exemption).

2. The following can claim ITEMIZED deductions: a. Corporations, whether domestic or

(resident) foreign b. General Professional Partnerships c. Individuals engaged in trade,

profession or business (citizen, resident alien, non-resident alien doing business in the Philippines)

d. Estates and trusts engaged in trade or business

e. Proprietary educational institutions and hospitals (non-profit)

f. Government-owned or controlled corporations

3. Only individuals, EXCEPT non-resident aliens, can elect between itemized deductions and OPTIONAL STANDARD DEDUCTION.

QUICK GLANCE The following are the deductions from gross income: v For individuals with gross

compensation income only: - Premium payments on health and/or

hospitalization insurance (if requisites are complied with)

- Personal Exemptions v For individuals with gross income

from business or practice of profession:

- Optional Standard Deduction [OR] Itemized Deductions

- Premium payments on health and/or hospitalization insurance (if requisites are complied with)

- Personal Exemptions v For corporations, general professional

partnerships, estates and trusts engaged in business, proprietary educational institutions and hospitals

(non-profit), and government-owned or controlled corporations - Itemized Deductions

D. Kinds of Itemized Deductions (BELT DID

CPR)

1. Expenses 2. Interest 3. Taxes 4. Losses 5. Bad debts 6. Depreciation 7. Depletion 8. Charitable and Other Contributions 9. Research and Development 10. Pension Trust

E. Expenses [Sec. 34(A)]

Ø Only deduction allowable à Ordinary and necessary trade, business or professional expenses

Ø REQUISITES: (SPOD RYN)

1. It must be ORDINARY AND necessary. • “Ordinary” - expense which is

normal in relation to the taxpayer’s business and the surrounding circumstances. The expense need not be recurring.

• “Necessary” – where the expenditure is appropriate or helpful in the development of the taxpayer’s business or that the same is proper for the purpose of realizing a profit or minimizing a loss.

è The TWO CONDITIONS MUST CONCUR. A court may decide on when an expense is, or is not, ordinary, but as much as possible, it will refuse to substitute its judgment for that of the taxpayer on the necessity of an expense.

2. It must be paid or incurred during the taxable YEAR.

3. It must be paid or incurred in carrying on or which are DIRECTLY attributable to, the development,

management, operation and/or

conduct of the trade, business or

exercise of a profession. 4. The amount must be REASONABLE. 5. It must be SUBSTANTIATED with

sufficient evidence, such as official receipts or other adequate records, showing: i. the amount of the expense being

deducted, and ii. the direct connection or relation of

the expense being deducted to the development, management, operation and/or conduct of the


TAXATION LAW 1

trade, business or profession of the taxpayer.

6. It is NOT CONTRARY to law, public policy or morals.

7. The tax required to be withheld on the amount paid or payable must have been PAID to the BIR by the taxpayer, who is constituted as a withholding agent of the government (for instance, withholding tax on compensation income paid to employees, fringe benefit tax on fringe benefits given to managerial and supervisory employees, etc.). (Sec. 2.58.5, RR 2-98 as amended by Sec. 6, RR 14-2002)

Ø EXAMPLES: (CERT)

1. Salaries, wages, and other forms of compensation for personal services

actually rendered, including the grossed-up monetary value (GMV) of fringe benefit furnished by the employer to the employee

2. Travel expenses, here and abroad, while away from home in the pursuit of trade, business or profession

3. Rentals and/or other payments which are required as a condition for the continued use or possession, for purposes of the trade, business or profession, of property to which the taxpayer has not taken or is not taking title or in which he has no equity other than that of a lessee, user or possessor

4. Entertainment, amusement and

recreation expenses that are directly connected to the development, management and operation of the trade, business or profession of the taxpayer, or that are directly related to or in furtherance of the conduct of his or its trade, business or exercise of a profession

§ Representation Expenses [Sec. 2,

RR 10-2002] – incurred by a taxpayer in connection with the conduct of his trade, business or exercise of profession, in entertaining, providing amusement and recreation to, or meeting with, a guest or guests at a dining place, place of amusement, country club, theater, concert, play, sporting event, and similar events or places.

§ Ceiling [Sec. 5, RR 10-2002] à The amount of actual entertainment, amusement and recreation expense paid or incurred within the taxable year by the taxpayer, but in no case shall such deduction exceed:

- For taxpayers engaged in sale of goods or properties: 0.5% of net sales (i.e., gross sales less sales returns/allowances and sales discounts)

- For taxpayers engaged in sale of services, including exercise of

profession and use or lease of properties: 1.0% of net revenue (i.e., gross revenue less discounts)

Ø Bribes, Kickbacks and Other Similar

Payments – No deduction shall be allowed for any payment made, directly or indirectly, to an official or employee of the national or local government, government-owned or -controlled corporation, or foreign government, or to a private corporation, general professional partnership, or a similar entity, if the payment constitutes a bribe or kickback.

Ø SPECIAL CASE: Expenses Allowable to

Private Educational Institutions [Sec. 34(2), RR 10-2002] à In addition to the expenses allowable as deductions, a private educational institution may at its option elect either: 1. to deduct expenditures otherwise

considered as capital outlays of depreciable assets incurred during the taxable year for the expansion of school facilities, or

2. to deduct allowance for depreciation thereof.

F. Interest [Sec 34(B)] Ø Deduction Allowable à The amount of

interest paid or incurred within a taxable year on indebtedness in connection with the taxpayer's profession, trade or business shall be allowed as deduction from gross income.

Ø REQUISITES (Sec. 34(B) as

implemented by Sec. 6, RR 13-2000): (WITTY CReP DL) 1. There is an INDEBTEDNESS. 2. The indebtedness is that of the

TAXPAYER. 3. The indebtedness is connected with

the taxpayer’s TRADE, profession, or business.

4. The interest must be legally DUE. 5. The interest must be stipulated in

WRITING. 6. The taxpayer is LIABLE to pay

interest on the indebtedness. 7. The indebtedness must have been

paid or accrued during the taxable YEAR.

8. The interest payment arrangement must not be between ReLATED taxpayers as mandated in Sec. 34(B)(2)(b), in relation to Sec. 36(B), both of the Tax Code of 1997.

9. The interest must not be incurred to finance PETROLEUM operations.

10. In case of interest incurred to acquire property used in trade, business or exercise of profession, the same was not treated as a CAPITAL expenditure,

Ø LIMITATION: The taxpayer's allowable

deduction for interest expense shall be reduced by an amount equal to 42% of the interest income subjected to final tax;


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provided, that effective January 1, 2009, the percentage shall be 33%.12

Purpose: To prevent tax arbitrage or the use of back- to-back loans to take advantage of the difference between the tax rate on interest income (20% final tax) and the rate of savings caused by the deduction of interest expense (35%-corporate rate)

ILLUSTRATION: On Jan. 1, 2007, A Corp borrowed P100,000 from B Bank at a rate of 10% per annum. On the same day A Corp. deposited the same amount to C Bank at 10% interest p.a. By the end of the year A Corp would have P10,000 interest income from C Bank, and P10,000 interest expense payable to B Bank. If not for the 42% limitation, the 2 transactions would result in tax savings for A Corp as follows:

Tax savings from deduction of interest expense (P10,000 x 35%

3,500

Less: Final tax on interest income (P10,000 x 20%)

2,000

Net Tax savings 1,500

Applying the limit, A corp.’s deductible interest expense would be:

Actual interest expense 10,000

Less: 42% of interest income

4,200

Deductible interest expense

5,800

Due to the limitation, the tax savings will be reduced from P 1,500 to P 30:

Tax savings on interest expense deduction (P 5,800 x 35%)

2,030

Less: Final Tax on interest income

2,000

Net Tax Savings 30

§ When is the limitation not

applicable? Interest incurred or paid by the taxpayer on all its business related taxes shall be fully deductible from gross income unpaid and shall not be subject to the limitation on deduction. Thus, such interest expense incurred or paid shall not be diminished by the percentage of interest income earned which had been subjected to final withholding tax. (Sec. 4(c), RR 13-2000)

Ø NON-DEDUCTIBLE INTEREST (Sec. 34(B)(2)(b) as implemented by Sec. 4(d), RR 13-2000) 1. Interest paid in advance by the

taxpayer who reports income on cash basis

§ When allowed as deduction: in the year the indebtedness is paid.

§ If the indebtedness is payable in periodic amortizations, the amount of

12 As amended by RA 9337

interest which corresponds to the amount of the principal amortized or paid during the year shall be allowed as deduction in such taxable year.

2. Interest payments made: (between related taxpayers [persons specified under Section 36 (B), see discussion on losses below-Subsection H]

3. Interest on indebtedness incurred to finance petroleum exploration

Ø OPTIONAL TREATMENT OF INTEREST

EXPENSE: At the option of the taxpayer, interest incurred to acquire property used in trade, business or exercise of a profession may be either (1) allowed as a DEDUCTION or (2) treated as a CAPITAL EXPENDITURE.

ILLUSTRATION: Mr. A wanted to acquire a delivery van worth P1,000,000 for his business. To finance this, he borrowed P1,000,000 from ABC Bank on January 1, 2005. The loan bears interest of 10%, and both the interest and principal are payable on December 31, 2005. For income tax purposes, how should Mr. A account for his interest expense in 2005? ANSWER: Mr. A has two options. First, he may choose to treat the P100,000 (10% of P1,000,000) interest expense As amended by RA 9337 as an outright deduction from his gross income in 2005 (which deduction shall be subject to the limitation that it be reduced by an amount equal to 42% of the taxpayer’s interest income subjected to final tax). Alternatively, he may choose to capitalize the interest expense by incorporating its amount to the cost of the vehicle obtained for his business. In this case, the vehicle will be recorded in his books at a cost of P1,100,000 (purchase price of P1,000,000 plus the interest expense of P100,000). The total cost of the vehicle will then be gradually allowed as deduction from the gross income of the succeeding taxable years as depreciation expense.

G. Taxes [Sec. 34(C)]

Ø Definition: The word ‘taxes’ means taxes proper and no deduction should be allowed for amounts representing interest, surcharge, or penalties incident to delinquency. (Sec. 80, RR-2)

Ø GENERAL RULE: All taxes, national or

local, paid or incurred during the taxable year in connection with the taxpayer's profession, trade or business, are deductible from gross income

Ø EXCEPTIONS:

§ Philippine income tax, except the fringe benefit tax

§ Income tax imposed by authority of any foreign country § Except when the taxpayer does

NOT signify his desire to avail of the tax credit for taxes of foreign countries, in which case the


TAXATION LAW 1

amount may be allowed as a deduction subject to the limitations set forth by law. (Note that a taxpayer qualified to take tax credits for foreign income taxes paid or incurred may alternatively claim them as deductions from gross income.)

§ Estate and donor’s taxes § Taxes assessed against local benefits

of a kind tending to increase the value of the property assessed (Special Assessments)

§ Value Added Tax § Fines and penalties due to late

payment of tax § Final taxes § Capital Gains Tax

Ø REQUISITES: (TEDY)

1. It must be paid or incurred within the taxable YEAR.

2. It must be paid or incurred in

connection with the taxpayer’s TRADE, profession or business.

3. It must be imposed DIRECTLY on the taxpayer.

4. It must not be specifically EXCLUDED by law from being deducted from the taxpayer’s gross income.

Ø EXAMPLES:

§ Import duties § Business taxes § Occupation taxes § Privilege and license taxes § Excise taxes § Documentary stamp taxes § Automobile registration fees § Real property taxes

Ø LIMITATION: In the case of a

nonresident alien individual engaged in trade or business (NRAETB) and a resident foreign corporation (RFC), the deductions for taxes shall be allowed only if and to the extent that they are connected with income from sources within the Philippines.

Ø Special Treatment of Foreign Income

Tax: A taxpayer qualified to take tax credits for foreign income taxes paid or incurred may alternatively claim them as deductions from gross income.

§ What is tax credit? A credit for

foreign income tax paid or incurred reduces the Philippine income tax that should be paid. Tax credit is given to a taxpayer in order to provide relief from too onerous a burden of taxation where the same income is subject to both foreign income tax and the Philippine income tax. In determining the tax credit that may be allowed a taxpayer, the foreign income tax should be understood to mean tax proper only; no credit shall be taken for any amount paid or incurred to the foreign country which represents interest, surcharge or penalty incident

to delinquency on the payment of the tax. In taking a tax credit:

Tax credit is taken for –

The foreign income tax

Tax credit is taken against –

The Philippine income tax

§ Who can claim a tax credit, and in

what amount13? 1. The amount of income taxes paid

or incurred during the taxable year to any foreign country a. Citizens b. Domestic corporations

2. The taxpayer’s proportionate share of such taxes of the general professional partnership/estate or trust paid or incurred during the taxable year to a foreign country, if his distributive share of the income of such partnership/estate or trust is reported for taxation a. Members of general

professional partnerships b. Beneficiaries of estates or

trusts

§ Who may NOT claim a tax credit?

1. Alien individuals 2. Foreign corporations

§ Substantiation requirements: The

tax credits shall be allowed only if the taxpayer establishes to the satisfaction of the Commissioner the following: 1. The total amount of income

derived from sources without the Philippines;

2. The amount of income derived from each country, the tax paid or incurred to which is claimed as a credit under said paragraph, such amount to be determined under rules and regulations prescribed by the Secretary of Finance; and

3. All other information necessary for the verification and computation of such credits.

§ Limitations: The amount of tax credit allowed is equivalent to the tax paid or incurred to a foreign country during the taxable year but not to exceed the following limits: 1. [Per Country Limit] The amount

of tax credit shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer's taxable income from sources within such country bears to his entire taxable income for the same taxable year; and

2. [Worldwide Limit] The total amount of the credit shall not exceed the same proportion of the tax against which such credit is taken, which the taxpayer's taxable income from sources

13 Amounts are subject to the limitations (per country and

overall) set forth by law.


