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Part 3 Barlis 1

1. It will be recognized as income during the year of receipt

2. Y will have to surrender to X the building after 10 years

3. Out of a mere parcel of land, he became the owner of the building

4. The income is to be declared for taxation purposes using 2 methods


(1) outright method

whatever is the FMV at the time of completion will be declared as an income

one time recognition

(2) spread out method

get the estimated value of the building at the end of the lease term

whatever is the estimated value of the building at the end of the lease term
will be spread out during th term of the lease

5. Principles about allowable deduction


(1) partake the nature of exemption, and therefore construed strictly against the taxpayer
(2) granted merely by virtue of legislative grace
6. Optional standard deduction
(1) option to claim a standard deduction
(2) the rate is fixed
(3) it is the tax payer who should indicate if he is availing, because by default, the taxpayer
is claiming itemized
(4) by default, it is itemized
(5) RA 9504 PSD
(6) can be claimed now not only by individual but also by corporation
(7) if the taxpayer is an individual, it is 40% of the gross sale
(8) if the taxpayer is a corporation, it is 40% of the gross income

(9) Under the old OSD, for individuals it is 10% of the gross income only

Now, it has been tremendously increased to 40%, and even based on gross sale

But for corporation, it is 140% of the gross income

(10) Gross sale 1M; Cost 600k; Gross income 400k

Individual tax payer

40% of 1M = 400k
Income is 0, no liability for taxes

Corporate taxpayer

40% of 400k = gross income


160K optional standard deduction

NET income = 440k which is subject toi 30% tax rate

(11) If the taxpayer claims the OSD, that means that he is waiving to claim the itemized

Optional is in lieu of the itemized deductions

7. If the taxpayer does not want the OSD, then he can claim the itemized, for as long as the
taxpayer is entitled to a deduction

Only taxpayers who are engaged in trade or business or practice of profession, are the ones
allowed to claim a deduction
8. ITEMIZED DEDUCTION (Sec 34)

(1) Bad debts


(2) Interest
(3) Taxes
(4) Expenses
(5) Depreciation
(6) Depletion
(7) Losses
(8) Charitable contribution
(9) Pension trust
(10)Research and development cost

B-I-T-E D-D-L C-P-R

These are the various kinds of itemized deductions

9. Expenses

(1) Ordinary and necessary business expenses

(2) Ordinary those that are reasonably incurred in connection with business

(3) Necessary those that have the tendency of reducing cost or expenses or increasing
profits

(4) Ordinary
1)salaries and wages of employees
2)water
3)administrative expense

(5) Business expense vs Capital expenditure


1) Renting office space, but constructed own office building and spent 20M. Is
that a business expense?

No. Because it is classified as capital expenditure

Capital expenditure are not business expenses

Capital expenditures are those extraordinary expenses where the benefit of the
taxpayer will be felt for more than 1 year

2)Construction of a building
3)Permanent improvements
4)Purchasing of machineries
5)Equipments, furniture, fixtures
6)Delivery trucks

Capital expenditures are not business expense. These are considered as assets of the
taxpayer

As assets of the taxpayer, they are not treated as expenses.

What to do with them is that, if they are depreciable, then subject them to depreciation
expenses

But they are never treated as outright business expense

A capital expenditure may be treated as a business expense

This is with respect to proprietary educational institutions

They can declare as outright business expense their capital expenditure if the capital
expenditure is for the purpose of school expansion

If the capital expenditure is for the purpose of school expansion, then the capital
expenditure may be treated as business expense of a proprietary educational institution
(6) Advertising expenses

Are they business expenses or capital expenditure?

Kraft said that advertising tends to increase profit, and therefore should be treated as
business expense

SC said that if it is an ordinary advertising, then it is a business expense. But if the


amount is so heavy, that it created goodwill on the product, and the goodwill created by
the advertisement can be felt by the taxpayer for not just one taxable year but for
several taxable year, then the advertising expense is not anymore an outright business
expense. It is to be considered as a capital expenditure. It must therefore be capitalized
and it must be amortized during the years for which the benefits should be felt

10. Interest

(1) Interest expenses may be deductible if the interest is:


1)On a loan for business purposes
2)That is in writing
3)The agreement to pay interest must also be in writing
4)The loan must be valid and subsisting indebtedness

It should not be one that has already prescribed

11. Bad debts

(1) it should be one that is already worthless

it is not just something that is estimated to be worthless, but it must be something that
is proven to be worthless

Exert all reasonable efforts of collection

Despite reasonable efforts of collection, there is no collection, then that can be


considered as bad debt
The claim for bad debt must be substantiated. It must be proven that the amount is
really worthless

12. Taxes

(1) it is deductible if the taxes is in connection with the taxpayers trade or business or the
practice of profession

(2) But the following taxes are not deductible

1)income tax
2)estate or donors tax
3)special assessment

This is the special assessment in the local government code

(3) CIR vs Central Luzon Drug Corporation

Is a tax as a credit, the same as a tax by way of a deduction?

