GENERAL PRINCIPLES OF TAXATION

A. TAXATION: ITS GENERAL CONCEPTS

1) Taxation as a power
As a power, taxation refers to the inherent power of the
state to demand enforced contributions for public purpose or
purposes.
i. Nature of the power of taxation
Inherent in sovereignty The power of taxation is
inherent in sovereignty as an incident or attribute
thereof, being essential to the existence of every
government. It can be exercised by the government even
if the Constitution is entirely silent on the subject.
a. Constitutional provisions relating to the power of
taxation do not operate as grants of the power to the
government. They merely constitute limitations upon a
power which would otherwise be practically without limit.
b. While the power to tax is not expressly provided for
in our constitutions, its existence is recognized by the
provisions relating to taxation.
In the case of Mactan Cebu International Airport
Authority vs. Marcos, Sept. 11, 1996, as an incident of
sovereignty, the power to tax has been described as
unlimited in its range, acknowledging in its very nature
no limits, so that security against its abuse is to be found
only in the responsibility of the legislative which imposes
the tax on the constituency who are to pay it.

Legislative in character The power to tax is

exclusively legislative and cannot be exercised by the
executive or judicial branch of the government.

Subject to constitutional and inherent limitations

Although in one decided case the Supreme Court called
it an awesome power, the power of taxation is subject to
certain limitations. Most of these limitations are
specifically provided in the Constitution or implied there
from while the rest are inherent and they are those
which spring from the nature of the taxing power itself
although, they may or may not be provided in the
Constitution. For example the power to tax may not be
delegated except when provided for by the constitution.

Is the Power to Tax the Power to Destroy?

In the case of Churchill, et al. vs. Concepcion (34
Phil 969) it has been ruled that:
The power to impose taxes is one so unlimited in
force and so searching in extent so that the courts
scarcely venture to declare that it is subject to any
restriction whatever, except such as rest in the discretion
of the authority which exercise it. No attribute of
sovereignty is more pervading, and at no point does the
power of government affect more constantly and

intimately all the relations of life than through the

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

Constitutional Restraints Re: Taxation is the Power

to Destroy
While taxation is said to be the power to destroy, it
is by no means unlimited. It is equally correct to
postulate that the power to tax is not the power to
destroy while the Supreme Court sits, because of
the constitutional restraints placed on a taxing power
that violated fundamental rights.
In the case of Roxas, et al vs. CTA (April 26, 1968),
the SC reminds us that although the power of taxation is
sometimes called the power to destroy, in order to
maintain the general publics trust and confidence in the
Government, this power must be used justly and not
treacherously. The Supreme Court held:
The power of taxation is sometimes called also
the power to destroy. Therefore it should be exercised
with caution to minimize injury to the proprietary rights
of a taxpayer. It must be exercised fairly, equally and
uniformly, lest the tax collector kill the hen that lays the
golden egg. And, in order to maintain the general public
trust and confidence in the Government this power must
be used justly and not treacherously.
The doctrine seeks to describe, in an extreme, the
consequential nature of taxation and its resulting
implications, to wit:
a. The power to tax must be exercised with caution to
minimize injury to proprietary rights of a taxpayer;
b. If the tax is lawful and not violative of any of the
inherent and constitutional limitations, the fact alone
that it may destroy an activity or object of taxation will
not entirely permit the courts to afford any relief; and

c. A subject or object that may not be destroyed by the

taxing authority may not likewise be taxed. (e.g. exercise
of a constitutional right)
Cases:
o Sison vs. Ancheta, 130 SCRA 654
o Municipality of Makati vs. Court of Appeals, 190 SCRA
206
ii. Importance of Taxation and the Lifeblood Doctrine
Rationale of Taxation - The Supreme Court held:
It is said that taxes are what we pay for civilized
society. Without taxes, the government would be paralyzed
for lack of the motive power to activate and operate it.
Hence, despite the natural reluctance to surrender part of
ones hard-earned income to the taxing authorities, every
person who is able must contribute his share in the running
of the government. The government for its part is expected
to respond in the form of tangible and intangible benefits
intended to improve the lives of the people and enhance
their moral and material values. The symbiotic
relationship is the rationale of taxation and should
dispel the erroneous notion that it is an arbitrary method of
exaction by those in the seat of power.
Taxation is a symbiotic relationship, whereby in
exchange for the protection that the citizens get from the
government, taxes are paid. (Commissioner of Internal
Revenue vs. Algue, Inc., et al., L-28896, Feb. 17, 1988)
The areas which used to be left to private enterprise
and initiative and which the government was called upon
to enter optionally, and only because it was better
equipped to administer for the public welfare than is any
private individual or group of individuals, continue to lose
their well-defined boundaries and to be absorbed within
activities that the government must undertake in its
sovereign capacity it is to meet the increasing social
challenges of the times.
Hence, the need for more
revenues. (Justice Makalintal in Sison vs. Ancheta, July 25,
1984)
iii. Justifications for the exercise of the taxing power
1. The Benefits-Protection Theory/Benefit-Received
Theory
The basis of taxation is the reciprocal duty of
protection between the state and its inhabitants. In return
for the contributions, the taxpayer receives the general
advantages and protection which the government affords
the taxpayer and his property.
Qualifications of the Benefit-Protection Theory:
a. It does not mean that only those who are able to pay
and do pay taxes can enjoy the privileges and protection
given to a citizen by the government.

b. From the contributions received, the government

renders no special or commensurate benefit to any
particular property or person.
c. The only benefit to which the taxpayer is entitled is that
derived from his enjoyment of the privileges of living in an
organized society established and safeguarded by the
devotion of taxes to public purposes. (Gomez vs. Palomar,
25 SCRA 829)
d. A taxpayer cannot object to or resist the payment of
taxes solely because no personal benefit to him can be
pointed out as arising from the tax. (Lorenzo vs. Posadas,
64 Phil 353)
2. Necessity Theory
Taxes proceed upon the theory that the existence of
the government is a necessity; that it cannot continue
without the means to pay its expenses; and that for those
means, it has the right to compel all citizens and properties
within its limits to contribute.
In a case, the Supreme Court held that:
Taxation is a power emanating from necessity. It is a
necessary burden to preserve the States sovereignty and
a means to give the citizenry an army to resist aggression,
a navy to defend its shores from invasion, a corps of civil
servants to serve, public improvements designed for the
enjoyment of the citizenry and those which come with the
States territory and facilities, and protection which a
government is supposed to provide. (Phil. Guaranty Co.,
Inc. vs. Commissioner of Internal Revenue, 13 SCRA 775).
3. Lifeblood Theory
Taxes are the lifeblood of the government, being
such, their prompt and certain availability is an imperious
need. (Collector of Internal Revenue vs. Goodrich
International Rubber Co., Sept. 6, 1965) Without taxes, the
government would be paralyzed for lack of motive power
to activate and operate it.
iv. Purposes and Objectives of Taxation
1.
Revenue to provide funds or property with which
the State promotes the general welfare and protection of
its citizens.
2.
Non-Revenue [PR2EP]
a. Promotion of General Welfare Taxation may be
used as an implement of police power in order to promote
the general welfare of the people. [see Lutz vs. Araneta (98
Phil 148) and Osmea vs. Orbos (G.R. No. 99886, Mar. 31,
1993)]
b. Regulation As in the case of taxes levied on
excises and privileges like those imposed in tobacco or
alcoholic products or amusement places like night clubs,
cabarets, cockpits, etc.
In the case of Caltex Phils. Inc. vs. COA (G.R. No.
92585, May 8, 1992), it was held that taxes may also be
imposed for a regulatory purpose as, for instance, in the

rehabilitation and stabilization of a threatened industry

which is affected with public industry like the oil industry.
c.
Reduction of Social Inequality this is made
possible through the progressive system of taxation where
the objective is to prevent the under-concentration of
wealth in the hands of few individuals.
d. Encourage Economic Growth in the realm of tax
exemptions and tax reliefs, for instance, the purpose is to
grant incentives or exemptions in order to encourage
investments and thereby promote the countrys economic
growth.
e. Protectionism in some important sectors of the
economy, as in the case of foreign importations, taxes
sometimes provide protection to local industries like
protective tariffs and customs duties. (Re Special Duties
under the Tariff and Customs Code; See also RA 8800 re
Safeguard Measures Act)
2) Taxation as a process
As a process, it is a means by which the sovereign, through
its law-making body, raises revenue to defray the necessary
expenses of the government. It is merely a way of apportioning
the costs of government among those who in some measures are
privileged to enjoy its benefits and must bear its burdens.
i. Stages in the tax process
1. Levy/Imposition
the act of imposition by the legislature such as by
its enactment of the law.
- determination of the persons, property or excises to
be taxed, the sum or sums to be raised, the due
date thereof and the time and manner of levying
and collecting taxes (strictly speaking, such refers
to taxation)
2. Assessment and Collection
- the act of administration and implementation of the
tax law by the executive through its administrative
agencies.
- consists of the manner of enforcement of the
obligation on the part of those who are taxed.

The two processes together constitute the taxation

system.
ii. Principles of a sound tax system
1. Fiscal Adequacy
- the sources of tax revenue should coincide with, and
approximate the needs of government expenditure.
Neither an excess nor a deficiency of revenue vis-vis the needs of government would be in keeping
with the principle.
- The principle of fiscal adequacy as a characteristic of
a sound tax system was originally stated by Adam
Smith in his Canons of Taxation (1776), as: Every
tax ought to be so contrived as both to take out and
to keep out of the pockets of the people as little as

possible over and above what it brings into the public

treasury of the state. It simply means that sources
of revenues must be adequate to meet government
expenditures and their variations. (ABAKADA vs.
Ermita, G.R. 168056, Sept. 1, 2005)
2. Administrative Feasibility
- tax system should be capable of being properly and
efficiently administered by the government and
enforced with the least inconveniences to the
taxpayer.
3. Theoretical Justice
- the tax burden should be in proportion to the
taxpayers ability to pay (ability-to-pay principle). The
1987 Constitution requires taxation to be equitable
and uniform.
** The non-observance of these canons, which are
merely intended to make the tax system sound, will not
render the tax impositions by the taxing authority invalid,
except to the extent that specific constitutional or statutory
limitations are impaired.

B. THE CONCEPT AND CHARACTERISTICS OF TAXES (LEMP3S)

1. It is an enforced contribution
2. It is proportionate in character - It is ordinarily based on the
taxpayers ability to pay.
3. It is levied by the law-making body of the State
4. The power to tax is a legislative power which under the Constitution
only Congress can exercise through the enactment of laws.
Accordingly, the obligation to pay taxes is a statutory liability.
5. A tax is not a voluntary payment or donation. It is not dependent on
the will or contractual assent, express or implied, of the person taxed.
Taxes are not contracts but positive acts of the government.
6. It is generally payable in money
7. Tax is a pecuniary burden an exaction to be discharged alone in the
form of money which must be in legal tender, unless qualified by law,
such as RA 304 which allows backpay certificates as payment of taxes.
8. It is levied on persons or property - A tax may also be imposed on
acts, transactions, rights or privileges.
9. It is levied for public purpose or purposes - Taxation involves, and a
tax constitutes, a burden to provide income for public purposes.
10.
It is levied by the State which has jurisdiction over the persons
or property. - The persons, property or service to be taxed must be
subject to the jurisdiction of the taxing state.
Scope of Legislative Taxing Power [S2 A P K A M]
1. subjects of Taxation (the persons, property or occupation etc. to be taxed)
2. amount or rate of the tax
3. purposes for which taxes shall be levied provided they are public purposes
4. apportionment of the tax
5. situs of taxation
6. method of collection

C. LIMITATIONS ON THE EXERCISE OF THE TAXING POWER

1) Inherent Limitations
i. Public Purpose
Important Points to Consider:
a. If taxation is for a public purpose, the tax must be
used:
a.1) for the support of the state or
a.2) for some recognized objects of governments or
a.3) directly to promote the welfare of the
community (taxation as an implement of police power)
b. The term public purpose is synonymous with
governmental purpose; a purpose affecting the
inhabitants of the state or taxing district as a
community and not merely as individuals.
c. A tax levied for a private purpose constitutes a
taking of property without due process of law.
d. The purposes to be accomplished by taxation need
not be exclusively public. Although private individuals
are directly benefited, the tax would still be valid
provided such benefit is only incidental.
e. The test is not as to who receives the money, but the
character of the purpose for which it is expended; not
the immediate result of the expenditure but rather the
ultimate.
f. In the imposition of taxes, public purpose is presumed.

Test in determining Public Purposes in tax

a. Duty Test whether the thing to be threatened by
the appropriation of public revenue is something which is
the duty of the State, as a government.
b. Promotion of General Welfare Test whether the
law providing the tax directly promotes the welfare of the
community in equal measure.

Cases:
a. Pascual vs. Secretary of Public Works, 110 Phil 331
The Court allowed petitioner to maintain a taxpayers
suit assailing the constitutional soundness of Republic Act
No. 920 appropriating P85,000 for the construction, repair
and improvement of feeder roads within private property.
All these cases involved the disbursement of public funds
by means of a law.

b. Lutz vs. Araneta, 98 Phil 148

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

c. Gomez vs. Palomar, 25 SCRA 827

The eradication of a dreaded disease is a public
purpose, but if by public purpose the petitioner means
benefit to a taxpayer as a return for what he pays, then it
is sufficient answer to say that the only benefit to which
the taxpayer is constitutionally entitled is that derived from
his enjoyment of the privileges of living in an organized
society, established and safeguarded by the devotion of
taxes to public purposes. Any other view would preclude
the levying of taxes except as they are used to
compensate for the burden on those who pay them and
would involve the abandonment of the most fundamental
principle of government that it exists primarily to provide
for the common good.
ii. Inherently Legislative
Rationale: Doctrine of Separation of Powers.
Taxation is purely legislative hence, Congress cannot
delegate the power to others.

Coverage, Object, Nature, Extent, Situs

Cases:
o Pepsi vs. Municipality of Tanauan, 69 SCRA 460
o Pepsi vs. City of Butuan, 24 SCRA 789
o
Exceptions to non-delegation:
a. Delegation to the President (Art.VI. Sec. 28(2)
1987 Constitution) / Flexible Tariff Clause
The power granted to Congress under this
constitutional provision to authorize the President to fix
within specified limits and subject to such limitations and
restrictions as it may impose, tariff rates and other duties
and imposts include tariffs rates even for revenue purposes
only. Customs duties which are assessed at the prescribed
tariff rates are very much like taxes which are frequently
imposed for both revenue-raising and regulatory purposes
(Garcia vs. Executive Secretary, et. al., G.R. No. 101273,
July 3, 1992)

Flexible Tariff Clause: Section 401 Modification of Duty,

Tariff and Customs Code of the Philippines (TCCP)

Provide the legal basis by which the

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

b. Delegations to the Local Government (Art. X. Sec.

5, 1987 Constitution)
It has been held that the general principle against
the delegation of legislative powers as a consequence of
the theory of separation of powers is subject to one wellestablished exception, namely, that legislative power may
be delegated to local governments. The theory of nondelegation of legislative powers does not apply in matters
of local concern. (Pepsi-Cola Bottling Co. of the Phil, Inc. vs.
City of Butuan, et . al., L-22814, Aug. 28, 1968)

NOTE: In MCIAA vs. Marcos, the Supreme Court ruled

that considering the present provisions of the Constitution,
Local Government Units power to tax is no longer just a
delegated power but a power granted by the Constitution.
c. Delegation to Administrative Agencies with
respect to aspects of Taxation not legislative in
character.
Examples: assessment and collection
Limitations on Delegation
a. It shall not contravene any Constitutional provisions or
inherent limitations of taxation;
b. The delegation is effected either by the Constitution or
by validly enacted legislative measures or statute; and
c. The delegated levy power, except when the delegation is
by an express provision of Constitution itself, should only
be in favor of the local legislative body of the local or
municipal government concerned.

Tax Legislation vis--vis Tax Administration

- Every system of taxation consists of two parts:
a. the elements that enter into the imposition of the
tax [S2 A P K A M], or tax regulation; and
b. the steps taken for its assessment and collection
or tax administration

If what is delegated is tax legislation, the delegation is

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

iii. Territoriality
Important Points to Consider:
1) Territoriality or Situs of Taxation means place of taxation
depending on the nature of taxes being imposed.
2) It is an inherent mandate that taxation shall only be
exercised on persons, properties, and excise within the
territory of the taxing power because:
b.1) Tax laws do not operate beyond a countrys
territorial limit.
b.2) Property which is wholly and exclusively within the
jurisdiction of another state receives none of the
protection for which a tax is supposed to be
compensation.
3) However, the fundamental basis of the right to tax is the
capacity of the government to provide benefits and
protection to the object of the tax. A person may be taxed,
even if he is outside the taxing state, where there is
between him and the taxing state, a privity of relationship
justifying the levy.

Factors to Consider in determining Situs of Taxation

1) kind and Classification of the Tax
2) location of the subject matter of the tax
3) domicile or residence of the person
4) citizenship of the person
5) source of income
6) place where the privilege, business or occupation is
being exercised

iv. International Comity

Important Points to Consider:
a. The property of a foreign state or government may not
be taxed by another.
b.
The grounds for the above rule are:
b.1) sovereign equality among states
b.2) usage among states that when one enter into
the territory of another, there is an implied
understanding that the power does not intend to
degrade its dignity by placing itself under the
jurisdiction of the latter
b.3) foreign government may not be sued without its
consent so that it is useless to assess the tax since it
cannot be collected
b.4) reciprocity among states
v. Tax Exemption of the Government
Important Points to Consider:
Reasons for Exemptions:
a.1) To levy tax upon public property would render
necessary new taxes on other public property for the
payment of the tax so laid and thus, the government
would be taxing itself to raise money to pay over to
itself;
a.2) In order that the functions of the government shall
not be unduly impede; and
a.3) To reduce the amount of money that has to be
handed by the government in the course of its
operations.

Unless otherwise provided by law, the exemption

applies only to government entities through which the
government immediately and directly exercises its
sovereign powers (Infantry Post Exchange vs. Posadas,
54 Phil 866)

Notwithstanding the immunity, the government may tax

itself in the absence of constitutional limitations.

Government-owned or controlled corporations, when

performing proprietary functions are generally subject
to tax in the absence of tax exemption provisions in
their charters or law creating them.

2) Constitutional Limitations
i. Due Process Clause
Basis: Sec. 1 Art. 3 No person shall be deprived of life,
liberty or property without due process of law x x x.
Requisites:
1. The interest of the public generally as distinguished from
those of a particular class require the intervention of the
state;
2. The means employed must be reasonably necessary to
the accomplishment for the purpose and not unduly
oppressive;
3. The deprivation was done under the authority of a valid
law or of the constitution; and

10

4. The deprivation was done after compliance with fair and

reasonable method of procedure prescribed by law.
In a string of cases, the Supreme Court held that in order
that due process of law must not be done in an arbitrary,
despotic, capricious, or whimsical manner.
Cases:
Villegas vs. Hiu Chiong Tsau Pao Ho, November 10,
1978
Requiring a person before he can be employed
to get a permit from the City Mayor of Manila who
may withhold or refuse it at will is tantamount to
denying him the basic right of the people in the
Philippines to engage in a means of livelihood. While
it is true that the Philippines as a State is not obliged
to admit aliens within its territory, once an alien is
admitted, he cannot be deprived of life without due
process of law which includes the means of
livelihood. The shelter of protection under the due
process and equal protection clause is given to all
persons, both aliens and citizens.

City of Baguio vs. De Leon, 25 SCRA 938

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

Sison vs. Ancheta, GR L-59431, 25 July 1984

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

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

1996
Unless there is due notice to the taxpaying
public, due compliance with Internal Revenue Tax
rules and regulations may not be reasonably
expected.
And most importantly, their strict
enforcement could possibly suffer from legal infirmity
in the light of the constitutional provision on `due
process of law' and the essence of the Civil Code
provision concerning effectivity of laws, whereby due
notice is a basic requirement.

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ii. Equal Protection Clause and the Rule on Uniformity

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

Important Points to Consider:

1. Equal protection of the laws signifies that all persons
subject to legislation shall be treated under circumstances
and conditions both in the privileges conferred and liabilities
imposed
2. This doctrine prohibits class legislation which
discriminates against some and favors others.

Cases:
Association of Customs Brokers vs. Manila, 93 Phil
107
While the tax in the Ordinance refers to
property tax and it is fixed ad valorem, it is merely
levied on all motor vehicles operating within Manila
with the main purpose of raising funds to be
expended exclusively for the repair, maintenance
and improvement of the streets and bridges in said
city. The ordinance imposes a license fee although
under the cloak of an ad valorem tax to circumvent
the prohibition in the Motor Vehicle Law. Further, it
does not distinguish between a motor vehicle for hire
and one which is purely for private use. Neither does
it distinguish between a motor vehicle registered in
Manila and one registered in another place but
occasionally comes to Manila and uses its streets and
public highways. The distinction is necessary if the
ordinance intends to burden with tax only those
registered in Manila as may be inferred from the
word operating used therein. There is an inequality
in the ordinance which renders it offensive to the
Constitution.

Ormoc Sugar Central vs. Ormoc Treasurer, 17

February 1968
The taxing ordinance should not be singular
and exclusive as to exclude any subsequently
established sugar central, of the same class as
plaintiff, for the coverage of the tax. As it is now,
even if later a similar company is set up, it cannot be
subject to the tax because the ordinance expressly
points only to Ormoc City Sugar Company, Inc. as the
entity to be levied upon.

Philreca vs. DILG. 10 June 2003

Supreme Court held that there is reasonable
classification under the Local Government Code to
justify the different tax treatment between electric
cooperatives covered by P.D. No. 269, as amended,
and electric cooperatives under R.A. No. 6938. First,
substantial distinctions exist between cooperatives
under P.D. No. 269, as amended, and cooperatives
under R.A. No. 6938. Second, the classification of taxexempt entities in the Local Government Code is
germane to the purpose of the law. Finally, Sections

12

193 and 234 of the Local Government Code permit

reasonable classification as these exemptions are not
limited to existing conditions and apply equally to all
members of the same class.
NOTE: see also Tio vs. Videogram, 151 SCRA 208.

Requisites for a Valid Classification

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

iii. Freedom of Religion

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

Important Points to Consider:

1. License fees/taxes would constitute a restraint on the
freedom of worship as they are actually in the nature of a
condition or permit of the exercise of the right.
2. However, the Constitution or the Free Exercise of
Religion clause does not prohibit imposing a generally
applicable sales and use tax on the sale of religious
materials by a religious organization. (see Tolentino vs.
Secretary of Finance, 235 SCRA 630)

Cases:
Free Exercise Clause
o American Bible Society vs. City of Manila, 101
Phil 386
In the case at bar the license fee herein involved
is imposed upon appellant for its distribution and sale
of bibles and other religious literature. It may be true
that in the case at bar the price asked for the bibles
and other religious pamphlets was in some instances
a little bit higher than the actual cost of the same but
this cannot mean that appellant was engaged in the
business or occupation of selling said "merchandise"
for profit. SC believes that the provisions of City of
Manila Ordinance No. 2529, as amended, cannot be
applied to appellant, for in doing so it would impair
its free exercise and enjoyment of its religious
profession and worship as well as its rights of
dissemination of religious beliefs.
With respect to Ordinance No. 3000, as amended,
which requires the obtention the Mayor's permit
before any person can engage in any of the
businesses, trades or occupations enumerated
therein, SC do not find that it imposes any charge
upon the enjoyment of a right granted by the
Constitution, nor tax the exercise of religious
practices.