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without the Philippines taxable bears to his entire taxable income for the same taxable year.

i.e.:

è NOTE: The second limitation applies where the taxpayer derives income from more than one foreign country.

ILLUSTRATION: D Co., a domestic corporation, had the following data for a year on taxable income and income taxes paid: Taxable Income, Country A P200,000 Taxable Income, Country B P100,000 Taxable Income, Philippines P700,000 Income Tax Paid – Country A

P 60,000

Income Tax Paid – Country B

P 38,000

What is the Philippine income tax still due, after credit for foreign income taxes? Should D Co. choose to treat income taxes paid to foreign countries as deductions from gross income, what is its Philippine income tax?

Answer: Scenario A: Tax Credit option is chosen.

Step 1: Compute for total taxable

income and Philippine income tax

Taxable Income, Country A 200,000

Taxable Income, Country B 100,000

Taxable Income, Philippines 700,000

Total Taxable Income from sources within and without the Phils 1,000,000

Philippine Income Tax (P1Mx 35%)

350,000

Step 2: Compute for Limitation A (Per Country Basis). To get tax credit per country under Limitation A, this formula is followed:

The result after applying the formula above is compared to the tax actually paid for each foreign country. The lower of the two amounts for each foreign country will be added to get the total tax credit allowed under Limitation A.

Amount

Allowed

(Whichever is Lower)

Country A

Limitation A 70,000 60,000

(200/1000 x 350,000)

Actually paid to Country A

60,000

Country B

Limitation B 35,000 35,000

(100/1000 x 350,000)

Actually paid to Country B

38,000

Tax credit allowed under Limitation A

95,000

Step 3: Compute for Limitation B (Overall Basis). To get tax credit (overall basis) under Limitation B, this formula is followed:

The result after applying the formula above is compared to the tax actually paid in total to foreign countries. The lower of the two amounts will be added to get the total tax credit allowed under Limitation B.

Amount Allowed

(Whichever is Lower)

Overall Limit:

300/1000 x 350,000

105,000

Total foreign income taxes paid

98,000

Tax credit

allowed under Limitation B

98,000

Step 4: Compare the respective tax credits allowed under Limitation A and Limitation B. The lower of the two amounts is the final allowable tax credit. In this case, the amount computed under Limitation A (P95,000) is lower, thus it becomes the final allowable tax credit. Step 5: Compute for the income tax still due.

Philippine Income tax 350,000

Less: Allowable Tax Credit 95,000

Philippine Income Tax still due 255,000

Taxable Income from sources outside the Phils x Phil. income = tax Taxable Income tax credit from all sources

Taxable Income from Foreign Country x Phil. income = tax Taxable Income tax credit from all sources

2. Taxable Income for all Foreign Countries x Phil. income = limit Worldwide tax Taxable Income

1. Taxable Income per Foreign Country x Phil. income = limit Worldwide tax Taxable Income


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Scenario B: Deduction option is chosen.

Taxable Income, Country A

P 200,000

Taxable Income, Country B

100,000

Taxable Income, Phils. 700,000 Total Taxable Income

(before deduction for foreign income tax)

P1,000,000 Less: Deductions for Foreign Income Taxes Paid Country A – P60,000 Country B – P38,000

(98,000) Net Taxable Income P 902,000

Philippine Income Tax (902,000 x 35%)

P 315,700

H. Losses [Sec. 34(D)] Ø Losses actually sustained during the

taxable year and not compensated for by insurance or other forms of indemnity shall be allowed as deductions: § If incurred in trade, profession or

business; § Of property connected with the trade,

business or profession, if the loss arises from fires, storms, shipwreck, or other casualties, or from robbery, theft or embezzlement.

Ø REQUISITES: (CATT DID)

1. The loss must be that of the TAXPAYER. -The loss is personal to the taxpayer and is not transferable or usable by another. The loss of a predecessor partnership is not deductible by a successor corporation. The loss of the parent company may not be deducted by its subsidiary.

2. The loss must be ACTUALLY sustained and charged off within

the taxable year. -However, if the loss is compensated by insurance or otherwise, the loss is postponed to a subsequent year in which it appears that no compensation at all can be had, or there is a remaining net loss (or there is no full compensation). Deduction will be denied if there is a measurable right to compensation for the loss, with ultimate collection reasonably clear. So where there is reasonable ground for reimbursement, the taxpayer must seek his redress and may not secure a loss deduction until he establishes that no recovery may be had. In other words, the taxpayer must first exhaust his remedies to recover or reduce his loss. (Plaridel Surety and Insurance Co. v. Collector, 21 SCRA 1187)

3. The loss is evidenced by a CLOSED

and completed transaction.

§ There should be an identifiable event that fixes the loss. For instance, when a loss results from a sale, the consummation of the sale is the identifiable event that fixes the loss, and the deduction should be claimed in the year that the sale was consummated. A sale is consummated only when there is delivery.

4. The loss is not claimed as a DEDUCTION for estate tax purposes.

5. The loss must not be compensated by INSURANCE or other forms of indemnity.

6. The loss must be connected with the taxpayer’s TRADE, business or profession.

7. In the case of casualty loss, declaration of loss (Sworn DECLARATION of Loss) must be filed within 45 days from the occurrence of the casualty loss. (RR 12-77)

§ Despite concurrence of

requisites, when is loss nonetheless NOT deductible? In computing net income, no deductions shall in any case be allowed in respect of losses from sales or exchanges of property directly or indirectly [between related taxpayers (Sec. 36 (B) ] 1. Between members of a family

- ”Family” -includes brothers and sisters (whole and half-blood), spouse, ancestors, and lineal descendants

2. Between an individual and corporation more than fifty percent (50%) in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual; or

3. Between two corporations more than fifty percent (50%) in value of the outstanding stock of which is owned, directly or indirectly, by or for the same individual;

4. Between the grantor and a fiduciary of any trust;

5. Between the fiduciary of a trust and the fiduciary of another trust if the same person is a grantor with respect to each trust;

6. Between a fiduciary of a trust and beneficiary of such trust.

Ø Obsolescence and worthlessness;

when deductible § Obsolescence: when the property has

to be discarded permanently because its usefulness is suddenly terminated.

§ Worthlessness: when it can be satisfactorily shown that the property had indeed become valueless.

Ø Other Types of Losses Recognized by

the Tax Code § Shrinkage in Value of Stocks (Sec.

99, RR-2) à no loss can be deducted from a mere shrinkage in value of


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such stock through fluctuation of the market. The loss allowable in such case is that actually suffered when

the stock is disposed of. If stock of a corporation becomes worthless, its cost or other basis determined in accordance with Revenue Regulation 2-98 may be deducted by the owner in the taxable year in which the stock became worthless, provided a

satisfactory showing of its

worthlessness be made, as in the case of bad debts.

§ Wagering Losses [Sec. 34 (D)(6)]à Wagering losses are deductible only to the extent of wagering gains. Therefore, if there are no wagering gains, wagering loss cannot be deducted. [Wagering gains and losses - gains and losses from transactions where the outcome depends upon chance.]

§ Loss from Wash Sales of Stocks or

Securities [Sec. 38] à A loss from a wash sale of stock or securities is generally not deductible from gross income. A wash sale is a sale under the following circumstances: 1. There was a sale or other

disposition of stock or securities at a loss.

2. Within a period beginning thirty days before, and ending thirty days after, the date of sale or disposition (known as the sixty-one day period), there was an acquisition of shares or securities (or option to acquire shares or securities).

i.e.:

---------------- x ----------------

3. The acquisition, or option, should be a purchase or exchange upon which gain or loss is recognized under the income tax law.

4. The stock or securities acquired were substantially the same as those disposed of.

5. The taxpayer is NOT a dealer in securities.

à INCOME TAX RULE: On the shares sold at a loss with

covering acquisitions, NO LOSS shall be recognized. On the shares sold at a loss with no

covering acquisitions, CAPITAL LOSS shall be recognized (See XIII. Capital Gains and Losses, for the income tax treatment). The loss not recognized shall be adjusted into (i.e., added to) the basis of the shares acquired within the sixty-one day period.

ILLUSTRATION: S Co., not a dealer in securities, on December 27, 2000, sold for P90,000, 1,000 shares of common stock of ZZ Company, that it acquired on January 20, 2000 for P110,000. On January 5, 2001, or nine days after the sale, it acquired 900 shares of common stock of the same company for P90,000. On June 10, 2001, the latest acquisition was sold for P120,000.

INCOME TAX IMPLICATIONS: § There would have been a loss

not recognized of P18,000 on the sale of December 27, 2000.

§ There would have been a gain of P12,000 on the sale of June 10, 2001.

SUPPORTING SOLUTION:

a. Determine if the sale is a wash sale à YES, because nine days after the December 27, 2000 sale (or within the sixty-one day period), S. Co. (which is not a dealer in securities) acquired shares of stock which were the same as those disposed of.

b. Computation of loss not

recognized

Acquisition Cost P110,000

Less: Selling Price 90,000

Total Loss P 20,000

No. of shares sold at a loss 1,000

Less: Number of shares acquired within the 61-day period

900

No. of shares acquired with no matching acquisition

100

Loss on a wash sale, not recognized

(900/1,000 * 20,000) P18,000

Capital Loss recognized

(100/1,000 * 20,000) P2,000

c. Computation of basis of the

shares acquired on January 5, 2001 (i.e., adjusted cost).

Acquisition Cost P 90,000

Add: Loss not recognized

18,000

Basis of the shares acquired on January 5, 2001

P108,000

d. Computation of the gain on

the sale of June 10, 2001

Selling Price P120,000

Less: Adjusted Basis

108,000

Gain on the Sale 12,000

30 days PRIOR OR 30 days AFTER to the sale the sale

Date of sale

Acquisition occurred EITHER:


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What if the taxpayer is a dealer in securities, and the transaction

from which the loss resulted, was made in the ordinary course of the business of such dealer? à The loss is deductible in full.

§ Corporate readjustment: Merger or

Consolidation14 [Sec. 40(C)] A merger or consolidation has income

tax consequences to the corporation which is a party to the merger or consolidation, to its stockholders, and to its security holders. To the corporation, or to its stockholders, or to its security holders, loss is not recognized from the merger or consolidation.

ILLUSTRATION: Y Co. was merged into Z Co. Y Co. transferred its properties with a book value of P2,000,000 to Z Co., for which it received shares of stock of Z Co. with a fair market value of P1,800,000. Mr. AA was a stockholder of Y Co., and he was asked to surrender his shares in Y Co. (which he acquired at a cost of P200,000) to the company (Y Co.), and received in return for the shares surrendered, shares of stock of Z Co. with a fair market value of P180,000. The merger had the following tax consequences:

To Y Co.

Fair Market Value of shares of Z Co. received

P1,800,000

Less: Book Value of properties transferred

2,000,000

Loss not recognized P 200,000

To Mr. AA:

Fair Market Value of Z Co. shares received

P 180,000

Less: Cost of Y Co. shares surrendered

200,000

Loss not recognized P18,000

Suppose a merger or consolidation resulted in a GAIN to the corporation, or

stockholder, or security holder, will the gain be recognized?

14 No gain or loss shall be recognized if in pursuance of a plan

of merger or consolidation - (a) 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; [property for stock] or

(b) 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; [stock for stock ] or

(c) 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 such corporation, a party to the merger or consolidation. [securities for securities]

à Gain will be recognized only if, on the exchange under the merger or consolidation, the taxpayer received cash or property. The gain to be recognized should not exceed the sum of money and the fair market value of the property received.

§ Corporate readjustment: Transfer to

Controlled Corporation [Sec. 40(C)] When a taxpayer transfers property to a corporation, in consideration of stock received for the transfer, as a result of which transfer, the taxpayer (alone or together with others not exceeding four [or a total of five]) gains control of the corporation15, no loss is recognized on the transfer of property.

Suppose the transfer resulted in

a GAIN to the transferor, will the gain be recognized? à Gain will be recognized only if on the transfer, the taxpayer received cash or property in addition to the shares received. The gain to be recognized shall not exceed the sum of money and fair market value of the property received.

è If before the transfer to the corporation, the transferor

already had control over the corporation, the gain or loss on the transfer will be recognized.

ILLUSTRATION: Mr. II transferred property to JJ Co., of which he had control. The property had a basis to him of P500,000. JJ Co. paid him with shares of stock with a fair market value of P450,000. Will there be a loss to recognize? Yes. This transfer does not qualify as a corporate readjustment.

BIR Ruling 383-87 (Nov. 25, 1987): Requirements for deductibility 1. Plan of reorganization should be

adopted by each of the corporation shown by acts of its duly constituted officers o Copy of the plan o Complete statement of the

cost or other basis of all property

o Statement of the amount of stock or securities and other property or money received from the exchange, including a statement of all distributions or other dispositions made thereof

o Statement of the amount and nature of any liabilities assumed upon the exchange.

15 Previous to the transfer there was no control, and it was the

transfer that resulted in control.


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2. Taxpayer (other than the corporation party to the reorganization) who received stocks or securities and other property shall be incorporated in his ITR for the taxable year in which the exchanges takes place a complete statement of facts pertinent to the non-recognition of gain or loss including: o Statement of the cost or

other basis of the stock or securities transferred in the exchange

o Statement in full amount of the stocks, securities, other property, and money including liabilities assumed upon the exchange.

§ Capital Losses (See XIII. Capital

Gains and Losses) § Abandonment Losses [Sec. 34(D)(7)]

• In the event a contract area where petroleum operations are undertaken is partially or wholly abandoned, ALL accumulated exploration and development expenditures pertaining thereto shall be allowed as a deduction: o Provided, That accumulated

expenditures incurred in that area prior to January 1, 1979 shall be allowed as a deduction only from any income derived from the same contract area.

o In all cases, notices of abandonment shall be filed with the Commissioner.