No

Under the old Senior Citizens Law, the discount was granted as a tax credit

Under the new Senior Citizens law, the discount now is a tax deduction

They are not the same

GI AD = NI
NI x TR% = TD

TD TC = NIT

Tax as a deduction here is part of allowable deduction


Tax as a credit is from tax, deduct tax credit

These two cannot be interchanged

If one does not have income, then tax credit will be useless

Because the tax credit is to be removed from a tax liability

If there is no tax liability, then tax credit will be useless

But if it is tax as a deduction, what will be affected will be the determination of the net
income

If GI is 10M and the allowable deduction is 15M, and tax as a deduction amounts to 5M.
So the total allowable deduction is 20M. the effect is that there will be net loss
amounting to 10M pesos

Still, one will not be liable for tax


The tax will be zero

But because there is a net loss, one can avail of the principle of the net operation loss
carry over

This is the big difference between tax as a deduction, and tax as a credit

13. Depreciation

(1) it is the estimated amount of the normal wear and tear of an asset

(2) There are various modes of depreciating an asset


1)straight line method
2)sum of the years digits method
3)declining balance method

These are allowable modes of depreciating asset

(3) If one has an asset, and one is using it, its value is diminishing by reason of its use
(4) Lands do not diminish in value by reason of its use. So, one does not depreciate land

(5) Brain is not diminished by reason of its use

14. Depletion

(1) Similar to depreciation, only that in depletion, it is applicable to taxpayers involved in


wasting assets

(2) wasting asset corporations are those engaged in extraction or utilization or exploitation
of natural resources

Oil for example, is normally, not replenished

Whenever oil is extracted, it is not immediately replenished

So whenever one extracts oil, his deposit of oil in a particular place is depleted. And that
is the reason for the deduction

Because he is depleting natural resource, it will be recognized as a depletion expenses

15. Losses

(1) Various kinds of losses under NIRC

1)Ordinary loss
2)Capital loss

(2) Ordinary loss is a loss arising from a dealing with an ordinary asset

(3) Capital loss is a loss arising from a dealing with a capital asset

(4) Ordinarily assets are capital assets

Assets are normally capital assets.


It is only ordinary when it falls under any of the following circumstances

And this list is exclusive

1) stocks in trade

2) properties included in the inventory of a taxpayer

3)properties held for sale in the ordinary course of business

4)real properties used in business

5)properties subject to depreciation which are used in business

If the property does not fall in this list, it is capital asset

(5) Those in the warehouse intended for sale are ordinary assets

(6) Raw materials are included in ordinary assets

(7) It is not true that a if a property arises by being in a business, it is already ordinary

If a taxpayer has accounts receivable, by being engaged in a business

They have receivables because they are allowing purchase by credit

The receivables are capital assets

They are capital because they will not fall under any of the items mentioned

(8) Capital loss vs ordinary loss

An ordinary loss is part of the allowable deduction

A capital loss _____

If a taxpayer has a gross income of 10M, and AD amounting to 5M


Then there is a loss of 5M

The 5M loss, because it is a loss arising from business, is called operating loss

The operating loss is different from an ordinary loss

Because an ordinary loss is part of AD

It is a specific item of the loss by reason of dealing with an ordinary asset

If one has a delivery truck, and it is worth 1M, and it was sold for 800k, there was a loss
of 200K, that is an ordinary loss, and that will form part of the AD

But the accumulated AD in excess of the Gross income, is classified as the operating loss

If the taxpayer has an operating loss, the taxpayer is not normally liable for tax, because
anyway taxpayer suffered loss

The operating loss of 5M, may lead to a possible claim for a net operating loss carry over

The net operating loss of a taxpayer may be carried over as a deduction from the gross
income for the next 3 succeeding taxable years

