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D.

DIVIDEND INCOME

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

Section 250. Dividends. Dividends, for the purpose of the


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

Code. Dividends paid by the domestic corporation to a


nonresident foreign corporation are taxable in full.

Section 251. Dividends paid in property. - Dividends paid in


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

Section 252. Stock dividends. - A stock dividend which


represents the transfer of surplus to capital account is not
subject to income tax. However, a dividend in stock may
constitute taxable income to the recipient thereof
notwithstanding the fact that the officers or director of the
corporation (as defined in section 84) choose to call such
distribution as a stock dividend. The distinction between a
stock dividend which does not, and one which does,
constitute income taxable to the shareholder is the
distinction between a stock dividend which works no change

in the corporate entity, the same interest In the same


corporation being represented after the distribution by more
shares of precisely the same character and a stock dividend
where there either has been a Change of corporate identity
or a change in the nature of the shares issued as dividends
whereby the proportional interest of the shareholders after
the distribution is essentially different from his former
interest. A stock dividend constitutes income if it gives the
shareholder an interest different from that which his former
stock holdings represented. A stock dividend does not
constitute income if the new shares confer no different rights
or interest than did the old - the new certificates plus the old
representing the same proportionate interest in the net asset
of the corporation as did the old.

Section 253. Sale of stock received as dividends. - Stock


issued by a corporation, as a dividend, does not constitute
taxable income to a stockholder in such corporation, but gain
may be derived or loss sustained by the stockholder, whether
individual or corporate, from the sale of such stock, which
gain or loss will be treated as arising from the sale or
exchange of a capital asset. (See section 34 of the Code.)
The amount of gain derived or loss sustained from the sale of
such stock, or from the sale of the stock with respect to
which it is issued, shall be determined in accordance with the
following rules:
(a) Where the stock issued as dividend is as or substantially
the same character or preference as the stock upon which
the stock dividend is paid, the cost of each share (or when
acquired prior to March, 1, 1913, the fair market value as of
such date) will be the quotient of the cost (or such fair
market value) of the old shares of stock divided by the total
number of the old and new shares.

(b) Where the stock issued as a dividend is in whole or in part


of a character or preference materially different from the
stock upon which the stock dividend is paid, the cost (and
when acquired prior to March 1,1913, the fair market value
as of such date) of the old shares of stock shall be divided
between such old stock and the new stock, in proportion, as
nearly as may be, to the respective value of each class of
stock old and new at the time the new shares of stock are
issued, and the cost (or when acquired prior to March 1,
1913, the fair market value as of such date) of each share of
stock will be the quotient of the cost (or such fair market
value as of March 1, 1913) of the class to which such share
belongs divided by the number of shares in that class.
(c) Where the stock with respect to which a stock dividend is
issued was purchased at different times and at different
prices and the identity of the lots cannot be determined, any
sale of the original stock, will be charged to the earliest
purchases, of such stock, and any sale of dividend stock
issued with respect to such stock will be presumed to have
been made from the stock issued with respect to the earliest
purchased stock, to the amount of the dividend chargeable to
such stock.
(d) Where the stock with respect to which a stock dividend is
declared was purchased at different times and at different
prices, and the dividend stock issued with respect to such
stock cannot be identified as having been issued with respect
to any particular lot of such stock, then any sale of such
dividend stock will be presumed to have been made from the
stock issued with respect to the earliest purchased stock, to
the amount of the stock dividend chargeable to such stock.

Section 254. Declaration and subsequent redemption of a


stock dividend. - A true stock dividend is not subject to tax on
its receipt in the hands of the recipient. Nevertheless, if a

corporation, after the distribution of a stock dividend,


proceeds to cancel or redeem its stock at such time and in
such manner as to make the distribution and cancellation or
redemption essentially equivalent to the distribution of a
taxable dividend, the amount received in redemption or
cancellation of the stock shall be treated as a taxable
dividend to the extent of the earnings or profits accumulated
by such corporation since March 1, 1913

Section 255. Sources of distribution. For the purpose of


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

Section 256. Distribution in liquidation. - In all case's where a


corporation (as defined in section 84) distributes all of its
property or assets in complete liquidation or dissolution, the
gain realized from the transaction by the stockholder,
whether individual or corporate, is taxable to the extent
recognized in section 34 (b) of the Code. For this purpose, the
term complete liquidation includes anyone of a series of
distributions made by a corporation in complete cancellation
or redemption of an of its stocks in accordance with a bona
fide plan of liquidation under which the transfer of all the

assets under liquidation is to be completed within a


reasonable time from the date of the first distribution, usually
not to exceed one year from the time of such first
distribution. If the amount received by the stockholder in
liquidation is less than the cost or other basis of the stock,
the loss in the transaction is deductible to the extent allowed
in section 34(c) of the Code.

Dividend represents a distribution of the profits by a


corporations

1. Kinds of dividends recognized in law

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


amount of money received

b. Property - when taxable, the measure of income is the


FMV of the property received. A dividend paid in shares of
stocks of another corporation, or in treasury stocks, is a
property dividend.

BIR Ruling No. 108-93


Facts: SEA COMMERCIAL COMPANY, INC. (SEACOM), is a
domestic corporation with an authorized capital stock of
Thirty Million Pesos (P30,000,000.00), divided into Thirty
Thousand (30,000) Preferred shares of stock and Two
Hundred Seventy Thousand (270,000) Common shares of
stock, all with a par value of One Hundred Pesos (P100.00)
per share, of which One Hundred Fifty Five Thousand Three

Hundred Two (150,302) Common shares of stock are issued


and outstanding as of 31 December 1991; and that as of 31
December 1991, it had a total stockholder's equity in the
amount of Thirty Four Million Seven Hundred Nine Thousand
Five Hundred Five Pesos (P34,709,505.00), which include
unrestricted retained earnings in the amount of Nineteen
Million Four Hundred Sixty Nine Thousand Four Hundred Forty
One Pesos (P19,469,441.00); that on 15 June 1992, the
Corporation declared all of its unrestricted retained earnings
as of 31 December 1991 as dividends in favor of stockholders
of record as of 15 June 1992, payable on or before 15 April
1993, that said dividends shall be distributed in the form of
cash in the amount of Seven Million Five Hundred Twenty
Thousand Three and 08/100 Pesos (P7,520,003.08), and the
following properties with a total book value of Eleven Million
Nine Hundred Forty Nine Thousand Four Hundred Thirty
Seven
and
92/100
Pesos
(P11,949,437.92).
The
aforementioned real and personal properties are capital
assets of the Corporation, which are not used and not
intended to be used by the Corporation in its ordinary course
of business; that the properties declared as dividends were
recorded in the books of the Corporation at their book values;
that the total book value of the property dividends is
equivalent only to Twenty-Five and 80/100 percent (25.8%) of
SEACOM'S assets for the year ended 31 December 1991; and
that the Corporation continues to do business and its
stockholders have no intention of liquidating the corporation
after the declaration of property dividends.

Ruling: The property dividend shall be recorded at the book


value in the books of both the issuing corporation and the
recipient stockholder. The BIR Ruling No. 21(c)(2)-028-89130-89 applying Sections 250 and 251 of Revenue
Regulations No. 2 stating that dividends paid in securities or
other property (other than its own stock) in which the

earnings of a corporation have been invested are income to


the recipient to the amount of the full market value of such
property when receivable by individual stockholders has
already been modified having been rendered obsolete by
Executive Order No. 37 (effective August 1, 1986) subjecting
to income tax at 0% effective January 1, 1989, dividends
received from a domestic corporation and the share of an
individual partner in a partnership subject to tax under
Section 24(a) of the Tax Code (BIR Ruling No. 276-91
December 26, 1991)
The proposed property dividend which shall be received by
the stockholders of SEACOM shall be subject to a final
withholding tax of zero (0%) percent, and the receiving
stockholders shall not be subject to any income or capital
gains tax arising from their receipt of these properties as
property dividend. (Section 21(c)(2) of the Tax Code, as
amended by Executive Order No. 37). However, certificates
authorizing transfer of real estate properties without
payment of the capital gains tax shall be secured from the
Revenue District Officer of the Revenue District where the
property is located before said properties are transferred in
the name of the recipient stockholders (BIR Ruling No. 028-89
dated February 22, 1989). Similarly, certificates authorizing
transfer of shares of stock without payment of the capital
gains tax shall be secured from the Revenue District Officer
of the Revenue District where the principal place of office of
the corporation declaring the dividends is located. It shall be
the ministerial duty of the Revenue District Officer to issue
said certificates.
SEACOM shall not be subject to any income or capital gains
tax on the difference between the fair market value and the
book value of the real estate properties declared and
distributed as property dividends. This is because there is no
realized gain considering the fact that the value used at the
time of distribution is the book value.