13

Tolentino vs. Secretary of Finance, 25 August

1994
The registration requirement is a central feature
of the VAT system, designed to provide a record of
tax credits because any person who is subject to the
payment of the VAT pays an input tax, even as he
collects an output tax on sales made or services
rendered. The registration fee is thus a mere
administrative fee, one not imposed on the exercise
of a privilege, much less a constitutional right.
iv. Freedom of Speech and of the Press
Basis: Sec. 4 Art. III. No law shall be passed abridging the
freedom of speech, of expression or of the press xxx

Important Points to Consider:

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

v. Uniformity, Equitability and Progressivity of Taxation

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

Important Points to Consider:

1.
Uniformity (equality or equal protection of the laws)
means all taxable articles or kinds or property of the
same class shall be taxed at the same rate. A tax is
uniform when the same force and effect in every place
where the subject of it is found.
2. Equitable
means
fair,
just,
reasonable
and
proportionate to ones ability to pay.
3. Progressive system of Taxation places stress on
direct rather than indirect taxes, or on the taxpayers
ability to pay
4. Inequality which results in singling out one particular
class for taxation or exemption infringes
no
cons938titutional limitation. (See Commissioner vs.
Lingayen Gulf Electric, 164 SCRA 27)
5. The rule of uniformity does not call for perfect uniformity
or perfect equality, because this is hardly attainable.

Cases:
o Tolentino vs. Secretary of Finance
c. Indeed, regressivity is not a negative standard for
courts to enforce. What Congress is required by the
Constitution to do is to "evolve a progressive system of
taxation." This is a directive to Congress, just like the
directive to it to give priority to the enactment of laws for
the enhancement of human dignity and the reduction of

14

social, economic and political inequalities (Art. XIII, Sec. 1),

or for the promotion of the right to "quality education" (Art.
XIV, Sec. 1). These provisions are put in the Constitution as
moral incentives to legislation, not as judicially enforceable
rights.
o City of Baguio vs. De Leon, 25 SCRA
vi. Non-imprisonment for non-payment of poll tax
Basis: Sec. 20 Art. III. No person shall be imprisoned for
debt or non-payment of poll tax.

Important Points to Consider:

1.The only penalty for delinquency in payment is the
payment of surcharge in the form of interest at the rate of
24% per annum which shall be added to the unpaid amount
from due date until it is paid. (Sec. 161, LGC)
2. The prohibition is against imprisonment for nonpayment of poll tax. Thus, a person is subject to
imprisonment for violation of the community tax law other
than for non-payment of the tax and for non-payment of
other taxes as prescribed by law.

vii. Non-impairment Clause

Basis: Sec. 10 Art. III. No law impairing the obligation of
contract shall be passed.

Important Points to Consider:

1. A law which changes the terms of the contract by
making new conditions, or changing those in the contract,
or dispenses with those expressed, impairs the obligation.
2.The non-impairment rule, however, does not apply to
public utility franchise since a franchise is subject to
amendment, alteration or repeal by the Congress when the
public interest so requires. (See MERALCO vs. Province of
Laguna, G.R. No. 131359, May 5, 1999)

Cases:
o Cagayan Power and Light Co. vs. CIR, G.R. No.
60126, September 25, 1985
SC held that Congress could impair petitioner's
legislative franchise by making it liable for income
tax from which heretofore it was exempted by virtue
of the exemption provided for in its franchise.
Republic Act No. 5431, in amending section 24 of
the Tax Code by subjecting to income tax all
corporate taxpayers not expressly exempted therein
and in section 27 of the Code, had the effect of
withdrawing petitioner's exemption from income
tax.
o Casanova s. Hord, 8 Phil 125
o RCPI vs. Provincial Assessor of South Cotabato, G.R.
131359, May 5, 1999
o City Government of Quezon City vs. Bayantel, G.R.
No. 162015, March 6, 2006

viii. Tax Exemption of Traditional Exemptees

15

Taxation of Properties Actually, Directly and Exclusively

used for Religious, Charitable and Educational
Purposes

Basis: Sec. 28(3) Art. VI. Charitable institutions, churches

and parsonages or convents appurtenant thereto,
mosques, non-profit cemeteries, and all lands, building,
and improvements actually, directly and exclusively used
for religious, charitable or educational purposes shall be
exempt from taxation.

Important Points to Consider:

a. Test of the tax exemption: the use and not ownership of
the property
b. To be tax-exempt, the property must be actually, directly
and exclusively used for the purposes mentioned.
c. The word exclusively means primarily.
NOTE: But see Lung Center vs. QC, 29 June 2004 stating
that exclusively means solely.
d. The exemption is not limited to property actually
indispensable but extends to facilities which are
incidental to and reasonably necessary for the
accomplishment of said purposes.
e. The constitutional exemption applies only to property
tax.
f. However, it would seem that under existing law, gifts
made in favor or religious charitable and educational
organizations would nevertheless qualify for donors gift
tax exemption. (Sec. 101(9)(3), NIRC)

Cases:
Lladoc vs. CIR, 14 Phil 292
Manifestly, gift tax is not within the exempting
provisions (Art VI, Sec. 28 (3)). A gift tax is not a
property tax, but an excise tax imposed on the transfer
of property by way of gift inter vivos, the imposition of
which on property used exclusively for religious
purposes, does not constitute an impairment of the
Constitution.

Abra Valley College vs. Aquino, 15 June 1988

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

Bishop of Nueva Segovia vs. Provincial Board of Ilocos

Norte, 51 Phil 352
The Supreme Court included in the exemption a
vegetable garden in an adjacent lot and another lot
formerly used as a cemetery. It was clarified that the
term "used exclusively" considers incidental use also.

16

Thus, the exemption from payment of land tax in favor

of the convent includes, not only the land actually
occupied by the building but also the adjacent garden
devoted to the incidental use of the parish priest. The
lot which is not used for commercial purposes but
serves solely as a sort of lodging place also qualifies for
exemption because this constitutes incidental use in
religious functions.

Herrera vs. QC Board of Assessment Appeals, 30

September 1961
Within the purview of the Constitutional exemption
from taxation, the St. Catherine's Hospital is a charitable
institution, and the fact that it admits pay-patients does
not bar it from claiming that it is devoted exclusively to
benevolent purposes, it being admitted that the income
derived from pay-patients is devoted to the
improvement of the charity wards. The existence of "St.
Catherine's School of Midwifery" does not, and cannot,
affect the exemption to which St. Catherine's Hospital is
entitled under our fundamental law. On the contrary, it
furnishes another ground for exemption.
Similarly, the garage in the building above referred to
which was obviously essential to the operation of the
school of midwifery and were entitled to transportation
thereto for Mrs. Herrera received no compensation as
directress of St. Catherine's Hospital were incidental to
the operation of the latter and of said school, and,
accordingly, did not affect the charitable character of
said hospital and the educational nature of said school.

Lung Center of the Philippines vs. QC, 29 June 2004

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

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

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

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

1987
The following are some of the highlights of the DOF order
governing the tax exemption of non-stock, non-profit
educational institutions:
1. The tax exemption is not only limited to revenues
and assets derived strictly from school operations like
income from tuition and other miscellaneous fees such as

17

matriculation, library, ROTC, etc. fees, but it also extends

to incidental income derived from canteen, bookstore and
dormitory facilities.
2. In the case, however, of incidental income, the
facilities mentioned must not only be owned and
operated by the school itself but such facilities must be
located inside the school campus. Canteens operated by
mere concessionaires are taxable.
3. Income which is unrelated to school operations like
income from bank deposits, trust fund and similar
arrangements, royalties, dividends and rental income are
taxable.
4. The use of the schools income or assets must be in
consonance with the purposes for which the school is
created; in short, use must be school-related, like the
grant of scholarships, faculty development, and
establishment of professional chairs, school building
expansion, library and school facilities.

Case: CIR vs. CA, 14 October 1998 (YMCA)

o YMCA is not an educational institution within the
purview of Article XIV, Section 4, paragraph 3 of the
Constitution.
The term educational institution or
institution of learning has acquired a well-known
technical meaning, of which the members of the
Constitutional Commission are deemed cognizant.
Under the Education Act of 1982, such term refers to
schools. The school system is synonymous with formal
education, which refers to the hierarchically structured
and chronological graded learnings organized and
provided by the formal school system and for which
certification is required in order for the learner to
progress through the grades or move to the higher
levels. The Court has examined the Amended Articles
of Incorporation and By-Laws of the YMCA, but found
nothing in them that even hints that it is a school or an
educational institution.

x. Tax Exemptions of Revenues and Assets, including

grants, endowments, donations or contributions to
Educational Institutions

Basis: Sec. 4(4) Art. XIV. Subject to the conditions

prescribed by law, all grants, endowments, donations or
contributions used actually, directly and exclusively for
educational purposes shall be exempt from tax.

Important Points to Consider:

1. The exemption granted to non-stock, non-profit
educational institution covers income, property, and
donors taxes, and custom duties.
2. To be exempt from tax or duty, the revenue, assets,
property or donation must be used actually, directly and
exclusively for educational purpose.

18

3. In the case or religious and charitable entities and nonprofit cemeteries, the exemption is limited to property
tax.
4. The said constitutional provision granting tax exemption
to non-stock, non-profit educational institution is selfexecuting.
5. Tax exemptions, however, of proprietary (for profit)
educational
institutions
require
prior
legislative
implementation. Their tax exemption is not selfexecuting.
6. Lands, Buildings, and improvements actually, directly,
and exclusively used for educational purposed are
exempt from property tax, whether the educational
institution is proprietary or non-profit.
xi. Origin or Revenue, Appropriation and Tariff Bills
Basis: Sec. 24 Art. VI. All appropriation, revenue or tariff
bills, bill authorizing increase of the public debt, bills of local
application, and private bills shall originate exclusively in the
House of Representatives, but the Senate may propose or
concur with amendments.
Under the above provision, the Senators power is not only
to only concur with amendments but also to propose
amendments. (Tolentino vs. Sec. of Finance, supra)
xii. Flexible Tariff Clause
- Delegation of Legislative Authority to Fix Tariff Rates,
Imports and Export Quotas

Basis: Sec. 28(2) Art. VI x x x The Congress may, by law,

authorize the President to fix within specified limits, and
subject to such limitations and restrictions as it may
impose, tariff rates, import and export quotas, tonnage and
wharfage dues, and other duties or imposts within the
framework of the national development program of the
government.

xiii.

Voting Requirements in connection with the

Legislative Grant for tax exemption
Basis: Sec. 28(4) Art. VI. No law granting any tax
exemption shall be passed without the concurrence of a
majority of all the members of the Congress.

The above provision requires the concurrence of a majority

not of attendees constituting a quorum but of all members
of the Congress.

xiv.

Non-impairment of the Supreme Courts jurisdiction

in Tax Cases
Basis: Sec. 5 (2) Art. VIII. The Congress shall have the
power to define, prescribe, and apportion the jurisdiction of
the various courts but may not deprive the Supreme Court
of its jurisdiction over cases enumerated in Sec. 5 hereof.
Sec. 5 (2b) Art. VIII. The Supreme Court shall have
the following powers: x x x(2) Review, revise, modify or
affirm on appeal or certiorari x x x final judgments and
orders of lower courts in x x x all cases involving the

19

legality of any tax, impost, assessment, or toll or any

penalty imposed in relation thereto.
xv. Taxation by Local Government Units

3) The Doctrine of Judicial Non-Interference / Power of

Judicial Review in Taxation
The courts cannot review the wisdom or advisability or
expediency of a tax. The courts power is limited only to the
application and interpretation of the law.
Judicial action is limited only to review where involves:
1. The determination of validity on the tax in relation to
constitutional precepts or provisions.
2. The determination, in an appropriate case, of the application of
the law.
4) Taxpayers Suit
It is only when an act complained of, which may include
legislative enactment, directly involves the illegal disbursement
of public funds derived from taxation that the taxpayers suit
may be allowed.
D. FORMS OF ESCAPE FROM TAXATION
1) Resulting to Losses to Governments Revenue
i. Tax Evasion
the use of the taxpayer of illegal or fraudulent means
to defeat or lessen the payment of a tax.
an illegal practice where a person, organization or
corporation intentionally avoids paying his/her/its
true tax liability. Those caught evading taxes are
generally subject to criminal charges and substantial
penalties.
Indicia of Fraud in Taxation
a.
Failure to declare for taxation purposes
true and actual income derived from business for
two consecutive years, and
b.
Substantial underdeclaration of income
tax returns of the taxpayer for four consecutive
years coupled with overstatement of deduction.
Evasion of the tax takes place only when there are no
proceeds. Evasion of Taxation is tantamount, fiscally
speaking, to the absence of taxation
ii. Tax Avoidance
is the use by the taxpayer of legally permissible
alternative tax rates or method of assessing taxable
property or income in order to avoid or reduce tax
liability.
is the legal utilization of the tax regime to one's own
advantage, in order to reduce the amount of tax that
is payable by means that are within the law.
Tax Avoidance is not punishable by law, a taxpayer
has the legal right to decrease the amount of what
otherwise would be his taxes or altogether avoid by
means which the law permits.

20

Distinction between Tax Evasion and Avoidance

Tax Evasion
vs.
Tax Avoidance
accomplished by legal
procedures or means which
accomplished by breaking
maybe contrary to the intent
the letter of the law
of the sponsors of the tax law
but nevertheless do not
violate the letter of the law
iii. Tax Exemption
is a grant of immunity, express or implied, to
particular persons or corporations from the
obligations to pay taxes.

Nature of Tax Exemption

1. It is merely a personal privilege of the grantee
2. It is generally revocable by the government
unless the exemption is founded on a contract which
is protected from impairment, but the contract must
contain the other essential elements of contracts,
such as, for example, a valid cause or consideration.
3. It implies a waiver on the part of the
government of its right to collect what otherwise
would be due to it, and in this sense is prejudicial
thereto.
4. It is not necessarily discriminatory so long as
the exemption has a reasonable foundation or rational
basis.

Rationale of tax Exemption

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

Grounds for Tax Exemptions

1. May be based on a contract in which case, the
public represented by the Government is supposed to
receive a full equivalent therefore
2. May be based on some ground of public policy,
such as, for example, to encourage new and
necessary industries.
3. May be created in a treaty on grounds of
reciprocity or to lessen the rigors of international
double or multiple taxation which occur where there
are many taxing jurisdictions, as in the taxation of
income and intangible personal property.

Equity, not a ground for Tax Exemption

There is no tax exemption solely on the ground
of equity, but equity can be used as a basis for
statutory exemption. At times the law authorizes
condonation of taxes on equitable considerations.
(Sec 276, 277, Local Government Code)

Kinds of Tax Exemptions

21

1. As to basis
a. Constitutional Exemptions Immunities from
taxation which originate from the Constitution
b. Statutory Exemptions Those which emanate
from Legislation
2. As to form
a. Express Exemption Whenever expressly
granted by organic or statute of law
b. Implied Exemption Exist whenever particular
persons, properties or excises are deemed exempt as
they fall outside the scope of the taxing provision itself
3. As to extent
a. Total Exemption Connotes absolute immunity
b. Partial Exemption One where collection of a
part of the tax is dispensed with

Principles Governing the Tax Exemption

1. Exemptions from taxation are highly disfavored by
law, and he who claims an exemption must be able to
justify by the clearest grant of organic or statute of law.
(Asiatic Petroleum vs. Llanes, 49 PHIL 466; Collector of
Internal Revenue vs. Manila Jockey Club, 98 PHIL 670)
2. He who claims an exemption must justify that the
legislative intended to exempt him by words too plain to
be mistaken. (Visayan Cebu Terminal vs. CIR, L-19530,
Feb. 27, 1965)
3. He who claims exemptions should convincingly
prove that he is exempt
4. Tax exemptions must be strictly construed (Phil.
Acetylene vs. CIR, L-19707, Aug. 17, 1967)
5. Tax Exemptions are not presumed. (Lealda Electric
Co. vs. CIR, L-16428, Apr. 30, 1963)
6. Constitutional grants of tax exemptions are selfexecuting (Opinion No. 130, 1987, Sec. Of Justice)
7. Tax exemption is personal.
8. Deductions for income tax purposes partake of the
nature of tax exemptions, hence, they are strictly
construed against the tax payer
9. A tax amnesty, much like a tax exemption is never
favored or presumed by law (CIR vs. CA, G.R. No.
108576, Jan. 20, 1999)
10. The rule of strict construction of tax exemption
should not be applied to organizations performing
strictly religious, charitable, and educational functions
2) Not Resulting to Losses
i. Shifting
Transfer of the burden of a tax by the original payer
or the one on whom the tax was assessed or
imposed to another or someone else
Impact of taxation is the point at which a tax is
originally imposed.
Incidence of Taxation is the point on which a tax
burden finally rests or settles down.
Relations
among
Shifting,
Impact
and
Incidence of Taxation the impact is the initial

22

phenomenon, the shifting is the intermediate

process, and the incidence is the result.
Kinds of Shifting:
1. Forward Shifting the burden of tax is
transferred from a factor of production through
the factors of distribution until it finally settles
on the ultimate purchaser or consumer
2. Backward Shifting effected when the burden
of tax is transferred from the consumer or
purchaser through the factors of distribution to
the factor of production
3. Onward Shifting this occurs when the tax is
shifted two or more times either forward or
backward

ii. Capitalization
the reduction in the price of the taxed object equal to
the capitalized value of future taxes which the
purchaser expects to be called upon to pay
iii. Transformation
The method whereby the manufacturer or producer
upon whom the tax has been imposed, fearing the
loss of his market if he should add the tax to the
price, pays the tax and endeavours to recoup himself
by improving his process of production thereby
turning out his units of products at a lower cost.
3) Illustrative Cases
i. Republic vs. Heirs of Cesar Jalandoni, 20 Sept 1965
Record shows that the three lots alleged to have been
excluded in the return were already declared in the earlier
return submitted by Bernardino Jalandoni as part of his
property and his wife for purposes of income tax, there is
reason to believe that their omission from the return
submitted by Cesar Jalandoni was merely due to an honest
mistake or inadvertence as properly explained by appellants.
We can hardly dispute this conclusion as it would be
stretching too much the imagination if we would find that,
because of such inadvertence, which appears to be
inconsequential, the heirs of the deceased deliberately
omitted from the return the three lots with the only purpose
of defrauding the government after declaring therein as
asset of the estate property worth P1,324,555.80.
The same thing may be said with regard to the alleged
undervaluation of certain sugar and rice lands reported by
Cesar Jalandoni for the same can at most be considered as
the result of an honest difference of opinion and not
necessarily an intention to commit fraud.
Finally, SC finds it unreasonable to impute with regard to
the appraisal made by appellants of the shares of stock of
the deceased simply because Cesar Jalandoni placed in his
return an aggregate market value instead of mentioning the
book value declared by said corporations in the returns filed
by them with the Bureau of Internal Revenue. The fact that
the value given in the returns did not tally with the book
value appearing in the corporate books is not in itself

23

indicative of fraud especially when it is taken into

consideration the circumstance that said book value only
became known several months after the death of the
deceased. Moreover, it is a known fact that stock securities
frequently fluctuate in value and a mere difference of
opinion in relation thereto cannot serve as proper basis for
assessing an intention to defraud the government.
ii. CIR vs. Norton and Harrisson, 31 August 1964
Based on an over-all appraisal of the circumstances
presented by the facts of the case, it yields to the conclusion
that the Jackbilt is merely an adjunct, business conduit or
alter ego, of Norton and Harrison and that the fiction of
corporate entities, separate and distinct from each, should
be disregarded. This is a case where the doctrine of piercing
the veil of corporate fiction, should be made to apply.
It may not be amiss to state in this connection, the
advantages to Norton in maintaining a semblance of
separate entities. If the income of Norton should be
considered separate from the income of Jackbilt, then each
would declare such earning separately for income tax
purposes and thus pay lesser income tax. The combined
taxable Norton-Jackbilt income would subject Norton to a
higher tax.
Thus the SC held that Norton & Harrison is liable for the
deficiency sales taxes assessed against it by the appellant
Commissioner of Internal Revenue
iii. Philippine Acetylene vs. CIR, 17 August 1967
Sales tax are paid by the manufacturer or producer who
must make a true and complete return of the amount of his,
her or its gross monthly sales, receipts or earnings or gross
value of output actually removed from the factory or mill,
warehouse and to pay the tax due thereon. The tax imposed
by Section 186 of the Tax Code is a tax on the manufacturer
or producer and not a tax on the purchaser except probably
in a very remote and inconsequential sense. Accordingly, its
levy on the sales made to tax-exempt entities like the
Napocor is permissible. On the other hand, there is nothing
in the language of the Military Bases Agreement to warrant
the general exemption granted by General Circular V-41
(1947). Thus, the expansive construction of the tax
exemption is void; and the sales to the VOA are subject to
the payment of percentage taxes under Section 186 of the
Tax Code. Therefore, tax exemption is strictly construed and
exemption will not be held to be conferred unless the terms
under which it is granted clearly and distinctly show that
such was the intention.
iv. CIR vs. American Rubber, 29 November 1966
In Philippine Packing Corporation vs. Collector of Internal
Revenue (100 Phil. 545 et seq.), it was ruled that the
exemption from sales tax established in Section 188(b) of
the Internal Revenue Tax Code in favor of sales of
agricultural products, whether in their original form or not,
made by the producer or owner of the land where produced
is not taken away merely because the produce undergoes
processing at the hand of said producer or owner for the

24

purpose of working his product into a more convenient and

valuable form suited to meet the demand of an expanded
market; that the exemption was not designed in favor of the
small agricultural producer, already exempted by the
subsequent paragraphs of the same Section 188, but that
said exemption is not incompatible with large scale
agricultural production that incidentally required resort to
preservative processes designed to increase or prolong
marketability of the product.
v. CIR vs. John Gotamco and Sons, 27 February 1987
Direct taxes are those that are demanded from the very
person who, it is intended or desired, should pay them; while
indirect taxes are those that are demanded in the first
instance from one person in the expectation and intention
that he can shift the burden to someone else. Herein, the
contractors tax is payable by the contractor but it is the
owner of the building that shoulders the burden of the tax
because the same is shifted by the contractor to the owner
as a matter of self-preservation. Such tax is an indirect tax
on the organization, as the payment thereof or its inclusion
in the bid price would have meant an increase in the
construction cost of the building.
Hence, the Contractees (WHO) exemption from indirect
taxes implies that contractor (Gotamco) is exempt from
contractors tax.
vi. Maceda vs. Macaraig, 31 May 1991, 8 June 1993
NAPOCOR is a non-profit public corporation created for the
general good and welfare, and wholly owned by the
government of the Republic of the Philippines. From the
very beginning of the corporations existence, NAPOCOR
enjoyed preferential tax treatment to enable the
corporation to pay the indebtness and obligation and
effective implementation of the policy enunciated in Section
1 of RA 6395. From the preamble of PD 938, it is evident
that the provisions of PD 938 were not intended to be strictly
construed against NAPOCOR. On the contrary, the law
mandates that it should be interpreted liberally so as to
enhance the tax exempt status of NAPOCOR. It is
recognized principle that the rule on strict interpretation
does not apply in the case of exemptions in favor of
government political subdivision or instrumentality. In the
case of property owned by the state or a city or other public
corporations, the express exception should not be construed
with the same degree of strictness that applies to
exemptions contrary to the policy of the state, since as to
such property exception is the rule and taxation the
exception.
vii. Contex vs. CIR, G.R. No. 151135, July 2, 2004
Exemptions from VAT are granted by express provision of
the Tax Code or special laws. Under Zero-rating, all VAT is
removed from the zero-rated goods, activity or firm. In
contrast, exemption only removes the VAT at the exempt
stage, and it will actually increase, rather than reduce the
total taxes paid by the exempt firms business or non-retail
customers. It is for this reason that a sharp distinction must

25

be made between zero-rating and exemption in designating

a value-added tax.
Apropos, the petitioners claim to VAT exemption in the
instant case for its purchases of supplies and raw materials
is founded mainly on Section 12 (b) and (c) of Rep. Act No.
7227, which basically exempts them from all national and
local internal revenue taxes, including VAT and Section 4 (A)
(a) of BIR Revenue Regulations No. 1-95.
On this point, petitioner rightly claims that it is indeed VATExempt and this fact is not controverted by the respondent.
In fact, petitioner is registered as a NON-VAT taxpayer per
Certificate of Registration issued by the BIR. As such, it is
exempt from VAT on all its sales and importations of goods
and services.
viii. CIR vs. Estate of Benigno Toda, Jr., G.R. No. 147188,
September 14, 2004
Tax evasion connotes the integration of three factors: (1)
the end to be achieved, i.e., the payment of less than that
known by the taxpayer to be legally due, or the nonpayment of tax when it is shown that a tax is due; (2) an
accompanying state of mind which is described as being
evil, in bad faith, willful, or deliberate and not
accidental; and (3) a course of action or failure of action
which is unlawful. All these factors are present in the instant
case.
The scheme resorted to by CIC in making it appear that
there were two sales of the subject properties, i.e., from CIC
to Altonaga, and then from Altonaga to RMI cannot be
considered a legitimate tax planning. Such scheme is
tainted with fraud.
Here, it is obvious that the objective of the sale to Altonaga
was to reduce the amount of tax to be paid especially that
the transfer from him to RMI would then subject the income
to only 5% individual capital gains tax, and not the 35%
corporate income tax. Altonagas sole purpose of acquiring
and transferring title of the subject properties on the same
day was to create a tax shelter. Altonaga never controlled
the property and did not enjoy the normal benefits and
burdens of ownership. The sale to him was merely a tax
ploy, a sham, and without business purpose and economic
substance. Doubtless, the execution of the two sales was
calculated to mislead the BIR with the end in view of
reducing the consequent income tax liability.

ix. John Hay Peoples Alternative Coalition vs. Lim,

et.al., G.R. No. 119775, October 24, 2003
It is clear that under Section 12 of R.A. No. 7227 it is only
the Subic SEZ which was granted by Congress with tax
exemption, investment incentives and the like. There is no
express extension of the aforesaid benefits to other SEZs
still to be created at the time via presidential proclamation.