(9) The 5M operating loss can be claimed as a deduction in the succeeding years

It can reduce the tax liability in the succeeding years

(10) Rules in NOLCO


1)losses from a tax exempt line, cannot be used as a deduction from a non tax
exempt line

2)losses during the year a tax payer is exempt, cannot be removed from gains
during that year when the tax payer is taxable

Suppose in 2101, the taxpayer is exempt, and in 2012 he became taxable


Here, the tax payer cannot claim the applicability of NOLCO

Because if the loss was incurred during the year a tax payer is exempt, that
cannot be claimed as a deduction during the year when he became taxable

3) 75% interest retention rule

X corporation always gaining


Y corporation always losing

Y has in its book has operating losses amounting to 1M

If X and Y corporation merged, with X as surviving, then X will acquire and


assume all obligation of Y corporation

Can X claim the NOLCO rule, because that is a right of the dissolving corporation
which by reason of the merger was transferred to X corporation?

No

Tax code imposes the 75% retention rule

That means that there must be no substantial change in the ownership or


business of the enterprise, in that not more than 75% of the ownership of the
corporation holding the operating losses should be changed

Meaning, at least 75% of the ownership of Y corporation should be maintained


in the surviving corporation X

If X company is owned by A, B, C, D and E equally (20%)

And Y is owned by A B C D F G, each owning 20%

They merged

Y has operating loss of 100M

X is the surviving corporation


The new X corporation will have the following percentage of ownership:

A, B, and C, each with 20 %

D owns 15 percent

E owns 15 percent
F owns 5 percent
G owns 5 percent

The 75% interest retention rule

No compliance with the 75% interest retention rule A B C D F G ownership is


only 70%

There is no compliance.
The new X corporation cannot claim the application of the NOLCO rule

(11) Capital losses


1) in connection with capital gains and losses

Rules
1) 6% of the selling price of FMV whichever is higher

2) sale of shares not listed in the stocks exchange

The tax is 6% based on the gain of the taxpayer

If the gain does not exceed 100k, the tax shall be 5%

If it is in excess of 100k, then it the tax will be 10%

3) Apply only the first 2 rules if the property is a real property or a share of
stock

If they are not real property or share of stock, then apply the following
special rules:
4) Special rules
1) loss limitation rule
2) holding period rule
3) net capital loss carry over rule

5) Loss limitation rule

Capital losses are deductible from capital gains only

One cannot deduct a capital loss from an ordinary gain

Taxpayer sold personal ring, he is not engaged in the business of rings

Selling price is 1M
Cost to him is 1.5 million

There is a loss
The loss is 500k, it is a capital loss

During this year, he has a gross income of 10M

Allowable deduction 9m
Can the capital loss in the ring cannot affect the net income of 1M

Because it will violate the loss limitation rule

It cannot be deducted from ordinary income

6) Holding period rule

If the asset has been held for short term holding period, any gain or loss shall
be recognized at the extent of 100%

But if it is for a long term period, any gain or loss will be recognized only to the
extent of 50%

A short term period is any period not exceeding 1 year

A long term period is any period exceeding 1 year


If the GI is 10 M
AD is 9M
NI is 1M

Capital transactions:
Short term CG 3M
Long term CL 5M

A short term capital will be recognized to the extent of 100%

A long term will be recognized to the extent of 50%

So one will recognize 2.5M

3M CG - 2.5 CL = 500k net capital gain

The capital gain of 500k will be added to the gross income

In other words, the net income will be 1.5 million

That will be the effect, in connection of the holding period

7) Net capital loss carry over rule

NCLCO

Under this rule, whatever is the net capital loss of the taxpayer during the
year, which cannot be removed from his ordinary income, by reason of the
loss limitation rule, may be carried over as a deduction from the capital gains
during the next succeeding taxable year (1 year only), in an amount not to
exceed the taxable income during the year the loss was sustained

2011
GI 10M
AD 9M
NI 1M

Capital transactions:
Short term capital gain 2M
Long term capital loss 8M
Short term capital gain will be recognized to the extent of 100%, so that is 2M

Long term capital loss will be recognized to the extent of 50%, so that is 4M

So have a net capital loss of 2M

Will this net capital loss affect the liability of tax with respect to the income of
1M?