Upon subsequent sale or other disposition of the property


received as dividends by the stockholders, the basis of such
shall also be its book value at the time of the dividend
distribution.
The amount of the documentary stamp tax on the Deeds of
Conveyance to be executed between SEACOM and the
recipient stockholders covering the real estate properties
declared as property dividends shall be based on the book
value of said real estate properties. The documentary stamp
tax that shall be collected shall be at the rate of ten (10)
pesos for every one thousand pesos (P1,000.00), or fractional
part thereof, of the book value of the real properties declared
as dividends (Section 196, Tax Code). On the other hand, the
documentary stamp tax on the Deeds of Conveyance to be
executed between SEACOM and the recipient stockholders
covering the shares of stock to be declared as property
dividends shall be based on the par value of the shares of
stocks, at the rate of fifty centavos (P0.50) for each two
hundred pesos (P200.00), or fractional part thereof, of the
value of the shares of stock declared as property dividends
(Section 176, Tax Code). In both cases, the documentary
stamp tax shall be due and payable on the day of execution
of the Deeds of Conveyance (Section 173, Tax Code).

c. Stock

Comm. v. Manning, 66 SCRA 14

Under a trust agreement, Julius Reese who owned 24,700


shares of the 25,000 common shares of MANTRASCO, and the

three private respondents who owned the rest, at 100 shares


each, deposited all their shares with the Trustees. The trust
agreement provided that upon Reese's death MANTRASCO
shall purchase Reese's shares. The trust agreement was
executed in view of Reese's desire that upon his death the
Company would continue under the management of
respondents. Upon Reese's death and partial payment by the
company of Reeses's share, a new certificate was issued in
the name of MANTRASCO, and the certificate indorsed to the
Trustees. Subsequently, the stockholders reverted the 24,700
shares in the Treasury to the capital account of the company
as stock dividends to be distributed to the stockholders.
When the entire purchase price of Reese's interest in the
company was paid in full by the latter, the trust agreement
was terminated, and the shares held in trust were delivered
to the company.
The Bureau of Internal Revenue concluded that the
distribution of the 24,700 shares of Reese as stock dividends
was in effect a distribution of the "assets or property of the
corporation." It therefore assessed respondents for deficiency
income taxes as well as for fraud penalty and interest
charges.
On a petition for review, the Supreme Court held that the
newly acquired shares were not treasury shares; their
declaration as treasury stock dividends was a complete
nullity and that the assessment by the Commissioner of fraud
penalty and the imposition of interest charges pursuant to
the provision of the Tax Code were made in accordance with
law.
Where by the use of a trust instrument as a convenient
technical device, respondents bestowed unto themselves the
full worth and value of a deceased stockholder's corporate
holding acquired with the very earnings of the companies,
such package device which obviously is not designed to carry

out the usual stock dividend purpose of corporate expansion


reinvestment, e.g., the acquisition of additional facilities and
other capital budget items, but exclusively for expanding the
capital base of the surviving stockholders in the company,
cannot be allowed to deflect the latter's responsibilities
toward our income tax laws. The conclusion is ineluctable
that whenever the company parted with a portion of its
earnings "to buy" the corporate holdings of the deceased
stockholders, it was in ultimate effect and result making a
distribution of such earnings to the surviving stockholders. All
these amounts are consequently subject to income tax as
being, in truth and in fact, a flow of cash benefits to the
surviving stockholders.
Where the surviving stockholders, by resolution, partitioned
among themselves, as treasury stock dividends, the
deceased stockholder's interest, and earnings of the
corporation over a period of years were used to gradually
wipe out the holdings therein of said deceased stockholder,
the earnings (which in effect have been distributed to the
surviving stockholders when they appropriated among
themselves the deceased stockholder's interest), should be
taxed for each of the corresponding years when payments
were made to the deceased's estate on account of his shares.
In other words, the Tax Commissioner may not asses the
surviving stockholders, for income tax purposes, the total
acquisition cost of the alleged treasury stock dividends in one
lump sum. However, with regard to payment made with the
corporation's earnings before the passage of the resolution
declaring as stock dividends the deceased stockholder's
interest (while indeed those earnings were utilized in those
years to gradually pay off the value of the deceased
stockholder's holdings), the surviving stockholders should be
liable (in the absence of evidence that prior to the passage of
the stockholder's resolution the contributed of each of the
surviving stockholder rose corresponding), for income tax
purposes, to the extent of the aggregate amount paid by the

corporation (prior to such resolution) to buy off the deceased


stockholder's shares. The reason is that it was only by virtue
of the authority contained in said resolution that the
surviving stockholders actually, albeit illegally, appropriated
and petitioned among themselves the stockholders equity
representing the deceased stockholder's interest.

Fisher v. Trinidad, 43 Phil 973

Are the "stock dividends" in the present case "income" and


taxable?
A dividend is defined as a corporate profit set aside,
declared, and ordered by the directors to be paid to the
stockholders on demand or at a fixed time. Until the dividend
is declared, the corporate profits belong to the corporation
and not to the stockholders, and are liable for the payment of
the debts of the corporation.
A stock dividend, when declared, is merely a certificate of
stock which evidences the interest of the stockholder in the
increased capital of the corporation. There is a clear
distinction between a cash dividend and a stock dividend.
The one is a disbursement to the stockholder of accumulated
earnings, and the corporation parts irrevocably with all
interest therein; the other involves no disbursement by the
corporation; the corporation parts with nothing to its
stockholder. When a cash dividend is declared and paid to
stockholders, such cash becomes the absolute property of
the stockholders and cannot be reached by the creditors of
corporation in the absence of fraud. The property
represented by a stock dividend, however, still being the
property of corporation, and not of the stockholder, it may be
reached by an execution against the corporation, and sold as

a part of the property of the corporation. In such a case, if all


of the property of the corporation is sold under execution,
then the stockholders certainly could not be charged with
having received an income by virtue of the issuance of the
stock dividend. If the ownership of the property represented
by a stock dividend is still in the corporation and not in the
holder of such stock, certainly such stock cannot be regarded
as income to the stockholder. The stockholder has received
nothing but a representation of an interest in the property of
the corporation and, as a matter of fact, he may never
receive anything, depending upon the final outcome of the
business of the corporation.

Held: "Stock dividends" are not "income," the same cannot


be taxed under that provision of Act No. 2833 which provides
for a tax upon income. Under the guise of an income tax,
property which is not an income cannot be taxed.

2. Measure of income in cash and property dividend

3. stock dividend

a. When taxable - if it gives the shareholder an interest


different from that which his former stock represented

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

b. When not taxable - if the new shares confer no different


interest or rights than the old

i) Adjusted cost per share where the stock received as


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

4. Liquidated Dividend

BIR Ruling 322-87


Facts: The Company is a trading concern and at present is in
the process of liquidation; and that individual stockholders
will receive their liquidating dividends in excess of their
investment.
Ruling: Since the individual stockholders of the Company will
receive upon its complete liquidation all its assets as
liquidating dividends, they will thereby realize capital gain or
loss. The gain, if any, derived by the individual stockholders
consisting of the difference between the fair market value of
the liquidating dividends and the adjusted cost to the
stockholders of their respective shareholdings in the said
corporation (Sec. 83 (a), Sec. 256, Income Tax Regulations)
shall be subject to income tax at the rates prescribed under

Section 21(a) of the Tax Code, as amended by Executive


Order No. 37.
Moreover, pursuant to Section 34(b) of the Tax Code, as
amended by Executive Order No. 37, only 50% of the
aforementioned capital gain is reportable for income tax
purposes if the shares were held by the individual
stockholders for more than twelve months and 100% of the
capital gains if the shares were held for less than twelve
months.

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

A distribution does not necessarily become a dividend by


reason of the fact that it is called a dividend by the
distributing corporation. "The ordinary connotation of
liquidating dividend involves the distribution of assets by a
corporation to its stockholders upon dissolution." The
determining element therefore is whether the distribution
was in the ordinary course of business and with intent to
maintain the corporation as a going concern, or after
deciding to quit with intent to liquidate the business.
Proceedings actually begun to dissolve the corporation or
formal action taken to liquidate it are but evidentiary and not
indispensable.
"The distinction between a distribution in liquidation and an
ordinary dividend is factual; the result in each case
depending on the particular circumstances of the case and
the intent of the parties. If the distribution is in the nature of
a recurring return on stock it is an ordinary dividend.
However, if the corporation is really winding up its business
or recapitalizing and narrowing its activities, the distribution
may properly be treated as in complete or partial liquidation

and as payment by the corporation to the stockholder for his


stock. The corporation is, in the latter instances, wiping out
all or Part of the stockholders' interest in the company . . ."

all subscribed by Don Andres. Don Andres transferred 1,250


shares each to his two sons, Jose and Andres, Jr., as their
initial investments in ANSCOR. Both sons are foreigners.