• In case a producing well is

subsequently abandoned, the unamortized costs thereof, as well as the undepreciated costs of equipment directly used therein, shall be allowed as a deduction in the year such well, equipment or facility is abandoned by the contractor: o Provided, That if such

abandoned well is reentered and production is resumed, or if such equipment or facility is restored into service, the said costs shall be included as part of gross income in the year of resumption or restoration and shall be amortized or depreciated, as the case may be.

§ Net Operating Loss Carry-Over

(NOLCO) [Sec. 34(D)(3)] The net operating loss16 of the business for any taxable year immediately preceding the current taxable year, which had not been

previously offset as deduction from

gross income shall be carried over as

16 Net operating loss is the excess of allowable deductions over

gross income (as defined in Sec. 32(A) of the NIRC).

a deduction from gross income for the next three (3) consecutive taxable years17 immediately following the year of such loss.

• REQUISITES: 1. Any net loss incurred in a taxable

year during which the taxpayer

was exempt from income tax shall not be allowed as a deduction.

2. A net operating loss carry-over (NOLCO) shall be allowed only if

there has been NO SUBSTANTIAL

CHANGE in the ownership of the business or enterprise. è There is no substantial change

when: a. 75% or more in nominal

value of outstanding issued shares, if the business is in the name of the corporation, is held by or on behalf of the same persons; or

b. 75% or more of the paid up capital of the corporation, if the business is in the name of the corporation, is held by or on behalf of the same persons.

• Applicability of the 75% interest rule o The 75% equity, ownership or interest rule shall only apply to a transfer or assignment of the taxpayer's net operating losses as a result of or arising from the said taxpayer's merger or consolidation or business combination with another person. In case the transfer or assignment of the taxpayer's net operating losses arises from the said taxpayer's merger, consolidation or combination with another person, the transferee or assignee shall NOT be entitled to claim the same as deduction from gross income UNLESS, as a result of the said merger, consolidation or combination, the shareholders of the transferor/assignor, or the transferor (in case of other business combinations) gains control of at least 75% or more in nominal value of the outstanding issued shares or paid up capital of the transferee/assignee (in case the transferee/assignee is a corporation) or 75% or more interest in the business of the transferee/assignee (in case the transferee/assignee is

17 Exception to the Three-Year Rule à For mines other

than oil and gas wells, a net operating loss without the benefit of incentives provided for under the Omnibus Investments Code of 1987, incurred in any of the first ten (10) years of operation may be carried over as a deduction from taxable income for the next five (5) years immediately following the year of such loss. The entire amount of the loss shall be carried over to the first of the five (5) taxable years following the loss, and any portion of such loss which exceeds, the taxable income of such first year shall be deducted in like manner form the taxable income of the next remaining four (4) years.


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other than a corporation). (Sec. 2.4, RR 14-2001)

o BIR Ruling 011-02, March

27, 2002 ààààThe 75% equity, ownership or interest rule does not apply in this case, since the transfer of the shares by the previous stockholders were through straight purchase and sale and not through merger, consolidation or business combination, such transfer did not cause a substantial change in ownership.

• Time of Determination of Substantial Change in the Ownership of the Business à the end of the taxable year when NOLCO is to be claimed as deduction (e.g., in the case of merger or consolidation of two or more corporations, such change shall be determined based on the ownership of the outstanding shares of stock issued or based on paid-up capital as of the end of the taxable year, and as a result of or arising from the said merger or consolidation). (Sec. 5, RR 14-2001)

• “By or on Behalf of the Same Persons”

o refers to the maintenance of

ownership despite change as when: No actual change in ownership is

involved in case the transfer involves

change from direct ownership to

indirect ownership, or vice versa.

ILLUSTRATION: Facts: P Corporation owns Q Corporation that has NOLCO. P Corporation transfers Q Corporation's shares to R Corporation in exchange for 100% of R Corporation shares. Held: Q Corporation's NOLCO is retained because Q Corporation's shares are held "by" R Corporation "on behalf of" P Corporation, the original owner.

No actual change in ownership is

involved as in the case of merger of

the subsidiary into the parent

company.

ILLUSTRATION: Facts: X Corporation owns 100% of Y Corporation. Y Corporation owns 100% of Z Corporation. Z Corporation has NOLCO. Z Corporation is merged into Y Corporation. Held: Z Corporation's NOLCO should be retained and transferred to Y Corporation. Prior to the merger, X Corporation already indirectly owned Z Corporation,

i.e., Z Corporation's shares were held "by" Y Corporation "on behalf of" X Corporation. After the merger, X now directly owns Z Corporation [absorbed corporation] which continues to exist in Y Corporation.

• Taxpayers Entitled to Deduct NOLCO from Gross Income.

1) Any individual (including estates and trusts) engaged in trade or business or in the exercise of his profession

-Special Rule: An individual who claims the 10% optional standard deduction shall not simultaneously claim deduction of the NOLCO. Further, the three-year reglementary period shall continue to run notwithstanding the fact that the aforesaid individual availed of the 10% optional standard deduction during the said period.

2) Domestic and resident foreign corporations subject to the normal income tax (e.g., manufacturers and traders) or preferential tax rates under the Code (e.g., private educational institutions, hospitals, and regional operating headquarters)

-Special Rule: Corporations cannot enjoy the benefit of NOLCO for as long as it is subject to MCIT in any taxable year. The three-year reglementary period on the carry-over of NOLCO shall continue to run notwithstanding the fact that the corporation paid its income tax under the "Minimum Corporate Income Tax" computation.

EXCEPTIONS (Who are not entitled

to deduct NOLCO): (bob-pie) 1. Offshore Banking Unit (OBU) of

a foreign banking corporation, and Foreign Currency Deposit Unit (FCDU) of a domestic or foreign banking corporation, duly authorized as such by the Bangko Sentral ng Pilipinas (BSP);

2. An enterprise registered with

the Board of Investments (BOI) with respect to its BOI-registered activity enjoying the Income Tax Holiday incentive. Its accumulated net operating losses incurred or sustained during the period of such Income Tax Holiday shall not qualify for purposes of the NOLCO;

3. An enterprise registered with

the Philippine Economic Zone Authority (PEZA), pursuant to R.A. No. 7916, as amended, with


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respect to its PEZA-registered business activity. Its accumulated net operating losses incurred or sustained during the period of its PEZA registration shall not qualify for purposes of the NOLCO;

4. An enterprise registered under

R.A. No. 7227, otherwise known as

the Bases Conversion and Dev’t

Act of 1992, e.g., SBMA-registered enterprises, with respect to its registered business activity. Its accumulated net operating losses incurred or sustained during the period of its said registered operation shall not qualify for purposes of the NOLCO;

5. Foreign corporations engaged in

international shipping or air

carriage business in the Philippines; and

6. In general, any person, natural or

juridical, enjoying exemption from income tax, pursuant to the provisions of the Code or any special law, with respect to its operation during the period for which the aforesaid exemption is applicable. Its accumulated net operating losses incurred or sustained during the said period shall not qualify for purposes of the NOLCO.

ILLUSTRATION OF NOLCO:

(In Pesos) 2000 2001 2002 2003 2004

Gross Income 500,000 600,000 700,000 500,000 800,000

Less: Deductions 900,000 500,000 750,000 420,000 450,000

Net Loss [OR] (400,000) (50,000)

Net Income before NOLCO* 100,000 80,000 350,000

Less: NOLCO

From 2000 (100,000) (80,000)

From 2002

(50,000)

Taxable Income 0 0 0 0 300,000

* - whichever is applicable

Explanation:

The unused net operating loss of P220,000 (400,000 – 100,000 – 80,000) of the year 2000 could not be carried over beyond 2003. The net operating loss of 2002 could be carried over to 2004, since it is within the three-year period. Q: As of yearend of 2004, what amount of NOLCO is available to the company for offsetting against (potential) gross income of succeeding taxable years? Answer: None. While there was an unused portion of the 2000 NOLCO, such had already expired by yearend of 2003. The 2002 NOLCO (P50,000) was completely used up in 2004. There is, therefore, no NOLCO available to the company for year 2005 and thereafter.

I. Bad Debts [Sec. 34(E)]

Ø Definition: debts resulting from the worthlessness or uncollectibility, in whole or in part, of amounts due the taxpayer by others, arising from money lent or from uncollectible amounts of income from goods sold or services rendered. (Sec. 2, RR 5-99 as amended by RR 25-2002)

Ø Deduction Allowed: Debts due to the

taxpayer actually ascertained to be worthless and charged off within the taxable year

Ø ”Actually ascertained to be worthless”

In general, a debt is not worthless simply because it is of doubtful value or difficult to collect. Worthlessness is not determined by an inflexible formula or slide rule calculation but upon the exercise of sound business judgment. The determination of worthlessness in a given case must depend upon the particular facts and the circumstances of the case. A taxpayer may not postpone a bad debt deduction on the basis of a mere hope of ultimate collection or because of a continuance of attempts to collect notes which have long become overdue, and where there is no showing that the surrounding circumstances differ from those relating to other notes which were charged off in a prior year. While a

> >

>


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mere hope probably will not justify postponement of the deduction, a reasonable possibility of recovery will permit the account to be carried along notwithstanding that the probabilities are that the debt may not be collected at all.

�� Good faith is not enough. –Taxpayer

must show also that he had reasonably investigated the relevant

facts and had drawn a reasonable inference from the information thus obtained by him. Where a taxpayer has failed to attach to his tax returns a statement showing the propriety of the deductions therein made for alleged bad debts, the account written off will be disallowed. (Collector v. Goodrich International Rubber Co., 21 SCRA 1336)

�� What does good faith require? à The

taxpayer may strike a middle course between pessimism and optimism and determine debts to be worthless in the exercise of sound business judgment based upon as complete information as is reasonably ascertainable. The taxpayer need not have perfect discernment. (Sec. 2, RR 5-99 as amended by RR 25-02)

Ø "Actually charged off from the

taxpayers books of accounts" means that the said receivable has been

cancelled and written-off from the said taxpayer's books of account. In no case

may any bad debt deduction be allowed

unless the facts pertaining to the money or

property lent and its cancellation or write-

off from the taxpayer's accounting records,

after having been determined that the same

has actually become worthless, have been

complied with by the taxpayer. (Sec. 2, RR 5-99 as amended by RR 25-02)

Ø EXCEPTIONS: The following are not deductible as bad debts:

1. debts not connected with profession, trade or business

2. debts sustained in a transaction entered into between family members or related taxpayers [see Sec. 36(B) or discussion on Losses above-Subsection H]

Ø REQUISITES: (PICU)

1. There must be an existing INDEBTEDNESS due to the taxpayer, which must be valid and legally demandable.

2. The debt must be connected with PROFESSION, trade or business.

3. The debt must be actually ascertained to be worthless or UNCOLLECTIBLE. (e.g., bankrupt debtor)

§ Determining uncollectibility àààà Before a taxpayer may charge off and deduct a debt, he must ascertain and must be able to demonstrate with reasonable degree of certainty the uncollectibility of the debt. The Commissioner of Internal Revenue

will consider ALL PERTINENT EVIDENCE, including

• the value of the collateral, if any, securing the debt and the

• financial condition of the debtor in determining whether a debt is worthless, or the

• assigning of the case for collection to an independent

collection lawyer who is not under the employ of the taxpayer and who shall issue a statement under oath showing the propriety of the deductions thereon made for alleged bad debts. (Sec. 3, RR 5-99 as amended by RR 25-2002)

§ Other factors

àààà The flight or disappearance of the debtor, the insolvency of the debtor, or the death of the debtor with insufficient properties to pay creditors, may indicate worthlessness of the debt.

§ Note: A creditor cannot deduct the

debt of an insolvent debtor as long as it is possible to proceed against the guarantor or surety who is insolvent. All efforts must be exhausted to collect from the guarantor or surety.

4. The debt must be actually CHARGED

OFF the books of accounts of the taxpayer as of the end of the taxable year.

à NOTE: The debts due a taxpayer may arise

out of securities held. But in a case where securities are ascertained to be worthless and charged off within the taxable year, and are capital assets, the loss to the taxpayer (other than a bank or trust company incorporated under the laws of the Philippines a substantial part of whose business is the receipt of deposits) will not be treated as bad debts, but as capital loss on the last day of the taxable year (See XIII. Capital Gains and Losses for the income tax treatment). The date that the securities were written off is immaterial. [Sec. 34(E)(2)]18

Ø GENERAL RULE: The determination by the Commissioner of Internal Revenue as to the worthlessness of bad debt is adequate.

Ø EXCEPTIONS: Who are required to submit

additional documents or to secure approval from their regulatory agencies before they are allowed to deduct bad debts from gross income?

18 ILLUSTRATION: Mr. A purchased bonds of B Co. on March 10,

2000 for P100,000 and held them as capital assets. On February 2, 2001, B Co. was declared by the Court as insolvent, and the bonds were totally worthless. Mr. A wrote off the bonds from his books of accounts on February 4, 2001. There is no bad debt for Mr. A. He would be considered to have a capital loss of P100,000 for the year 2001. The holding period of the bonds was from March 10, 2000 to December 31 2001, or more than 12 months. The capital loss would be considered at 50%, or at P50,000. (See XIII. Capital Gains and Losses for the detailed explanation on income tax treatment of capital asset transactions.)


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1. Banks: Without prejudice to the Commissioner’s determination of the worthlessness and uncollectibility of debts, the taxpayer shall submit a

Bangko Sentral ng Pilipinas (BSP) /

Monetary Board written approval of the

writing off of the indebtedness from the banks' books of accounts at the end of the taxable year. Requirements for deductibility (RR

5-99) �� Bad debts uncollected for 6 months �� Resolution by the BOD of the bank �� Approval by the monetary board

2. In no case may a receivable from an

insurance or surety company be written-off from the taxpayer's books and claimed as bad debts deduction unless such company has been declared closed due to insolvency or for

any such similar reason by the

Insurance Commissioner.