26

While the grant of economic incentives may be essential to

the creation and success of SEZs, free trade zones and the
like, the grant thereof to the John Hay SEZ cannot be
sustained. The incentives under R.A. No. 7227 are exclusive
only to the Subic SEZ, hence, the extension of the same to
the John Hay SEZ finds no support therein.
More importantly, the nature of most of the assailed
privileges is one of tax exemption. It is the legislature,
unless limited by a provision of the state constitution that
has full power to exempt any person or corporation or class
of property from taxation, its power to exempt being as
broad as its power to tax.
The challenged grant of tax exemption would circumvent
the Constitutions imposition that a law granting any tax
exemption must have the concurrence of a majority of all
the members of Congress.
x. See also: CIR vs. Yutivo and Sons (1961) and CIR vs.
Seagate Technology (Phils.), G.R. No. 153866, 11 February
2005.
E. RULES OF CONSTRUCTION OF TAX LAWS
1) On the interpretation and construction of tax statutes, legislative
intention must be considered.
2) In case of doubt, tax statutes are construed strictly against the
government and liberally construed in favor of the taxpayer.
3) The rule of strict construction against the government is not applicable
where the language of the tax law is plain and there is no doubt as to
the legislative intent.
4) The exemptions (or equivalent provisions, such as tax amnesty and tax
condonation) are not presumed and when granted are strictly construed
against the grantee.
5) The exemptions, however, are construed liberally in favor of the grantee
in the following:
i. When the law so provides for such liberal construction;
ii. Exemptions from certain taxes granted under special circumstances
to special classes of persons;
iii. Exemptions in favor of the Government, its political subdivisions;
iv. Exemptions to traditional exemptees, such as, those in favor of
charitable institutions.
6) The tax laws are presumed valid.
7) The power to tax is presumed to exist.

Case: CIR vs. CA and Ateneo, 18 April 1997

The doctrine in the interpretation of tax laws is that (a) statute will not
be construed as imposing a tax unless it does so clearly, expressly, and
unambiguously. . . . (A) tax cannot be imposed without clear and
express words for that purpose. Accordingly, the general rule of
requiring adherence to the letter in construing statutes applies with
peculiar strictness to tax laws and the provisions of a taxing act are not
to be extended by implication. In case of doubt, such statutes are to
be construed most strongly against the government and in favor of the
subjects or citizens because burdens are not to be imposed nor
presumed to be imposed beyond what statutes expressly and clearly
import.
Ateneos Institute of Philippine Culture never sold its services for a fee

27

to anyone or was ever engaged in a business apart from and

independently of the academic purposes of the university. Funds
received by the Ateneo de Manila University are technically not a fee.
They may however fall as gifts or donations which are tax-exempt as
shown by private respondents compliance with the requirement of
Section 123 of the National Internal Revenue Code providing for the
exemption of such gifts to an educational institution.

F. THE CONCEPT OF TAX LAWS

1) Nature
Prospectivity of Tax Laws
General Rule: Taxes must only be imposed prospectively
Exception: The language of the statute clearly demands or
express that it shall have a retroactive effect.

Important Points to Consider

1.
In order to declare a tax transgressing the due
process clause of the Constitution it must be so harsh and
oppressive in its retroactive application (Fernandez vs.
Fernandez, 99 PHIL934)
2.
Tax laws are neither political nor penal in nature
they are deemed laws of the occupied territory rather than the
occupying enemy. (Hilado vs. Collector, 100 PHIL 288)
3.
Tax laws not being penal in character, the rule in
the Constitution against the passage of the ex post facto laws
cannot be invoked, except for the penalty imposed.

2) Sources
i. Constitution
Other Constitutional Provisions related to
Taxation
1. Subject and Title of Bills (Sec. 26(1) 1987
Constitution)
Every Bill passed by Congress shall embrace only
one subject which shall be expressed in the title
thereof.
NOTE: In the Tolentino E-VAT case, supra, the
E-vat, or the Expanded Value Added Tax Law (RA
7716) was also questioned on the ground that the
constitutional requirement on the title of a bill was not
followed.
2. Power of the President to Veto items in an
Appropriation, Revenue or Tariff Bill (Sec.
27(2), Art. VI of the 1987 Constitution)
The President shall have the power to veto
any particular item or items in an Appropriation,
Revenue or Tariff bill but the veto shall not
affect the item or items to which he does not
object.

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3. Appropriation of Public Money for the benefit

of any Church, Sect, or System of Religion
(Sec. 29(2), Art. VI of the 1987 Constitution)
No public money or property shall be
appropriated, applied, paid or employed, directly or
indirectly for the use, benefit, support of any sect,
church, denomination, sectarian institution, or
system of religion or of any priest, preacher,
minister, or other religious teacher or dignitary as
such except when such priest, preacher, minister or
dignitary is assigned to the armed forces or to any
penal institution, or government orphanage or
leprosarium.
4. Taxes levied for Special Purpose (Sec. 29(3),
Art. VI of the 1987 Constitution)
All money collected or any tax levied for a
special purpose shall be treated as a special fund
and paid out for such purpose only. It the purpose for
which a special fund was created has been fulfilled or
abandoned the balance, if any, shall be transferred to
the general funds of the government.
An example is the Oil Price Stabilization
Fund created under P.D. 1956 to stabilize the prices
of imported crude oil.
In a decided case, it was held that where
under an executive order of the President, this
special fund is transferred from the general fund to a
trust liability account, the constitutional mandate is
not violated. The OPSF, according to the court,
remains as a special fund subject to COA audit
(Osmea vs. Orbos, et al., G.R. No. 99886, Mar. 31,
1993)
5. Allotment to Local Governments
Basis: Sec. 6, Art. X of the 1987 Constitution
Local Government units shall have a just
share, as determined by law, in the national taxes
which shall be automatically released to them.
ii. Statutes
iii. Issuances by the Secretary of Finance
iv. Administrative Issuance by the BIR
Cases:
CIR vs. CA and Fortune, G.R. No. 119761, 29 August
1996
Prior to the issuance of RMC 37-93, the brands
were in the category of locally manufactured
cigarettes not bearing foreign brands, subject to 45%
ad valorem tax. Without RMC 37-93, the enactment
of RA7654 would not have new tax rate
consequences on the companys products. In issuing
RMC 37-93, the BIR legislated under its quasilegislative authority and not simply interpreted the
law. When an administrative rule goes beyond
merely providing for the means that can facilitate or
render least cumbersome the implementation of the

29

law but substantially adds to or increases the burden

of those governed. It behooves the agency to accord
at least to those directly affected a chance to be
heard, and thereby be duly informed, before that
new issuance is given the force and effect of law.

PB Com vs. CIR, 28 January 1999

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

v. Tax Ordinances
vi. Tax Treaties
exist between many countries on a bilateral basis to
prevent double taxation
See CIR vs. SC Johnson and Son, 26 June 1999
G. OTHER DOCTRINES IN TAXATION
Imprescriptibility of Taxes
General Rule: Taxes are imprescriptible
Exception: When provided otherwise by the tax law itself.
Example: NIRC provides for statutes of limitation in the assessment
and collection of taxes therein imposed
Important Point to Consider
The law on prescription, being a remedial measure, should be liberally
construed to afford protection as a corollary, the exceptions to the law
on prescription be strictly construed. (CIR vs. CA. G.R. No. 104171,
Feb. 24, 1999)

Doctrine of Equitable Recoupment

It provides that a claim for refund barred by prescription may be
allowed to offset unsettled tax liabilities should be pertinent only to taxes
arising from the same transaction on which an overpayment is made and
underpayment is due.
This doctrine, however, was rejected by the Supreme Court, saying
that it was not convinced of the wisdom and proprietary thereof, and that
it may work to tempt both the collecting agency and the taxpayer to
delay and neglect their respective pursuits of legal action within the
period set by law. (Collector vs. UST, 104 PHIL 1062)

INCOME TAXATION
BASIC CONCEPT OF PHILIPPINE INCOME TAXATION
A.

CONCEPT OF INCOME
1. INCOME , defined;
It is understood as follows:
a. Income is all wealth that flows into the taxpayer other than
a mere return of capital;

30

b. It includes all gains or profit as well as gains from sale or

transfer of property whether real or personal, ordinary or
capital asset;
c. The gains derived from capital, from labor, or both
combined, provided it is understood to include profit
gained through a sale or conversion of capital assets( Black
Law Dictionary);
d. The amount of money coming to a person or corporation
within specified time, whether as payment for services,
interest or profit from investment. ( Fisher Vs. Trinidad 43
Phil 973, Conwi vs. CTA 213 SCRA 83)
2. CAPITAL, defined
Accumulated goods, possessions and assets used for the
production of profits and wealth.
- Owners equity in the business.
3. INCOME vs. CAPITAL
Income as contrasted with the capital
1. The essential difference between capital and income is that
capital is a fund while, income is a flow;
2. Capital is wealth while, income is the service of wealth;
3. The fact is that property is the tree, income is the fruit; labor
is the tree, income is the fruit; capital is the tree, income is
the fruit. (Madrigal vs. Rafferty 38 Phil 414)
B. Forms of Income
Income may either be received in the form of:
1.
Cash income pertains to money or money
substitutes derived as compensation or earning derived from labor,
practice of profession and conduct of business.
2.
Property income denotes the earned right of
ownership over tangible or intangible thing as a result of labor,
business or practice of profession.
3.
Services income based on the performance
received in payment for the work previously rendered by one person
to another.
4.
Combination of cash, services or property.
C. Classification of Income
1.
Compensation Income the gain derived from
labor especially employment such as salaries and commission.
2.
Profession or Business Income the value
derived from an exercise of profession, business or utilization of
capital assets. e.g. income derived from sale of assets used in trade
or business
3.
Passive Income income in which the taxpayer
merely waits for the amount to come in. e. g. interest derived from
bank accounts
4.
Capital Gain an income derived from the sale of
assets not used in trade or business. e.g. income from sale of
personal property
B. TEST APPLIED IN DETERMINING THE EXISTENCE OF INCOME
1. Severance test/ realization test
- as a capital or investment is not income subject to tax, the
gain or profit derived from the exchange or transaction of said
capital by the taxpayer for his separate used benefit and
disposal is income subject to tax.

31

There is no taxable income until there is separation from

capital of something of exchangeable value, thereby
supplying the realization or transmutation that would result in
the receipt of income.
Under this doctrine, in order that income may exist, it is
necessary that there be a separation from capital of
something of exchangeable value.

2. TAX benefit rule

Economic benefit rule -That even without the sale or other
disposition if by reason of appraisal, the cost basis is used as
the new tax base for purposes of computing the allowable
depreciation expense, the net difference between the original
cost basis and new basis due to appraisal is taxable.
An income is constructively received by a person when - it
is credited to the amount of or segregated in his favor and which
maybe drawn by him at any time without any limitations e. g.:
o Interest credited on savings bank deposits dividends
applied by the corporation against the indebtedness of
stockholder
o Share in the profit of a partner in General Professional
Partnership
3. Claim of right doctrine
applicable only in those instances where money is taken, it
does not involve the money or other proceeds from
embezzled or stolen personal or other property. Thus,
proceeds of stolen or embezzled property are taxable income,
because even income from illegal sources is taxable.
Ownership thereof is not in issue; the culprit has an obligation
to return the same.
4. Income from whatever sources
All income not expressly excluded or exempted from the class
of taxable income, irrespective of the voluntary or involuntary
action of the taxpayer in producing the income.
C. REQUISITES FOR THE TAXABILITY OF AN INCOME
1. Existence of a gain - Gain is a sine qua non or an indispensable
requisite to the existence of taxable income. If a taxpayer receives
no profit from his labor or transaction, then such condition will not
give rise to taxability of income.

There must be a value received in the form of cash or its equivalent

as a result of rendition of service or earnings in excess of capital
invested.
A mere expectation of profits is not an income
A transaction where- by nothing of exchangeable value comes to or
is received by the taxpayer does not give rise to or create taxable
income.
Items or amounts received which do not add to the taxpayers net
worth or redound to his benefits such as amounts merely deposited
or entrusted to him are not considered as gains (CIR vs. Tours
specialist, 183 SCRA 402).
Gain need not be necessarily in cash. It may be in form of payment,
reduction or cancellation of Ts indebtedness, or gain from exchange
of property.

32

2. Realization of a gain
a. Actual gain gain must be realized and receive.
b. Constructive receipt profit is set aside, declared
- When an income is credited to the account of or set aside for,
a taxpayer and which may be drawn by him at any time,
without any substantial limitation or condition upon which
payment is to be made.
GENERAL RULE: A mere increase in the value of property without
actual realization, either through sale or other disposition, is not
taxable. The increase in value is a mere unrealized increase in capital.
EXCEPT: ECONOMIC BENEFIT PRINCIPLE (BIR RULING NO. 029 98,
MARCH 19, 1998)
That even without the sale or other disposition if by reason of
appraisal, the cost basis is used as the new tax base for purposes
of computing the allowable depreciation expense, the net
difference between the original cost basis and new basis due to
appraisal is taxable.

An income is constructively received by a person when - it is

credited to the amount of or segregated in his favor and which
maybe drawn by him at any time without any limitations e. g.:
Interest credited on savings bank deposits
Dividends applied by the corporation against the indebtedness of
stockholder
Share in the profit of a partner in General Professional Partnership

3. Gains must not be excluded (sec 32b)

- any amount receive by an officer or employee or by his heirs from
the employer as a consequence of separation from service because
of death, sickness or other physical disability or for any other cause
beyond his control.
The gain must not be exempted.
Property or money received by a taxpayer in which he has no
business transaction right to retain, but a duty to return To the one
person from whom it was received is not considered as income (e.
g. payment by mistake). Reason: The receipt is offset by a liability
to the party making the excess payment. However, where the duty
to return is unclear, the recipient may be required to pay the tax.
D. THE PHILIPPINE INCOME TAX SYSTEM
1. Type of income tax systems
a. Schedular system vs. Global system
Schedular system
- a system employed where the income tax treatment varies
and is made to depend on the kind or category of taxable
income of the taxpayer.
- the system that itemizes the different oncom and provide for
varied percentages of tax, to be applied thereto. It has
different rates.
* individual taxpayer fallows the scheduler tax system because
their income from different sources are classified into
compensation income, business income, passive income, capital
gain derived from sale of shares of stock or sale of real property.
These incomes are categorized and treated differently.
Global income tax system

33

it is a tax system whereby gross compensation income is

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

corporate taxpayer adopts the global system of

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

Distinctions between schedular and global treatment in income

tax
1. Under the scheduler treatment there are different tax rates while under
the global treatment there is a unitary or single tax rate;
2. Under the shedular treatment there are different categories of taxable
income while under the global treatment there is no need for
classification as all taxpayer are subjected to single rate;
3. Shedular is usually used in the income of individual taxpayer while
global is usually applied to corporation.
b. Schedular rates of taxes vs. Schedular system
2. Philippine income tax system as a semi global/ mixed
system.
E. CRITERIA IN IMPOSING PHILIPPINE INCOME TAXES
1. Place where income was earned
- income is taxable depending on the nature of taxpayer. Citizens of
the Philippines and domestic corporation are taxable on income
from all sources whether earned within or without; non residents
citizen, resident alien, non resident alien and foreign corporation are
taxable on income only from sources realized within the Philippines.
2. Residency- test of residency
- maintenance of residence here in the Philippines.
- Actual physical presence in the Philippines
- Though there is an intention to return, if the Taxpayer
temporarily resides in the Philippines on an extended stay.
3. Citizenship
F. THE INCOME TAXPAYER AND THE GENERAL PRINCIPLE OF THEIR
TAXABILITY (Tax Situs for Income Purposes)
1. General principle of income taxation (sec 23 NIRC)
Except when otherwise provided by NIRC:
a. A citizen of the Philippines residing therein is taxable on all income
derived from sources within and without the Philippines;
b. A nonresident citizen is taxable only on income derived from
sources within the Philippines;
c. An individual citizen of the Philippines who is working and deriving
income from abroad as an overseas contract worker is taxable only
on income derived from sources within the Philippines: Provided,
That a seaman who is a citizen of the Philippines and who receives
compensation for services rendered abroad as a member of the

34

complement of a vessel engaged exclusively in international trade

shall be treated as an overseas contract worker;
d. An alien individual, whether a resident or not of the Philippines, is
taxable only on income derived from sources within the Philippines;
e. A domestic corporation is taxable on all income derived from
sources within and without the Philippines; and
f. A foreign corporation, whether engaged or not in trade or business
in the Philippines, is taxable only on income derived from sources
within the Philippines.
2. Individual Taxpayer
a.) Classification of Individual Taxpayer
1. Citizens of the Philippines may be classified into;
(a) Resident Citizens (RC) -> those residing in the Phils.
(b) Non-resident Citizens -> those not residing in the Phils.

A non-resident citizens means (sec. 22 (E) National Internal

Revenue Code (NIRC):
1. One who establishes to the satisfaction of the Commissioner
of Internal Revenue (CIR) the fact of his physical presence
abroad with a definite intention to reside therein.
2. A citizen of the Phils. who leaves the country during the
taxable year to reside abroad, either as immigrant or for
employment or on permanent basis.
3. A citizen of the Phils. who works and derive from abroad and
whose employment thereat requires him to be physically
present abroad most of the time during the taxable year.
4. A citizen who has been previously considered as non-resident
citizen and who arrives in the Phils. at any time during the
taxable year to reside permanently in the country. (He shall
be considered a NRC for the taxable year in which he arrives
in the Phils. with respect to his income derived from sources
abroad until the date of his arrival in the Phils.)

Rev. Regulations. No. 9-73, November 26, 1973 - The continuity of

residence abroad is not essential. If physical presence is established,
such physical presence for the calendar year is not interrupted by
reasons of travels to the Phils.
2. Aliens / Foreigners
(a.)
Resident aliens (RA) -> those residing in the
Philippines though not a citizen thereof.
(b.)
Non resident aliens (NRA)
->
those not
residing in the Phils.
1.)Those engaged in trade or business in the Phils. (NRAETB)
2.)Those not engaged in trade / business in the Phils. (NRANETB).
A non-resident alien individual who came to the Phils. and stayed
therein for an aggregate period of more than 180 days during any
calendar year shall be deemed a NRA doing business in the Phils.
The term engaged in trade / business denotes habitually or
sustained activity.
Resident aliens are those who are actually present in the Phils.
and who are not mere transients or sojourners. For tax purposes a
resident alien is:

35

1.) An alien who lives in the Phils. with no definite intention to stay
as a resident.
2.) One who comes in the Phils. for definite purposes which in its
very nature would require on extended stay and to that end,
makes his home temporarily in the Phils.
3.) An alien who stay within the Phils. for more than 12 months
from the date of his arrival in the Phils.
Residence does not mean mere physical presence. What makes an
alien resident or a non-resident alien is his intention with regard to the
length and nature of his stay.
b.) Personal and Additional Exemptions
Nature & Purpose: Personal and additional exemptions are fixed
amounts which are in the nature of deduction and are intended to substitute
for the disallowance of personal or living expenses as deductible items.
Reciprocity means that the foreign country where the nonresident alien
is a citizen or subject grants exemption to Filipinos not residing there but
doing trade or business, or exercising profession therein.
The extent of personal exemptions allowed to such non-resident alien
shall be in the amount equal to the exemptions allowed in the income
tax law in the country of which he is a subject or citizen, to citizens of
the Phils. not resident in such country not to exceed the amount fixed
under our laws. (Sec. 36 [D], NIRC).
Personal Exemptions for RC, NRC, and RA
Taxpayer
1. Single person including a married
person judicially decreed as
legally separated
2. Each married person
3. Head of family
HEAD OF FAMILY
woman with;

Exemption
(amount)
P 20k
P 32k
P 25k

is one who is unmarried or legally separated man or

(1) One or both parents

(a) Living with the taxpayer.
(b) Dependent upon the taxpayer for their chief support.
(2)
One or more brothers (a) Living with the taxpayer
(b) Dependent upon the T for chief support
(c) Not more than 21 yrs. of age
(d) Not married
(e) Not gainfully employed
(3)One or more legitimate recognized natural / legally adopted children.
(b)living with the Taxpayer
(c) dependent upon the Taxpayer for chief support
(d)not more than 21 yrs. of age
(e) not married
(f) not gainfully employed

Regardless of age, such children, brothers or sisters qualify a Taxpayer as

head of family is they are incapable of self-support because of mental or
physical defect.

36

CHIEF SUPPORT -> means principal or main support. More than fifty
percent (50%) being provided to certain dependents is enough. This
phrase does not necessarily mean that the dependent derives no name at
all, he may still derive income but the same is insufficient to support him.