Gains resulting from distributions made in complete


liquidation or dissolution of a corporation as specifically
contemplated in section 25 (a) of the former Income Tax Law,
are taxable as income, whether the stockholder happens to
be an individual or a corporation. Section 25 (a) of the law,
far from limiting the taxability, provides that the gain thus
realized is a "taxable income" under the law so long as a
gain is realized, it will be a taxable income whether the
distribution comes from the earnings or profits of the
corporation or from the sale of all of its assets in general, so
long as the distribution is made "in complete liquidation or
dissolution."

Stock dividends were declared on 1947, 1949 and 1963.On


December 30, 1964 Don Andres died. As of that date, he has
a total shareholdings of 185,154 shares - 50,495 of which are
original issues and the balance of 134,659 shares as stock
dividend declarations. One-half of that shareholdings were
transferred to his wife, Doa Carmen Soriano, as her conjugal
share. The other half formed part of his estate.

5. Essentially Equivalent to distribution of taxable dividends

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

Sometime in the 1930s, Don Andres Soriano, a citizen and


resident of the United States, formed the corporation A.
Soriano Y Cia, predecessor of ANSCOR, with a P1,000,000.00
capitalization divided into 10,000 common shares at a par
value of P100/share. ANSCOR is wholly owned and controlled
by the family of Don Andres, who are all non-resident aliens.
In 1937, Don Andres subscribed to 4,963 shares of the 5,000
shares originally issued. The authorized capital stock was
increased to P2,500,000.00 divided into 25,000 common
shares with the same par value with only 10,000 issued and

ANSCOR increased its capital stock to P20M and in 1966 to


P30M. In the same year, stock dividends worth 46,290 and
46,287 shares were respectively received by the Don Andres
estate and Doa Carmen from ANSCOR. Hence, increasing
their accumulated shareholdings to 138,867 and 138,864
common shares each.
On December 28, 1967, Doa Carmen requested a ruling
from the United States Internal Revenue Service (IRS),
inquiring if an exchange of common with preferred shares
may be considered as a tax avoidance scheme under Section
367 of the 1954 U.S. Revenue Act. By January 2, 1968,
ANSCOR reclassified its existing 300,000 common shares into
150,000 common and 150,000 preferred shares. The IRS
opined that the exchange is only a recapitalization scheme
and not tax avoidance. Consequently, Doa Carmen
exchanged her whole 138,864 common shares for 138,860 of
the newly reclassified preferred shares. The estate of Don
Andres in turn, exchanged 11,140 of its common shares for
the remaining 11,140 preferred shares, thus reducing its (the
estate) common shares to 127,727.

ANSCOR redeemed 28,000 common shares from the Don


Andres estate. By November 1968, the Board further

increased ANSCORs capital stock to P75M divided into


150,000 preferred shares and 600,000 common shares.
About a year later, ANSCOR again redeemed 80,000 common
shares from the Don Andres estate further reducing the
latters common shareholdings to 19,727.

essentially equivalent to the distribution of taxable


dividend, making the proceeds thereof taxable under the
provisions of the above-quoted law.

In 1973, after examining ANSCORs books of account and


records, Revenue examiners issued a report proposing that
ANSCOR be assessed for deficiency withholding tax-atsource, pursuant to Sections 53 and 54 of the 1939 Revenue
Code, for the year 1968 and the second quarter of 1969
based on the transactions of exchange and redemption of
stocks.

General Rule

Subsequently, ANSCOR filed a petition for review with the


CTA assailing the tax assessments on the redemptions and
exchange of stocks.
The bone of contention is the interpretation and application
of Section 83(b) of the 1939 Revenue Act which provides:
Sec. 83. Distribution of dividends or assets by corporations. (b) Stock dividends - A stock dividend representing the
transfer of surplus to capital account shall not be subject to
tax. However, if a corporation cancels or redeems stock
issued as a dividend at such time and in such manner as to
make the distribution and cancellation or redemption, in
whole or in part, essentially equivalent to the distribution of a
taxable dividend, the amount so distributed in redemption or
cancellation of the stock shall be considered as taxable
income to the extent it represents a distribution of earnings
or profits accumulated after March first, nineteen hundred
and thirteen. (Italics supplied).
Specifically, the issue is whether ANSCORs redemption of
stocks from its stockholder as well as the exchange of
common with preferred shares can be considered as

Section 83(b) of the 1939 NIRC was taken from Section


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

the corporate properties. As capital, it is not yet subject to


income tax. It should be noted that capital and income are
different. Capital is wealth or fund; whereas income is profit
or gain or the flow of wealth. The determining factor for the
imposition of income tax is whether any gain or profit was
derived from a transaction.

The Exception

equivalent of a taxable dividend is a question of fact, which


is determinable on the basis of the particular facts of the
transaction in question. No decisive test can be used to
determine the application of the exemption under Section
83(b) The use of the words such manner and essentially
equivalent negative any idea that a weighted formula can
resolve a crucial issue - Should the distribution be treated as
taxable dividend. On this aspect, American courts developed
certain recognized criteria, which includes the following:

However, if a corporation cancels or redeems stock issued


as a dividend at such time and in such manner as to make
the distribution and cancellation or redemption, in whole or in
part, essentially equivalent to the distribution of a taxable
dividend, the amount so distributed in redemption or
cancellation of the stock shall be considered as taxable
income to the extent it represents a distribution of earnings
or profits accumulated after March first, nineteen hundred
and thirteen. (Emphasis supplied).

1) the presence or absence of real business purpose,

Although redemption and cancellation are generally


considered capital transactions, as such, they are not subject
to tax. However, it does not necessarily mean that a
shareholder may not realize a taxable gain from such
transactions. Simply put, depending on the circumstances,
the proceeds of redemption of stock dividends are essentially
distribution of cash dividends, which when paid becomes the
absolute property of the stockholder. Thereafter, the latter
becomes the exclusive owner thereof and can exercise the
freedom of choice. Having realized gain from that
redemption, the income earner cannot escape income tax.

5) the presence of a substantial surplus and a generous


supply of cash which invites suspicion as does a meager
policy in relation both to current earnings and accumulated
surplus.

As qualified by the phrase such time and in such manner,


the exception was not intended to characterize as taxable
dividend every distribution of earnings arising from the
redemption of stock dividends. So that, whether the amount
distributed in the redemption should be treated as the

2) the amount of earnings and profits available for the


declaration of a regular dividend and the corporations past
record with respect to the declaration of dividends,
3) the effect of the distribution as compared with the
declaration of regular dividend,
4) the lapse of time between issuance and redemption,

REDEMPTION AND CANCELLATION


For the exempting clause of Section 83(b) to apply, it is
indispensable that: (a) there is redemption or cancellation;
(b) the transaction involves stock dividends and (c) the time
and manner of the transaction makes it essentially
equivalent to a distribution of taxable dividends. Of these,
the most important is the third.
Redemption is repurchase, a reacquisition of stock by a
corporation which issued the stock in exchange for property,

whether or not the acquired stock is cancelled, retired or held


in the treasury. Essentially, the corporation gets back some of
its stock, distributes cash or property to the shareholder in
payment for the stock, and continues in business as before.
The redemption of stock dividends previously issued is used
as a veil for the constructive distribution of cash dividends. In
the instant case, there is no dispute that ANSCOR redeemed
shares of stocks from a stockholder (Don Andres) twice
(28,000 and 80,000 common shares). But where did the
shares redeemed come from? If its source is the original
capital subscriptions upon establishment of the corporation
or from initial capital investment in an existing enterprise, its
redemption to the concurrent value of acquisition may not
invite the application of Sec. 83(b) under the 1939 Tax Code,
as it is not income but a mere return of capital. On the
contrary, if the redeemed shares are from stock dividend
declarations other than as initial capital investment, the
proceeds of the redemption is additional wealth, for it is not
merely a return of capital but a gain thereon.
It is not the stock dividends but the proceeds of its
redemption that may be deemed as taxable dividends. Here,
it is undisputed that at the time of the last redemption, the
original common shares owned by the estate were only
25,247.5. This means that from the total of 108,000 shares
redeemed from the estate, the balance of 82,752.5 (108,000
less 25,247.5) must have come from stock dividends.
Besides, in the absence of evidence to the contrary, the Tax
Code presumes that every distribution of corporate property,
in whole or in part, is made out of corporate profits, such as
stock dividends. The capital cannot be distributed in the form
of redemption of stock dividends without violating the trust
fund doctrine - wherein the capital stock, property and other
assets of the corporation are regarded as equity in trust for
the payment of the corporate creditors. Once capital, it is
always capital. That doctrine was intended for the protection
of corporate creditors