Ø Recovery of Bad Debts Previously Deducted (Tax Benefit Rule) (Sec. 4, RR 5-99) The recovery of bad debts previously allowed as deduction in the preceding year or years shall be included as part of the taxpayer's gross income in the year of such recovery to the extent of the income tax benefit of said deduction.

J. Depreciation [Sec. 34(F)]

Ø Definition: Depreciation is the gradual diminution of the useful value of tangible property resulting from wear and tear and normal obsolescence. The term is also applied to amortization of the value of intangible assets (i.e., patents), the use of which in the trade or business is definitely limited in duration.

Ø Deduction Allowable: There shall be allowed

as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including reasonable allowance for obsolescence) of property used in the trade or business. The rationale for this is that property gradually approaches a point where its usefulness is exhausted.

§ What if the property is used in

business and for personal purposes? The depreciation expense must be pro-rated; only the portion attributable to business use is deductible.

e.g., the car of the petitioner was used more for business than for personal purposes. He was a law practitioner, a law professor and engaged in business. He had only one car. Consequently, ¾ of the value of the depreciation of the car may be considered as business related, while ¼ thereof represents non-deductible personal expense. (Jamir v. Collector, CTA Case No. 443, November 28, 1959)

Ø Who may take depreciation: The person

who sustains an economic loss from the decrease in property value due to

depreciation gets the deduction. Ordinarily, this is the person who owns and has a capital investment in the property.

Ø When to deduct depreciation: The period of

depreciation starts when the asset is placed in service. It ends when the asset is disposed of, or its usefulness exhausted.

Ø REQUISITES: (TRUCE)

1. The allowance for depreciation must be for property used in the TRADE or business, or those not being used temporarily during the year (Conwell Bros. Co. v. Collector, CTA Case No. 411).

2. The asset must have a limited USEFUL life.

3. The allowance for depreciation must be REASONABLE.

4. The allowance must be CHARGED off during the taxable year from the taxpayer’s books of accounts.

5. The total allowances must not EXCEED the cost of the property.

Ø What is the appropriate useful life of the

property? What rate of depreciation must be

applied?

Generally, the estimated useful life is determined by the taxpayer himself. HOWEVER, where the taxpayer and the Commissioner have entered into an agreement in writing specifically dealing with the useful life and rate of depreciation of any property, the rate so agreed upon shall be binding on both the taxpayer and the national Government in the absence of

facts and circumstances not taken into

consideration during the adoption of such

agreement.

The responsibility of establishing the existence of such facts and circumstances shall rest with the party

initiating the modification.

General Rule: Any change in the agreed rate and useful life of the depreciable property as specified in the agreement shall not be effective for

taxable years prior to the taxable year

in which notice in writing by certified

mail or registered mail is served by the party initiating such change to the other party to the agreement.

Exception: Where the taxpayer has adopted such useful life and depreciation rate for any depreciable property and claimed the depreciation expenses as deduction from his gross income, without any written objection on the part of the Commissioner or his duly authorized representatives, the aforesaid useful life and depreciation rate so adopted by the taxpayer for the depreciable asset.

Ø Methods and Rates of Depreciation

1. Straight-line method


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The depreciation expense deductible in each of the years of the property’s estimated useful life is constant.

ILLUSTRATION: H Co. acquired a machine at a cost of P380,000. It has no scrap (or salvage) value, and the useful life is estimated at 25 years. The depreciation expense per year is P15,000, computed as follows:

2. Declining-balance method, using a rate

not exceeding twice the rate for straight

line method

Under this method, the depreciation

allowance per year varies. Depreciation is largest in the first year and continually decreases towards the end of the useful life of the property. The depreciation rate under the straight-line method is first computed, and the result is multiplied with the rate relative to the straight-line method rate. The product (the “declining balance rate”) is then multiplied to the yearly declining balance of the property (i.e., book value of the property at the start of the current year, which is equal to its original cost minus its accumulated depreciation) to determine the deduction for depreciation for the current year. However, in the last year of the asset’s estimated life, the depreciation is equal to the book value of the property at the start of that year (i.e., the amount of depreciation must be just enough to reduce the property’s book value to zero). Note that the salvage value is ignored in the declining balance method. ILLUSTRATION: P Company acquired a machine on January 1, 2002 at a cost of P400,000. It had a scrap value of P50,000, and a useful life of 4 years. The company uses the declining balance method, at a rate of one and a half that of the straight line method. Determine the depreciation chargeable in years 2002, 2003, 2004 and 2005.

Step 1: Compute for the depreciation rate under the straight-line method.

Step 2: Compute for the Declining

Balance Rate (DBR).

Step 3: Apply the Declining Balance Rate to the book value of the property at the start of the current

year. Year 2002:

Book value of the property ***

P400,000

Multiplied by: DBR 37.5% Deduction for Depreciation

P150,000

*** à Since this is the year of the acquisition, the book value of the property at the start of the year is equal to its original cost.

Year 2003:

Original Cost P 400,000 Less: Accumulated Depreciation

150,000

Book Value of the Property, start of current year

P 250,000

Multiplied by: DBR

37.5%

Deduction for Depreciation

P 93,750

Year 2004:


Year 2002 – P150,000

Year 2003 – P93,750

243,750


P 156,250 Multiplied by: DBR

37.5%

Deduction for Depreciation

P58,593.75

Declining = Straight Line Rate Relative to Balance Rate Depreciation Rate x the Straight Line Depreciation Rate = ¼ x 1.5 = 37.5%

Straight Line = 1 _ _

Depreciation Rate Estimated Useful Life

= ¼, or 25%

Depreciation = [(380,000 – 0) / 25] Expense [OR] = (1/25) x (380,000 – 0)

Formula: Deduction = Cost – Salvage Value__ for Depreciation Estimated Useful Life of the Property

NOTE: (Cost – Salvage Value) is known as the depreciable cost.

Alternative Method: Depreciation = 1 _ _ Rate Estimated Useful Life of the Property

Deduction for = Depreciation x (Cost– Salvage Value)

Depreciation Rate


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Year 2005:


Year 2002 – P150,000

Year 2003 – P93,750

Year 2004 – P58,593.75

302,343.75


P 97,656.25

Deduction for Depreciation ***

P97,656.25

*** The deduction for depreciation in 2005 is equal to the book value of the property at the start of the year because the machine had a useful life of 4 years, which ended in 2005.

3. Sum-of-the-years-digit method

Under this method, the annual depreciation is computed by applying a changing fraction to the depreciable cost of the property (original cost reduced by the salvage value). In the fraction, the numerator is the number of remaining years of the estimated useful life of the property and the denominator is the sum of the numbers representing the years of the property’s life. ILLUSTRATION: On January 1, 2001, J Company acquired a machine at a cost of P105,000. It had a salvage value of P5,000, and an estimated useful life of 5 years. The company uses the sum-of-the-years method in determining depreciation. Determine the depreciation chargeable in years 2001, 2002, 2003, 2004 and 2005. Step 1: Compute for the sum of the numbers representing the years of

the property’s life. The property has an estimated useful life of 5 years. The sum, therefore, is 15 (5 + 4 + 3 + 2 + 1). This sum will be used as the denominator in the fraction. Step 2: Compute for the depreciable

cost of the property. The depreciable cost is P100,000 (P105,000 – P5,000). Step 3: Compute for the yearly deduction for depreciation (Column D).

A B

(A/15)

C D

(= B x C)

Year Remainin

g Useful

Life

(Reckoning Point: Start of

the Year)

Resulti

ng

Fractio

n

Depreciabl

e Cost

Deduction

for

Depreciati

on

2001 5 5/15 P105,000 P35,000 2002 4 4/15 P105,000 P28,000 2003 3 3/15 P105,000 P21,000 2004 2 2/15 P105,000 P14,000 2005 1 1/15 P105,000 P7,000

4. Any other method which may be

prescribed by the Secretary of Finance

upon recommendation of the

Commissioner

Ø Special Rules:

§ Depreciation of Properties Used in

Petroleum Operations – • An allowance for depreciation in

respect of all properties DIRECTLY related to production of petroleum shall be allowed under the straight-line or declining-balance method of depreciation at the option of the service contractor. However, if the service contractor initially elects the declining-balance method, it may

shift to the straight-line method. The useful life of properties used in or related to production of petroleum shall be ten (10) years or such shorter life as may be permitted by the Commissioner.

• Properties NOT USED DIRECTLY in the production of petroleum shall be depreciated under the straight-line method on the basis of an estimated useful life of 5 years.

§ Depreciation of Properties Used in

Mining Operations – An allowance for depreciation in respect of all properties used in mining operations other than petroleum operations, shall be computed as follows: • At the normal rate of depreciation if

the expected life is ten (10) years

or less; or • Depreciated over any number of

years between five (5) years and the expected life if the latter is

more than ten (10) years, and the depreciation thereon allowed as deduction from taxable income: Provided, That the contractor notifies the Commissioner at the beginning of the depreciation period which depreciation rate allowed will be used.

§ Depreciation Deductible by Nonresident

Aliens Engaged in Trade or Business

(NRAETB) or Resident Foreign

Corporations (RFC)


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- A reasonable allowance for the deterioration of property arising out of its use or employment or its non-use in the business, trade or profession shall be permitted only when such property is located in the Philippines.

K. Depletion of Oil and Gas Wells and Mines [Sec. 34(G)]

Definition: Depletion is the exhaustion of natural resources due to production. It is the reduction of cost or value of natural resources such as oil and gas wells and mines as the resources are converted into inventories.

Limitation: A reasonable allowance for depletion computed using the cost-depletion method shall be granted provided that the allowance for depletion shall not exceed the capital invested.

ILLUSTRATION: Land containing natural resources was purchased for P100,900,000. It was estimated that the land, after exploitation of its natural resources, will have a value of P900,000. It was estimated that the natural resource supply was 5,000,000 tons. If withdrawal of resources from the land in 2005 was 500,000 tons, how much was the deduction for the year?

Purchase Price P100,900,000 Less: Residual Value of the Land

900,000 Depletion Base P100,000,000 Divided by: Estimated Resource Supply, in tons

5,000,000

Depletion Base per ton P20 Multiplied by: Withdrawal of Resources in 2005, in tons

500,000

Depletion Expense, 2005 P 10,000,000

Allowable Deduction for a Nonresident Alien

individual Engaged in Trade or Business or a Resident Foreign Corporation à Allowance for depletion of oil and gas wells or mines shall be authorized only in respect to oil and gas wells or mines located within the Philippines.

L. Charitable and Other Contributions [Sec. 34(H)]

REQUISITES: (TEE / BE) 1. The charitable contribution must actually be

paid or made to the ENTITIES specified by

law (i.e., Philippine government or any political subdivision thereof exclusively for public purposes, or any of the accredited domestic corporations or associations specified in the NIRC).

1. It must be made within the TAXABLE year. 2. It must be EVIDENCED by adequate

receipts or records. 3. Additional Requisite for Contributions Other

than Money: The amount of charitable contribution of property other than money shall be BASED on the acquisition cost of the property (i.e., not the fair market value at the time of the contribution).

4. Additional Requisite for Contributions subject

to the statutory limitation: It must not EXCEED 10% (individual) or 5%

(corporation) of the taxpayer’s taxable income before charitable contributions.

Kinds of Contributions: 1. Contributions deductible in full 2. Contributions subject to the statutory limit

Contributions Deductible in Full: (FoNG) 1. Donations to the Government - Donations to

the Government of the Philippines or to any of its agencies or political subdivisions, including fully-owned government corporations, exclusively to finance, to provide for, or to be used in undertaking PRIORITY ACTIVITIES in: • education, • health, • youth and sports development, • human settlements, • science and culture, and • in economic development,according to a National Priority Plan determined by the National Economic and Development Authority (NEDA), in consultation with appropriate government agencies, including its regional development councils and private philanthropic persons and institutions. è Any donation which is made to the Government or to any of its agencies or political subdivisions not in accordance with

the said annual priority plan shall be considered a contribution subject to the statutory limit.

2. Donations to Certain Foreign Institutions

or International Organizations - Donations to foreign institutions or international organizations which are fully deductible in pursuance of or in compliance with agreements, treaties, or commitments entered into by the Government of the Philippines and the foreign institutions or international organizations or in pursuance of special laws;

3. Donations to Accredited Non-government

Organizations - The term "non-government organization" means a non-profit domestic corporation: • Organized and operated exclusively for: (CRWSH Cys ChE Com)

-Scientific, -Research, -Educational, -Character-building and youth and sports development, -Health, -social Welfare, -Cultural or -CHaritable purposes, or -a COMbination thereof, no part of the net income of which

inures to the benefit of any private individual;

• Which, not later than the 15th day of the third month after the close of the accredited non-government organizations’ taxable year in which contributions are received, makes utilization directly for the active conduct of the activities constituting the purpose or function for which it is organized and operated,


TAXATION LAW 1

-UNLESS an extended period is granted by the Secretary of Finance;

• The level of administrative expense shall,

on an annual basis, not exceed thirty percent (30%) of the total expenses; (Sec. 1, RR 13-1998) and

• The assets of which, in the event of dissolution, would be distributed to -another nonprofit domestic corporation organized for similar purpose or purposes, or -to the state for public purpose, or -would be distributed by a court to another organization to be used in such manner as in the judgment of said court shall best accomplish the general purpose for which the dissolved organization was organized.

