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Taxation 101: Basic Rules and Principles in Philippine Taxation

by: JR Lopez Gonzales Faculty, Political Science Department, MSU-IIT
This is the supplementary manuscript for the Political Science 2 Seminar Series on Philippine Taxation. In a nutshell, this document summarizes some of the basic rules, its nature, and purpose of taxation. A brief history of Philippine tax system, and those institutions exempted for paying taxes is also included.

Taxation Taxation is the imposition of financial charges or other levies, upon a taxpayer (an individual or legal entity) by a state such that failure to pay is punishable by law. When taxes are not fully paid, civil penalties (such as fines or forfeiture) or criminal penalties (such as incarceration) may be imposed on the non-paying entity or individual. It is a mode by which government make exactions for revenue in order to support their existence and carry out their legitimate objectives (Tax Law and Jurisprudence by Justice Vitug, 2000). It is the inherent power by which the sovereign state imposes financial burden upon persons and property as a means of raising revenues in order to defray the necessary expenses of the government (Tax Digest by Crescencio Co Untian 2002 ed). Nonetheless, it is the most pervasive and the strongest of all the powers of the government. Taxes are the lifeblood of the government, without which, it cannot subsist. History of Taxation The first known system of taxation was in Ancient Egypt around 3000 BC - 2800 BC in the first dynasty of the Old Kingdom. In Biblical times, tax is already prevalent. According to Genesis 47:24: But when the crop comes in, give a fifth of it to Pharaoh. The other four-fifths you may keep as seed for the fields and as food for yourselves and your households and your children. Earliest taxes in Rome are called as portoria were customs duties on imports and exports. Augustus Caesar introduced the inheritance tax to provide retirement funds for the military. The tax was five percent on all inheritances except gifts to children and spouses . In England, taxes were first used as emergency measures. History of Taxation in the Philippines The pre-colonial society, being communitarian, did not have taxes. But this radically changed upon the coming of the Spanish colonizers in 1521.