With respect to the third requisite, ANSCOR redeemed stock


dividends issued just 2 to 3 years earlier. The time alone that
lapsed from the issuance to the redemption is not a sufficient
indicator to determine taxability. It is a must to consider the
factual circumstances as to the manner of both the issuance
and the redemption. The time element is a factor to show a
device to evade tax and the scheme of cancelling or
redeeming the same shares is a method usually adopted to
accomplish the end sought. Was this transaction used as a
continuing plan, device or artifice to evade payment of
tax? It is necessary to determine the net effect of the
transaction between the shareholder-income taxpayer and
the acquiring (redeeming) corporation. The net effect test
is not evidence or testimony to be considered; it is rather an
inference to be drawn or a conclusion to be reached. It is also
important to know whether the issuance of stock dividends
was dictated by legitimate business reasons, the presence of
which might negate a tax evasion plan.
The issuance of stock dividends and its subsequent
redemption must be separate, distinct, and not related, for
the redemption to be considered a legitimate tax scheme.
Redemption cannot be used as a cloak to distribute corporate
earnings. Otherwise, the apparent intention to avoid tax
becomes doubtful as the intention to evade becomes
manifest.
Depending on each case, the exempting provision of Sec.
83(b) of the 1939 Code may not be applicable if the
redeemed shares were issued with bona fide business
purpose, which is judged after each and every step of the
transaction have been considered and the whole transaction
does not amount to a tax evasion scheme.
It is the net effect rather than the motives and plans of the
taxpayer or his corporation that is the fundamental guide in
administering Sec. 83(b). This tax provision is aimed at the

result. It also applies even if at the time of the issuance of


the stock dividend, there was no intention to redeem it as a
means of distributing profit or avoiding tax on dividends. The
existence of legitimate business purposes in support of the
redemption of stock dividends is immaterial in income
taxation. It has no relevance in determining dividend
equivalence. Such purposes may be material only upon the
issuance of the stock dividends. The test of taxability under
the exempting clause, when it provides such time and
manner as would make the redemption essentially
equivalent to the distribution of a taxable dividend, is
whether the redemption resulted into a flow of wealth. If no
wealth is realized from the redemption, there may not be a
dividend equivalence treatment.
The three elements in the imposition of income tax are: (1)
there must be gain or profit, (2) that the gain or profit is
realized or received, actually or constructively,and (3) it is
not exempted by law or treaty from income tax. Any business
purpose as to why or how the income was earned by the
taxpayer is not a requirement. Income tax is assessed on
income received from any property, activity or service that
produces the income because the Tax Code stands as an
indifferent neutral party on the matter of where income
comes from.
As stated above, the test of taxability under the exempting
clause of Section 83(b) is, whether income was realized
through the redemption of stock dividends. The redemption
converts into money the stock dividends which become a
realized profit or gain and consequently, the stockholders
separate property.Profits derived from the capital invested
cannot escape income tax. As realized income, the proceeds
of the redeemed stock dividends can be reached by income
taxation regardless of the existence of any business purpose
for the redemption.

A review of the cited American cases shows that the


presence or absence of genuine business purposes may be
material with respect to the issuance or declaration of stock
dividends but not on its subsequent redemption. The
issuance and the redemption of stocks are two different
transactions. Although the existence of legitimate corporate
purposes may justify a corporations acquisition of its own
shares under Section 41 of the Corporation Code, such
purposes cannot excuse the stockholder from the effects of
taxation arising from the redemption. If the issuance of stock
dividends is part of a tax evasion plan and thus, without
legitimate business reasons the redemption becomes
suspicious which may call for the application of the
exempting clause. The substance of the whole transaction,
not its form, usually controls the tax consequences.
After considering the manner and the circumstances by
which the issuance and redemption of stock dividends were
made, there is no other conclusion but that the proceeds
thereof are essentially considered equivalent to a distribution
of taxable dividends. As taxable dividend under Section
83(b), it is part of the entire income subject to tax under
Section 22 in relation to Section 21of the 1939 Code.
Moreover, under Section 29(a) of said Code, dividends are
included in gross income. As income, it is subject to income
tax which is required to be withheld at source. The 1997 Tax
Code may have altered the situation but it does not change
this disposition.

EXCHANGE OF COMMON WITH PREFERRED SHARES


Exchange is an act of taking or giving one thing for another
involving reciprocal transfer and is generally considered as a
taxable transaction. The exchange of common stocks with
preferred stocks, or preferred for common or a combination
of either for both, may not produce a recognized gain or loss,

so long as the provisions of Section 83(b) is not applicable.


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

1. Bad Debt Recovery

2. Forgiveness of indebtedness

RR-2, Section 50. Forgiveness of indebtedness The


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

3. Tax Refunds - for income tax purposes, as a general rule,


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

RMC. No. 13-80


E. INCOME FROM ANY SOURCE WHATEVER

Refunds/Tax Credits under Section 295 of the Tax Code.


Taxes previously claimed and allowed as deductions, but

subsequently refunded or granted as tax credit pursuant to


Section 295 of the Tax Code, should be declared as part of
the gross income of the taxpayer in the year of receipt of the
refund or tax credit. However, the following taxes, when
refunded or credited, are not declarable for income tax
purposes inasmuch as they are not allowable as deductions:
Income tax imposed in Title III of the Tax Code;
Income, war-profit and excess profits taxes imposed by
authority of a foreign country; but this deduction shall be
allowed in the case of a taxpayer who does not signify in his
return his desire to have to any extent the benefits of
paragraph (3) of this subsection (relating to credit for taxes
of foreign countries);
Estate and gift taxes;

The tax credits granted should form part of the gross income
to the enterprise in the year of receipt of tax credit as said
taxes paid are considered allowable deductions for income
taxes purposes.
In some cases, a registered BOI and tourism enterprise
assumes payment of taxes withheld and due from the foreign
lender-remittee on interest payments on foreign loans. In
such cases, the enterprise is given a tax credit for taxes
withheld subject to certain conditions. (Sec. 7(f), R.A. No.
5186; Sec. 8(c), P.D. No. 535)
Said taxes assumed by the registered enterprise represent
necessary and ordinary expenses incurred by the enterprise;
hence, deductible from its gross income. Therefore, the tax
credits granted necessarily constitute taxable income of the
enterprise.

Taxes assessed against local benefits of a kind tending to


increase the value of the property assessed;
Stock transaction tax;
Energy tax; and
Taxes which are not allowable as deductions under the law.

Special Tax Credits granted under R.A. 5186; R.A. 6135 and
P.D. 535. These tax credits and their tax consequences are
as follows:
Sales, compensating and specific taxes are paid on supplies
and raw materials imported by a registered export producer.
Said taxes are given as tax credit to be used in the payment
of taxes, duties, charges and fees due to the national
government in connection with its operations. (Sec. 7(a), R.A.
No. 6135)

4. Damage Recovery - compensatory damages, as


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

5. Prizes and Winnings - generally taxable. Such payments


constitute gains derived from labor.

Not taxable if recipient selected without any action on his


part to enter the contest or proceedings; and the recipient is
not required to render substantial future services as a
condition for receiving the prize or award.

Those granted to athletes shall be exempt from income tax.