• All the members of the Board of Trustees of

the non-stock, non-profit corporation, organization or NGO do not receive compensation or remuneration for their service to the aforementioned organization. (added by Sec. 3, RR 13-1998)

Utilization means: a. Any amount, including admin expenses, paid or

utilized by an accredited NGO to accomplish one or more of its purposes

b. Any amount paid to acquire an asset used directly in carrying out one or more purposes for which the accredited NGO was created or organized; or

c. Any amount set aside for a specific project which comes within the NGO’s purpose/s, but the NGO has to establish that the amount will be utilized within at least five (5) years, and that the project will be better accomplished by setting aside such amount than by immediate payments of funds

d. Any amount in cash or in kind invested in any activity related to the purpose for which the NGO was created

e. Any amount invested in capital sustaining and generating activities. Provided that, any income derived from those investments shall be exclusively used in activities directly related to one or more of its purposes (Sec. 1, RR 13-1998)

Contributions subject to the Statutory Limit (DNGS) 1. Contributions made to the Government or any

of its agencies or political subdivisions exclusively for public purposes (contributions for non-priority activities)

2. Contributions made to accredited domestic

corporation or associations Organized exclusively for

o religious, o charitable, o scientific, o youth and sports development, o cultural or o educational purposes or o for the rehabilitation of veterans

3. Contributions to social welfare institutions

4. Contributions to non-government

organizations è no part of the net income of which inures to the benefit of any private stockholder or individual

• Statutory Limit: Amount deductible must

not be in excess of: § 10% in the case of an individual, and § 5% in the case of a corporation, of the taxpayer's taxable income derived from trade, business or profession before the deduction for contributions and donations. è In other words, the amount deductible is the actual contribution or the statutory limit computed, whichever is lower.

ILLUSTRATION: N Co. had a gross income from business of P1,000,000 and allowable deductions (except deductions for contributions) of P400,000. It made during the year a contribution that is fully deductible of P10,000 and contributions subject to limitation of P50,000. Compute for the total deduction for contributions and the taxable income of the company. ANSWER: The total deduction for contributions is P40,000, and the taxable income is P560,000.

SUPPORTING SOLUTION:

Gross Income P1,000,000 Less: Allowable Deductions (except deduction for contributions)

400,000

Taxable Income before deduction for contributions P 600,000

Multiplied by: Statutory Limit (%) 5%

Statutory Limit (in Pesos) P 30,000

Actual Contributions made (subject to limitation) P 50,000

Allowable Deduction for Contributions subject to limitation (whichever is lower)

P 30,000

Taxable Income before deduction for contributions P 600,000 Less: Allowable Deduction for Contributions

40,000

Deductible in Full Allowable Deduction for Contributions subject to limitation

P 10,000

30,000 Taxable Income P 560,000


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M. Research and Development [Sec. 34(L)] Definition: R&D costs are for improvements of processes and formulas as well as the development of improved or new products. As a general rule, R&D only extends from the laboratory or drawing board to prototype status; i.e., so long as an activity still contains an element of uncertainty/technical risk, it is within the realm of R&D. Ø Quality control, routine product testing, data

collection, efficiency surveys, management studies, market research and sales promotion are NORMALLY NOT CONSIDERED R&D ACTIVITIES.

Tax Treatment: R&D expenditures which are paid or incurred by a taxpayer during the taxable year in connection with his trade, business or profession may be treated EITHER as: 1. Ordinary and necessary expenses allowed

as deduction during the taxable year when paid or incurred (i.e., as an outright deduction for the full expenditure), or

2. Deferred asset (or deferred expense) which is periodically subject to amortization

At the election of the taxpayer, the following R&D expenditures may be treated as deferred assets: 1. Those paid or incurred by the taxpayer in

connection with his trade, business or profession.

2. Those not treated as expenses. 3. Those chargeable to capital account but not

chargeable to depreciable property.

In computing taxable income, such deferred expenses shall be allowed as deduction ratably distributed over a period of not less than sixty (60) months as may be elected by the taxpayer (beginning with the month in which the taxpayer first realizes benefits from such expenditures). -The taxpayer may elect this alternative not later than the time prescribed by law for filing the return for such taxable year (April 15). The method so elected, and the period selected by the taxpayer, shall be adhered to in computing taxable income for the taxable year for which the election is made and for all subsequent taxable years UNLESS with the approval of the Commissioner, a change to a different method is authorized with respect to a part or all of such expenditures. -The election shall not apply to any expenditure paid or incurred during any taxable year prior to the taxable year for which the taxpayer makes the election. Limitations on Deduction: The above tax treatment of R&D expenses does NOT apply to: 1. Any expenditure for the acquisition or

improvement of land or the improvement of depreciable property, used in connection with research and development.

2. Any expenditure incurred in ascertaining the existence, location, extent, or quality of any deposit of ore or other mineral, including oil or gas.

NOTE: Cost of acquisition or improvements of property subject to depreciation or depletion used in research and development becomes part of the cost of the asset, and deduction from it is by

way of depreciation or depletion, as the case may be. ILLUSTRATION:

Q Co., a manufacturer of food seasoning, is continuously conducting research and development on its product lines. In early January 2004, it completed the extension and improvement of its research and development building at a cost of P1,000,000. The extension has an estimated useful life of 25 years. The company also incurred an aggregate of P1,800,000 for other research and development costs. Determine the tax treatment of the various expenditures.

ANSWER:-The P1,000,000 cost of expansion of the building cannot be deducted as research and development costs in 2004. However, depreciation of P40,000 may be recognized yearly for 25 years (P1,000,000 / 25 years). -The other costs of P1,800,000 may be either: a. An outright deduction from gross income for P1,800,000 in 2004; [OR] b. A deferred expense of P1,800,000, from which there shall be a monthly deduction of P1,800,000 divided by 60 months (cannot be shorter, but can be longer), or P30,000 per month, beginning with the first month from which benefits were acquired from the expenditure. The aggregate of monthly deductions for a given taxable year is then deductible from that year’s gross income.

N. Pension Trusts [Sec. 34(J)] Deduction Allowable: An employer establishing or maintaining a pension trust to provide for the payment of reasonable pensions to his employees shall be allowed as a deduction (in addition to the contributions to such trust during the taxable year to cover the pension liability accruing during the year, allowed as a deduction under Sec. 34(A)(1) [Ordinary and Necessary Expenses]) a reasonable amount transferred or paid into such trust during the taxable year in excess of such contributions REQUISTES: Such reasonable amount will only be allowed as a deduction if it: 1. has not theretofore been allowed as a

deduction, and 2. is apportioned in equal parts over a period of

ten (10) consecutive years beginning with the year in which the transfer or payment is made.

Background Concepts: The rules in the law on deduction for pension payments to employees apply to a pension plan that is funded. An employer does not provide for pension for his employees in his initial years of operations. A pension plan is usually set up after some years of operations have gone by, when the employer is already financially capable of providing benefits to his employees. Since the benefits from any pension plan consider the length of service of the employee, the plan

should take into account the services of the

employees who were already with the employer

even before the plan was set up. Such past services will require a lump sum payment to the pension fund; this is called “past-service cost.” For each year after the pension plan was set up, there should be payment to the fund for pension for the services rendered during the year by the employees. This is called “present service cost.” • Present service cost – deductible in full in the

year transferred or paid into the trust; covered by Sec. 34(A)(1) [Ordinary and Necessary Expenses]

• Past-service cost – amount so transferred is apportioned and deductible in equal parts over a period of ten (10) consecutive years


TAXATION LAW 1

beginning with the year in which the transfer or payment is made; covered by Sec. 34(J) [Pension Trusts]

ILLUSTRATION: F Co. established a pension trust in 2001, transferring thereto a lump sum payment of P500,000 to cover past services rendered by its employees. Additionally, the terms of the trust are such that P20,000 in pension liability would accrue yearly, covering services rendered during the year by its employees. Determine the total deduction on account of the pension trust allowed to F Co. from 2001 onwards.

Year Yearly Amortization

of Past Service

Cost (= 1/10 of P500,000)

[covered by Sec. 34(J)]

Current Liability / Present Service Cost

[covered by Sec. 34(A)(1)]

TOTAL

2001 P50,000 P20,000 P70,000 2002 P50,000 P20,000 P70,000

2003 P50,000 P20,000 P70,000 2004 P50,000 P20,000 P70,000 2005 P50,000 P20,000 P70,000 2006 P50,000 P20,000 P70,000 2007 P50,000 P20,000 P70,000 2008 P50,000 P20,000 P70,000

2009 P50,000 P20,000 P70,000 2010 P50,000 P20,000 P70,000 2011

onwards - P20,000 P20,000

O. Special Provisions Regarding Income and Deductions of Insurance Companies, Whether Domestic or Foreign [Sec. 37]

Special Deduction Allowed to Insurance Companies. - In the case of insurance companies, whether domestic or foreign doing business in the Philippines, the net additions, if any, required by law to be made within the year to reserve funds and the sums other than dividends paid within the year on policy and annuity contracts may be deducted from their gross income. However, the released reserve should be treated as income for the year of release.

Mutual Insurance Companies. - In the case of mutual fire and mutual employers' liability and mutual workmen's compensation and mutual casualty insurance companies requiring their members to make premium deposits to provide for losses and expenses, said companies shall not return as income any portion of the premium deposits returned to their policyholders, but shall return as taxable income all income received by them from all other sources plus such portion of the premium deposits as are retained by the companies for purposes other than the payment of losses and expenses and reinsurance reserves. Mutual Marine Insurance Companies. - Mutual marine insurance companies shall include in their return of gross income, gross premiums collected and received by them less amounts paid to policyholders on account of premiums previously paid by them and interest paid upon those amounts between the ascertainment and payment thereof.

Assessment Insurance Companies. - Assessment insurance companies, whether domestic or foreign, may deduct from their gross income the actual deposit of sums with the officers of the Government of the Philippines pursuant to law, as additions to guarantee or reserve funds. Allocation of Income and Deductions [Sec. 50] - In the case of two or more organizations, trades or businesses (whether or not incorporated and whether or not organized in the Philippines) owned and controlled directly or indirectly by the same interests, the Commissioner is authorized to distribute, apportion or allocate gross income or deductions between or among such organization, trade or business, if he determines that such distribution, apportionment or allocation is necessary in order: (a) to prevent evasion of taxes; or (b) to clearly reflect the income of any such organizations, trades or businesses.


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XII. NONXII. NONXII. NONXII. NON----DEDUCTIBLE EXPENSES DEDUCTIBLE EXPENSES DEDUCTIBLE EXPENSES DEDUCTIBLE EXPENSES [Sec.

36] GENERAL RULE: In computing net income, no deduction shall be allowed in respect to: (PIRI) 1. Personal, living or family expenses –

Rationale: not related to conduct of trade or business

2. Any amount paid out for new buildings or for permanent improvements, or betterments made to increase the value of any property or

estate EXCEPTION: Intangible drilling and development costs incurred in petroleum operations which are deductible under Sec. 34(G)(1)

3. Any amount expended in restoring property or in making good the exhaustion thereof for which an allowance [for depreciation or depletion] is or has been made (i.e., Major Repairs)

NOTE: Nos. (2) and (3) are capital expenditures. Examples are: a. The cost of defending or perfecting title to

property constitutes a part of the cost of the property and is not a deductible expense.

b. The amount expended for architect’s services is part of the cost of the building

c. Expenditures to promote the sales of additional capital stock or the cost, commissions and fees for obtaining stock subscriptions are capital expenses. (Atlas Consolidated Mining Co. v. Commissioner, 102 SCRA 246)

4. Premiums paid on any life insurance policy

covering the life of any officer, employee, or

person financially interested in the trade or

business carried on by the taxpayer, when the taxpayer is directly or indirectly a beneficiary

under such policy. • A person is said to be “financially

interested” in the taxpayer’s business, if he is a stockholder thereof or he is to receive as his compensation a share of the profits of the business.

ILLUSTRATION:

CASE 1 CASE 2

Insured

Officer, employee, or

person financially

interested in the taxpayer’s trade

or business


person financially interested in the taxpayer’s trade

or business

Beneficiary of Life

Insurance Policy

Company


person financially interested in the taxpayer’s trade

or business

Premium a deductible expense?

NO (covered by Sec. 36)

YES (Premium is likewise a fringe benefit on the

part of the beneficiary.)

XIII. CAPITAL GAINS ANDXIII. CAPITAL GAINS ANDXIII. CAPITAL GAINS ANDXIII. CAPITAL GAINS AND LOSSES LOSSES LOSSES LOSSES [Sec.

39] Definitions: Net Capital Gain – the excess of the gains from sales or exchanges of capital assets over the losses from such sales or exchanges Net Capital Loss – means the excess of the losses from sales or exchanges of capital assets over the gains from such sales or exchanges Holding Period – the length of time the asset was held by the taxpayer Meaning of sale or exchange – requirements for capital gain § Gain or loss is recognized in a sale or exchange

of property if the following conditions are satisfied: 1. The property received in exchange is

essentially different from the property disposed of;

2. The property received has a market value

Sale – a delivery of goods for money Exchange – a delivery of goods for goods received. HOWEVER, there are transactions which the law considers sales or exchanges though they do not meet the definitions given. These are: 1. Retirement of bonds, etc. 2. Short sales of properties19 3. Failure to exercise a privilege or option to buy

or sell property; 4. Securities becoming worthless. 5. Receipt of a liquidating dividend Percentage taken into account (Long-term / Short term) by taxpayers: § Taxpayers Other than a Corporation (i.e.,

individual taxpayers and taxpayers treated as individuals, such as estates and trusts) - 100% if the capital asset was held for not

more than 12 months - 50% if the capital asset has been held for

more than 12 months NOTE:

o GENERAL RULE: For purposes of computing capital loss and capital gain, the actual holding period is taken into account.

o EXCEPTION: If securities become

worthless during the taxable year and are capital assets, the loss resulting therefrom shall be considered as a loss from the sale or exchange, on the last day of such taxable year, of capital assets. [Sec. 34(D)(4)(b)]

§ Corporate Taxpayers – 100% of the capital gain or loss, regardless of the holding period

Limitation on Capital Losses GENERAL RULE: Losses from sales or exchanges of capital assets shall be allowed only to the extent of the gains from such sales or exchanges.

19 A transaction in which a speculator sells securities which he does not own in anticipation of a decline in its price. The seller intends to cover the sale by purchasing the securities when the price declines, in which case he will make a profit.


