Revenue Regulations 02-40 Page 1 of 40

REVENUE REGULATIONS NO. 02-40 80,000 90,000 10,000 48% 4,800 32,080
90,000 100,000 10,000 50% 5,000 37,080
February 10, 1940
100,000 120,000 20,000 52% 10,400 47,480
120,000 140,000 20,000 53% 10,600 58,080
INCOME TAX REGULATIONS 140,000 160,000 20,000 54% 10,800 68,880
160,000 200,000 40,000 55% 22,000 90,880
SECTION 1. Scope. In accordance with the provisions of Sections 4 (I) and 338 of 200,000 250,000 50,000 56% 28,000 118,880
Commonwealth Act No. 466, otherwise known as the National Internal Revenue Code, the following 250,000 300,000 50,000 57% 28,500 147,380
regulations affecting Sections 19 to 84 of the same Code relating to the income tax are hereby 300,000 400,000 100,000 58% 58,000 205,380
promulgated to supersede all circulars, precedents, rulings, and regulations heretofore published on 400,000 500,000 100,000 59% 59,000 264,380
the same subject, and they shall be known as Revenue Regulations No. 2, or the Income Tax 500,000 - - 60% - -
Regulations: Note: Taxable income is arrived at after deducting personal and additional exemptions to which
taxpayer is entitled.
(Only the section numbers of the Code are given below as their texts will be found in the same Code. (Section 22 of the Code)
They serve as captions of the pertinent provisions of the Regulations.)
(Section 20 of the Code) SECTION 5. Definition. A "non-resident alien individual" means an individual
(a) Whose residence is not within the Philippines; and
SECTION 2. Application of title. Section 20 provides that the provisions of Title II of the National (b) Who is not a citizen of the Philippines.
Internal Revenue Code shall apply only to income received from January 1, 1939.
(Section 21 of the Code) An alien actually present in the Philippines who is not a mere transient or sojourner is a resident of the
Philippines for purposes of the income tax. Whether he is a transient or not is determined by his
SECTION 3. Persons considered citizens of the Philippines. The following shall be considered intentions with regard to the length and nature of his stay. A mere floating intention indefinite as to
citizens of the Philippines: time, to return to another country is not sufficient to constitute him a transient. If he lives in the
(1) Those who were citizens of the Philippines at the time of the adoption of the Constitution of the Philippines and has no definite intention as to his stay, he is a resident. One who comes to the
Philippines. Philippines for a definite purpose which in its nature may be promptly accomplished is a transient. But
(2) Those born in the Philippines of foreign parents who, before the adoption of the Constitution, had if his purpose is of such a nature that an extended stay may be necessary for its accomplishment, and
been elected to public office in the Philippines. to that end the alien makes his home temporarily in the Philippines, he becomes a resident, though it
(3) Those whose fathers are citizens of the Philippines. may be his intention at all times to return to his domicile abroad when the purpose for which he came
(4) Those whose mothers are citizens of the Philippines and, upon reaching the age of majority, has been consummated or abandoned.
elect Philippine citizenship.
(5) Those who are naturalized in accordance with law. (Sec. 1, Article IV, Constitution of the SECTION 6. Loss of residence by alien. An alien who has acquired residence in the Philippines
Philippines.) retains his status as a resident until he abandons the same and actually departs from the Philippines.
Philippine citizenship may be lost or reacquired in the manner provided by law. A foreigner who has An intention to change his residence does not change his status as a resident alien to that of a
come to reside in the Philippines and has filed his petition to acquire Philippine citizenship but has not nonresident alien. Thus an alien who has acquired a residence in the Philippines is taxable as a
yet received the requisite naturalization certificate still remains an alien. resident for the remainder of his stay in the Philippines.

SECTION 4. Tax on citizens and residents. Section 21 imposes progressive rates of income SECTION 7. Taxation of aliens in general. For purposes of income tax, alien individuals are
taxes on citizens and residents, starting from 3 per cent upon the amount by which the net income divided generally into two classes, namely, resident aliens and non-resident aliens. Resident aliens
does not exceed P2,000 and rising gradually to 60 per cent upon the amount by which the net income are taxable in the same manner as citizens of the Philippines, that is, a resident alien is taxable on
exceeds P500,000. (Conforms with amendments by R.A. 2343, effective June 20, 1959.) income derived from all sources including sources without the Philippines. Non-resident aliens are
The following is a table, showing the rates of income tax under Section 21, as amended by Section 1 taxable only on income from sources within the Philippines.
of R.A. No. 2343, applicable to income received from Jan. 1, 1959 and for fiscal periods ending after
June 30, 1959: SECTION 8. Taxation of non-resident aliens; classification. Non-resident alien individuals are
divided into two classes: (1) Those engaged in trade or business within the Philippines, and (2) those
1 2 3 4 5 6 not engaged in trade or business within the Philippines. Non-resident aliens falling within the first
Exceeding Not Bracket Rate Tax on Each Cumulative class are subject to the graduated rates established in Section 21 with respect to their net income
Exceeding of Tax Bracket Amount of Tax from sources within the Philippines. Non-resident aliens falling within the second class are subject to
P- P2,000 2,000 3% P60 P60 a flat rate of 20 per cent on their total income from sources within the Philippines, if such total income
2,000 4,000 2,000 6% 120 180 does not exceed P23,800, otherwise, the graduated rates established in Section 21 will apply to the
4,000 6,000 2,000 9% 180 360 total income if it exceeds P23,800. (Conforms with amendments by R.A. 2343, effective June 20,
6,000 8,000 2,000 16% 320 680 1959.)