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

rendered under an employer-employee relationship where no


deductions shall be allowed under this section other than
Subsection M [Premium payments on Health and/or
Hospitalization Insurance of an Individual Taxpayer] hereof, in
computing taxable income, subject to income tax under
sections

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

Gutierrez v. Collector, 101 Phil 743

Individual resident alien


25(A)
Non-resident alien engaged in trade or business within the
Philippines
26

The compensation or income derived from the expropriation


of property located in the Philippines is an income from
sources within the Philippines and subject to the taxing
jurisdiction of the place.

members of general professional partnerships


27(A)
domestic corporations
27(B)
proprietary educational institutions and hospitals
27(C)

DEDUCTIONS

government-owned or controlled corporations, agencies, or


instrumentalities

A. Classes Of Deductions (Sec. 34)

28(A)(1)
resident foreign corporations

Deductions from Gross Income. Except for taxpayers


earning compensation income arising from personal services

there shall be allowed the following deductions from gross


income:
(a) Expenses

(a) Optional Standard Deduction


(b) Itemized Deductions

(b) Interest

(c) premium payments on health and/or hospitalization


insurance; and

(c) Taxes

(d) Personal exemptions

(d) Losses
(e) Bad debts

Corporations:

(f) Depreciation

Itemized deductions

(g) Depletion of oil and gas wells and mines


(h) Charitable and other contributions

Formula:

(i) Research and development

Individual

(j) Pension trusts

Corporations
All Income

The following are the deductions from the gross income to


arrive at the taxable income.

- Exclusions (Sec. 32[B])


Gross Income
- Allowable deductions (Sec. 34)

Individuals:
Gross compensation
relationship only

Net Income
income

from

employer-employee

- Personal Exemptions (Sec. 35)

Gross income from business or practice of profession

Taxable Net Income

(a) premium payments on health and/or hospitalization


insurance; and

x Tax Rate

(b) personal exemptions

- Creditable W/holding Tax

Income Tax Due

- Tax credit
Income Tax Payable
All Income
- Exclusions (Sec. 32[B])
Gross Income
- Allowable deductions (Sec. 34)
Taxable Net Income
x Tax Rate
Income Tax Due
- Creditable Withholding Tax

The OSD is a deduction from gross income allowed to be


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

- Tax credit
Income Tax Payable
2. Itemized Deductions

1. Optional Standard Deduction for Individuals (OSD)

A taxpayer may claim the following itemized deductions


from gross income from business or practice of profession

Sec. 34(L)

(a) Expenses

In lieu of the deductions allowed, an individual subject to tax


under Section 24, other than a nonresident alien, may elect a
standard deduction in an amount not exceeding 10% of his
gross income.

(b) Interest
(c) Taxes
(d) Losses
(e) Bad debts

Discussion (V. D. Reyes):

(f) Depreciation

(g) Depletion of oil and gas wells and mines


(h) Charitable and other contributions

In computing taxable income, no deduction shall in any case


be allowed for:

(i) Research and development

(a) personal, living or family expenses;

(j) Pension trusts

The Sec. of Finance, upon the recommendation of the CIR


may prescribe by regulation limitations or ceilings for any of
the itemized deductions (a) to (j), subject to the following
conditions:
(a) only after public hearing shall have been held for such
purposes;
(b) considering the following factors:
1. adequacy of the prescribed limits on the
expenditure requirements of each particular industry

actual

2. effects of inflation on expenditure levels


(c) no ceiling shall further be imposed on items of expenses
already subject to ceilings under present law.

(b) any amount paid out for new buildings or for permanent
improvements, or betterments made to increase the value of
any property or estate;
(c) any amount expended in restoring property or in making
good the exhaustion thereof for which an allowance is or has
been made;
(d) premiums paid on any life insurance policy covering the
life of any officer or employee, or of any person financially
interested in any trade or business carried on by the
taxpayer, individual or corporate, when the taxpayer is
directly or indirectly a beneficiary under such policy.

And, no deduction shall be allowed for:


(a) losses from sales or exchanges of property;
(b) interest expense;

Any amount paid or payable which is otherwise deductible


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

(c) bad debts

Items not deductible:

2) except in the case of distributions in liquidation, between


an individual and a corporation more than 50% in value or

where the transaction is between related taxpayers, as


follows:
1) between members of a family. For purposes of this
paragraph, the family of an individual shall include only his
brothers and sisters (whether by the whole or half blood),
spouse, ancestors, and lineal descendants;

the outstanding stock of which is owned, directly, or


indirectly by or for such individual;

operation and/or conduct of the trade, business or exercise of


a profession, including:

3) except in the case of distribution in liquidation, between


two corporations more than 50% in value of the outstanding
stock of each of which is owned, directly or indirectly, by or
for the same individual, if either one of such corporations,
with respect to the taxable year of the corporation preceding
the date of the sale or exchange was, under the law
applicable to such taxable year a personal holding company
or a foreign personal holding company. (There are no more
personal holding companies or foreign personal holding
companies under the NIRC).

(i) A reasonable allowance for salaries, wages, and other


forms of compensation for personal services actually
rendered, including the grossed-up monetary value of fringe
benefit furnished or granted by the employer to the
employee: Provided, That the final tax imposed under Section
33 hereof has been paid;

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

(iii) A reasonable allowance for rentals and/or other payments


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

5) Between the fiduciary of a trust and the fiduciary of


another trust if the same person is the grantor with respect
to each trust;
6) Between a fiduciary of a trust and a beneficiary of such
trust.

B. Expenses In General

Sec. 34(A), NIRC


(1) Ordinary and Necessary Trade, Business or Professional
Expenses.
(a) In General. There shall be allowed as deduction from
gross income all the ordinary and necessary expenses paid or
incurred during the taxable year in carrying on or which are
directly attributable to, the development, management,

(ii) A reasonable allowance for travel expenses, here and


abroad, while away from home in the pursuit of trade,
business or profession;

(iv) A reasonable allowance for entertainment, amusement


and recreation expenses during the taxable year, that are
directly connected to the development, management and
operation of the trade, business or profession of the
taxpayer, or that are directly related to or in furtherance of
the conduct of his or its trade, business or exercise of a
profession not to exceed such ceilings as the Secretary of
Finance may, by rules and regulations prescribe, upon
recommendation of the Commissioner, taking into account
the needs as well as the special circumstances, nature and
character of the industry, trade, business, or profession of
the taxpayer: Provided, That any expense incurred for
entertainment, amusement or recreation that is contrary to
law, morals, public policy or public order shall in no case be
allowed as a deduction.

(b) Substantiation Requirements. No deduction from gross


income shall be allowed under Subsection (A) hereof unless
the taxpayer shall substantiate with sufficient evidence, such
as official receipts or other adequate records: (i) the amount
of the expense being deducted, and (ii) the direct connection
or relation of the expense being deducted to the
development, management, operation and/or conduct of the
trade, business or profession of the taxpayer.
(c) Bribes, Kickbacks and Other Similar Payments. No
deduction from gross income shall be allowed under
Subsection (A) hereof for any payment made, directly or
indirectly, to an official or employee of the national
government, or to an official or employee of any local
government unit, or to an official or employee of a
government-owned or -controlled corporation, or to an official
or employee or representative of a foreign government, or to
a private corporation, general professional partnership, or a
similar entity, if the payment constitutes a bribe or kickback.
(2) Expenses Allowable to Private Educational Institutions.
In addition to the expenses allowable as deductions under
this Chapter, a private educational institution, referred to
under Section 27(B) of this Code, may at its option elect
either: (a) to deduct expenditures otherwise considered as
capital outlays of depreciable assets incurred during the
taxable year for the expansion of school facilities, or (b) to
deduct allowance for depreciation thereof under Subsection
(F) hereof.

resale, with proper adjustment for opening and closing


inventories, is deducted from gross sales in computing gross
income. Among the items included in business expenses are
management expenses, commissions, labor, supplies,
incidental repairs, operating expenses of transportation,
equipment used in the trade or business, traveling expenses
while away from home solely in the pursuit of a trade or
business, advertising and other selling expenses, together
with insurance premiums against fire, storm, theft, accident,
or other similar losses in the case of a business, and rental
for the use of business property. A taxpayer is entitled to
deduct the necessary expenses paid in carrying on his
business from his gross income from whatever source.

Sec. 66. Traveling Expenses. Traveling expenses as


ordinarily understood, include transportation expenses and
meals and lodging. If the trip is undertaken for other tan
business purposes, the transportation expenses are personal
expenses, and the meals and lodging are living expenses,
and therefore, not deductible. If the trip is solely on business,
the reasonable and necessary traveling expenses, including
transportation expenses, meals, and lodging, become
business instead of personal expenses.

(Sec. 65-76, RR-2)

(a) If, then, an individual, whose business requires him to


travel, receives a salary as full compensation for his services,
without reimbursement for traveling expenses, or is
employed on a commission basis with no expenses
allowance, his traveling expenses, including the entire
amount expended for meals and lodging, are deductible from
gross income.

Sec. 65. Business Expenses. Business expenses deductible


from gross income include the ordinary and necessary
expenditures directly connected with or pertaining to the
taxpayers trade or business. The cost of goods purchased for

(b) If an individual receives a salary and is also repaid his


actual traveling expenses, he shall include in his gross
income, the amount so repaid and may deduct such
expenses.