No, because of the loss limitation rule

The liability during year loss was incurred will still be based on 1M net income

But on the succeeding year:


2012
GI 15M
AD 10M
NI 5M

CT:
STCG 2M
LTCL - 0
NCG = 1M (because the 1M LTCL from previous year was deducted)

There will be a net capital loss carry over

He cannot carry over the entire 2M

The carrying over as a deduction is an amount not to exceed the taxable


income during the year the loss was sustained. Meaning the 2M cannot be
carried over as a deduction in its entirety because the taxable income during
the year the loss was sustained is only 1M

So the net capital loss carry over shall be limited only to 1M pesos

So we will have a net capital gain amounting to 1M pesos

Net capital gain of 1M will be added to the gross net income of 15M

Therefore, the taxable income shall be 6M


8) These rules (3 rules above) are applicable if the tax payer is an individual
income tax payer

If it is a corporate tax payer, only the loss limitation rule will apply

The holding period rule, and the net capital loss carry over rule is not
applicable to corporate taxpayer

9) X bought a house and lot in LA. He bought it in year 2000 in the amount of
10M. In 2010, the property he sold it for 20M.

He is a resident of the Philippines

What is the effect of this in connection with the tax liability of X during this
year?

Is there an inclusion in his income?

Selling price 20M


Cost 10 m
Gain = 10M

It will not be subjected to CPG of 6% of gross selling price or FMV whichever is


higher.

This is because the parcel of land is not here in the Philippines

It will violate the principle of territoriality

It is still a gain

Applying the holding period rule, we recognize only 50%

What is to be included in the gross income of X is 5M


16. GI AD = NI

NI (tax treatment between individual and corporate taxpayer are different)

Individual taxpayer:

After the NI, there is need to reduce tax base of a taxpayer by reason of his personal exemptions

That would be:

Either a basic personal exemption or additional exemption

A basic personal exemption is the amount equivalent to the basic subsistence of a person

Meaning, with that amount one can survive a minimum or basic subsistence

The amount of basic personal exemption under RA 9504 is 50,000

Whether single or married


If married, then 50k each
Working or not working

Additional exemption is by having a qualified dependent child or children

It is in the amount of 25k per child, maximum of 4

If 4 children, then that is 100k exemption

That is why having children is a form of tax avoidance

But take note of the consequences of this tax avoidance mechanism

For spouses, it is the husband who can claim the additional exemption

Except, if the husband waives, or if he is not earning anything, or the husband is earning those
amounts that is already excluded by taxation

Then under those circumstances, then it is the wife who can claim the additional exemption
But it cannot be both the husband and the wife. Only one will be able to claim

For those who are not married, if one has a qualified dependent child, then he can claim an
additional exemption

A qualified dependent child is:


1) a child of the taxpayer,
2) who is living with the taxpayer
3) and dependent upon the tax payer for chief support

4) not married
5) not gainfully employed
6) not over 21 years of age

Those who are over 21 are no longer qualified, unless the child is physically and mentally
unable of rendering self support

If a child was born almost at the end of the year, is he qualified to be a dependent for the
entire year?

Yes

If he dies during the year, is he still qualified?

Yes

If the child marries during the year, he is still qualified

But the following year, the child is not already qualified

Those changes that are favorable to the taxpayer will immediately be considered.
But those changes that are not favorable to the taxpayer will not yet be considered on that year
that it has taken place. It will be considered the following year

This is the general rule

But there are exceptions

The general rule is founded on Sec 35c of the NIRC


Anything that is not governed by Sec 35c of the NIRC will follow this rule:

Whatever is the status at the end of the year, shall be determinative of the qualification

17. Requirements not affected by Section 35C

(1) living with


(2) dependent upon the taxpayer for chief support

change in the residence of the dependent

change in the person giving chief support

If X and Y are not married, and their child is A, and at the beginning of the year, A is residing with
A. But there was an agreement that A will permanently reside now with Y

During this year, can X claim A as a dependent?


No more.

Because there is now a change in the residence of the dependent

He is not anymore living with the taxpayer

We did not apply the rule that favorable changes are considered and unfavorable changes are
not yet considered (Sec 35c)

This is because it is a situation not found in 35c (that the taxpayer marries, or should have
additional dependents)

From NI PE = TI
From TI, apply the rates in the tax code

Corporate taxpayer

If the corporation is an ordinary taxpayer, subject to the normal tax rate, multiply it with 30%
and that is the tax liability of the corporation

part 4 Barlis

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