LIVING WITH -> requires the Taxpayer and his dependent to actually be
residing together but temporary absence from their common residence
brought by face of circumstances such as:
(a) The Taxpayer is away on business
(b) The dependent who may be boarding elsewhere is in pursuit of
education.

GAINFULLY EMPLOYED means that the dependent will only qualify as

such if he derives no income for himself, or he is employed but his income
is not sufficient to support him independently outside of the principal/chief
support afforded to him by the taxpayer.

RA 7432 in relation to exemptions

RA 7432 (approved April 23, 1992) expressly allows a qualified senior
citizens to be claimed as dependents by those who care for them whether
a relative or not.

Additional Exemption
Rule:
An additional exemption of P8,000 is granted to Taxpayer for
each, but not exceeding four (4) of his :
(a) Legitimate, illegitimate and/or legally adopted children
(b) Living with the Taxpayer
(c) Chiefly dependent upon him for support
(d) Not more than 21 yrs. old
(e) Unmarried
(f) Not gainfully employed.

1.)

Take note of the following rules:

Personal exemption of married persons:
a. If not legally separated, each spouse is entitled to P32k as personal
exemption.
b. If legally separated, each is entitled to P20k as a single individual
unless qualifies as head of family.
c. Where only one (1) of the spouses is deriving income, only such
spouse shall be allowed the personal exemption.

2.)

For additional exemption

a.) For married individuals can be claimed by only 1 of the spouses.
b.) For legally separated spouses, it can be claimed only by the spouse
who has custody of the children; but the amount claimed by both
shall not exceed the maximum allowed.
c.) Additional exemption can be claimed only by the husband unless:
i. he waives his right in favor of his wife;
ii. the husband is working abroad; or
iii. the wife is the one deriving income.

3.) The law requires that married individuals, the husband and wife
although required to file one (1) income tax return, should nevertheless
compute their individual income separately. If any income of the

37

spouses cannot be definitely attributable to or identifiable as income

exclusively earned as realized by either of the spouses, the same shall
be divided equally between the spouses.

Rules on change of Status

These are:
1.) If the taxpayer marries or should have additional dependent(s)
during the taxable year, the taxpayer may claim the
corresponding additional exemption, as the case may be, in full
for such year.
2.) If the taxpayer dies during the taxable year, his estate may still
claim the personal and additional exemption for himself and his
dependents as if he died at the close of such year.
3.) If the spouse or any of the dependents dies or if any of such
dependents marries, becomes twenty-one (21) years old or
becomes gainfully employed during the taxable year, the
taxpayer may still claim the same exemptions as if the spouse or
any of the dependents died, or as if such dependents married,
became twenty-one (21) years old or become gainfully employed
at the close of such year.

Any income or gain derived in which a final tax is imposed shall no longer
be included in the taxable net income of the taxpayer (applicable only to
citizens and aliens)
Final tax is imposed without deduction. Neither is the provision on
personal additional applicable.
Aliens employed by RAHQs & ROHQs, OBUs, Petroleum service contractor
& subcontractor of a multinational corporations are entitled to 15% tax,
only on those:
Salaries, wages, annuities, honoraria and the like as
received from such RAHQs or ROHQs.
Provided that the same tax treatment is extended to Filipino
employees having the same position in such entities.

3. Tax on corporations (Corporate Taxpayers)

a.) Corporation defined (Sec. 24(b) Tax Code) - The term shall include
partnership, no matter how created or organized, joint stock companies, joint
accounts, or insurance companies, but does not include general professional
partnerships and a joint venture or consortium formed for the purpose of
undertaking construction projects or engaging in petroleum, coal, geothermal
and other energy operations pursuant to operating or consortium agreement
under a service contract with the government.
General professional partnership (GPP) - are formed by persons for the
role purpose of exercising their common profession, no part of the income of
which is derived from engaging in any trade & business.
Corporations are classified into two classes namely:
(1) Domestic -> those created or organized in the Phils. or under its
laws.
(2) Foreign -> those created organized or existing under any laws
other than those of the Phils. and they are either;
Resident foreign = those foreign corporation engaged in
trade or business within the Phils.

38

 Non-resident = those foreign corporation not engaged in

trade or business within the Phils.
DOING OR ENGAGING IN or TRANSACTING BUSINESS
-> The term implies a continuity of commercial dealings and arrangements
and contemplates to that extent, the performance of acts or works or the
exercise of some of the functions normally insistent to and in the progressive
prosecution of commercial gain or for the purpose and the object of the
business organization (Comm. vs. British Overseas Airways Corporation
BOAC case 149 S 395)
A. Tax On Domestic Corporation (Sec. 27 of NIRC)
Except as otherwise provided in the Tax Code, Domestic corporations
duly organized and existing under the Philippine laws shall be subject to the
following tax rates based on their gross income derived from sources within
or without the Phils.
35%
34%
33%
32%

for 1997 and prior years

effective January 01, 1998
effective January 01, 1999
effective January 01, 2000

(1) Proprietary Educational Institutions / non-profit hospitals - Except

those income subject to final tax, proprietary educational institutions/ nonprofit are taxable with the tax rate of 10% on their gross income.

Proprietary Educational Institution means any private school

maintained and administered by private individuals or groups within
an issued permit from the DECS, CHED or TESDA.

Predominance Test / Preponderance Test means that if the gross

income from unrelated trade, business or other activity exceeds 50%
of the total gross income derived by any educational institution or
hospital from all sources the normal tax shall be imposed on the
entire taxable income.

Unrelated trade, business or other activity means any trade

business or other activity, the conduct of which is not substantially
related to the exercise or performance by such educational institution
or hospital of its primary purpose or function.

Article XIV Sec. 4 (3) of the Constitution provides that all revenues
and assets of non-stock and non-profit educational institution used
actually, directly and exclusively for educational purposes are exempt
from taxes and duties.

(2)
Government owned or controlled corporations (GOCCs) GOCCs,
agencies or its instrumentality shall pay applicable corporate income tax
rates except: GSIS, SSS, PHIC, PCSO and PAGCOR.

Tax Imposed on Domestic corporations

(1.) Normal Corporate Income Tax (NCIT) -> the tax rate of 32% (as of
Jan. 1, 2000) is imposed on any income derived, within and without the
Phils. Except on those passive income (Section 27 (A) NIRC)

39

(2.) Gross Income Tax Option -> The President upon the recommendation
of the Secretary of Finance may, effective January 1, 2000, allow
corporations the option to be taxed at fifteen percent (15%) of gross
income provided that the following conditions are met therein:
a. a tax effort ratio of 20% of GNP
b. a ratio of 40% of income tax collection to total tax revenues
c. a VAT effort of 4% of GNP and
d. a 0.9% ratio of the Consolidated Public Sector Final Position (CPSFP)
to Gross National Product (GNP)
The option to be taxed based on gross income shall be available only
to firms whose ratio of cost of sales to gross sales or receipts from all
sources does not exceed fifty-five percent (55%).
The election of the gross income tax option shall be irrevocable for
three (3) consecutive taxable years during which the corporation is
qualified under the scheme.
Definition of Terms
a. Gross Income derived from business shall be equivalent to gross
sales returns, discounts and allowance and cost of goods.
b. Cost of goods sold shall include all business expenses directly
incurred to produce the merchandize to bring them to their present
location and use.
c. For trading and merchandising concern, Cost of goods sold shall
include the invoice cost of the goods sold, plus import duties freight in
transporting the goods to the place where the goods are actually sold,
including insurance while the goods are in transit.
d. For manufacturing concern, Cost of goods manufactured and sold
shall include all costs of production of finished goods, such as raw
materials used, direct labor and manufacturing overhead, freight cost,
insurance premiums and other costs incurred to bring the raw
materials to the factory or warehouse.
e. In sale of service, gross income means gross receipt less sales
returns, allowance and discounts.
(3.) Minimum Corporate Income Tax (MCIT) -> a tax rate of 2% is
imposed on the gross income of domestic corporations and resident
foreign corporations.
Rationale: MCIT is designed to forestall the prevailing practice of
corporation or over-claiming deductions in order to reduce their
income tax payments.

Requisites:
a. It is imposed beginning the fourth (4th) taxable year immediately
following the taxable yr. in which such corporation starts its
business operation.
b. It is imposable only if such corporation has zero or negative taxable
income or whenever the amount of MCIT is greater than the
Normal Corporate Income Tax (NCIT) due from such corporation.

Carry Forward of Excess Minimum Tax

-> any excess of the minimum corporate income tax (MCIT) over the
normal income tax shall be carried forward on an annual basis and
credited against the normal income tax for the three (3) immediately
succeeding taxable yrs.

Instances when MCIT may be suspended by the Secretary of Finance

40

-> The Sec. of Finance, upon recommendation of the Commissioner

may suspend the imposition of MCIT, upon showing that the
corporation suffers losses due to any of the following causes:
a. Prolonged labor dispute (e.g. strikes for more than 6 months)
b. Legitimate business reverses (e.g. theft)
c. Force majeure (e.g. war)
(4.) Final tax on certain Passive Income
-> refer to previous note

The following corporations are not subject to MCIT

(1.) Proprietary Educational Institution if enjoys preferential tax rate
(2.) Non-profit hospitals
(3.) Depository banks under expended FCDU
(4.) International carriers
(5.) Offshore Banking Units
(6.) ROHQs of resident foreign corp.
(7.) Other corporations not subject to the normal tax rate
B. Tax on Foreign Corporations (Sec. 28 of NIRC)
(1.) Resident Foreign Corporation Engaged in Trade or business in
the Phils. (RFC) - Foreign Corporation shall be taxed on income derived
from sources within the Philippines.
Tax Imposed on Resident Foreign Corporation (RFC)
(1.) NCIT -> 32% effective Jan. 01, 2000 and thereafter
(2.) Gross Income Tax Option -> 15% tax rate on gross income of RFC is also
applicable.
(3.) Minimum Corporate Income Tax (MCIT) -> 2% based on gross income is
also applicable
(4.) Tax on Branch Profits Remittances -> subject to 15% based on the total
profits applied or earmarked for remittance w/o any deduction
for the tax component thereof:
except :

Those activities registered w/ the PEZA; interests dividends, rents

and royalties; remuneration for technical services, salaries, and
wages; premiums, annuities, emoluments; capital gains, profit
and income.

(5.) Final tax on certain Passive Income - the same tax rates as imposed to
domestic corporation = is also applicable to RFC except: the imposition of
capital gain tax (6%) on sale of real property (capital asset) located in the
Phils.

A different tax rate is imposed on the following RFCs

(a.) Intl carrier -> 2 % on Gross Philippine Billing

Intl air carrier = Gross Philippine Billings refer to the amount of
gross revenue from (a) carriage of persons, excess baggage cargo and
mail originating from the Phils. in a (b) continuous and uninterrupted
flight, irrespective of the place of sale or issue and the place of payment
of the ticket or passage document.

41

Take note: For a flight w/c originates from the Phils. but transhipment of
passenger takes place at any port outside the Phils., only the aliquot
portion of the cost of the ticket corresponding to the leg flow from the
Phils. to the point of transhipment shall form part of the GPB.

In International shipping, Gross Phil. Billing means gross revenue

whether for passenger, cargo or mail originating from the Philippines up
to the final destination regardless of the place of sale or payments of
the passage or freight documents.

(b) Regional / Area Headquarters (RAHQs) -> tax exempt

-> These are branches established in the Phils. by a multinational
companies but they do not earn or derive income here and their
functions are limited to being a supervisory communication and
coordinating center for their affiliates.
(c.) Regional Operating Headquarters (ROHQs) -> subject to 10% tax.
-> these are branches established in the country by multinational
companies which are engaged in any of the following:
general administration & planning;
business planning
business development (and the like)
(d.)
Offshore Banking Units authorized by Bangko Sentral ng Pilipinas
EXCEPT: RA 9294.
(2.) Non-Resident Foreign Corporations (NRFCNETB) - are subject to 32%
tax rate (effective Jan. 1, 2000 and thereafter) on all income derived
from sources within the Phils. except on certain passive income
NRFCs are not entitled to deduction as well as exemption (personal and
additional exemption)

TAX SPARING RULE / CREDIT

- provides that a final withholding tax at the rate of 15% shall be
imposed for the amount of cash and /or property dividends received from
a domestic corporation by non-resident Foreign corporation subject to
the condition that the country in which the NRFC is domiciled shall allow
a credit against the tax due from NRFC taxes deemed to have been paid
in the Phils. equivalent to 17% which represents the difference between
the regular income tax rate of 32% and the usual corporate rate of 15%.

Take note:
Tax sparing credit applies only when the conditions for its availment are
clearly established by the taxpayer. Since the concession is in the
nature of a tax exemption.
The
15% reduced tax must actually be paid and the 17% must be
deemed paid tax.
The 15% tax on dividends is applicable if the country where the
recipient NREC is domiciled does not imposed any tax on dividend
received by said recipient foreign corporation (BIR Ruling, March 30,
1977)
Improperly accumulated earnings tax (IAET) (sec. 29 NIRC)

Nature and Purpose: The improperly accumulated earning tax of 10% in

addition to the regular corporate income tax shall apply to every
corporation formed or availed for the purpose of avoiding of any other

42

corporation by permitting earnings and profit to accumulate instead of

being divided or distributed.

The term Improperly accumulated taxable income means taxable

income adjusted by:
(1) Income exempt from tax
(2) Income excluded from gross income
(3) Income subject to final tax
(4) The amount of NOLCO deducted and reduced by the sum of:
a. Dividends actually or constructively paid and
b. Income tax paid for the Taxable year.

Formula:
Taxable income
add: Income exempt from tax
Income subject to final tax
Income excluded from gross income
Amount of NOLCO deducted
Less:
Dividends actually or constructively paid
Income tax paid for the yr.
Improperly accumulated Taxable
Income

Improperly Accumulated Earnings Tax does not apply to the following:

(1.) Banks and other non-banks financial intermediaries
(2.) Publicly held corporations
(3.) Insurance companies
Presumptions of Improper accumulations - There is a prima facie
evidence of a purpose by a corporation to avoid the tax upon its
shareholders or members:
(1)Where the corporation is a mere holding company.
(2)Where the corporation is an investment company where more than
50% of its outstanding stock is owned directly/ indirectly by one person
during the taxable year.
(3)Where the corporation permits its earnings or profits to be accumulated
beyond the reasonable needs of the business.
Reasonable needs of the business includes the reasonably anticipated
needs of the business e.g. investment of corporations profits in a
business related to taxpayers business.

Purpose: To compel the corporations to distribute dividends to the

stockholders (subject to dividend tax)

Instances of Reasonable Accumulations:

(1) It is retained for working capital needed by the business
(2) It is invested in addition to plant property and equipment reasonably by
the business
(3) In accordance with contract obligations, it is placed to the credit of a
sinking fund for the purposes of retiring bonds issued by the
corporation.

FROM TAXES ON CORPORATIONS (Sec. 30 of NIRC): The following shall not

be taxed in respect to income received by them:
(a.) Labor, agricultural or
principally for profit.

horticultural

organization

not

organized

43

(b.) Mutual savings bank not having a capital stock represented by shares
and cooperative banks w/o capital stock organized and operated for
mutual purposes and without profit.
(c.) A beneficiary society or association operating for exclusive benefit of
the members or a mutual aid association or non-stock corporation
organized by employees providing benefits exclusively to its members
or their dependents.
(d.) Cemetery company owned and operated for the exclusive benefits of
its member
(e.) Non-stock corporation or association organized and operated
exclusively for religious, scientific, athletic, or cultural purposes, or for
the rehabilitation of veterans, no part of it net income or asset shall
belong to or inure to the benefit of any member, organizer, or officer
or any specific person
(f.) Business league chamber of commerce, or board of trade not
organized for profit and no part of the net income of which inures to
the benefit of any private stockholder or individual
(g.) Civic league or association not organized for profit but operated
exclusively for the promotion of social welfare
(h.) A non-stock and non-profit educational institution.
NOTE: Refer to Article XIV Section 4(3), 1987 Constitution.
(i.) Farmers fruit growers or like organization organized and operated as
sales agent for the purpose of marketing the products of its member.
(j.) Farmers or other mutual typhoon or fire insurance company or like
organization of a purely local character, the income of which consists
solely of assessment, dues and fees collected from members for the
sole purpose of meeting its expenses.
(k.) Government educational institution
Income of whatever kind and character of the foregoing organizations
from any of their properties, real or personal or from any of their activities
conducted for profit regardless of the disposition made of such income
shall be subject to tax.
C. Tax on Partnership and Co-ownership
PARTNERSHIP is a contract whereby two or more persons bind themselves
to contribute money, property, or industry to a common fund with the
intention of dividing the profits among themselves.

Exemptions from taxes on corporations (Sec. 30 of NIRC): The

following shall not be taxed in respect to income received by them:
(a.) Labor, agricultural or horticultural organization not organized
principally for profit.
(b.) Mutual savings bank not having a capital stock represented by shares
and cooperative banks w/o capital stock organized and operated for
mutual purposes and without profit.
(c.) A beneficiary society or association operating for exclusive benefit of
the members or a mutual aid association or non-stock corporation
organized by employees providing benefits exclusively to its members
or their dependents.
(d.) Cemetery company owned and operated for the exclusive benefits of
its member
(e.) Non-stock corporation or association organized and operated
exclusively for religious, scientific, athletic, or cultural purposes, or for
the rehabilitation of veterans, no part of it net income or asset shall
belong to or inure to the benefit of any member, organizer, or officer
or any specific person

44

(f.) Business league chamber of commerce, or board of trade not

organized for profit and no part of the net income of which inures to
the benefit of any private stockholder or individual
(g.) Civic league or association not organized for profit but operated
exclusively for the promotion of social welfare
(h.) A non-stock and non-profit educational institution.
NOTE: Refer to Article XIV Section 4(3), 1987 Constitution.
(i.) Farmers fruit growers or like organization organized and operated as
sales agent for the purpose of marketing the products of its member.
(j.) Farmers or other mutual typhoon or fire insurance company or like
organization of a purely local character, the income of which consists
solely of assessment, dues and fees collected from members for the
sole purpose of meeting its expenses.
(k.) Government educational institution
Income of whatever kind and character of the foregoing organizations
from any of their properties, real or personal or from any of their activities
conducted for profit regardless of the disposition made of such income
shall be subject to tax.
Partnership not subject to income tax, which include the following;
a. General Professional partnership
b. Joint venture or consortium agreement formed for the purpose of
undertaking
construction projects or
engaging in petroleum, coal, geothermal and other energy
operations pursuant to an operating or consortium agreement
under a service contract with the government. Partnership
subject to income tax / Business Partnership
-> All other partnership except GPP and Joint Venture, no matter
how created or organized are considered corporation subject to
corporate income tax.

BIR RULING No. 162 June 11, 1987

A partners contribution of real property to the partnership fund is not
subject to income tax.

CO-OWNERSHIP is created whenever the ownership of an undivided thing or

right belongs to different persons.
GEN. RULE: Co-ownership is exempt from income tax because the activities of
the co-owners are usually limited to the preservation of the properties
owned in common and the collection of the income therefrom.
EXCEPTIONS: (When co-ownership is subject to tax).
(1) When the income of the co-ownership is invested by the co-owners in
other income-producing properties or income-producing activities, and
(2) When there is no attempt to divide inherited property for more than ten
(10) years and the said property was not under any administration
proceedings nor held in trust, an unregistered partnership is deemed to
exist.
Tax liability of co-owners -> The co-owners in exempt co-ownership
shall be viable for income tax only in their separate and individual
capacity.
Filing of return -> The owners shall report and include in their
respective personal income tax returns their shares of the net income
of the co-ownership.

45

4. Tax on Estates and Trusts (sec. 60. NIRC)

Estate is the mass of property, rights and obligations left behind by the
decedent upon his death.
Estates may be classified as follows:
1. Estates not under judicial settlement - are subject to income tax
generally as mere co-ownership.
- The tax liability on income of the co-ownership levied directly on the
co-owners. Thus, the heirs shall include in their respective returns their
distributive shares of the net income of the estate.
2. Estates under judicial settlement - are subject to income tax in
the same manner as individual.
- Income received during the settlement of the estate is taxable to the
fiduciary (guardian, executor, trustee, and administrator).
- The return should be filed by executor or administrator of the trust.
Trust is an arrangement created by will or co-agreement under which title to
property is passed to another for conservation or investment with the income
therefrom and ultimately the corpus (principal) to be distributed in
accordance with the directions of the creator as expressed in the governing
instrument.
2 Kinds of Trust :
1. Irrevocable Trust -> is considered as a separate taxpayer.
2. Revocable Trust -> is one where at anytime the power to revest the
title to any part of the corpus of the trust is vested:
(a.) in the grantor (creator of the trust) either alone or in conjunction with
any person not having a substantial adverse interest in the disposition
of such part of the corpus or the income therefrom; or
(b.) in any person not having a substantial adverse interest in the
disposition of such part of the corpus or the income therefrom.
NOTE: The tax shall be imposed on taxable income of the grantor.
Various trusts subject to income tax.
(1.) Trust where income is accumulated for the benefit of certain or
uncertain persons or persons with contingent interest.
(2.) Trust where income is accumulated or held for future distribution
under the terms of the will or trust.
(3.) Trust where income is to be distributed currently by the fiduciary to
the beneficiaries.
(4.) Trust where income collected by a guardian of an infant is held or
distributed as the court may direct.
(5.) Trust where income in the discretion of the fiduciary may be either
distributed to the beneficiaries or accumulated.
Exempt Trust - The tax imposed on estate and trust does not apply to
EMPLOYERS TRUST provided that the following conditions are satisfied:
(1.) The employees trust forms part of a pensions, stocks, bonus or profit
sharing plan of an employer for the benefit of some or all of its
employees.
(2.) Contributions are made to the trust by such employer, or employees,
or both for the purpose of distributing to such employees the earnings

46

and principal of the trust and accumulated by the trust in accordance

with such plan.
(3.) No part of the corpus or income shall be used for or diverted to,
purpose other than for the exclusive benefit of his employees.
Consolidation of income in trusts
(1.) If there are two or more trusts created
(2.) The same are created by the same person (grantor)
(3.) and the beneficiary of such is the same person in each instance.
Take note: Rules applicable in the computation of the tax on estates and
trusts:
(1.) The same rules in the determination of gross income for individuals
are applicable.
(2.) The same deductions allowed to an individual taxpayer are also
allowed, in addition of the following deductions:
(a.) amount of its income which is to be distributed currently to the
beneficiaries, and
(b.) Amounts of its income for the taxable year which is properly
paid or credited during such year to any heir, legatee, or
beneficiary, but the amount so allowed as a deduction shall be
included in computing the taxable income of the heir, legatee,
or beneficiary.
(3.) Personal Exemption of P20k is also applicable
(4.) The graduated rates of tax used for individuals taxpayers are also
applicable

The deductions mentioned are not available to TRUSTS administered in

foreign country.