(c) If an individual receives a salary and also an allowance for


meals and lodging, as for example, a per diem allowance in
lieu of subsistence, the amount of the allowance should be
included in gross income and the cost of such meals and
lodging may be deducted therefrom.
A payment for the use of a sample room at a hotel for the
display of goods is a business expense. Only such expenses
are reasonable and necessary in the conduct of the business
and directly attributable to it may be deducted. A taxpayer
claiming the benefit of the deductions referred to herein must
attach to his return a statement showing (1) the nature of the
business in which he engaged; (2) the number of days away
from home during the taxable year on account of business;
(3) the total amount of expenses incident to meals and
lodging while absent from home and business during the
taxable year; (4) the total amount of other expenses incident
to travel and claimed as a deduction.
Claim for the deductions referred to herein must be
substantiated, when required by the CIR by record showing in
detail the amount and nature of the expenses incurred.

Sec. 67. Cost of Materials. Taxpayers carrying materials and


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

return is made, provided the net income is clearly reflected


by this method.

Sec. 68. Repairs. The cost of incidental repairs which


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

Sec. 69. Professional Expenses. A professional may claim


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

Sec. 70. Compensation for personal services. Among the


ordinary and necessary expenses paid or incurred in carrying
on any trade or business may be included a reasonable
allowance for salaries or other compensation for personal

services actually rendered. The test of deductibility in the


case of compensation payments is whether they are
reasonable and are, in fact, payments purely for service. This
test and its practical application may be further stated and
illustrated as follows:
(1) Any amount paid in the form of compensation, but not in
fact as the purchase price services, is not deductible. (a) an
ostensible salary paid by a corporation may be a distribution
of dividend on stock. This is likely to occur in the case of a
corporation having few shareholders, practically all of whom
draw salaries. If in such a case the salaries are in excess of
those ordinarily paid for similar services, and the excessive
payment correspond or bear a close relationship to the
stockholder of the officers or employees, it would seem likely
that the salaries are not paid wholly for services rendered,
but that the excessive payments are a distribution of
earnings upon the stock. (b) An ostensible salary may be in
part payment for property. This may occur, for example,
where a partnership sells out to a corporation, the former
partners agreeing to continue in the service of the
corporation. In such a case it may be found that the salaries
of the former partners are not merely for services, but in part
constitute payment for the transfer of their business.
(2) The form or method of fixing compensation is not decisive
as to the deductibility. While any form of contingent
compensation invites scrutiny as a possible distribution of
earnings of the enterprise, it does not follow that payments
on a continent basis are to be treated fundamentally on any
basis different from that applying to compensation at a flat
rate. Generally speaking, if contingent compensation is paid
pursuant to a free bargain between the employer and the
individual made before the services are rendered, not
influenced by any consideration on the part of the employer
other than that of securing on fair and advantageous terms
the services of the individual, it should be allowed as a

deduction even though in the actual working out of the


contract it may prove to be greater than the amount which
would ordinarily be paid.
(3) In any event the allowance for compensation paid may
not exceed what is reasonable in all the circumstances. It is
in general just to assume that reasonable and true
compensation is only such amount as would ordinarily be
paid for like services by like enterprises in like circumstances.
The circumstances to be taken into consideration are those
existing at the date when the contract for services was
made, not those existing at the date when the contract is
questioned.

Sec. 71. Treatment of excessive compensation. The income


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

Sec. 72. Bonuses to employees. Bonuses to employees will


constitute allowable deductions from gross income when
such payments are made in good faith and as additional
compensation for the services actually rendered by the
employees, provided such payments, when added to the
stipulated salaries do not exceed a reasonable compensation,
for the services rendered. It is immaterial whether such

bonuses are paid in cash or in kind or partly in cash and


partly in kind. Donations made to employees and others,
which do not have in them the element of compensation or
are in excess of reasonable compensation for services, are
not deductible from gross income.

Sec. 73. Pensions, compensation for injuries. Amounts paid


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

Sec. 74. Rentals. Where a leasehold is acquired for


business purposes for a specified sum, the purchaser may
take as a deduction in his return an adequate part of such
sum each year, based on the number of years as the lease
has to run. Taxes paid by a tenant to or for a landlord for
business property are additional rent and constitute a
deductible item to the tenant and taxable income to the
landlord; the amount of the tax being deductible by the
latter. The cost borne by lessee in erecting buildings or
making permanent improvements on ground of which he is
lessee is held to be a capital investment and not deductible
as a business expense. In order to return to such taxpayer his
investment of capital, an annual deduction may be made

from gross income of an amount equal to the cost of such


improvements divided by the number of years remaining of
the term of the lease, and such deduction shall be in lieu of a
deduction for depreciation. If the remainder of the term of
lease is greater than the probable life of the building erected,
or of the improvements made, this deduction shall take the
form of an allowance for depreciation.

Sec. 75. Expenses of farmers. A farmer who operates a


farm for profit is entitled to deduct from gross income as
necessary expenses all amounts actually expended in the
carryon on of the business of arming. The cost of ordinary
tools of short life or small cost, such as hand tools, including
shovels, rakes, etc., may be included. The cost of feeding and
raising livestock may be treated as an expense deduction, in
so far as such cost represents actual outlay, but not including
the value of farm produce grown upon the far, or the laborer
of the taxpayer. Where a farmer is engaged in producing
crops which take more than a year from the time of planting
to the process of gathering and disposal, expenses deducted
may be determined upon the crop basis, and such deductions
must be taken in the year in which the gross income from the
crop has been realized. The cost of farm machinery,
equipment, and farm buildings represents a capital
investment and is not allowable deduction as an item of
expense. Amounts expended in the development of farms,
orchards, and ranches, prior to the time when the productive
state is reached may be regarded as investments of capital.
Amounts expended in purchasing work, breeding or dairy
animals are regarded as investments of capital, and may be
depreciated unless such animals are included in an inventory
in accordance with section 149 of these regulations. The
purchase price of transportation equipment if used wholly
used in carrying on farm operations, is not deductible but is
regarded as an investment of capital. The cost of gasoline or

fuel, repairs, and upkeep of the transportation equipment if


used wholly in the business of farming is deductible as an
expense; if used partly for business purposes and partly for
the pleasure or convenience of the taxpayer or his family,
such cost may be apportioned according to the extent of the
use for purposes of business and pleasure or convenience,
and only the proportion of such cost justly attributable to
business purposes is deductible as a necessary expense. If a
farm is operated for recreation or pleasure and not on a
commercial basis, and if the expenses incurred in connection
with the farm are in excess of the receipt therefrom, the
entire receipts from the sale of products may be ignored in
rendering a return of income, and the expenses incurred,
being regarded as personal expenses, will not constitute
allowable deduction.

Sec. 76. When charges are deductible. Each years return,


so far as practicable, both as to gross income and deductions
therefrom, should be complete in itself, and taxpayers are
expected to make every reasonable effort to ascertain the
facts necessary to make a correct return. The expenses,
liabilities, or deficit of one year cannot be used to reduce the
income of a subsequent year. A taxpayer has the right to
deduct all authorized allowances and it follows that if he does
not within any year deduct certain of his expenses, losses,
interests, taxes, or other charges, he cannot deduct them
from the income of the next or any succeeding year. If it is
recognized, however, that particularly in a going business of
any magnitude there are certain overlapping items both of
income and deduction, and so long as those overlapping
items do not materially distort the income, they may be
included in the year in which the taxpayer, pursuant to a
consisting policy, takes them into his accounts. Judgments or
other binding judicial adjudication, on account of damages
for patent infringement, personal injuries, or other cause, are

deductible from gross income when the claim is so


adjudicated or paid, unless taken under other methods of
accounting which clearly reflect the correct deduction, less
any amount or such damages as may have been
compensated for by insurance or otherwise. If subsequent to
its occurrence, however, a taxpayer first ascertains the
amount of a loss sustained during a prior taxable year which
has not been deducted from gross income, he may render an
amended return for such preceding taxable year including
such amount of loss in the deduction from gross income and
may in proper cases file a claim for refund of the excess tax
paid by reason of the failure to deduct such loss in the
original return. A loss from theft or embezzlement occurring
in one year and discovered in another is ordinarily deductible
for the year in which sustained.