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SPECIAL RULE FOR BANKS AND TRUST COMPANIES: If a bank or trust company incorporated under the laws of the Philippines, a substantial part of whose business is the receipt of deposits or the sale of bond, debenture, note, certificate or other evidence of indebtedness, any loss resulting from such sale shall not be subject to the foregoing limitation and shall not be included in determining the applicability of such limitation to other losses. è Rationale: The securities mentioned are ordinary assets of the bank or trust company.

Formula: (Sec. 134, RR2)

Taxable net income = Ordinary net income + net taxable capital gains

Net taxable capital gains = Gains of sales of capital assets, or 50% thereof – Losses from sales of capital assets, or 50% thereof Net Capital Loss Carry-over: If an individual taxpayer sustains a net capital loss in a taxable year, such loss (in an amount not in excess of the

net income20 for such year) shall be treated in the succeeding taxable year as a loss from the sale or exchange of a capital asset held for not more than 12 months (100% deduction). ILLUSTRATIONS: Mr. O, a citizen of the Philippines, single, had the following data for 2001 and 2002:

2001 2002

Net Income, Business 80,000 90,000

Interest Income from notes of clients

4,000 2,000

Capital Gain on assets: 50,000

70,000

Shares of foreign corporations, held for 3 years

Jewelry, held for 10 months

Capital Loss on bonds, held for 4 months

120,000 -

20 Net Income à should be understood as taxable income

(Executive Order No. 37)


TAXATION LAW 1

Mr. O’s taxable income for 2001 was P64,000, and for 2002 was P78,000, computed as follows:

2001 2002

Net Income, Business P 80,000 P 90,000 Interest Income 4,000 2,000 Ordinary Net Income P84,000 P92,000 Capital Gain (50%) P25,000 Capital Gain (100%) P70,000 Capital Loss (100%) (120,000)

Net Capital Loss

(P95,000)

Net Capital Loss Carry-Over from 2001

(64,000)

Net Capital Gain [70,000 – 64,000] 6,000 Total P98,000 Less: Basic Personal Exemption (20,000) (20,000)

Taxable Income

P64,000 P78,000

Legend:

P Co., a domestic corporation, had the following results of operations for a taxable year:

Ordinary Net Income P52,000

Gain on sale of capital asset, held for ten months 2,000 Gain on sale of capital asset, held for eighteen months 2,000 Loss on sale of capital asset, held for six months 1,100 Loss on sale of capital asset, held for twenty months 2,000

and in the preceding year it had a net capital loss of P1,500 and a taxable income of P60,000. The taxable income of the corporation for the year is computed as follows***:

Ordinary net income P52,000 Gain on sale of capital asset, held for ten months (100%) P2,000 Gain on sale of capital asset, held for eighteen months (100%)

2,000

Total Capital Gains P4,000 Loss on sale of capital asset, held for six months (100%) P1,100 Loss on sale of capital asset, held for twenty months (100%) 2,000

Total Capital Loss 3,100

Net Capital Gain 900

Taxable Income P52,900

*** For corporations, capital gains and losses are always considered at 100%, and there is no net capital loss carry-over.

SUMMARY OF RULES For Corporations: 1. Corporations shall recognize 100% of the capital gain or loss, regardless of the holding period. 2. Corporations cannot carry-over net capital loss. 3. Losses from sales or exchanges of capital assets shall be allowed only to the extent of the gains from

such sales or exchanges.

For Individuals, and Taxpayers Treated as Individuals: 1. The holding period is relevant in determining the percentage of capital gains and losses to be taken into

account, as follows: - 100% if the capital asset was held for not more than 12 months - 50% if the capital asset was held for more than 12 months

2. Net capital loss (in an amount not in excess of the net income for such year) shall be treated in the succeeding taxable year as a loss from the sale or exchange of a capital asset held for not more than 12 months (100% deduction)

3. Losses from sales or exchanges of capital assets shall be allowed only to the extent of the gains from such sales or exchanges.

>

>

>

> Net Capital Loss Carry-Over from the previous year

To determine the maximum that may be carried over to the next year: Taxable Income


TAXATION LAW 1

XIV. SITUS OF TAXATIONXIV. SITUS OF TAXATIONXIV. SITUS OF TAXATIONXIV. SITUS OF TAXATION [Sec. 42] A. Gross Income From Sources Within the

Philippines •••• Interests derived from sources within the

Philippines, and interest on bonds, notes or other interest-bearing obligations of residents, corporate or otherwise

•••• Dividends •••• Compensation for labor or personal services

performed in the Philippines •••• Rentals and royalties from property located in

the Philippines or from any interest in such property, including rentals or royalties for:

(a) The use of or the right or privilege to use in the Philippines any copyright, patent, design or model, plan, secret formula or process, goodwill, trademark, trade brand or other like property or right; (b) The use of, or the right to use in the Philippines any industrial, commercial or scientific equipment; (c) The supply of scientific, technical, industrial or commercial knowledge or information; (d) The supply of any assistance that is ancillary and subsidiary to, and is furnished as a means of enabling the application or enjoyment of, any such property or right as is mentioned in paragraph (a), any such equipment as is mentioned in paragraph (b) or any such knowledge or information as is mentioned in paragraph (c); (e) The supply of services by a nonresident person or his employee in connection with the use of property or rights belonging to, or the installation or operation of any brand, machinery or other apparatus purchased from such nonresident person; (f) Technical advice, assistance or services rendered in connection with technical management or administration of any scientific, industrial or commercial undertaking, venture, project or scheme; and (g) The use of or the right to use:

(i) Motion picture films; (ii) Films or video tapes for use in connection with television; and (iii) Tapes for use in connection with radio broadcasting.

•••• Gains, profits and income from the sale of real property located in the Philippines

•••• Gains; profits and income from the sale of personal property

B. Taxable Income From Sources Within the Philippines

GENERAL RULE. – Deduct the expenses, losses and other deductions properly allocated thereto and a ratable part of expenses, interests, losses and other deductions effectively connected with the business or trade conducted exclusively within the Philippines which cannot definitely be allocated to some items or class of gross income: Provided, That such items of deductions shall be allowed only if fully substantiated by all the information necessary for its calculation. The remainder, if any, shall be treated in full as taxable income from sources within the Philippines. EXCEPTION. - No deductions for interest paid or incurred abroad shall be allowed unless indebtedness was actually incurred to provide

funds for use in connection with the conduct or operation of trade or business in the Philippines. C. Gross Income From Sources Without the

Philippines. (1) Interests other than those derived from sources within the Philippines as provided in A. (2) Dividends other than those derived from sources within the Philippines as provided in A. (3) Compensation for labor or personal services performed without the Philippines; (4) Rentals or royalties from property located without the Philippines or from any interest in such property including rentals or royalties for the use of or for the privilege of using without the Philippines, patents, copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises and other like properties; and (5) Gains, profits and income from the sale of real property located without the Philippines.

D. Taxable Income From Sources Without the

Philippines. - Deduct from the gross income from sources without the Philippines (a) the expenses, losses, and other deductions

properly apportioned or allocated thereto and

(b) a ratable part of any expense, loss or other deduction which cannot definitely be allocated to some items or classes of gross income.

The remainder, if any, shall be treated in full as taxable income from sources without the Philippines. E. Income From Sources Partly Within and

Partly Without the Philippines. § Allocated or apportioned to sources within or

without the Philippines, under the rules and regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner

§ For the purpose of computing the taxable income therefrom, where items of gross income are separately allocated to sources within the Philippines, there shall be deducted: (a) the expenses, losses and other deductions

properly apportioned or allocated thereto, and

(b) a ratable part of other expenses, losses or other deductions which cannot definitely be allocated to some items or classes of gross income.

The remainder, if any, shall be included in full as taxable income from sources within the Philippines.

§ In the case of gross income derived from sources partly within and partly without the Philippines, the taxable income may first be computed by deducting the expenses, losses or other deductions apportioned or allocated thereto and a ratable part of any expense, loss or other deduction which cannot definitely be allocated to some items or classes of gross income; and the portion of such taxable income attributable to sources within the Philippines may be determined by processes or formulas of general apportionment prescribed by the Secretary of Finance.

§ Gains, profits and income from the sale of

personal property


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(a) produced (in whole or in part) by the taxpayer within and sold without the Philippines, or

(b) produced (in whole or in part) by the taxpayer without and sold within the Philippines,

shall be treated as derived partly from sources within and partly from sources without the Philippines.

F. Gains, profits and income derived: (a) from the purchase of personal property within

and its sale without the Philippines, or (b) from the purchase of personal property without

and its sale within the Philippines shall be treated as derived entirely form sources within the country in which sold: Provided,

however, That gain from the sale of shares of stock in a domestic corporation shall be treated as derived entirely form sources within the Philippines regardless of where the said shares are sold. The transfer by a nonresident alien or a foreign corporation to anyone of any share of stock issued by a domestic corporation shall not be effected or made in its book unless: ØØØØ the transferor has filed with the Commissioner

a bond conditioned upon the future payment by him of any income tax that may be due on the gains derived from such transfer, or

ØØØØ the Commissioner has certified that the taxes, if any, imposed in this Title and due on the gain realized from such sale or transfer have been paid. It shall be the duty of the transferor and the corporation the shares of which are sold or transferred, to advise the transferee of this requirement.

ØØØØ Definition of Royalties - Philamlife vs. CTA

[CA GR SP 31283 April 25, 1995] The CTA ruled that it is not the presence of any property from which one derives rentals and royalties that is controlling, but rather it includes royalties for the supply of scientific, technical, industrial, or commercial knowledge

or information .

XV. INSTALLMENT BASISXV. INSTALLMENT BASISXV. INSTALLMENT BASISXV. INSTALLMENT BASIS [Sec. 49]

A. Sales of Dealers in Personal Property – A person who regularly sells or otherwise disposes of personal property on the installment plan may return as income therefrom in any taxable year that proportion of the installment

payments actually received that year, which the

gross profit realized or to be realized when

payment is completed, bears to the total

contract price.

B. Sales of Realty and Casual Sales of

Personal Property 1. A casual sale or other casual disposition of

personal property (other than property of a kind

which would properly be included in the

inventory of the taxpayer if on hand at the

close of the taxable year) for a price exceeding One thousand pesos (P1000); or

2. A sale or other disposition of real property èèèè In either case the initial payments must

NOT exceed 25% of the selling price

'Initial payments' means the payment received in cash or property other than evidences of indebtedness of the purchaser during the taxable period in which the sale or other disposition is made.

è Income Tax Treatment: Income may be returned on the same basis as sales of dealers in personal property (see section A)

C. Sales of Real Property Considered as Capital Asset by Individuals – An individual who sells or disposes of real property, considered as capital asset, and is otherwise qualified to report the gain therefrom under Subsection (B) may pay the capital gains tax in installments.

D. Tax Evasion vs. Tax Avoidance [CIR vs. Estate of Toda (Sept, 14, 2004)]

Tax Evasion Tax Avoidance

– a scheme used outside of those lawful means and when availed of, it usually subjects the taxpayer to further or additional civil or criminal liabilities

tax saving device within the means sanctioned by law, used by the taxpayer in good faith and at arms length

FORMULA:

Gross Profit Installment payments Income to be

---------------------- X actually received = reported for

Contract price the year


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XVI. RETURNS AND PAYMENTS OF XVI. RETURNS AND PAYMENTS OF XVI. RETURNS AND PAYMENTS OF XVI. RETURNS AND PAYMENTS OF

TAX / WITAX / WITAX / WITAX / WITHHOLDING TAXES THHOLDING TAXES THHOLDING TAXES THHOLDING TAXES

A. Returns and Payment of Tax 1. Individual Return (Sec. 51, NIRC) a. Who are required to file

(a) Every Filipino citizen residing in the Philippines;

(b) Every Filipino citizen residing outside the Philippines, on his income from sources within the Philippines;

(c) Every alien residing in the Philippines, on income derived from sources within the Philippines; and

(d) Every nonresident alien engaged in trade or business or in the exercise of profession in the Philippines.

b. Those not required to file The following individuals shall not be required to file an income tax return:

a. An individual whose gross income does not

exceed his total personal and additional

exemptions for dependents under Section 35 Exception: That a citizen of the Philippines and any alien individual engaged in business or practice of profession within the Philippines shall file an income tax return, regardless of the amount of gross income; b. An individual with respect to pure

compensation income, as defined in Section 32 (A)(1), derived from sources within the Philippines, the income tax on which has been correctly withheld under the provisions of Section 79 of this Code Exceptions: i. an individual deriving compensation concurrently from two or more employers at any time during the taxable year ii. an individual whose compensation income derived from sources within the Philippines exceeds Sixty thousand pesos (P60,000)

c. An individual whose sole income has been subjected to final withholding tax pursuant to Section 57(A) of this Code d. An individual who is exempt from income tax pursuant to the provisions of this Code and other laws, general or special.

Any individual not required to file an income tax return may nevertheless be required to file an information return pursuant to rules and regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner.

SPECIAL RULES: 1. Husband and Wife →→→→ Married individuals, whether citizens, resident or nonresident aliens, who do not derive income purely from compensation, shall file a return for the taxable year to include the income of both spouses, but where it is impracticable for the spouses to file one return, each spouse may file a separate return of income but the returns so filed shall be consolidated by the Bureau for purposes of verification for the taxable year. 2. Return of Parent to Include Income of Children →→→→ The income of unmarried minors

derived from property received from a living parent shall be included in the return of the parent, except

o when the donor's tax has been paid on such

property, or o when the transfer of such property is exempt

from donor's tax.

3. Persons Under Disability →→→→ If the taxpayer is unable to make his own return, the return may be made by his duly authorized agent or

representative or by the guardian or other person charged with the care of his person or property, the principal and his representative or guardian assuming the responsibility of making the return and incurring penalties provided for erroneous, false or fraudulent returns.