G. SOURCES OF INCOME
1. Services / compensation
- all kind of compensation for services rendered as a result of
employer-employee relationship.
- It includes;
a. salaries, wages, fees, allowances;
b. commissions paid to salesperson or those paid in insurance
premium;
c. compensation paid for services on the basis of percentage on
profits;
d. honoraria, directors fee;
e. bonuses, tips;
f. allowance for transportation, representation or entertainment;
g. pensions or retiring allowance paid by private persons or by the
government;
h. amount receive from refraining from rendering services
i. Christmas gift based upon fixed percentile of salaries given to
employees during holidays
j. Amount receive as an special award for special services
k. Prize won in competitive contest conducted for non commercial or
commercial purposes
l. Proceeds from profit sharing and other benefit received in cash or in
kind.
To be taxable the requisites are:

47

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

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

Tips or gratuities paid directly to an employee by a customer of the

employer which is not accounted for by the employee to the employer
are considered taxable income.
1. Compensation for services in whatever form paid, including but
not limited to;
a. Salaries refer to earnings received periodically for regular work
other than manual labor.
b. Wages are earnings received usually according to specified
intervals of work, as by the hour, day or week.
c. Fees - amount received by an employee for the services
rendered to the employer.
d. Commission refers to percentage of total or a certain quota of
sales volume attained as part of incentives, such a sales
commission.
e. Similar items like pension or retiring allowance.

A pension awarded to a person where no services have been

rendered are mere gifts or gratuities and not taxable as income.
They are subject to donors tax payable by the donee.
Compensation for personal services is taxable when:
a. Income for services rendered is taxable in the year of receipt.
(cash basis)
b. Cash, property or services earned during the taxable year though
not actually received are deemed to have accrued to the taxpayer
and are classified as income (accrual basis).
Forms of Compensation
a. money
b. in kind
Compensation paid to an employee of a corporation in its
stock is to be treated as if the corporation sold the stock for
its market value and paid to the employee in cash.
Living quarters furnished to the employee in addition to cash
salary. The rental value should be reported as income.
Meals given to employee, the value thereof substitutes
income.
CONVENIENCE OF THE EMPLOYER RULE
- The allowances furnished to the employee which are for the
convenience and advantage of the employer or for proper
performance of the employees duty, shall not be taxable on
the part of the employee receiving the same.
- REQUISITES:
a. They must be furnished within the employer business
premises.
b. The employer accepts the same as a condition of his
employment
--- Promissory notes or other evidence of indebtedness received in
payment of services are considered as income to the extent of their fair
market value.

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--- An individual who performs services for a creditor, who in

consideration thereof cancels his debt, income to that amount is realized by
the debtor as compensation for his services. However, if the creditor
condones /cancels the debt without any service rendered by the debtor, the
amount of such debt is a gift and need not be included in the gross income of
the debtor. The amount is subjects to donors tax.
c. Both in money and in kind.
2. Interest income
refers to the compensation for the use of money or forbearance for its
used or arising from indebtedness.
- An earning derived from depositing or lending of money, goods or credits.
GENERAL RULE: Interest received by a taxpayer, whether usurious or not, is
subject to income tax.
EXCEPT: When interest income is exempted by law from income tax.
- Central bank circular No. 416, dated July 29 1974, increased and fixed
the legal rate of interest at 12% per annum applicable to loans or
forbearance of money, goods or credit and court judgment thereon
pursuant to the Usury law. Later on December 10, 1982, it amended
its previous Circular and directed that rate of interest including
commissions, premiums, fees and other charges, on loan or
forbearance of money, goods or credit Regardless of their maturity
and whether secured or unsecured that may be collected by any
person, whether natural or juridical shall not be subject to any ceiling
prescribed under the Usury Law, as amended. However, the 6% legal
rate of interest under the Civil Code remained valid and still applies
to other kind of monetary judgment which has nothing to do with
loans or forbearance of money, goods or credits.
- Interest may refer, also to interest income from peso bank deposit
which is subject to final tax of 20%. However, this interest income is
not included to the gross income but, together with other withholding
taxes, it is deductible form the tax due to arrive at the amount still
payable or refundable, as the case may be. ( NDC vs. CIR 151 SCRA
472)

Contractors tax is a tax imposed upon the privilege of engaging

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

3. Dividends
- Means any distributions made by a stock corporation to its stockholders
out of its earnings or profits and payable to its stockholders in money or
other property.
- a corporate profit set aside, declared and ordered by the Board of
Directors to be paid to the Stockholders on demand or at a fixed time. It
may be classified into:
1.
2.
3.
4.

Cash dividend
property dividend
stock dividend
liquidating dividend

49

5. script dividend
6. other dividend indirectly paid
NON TAXABLE INTER CORPORATE PRINCIPLE
Dividends from the domestic/resident corporations and shares in
profits of taxable partnerships received by domestic/resident corp.
are exempt from income tax.
Sources of dividends payment: Every dividend declared by a
corporation is presumed to come from the most recently
accumulated profit.
Taxable dividends include the following:
(a) Cash Dividend a dividend paid in cash and is taxable to the
extent of the cash received.
(b)Liquidating dividend a dividend distributed to the SHs
upon dissolution of the corporation.
(c) Scrip Dividend issued in a form of promissory note and it is
taxable in its Fair Market Value.
(d)Indirect dividend when a corporation forgives the
indebtedness of its stockholders, the transaction has the
effect of payment of dividend to the extent of the amount of
the debt.
(e) Property dividend a dividend paid in property of a
corporation such as stock investment, bands or securities held
by the corporation and to the extent of the FMV of the
property received at the time of the distribution.
(f) Stock Dividend Involves the transfer of a portion of
retained earnings to capital stock by action of stockholders. It
simply means the capitalization of retained earnings.
GENERAL RULE: A mere issuance of stock dividends is not subject to income
tax, because it merely represents capital and it does not constitute income to
its recipient. Before disposition thereof, stock dividends are nothing but a
representation of interest in the corporate entity.
EXCEPTIONS: When stock dividends are subject to tax:
a.) These shares are later redeemed for a consideration by the
corporation or otherwise conveyed by the stockholder to the extent
of such contribution. Under the NIRC, if a corporation, after the
distribution of a non-taxable stock dividend, proceeds to cancel or
redeem its stock at such time and in such manner as to make the
distribution and cancellation or redemption essentially equivalent
to the distribution of a tax of a taxable dividend, the amount
received in redemption or cancellation of the stock shall be treated
as a taxable dividend to the extent that it represents a distribution
of earnings or profits. (Sec.73 (B), NIRC). Depending on the
circumstances, corporate earnings may be distributed under the
guise of initial capitalization by declaring the stock dividends
previously issued and later redeem or cancel said dividends by
paying cash to the stockholder. This process amounts to
distribution of taxable dividends which is just delayed so as to
escape the tax. (CIR vs. CA, 301 SCRA 152)
b.) The recipient is other than the stockholder. (Bachrach vs. Seifert,
57 PHIL 483)
c.) A change in the stockholders equity results by virtue of the stock
dividend issuance.
Stock dividend is classified into:

50

(1). Non taxable is one where the new shares confer the same rights
and interest as the old share. There is no change in the corporate
identity.
After the distribution thereof, there is no change in the
proportionate interest of SHs.
(2). Taxable Stock dividend is one where there either has been a change
of corporate identity or a change in the nature of the shares, where the
proportionate interest of the SHs changes.

Under the corp. code, stock dividend being one payable in

capital stock, cannot be declared out of outstanding capital stock
but from retained earnings of the corporation.

Where corporate earnings are used to purchase

outstanding stocks treated as treasury stock (stocks issued and
fully paid for and subsequently reacquired by the corporation of
purchase, redemption or through same other means) as a
technical but prohibited device, to avoid the effects of income
taxation, distribution of said corporate earnings in the form of
stock dividend will subject SHs receiving them to income tax. The
corporation parting with a portion of its earnings to buy the
outstanding stock is in ultimate effect and result making a
distribution of such earnings to the stockholders. (Commissioner
vs. Manning, 66 SCRA 14)
4. Gains derived from dealings in property
refers to the income derived from the sale and or exchange of assets,
which result in gain because of the excess of the amount of value
received by the taxpayer.
GENERAL RULE: The entire amount of the gain or loss arising from the
transaction shall be taxable or deductible, or the case may be.
Note: (Gross Income from sources within the Philippines)
* Gains, profits, and income from the sale of real property located in the
Phils. and
* Gains, profits, and income from sale of personal property, treated as
derived entirely from the country where it is sold.
Exception to the rule: gain from the sale of shares of stock in a
domestic corporation which is treated as derived entirely from sources
within the Phils. regardless of where the shares are sold.
Passage of title test: it is the prevailing view that in ascertaining the
place of sale, the determination of where and when the title to the
goods passes from the seller to the buyer is decisive.
5. Royalty Income
these are the compensations or payments for the use of property and are
paid to the owner of a right.
6. Rental Income
refers to earning derived from leasing real estate as well as personal
property. It includes all other obligations assumed to be paid by the lessee
to the third party in behalf of the lessor.
Taxes paid by the tenant (lessee) to or for a lessor for a business
property are additional rent and constitute income taxable to the
lessor.

Advanced rentals:

51

(a). if the advanced rental is a Security Deposit which restricts the

lessor as to its use -- such amount shall be excluded in the
determination of rental income.
(b). If the advance rental is Prepaid Rental received without
restriction as to its use the entire amount is taxable in the year
it is received.
Permanent improvements made by the lessee on leased
property.
When the lessee makes improvements on the leased property
and the said improvements will belong to the lessor upon the
expiration of the lease contract, the lessor may report the income
there from upon either by the following methods:
(a). Outright method the lessor will report as income the FMV
(fair market value) of the improvements on the year of completion.
(b). Spread out method the lessor may spread over the life of
the lease the estimated depreciated value of such improvements at
the termination of the lease and report as income of each year of
the lease an aliquot part theory.

Income resulting from pre mature termination of the lease

contract.
RULES:
1. If the improvement is destroyed before the termination of the
lease contract -- the lessor is entitled to deduct as a loss for
the year when such destruction takes place the amount
previously reported as income.
2. If the lease is terminated prior to the expiration of the lease
contract for any reason, other than a bonafide sale to the
lessor the lessor received additional income for the year
the value of the improvements exceed the amount of income
already reported.

Income of corporation from leased property. Where the property

of a corporation is leased to the lessee in consideration that the
latter shall pay in lieu of rental an amount equivalent to a certain
rate of dividend on the lessors capital stock; it shall be
considered as;
(a). Rentals (income) to lessee and lessor (income to the
corp.)
(b). Dividend from the lessor corporation as far as the
shareholders are concerned.

Rent and royalties

- rent is the consideration for the use of property, real or personal paid
by the lessee to a lessor through a contract of lease by which the latter
temporarily grants the enjoyment of certain property to the former who
undertakes to pay rent or a price certain thereof, for which contract to
last for a definite on indefinite period, but in no case to exceed 99
years.
- Royalties on the other hand, are payment for the use of property which
includes earning from copy right, trademarks, patents, and natural
resources under a lease. Royalties are subject to final tax as follows:
a. 10% for books, literary works and musical composition;
b. 20% for the use of other property.

52

DETERMINATION OF GROSS INCOME AND THE RULES ON

INCLUSIONAND EXCLUSION FROM GROSS INCOME
A. The Concept of Gross Income
a. Gross Income, definition
- means all income derived during a taxable year by a taxpayer
from whatever source, whether legal or illegal.

The term derived from whatever source implies the inclusion of

all income under the law, irrespective of the voluntary or
involuntary action of the taxpayer in producing the gains.
It includes illegal gains arising from gambling, betting, lotteries
extortion and fraud.
b. Gross Income v. Gross Sales/ Receipts
Where gross income pertains to all income during a taxable
year derived from whatever source, gross sales or gross
receipts, however, refers to the total invoice value of sales, before
deducting for customer discounts, allowances, or returns. Gross
Income derived from business shall be equivalent to gross sales
returns, discounts and allowance and cost of goods.

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

a. Taxable Income, Definition (sec 31)
means the pertinent items of gross income less the deductions
and/or personal and additional exemptions, if any, authorized for such
types of income by the NIRC or other special laws
b. Inclusions (sec 32A)
Items included in the determination of Gross Income, but not
limited to the following; (C - G2IR2P3AD)
1. Compensation for services in whatever form paid, including but
not limited to;
a. Salaries refer to earnings received periodically for regular
work other than manual labor.
b. Wages are earnings received usually according to specified
intervals of work, as by the hour, day or week.
c. Fees - amount received by an employee for the services
rendered to the employer.
d. Commission refers to percentage of total or a certain quota
of sales volume attained as part of incentives, such a sales
commission.

53

e. Similar items like pension or retiring allowance.

2. Gross income derived from the conduct of trade, business or the
exercise of a profession.
3. Gains derived from dealings in property refers to the income
derived from the sale and or exchange of assets, which result in gain
because of the excess of the amount of value received by the taxpayer.
4. Royalty Income these are the compensations or payments for
the use of property and are paid to the owner of a right.
5. Rental Income refers to earning derived from leasing real estate
as well as personal property. It includes all other obligations
assumed to be paid by the lessee to the third party in behalf of
the lessor.
6. Interest Income - an earning derived from depositing or lending of
money, goods or credits.
GENRULE: Interest received by a taxpayer, whether usurious or
not, is subject to income tax.
EXCEPT: When interest income is exempted by law from income
tax.
7. Prizes and winnings
8. Pension -refers to allowance paid regularly to a person on his
retirement or to his dependents on his death, in consideration of
past services, meritorious work, age, loss or injury.
9. Partners distributive profits from the net income of a General
Professional Partnership.
NOTE: Gen. Professional Partnership - is created by a group of
individuals for the purpose of exercising their common profession.
E. g. Law firm
10. Annuities - amount payable yearly or at other regular intervals
for a certain or uncertain period ; they also represent as
installment payments for life insurance sold by insurance
companies.

If the part of annuity payments represent interest = taxable

income.
If the annuity is a mere return of premium = not taxable.
11. Dividends - Means any distributions made by a stock corporation
to its SHs (stockholders) out of its earnings or profits and
payable to its SHs in money or other property.

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

1). Life Insurance Proceed
The proceeds of life insurance policies paid to the heirs or
beneficiaries upon the death of the insured, whether in a single
sum or otherwise.

54

Reason for exclusion: The contract of insurance is a contract

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

Instances when proceeds from insurance are taxable:

a.) Where proceeds are held by the insurer under an
agreement to pay interest. The interest is included in
determination of gross income.
b.) Where the transfer is for valuable consideration.

2.) Amount Received by Insured as Return of Premium

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

Reason for the exclusion: The return of premium is a mere

return of capital. However, where the included in the gross
amount received exceed the aggregate premiums paid, the
excess shall be income.

3.) Gift, Bequests, and Devises

The value of the property acquired by gift, devise, or descent
shall be excluded. However, the income from such property, as
well as gift, bequest, devise, or descent of income from property,
in cases of transfers of divided interest, shall be included in gross
income.
4). Income Exempt under Treaty
Income of any kind, to the extent required by any treaty
obligation binding upon the Government of the Philippines.
5.) Compensation for Injuries or Sickness
Amounts received, through Accident or Health Insurance or
under Workmens Compensation Acts, as compensation for
personal injuries or sickness, plus the amounts of any damages
received, whether by suit or agreement, on the account of such
injuries or sickness.
Example of damages recovered from personal injuries: Moral
damages for personal injuries.
If the award of damages is to compensate loss of property or
an award of damages to compensate loss of income / profits,
such is subject to tax.
6.) Retirement Benefits, Pension, Gratuities, etc.
7.) Miscellaneous Items
a.)
Income derived by Foreign Government Income derived
from investments in the Philippines in loans, stocks, bonds or
other domestic securities or from interest on deposits in banks in
the Philippines by:
(i) Foreign governments,
(ii) Financing institutions owned, controlled or enjoying
refinancing from foreign governments, and
(iii) International or regional financial institutions established by
foreign governments.
b.)
Income derived by the Government or its Political
Subdivision Income derived from any public utility or from the

55

exercise of any essential governmental function accruing to the

Government of the Philippines or to any political subdivision
thereof.
c.) Prizes and Award - Prizes and award to be excluded, the
following conditions must concur;
(1) Prizes and award made primarily in recognition of
religious, charitable, scientific, educational, artistic,
literary, or civic achievement.
(2) The recipient was selected without any action on his part
to enter the contest or proceeding.
(3) The recipient is not required to render substantial future
services as a condition in receiving the award.
d.) Prizes and Award in Sports Competition - All prizes and award
granted to athletes in local and international sports competitions
and tournaments whether held in the Phils. Or abroad and
sanctioned by sports associations.
e.) 13th Month Pay and Other Benefits shall not exceed P30k.

The

total

exclusion

f.) GSIS, SSS, Medicare and Other Contributions

g.) Gains from the Sale of Bonds, Debentures or other Certificates
of Indebtedness with maturity of more than five (5) years.
h.) Gains from Redemption of Shares in Mutual Fund.
C. The Rules as Applied to
Benefits

Compensation Income and Other

1) Taxability of Compensation Income and the Application of the

Employers Convenience Rule

Compensation Income, defined

- all kinds of compensation for services rendered as a result of an
employer-employee relationship. They include:
a. salaries, wages, fees, allowances;
b. commissions paid to salespersons or those paid on
insurance premiums;
c. compensation for services on the basis of a percentage of
profits;
d. honoraria, directors fees;
e. bonuses, tips;
f. allowances
for
transportation,
representation
and
entertainment;
g. pensions or retiring allowances paid by private persons or
by the government (excepts pensions exempt by law from
tax)
h. amounts received for refraining from rendering services
(also constitute taxable income)
i. Christmas gifts based upon fixed percentile of salaries
given to employees during the holidays;
j. amounts received as award for special services or for
suggestions to employer or for the prevention of
theft/robbery
k. prizes won in competitive contests conducted for
commercial or non-commercial purposes

56

l. proceeds from profit sharing and other benefits paid in

cash or in kind.

Forms of Compensation
a. money
b. in kind
Compensation paid to an employee of a corporation in its
stock is to be treated as if the corporation sold the stock for
its market value and paid to the employee in cash.
Living quarters furnished to the employee in addition to cash
salary. The rental value should be reported as income.
Meals given to employee, the value thereof substitutes
income.
EMPLOYERS CONVENIENCE RULE
The allowances furnished to the employee which are for
the convenience and advantage of the employer or for proper
performance of the employees duty, shall not be taxable on the
part of the employee receiving the same.
REQUISITES:
a. They must be furnished within the employer business permit.
b. The employer accepts the same as a condition of his
employment
--- Promissory notes or other evidence of indebtedness received
in payment of services are considered as income to the extent of
their fair market value.
--- An individual who performs services for a creditor, who in
consideration thereof cancels his debt, income to that amount is
realized by the debtor as compensation for his services.
However, if the creditor condones /cancels the debt without any
service rendered by the debtor, the amount of such debt is a gift
and need not be included in the gross income of the debtor. The
amount is subjects to donors tax.
c. Both in money and in kind.
2) Retirement Payments, Pensions and Gratuities
Retirements benefits received under RA 7641 and those received
by officials and employees of private firms in accordance with
reasonable PRIVATE BENEFIT PLAN.
Requisites:
(1.) The retiring official or employees has been in service of the
same employer for at least ten years.
(2.) Is not less than 50 yrs. of age at the time of his retirement.
(3.) And is available to official or employee only once.
Private retirement benefit plan
A reasonable private benefit plan means a pension;
gratuity, stock bonus or profit sharing plan maintained by an
employer for the benefit of some or all of his employees
a.) wherein contributions are made by such employer or
employees, or both, for the purpose of distributing to such
employer the earnings and principal of the fund thus
accumulated; and

57

b.) wherein said plan provides that at no time shall any part of
the principal or income of the fund be used for, or be diverted to,
any purpose other than for the exclusive benefit of said
employee
3) Separation Payments
Any amount received by an official or employees or by his heirs
from the employer as a consequence of separation from service
due to death, sickness or other physical disability beyond the
control of the said official or employer.
4) Leave Benefits
The terminal leave pay of government employees whose
employment is co-terminus is exempt since it falls within the
meaning of the phrase for any cause beyond the control of the said
official or employees (BIR Ruling 143-98)
5) 13th Month Pay and other Bonuses
13th month pay equivalent to the mandatory one (1) month basic
salary of officials and employees (national or local), including GOCC,
and of private offices received after the 12th month ay beginning
1994 and similar benefits, provided the total amount is P30k and
below, likewise exempt from withholding tax but any amount in
excess thereto shall be taxable and also subject to withholding tax
6) SSS/GSIS/other contributions (Phil-Health/Pag-ibig) and
Union Dues
7) Fringe Benefits (Sec 33)
Fringe benefit, defined
means any good, service or other benefit furnished or
granted in cash or in kind by an employer to an individual
employee (except rank-and-file employees) such as but not
limited to the following:
1. housing;
2. expense account;
3. vehicle of any kind;
4. household personnel, such as maid, driver and
others;
5. interest on loan at less than market rate to the
extent of the difference between the market rate and
actual rate granted;
6. membership fees, dues and other expenses borne by
the employer for the employee in social and athletic
clubs or other similar organizations;
7. expenses for foreign travel;
8. holiday and vacation expenses;
9. educational assistance to the employee or his
dependents;
10.
life or health insurance and other non-life
insurance premiums or similar amounts in excess of
what the law allows.

Pursuant to Revenue Regulations No. 3 98 (dated May 21,

1998) implementing section 33 of the Tax Code, the special
treatment of fringe benefits shall be applied to fringe benefits
given or furnished to managerial or supervising employees and
not to the rank and file.

58

Rank and file means all employees who are holding neither
managerial nor supervisory.
Managerial Employee is one who is vested with powers or
prerogatives to lay down and execute management policies and/or
to hire, transfer, lay off, recall, discharge, assign, or discipline
employees.
Supervisory Employees are those who, in the interest of the
employer, effectively recommend such managerial actions if the
exercise of such authority is not merely routinely or clerical in
nature but requires the use of independent judgment.
The regulation does not cover those benefits properly forming part
of compensation income subject to withholding tax.
Fringe Benefit Tax (FBT) refers to monetary burden imposed
on any good, services or other benefits furnished or granted by an
employer, in cash or in kind, in addition to basic salaries, to an
individual employee, except rank and file employee.
VALUATION OF THE FRINGE BENEFITS

Fringe Benefit (forms)

Value of Fringe Benefits
1). Money
The value is the amount received
2). Property with owner ship transferred Fair market value of the property
to the employee.
3). Property w/o transfer of ownership
Depreciation value of the property
D. The Rules as Applied to Trade/Business or Professional Income
(a). Determination of gross income in case of manufacturing,
merchandising or mining business.
Formula: Gross Income =
sold) + other income

(Gross Sales cost of goods

(b). Income from a long term contract long term contract means
building, installation and construction contract covering a period in
excess of one year.
NOTE: any income derived from these contracts shall be
reported upon the basis of Percentage of Completion.
(c). Income from farming may be reported in any of the following
methods:
(1). Cash basis no inventory is used in determining profits.
(2). Accrual basis an inventory is used in determining profits.
(3). Crop basis it is generally used when the farmer is engaged
in producing crops which take more than a year to gather and
dispose of from the time of planting.
E. The Rules as Applied to Passive Income
a.Royalties, Prizes and Winnings
Royalties
Royalties are subject to 20% final withholding tax
Royalties on publication of books, literary works, musical
composition are subject to 10% final withholding tax
Prizes and winnings

59

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

taxable.
Prizes and winnings are subject to 20% final tax.
Provided; 1. more than P10k
2.won in the Philippines
Where the amount of prizes or winning is P10k or less
subject to schedular rate.
b.Interest Income from Bank Deposits and Deposit
Substitutes
Savings deposits
- subject to 20% final withholding tax
Time deposits
- longer than 5 years exempt from final withholding tax
- if pre-terminate, subject to final withholding tax
4 years less than 5 years
5%
3 years less than 4 years
12%
Less than 3 years
20%

Foreign currency deposits

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

c. Dividends
Cash dividends are subject to 10% final withholding tax
other kinds of dividends are not subject to final withholding
tax
NON TAXABLE INTER CORPORATE PRINCIPLE
Dividends from the domestic corporation and shares in
profits of taxable partnerships received by domestic corp. are
exempt from income tax.
Sources of dividends payment: Every dividend declared by
a corporation is presumed to come from the most recently
accumulated profit.
Taxable dividends include the following:
i)
Cash Dividend a dividend paid in cash and is
taxable to the extent of the cash received.
ii)
Liquidating dividend a dividend distributed to the
SHs upon dissolution of the corporation.
iii) Scrip Dividend issued in a form of promissory note
and it is taxable in its FMV
iv) Indirect dividend when a corporation forgives the
indebtedness of its stockholders, the transaction has the
effect of payment of dividend to the extent of the amount
of the debt.
v)
Property dividenda dividend paid in property of a
corporation such as stock investment, bands or securities
held by the corporation and to the extent of the FMV of
the property received at the time of the distribution.
vi) Stock Dividend -- Involves the transfer of a portion of
retained earnings to capital stock by action of
stockholders. It simply means the capitalization of
retained earnings.
GENRULE: A mere issuance of stock dividends is not subject to
income tax, because it merely represents capital and it does not

60

constitute income to its recipient. Before disposition thereof,

stock dividends are nothing but a representation of interest in
the corporate entity.