1. Requisites For Deductibility

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

Doctrine: To be deductible, said business expenses must be


ordinary and necessary expenses paid or incurred in carrying
on any trade or business

Facts: Visayan Cebut Terminal (VCTC) is a corporation


organized for the purpose of handling arrastre operations in
the port of Cebu. It filed its ITR, certain entries therein were
disallowed as expenses pertaining to the salaries of 2
officers, miscellaneous expenses, and representation

expenses. VCTC questions the disallowance of deductions


claimed for representation expenses.

Held: disallowance proper. To be deductible, said business


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

An expense is considered ordinary, if it is normal in relation


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

2. Compensation For Personal Services


Discussion:
Sec. 70-72, RR-2
An expense must satisfy the following conditions to be
deductible from gross income under the category of
expenses, in general:
(a) it must be ordinary and necessary
(b) it must be paid or incurred within the taxable year
(c) it must be in carrying on, or directly attributable to, the
development, management, operation and/or conduct of the
trade, business or exercise of profession; and
(d) Substantiated by official receipts or other adequate
records.

Sec. 70. Compensation for personal services. Among the


ordinary and necessary expenses paid or incurred in carrying
on any trade or business may be included a reasonable
allowance for salaries or other compensation for personal
services actually rendered. The test of deductibility in the
case of compensation payments is whether they are
reasonable and are, in fact, payments purely for service. This
test and its practical application may be further stated and
illustrated as follows:
(1) Any amount paid in the form of compensation, but not in
fact as the purchase price services, is not deductible. (a) an
ostensible salary paid by a corporation may be a distribution
of dividend on stock. This is likely to occur in the case of a
corporation having few shareholders, practically all of whom
draw salaries. If in such a case the salaries are in excess of
those ordinarily paid for similar services, and the excessive

payment correspond or bear a close relationship to the


stockholder of the officers or employees, it would seem likely
that the salaries are not paid wholly for services rendered,
but that the excessive payments are a distribution of
earnings upon the stock. (b) An ostensible salary may be in
part payment for property. This may occur, for example,
where a partnership sells out to a corporation, the former
partners agreeing to continue in the service of the
corporation. In such a case it may be found that the salaries
of the former partners are not merely for services, but in part
constitute payment for the transfer of their business.
(2) The form or method of fixing compensation is not decisive
as to the deductibility. While any form of contingent
compensation invites scrutiny as a possible distribution of
earnings of the enterprise, it does not follow that payments
on a continent basis are to be treated fundamentally on any
basis different from that applying to compensation at a flat
rate. Generally speaking, if contingent compensation is paid
pursuant to a free bargain between the employer and the
individual made before the services are rendered, not
influenced by any consideration on the part of the employer
other than that of securing on fair and advantageous terms
the services of the individual, it should be allowed as a
deduction even though in the actual working out of the
contract it may prove to be greater than the amount which
would ordinarily be paid.
(3) In any event the allowance for compensation paid may
not exceed what is reasonable in all the circumstances. It is
in general just to assume that reasonable and true
compensation is only such amount as would ordinarily be
paid for like services by like enterprises in like circumstances.
The circumstances to be taken into consideration are those
existing at the date when the contract for services was
made, not those existing at the date when the contract is
questioned.

Sec. 71. Treatment of excessive compensation. The income


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

Sec. 72. Bonuses to employees. Bonuses to employees will


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

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

Doctrine: Bonuses, when made in good faith and as


additional compensation for services actually rendered,
provided such payments when added to the stipulated

salaries do not exceed a reasonable compensation for


services, are deductible.

Facts: Petitioner filed its ITR and claimed deductions for


certain items representing salaries, directors fees and
bonuses of its non-resident president and VP, bonuses of
some of its resident officers and employees, and interest on
earned but unpaid salaries and bonuses of its officers and
employees.

Held: Bonuses to employees made in good faith and as


additional compensation for the services actually rendered
by the employees are deductible, provided such payments,
when added to the stipulated salaries, do not exceed a
reasonable compensation for the services rendered. The
conditions precedents to the deduction of bonuses to
employees are: (1) the payment of the bonuses is in fact
compensation; (2) it must be for personal services actually
rendered and (3) the bonuses when added to the salaries, are
reasonable when measured by the amount and quality of the
services performed with relation to the business of the
particular taxpayer.
There is no fixed test for determining reasonableness of a
given bonus as compensation. This depends upon many
factors one of them being the amount and quality of the
services performed with relation to the business. Other tests
are: Payment must be made in good faith. The character of
the taxpayers business, the value and amount of its net
earnings, its locality, the type and extent of the services
rendered, the salary policy of the corporation. The size of the
particular business, the employees qualifications and
contributions to the business venture and general economic
conditions. However, in determining whether the particular

salary or compensation payments is reasonable, the situation


must be considered as a whole. Ordinarily, no single factor is
decisive. It is important to keep in mind that it seldom
happens that the application of one test can give a
satisfactory answer, and that ordinarily, it is the interplay of
several factors, properly weighed for the particular case,
which must furnish the final answer.

Discussion:

Salaries, wages, fees, commissions, and similar


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

3. Traveling/Transportation Expenses

Sec. 66, RR-2

Traveling Expenses.Traveling expenses as ordinarily


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

lodging while absent from home and business during the


taxable year; (4) the total amount of other expenses incident
to travel and claimed as a deduction.
Claim for the deductions referred to herein must be
substantiated, when required by the CIR by record showing in
detail the amount and nature of the expenses incurred.

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

(B)(7) Expenses for Foreign Travel


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

(b) In the absence of documentary evidence showing that the


employees travel abroad was in connection with business
meetings or conventions, the entire cost of the ticket,
including cost of hotel accommodations and other expenses
incident thereto shouldered by the employer, shall be treated
as taxable fringe benefits. The business meetings shall be
evidence by official communications from business
associates abroad indicating the purpose of the meetings.
Business conventions shall be evidenced by official
invitations/comm8nications from the host organization or
entity abroad. Otherwise, the entire cost thereof shouldered
by the employer shall be treated as taxable fringe benefits of
the employee.
(c) Traveling expenses which are paid by the employer for the
travel of the family members of the employee shall be
treated as taxable fringe benefits of the employee.

4. Cost Of Materials

Sec. 67, RR-2


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

Discussion:

A reasonable allowance for travel expenses abroad, or in


the Philippines while away from home in the pursuit of trade,
business or profession, is deductible as gross income.

5. Repairs

Travel expenses include transportation, meals, and lodging.

Sec. 68, RR-2

Requisites

The cost of incidental repairs which neither materially add to


the value of the property nor appreciably prolong its life, but
keep it in an ordinarily efficient operating condition, may be
deducted as expense, provided the plant or property account
is not increased by the amount of such expenditure. Repairs
in the nature of replacement, to the extent that they arrest
deterioration and appreciably prolong the life of the property

(1) Must be paid or incurred while away from home.


(2) Must be in the pursuit of trade, business, or profession.

should be charged against the depreciation reserves if such


account is kept.

6. Expenses Under Lease Agreements

Sec. 74, RR-2


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

Discussion:

In addition to the periodic payments made by the lessee to


the lessor for the use of the latters property, a lessee may
take deductions:
(a) Where a leasehold is acquired for business purposes for a
specified sum, the purchaser may take deduction in his
return for an aliquot part of such sum each year, based on
the number of years the lease will run;
(b) Taxes paid by a lessee to or for the lessor, and other
obligations of the lessor paid by the lessee under a lease
contract, constitute additional deductible rent expense for
the lessee;
(c) The cost of leasehold improvements may be recovered by
the lessee over the remaining term of the lease, or over the
life of the improvements, whichever is shorter.

7. Expenses For Professionals

Sec 69, RR-2


A professional may claim as deductions the cost of supplies
used by him in the practice of his profession, expenses paid
in the operations and repair of transportation equipment
used in making professional calls, dues to professional
societies, and subscriptions to professional journals, the rent
paid for office rooms, the expenses of the fuel, light, water,
telephones, etc., used in such offices, and the hire of office
assistants. Amounts currently expended for books, furniture,
and professional instruments and equipment, the useful life
of which is short, may be deducted. But amounts expended
for books, furniture, and professional instruments and

equipment of a permanent character are not allowable as


deductions.