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2 During the Spanish Period, revolutionary income-generating means were introduced by the government. Polo Y Servicio (Forced Labor) It is the forced labor for 40 days of men ranging from 16 to 60 years of age who were obligated to give personal services to community projects. One could be exempted from the polo by paying a fee called falla (which was worth one and a half real). Falla is a corruption of the Spanish word falta which means absence. Manila-Acapulco Galleon Trade The Manila-Acapulco Galleon Trade was the main source of income for the colony during its early years. Service was inaugurated in 1565 and continued into the early 19th century. The Galleon trade brought silver from New Spain and silk from China by way of Manila. This way, the Philippines earned its income through buy and sell - that is, they bought silk from China for resale to New Spain and then bought American silver for resale to China. However, it resulted in cultural and commercial exchanges between Asia and the Americas that led to the introduction of new crops and animals to the Philippines notably tobacco that gave the colony its first real income which benefit extended to the common Indio. The trade lasted for over two hundred years, and ceased in 1821 with the secession of American colonies from Spain. Encomienda The encomienda system was introduced in 1570. It was introduced by the Spaniards to facilitate the conquest and pacification of the Philippines. It comes from the word, encomendar which means to take charge of or to entrust. The encomenderos were given full authority to manage the encomienda by collecting tribute from the inhabitants and govern people living on it. In 1591, there were 267 encomiendas in the Philippines. Tribute Tribute was the residence tax during the Spanish times. It may be paid in cash or kind, partly, or wholly. The rate was originally set as eight reales but was raised to ten in 1602 then to twelve reales in 1851 and 14 in 1874. In 1884, the tribute was replaced by the cedula personal or personal identity paper, equivalent to the present residence tax or community tax certificate (CTC). What is a cedula? In the 19th century, it was an identification card that had to be carried at all times. A person who could not present his or her cedula to a guardia civil could then be detained for being indocumentado. Andres Bonifacio and other Katipuneros tore their cedulas in August 1896, signaling the start of the Philippine Revolution. On its present usage, a cedula or community tax certificate is a legal identity document in the Philippines. Issued by cities and municipalities to all persons that have reached the age of majority and upon payment of a community tax, it is considered as a primary form of identification in the Philippines and is one of the closest single documents the Philippines has to a national system of identification, akin to a driver's license and a passport.
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The residence tax, and in turn, the cdula, were abolished with the coming of American rule. No such tax would be imposed again until January 1, 1940, when Commonwealth Act No. 465 went into effect, mandating the imposition of a base residence tax of fifty centavos and an additional tax of one peso based on factors such as income and real estate holdings. The payment of this tax would merit the issue of a residence certificate. However, persons who are ineligible to pay the residence tax may be issued a certificate for twenty centavos. Corporations were also subject to the residence tax. Significant amendments to the residence tax law were put into effect first in 1973, following the enactment of the Local Tax Code, with amendments on the allocation of the residence tax and on who are covered under it, as well as payment provisions. The cedula has evolved into the community tax certificate under the Local Government Code of 1991. The code authorizes cities and municipalities to collect annual community tax from corporations, and from residents aged 18 and above who have been employed on a wage basis for at least 30 consecutive days, or who are engaged in business, or who are required by law to file an income tax return. Why is the cedula important? A person is required to present a cedula when he or she acknowledges a document before a notary public; takes an oath of office upon election or appointment to a government position; receives a license, certificate or permit from a public authority; pays a tax or fee; receives money from a public fund; transacts official business; or receives salary from a person or corporation. The Four Rs of Taxation Taxation has four main purposes or effects: Revenue The taxes raise money to spend on armies, roads, schools and hospitals, and on more indirect government functions like market regulation or legal systems. Repricing Taxes are levied to address externalities; for example, tobacco is taxed to discourage smoking, and a carbon tax discourages use of carbon-based fuels. Redistribution Normally, this means transferring wealth from the richer sections of society to poorer sections. Representation The American revolutionary slogan "no taxation without representation" implied this: rulers tax citizens, and citizens demand accountability from their rulers as the other part of this bargain. Studies have shown that direct taxation (such as income taxes) generates the greatest degree of accountability and better governance, while indirect taxation tends to have smaller effects.
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4 Why Tax? The theory underlying basis of taxation is governmental necessity because without it, government can neither exist nor endure. The governments ability to serve the people depends upon the taxes that are collected. Taxes are indispensable in the government operation and without it, the government will be paralyzed. The main purpose of taxation is to accumulate funds for the functioning of the government machineries. No government in the world can run its administrative office without funds and it has no such system incorporated in itself to generate profit from its functioning1. The power of taxation may be used as an implement of the police power of the state through the imposition of taxes with the end view of regulating a particular activity. For example, the imposition of taxes to the video industry as a regulatory measure considering the rampant unfair competition posed by rampant film piracy; the erosion of the moral fiber of the viewing public brought about by the availability of unclassified and unreviewed video tapes containing pornographic films and films with brutally violent sequences and; losses in government due to the drop in the theatrical attendance. The Philippine Tax System Tax law in the Philippines covers national and local taxes. National taxes refer to national internal revenue taxes imposed and collected by the national government through the Bureau of Internal Revenue (BIR) and local taxes refer to those imposed and collected by the local government2. National Tax Law3 The 1987 Philippine Constitution sets limitations on the exercise of the power to tax. The rule of taxation shall be uniform and equitable. The Congress shall evolve a progressive system of taxation. (Article VI, Section 28, Paragraph 1). All money collected on any tax levied for a special purpose shall be treated as a special fund and paid out for such purpose only. If the purpose for which a special fund was created has been fulfilled or abandoned, the balance, if any, shall be transferred to the general funds of the Government. (Article VI, Section 29, Paragraph 3). The Branches of Government vis--vis the Tax Law The Congress may, by law, authorize the President to fix within specified limits, and subject to such limitations and restrictions as it may impose, tariff rates, import and export quotas, tonnage and wharfage dues, and other duties or imposts within the framework of the national development program of the Government (Article VI, Section 28, Paragraph 2). The President shall have the power to veto any particular item or items in an appropriation, revenue, or tariff bill, but the veto shall not affect the item or items to which he does not object (Article VI, Section 27, Paragraph 2).