EXCEPTIONS: When stock dividends are subject to tax;

1. These shares are later redeemed for a consideration by the
corporation or otherwise conveyed by the stockholder to the
extent of such contribution. Under the NIRC, if a corporation,
after the distribution of a non-taxable stock dividend,
proceeds to cancel or redeem its stock at such time and in
such manner as to make the distribution and cancellation or
redemption essentially equivalent to the distribution of a tax
of a taxable dividend, the amount received in redemption or
cancellation of the stock shall be treated as a taxable
dividend to the extent that it represents a distribution of
earnings or profits. (Sec.73 (B), NIRC). Depending on the
circumstances, corporate earnings may be distributed under
the guise of initial capitalization by declaring the stock
dividends previously issued and later redeem or cancel said
dividends by paying cash to the stockholder. This process
amounts to distribution of taxable dividends which is just
delayed so as to escape the tax. (CIR vs. CA, 301 SCRA 152)
2. The recipient is other than the stockholder. (Bachrach vs.
Seifert, 57 PHIL 483)
3. A change in the stockholders equity results by virtue of the
stock dividend issuance.
Stock dividend is classified into;
(1). Non taxable is one where the new
shares confer the same rights and interest as the old share.
There is no change in the corporate identity. After the
distribution thereof, there is no change in the proportionate
interest of SHs.
(2). Taxable Stock dividend is one where
there either has been a change of corporate identity or a
change in the nature of the shares, where the proportionate
interest of the SHs changes.
Under the corp. code, stock dividend being one payable in
capital stock, cannot be declared out of outstanding capital stock
but from retained earnings of the corporation.
Where corporate earnings are used to purchase
outstanding stocks treated as treasury stock (stocks issued and
fully paid for and subsequently reacquired by the corporation of
purchase, redemption or through same other means) as a
technical but prohibited device, to avoid the effects of income
taxation, distribution of said corporate earnings in the form of
stock dividend will subject SHs receiving them to income tax. The
corporation parting with a portion of its earnings to buy the
outstanding stock is in ultimate effect and result making a
distribution of such earnings to the stockholders. (Commissioner
vs. Manning, 66 SCRA 14)
4. Sale of Real Property Classified as Capital Asset
- subject to 6% final withholding tax

61

5. Sale of Shares of Stocks Not Listed nor Traded in the Stock

Exchange (based on gain)
P100k and below
5%
More than P100k
10%
F. The Rules as Applied to Other Sources of Income
(a) Cancellation of Indebtedness
(b)Income from Lease and Leasehold Improvements
(c) Income from Installment Transactions
As a general rule, the whole profit accruing from a sale of
property is taxable as income in the year the sale is made.
But, if not all of the sale price is received during such year,
and a statute provides that income shall be taxable in the
year in which it is "received," the profit from an installment
sale is to be apportioned between or among the years in
which such instalments are paid and received. (Banas vs. CA,
G.R. No. 102967, February 10, 2000)
(d)Income from Long-Term Construction Projects
G. Exclusions by Reason of Special Laws
a. Prizes received by winners in charity horse race sweepstakes from
PCSO.
b. Back pay benefits
c. Income of cooperative marketing association
d. Salaries and stipends in dollars received by non Filipino citizens
on the technical staff of IRRI (International Rice Research Institutes).
e. Supplemental allowances per diem, benefits received by officer or
employees of the Foreign Service.
f. Income from bonds and securities for sale in the international
market.
DEDUCTIONS FROM GROSS INCOME
A. The Concept of Allowable Deductions
a. DEDUCTIONS, defined
These are items that are originally part and must be
included in the taxpayers gross income but are allowed to
be subtracted therefrom to determine the net income.
b. DEDUCTIONS vs. EXCLUSIONS
DEDUCTIONS
1. Deductions are disbursements,
expenses or losses that the law
allows to reduce gross income.
They represent generally, though
not
exclusively
expenditures,
other
than
the
capital
expenditures, connected with the
production of income.

EXCLUSIONS (Non-taxable items)

1. These are certain items which
could be properly taxed as income
yet the law specifically exclude
then from taxation either on the
basis of public consideration or
from
the
fact
that
the
transmutation of economic gain is
not essentially the result of labor
and efforts of the taxpayer.
2. The allowable deductions from 2. They are not included in the
gross income are limited to those income
tax
return
unless
that are related to the taxpayers information regarding them is

62

business or profession; the only specifically called for.

exceptions are a.) charitable
contributions and b.) some kinds
of losses.
3. Taxpayers who are taxed only 3. It may be availed of by all kinds
for
net
income
within
the of taxpayers.
Philippines (NRAEBI and RFC) can
only claim deductions incurred in
carrying on such business in the
Philippines.
c. DEDUCTIONS WHEN ALLOWED
Deductions are matters of legislative grace. A taxpayer can
only deduct an item or amount from gross income if there
is a law authorizing such a deduction. The taxpayer must
be able to point to the specific provision of the statute
authorizing such deduction and that he must be able to
prove that he is entitled to it.
These allowable deductions can be availed of only if it is
shown that the tax required to be deducted and withheld
therefrom has been paid to the BIR (Rev. Reg. No. 2, April
17, 1998)
d. DEDUCTIONS vs. TAX CREDIT
1.
Tax credit it is the right of an income taxpayer to
deduct from income tax payable the foreign income tax he
has paid to his foreign country subject t limitations.
- Subtracted from the tax itself
- It reduces the taxpayers liability dollar for dollar.
Deductions subtracted from the gross income before
the tax is computed
- It reduces the taxable income upon which the tax
liability is calculated.
CASES:
i. CIR vs. Central Luzon Drug Corp., April 15, 2005
A tax credit differs from a tax deduction. On the one
hand, a tax credit reduces the tax due, including
whenever applicable the income tax that is
determined after applying the corresponding tax rates
to taxable income. A tax deduction, on the other,
reduces the income that is subject to tax in order to
arrive at taxable income. To think of the former as the
latter is to avoid, if not entirely confuse the use. A tax
credit is used only after the tax has been computed, a
tax deduction, before.
ii. CIR vs. Central Luzon Drug Corp., June 26, 2006
The 20% discount required by RA 7432 to be given to
senior citizens is a tax credit, not a deduction from the
gross sales of the establishment concerned. The
definition of tax credit found in Sec. 2(1) of Rev. Reg.
No. 2-94 is erroneous as it refers to a tax credit as the
amount representing the 20% discount that shall be
deducted by the said establishment from their gross
sales for VAT and other percentage tax purposes.
iii. Bicolandia Drug Corp. vs. CIR, June 22, 2006

63

The term cost in Sec. 4(a) of RA No. 7432 (Senior

Citizens Act) refers to the amount of the 20% discount
extended by a private establishment to senior citizens
in their purchase of medicines. This amount shall be
applied as a tax credit and may be deducted from the
tax liability of the entity concerned, if there is no current
tax due or the establishment reports a net loss for the
period, the period may be carried over to the
succeeding taxable year.
B. KINDS OF ALLOWABLE DEDUCTIONS
1. Itemized or Actual Deductions items or amounts, which the law
allows to be deducted from gross income in order to arrive at taxable
income.
2. Optional Stand Deductions These are deductions in lieu of the
itemized deductions. It us 10% of the gross income of the taxpayer
from business or profession.
3. Special Deductions these are deductions allowed to be deducted in
addition to the itemized deductions allowable to corporations which
may be availed of by insurance companies, mutual insurance
companies, mutual marine insurance companies, assessment
insurance companies, estates and trusts and private educational
institutions.
C. THE OPTIONAL STANDARD DEDUCTION (OSD)
These are deductions in lieu of the itemize deductions. It is 10%
of the gross income of the taxpayer from business or profession.
o Only citizens and resident aliens in business, trade or
profession may elect the OSD.
o Corporations are not allowed to choose OSD.
o The choice must be signified in the income tax return of
the taxpayer and once chosen, it is irrevocable for the
taxable year for which the return is made.
o No need to include financial statements in the return of
OSD was claimed.
o It cannot be used as a deduction from compensation
income.
D. ITEMIZED DEDUCTIONS: Concepts, Kinds, Rules and Requisites
Who can claim the itemized deductions?
1. Corporations
2. General Professional Partnership
3. Individuals engaged in trade, business or profession
4. Estate and Trust engaged in trade or business

If the taxpayer failed to elect the kind if deduction in his income

tax, he shall be considered as having availed himself of the
itemized deduction.
a) General Business Expenses
- Capital Expenditure vs. Ordinary Expenditure
Property Acquired must have a useful life of not more
than one year to qualify as an ORDINARY
EXPENDITURE.
o Deductible in full if many receipt
If it has a useful life of more than one year, then the
expenditure is CAPITAL EXPENDITURE.

64

o Gradual deduction only.

-

Rule Re: Proprietary Education Institutions

Expenses to Private Educational Institutions those
undertaken to achieve improvements in education
activities and expansion of school facilities.

The taxpayer has the option:

i. To deduct expenditures otherwise considered as
capital outlays of depreciable assets incurred for the
expansion of school facilities; or
ii.
To deduct allowance for depreciation thereof.

Where the expansion has been claimed as a deduction,

no further claims for yearly depreciation of the school
facilities are allowed.

Reasonableness Test
a. CIR vs. Gen. Foods, Inc. April 24, 2003
- There is yet to be clear-cut criteria or fixed test for
determining the reasonableness of an advertising
expense. There being no hard and fast rule on the
matter, the right to a deduction depends n a no. of
factors such as but not limited to: the type and size
of business in which the taxpayer is engaged; the
volume and amount of its net earnings; the nature of
the expenditure itself; the intention of the taxpayer
and the general economic conditions. It is the
interplay of these, among other factors and properly
weighed, that will yield a proper evaluation.
b. CM Hoskins vs. CIR, Nov. 28, 1969
1. Other tests suggested are: a.) payment must be
made in good faith; b.) the character of the
taxpayers business; c.) the volume and amount of
its net earnings; d.) the size of a particular business;
e.) the employees qualifications and contributions to
the business venture; and f.) general economic
conditions.

Representation Expense
Requisites:
- It must be ordinary, reasonable and necessary;
- It must be directly connected or related to or in
furtherance of the conduct of his trade, business or
exercise of a profession;
- It must not be contrary to law, morals, public policy or
public order;
- It must not exceed the ceiling that may be prescribed
by the Sec. of Finance; and
- It must be supported by official receipts or adequate
records.

Substantiation Rule and the Cohan Doctrine

Substantiation Doctrine
1. All
business
expense
deductions
must
substantiated with:
a. Receipts or adequate records;
b. Amount of expense;

be

65

c. Date and place of expense;

d. Purpose of expense; and
e. Professional or business
expense.

relationship

of

COHAN Doctrine
Authority of the BIR to allow a taxpayer to deduct a
certain percentage even without receipt provided
the surrounding circumstances will show that the
expense is incurred.
- Case:
a. Gancayco vs. Collector, 1 SCRA 980
- Representation expenses cannot be
allowed as an income tax deduction in
the absence of receipts, invoices or
vouchers supporting said expenses and
in case the taxpayer cannot specify the
items constituting said expenses.
-

b) Bad Debts
Requisites for Deductibility of Bad Debts:
i. There must be a valid and subsisting debt;
ii. The debt must be actually ascertained to be worthless
and uncollectible during the taxable year;
iii. The obligation is not between related parties;
iv. The debt is charged off within the year; and
v. The debt must be connected with the trade, business
or profession of the taxpayer.
Tax Benefit Rule
This doctrine holds that a recovery of bad debts
previously deducted from gross income constitutes
taxable income if in the year the account was written
off, the deduction resulted in a tax benefit, e.g., in the
reduction of taxable income of the taxpayer.
This doctrine can only be availed of by a Creditor and
never by a Debtor.
c) Interests
i. Requisites for Deductibility
1. There is an indebtedness;
2. The indebtedness must be that of the taxpayer;
3. In connection with taxpayers profession, trade or
business;
4. There is liability to pay interest on the debt;
5. The interest must have been paid or incurred within
the year;
6. It must be legally due and stipulated in writing;
7. It must not be expressly disallowed by law to be
deducted from taxpayers gross income;
8. It must be within the limit set by law; and
9. It must not be in favor of a relative.
ii. On Capital Expenditure

66

Whenever a taxpayer opts to claim interest expense

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

iii. Rules Re: Deductibility

Interest payment to be deductible must be incurred
within the taxable year on indebtedness connected
with the taxpayers profession, trade or business.
However, if the interest was paid on indebtedness
incurred or continued to purchase or carry obligations
the interest upon which is exempt from taxation as
income, then the interest payment shall be deductible.
iv. Tax Arbitrage Scheme (Rev. Regs. 13-2000)
v. Interest on Tax Delinquencies
Case: CIR vs. Itogon Suyoc Mines, July 29, 1969
The NIRC provides that interest upon the amount
determined as a deficiency shall be assessed and shall be
paid upon notice and demand from the CIR at the rate
therein specified (Sec. 51(d), NIRC). The imposition of the
monthly interest to the State for the delay in paying the
tax and for the concomitant use by the taxpayer of the
funds that rightfully should be in the governments hands.
d) Taxes
i. Requisites for Deductibility
Paid or incurred within the taxable year;
Must not be specifically excluded by law
from being deducted from taxpayers
gross income; and
Deductible only by the person(s) upon
whom the tax is imposed by law.
ii. Deductible Taxes
Import duties
Business taxes VAT, other percentage
taxes and excise taxes
Privilege or occupation taxes, licenses
Documentary stamp taxes
Income war-profits and excess-profits
taxes imposed by the authority of any
foreign country only if the taxpayer does
not signify in his return his desire to have
any extent the benefits of the provisions
of law allowing credits against the tax for
taxes of foreign countries
Any other taxes of every amount and
nature paid directly to the government or
any political subdivision.
iii. Non-deductible Taxes
Income Tax
Estate and gift taxes
Special assessment or levies on properties
Energy Tax

67

Taxes not related with the trade, business or

profession of the taxpayer
Taxes which are final
Income taxes imposed by authority of any foreign
country if the taxpayer signifies in his return, his
intention to avail of tax credit for the said taxes.

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

ii.

Intangible property, the use of which in trade or

business is of limited duration like patents,
copyrights, royalties and franchises.

Allowable modes of depreciation

Straight-line method this method spreads the total
depreciation over the useful life of the assets.
Declining-balance method this method uses a rate
to the declining book value of the assets.
Working-hours method the total working hours of
the machine until its retirement is estimated and a
charge per hour is determined.
Unit of production method the estimated service
life is stated in units of products instead of working
hours.
Sum-of-the-years digit method this is a method of
depreciation where bigger depreciation expenses
are provided during the early years of the fixed
assets which gradually diminish until the total
depreciation is equal the cost of the assets.
Any other method which may be prescribed by the
Dept. of Finance upon recommendation of the CIR.\

f) Depletion
i. This is the removal, extraction or exhaustion of a natural
resource such as mines and gas wells as a result of
production or severance from such mines or walls.
g) Losses
Requisites:
a. The loss must be that of the taxpayer;
b. Actually sustained during the taxable year;
c. Not compensated by insurance or other form of
indemnity;
d. Evidenced by a closed and completed transaction;
e. Not claimed as a deduction for estate tax purposes; and
f. If it is a casualty loss, must be reported to the
concerned authorities within prescribed time (45 days).

Types of Losses:

68

ORDINARY LOSSES
Occurs when the
expenses are more
than gross income
or sale of ordinary
asset
To
a
domestic
corporation all
losses
actually
sustained
and
charged off within
the taxable year
and
not
compensated
for
by insurance or
other
form
of
indemnity.
To RC or a NRAETB
losses actually
sustained
during
the year in trade,
business
or
profession
conducted
within
the Phils. and not
compensated
by
insurance or other
form of indemnity.

CAPITAL LOSSES
SPECIAL LOSSES
Can
be Kinds:
deductible only g. Wagering losses
from
capital
deductible only to
gains
the extent of gain
or winnings.
Subject to the h. Losses on wash
sales of stocks
Loss Limitation
not
deductible
Rule
because these are
considered
as
artificial loss.
i. Abandonment
losses in petroleum
operation
and
producing well.
j. Losses
due
to
voluntary
removal
Kinds of capital
of building incident
losses:
to
renewal
or
a. Losses from sale
replacements

or exchange of
deductible
expense
capital assets
from gross income.
b. Losses resulting
k.
Loss of useful value
from
securities
of assets due to
becoming
changes
in
worthless
and
business
which are capital
conditions.
assets
c. Losses due to l. Losses from sales
or exchanges of
failure
to
property between
exercise privilege
related taxpayers.
or option to buy
m. Loss of farmers.
or sell property

Net Operating Loss Carry Over (NOLCO)

o Case: PICOP vs. CIR, Dec. 01, 1995
It is thus clear that under our law, and
outside the special realm of BOI-registered
enterprises, there is no such thing as a carryover of net operating loss. To the contrary,
losses must be deducted against current
income in the taxable year when such losses
were incurred. Moreover, such losses may be
charged off only against income earned in
the same taxable year when the losses were
incurred.
o NOLCO This refers to the excess of allowable
deduction over gross income. It can be carried
over as a deduction from gross income for the
next 3 consecutive years immediately following
the year of such loss.
o 75% Interest Retention Rule
NOLCO should be allowed only if there has
been no substantial change in the
ownership of the business or enterprise in
that

69

Not less than 75% in nominal value of

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

h) Charitable Contributions
i. With Limitation
1. Donations to the government of the Phils. or any of its
agencies or political subdivisions for exclusively public
purposes.
2. Donations to accredited domestic corp. or associations
organized and operated exclusively for religious,
charitable, scientific, youth and sports development,
cultural, educational, rehabilitation of veterans, social
welfare institution and NGO.
ii. Deduction in full
1. Donations to the government or political subdivisions
including fully owner GOCCs to be used exclusively in
undertaking priority activities in educational, health,
youth and sport devt. provided however, that any
donation to the government NOT in accordance with the
priority plan shall be the subject to the limitation of 5%
or 10%.
2. Donations to foreign institutions or international
organizations in compliance with agreements, treaties
or commitments.
3. Donations to accredited NGOs.
4. Donations to traditional exemptees.
i) Pension Trusts
An employer establishing or maintaining a pension trust to
provide for the payment of reasonable amount transferred
or paid into such trust during the taxable year in excess of
such contributions, but only if such amount:
i. Has not theretofore been allowed as a deduction;
ii. Is apportioned in equal parts over a period of 10
consecutive years in which the transfer or payment is
made.
j) Research and Development Costs
i. Amount Deductible amount rateably distributed over
a period of 60 months beginning the month, taxpayer
realized benefits from such expenditures.
k) Other Forms of Deductions (Sec. 37 NIRC)
a. Special Deductions Allowed to Insurance Companies;
b. Mutual Insurance Companies;
c. Mutual Marine Insurance Companies;
d. Assessment Insurance Companies;
e. Estates and Trusts; and
f. Private Educational Institutions
Insurance companies

70

 Whether domestic or foreign, doing business in the Phils., they

are allowed to deduct, in addition to the itemized deductions under
Section 34 of the Tax Code, the following:
1.) Net additions, if any, required by law to be made within the year
to reserve funds, and
2.) Sums other than dividends paid within the year on policy and
annuity contracts. The released reserve shall be treated as
income for the year of release. (Sec. 37, [A], NIRC, Sec. 126,
Regs.)
Mutual insurance companies
These companies (other than mutual life & mutual marine) are
allowed to deduct from gross income the following:
1.) Any portion of the premium deposits returned to the policy
holders
2.) Such portion of the premium deposits as are retained for the
payment of losses, expenses and reinsurance reserves. (Sec. 37,
B, NIRC; Sec. 127, Regs.)
Mutual marine insurance companies
They are entitled to deduct from gross income the following:
1.) Amounts repaid to policy holders on account of premium
previously paid by them; and
2.) Interest paid upon those amounts between the ascertainment
date and the date of its payment. (Sec. 37, [C], NIRC, Sec. 128,
Regs.)
Assessment insurance companies
Whether domestic or foreign, they may deduct in a taxable year
the sum actually deposited with the officers of the govt. of the
Phils., pursuant to law as additions to guarantee or reserve funds.
(Sec. 37 [D], NIRC).

SPECIAL INCOME TAX TREATMENT OF GAINS AND LOSSES

FROM DEALINGS IN PROPERTY
A. Background of the special rules
B. Ordinary Assets v. Capital Assets
Ordinary Assets refer to properties held by the taxpayer in the
pursuit of his profession, trade or business, they are:
i. Stock in Trade;
ii. Property of a kind which would properly be included in the
inventory if on hand at the close of the taxable year;
iii. Property held by the taxpayer primarily for sale to customers in
the ordinary course of trade or business;
iv. Property used in trade or business which is subject to the
allowance for depreciation; and
v. Real property used in trade or business. (Sec. 39, [A], NIRC)
Capital Asset means property held by the taxpayer (whether or not
connected with his trade or business) but does not include:
i. Stock in trade;
ii. Property of a kind which would properly be included in the
inventory if on hand at the close of the taxable year;

71

iii. Property held by the taxpayer primarily for sale to customers in

the ordinary course of trade or business;
iv. Property used in trade or business which in subject to the
allowance for depreciation; and
v. Real property used in trade or business. (Sec. 39, [A], NIRC)
This is an enumeration by exclusion, all others not enumerated
are capital assets.
C. Rules on Ordinary Gains and Losses
Ordinary income (ordinary gain) includes any gain from the sale
or exchange of property which is not a capital asset (Sec. 22, [Z], NIRC)
Ordinary Loss includes any loss from the sale or exchange of
property which is not a capital asset. (Sec. 22, [Z], NIRC)

Income Tax Treatment on the Sale or Exchange of Ordinary Assets

The general rule in income taxation apply both as to the gain and as
to the loss, any gain shall be reported as ordinary income and any
loss may be allowed as a deduction in gross income.