8. Expenses For Farmers

Sec. 75, RR-2


A farmer who operates a farm for profit is entitled to deduct
from gross income as necessary expenses all amounts
actually expended in the carryon on of the business of
arming. The cost of ordinary tools of short life or small cost,
such as hand tools, including shovels, rakes, etc., may be
included. The cost of feeding and raising livestock may be
treated as an expense deduction, in so far as such cost
represents actual outlay, but not including the value of farm
produce grown upon the far, or the laborer of the taxpayer.
Where a farmer is engaged in producing crops which take
more than a year from the time of planting to the process of
gathering and disposal, expenses deducted may be
determined upon the crop basis, and such deductions must
be taken in the year in which the gross income from the crop
has been realized. The cost of farm machinery, equipment,
and farm buildings represents a capital investment and is not
allowable deduction as an item of expense. Amounts
expended in the development of farms, orchards, and
ranches, prior to the time when the productive state is
reached may be regarded as investments of capital. Amounts
expended in purchasing work, breeding or dairy animals are
regarded as investments of capital, and may be depreciated
unless such animals are included in an inventory in
accordance with section 149 of these regulations. The
purchase price of transportation equipment if used wholly

used in carrying on farm operations, is not deductible but is


regarded as an investment of capital. The cost of gasoline or
fuel, repairs, and upkeep of the transportation equipment if
used wholly in the business of farming is deductible as an
expense; if used partly for business purposes and partly for
the pleasure or convenience of the taxpayer or his family,
such cost may be apportioned according to the extent of the
use for purposes of business and pleasure or convenience,
and only the proportion of such cost justly attributable to
business purposes is deductible as a necessary expense. If a
farm is operated for recreation or pleasure and not on a
commercial basis, and if the expenses incurred in connection
with the farm are in excess of the receipt therefrom, the
entire receipts from the sale of products may be ignored in
rendering a return of income, and the expenses incurred,
being regarded as personal expenses, will not constitute
allowable deduction.

9. Entertainment Expenses

RR 3-98
(B)(2) Expense Account.
(a) In general, expenses incurred by the employee but which
are paid by his employer shall be treated as taxable fringe
benefits, except when the expenditures are duly receipted for
and in the name of the employer and the expenditures do not
partake the nature of a personal expense attributable to the
employee.
(b) Expenses paid for by the employee but reimbursed by his
employer shall be treated as taxable benefits, except only

when the expenditures are duly receipted for and in the


name of the employer and the expenditures do not partake
the nature of a personal expense attributable to the said
employee.

e. It must be duly substantiated by adequate proof. The


official receipts, or invoices, or bills or statements of accounts
should be in the name of the taxpayer claiming the
deduction; and

(c) Personal expenses of the employee (like purchases of


groceries for the personal consumption of the employee and
his family members) paid for or reimbursed by the employer
to the employee shall be treated as taxable fringe benefits of
the employee whether or not the same are duly receipted for
in the name of the employer.

f. The appropriate amount of withholding tax, if applicable,


should have been withheld therefrom and paid to the BIR

Entertainment, amusement, and recreation expenses are


allowable as deductions from gross income if:

RR 10-02
Sec. 4. Requisites for Deductibility of
Amusement, and Recreation Expense.

Discussion:

Entertainment,

a. It must be paid or incurred during the taxable year


b. It must be:
i. Directly connected to the development, management, and
operation of the trade, business or profession of the
taxpayer; or
ii. Directly related to or in furtherance of the conduct of his or
its trade, business, or exercise of a profession;
c. It must not be contrary to law, morals, good customs,
public policy, or public order;
d. It must not have been paid, directly or indirectly, to an
official or employee of the national government, or any local
government unit, or of any GOCC, or of a foreign government
, or to a private individual, or corporation, or general
professional partnership, or a similar entity, if it constitutes a
bribe, kickback, or other similar payment.

(a) Directly connected to the development, management,


and operation of the trade, business or profession of the
taxpayer, or
(b) Directly related to or in the furtherance of, his trade or
business, or exercise of profession

The deduction shall not exceed such ceilings as the Sec. of


Finance may, by rules and regulations, prescribe, upon the
recommendation of the CIR, taking into account the needs as
well as the special circumstances, nature, and character of
the industry, trade, business, or profession of the taxpayer.

10. Expenses For Private Educational Institutions

An expenditure for expansion of facilities is a capital


expenditure which under sound accounting practices, has to
be capitalized or made part of the cost of the asset. However,
for income tax purposes, private educational institutions
may:
(a) Deduct such expenditures from the gross income of the
year in which they were made; or
(b) Capitalize the expenditure and claim deduction by way of
depreciation.

11. Alhambra Cigar & Cigarette Mfg. Co. v. Collector (GR L12026, May 29, 1959)

Whenever a controversy arises on the deductibility for


purposes of income tax of certain items for alleged
compensation of officers of the taxpayer corporation, two
questions become material, namely: (a) Have personal
services been actually rendered by said officers? (b) in the
affirmative case, what is the reasonable allowance therefore?

12. Calanoc v. Collector (113 Phil 499)

Facts: Calanoc was authorized to solicit and receive


contribution for orphans and destitute children of the Child
Welfare Workers Club. He financed and promoted a boxing
and wrestling exhibition for the said charitable purpose. CIR

demanded payment of amusement tax for the exhibition


based on an opinion from the Sec. of Finance that exemption
from payment of amusement tax may be denied where the
net proceeds are not substantial or where the expenses are
exorbitant. Petitioner admitted that he could not justify the
other expenses, such as those for police protection and gifts.

Held: The payment for police protection is illegal as it is a


consideration given by the petitioner to the police for the
performance by the latter of the functions required by them
to be rendered by law. The expenditures for the gifts, for
parties, and other items for representation are rather
excessive, considering that the purpose of the exhibition was
for a charitable cause.

13. Constructive Dividends

Sec. 70, RR-2


Sec. 70. Compensation for personal services. Among the
ordinary and necessary expenses paid or incurred in carrying
on any trade or business may be included a reasonable
allowance for salaries or other compensation for personal
services actually rendered. The test of deductibility in the
case of compensation payments is whether they are
reasonable and are, in fact, payments purely for service. This
test and its practical application may be further stated and
illustrated as follows:
(1) Any amount paid in the form of compensation, but not in
fact as the purchase price services, is not deductible. (a) an

ostensible salary paid by a corporation may be a distribution


of dividend on stock. This is likely to occur in the case of a
corporation having few shareholders, practically all of whom
draw salaries. If in such a case the salaries are in excess of
those ordinarily paid for similar services, and the excessive
payment correspond or bear a close relationship to the
stockholder of the officers or employees, it would seem likely
that the salaries are not paid wholly for services rendered,
but that the excessive payments are a distribution of
earnings upon the stock. (b) An ostensible salary may be in
part payment for property. This may occur, for example,
where a partnership sells out to a corporation, the former
partners agreeing to continue in the service of the
corporation. In such a case it may be found that the salaries
of the former partners are not merely for services, but in part
constitute payment for the transfer of their business.
(2) The form or method of fixing compensation is not decisive
as to the deductibility. While any form of contingent
compensation invites scrutiny as a possible distribution of
earnings of the enterprise, it does not follow that payments
on a continent basis are to be treated fundamentally on any
basis different from that applying to compensation at a flat
rate. Generally speaking, if contingent compensation is paid
pursuant to a free bargain between the employer and the
individual made before the services are rendered, not
influenced by any consideration on the part of the employer
other than that of securing on fair and advantageous terms
the services of the individual, it should be allowed as a
deduction even though in the actual working out of the
contract it may prove to be greater than the amount which
would ordinarily be paid.

(3) In any event the allowance for compensation paid may


not exceed what is reasonable in all the circumstances. It is

in general just to assume that reasonable and true


compensation is only such amount as would ordinarily be
paid for like services by like enterprises in like circumstances.
The circumstances to be taken into consideration are those
existing at the date when the contract for services was
made, not those existing at the date when the contract is
questioned.

14. RR 10-2002

Ceilings for Entertainment, Amusement and Recreational


Expenses (July 10, 2002)

There shall be allowed a deduction from gross income for


entertainment, amusement, and recreation (EAR) expense, in
an amount equivalent to the actual EAR expense paid or
incurred within the taxable year by the taxpayer, but in no
case shall such deduction exceed 0.50% of net sales (i.e.,
gross sales less sales returns/allowances and sales discounts)
for taxpayers engaged in sale of goods or properties; or
1.00% of net revenue (i.e., gross revenue less discounts) for
taxpayers engaged in sale of services, including exercise of
profession and use or lease of properties. However, if the
taxpayer is deriving income
from
both
sale
of
goods/properties and services, the allowable EAR expense
shall in all cases be determined based on an apportionment
formula taking into consideration the percentage of the net
sales/net revenue to the total net sales/net revenue, but
which in no case shall exceed the minimum percentage
ceiling provided.

Net Sales/net revenue


Apportionment formula:

x Actual Expense
Total Net sales and net revenue