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http://www.business.mapsofindia.com/india-tax/concepts/purpose-taxation.html http://www.bir.gov.ph/legalmatters/8757.htm 3 http://www.bir.gov.ph/hom_issrul.html

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5 The Supreme Court has the power to: review, revise, reverse, modify, or affirm on appeal or certiorari, as the law or the Rules of Court may provide, final judgments and orders of lower courts in all cases involving the legality of any tax, impost, assessment, or toll, or any penalty imposed in relation thereto (Article VIII, Section 5, Paragraph 2b). The Forms of Taxes Imposed on Persons and Property A) Personal, capitation or poll taxes. These are taxes of fixed amount upon residents or persons of a certain class without regard to their property or business. B) Property taxes. Taxes assessed on things or property of a certain class. Under this are the following: a. Real property Taxes - an annual tax that may be imposed by a province or city or a municipality on real property such as land, building, machinery and other improvements affixed or attached to real property. b. Estate Tax (Inheritance tax) - a tax on the right of transmitting property at the time of death and on the privilege that a person is given in controlling to a certain extent the disposition of his property to take effect upon death. c. Gift or Donors Tax - a tax on the privilege of transmitting ones property or property rights to another or others without adequate and full valuable consideration. Taxable gifts may either be real, personal, tangible or intangible. Tax imposed on donations inter-vivos or those made between living persons to take effect during the lifetime of the donor. d. Capital gains tax (sale of capital assets) - tax imposed on the sale or exchange of property . Tax imposed on the gains presumed to have been realized by the seller for the sale, exchange or other disposition of real property located in the Philippines, classified as capital assets C) Income Taxes - Taxes imposed on the income of the taxpayers from whatever sources it is derived. Tax on all yearly profits arising form property, possessions, trades or offices. These are taxes on a persons income, emoluments and profits. D) Excise or License taxes - Taxes imposed on the privilege, occupation or business not falling within the classification of poll taxes or property taxes. These are imposed on alcohol products (except tuba, basi, tapuy and similar domestic fermented liquor; On tobacco products; on petroleum products like lubricating oils, grease, processed gas etc; on mineral products such as coal and coke and quarry resources; on miscellaneous articles such as automobiles. Under these, we have the following: 1. Documentary stamp tax - a tax imposed upon documents, instruments, loan agreements and papers and upon acceptance of assignments, sales and transfers of obligation, rights or property incident thereto. 2. Value Added Tax (VAT) - is imposed on any person who, in the course of trade or business sells, barters, exchanges, leases, goods or properties, renders services, or engages in similar transactions. It is an indirect tax and the amount of the tax may be shifted or passed on the to buyer, transferee or lessee of the goods, properties or services. Tax imposed and collected on every sale, barter, exchange or transaction deemed sale of taxable goods, properties, lease of goods, services or properties in the course of trade as
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6 they pass along the production and distribution chain. The present value-added tax inclusive in these sales is in twelve percent (12%). Who should Pay Taxes? A. Individuals a. Resident citizens. Resident citizens are taxed on their compensation business and other sources derived from sources within and without the Philippines. b. Non-resident citizens. A non-resident citizen is one who establishes to the satisfaction of the Commissioner the fact of his physical presence abroad with a definite intention to reside therein. He is a citizen of the Philippines who leaves the Philippines during the taxable year to reside abroad, either as an immigrant of for employment on a permanent basis. Non-resident citizens are taxed on their income derived from sources within the Philippines. Their income derived from Philippine sources is subject to tax exactly in the same manner as such income would have been subjected to tax if received by resident citizens. Income derived from foreign sources is tax exempt. c. Resident aliens. Resident aliens are taxed on their net income derived from sources within the Philippines.Their income derived from Philippine sources is subject to tax exactly in the same manner as such income would have been subjected to tax if received by non-resident citizens. d. Non-resident aliens who may either be: a) Engaged in trade or business (the term denotes habituality or sustained activity) and he is deemed to be engaged in business if his aggregate stay in the Philippines exceeds 180 days for each calendar year. They are taxed on their income from sources within the Philippines and not from without the Philippines. b) Not engaged in trade or business. Non-resident aliens not engaged in trade or business in the Philippines is subject to tax on their gross income at 25%. They are not entitled to any personal or additional exemptions. B. Corporations Also including partnerships, no matter how created, joint stock companies, joint accounts, associations or insurance companies. For income tax purposes, these corporations may be grouped into: A. Domestic corporations or corporations organized and existing under the laws of the Philippines. Domestic corporations are taxed on their income derived from source within the Philippines and without the Philippines. B. Foreign corporations which may either be: a) Resident foreign corporation (engaged in trade or business). Resident foreign corporations are liable to pay taxes for profits, including interests, dividends, rents, royalties,
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7 profits or income remitted abroad to its mother company is subject to 15% remittance tax computed on the actual amount remitted. b). Non-resident foreign corporations (not engaged in trade or business). Nonresident foreign corporations are taxed on their income derived from sources within (not without) from the Philippines at the rate of 32%. C. Estate under judicial settlement is subject to income tax in the same manner as individuals. Its own status is dependent on the status of the decedent immediately prior to his death. Thus, where the decedent was a resident citizen then the income taxability of his estate would be that applicable to resident citizens. D. Trusts irrevocable both as to the trust property and as to the income. It is taxed exactly in the same way as estates under judicial settlement and its status as an individual is that of the trustor. What is Tax Evasion? Tax evasion happens when there is fraud through pretension and the use of other illegal devices to lessen ones taxes. Under-declaration of income, non-declaration of income and other items subject to tax, under-appraisal of goods subject to tariff, and over-declaration of deductions are some of the ways on how tax evaders operate. Tax avoidance, on the other hand, involves the legal rearrangements of one's economic activities in order to lower the tax liability. This is done by moving capital or labor to areas, geographical or otherwise, where tax rates are lower and/or by manipulating the tax parameters through the legal means to spread or defer the tax liability over time thereby effectively reducing the tax rate. Tax evasion is done by a taxpayer either singly or in collusion with some tax collection functionary, while tax avoidance is done singly or with the help of some tax expert like a lawyer and an accountant. Who are Exempted to Pay Taxes? The Omnibus Investment Code of 1987 lays out tax incentives administered by the BOI of the Department of Taxation and Development, and the annual Investment Priorities Plan (IPP) sets out the investment areas, national and regional, to which these incentives currently pertain. In 2002 the national list included export activities, industrial development and mining, agricultural/fishery production and processing, logistics, drugs and medicine, engineered products, environmental projects, IT services, Infrastructure, mass housing projects, R and D activities, social service, tourism, patriotic and documentary motion pictures and new projects with a minimum cost of $2 million. Special economic zones (SEZs) can be designated as export processing, free trade and/or information technology (IT) parks, each designation providing a schedule of tax holidays, exemptions from import duties on capital goods and raw material, and preferential income tax rates with more favorable treatment accorded pioneer industries over nonpioneer or expanding companies.