Exemplification of Rules
If an individual taxpayer is engaged in real estate business or is a
real estate dealer, the gains he may derive from the said activity
will be considered as ordinary income and the losses he may incur is
deductible from his gross income. The 6% tax imposed on the sale
of real property which is a capital asset is inapplicable to him.

If a domestic corporation is engaged in real estate business, the

gains it may derive from said activity is considered as ordinary
income and any loss incurred is considered as an ordinary loss. The
loss is deductible from the corporations ordinary income and from
its income from any other source whether ordinary or capital.
Ordinary losses (whether the taxpayer is an individual or a
corporation) are deductible either from ordinary gains or capital
gains.

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

a. Rules on Real Property Classified as Capital Asset
(1.) Definition of terms:
i. Capital gain is the gain from the sale or exchange of capital
assets.
ii. Capital loss is the loss incurred from the sale or exchange of
capital assets.
iii. Net Capital gain is the excess of the gains from sales or
exchange of capital assets over the losses from such sales or
exchanges (Sec. 39, [A, 2], NIRC).
iv. Net capital Loss is the excess of the losses from sales or
exchanges of capital assets over the gains from such sales or
exchanges. (Sec. 39, [A, 3], NIRC).
(2.) Tax Treatment of Capital gains and Capital losses
a.)

As to Individual Taxpayers
a.1) On personal property classified as capital asset (other
than shares of stock)

72

The following are the applicable rules:

a. The percentages of gain or loss to be taken into
account shall be 100% if the capital asset has been held for 12 months
or less; and
50% if the capital asset has been held for more than
12 months (holding period rule)
b. Capital losses shall be deducted only to the extent of
the capital gains (loss limitation rule)
c. Net Capital Loss Carry Over Rule is applicable.
a.2) On real property classified as capital assets
The following are the applicable rules;
a. A final capital gains tax is imposed on individuals
including estates and trusts computed as follows:
tax base: gross selling price or fair market value,
whichever is higher
tax rate: 6%
b. The tax is imposed on capital gains presumed to
have been realized from the sale, exchange or
disposition of real property located in the Phils.
classified as capital assets including pacto de retro
sales and other forms of conditional sales (such as
mortgage foreclosure sale)
c. The tax shall be in lieu of the income tax imposed on
individuals under graduated rates in Sec. 24,
[A].Capital gains from sale of real property shall not
be included in the gross income of the individual
taxpayer.
d. There are two situations wherein the 6% final tax
rate may not be applied, to wit:
i. If the real property classified as capital asset is
sold to the government or any of its political
subdivisions or to govt. owned or controlled
corporations, the 6% final tax rate or the
graduated income tax rates may be used on
the actual gain of the taxpayer, at the option of
the taxpayer; and
ii. If the principal residence of the individual
taxpayer is sold and the proceeds of the sale is
used to acquire or construct a new residence
within 18 months from the date of the sale, the
sale is exempt from income tax provided:
B.1) That the Commissioner is notified by the
taxpayer within thirty (30) days from the date
of the sale or disposition through a prescribed
return of his intention to avail of tax
exemption;
B.2) The tax exemption can only be availed of
once every ten (10) years; and
B.3)
If there is no full utilization of the
proceeds of the sale or disposition, the portion

73

of the gain presumed to have been realized

from the sale or disposition shall be subject to
capital gains tax.
e. The sale of rights over realty, although classified as
real property under the Civil Code, is not subject to
capital gains tax because the situs of these rights
follow their owner who may not be located in the
Phils. Only real property located in the Phils. is
subject to capital gains tax. (Sec. 24 [b, 1], NIRC; BIR
Ruling No. 083-99, June 22, 1999).

b. Rules on Gains or Losses From Sale of Shares of Stocks Not

Listed or Traded in the Stock Exchange by Non-dealers in
Securities
a. A final capital gains tax is imposed on capital gain from
sale of shares of stock, computed as follows:
1. On non-listed stocks or on sales of shares (listed or
unlisted with stock exchanges): not effected through the
stock exchanges:
5% on net capital gains not over P100, 000
10% on net capital gains in excess
of P100, 000
(Sec. 24, [C], 25 [B], 27 [D, 2], 28
[A, 7, C], [B, 5, C])
2. For sale of shares listed and traded in the stock
exchange the same shall be exempt from income tax
but it shall be subject to a Stock Transfer Tax of of 1%
of the Gross Selling Price.
b.

The final capital gains tax is in lieu of the ordinary income

tax on individuals, corporations and other taxpayers
(estates & trusts).

c.

The net capital gains on stock transactions shall not be

included in the gross income of the seller or transferor in
computing his income tax liability.

d.

It is a final tax, which shall in no case, be allowed as a

deduction against income or credited against income tax or
any other tax

e.

Also subject to a stock transfer tax at a different rate are

shares of stock sold or exchanged through initial public
offering.

c. Rules Regarding Other Capital Assets

A. Loss Limitation Rule provides that Capital losses are
deductible only to the extent of capital gains.
B. Holding Period Rule refers to the percentages of the gain or
loss taken into account in computing the net capital gain net
capital loss and net income. The percentages are:
- 100% - if the capital asset has been held for not more
than twelve (12) months (short-term); and

74

- 50% - if the capital asset has been held for more than
twelve (12) months (long-term)

The holding period of capital assets is only applicable to

individual taxpayer and not to corporations.

C.

Net Capital Loss Carry Over (NCLCO) Rule means that:

i. If any taxpayer, other than a corporation, sustains in
any taxable year a net capital loss;
ii.
Such net capital loss cannot be deducted from
ordinary income due to the loss limitation rule;
iii. Such loss could be carried over to the next taxable
year (not thereafter) as a deduction against net capital
gain in an amount not in excess of the taxable income (i.e.
net income before exemptions) in the year the loss was
sustained; and
iv. Such loss shall be treated as a loss from the sale or
exchange of capital assets held for not more than twelve
(12) months. (Sec. 39, [D], NIRC)

Limitation on Capital losses

General Rule: Capital losses are allowed only to the
extent of capital gains.
Exception: Any loss sustained by a domestic bank or trust
company from the sale of bonds, debentures, notes or certificates
or other evidences of indebtedness issued by any corporation
including those issued by the government is considered as an
ordinary loss and deductible from ordinary income.
Reason: Banks and trust companies are considered as
dealers in securities, hence, these securities are considered as
property primarily held for sale to customers in the ordinary
course of business.

E. Special Capital Transactions

The following are considered as sales or exchanges of capital assets:
1. Retirement of bonds with interest coupons or in registered
form
Amounts received by the holder upon the retirement of bonds,
debentures, notes or certificates or other services of
indebtedness issued by any corporation (including those issued
by a govt. or political subdivision thereof) with the interest
coupons or in registered forms, shall be considered as amounts
received in exchange thereof. (Sec. 39, [E], NIRC)
2. Short sales of property
A short sale takes place when a seller first make a sale of stock or
security which he does not own (he merely borrows the stock
certificate through or from his stock broker) and subsequently
buys or covers the stock to complete the transaction.
The seller sells the shares short in the expectation of a
decrease in value thereof within a reasonably short period of time.
He covers his short sale when the expected decrease in the value
materializes or when the time for the return of the borrowed shares
comes.
1.) Failure to exercise privilege or option to buy or sell property

75

 Gains or losses attributable to the failure to exercise privileges or

options to buy and sell property shall be considered as capital
gains or losses, such as the option given to a taxpayer to buy an
agricultural land is a capital asset and the gain or the loss that
may be incurred by him from the disposition of said option is
either a capital gain or a capital loss.
2.) Securities becoming worthless
If any securities which are capital assets are ascertained to be
worthless and written off during the taxable year, the loss
resulting therefrom in the case of a taxpayer other than a bank or
a trust company incorporated under the laws of the Phils. a
substantial part of whose business is the receipt of deposits, is
considered a capital loss.
3.) Distribution in liquidation
If, in liquidation or dissolution, the corporation acquires its own
stock and exchanges its assets (land) for the shares, the
shareholders who surrendered their shares for land shall likewise
be subject to the capital gains tax prescribed under Section 24
(C) of the Tax Code.
Gains or losses from liquidating dividends are considered as
capital gains or losses inasmuch as liquidating dividends are
considered as full payment from the corporation in exchange for
stocks held by the stockholders.
4.) Readjustment of interest in a general professional
partnership
When a partner retires from a general professional partnership or
the partnership is dissolved, he realizes a gain or loss measured
by the difference between the price he received for his interest
and cost to him of his interest in the partnership.
F. Wash Sale
- is a sale of securities where substantially identical securities are
acquired or purchased within a 61-day period beginning 30 days before
the sale and ending 30 days after the sale. (Sec. 38, [A], NIRC).
Requisites for non-deductibility:
1) The sale or other disposition of stocks or securities resulted in a
loss;
2) There was an acquisition, or contract or option for acquisition of
stock or securities within thirty (30) days before the sale or thirty
(30) days after the sale; and
3) The stock or securities sold where substantially the same as
those acquired within the 61-day period.
The word acquired means acquired by purchase or by an
exchange, and comprehends cases where the taxpayer has
entered into a contract or option within the sixty-one-day
period to acquire by a purchase or by such an exchange (Sec.
131, [f], Regs.)
Substantially identical means that the stock must be of
the same class, or in the case of bonds, the terms thereof
must be the same.
The following are not substantially identical:

76

i.
ii.
iii.
iv.

The common stock and the preferred stock of the same

corporation;
A non-voting stock and a stock with voting power;
The stock of the corporation and the stock of another
corporation; and
Two series of bonds where one is secured by a mortgage and
the other is not; or which differ as to interest rates.

G. Installment Sales v. Deferred Sales

Installment Sale is a sale in which proceeds are received over a period
of time. Gain on an installment sale is recognized as the selling price
received, not including interest. Proceeds are received in more than one tax
year.
H. Instances When Gains are Taxable But Losses are Non-deductible
TRANSACTIONS RESULTING IN TAXABLE GAINS BUT
RECOGNITION OF LOSSES
a. Transactions between related taxpayers (Sec, 36, NIRC)
b. Illegal transactions
c. Wash sales (except those made by dealers in securities)
d. Exchanges not solely in kind in mergers and consolidations
1)

NON-

If in connection with an exchange described earlier resulting

in non-recognition of gains or losses, an individual, a shareholder,
a security holder or a corporation receives not only stock or
securities permitted to be received without the recognition of
gain or loss, but also money and/or property, the gain, if any, but
not the loss, shall be recognized but in an amount not in excess
of the sum of the money and the fair market value of such other
property received.
Provided, that as to the shareholder, if the money
and/or property received has the effect of a distribution of a
taxable dividend, there shall be taxed as dividend to the
shareholder an amount of the gain recognized not in excess of
his proportionate share of the undistributed earnings and profits
of the corporation, the remainder if any, of the gain recognized
shall be treated as a capital gain. (Sec. 40, [3, a])

2)

If a corporation which is a party to the merger or

consolidation receives not only stock permitted to be received
without the recognition of gain or loss, but also money and/or
property, and does not distribute it in pursuance of the plan of
merger or consolidation, the gain, if any, shall be recognized in
an amount not in excess of the sum of such money and the fair
market value of such other property so received, which is not
distributed. (Sec. 40, C,[3, b])

3)

If a taxpayer receives stock or securities which would be

permitted to be received without the recognition of the gain if it
were the sole consideration, and as part of consideration,
another party to the exchange assumes a liability of the
taxpayer, or acquires from the taxpayer property subject to a
liability, then such assumption or acquisition shall not be treated
as money and/or other property, and, therefore any gain or loss
would still not be recognized if no money and/or property was
involved in the exchange.

77

4)

If the amount of the liabilities assumed plus the amount

of the liabilities to which the property is subject, exceed the total
of the adjusted basis of the property transferred pursuant to such
exchange, then such shall be considered as a gain from the sale
or exchange of a capital asset or of property, which is not a
capital asset, as the case may be. (Sec. 40, [C, 4], NIRC)

e. Sales or exchanges which are not at arms length

I. Instances when Gains and Losses are Not Recognized for Tax
purposes
SALES OR EXCHANGES RESULTING IN
NON-RECOGNITION OF GAINS OR LOSSES
a) Exchange solely in kind (exchange of property solely for
stocks) in legitimate mergers or consolidations.
- A corporation which is a party to a merger or
consolidation exchanges property solely for stock in a
corporation which is a party to the merger or
consolidation;
- A corporation which is a party to a merger or
consolidation receives in exchange for property not only
stock of another corporation but also money and/or other
property and distributes it in pursuance of the plan of
merger or consolidation. [Section 40(c)(3)(6)(i)]
- A shareholder exchanges stock in a corporation
which is a party to the merger or consolidation solely for
the stock of another corporation, also a party to the
merger or consolidation.
- A security holder of a corporation which is a
party to the merger or consolidation exchanges his
securities in such corporation solely for stock or securities
in another corporation, a party to the merger or
consolidation.
b) Transfer or exchange of property for stock resulting in
acquisition of corporate control
A person exchanges his property for stock or unit of
participation in a corporation of which as a result of
such exchange said person, alone or together with
others, not exceeding four persons, gains control of
said corporation
Control means ownership of stocks in a corporation
possessing at least 51% of the total voting power of
all classes of stock entitled to vote.
The items enumerated above are also called taxexempt exchanges.
TAXATION OF INCOME OF INDIVIDUAL TAXPAYERS
A. Classification of Individual Taxpayers and the Factors affecting
their Taxability
Citizens of the Philippines may be classified into:
a.)
Resident Citizens (RC)

78

 Citizens of the Philippines who are taxed on their income within

and without the country
Individual who is:
engaged in trade or business
In the exercise of his profession
Employed, earning purely compensation income
Not engaged in trade or business or in the exercise of his
profession nor employed but has some income
Has mixed income
b.)
Non-resident Citizens (NRC)
Those not residing in the Philippines
A Filipino citizen who: (sec. 22 (E) National Internal Revenue Code
(NIRC)
One who establishes to the satisfaction of the
Commissioner of Internal Revenue (CIR) the fact of his
physical presence abroad with a definite intention to
reside therein.
A citizen of the Philippines who leaves the country during
the taxable year to reside abroad, either as immigrant or
for employment or on permanent basis.
A citizen of the Philippines who works and derive from
abroad and whose employment thereat requires him to be
physically present abroad most of the time during the
taxable year.
A citizen who has been previously considered as nonresident citizen and who arrives in the Philippines at any
time during the taxable year to reside permanently in the
country. (He shall be considered a NRC for the taxable
year in which he arrives in the Philippines with respect to
his income derived from sources abroad until the date of
his arrival in the Philippines)
NOTE: Rev. Regulations. No. 9-73, November 26, 1973 - The continuity
of residence abroad is not essential. If physical presence is established, such
physical presence for the calendar year is not interrupted by reasons of
travels to the Philippines.
Three types of Non resident Citizen
a. Immigrants
b. Employees of a foreign entity on a permanent basis
c. overseas contract workers
Immigrants and Employees of a foreign entity on a permanent basis
are treated as NRC from the time they depart from the Philippines. However,
overseas contract workers must be physically present abroad most of the
time during the calendar year to qualify as NRC.
An overseas contract worker (OCW) is taxable only on income derived
from sources within the Philippines. Sec 23(b) (c)
A seaman is considered as an OCW provided the following
requirements are present:
a. receives compensation for services rendered abroad
as
a
member of the complement of a vessel, and
b. such vessel is engaged exclusively in international trade.

Aliens or foreigners

79

a.)

Resident aliens (RA)

Those residing in the Philippines though not a citizen thereof.
RA is taxed only on income within the Philippines
RA is one who comes to the Philippines for a definite purpose
which is in its nature would require an extended stay, and
makes his home temporarily in the country

b.)

Non resident aliens (NRA)

Those not residing in the Philippines and not a citizen of the
Philippines
Those engaged in trade or business in the Philippines
(NRAETB)
This includes the performance of the functions of a public
office. It shall not include performance off services as an
employee
An alien whose aggregate period of stay in the Philippines is
more than 180 days during any calendar year.
Those not engaged in trade / business in the Philippines
(NRANETB).
An alien whose aggregate period of stay in the Philippines
does not exceed 180 days during any calendar year
regardless of whether he actually engages himself in trade or
business in the Philippines.

c.)Special Aliens
Individuals employed by:
Regional or area headquarters and regional operating
headquarters on multinational companies (MNC) in the
Philippines
Offshore banking units (OBU) established in the
Philippines
Foreign Service contractors or sub contractors engaged in
petroleum operations in the Philippines.
They are taxed only at 15% preferential income tax rate on
their gross compensation income from sources within the
Philippines
B. Rules Applicable to Returnable Income
C. Rules Applicable to Passive Income

Rates of Tax on Certain Passive Income of Individual Taxpayer

Tax Rate & Tax Base

80

Passive Income (Subject to

CITIZEN
NRAETB
Final Tax)
& RA
1. Royalties
20%
20%
except:
(a) Books, literacy works
10%
10%
(b) musical compositions
10%
10%
2. Prizes (exceeding P10k) &
20%
20%
other winnings (except:
PCSO & LOTTO winnings)
3. Interest on bank deposits
20%
20%
4. Interest under Expanded
7.5%
exempt
foreign currency deposit
system
5.
Interest
on
long-term
deposits
> 5 yrs.
exempt exempt
< 3 yrs.
20%
20%
3 to < 4 yrs.
12%
12%
6. Dividend from Domestic
10%
10%
corporation, joint stock
company insurance or
mutual fund comp. and
ROHQs of Multinational
comp.
7. Capital gains from the sale
6%
6%
of real property located in
(GSP/
the Phils.
FMV,
whichev
er is
higher)
8. Sales of Shares of Stocks
5% - not
5%
not traded in local exchange exceedi
ng
10%
P100k
10% amount
in
excess
of P100k
9. Cash and/ or property
dividends

beginning Jan.
6%
20%
8%
1998
10%

beginning Jan.
1999

beginning Jan.
2000

NRANET
B
-

Exempt

exempt
20%
12%
10%

6%

5%
10%

25%

Any income or gain derived in which a final tax is imposed shall no longer
be included in the taxable net income of the taxpayer (applicable only to
citizens and aliens)

Final tax is imposed without deduction.

personal additional applicable.

Aliens employed by RAHQs & ROHQs, OBUs, Petroleum service contractor

& subcontractor of a multinational corporations are entitled to 15% tax,
only on those:

Neither is the provision on

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 Salaries, wages, annuities, honoraria and the like as

received from such RAHQs or ROHQs.
Provided that the same tax treatment is extended to Filipino
employees having the same position in such entities.
D. Personal Exemptions
Nature & Purpose: Personal exemptions are fixed amounts which
are in the nature of deduction and are intended to substitute for the
disallowance of personal or living expenses as deductible items.

Basic Personal Exemptions

Individuals who are either earning compensation income, engaged
in business or deriving income from the practice of profession are
entitled to personal exemptions as follows:
For single individual or married individual judicially decreed as legally
separated with no qualified dependents...P
20,000.00
For
head
of
family........P
25,000.00
For each married individual *........P
32,000.00
Note: In case of married individuals where only one of the spouses is
deriving gross income, only such spouse will be allowed to claim the
personal exemption.
Basic Personal Exemptions for RC, NRC, and RA
Taxpayer
Exemption
(amount)
1. Single person including a married person
P 20k
judicially decreed as legally separated
2. Head of family
P 25k
3. Each married person
P 32k
HEAD OF FAMILY - is one who is unmarried or legally separated man or
woman with;
(1) One or both parents
(a) Living with the taxpayer.
(b)Dependent upon the taxpayer for their chief support.
(2)
One or more brothers (a) Living with the taxpayer
(b)Dependent upon the taxpayer for chief support
(c) Not more than 21 yrs. of age
(d)Not married
(e) Not gainfully employed
(3)One or more legitimate recognized natural / legally adopted children.
(a) living with the Taxpayer
(b)dependent upon the Taxpayer for chief support
(c) not more than 21 yrs. of age
(d)not married
(e) not gainfully employed

Regardless of age, such children, brothers or sisters qualify a Taxpayer as

head of family is they are incapable of self-support because of mental or
physical defect.

82

CHIEF SUPPORT - means principal or main support.

More than fifty
percent (50%) being provided to certain dependents is enough. This
phrase does not necessarily mean that the dependent derives no name at
all, he may still derive income but the same is insufficient to support him.

LIVING WITH - requires the Taxpayer and his dependent to actually be

residing together but temporary absence from their common residence
brought by face of circumstances such as:
(a) The Taxpayer is away on business
(b) The dependent who may be boarding elsewhere is in pursuit of
education.

GAINFULLY EMPLOYED means that the dependent will only qualify as

such if he derives no income for himself, or he is employed but his income
is not sufficient to support him independently outside of the principal/chief
support afforded to him by the taxpayer.

RA 7432 in relation to exemptions

RA 7432 (approved April 23, 1992) expressly allows a qualified senior
citizen to be claimed as dependents by those who care for them whether
a relative or not.

Additional Exemptions
An additional exemption of P8, 000 is granted to Taxpayer for each, but not
exceeding four (4) of his:
(a) Legitimate, illegitimate and/or legally adopted children
(b) Living with the Taxpayer
(c) Chiefly dependent upon him for support
(d) Not more than 21 yrs. old
(e) Unmarried
(f) Not gainfully employed.

The maximum amount of P 2,400 premium payments on health and/or

hospitalization insurance can be claimed if:
Family gross income yearly should not be more than P 250,000
For married individuals, the spouse claiming the additional exemptions
for the qualified dependents shall be entitled to this deduction
Persons entitled to personal and additional exemption
Taxpayer
PE
AE
HHIP
1.Resident citizen

2.Non- resident
(for income
(income
X
(NRC)
derived w/in)
from w/in)
3. Resident alien
(income
(w/in)

(RA)
from w/in)
(by way of
4. NRAETB
X
X
reciprocity)
5. NRANEBT
X
X
X
(only up to
6. Estate
X
X
P20k)
(only up to
7. Trust
X
X
P20k)
Reciprocity means that the foreign country where the nonresident alien
is a citizen or subject grants exemption to Filipinos not residing there but
doing trade or business, or exercising profession therein.

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 The extent of personal exemptions allowed to such non-resident alien

shall be in the amount equal to the exemptions allowed in the income
tax law in the country of which he is a subject or citizen, to citizens of
the Philippines not resident in such country not to exceed the amount
fixed under our laws. (Sec. 36 [D], NIRC).