Signature Presumed →→→→ The fact that an individual's name is signed to a filed return shall be prima facie evidence for all purposes that the return was actually signed by him. c. Where to file Except in cases where the Commissioner otherwise permits, the return shall be filed: è If person has legal residence or place of business in the Philippines - with an authorized agent bank, Revenue District Officer, Collection Agent or duly authorized Treasurer of the city or municipality in which such person has his legal residence or principal place of business in the Philippines

è If there be no legal residence or place of business in the Philippines - with the Office of the Commissioner. d. When to file - The return of any individual specified above shall be filed on or before the fifteenth (15th) day of April of each year covering income for the preceding taxable year. e. Where to pay (Sec. 56, NIRC) The total amount of tax imposed by this Title shall be paid by the person subject thereto at the time the return is filed.

When the tax due is in excess of Two thousand pesos (P2,000), the taxpayer other than a corporation may elect to pay the tax in two (2) equal installments in which case: 1. the first installment shall be paid at the time

the return is filed and 2. the second installment, on or before July 15

following the close of the calendar year 3. if any installment is not paid on or before the

date fixed for its payment, the whole amount of the tax unpaid becomes due and payable, together with the delinquency penalties.

f. Capital gains on shares of stocks and real estate FILING A RETURN Individuals subject to tax on capital gains: (a) From the sale or exchange of shares of stock

not traded thru a local stock exchange as prescribed under Section 24(c) shall file a return within thirty (30) days after each transaction and a final consolidated return on or before April 15 of each year covering all stock transactions of the preceding taxable year; and


TAXATION LAW 1

(b) From the sale or disposition of real property under Section 24(D) shall file a return within thirty (30) days following each sale or other disposition.

PAYMENT The total amount of tax imposed and prescribed shall be paid on the date the return prescribed is filed by the person liable. If the seller submits proof of his intention to avail himself of the benefit of exemption of capital gains under existing special laws, no such payments shall be required. o In case of failure to qualify for exemption

under such special laws and implementing rules and regulations, the tax due on the gains realized from the original transaction shall immediately become due and payable.

o If the seller, having paid the tax, submits such proof of intent within six (6) months from the registration of the document transferring the real property, he shall be entitled to a refund of such tax upon verification of his compliance with the requirements for such exemption.

o In case the taxpayer elects and is qualified to report the gain by installments, the tax due from each installment payment shall be paid within (30) days from the receipt of such payments.

g. Quarterly declaration of income tax (Sec. 74, NIRC) Every individual subject to income tax under Sections 24 and 25(A) of this Title, who is receiving self-employment income, whether it constitutes the sole source of his income or in combination with salaries, wages and other fixed or determinable income, shall make and file a declaration of his estimated income for the current taxable year on or before April 15 of the same taxable year.

In general, self-employment income consists of the earnings derived by the individual from the practice of profession or conduct of trade or business carried on by him as a sole proprietor or by a partnership of which he is a member. 1. Nonresident Filipino citizens, with respect to

income from without the Philippines, and nonresident aliens not engaged in trade or business in the Philippines, are not required to render a declaration of estimated income tax.

2. The declaration shall contain such pertinent information as the Secretary of Finance, upon recommendation of the Commissioner, may, by rules and regulations prescribe. An individual may make amendments of a declaration filed during the taxable year under the rules and regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner.

Estimated tax means the amount which the individual declared as income tax in his final adjusted and annual income tax return for the preceding taxable year minus the sum of the credits allowed under this Title against the said tax. If, during the current taxable year, the taxpayer reasonably expects to pay a bigger income tax, he shall file an amended declaration during any interval of installment payment dates.

Return and Payment of Estimated Income Tax by Individuals: The amount of estimated income with respect to which a declaration is required shall be paid in four (4) installments: o 1st installment - at the time of the declaration o 2nd installment - on August 15 of the current

year o 3rd installment – on November 15 of the

current year o 4th installment - on or before April 15 of the

following calendar year when the final adjusted income tax return is due to be filed

h. Substituted filing for ITR of Salaried Individuals RR 19-2002

Certificate of Compensation Payment/Tax Withheld (BIR Form No. 2316). — In general, every employer required to deduct and withhold the tax on compensation including fringe benefits given to rank and file employees, shall furnish every employee the Certificate of Compensation Payment/Tax Withheld (BIR Form No. 2316), on or before January 31 of the succeeding calendar year, or if the employment is terminated before the close of such calendar year, on the day on which the last payment of compensation is made. Failure to furnish the same shall be a ground for the mandatory audit of payor’s income tax liabilities (including withholding tax) upon verified complaint of the payee.

The Certificate of Compensation Payment/Tax Withheld (BIR Form No. 2316) shall contain a certification to the effect that the employer’s filing of BIR Form No. 1604-CF shall be considered as a substituted filing of the employee’s income tax return to the extent that the amount of compensation and tax

withheld appearing in BIR Form No. 1604-CF as

filed with BIR is consistent with the

corresponding amounts indicated in BIR Form

No. 2316. It shall be signed by both the employee and employer attesting to the fact that the information stated therein has been verified and is true and correct to the best of their knowledge. Withholding agents/employers are required to retain copies of the duly signed BIR Form No. 2316 for a period of three (3) years.

The employee who is qualified for substituted filing of income tax return under these regulations, shall no longer be required to file income tax return (BIR Form No. 1700) since BIR Form No. 1604-CF shall be considered a substituted return filed by the employer. BIR Form No. 2316, duly certified by both employee and employer, shall serve the same purpose as if a BIR Form No. 1700 had been filed, such as proof of financial capacity for purposes of loan, credit card, or other applications, or for the purpose of availing tax credit in the employee’s home country and for other purposes with various government agencies. This may also be used for purposes of securing travel tax exemption, when necessary.

However, information referring to the certification, appearing at the bottom of BIR Form No. 2316, shall not be signed by both the employer and the employee if the latter is not qualified for substituted filing. In which case, BIR Form No. 2316 furnished by the employer to the employee shall be attached to the employee’s


TAXATION LAW 1

Income Tax Return (BIR Form No. 1700) to be filed on or before April 15 of the following year.

i. Modes of Payment of Taxes Through Banks RR 16-2002 SECTION 3. Modes Of Payment To Authorized Agent Banks. — Aside from the electronic payment system currently used by some taxpayers in paying their BIR taxes, the rest shall pay their tax liabilities through any of the following modes: a) "Over–the–counter cash payment" -

payment of taxes to an authorized agent bank in the currencies that are legal tender in the Philippines. The maximum amount allowed per tax payment shall not exceed ten thousand pesos (P10,000.00)

b) "Bank debit system" - taxpayer, through a bank debit memo/advice, authorizes withdrawals from his bank accounts for payment of tax liabilities.

c) "Checks" refers to a bill of exchange or Order Instrument drawn on a bank payable on demand.

The following checks are, however, NOT acceptable as check payments for internal revenue taxes: (SUESAP) 1. Accommodation checks — checks issued or

drawn by a party other than the taxpayer making the payment;

2. Second endorsed checks — checks issued to the taxpayer as payee who indorses the same as payment for taxes;

3. Stale checks — checks dated more than six (6) months prior to presentation to the authorized agent bank;

4. Postdated checks — checks dated a day or several days after the date of presentation to the authorized agent bank;

5. Unsigned checks 6. Checks with alterations/Erasures.

AABs accepting checks as payment must see to it that the check covers one tax type for one return period only. Second indorsement of checks which are payable to the BIR or Commissioner of Internal Revenue is absolutely prohibited

2. Corporation Regular Returns a. Quarterly Income Tax (Sec. 75, NIRC) Every corporation shall file in duplicate a quarterly summary declaration of its gross income and deductions on a cumulative basis for the preceding quarter or quarters upon which the income tax, shall be levied, collected and paid.

↓ The tax so computed shall be decreased by the amount of tax previously paid or assessed during the preceding quarters and shall be paid not later than sixty (60) days from the close of each of the first three (3) quarters of the taxable year, whether calendar or fiscal year. b. Final Adjustment Return (Sec. 76, NIRC) Every corporation liable to tax shall file a final adjustment return covering the total taxable income for the preceding calendar or fiscal year. If the sum of the quarterly tax payments made during the said taxable year is not equal to

the total tax due on the entire taxable income of that year, the corporation shall either: (A) Pay the balance of tax still due; or (B) Carry-over the excess credit; or (C) Be credited or refunded with the excess amount paid, as the case may be. In case the corporation is entitled to a tax credit or refund of the excess estimated quarterly income taxes paid, the excess amount shown on its final adjustment return may be carried over and credited against the estimated quarterly income tax liabilities for the taxable quarters of the succeeding taxable years. Once the option to carry-over and apply the excess quarterly income tax against income tax due for the taxable quarters of the succeeding taxable years has been made, such option shall be considered irrevocable for that taxable period and no application for cash refund or issuance of a tax credit certificate shall be allowed.

c. When to File (Sec. 77, NIRC) Quarterly declaration – shall be filed within sixty (60) days following the close of each of the first three (3) quarters of the taxable year. The final adjustment return – shall be filed on or before the fifteenth (15th) day of April, or on or before the fifteenth (15th) day of the fourth (4th) month following the close of the fiscal year, as the case may be. Extension of Time to File Returns – The Commissioner may, in meritorious cases, grant a reasonable extension of time for filing returns of income (or final and adjustment returns in case of corporations)

d. Where to File (Sec. 77, NIRC) Except as the Commissioner otherwise permits, the quarterly income tax declaration required in Section 75 and the final adjustment return required in Section 76 shall be filed with: o the authorized agent banks or o Revenue District Officer or o Collection Agent or o duly authorized Treasurer of the city or

municipality having jurisdiction over the location of the principal office of the corporation filing the return or place where its main books of accounts and other data from which the return is prepared are kept.

e. When to Pay (Sec. 77, NIRC) The income tax due on the corporate quarterly returns and the final adjustment income tax shall be paid at the time the declaration or return is filed in a manner prescribed by the Commissioner.

f. Capital Gains on Shares of Stock Every corporation deriving capital gains from the sale or exchange of shares of stock not traded thru a local stock exchange as prescribed under Sections 24 (c), 25 (A)(3), 27 (E)(2), 28(A)(8)(c) and 28 (B)(5)(c), shall file a return within thirty (30) days after each transaction and a final consolidated return of all transactions during the taxable year on or before the fifteenth (15th) day of the fourth (4th) month following the close of the taxable year.


TAXATION LAW 1

g. Return of Corporations Contemplating Dissolution / Reorganization

Every corporation shall, within thirty (30) days after the adoption by the corporation of a resolution or plan for its dissolution, or for the liquidation of the whole or any part of its capital stock, including a corporation which has been notified of possible involuntary dissolution by the Securities and Exchange Commission, or for its reorganization, render a correct return to the Commissioner, verified under oath, setting forth the terms of such resolution or plan and such other information as the Secretary of Finance, upon recommendation of the commissioner, shall, by rules and regulations, prescribe.

The dissolving or reorganizing corporation shall, prior to the issuance by the Securities and Exchange Commission of the Certificate of Dissolution or Reorganization, as may be defined by rules and regulations prescribed by the Secretary of Finance, upon recommendation of the Commissioner, secure a certificate of tax clearance from the Bureau of Internal Revenue which certificate shall be submitted to the Securities and Exchange Commission.

Sec. 244. RR-2 All corporations, partnerships, joint accounts and associations, contemplating dissolution or retiring from business without formal dissolution, shall, within 30 days after the approval of such resolution authorizing their dissolution, and within the same period after their retirement from business, file their IT returns covering the profit earned or business done by them from the beginning of the year up to the date of such dissolution or retirement and pay the corresponding IT due thereon upon demand of the Commissioner. In addition to the IT return, they shall also submit within the same period the following: (a) a copy of the resolution authorizing such

dissolution; (b) balance sheet at the date of dissolution or

retirement and a profit and loss statement covering the period from the beginning of the taxable year to the date of dissolution or retirement;

(c) in the case of a corporation, the names and addresses of the shareholders and the number and par value of the shares held by each; and in case of a partnership, joint account or association, the name of the partners or members and the capital contributed by each;

(d) the value and a description of the assets received in liquidation by each shareholder;

(e) the name and address of each individual or corporation, other than shareholders, if any, receiving assets at the time of dissolution together with a description and the value of the assets received by such individuals or corporations and the consideration if any, paid by each of them for the assets received.

B. WITHHOLDING TAX 1. Final Withholding Tax at Source Sec. 57. NIRC

Subject to rules and regulations the Secretary of Finance may promulgate, upon the recommendation of the Commissioner, requiring the filing of income tax return by certain income

payees, the tax imposed or prescribed by Sections 24(B)(1), 24(B)(2), 24(C), 24(D)(1); 25(A)(2), 25(A)(3), 25(B), 25(C), 25(D), 25(E), 27(D)(1), 27(D)(2), 27(D)(3), 27(D)(5), 28 (A)(4), 28(A)(5), 28(A)(7)(a), 28(A)(7)(b), 28(A)(7)(c), 28(B)(1), 28(B)(2), 28(B)(3), 28(B)(4), 28(B)(5)(a), 28(B)(5)(b), 28(B)(5)(c); 33; and 282 of the NIRC on specified items of income shall be withheld by payor-corporation and/or person and paid in the same manner and subject to the same conditions as provided in Section 58 of the NIRC. Withholding of Creditable Tax at Source. - The Secretary of Finance may, upon the recommendation of the Commissioner, require the withholding of a tax on the items of income payable to natural or juridical persons, residing in the Philippines, by payor-corporation/persons as provided for by law, at the rate of not less than one percent (1%) but not more than thirty-two percent (32%) thereof, which shall be credited against the income tax liability of the taxpayer for the taxable year. Tax-free Covenant Bonds. - In any case where bonds, mortgages, deeds of trust or other similar obligations of domestic or resident foreign corporations, contain a contract or provisions by which the obligor agrees to pay any portion of the tax imposed in this Title upon the obligee or to reimburse the obligee for any portion of the tax or to pay the interest without deduction for any tax which the obligor may be required or permitted to pay thereon or to retain therefrom under any law of the Philippines, or any state or country, the obligor shall deduct bonds, mortgages, deeds of trust or other obligations, whether the interest or other payments are payable annually or at shorter or longer periods, and whether the bonds, securities or obligations had been or will be issued or marketed, and the interest or other payment thereon paid, within or without the Philippines, if the interest or other payment is payable to a nonresident alien or to a citizen or resident of the Philippines.