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8 Tax exemptions are limited to those granted by law. However, no law granting any tax exemption shall be passed without the concurrence of a majority of all the members of the Congress. (Article VI, Section 28, Paragraph 4). The Constitution expressly grants tax exemption on certain entities/institutions such as 1. Charitable institutions, churches, parsonages or convents appurtenant thereto, mosques, and nonprofit cemeteries and all lands, buildings and improvements actually, directly and exclusively used for religious, charitable or educational purposes (Article VI, Section 28, Paragraph 3). 2. Non-stock non-profit educational institutions used actually, directly, and exclusively for educational purposes. (Article XVI, Section 4 (3)). On the other hand, exempted to tax as stated in the Article 283 of Rules and Regulations Implementing Local Government Code of 1991 (RA 7160):  Local water districts  Cooperatives duly registered under RA 6938, otherwise known as the Cooperative Code of the Philippines  Non-stock and non-profit hospitals and educational institutions  Business enterprise certified by the Board of Investments (BOI) as pioneer or nonpioneer for a period of six and four years, respectively, from the date of registration  Business entity, association, or cooperative registered under RA 6810  Printer and/or publisher of books or other reading materials prescribed by DECS (now DepEd) as school texts or references, insofar as receipts from the printing and / or publishing thereof are concerned.

About the Speaker

JR Lopez Gonzales attained his bachelors degree in Political Science with the distinction of cum laude in 2009. He is currently the Editor-in-Chief of MSU College of Law - Iligans schoolpaper. He is the resident political blogger at politikalon.blogspot.com. He is a third year law student and he is currently on his third year of teaching in college. He is a lifetime member of Toastmasters International.

This document is uploaded by PoliTikalon Blog: http://www.politikalon.blogspot.com. The reading of this note is advised to be coupled with the downloadable PowerPoint presentation at: http://www.slideshare.net/JRLopezGonzales/taxation-101-basic-rules-and-principles-in-philippine-taxation-by-jr-lopezgonzales-for-msu-iit-political-science-seminar.