Rules on change of Status

These are:
1.) If the taxpayer marries or should have additional dependent(s)
during the taxable year, the taxpayer may claim the
corresponding additional exemption, as the case may be, in full
for such year.
2.) If the taxpayer dies during the taxable year, his estate may still
claim the personal and additional exemption for himself and his
dependents as if he died at the close of such year.
3.) If the spouse or any of the dependents dies or if any of such
dependents marries, becomes twenty-one (21) years old or
becomes gainfully employed during the taxable year, the
taxpayer may still claim the same exemptions as if the spouse or
any of the dependents died, or as if such dependents married,
became twenty-one (21) years old or become gainfully employed
at the close of such year.
E. Taxation of Married Individuals
1. Personal exemption of married persons:
If not legally separated, each spouse is entitled to P32k as personal
exemption.
If legally separated, each is entitled to P20k as a single individual
unless qualifies as head of family.
Where only one (1) of the spouses is deriving income, only such
spouse shall be allowed the personal exemption.
2. For additional exemption
a. For married individuals can be claimed by only 1 of the spouses.
b. For legally separated spouses, it can be claimed only by the spouse
who has custody of the children; but the amount claimed by both shall
not exceed the maximum allowed.
c. Additional exemption can be claimed only by the husband unless:
i. he waives his right in favor of his wife
ii. the husband is working abroad
iii. the wife is the one deriving income.
3. The law requires that married individuals, the husband and wife
although required to file one (1) income tax return, should nevertheless
compute their individual income separately. If any income of the spouses
cannot be definitely attributable to or identifiable as income exclusively
earned as realized by either of the spouses, the same shall be divided
equally between the spouses.
F. Taxation of Minors
Income of unmarried minors derived from property received by the living
parent shall be included in the return of the parent except:
a. when donors tax has been paid on such property, or
b. when transfer of such property is exempt from donors tax.
G. Tax Returns and Other Administrative Requirements

84

Tax Return - this is a report made by the taxpayer to the BIR of all gross
income received during the taxable year, the allowable deductions
including exemptions, the net taxable income, the income tax rate, the
income tax due, the income tax withheld, if any, and the income tax still
to be paid or refundable.
Individuals Required to File Income Tax Return
1. Resident Citizen
2. Non-Resident Citizen on income from within the Philippines
3. Resident alien on income from within the Philippines
4. NRAETB on income from within the Philippines
5. an individual (citizen/aliens) engaged in business or practice of a
profession within the Philippines regardless of the amount of gross
income
6. Individual deriving compensation income concurrently from two or
more employers at any time during the taxable year and
7. Individual whose pure compensation income derived from sources
within the Philippines exceed P60,000.
Individuals Exempt from Filing Income Tax Return
1. individuals whose gross income does not exceed total personal and
additional exemptions
2. individuals with respect to pure compensation income derived from
sources within the Philippines, the income tax on which has been
correctly withheld
3. individuals whose sole income has been subjected to final withholding
tax, and
4. individuals who are exempt from income tax
Where To File
1. legal residence- authorized agent bank; Revenue District Officer;
Collection agent or duly authorized treasurer
2. Principal Place of business
3. Office of the Commissioner
Time for Filing
April 15- for those earning sole compensation or solely business,
practice of profession or combination of business and compensation
Extension of Time to File Return
The Commissioner may on meritorious cases grant a reasonable
extension of time for filing income tax return and may subject the
imposition of twenty percent (20%) interest per annum from the original
due date.
TAXATION OF INCOME OF CORPORATE TAXPAYERS
A. Definition of a Corporation
CORPORATION (Sec. 24(b) Tax Code)
- The term shall include partnership, no matter how created or
organized, joint stock companies, joint accounts, or insurance
companies, but does not include general professional partnerships and
a joint venture or consortium formed for the purpose of undertaking
construction projects or engaging in petroleum, coal, geothermal and
other energy operations pursuant to operating or consortium
agreement under a service contract with the government.

85

GENERAL PROFESSIONAL PARTNERSHIP (GPP)

- are formed by persons for the role purpose of exercising their common
profession, no part of the income of which is derived from engaging in
any trade & business.
B. Tests In Determining The Existence Of A Corporation
C. Tests Applied To Partnerships, Co-Ownerships, And Estates
1. Evangelista vs. CIR (102 Phil 140)
The term partnerships does not only refer to partnerships in
its technical meaning.
The phrase no matter how created or organized includes
that a joint venture need not be undertaken in any of the standard
forms or in conformity with the usual requirements of the law on
partnerships in order that one could be deemed to be so for tax
purposes
Also included are joint accounts and associations, none of which
have a legal personality of its own independent of that of its
members
2. Ona vs. CIR (45 SCRA 74)
co- ownerships become taxable in the event co-owners used the
properties as a common fund with intent to produce profits
3.

Obillos vs. CIR (October 19, 1985)

mere sharing of gross returns does not of itself establish or
constitute a taxable partnership, whether or not the persons
sharing them have joint or common interest
there is no taxable partnership where the children of Obillos had
no intention to divide profits among themselves
there must be an unmistakable intention to form a partnership or
joint venture
a sale of co-ownership property does not necessarily establish
that intention

4.

Pascual and Dragon vs. CIR (October 18, 1988)

mere sharing of gross returns does not of itself establish or
constitute a taxable partnership
where two persons purchased two parcels of land in 1965 and
another three parcels in 1966, which they later sold at a profit
the character of habituality peculiar to business transactions for
the purposes of gain must be present
the sharing of returns is but a consequence of a joint or common
interest in the property
there must be a clear intention to form a partnership

5. Afisco Insurance Corp. vs. CIR ( January 25, 1999)

a pool of machinery insurers is a taxable association or
corporation as an unregistered partnership
Reasons:
(1) The pool has a common fund, consisting of money and other
valuables that are deposited in the name and credit of the pool.
This common fund pays for the administration and operation
expenses of the pool.
(2) The pool functions through an executive board which resembles
the board of directors of a corporation, composed of one
representative for each of the ceding companies.

86

(3) True, the pool itself is not a reinsurer and does not issue any
insurance policy: however, its work is indispensable, beneficial
and economically useful to the business of the ceding
companies and Munich, because without it they would not have
received their premiums. The ceding companies share in the
business ceded to the pool and in the expenses according to
a Rules of Distribution annexed to the Pool Agreement. Profit
motive or business is, therefore, the primordial reason for the
pools formation.
D. Kinds of Corporations
1. Domestic
those created or organized in the Philippines or under its laws.
2. Foreign
those created organized or existing under any laws other than
those of the Philippines, and they are either:
a. Resident
those foreign corporation engaged in trade or business within the
Philippines
b. Non-resident
those foreign corporation not engaged in trade or business
within the Philippines

DOING OR ENGAGING IN or TRANSACTING BUSINESS

- The term implies a continuity of commercial dealings and
arrangements and contemplates to that extent, the performance of
acts or works or the exercise of some of the functions normally
insistent to and in the progressive prosecution of commercial gain or
for the purpose and the object of the business organization (Comm.
vs. British Overseas Airways Corporation BOAC case 149 S 395)
E. Rules Applicable To Passive Income
1. Tax Sparing Rule
- provides that a final withholding tax at the rate of 15% shall be
imposed for the amount of cash and /or property dividends received
from a domestic corporation by non-resident Foreign corporation
subject to the condition that the country in which the NRFC is
domiciled shall allow a credit against the tax due from NRFC taxes
deemed to have been paid in the Phils. equivalent to 17% which
represents the difference between the regular income tax rate of
32% and the usual corporate rate of 15%.
Note:
1. Tax sparing credit applies only when the conditions for its availment
are clearly established by the taxpayer. Since the concession is in
the nature of a tax exemption.
2. The 15% reduced tax must actually be paid and the 17% must be
deemed paid tax.
3. The 15% tax on dividends is applicable if the country where the
recipient NREC is domiciled does not imposed any tax on dividend
received by said recipient foreign corporation (BIR Ruling, March 30,
1977)
a. CIR vs. Procter and Gamble PMC (160 SCRA 560 and 204 SCRA
377)

87

Procter and Gamble (Phil.) is a domestic corporation and a

wholly-owned subsidiary of Procter and Gamble (USA), a nonresident foreign corporation. Over a number of years, PCMCPhil. had paid income tax on its net income, and from the
remaining net profits, dividends were declared. An income tax
of 35% on the dividends were withheld by it and paid to the
BIR.
It invoked the tax-sparing credit provision of the NIRC, filed
a claim for refund of the 20% point portion of the 35% point
whole tax paid. The CTA ordered the refund. The SC ruled that
the preferential 15% tax is inapplicable to the case because of
the failure of the claimant to :
(1)show the actual amount credited by the US
Government;
(2)present the US income tax returns of PCMC-USA, the
parent company;
(3)submit a duly authenticated document evidencing the
tax credit of the 20% differential.
However, this case was reversed by the Supreme Court in
an en banc resolution (204 SCRA 377; Dec. 2, 1991) and ruled
on the applicability of the preferential 15% tax because it was
established that the NIRC does not require that the US tax law
deems the parent company to have paid the 20% of tax
waived by the Philippines. The NIRC only requires that the US
shall allow PCMC-USA deemed paid tax credit equivalent to
20%.
F. Taxes on Corporations
1)
Tax On Domestic Corporation (Sec. 27 of NIRC)
Except as otherwise provided in the Tax Code, Domestic
corporations duly organized and existing under the Philippine laws shall
be subject to the following tax rates based on their gross income
derived from sources within or without the Phils.
35% - for 1997 and prior years
34% - effective January 01, 1998
33% - effective January 01, 1999
32% - effective January 01, 2000

Proprietary Educational Institutions / non-profit hospitals - Except

those income subject to final tax, proprietary educational institutions/
non-profit are taxable with the tax rate of 10% on their gross income.
Proprietary Educational Institution means any private school
maintained and administered by private individuals or groups within
an issued permit from the DECS, CHED or TESDA.

Predominance Test / Preponderance Test means that if the gross

income from unrelated trade, business or other activity exceeds 50%
of the total gross income derived by any educational institution or
hospital from all sources the normal tax shall be imposed on the
entire taxable income.

Unrelated trade, business or other activity means any trade

business or other activity, the conduct of which is not substantially
related to the exercise or performance by such educational institution
or hospital of its primary purpose or function.

88

Article XIV Sec. 4 (3) of the Constitution provides that all revenues
and assets of non-stock and non-profit educational institution used
actually, directly and exclusively for educational purposes are exempt
from taxes and duties.

Government owned or controlled corporations (GOCCs) GOCCs,

agencies or its instrumentality shall pay applicable corporate income
tax rates except: GSIS, SSS, PHIC, PCSO and PAGCOR.
Specific Taxes Imposed on Domestic Corporations
(1.) Normal Corporate Income Tax (NCIT) - the tax rate of 32% (as
of Jan. 1, 2000) is imposed on any income derived, within and
without the Phils. Except on those passive income (Section 27
(A) NIRC)
(2.) Gross Income Tax Option - The President upon the
recommendation of the Secretary of Finance may, effective
January 1, 2000, allow corporations the option to be taxed at
fifteen percent (15%) of gross income provided that the following
conditions are met therein:
a. a tax effort ratio of 20% of GNP
b. a ratio of 40% of income tax collection to total tax revenues
c. a VAT effort of 4% of GNP and
d. a 0.9% ratio of the Consolidated Public Sector Final Position
(CPSFP) to Gross National Product (GNP)
Note:
1. The option to be taxed based on gross income shall be
available only to firms whose ratio of cost of sales to gross
sales or receipts from all sources does not exceed fifty-five
percent (55%).
2. The election of the gross income tax option shall be
irrevocable for three (3) consecutive taxable years during
which the corporation is qualified under the scheme.

Definition of Terms
Gross Income derived from business shall be equivalent to gross
sales returns, discounts and allowance and cost of goods.
Cost of goods sold shall include all business expenses directly
incurred to produce the merchandize to bring them to their present
location and use.
For trading and merchandising concern, Cost of goods sold shall
include the invoice cost of the goods sold, plus import duties freight
in transporting the goods to the place where the goods are actually
sold, including insurance while the goods are in transit.
For manufacturing concern, Cost of goods manufactured and sold
shall include all costs of production of finished goods, such as raw
materials used, direct labor and manufacturing overhead, freight
cost, insurance premiums and other costs incurred to bring the raw
materials to the factory or warehouse.
In sale of service, gross income means gross receipt less sales
returns, allowance and discounts.
(3.) Minimum Corporate Income Tax (MCIT) - a tax rate of 2% is
imposed on the gross income of domestic corporations and
resident foreign corporations.

89

Rationale:
MCIT is designed to forestall the prevailing
practice of corporation or over-claiming deductions in order to
reduce their income tax payments.
Requisites:
a. It is imposed beginning the fourth (4th) taxable year immediately
following the taxable yr. in which such corporation starts its
business operation.
b. It is imposable only if such corporation has zero or negative
taxable income or whenever the amount of MCIT is greater than
the Normal Corporate Income Tax (NCIT) due from such
corporation.

Carry Forward of Excess Minimum Tax

- any excess of the minimum corporate income tax (MCIT) over the
normal income tax shall be carried forward on an annual basis and
credited against the normal income tax for the three (3) immediately
succeeding taxable yrs.

Instances when MCIT may be suspended by the Secretary of Finance

- The Sec. of Finance, upon recommendation of the Commissioner
may suspend the imposition of MCIT, upon showing that the
corporation suffers losses due to any of the following causes:
a. Prolonged labor dispute (e.g. strikes for more than 6 months)
b. Legitimate business reverses (e.g. theft)
c. Force majeure (e.g. war)

Corporations not subject to MCIT

i. Proprietary Educational Institution if enjoys preferential tax rate
ii. Non-profit hospitals
iii. Depository banks under expended FCDU
iv. International carriers
v. Offshore Banking Units
vi. ROHQs of resident foreign corp.
vii. Other corporations not subject to the normal tax rate
(4.) Final tax on certain Passive Income
- refer to previous note
2) Tax on Foreign Corporations (sec. 28 of NIRC)
(a.) Resident Foreign Corporation Engaged in Trade or
business in the Phils. (RFC) - Foreign Corporations shall be
taxed on income derived from sources within the Philippines.
Tax Imposed on Resident Foreign Corporation (RFC)
(1.) NCIT - 32% effective Jan. 01, 2000 and thereafter
(2.) Gross Income Tax Option - 15% tax rate on gross income of
RFC is also applicable.
(3.) Minimum Corporate Income Tax (MCIT) - 2% based on gross
income is also applicable
(4.) Tax on Branch Profits Remittances - subject to 15% based
on the total profits applied or earmarked for remittance w/o
any deduction for the tax component thereof:
Except: Those activities registered w/ the PEZA;
interests dividends, rents and royalties; remuneration for
technical services, salaries, and wages; premiums,
annuities, emoluments; capital gains, profit and income.
(5.) Final tax on certain Passive Income - the same tax rates as
imposed to domestic corporation = is also applicable to RFC

90

except: the imposition of capital gain tax (6%) on sale of real

property (capital asset) located in the Phils.
Note: A different tax rate is imposed on the following RFCs
(a.) Intl carrier - 2 % on Gross Philippine Billing
o Intl air carrier = Gross Philippine Billings refer to the amount
of gross revenue from (a) carriage of persons, excess baggage
cargo and mail originating from the Phils. in a (b) continuous and
uninterrupted flight, irrespective of the place of sale or issue and
the place of payment of the ticket or passage document.
o Note: For a flight w/c originates from the Phils. but transhipment
of passenger takes place at any port outside the Phils., only the
aliquot portion of the cost of the ticket corresponding to the leg
flow from the Phils. to the point of transhipment shall form part of
the GPB.
o In International shipping, Gross Phil. Billing means gross
revenue whether for passenger, cargo or mail originating from
the Phils. up to the final destination, regardless of the place of
sale or payments of the passage or freight documents.
British Overseas Airways Corp. vs. CIR (149 SCRA 395)
- an international airline with no landing rights is
considered doing business in the Philippines
- Reasons:
a) Series of sale of transport documents (airline
tickets)
b) Continuity of commercial transactions
c) Appointment of an agent is an indication that it is
doing business in the Philippines
- Note: This BOAC doctrine is modified by RR 15-2002
insofar as the Tax Situs of transport documents is
concerned. RR 15-2002 provides that the sale of
transport documents is the origin of the passenger,
cargo, or excess baggage, irrespective of place of
sale and place of payment thereof
(b.)
Regional / Area Headquarters (RAHQs) - tax exempt
- These are branches established in the Phils. by a multinational
companies but they do not earn or derive income here and their
functions are limited to being a supervisory communication and
coordinating center for their affiliates.
(c.) Regional Operating Headquarters (ROHQs) - subject to 10% tax.
- These are branches established in the country by multinational
companies which are engaged in any of the following:
general administration & planning;
business planning
business development (and the like)
(d.) Offshore Banking Units authorized by Bangko Sentral ng Pilipinas
EXCEPT: RA 9294.
(b.) Non-Resident Foreign Corporations (NRFCNETB) - are
subject to 32% tax rate (effective Jan. 1, 2000 and thereafter)
on all income derived from sources within the Phils. except on
certain passive income (refer to Table #1).

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Note: NRFCs are not entitled to deduction as well as exemption

(personal and additional exemption)
IMPROPERLY ACCUMULATED EARNINGS TAX (IAET) (Sec. 29 NIRC)
Nature and Purpose: The improperly accumulated earning tax of
10% in addition to the regular corporate income tax shall apply to every
corporation formed or availed for the purpose of avoiding of any other
corporation by permitting earnings and profit to accumulate instead of
being divided or distributed.

The term Improperly accumulated taxable income means taxable

income adjusted by:
1) Income exempt from tax
2) Income excluded from gross income
3) Income subject to final tax
4) The amount of NOLCO deducted and reduced by the sum of:
a) Dividends actually or constructively paid and
b) Income tax paid for the Taxable year.

Formula:
Taxable income
Add: Income exempt from tax
Income subject to final tax
Income excluded from gross income
Amount of NOLCO deducted
Less:
Dividends actually or constructively paid
Income tax paid for the yr.
Improperly accumulated Taxable Income

Improperly Accumulated Earnings Tax does not apply to the following:

1) Banks and other non-banks financial intermediaries
2) Publicly held corporations
3) Insurance companies

Presumptions of Improper accumulations - There is a prima facie

evidence of a purpose by a corporation to avoid the tax upon its
shareholders or members:
1) Where the corporation is a mere holding company.
2) Where the corporation is an investment company where more than
50% of its outstanding stock is owned directly/ indirectly by one
person during the taxable year.
3) Where the corporation permits its earnings or profits to be
accumulated beyond the reasonable needs of the business.
Reasonable needs of the business includes the reasonably anticipated
needs of the business e.g. investment of corporations profits in a
business related to taxpayers business.

Purpose: To compel the corporations to distribute dividends to the

stockholders (subject to dividend tax)

Instances of Reasonable Accumulations:

1) It is retained for working capital needed by the business
2) It is invested in addition to plant property and equipment
reasonably by the business
3) In accordance with contract obligations, it is placed to the credit of
a sinking fund for the purposes of retiring bonds issued by the
corporation.

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a. Cyanamid Phils. vs. CA (January 20, 2000)

If the CIR determined that the Corporation avoided the tax
on shareholders by permitting earnings or profits to accumulate,
and the taxpayers contested such a determination, the burden of
proving
the determination
wrong,
together
with
the
corresponding burden of first going forward with evidence, is on
the taxpayer. This applies even if the corporation is not a mere
holding or investment company and does not have an
unreasonable accumulation of earnings or profits.
In order to determine whether profits are accumulated for
the reasonable needs of the business to avoid the surtax upon
shareholders, it must be shown that the controlling intention of
the taxpayer is manifested at the time of accumulation, not
intentions declared subsequently, which are mere afterthoughts.
Also, the accumulated profits must be used within a reasonable
time after the close of the taxable year. Petitioner did not
establish, by clear and convincing evidence that such
accumulation of profit was for the immediate needs of the
business.
In 1981, the working capital of Cyanamid was more than
twice its current liabilities, projecting adequacy in working
capital. Available income covered expenses or indebtedness for
that year, and there appeared no reason to expect an impending
'working capital deficit' which could have necessitated an
increase in working capital, as rationalized by petitioner.
Furthermore, Under Section 25 of the 1977 NIRC, as
amended, the following corporations exempt from the imposition
of improperly accumulated tax: (a) banks; (b) non-bank financial
intermediaries; (c) insurance companies; and (d) corporations
organized primarily and authorized by the Central Bank of the
Philippines to hold shares of stocks of banks. Petitioner does not
fall among those exempt classes.
G. Exempt Organizations and Corporations (Sec. 30 of NIRC)
The following shall not be taxed in respect to income received by them:
1. Labor, agricultural or horticultural organization not organized
principally for profit.
2. Mutual savings bank not having a capital stock represented by shares
and cooperative banks w/o capital stock organized and operated for
mutual purposes and without profit.
3. A beneficiary society or association operating for exclusive benefit of
the members or a mutual aid association or non-stock corporation
organized by employees providing benefits exclusively to its members
or their dependents.
4. Cemetery company owned and operated for the exclusive benefits of
its member
5. Non-stock corporation or association organized and operated
exclusively for religious, scientific, athletic, or cultural purposes, or for
the rehabilitation of veterans, no part of it net income or asset shall
belong to or inure to the benefit of any member, organizer, or officer
or any specific person
6. Business league chamber of commerce, or board of trade not
organized for profit and no part of the net income of which inures to
the benefit of any private stockholder or individual
7. Civic league or association not organized for profit but operated
exclusively for the promotion of social welfare
8. A non-stock and non-profit educational institution.
All revenues and assets of non-stock, non-profit educational
institutions used actually, directly, and exclusively for educational

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purposes shall be exempt taxes and duties. [Article XIV Section 4(3),
1987 Constitution.]
9. Farmers fruit growers or like organization organized and operated as
sales agent for the purpose of marketing the products of its member.
10. Farmers or other mutual typhoon or fire insurance company or like
organization of a purely local character, the income of which consists
solely of assessment, dues and fees collected from members for the
sole purpose of meeting its expenses.
11. Government educational institution
Income of whatever kind and character of the foregoing organizations
from any of their properties, real or personal or from any of their activities
conducted for profit regardless of the disposition made of such income
shall be subject to tax.
H. Tax Returns And Other Administrative Requirements
i.

Who are required to file

a. Corporation subject to tax having existed during the taxable
year, whether with income or not
b. Corporation in the process of liquidation or receivership
c. Insurance company doing business in the Philippines or deriving
income therein
d. Foreign corporation having income from within the Philippines
e. Those exempt from income tax under Section 30 of the NIRC but
has not shown proof of exemption

ii.

What and when to file

Quarterly returns on the first three quarters to be filed within 60
days after the close of the quarter basis and the final or adjusted
return on the 15th day of the fourth month following g the close of
the fiscal or calendar year.

iii.

When to pay
Pay as you file system. The tax subject of the return should be
paid within same time the return is filed.

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95

Rates and Tax base on Corporate Taxpayers in General Taxpayers

Taxes Imposed

1.) Normal Corporate Income Tax

(NCIT)
2.) Minimum Corporate Income Tax
(MCIT)
3.) Branch Remittance Tax
4.) Improperly Accumulated Earning
Tax (IAET)
5.) Passive Incomes (Final tax)
a. Interest
Peso bank deposits
- Foreign Currency Deposit Units
b. Royalties
c. Capital gains from sales of share of
stock not traded in the stock
< P100k
> P 100k
d. Income of a depository bank under
Foreign Currency Deposit Units
e. Capital gains from sale of real
property situated in the Phils.
(capital assets)

f. Interest on foreign loan

g. Intercorporate dividends

(Tax Rates and Tax Base)

Domestic Corp.
RFC
Net income
Net Income
32% (Jan. 1, 2000)

32%

2%

2%

NRFC
Gross
Income
32%

15%
10%

10%

10%

20%
7.5%
20%

20%
7.5%
20%

exempt

5%
Exempt (RA 9294)

5%
Exempt (RA
9294)

10%

10%

6%
10%
exempt

10%
exempt

5%
Exempt (RA
9294)

20%
15%

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