2. Withholding of Creditable Tax RR 2-98 Under the creditable withholding tax system, taxes withheld on certain income payments are intended to equal or at least approximate the tax due of the payee on said income.

The income recipient is still required to file an income tax return, to report the income and/or pay the difference between the tax withheld and the tax due on the income. Taxes withheld on income payments covered by the expanded withholding tax and compensation income are creditable in nature.

RR 12-2001

The amounts subject to withholding tax under this paragraph shall include not only fees but also per diems, allowances and any other form of income payments not subject to withholding tax on compensation.

In the case of professional entertainers, professional athletes, directors involved in movies, stage, radio, television and musical productions and other recipients of talent fees, the amounts subject to withholding tax shall also


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include amounts paid to them in consideration for the use of their names or pictures in print, broadcast, or other media or for public appearances, for purposes of advertisements or sales proportion.

Furthermore, in order to determine the applicable tax rate (10% or 20%) to be applied/withheld by the withholding agent, every professional entertainer, professional athlete, director involved in movies, stage, radio, television and musical productions and other recipients of talent fees shall annually disclose his gross income for the current year to the BIR, by submitting a notarized sworn declaration thereof, copy furnished all the current payors of the declaration duly stamped received by the BIR. The disclosure should be filed on June 30 of each year or within fifteen (15) days after the end of the month the talent's income reaches P720,000, whichever comes earlier. In case his total gross income is less than P720,000 as of June 30, he/she shall submit a second disclosure within fifteen (15) days after the end of the month that his/her gross income for the current year to date reaches P720,000. The initial disclosure after the effectivity of these Regulations shall be filed on or before September 30, 2001 or within fifteen (15) days after the effectivity of these Regulations, whichever comes later. In case of failure to submit the annual declaration/disclosure to the BIR, the payor shall withhold the tax at the rate of 20%.

If an individual recipient receives talent fees in addition to salaries from the same payor, the said talent fees shall be considered as supplemental compensation and, thus, be subject to the withholding tax on compensation."

3. Return and Payment of Tax Sec. 58 Quarterly Returns and Payments of Taxes

Withheld. - Taxes deducted and withheld under Section 57 by withholding agents shall be covered by a return and paid to, except in cases where the Commissioner otherwise permits, an authorized Treasurer of the city or municipality where the withholding agent has his legal residence or principal place of business, or, where the withholding agent is a corporation, where the principal office is located.

The taxes deducted and withheld by the withholding agent shall be held as a special fund in trust for the government until paid to the collecting officers.

The return for final withholding tax shall be filed and the payment made within twenty-five (25) days from the close of each calendar quarter, while the return for creditable withholding taxes shall be filed and the payment made not later than the last day of the month following the close of the quarter during which withholding was made: Provided, That the Commissioner, with the approval of the Secretary of Finance, may require these withholding agents to pay or deposit the taxes deducted or withheld at more frequent intervals when necessary to protect the interest of the government.

Statement of Income Payments Made and Taxes Withheld. - Every withholding agent required to deduct and withhold taxes under Section 57 shall furnish each recipient, in respect to his or its receipts during the calendar quarter or year, a written statement showing the income or other payments made by the withholding agent during such quarter or year, and the amount of the tax deducted and withheld therefrom, simultaneously upon payment at the request of the payee, but not later than the twentieth (20th) day following the close of the quarter in the case of corporate payee, or not later than March 1 of the following year in the case of individual payee for creditable withholding taxes. For final withholding taxes, the statement should be given to the payee on or before January 31 of the succeeding year. Annual Information Return. - Every withholding agent required to deduct and withhold taxes under Section 57 shall submit to the Commissioner an annual information return containing the list of payees and income payments, amount of taxes withheld from each payee and such other pertinent information as may be required by the Commissioner. In the case of final withholding taxes, the return shall be filed on or before January 31 of the

succeeding year, and for creditable withholding taxes, not later than March 1 of the year following the year for which the annual report is being submitted. This return, if made and filed in accordance with the rules and regulations approved by the Secretary of Finance, upon recommendation of the Commissioner, shall be sufficient compliance with the requirements of Section 68 of the NIRC in respect to the income payments.

The Commissioner may, by rules and regulations, grant to any withholding agent a reasonable extension of time to furnish and submit the return required in this Subsection. Income of Recipient. - Income upon which any creditable tax is required to be withheld at source under Section 57 shall be included in the return of its recipient but the excess of the amount of tax so withheld over the tax due on his return shall be refunded to him subject to the provisions of Section 204; if the income tax collected at source is less than the tax due on his return, the difference shall be paid in accordance with the provisions of Section 56. All taxes withheld pursuant to the provisions of this Code and its implementing rules and regulations are hereby considered trust funds and shall be maintained in a separate account and not commingled with any other funds of the withholding agent. Registration with Register of Deeds. - No registration of any document transferring real property shall be effected by the Register of Deeds unless the Commissioner or his duly authorized representative has certified that such transfer has been reported, and the capital gains or creditable withholding tax, if any, has been paid: Provided, however, That the information as may be required by rules and regulations to be prescribed by the Secretary of Finance, upon


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recommendation of the Commissioner, shall be annotated by the Register of Deeds in the Transfer Certificate of Title or Condominium Certificate of Title: Provided, further, That in cases of transfer of property to a corporation, pursuant to a merger, consolidation or reorganization, and where the law allows deferred recognition of income in accordance with Section 40, the information as may be required by rules and regulations to be prescribed by the Secretary of Finance, upon recommendation of the Commissioner, shall be annotated by the Register of Deeds at the back of the Transfer Certificate of Title or Condominium Certificate of Title of the real property involved: Provided, finally, That any violation of this provision by the Register of Deeds shall be subject to the penalties imposed under Section 269 of this Code.

C. Withholding on Wages Sec. 78. Definitions. Wages - The term 'wages' means all remuneration (other than fees paid to a public official) for services performed by an employee for his employer, including the cash value of all remuneration paid in any medium other than cash, except that such term shall not include remuneration paid:

(1) For agricultural labor paid entirely in products

of the farm where the labor is performed, or (2) For domestic service in a private home, or (3) For casual labor not in the course of the

employer's trade or business, or (4) For services by a citizen or resident of the

Philippines for a foreign government or an international organization.

If the remuneration paid by an employer to an employee for services performed during one-half (1/2) or more of any payroll period of not more than thirty-one (31) consecutive days constitutes wages, all the remuneration paid by such employer to such employee for such period shall be deemed to be wages; but if the remuneration paid by an employer to an employee for services performed during more than one-half (1/2) of any such payroll period does not constitute wages, then none of the remuneration paid by such employer to such employee for such period shall be deemed to be wages. Payroll Period - a period for which payment of wages is ordinarily made to the employee by his employer, and the term "miscellaneous payroll

period" means a payroll period other than, a daily, weekly, biweekly, semi-monthly, monthly, quarterly, semi-annual, or annual period. Employee - any individual who is the recipient of wages and includes an officer, employee or elected official of the Government of the Philippines or any political subdivision, agency or instrumentality thereof. The term "employee" also includes an officer of a corporation. Employer - means the person for whom an individual performs or performed any service, of whatever nature, as the employee of such person, except that: (1) If the person for whom the individual performs

or performed any service does not have control of the payment of the wages for such

services, the term "employer" (except for the purpose of Subsection (A)) means the person having control of the payment of such wages; and

(2) In the case of a person paying wages on behalf of a nonresident alien individual, foreign partnership or foreign corporation not engaged in trade or business within the Philippines, the term "employer" (except for the purpose of Subsection (A)) means such person.

Sec. 79. Income Tax Collected at Source Requirement of Withholding - Every employer making payment of wages shall deduct and withhold upon such wages a tax determined in accordance with the rules and regulations to be prescribed by the Secretary of Finance, upon recommendation of the Commissioner: Provided, however, That no withholding of a tax shall be required where the total compensation income of an individual does not exceed the statutory minimum wage, or five thousand pesos (P5,000.00) per month, whichever is higher. Tax Paid by Recipient - If the employer, in violation of the provisions of this Chapter, fails to deduct and withhold the tax as required under this Chapter, and thereafter the tax against which such tax may be credited is paid, the tax so required to be deducted and withheld shall not be collected from the employer; but this Subsection shall in no case relieve the employer from liability for any penalty or addition to the tax otherwise applicable in respect of such failure to deduct and withhold. Refunds or Credits - (1) Employer. - When there has been an

overpayment of tax under this Section, refund or credit shall be made to the employer only to the extent that the amount of such overpayment was not deducted and withheld hereunder by the employer.

(2) Employees. - The amount deducted and

withheld under this Chapter during any calendar year shall be allowed as a credit to the recipient of such income against the tax imposed under Section 24(A) of this Title. Refunds and credits in cases of excessive withholding shall be granted under rules and regulations promulgated by the Secretary of Finance, upon recommendation of the Commissioner.

Any excess of the taxes withheld over the tax due from the taxpayer shall be returned or credited within three (3) months from the fifteenth (15th) day of April. Refunds or credits made after such time shall earn interest at the rate of six percent (6%) per annum, starting after the lapse of the three-month period to the date the refund of credit is made. Refunds shall be made upon warrants drawn by the Commissioner or by his duly authorized representative without the necessity of counter-signature by the Chairman, Commission on Audit or the latter's duly authorized representative as an exception to the requirement prescribed by Section 49, Chapter 8, Subtitle B, Title 1 of Book V of Executive Order No. 292, otherwise known as the Administrative Code of 1987.


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Personal Exemptions - In General. - Unless otherwise provided by this Chapter, the personal and additional exemptions applicable under this Chapter shall be determined in accordance with the main provisions of this Title.

Exemption Certificate. - (a) When to File. - On or before the date of

commencement of employment with an employer, the employee shall furnish the employer with a signed withholding exemption certificate relating to the personal and additional exemptions to which he is entitled.

(b) Change of Status. - In case of change of status of an employee as a result of which he would be entitled to a lesser or greater amount of exemption, the employee shall, within ten (10) days from such change, file with the employer a new withholding exemption certificate reflecting the change.

(c) Use of Certificates. - The certificates filed hereunder shall be used by the employer in the determination of the amount of taxes to be withheld.

(d) Failure to Furnish Certificate. - Where an employee, in violation of this Chapter, either fails or refuses to file a withholding exemption certificate, the employer shall withhold the taxes prescribed under the schedule for zero exemption of the withholding tax table determined pursuant to Subsection (A) hereof.

Withholding on Basis of Average Wages - The Commissioner may, under rules and regulations promulgated by the Secretary of Finance, authorize employers to: (1) estimate the wages which will be paid to an

employee in any quarter of the calendar year; (2) determine the amount to be deducted and

withheld upon each payment of wages to such employee during such quarter as if the appropriate average of the wages so estimated constituted the actual wages paid; and

(3) deduct and withhold upon any payment of wages to such employee during such quarter such amount as may be required to be deducted and withheld during such quarter without regard to this Subsection.

Husband and Wife - When a husband and wife each are recipients of wages, whether from the same or from different employers, taxes to be withheld shall be determined on the following bases: (1) The husband shall be deemed the head of the family and proper claimant of the additional exemption in respect to any dependent children, unless he explicitly waives his right in favor of his wife in the withholding exemption certificate. (2) Taxes shall be withheld from the wages of the wife in accordance with the schedule for zero exemption of the withholding tax table prescribed in Subsection (D)(2)(d) hereof.

Nonresident Aliens - Wages paid to nonresident alien individuals engaged in trade or business in the Philippines shall be subject to the provisions of this Chapter.

Year-End Adjustment - On or before the end of the calendar year but prior to the payment of the compensation for the last payroll period, the employer shall determine the tax due from each

employee on taxable compensation income for the entire taxable year in accordance with Section 24(A). The difference between the tax due from the employee for the entire year and the sum of taxes withheld from January to November shall either be withheld from his salary in December of the current calendar year or refunded to the employee not later than January 25 of the succeeding year.

Sec. 79. Liability for Tax

Employer - The employer shall be liable for the withholding and remittance of the correct amount of tax required to be deducted and withheld under this Chapter. If the employer fails to withhold and remit the correct amount of tax as required to be withheld under the provision of this Chapter, such tax shall be collected from the employer together with the penalties or additions to the tax otherwise applicable in respect to such failure to withhold and remit. Employee - Where an employee fails or refuses to file the withholding exemption certificate or willfully supplies false or inaccurate information thereunder, the tax otherwise required to be withheld by the employer shall be collected from him including penalties or additions to the tax from the due date of remittance until the date of payment. On the other hand, excess taxes withheld made by the employer due to: (1) failure or refusal to file the withholding

exemption certificate; or (2) false and inaccurate information shall not be

refunded to the employee but shall be forfeited in favor of the Government.

Sec. 81. Filing of Return and Payment of Taxes Withheld Except as the Commissioner otherwise permits, taxes deducted and withheld by the employer on wages of employees shall be covered by a return and paid to an authorized agent bank, Collection Agent, or the duly authorized Treasurer of the city or municipality where the employer has his legal residence or principal place of business, or in case the employer is a corporation, where the principal office is located.

The return shall be filed and the payment made within twenty-five (25) days from the close of each calendar quarter: Provided, however, That the Commissioner may, with the approval of the Secretary of Finance, require the employers to pay or deposit the taxes deducted and withheld at more frequent intervals, in cases where such requirement is deemed necessary to protect the interest of the Government. The taxes deducted and withheld by employers shall be held in a special fund in trust for the Government until the same are paid to the said collecting officers.

Documents

UP 2008 Taxation Law (Taxation 1)