8,000 10,000 2,000 20% 400 1,080
10,000 20,000 10,000 24% 2,400 3,480 The phrase "engaged in trade or business within the Philippines" includes the performance of
20,000 30,000 10,000 30% 3,000 6,480 personal services within the Philippines. Whether a non-resident alien has an "office or place of
30,000 40,000 10,000 36% 3,600 10,080 business," however, implies a place for the regular transaction of business and does not include a
40,000 50,000 10,000 40% 4,000 14,080 place where casual or incidental transactions might be, or are, effected. Neither the beneficiary nor
50,000 60,000 10,000 42% 4,200 18,280 the grantor of a trust, whether revocable or irrevocable, is deemed to be engaged in trade or business
60,000 70,000 10,000 44% 4,400 22,680 in the Philippines or to have an office or place of business therein, merely because the trustee is
70,000 80,000 10,000 46% 4,600 27,280 engaged in trade or business in the Philippines or has an office or place of business therein. (Test of
Revenue Regulations 02-40
"office or place of business" was deleted by R.A. 2343.)
(Section 23 of the Code)
SECTION 9. Personal exemption. Personal exemption is an arbitrary amount allowed for
personal, living, or family expenses of the taxpayer. It is allowed to citizens of the Philippines, to
resident aliens, and to non-resident aliens in certain cases. The procedure of arriving at the tax due
after giving effect to the exemptions allowable is set forth in Section 4 of these regulations. EHcaDT
SECTION 10. Personal exemption of single individuals. A single individual is entitled to a personal
exemption of P1,800.
SECTION 11. Personal exemption of married persons and heads of family. A married person is
entitled to a personal exemption of P3,000. Only one exemption of P3,000 is allowed with respect to
the aggregate income of both husband and wife. (Conforms with amendments by R.A. 2343, effective
June 20, 1959.)
A head of family is an individual who actually supports and maintains in one household one or more
individuals, who are closely connected with him by blood relationship, relationship by marriage, or by
adoption, and whose right to exercise family control and provide for these dependent individuals is
based upon some moral or legal obligation. In the absence of continuous actual residence together,
whether or not a person with dependent relatives is a head of a family within the meaning of the
statute must depend on the character of the separation. If a father is absent on business, or a child or
other dependent is away at school or on a visit, the common home being still maintained, the
additional exemption applies. If, moreover, through force of circumstances a parent is obliged to
maintain his dependent children with relatives or in a boarding house while he lives elsewhere, the
additional exemption may still apply. If, however, without necessity, the dependent continuously
makes his home elsewhere, his benefactor is not the head of a family, irrespective of the question of
support. A resident alien with children abroad is not thereby entitled to credit as the head of a family.
Chief support means principal or main support. Partial support not amounting to chief support will not
entitle the taxpayer to claim exemption as a head of a family.
Under the law the following persons are entitled to P3,000 exemption: (a) a married man; (b) a
married woman; and (c) an unmarried man or woman with one or both parents, or one or more
brothers or sisters, or one or more legitimate, recognized natural, or adopted children living with and
dependent upon him or her for their chief support, where such brothers, sisters, or children are not
more than 23 years of age, unmarried and not gainfully employed or where such children are
incapable of self-support because mentally or physically defective. (Conforms with amendments by
R.A. 2343, effv. June 20, 1959.)
SECTION 12. Additional exemption for dependents. The taxpayer is entitled to an additional
exemption of P1,000 for each legitimate, recognized natural, or adopted child wholly dependent upon
and living with such person, if such dependent is not more than 23 years of age, unmarried and not
gainfully employed or incapable of self-support because mentally or physically defective, provided that
the person claiming additional exemption is a head of family. The children with respect to whom
additional exemption is claimed must be wholly dependent upon the taxpayer for support. (Conforms
with amendments by R A. 2343, effv. June 20, 1959.)
SECTION 13. Change of status. If the status of the taxpayer, insofar as it affects the personal and
additional exemptions, changes during the taxable year by reason of his death, the amount of the
personal and additional exemptions shall be apportioned, in accordance with the number of months
before and after such change. For the purpose of such apportionment, a fractional part of a month
shall be disregarded unless it amounts to more than half a month in which case it shall be considered
as one month. (Conforms with amendment by R.A. 590, effv. Sept. 22, 1950.)
SECTION 14. Personal exemption of non-resident aliens. A non-resident alien is entitled to a
personal exemption in an amount equal to the exemptions allowed by the income tax law in the
country of which he is a citizen or subject to citizens of the Philippines. The exemption allowed to non-
resident aliens is a reciprocal one; that is, it is only allowed if the country of said non-resident aliens
allows similar exemptions to Filipinos not residing in such country but deriving income from sources
Page 2 of 40
therein. If the country of which the non-resident alien is a citizen or subject does not have any income
tax law, such non-resident alien will not be entitled to personal exemption.
(Section 24 of the Code)
SECTION 15. Income tax on corporations. The law imposes an annual income tax of 22 per
centum upon that portion of the net income of every corporation not in excess of P100,000 and 30 per
cent on the excess. The term "corporation" includes partnership no matter how created or organized,
joint-stock companies, joint-account (cuentas en participacion), association, or insurance companies
but does not include duly registered general co-partnership (companias colectivas). The tax is upon
net income, which is undetermined by subtracting from the gross income, as defined in the law, the
allowable deductions. (Conforms with amendments by R.A. 2343, effv. June 20, 1959.)
SECTION 16. Corporations liable to tax. Every corporation, domestic or foreign, not otherwise
exempt from tax under Title II or any other law, is liable to tax. A domestic corporation is taxed on its
income from sources within and without the Philippines, but a foreign corporation is taxed only on its
income form sources within the Philippines.
The tax imposed by law on corporations is not imposed only upon such corporations as are organized
and operated for profit. Any corporation, firm or association, no matter how created or organized, or
what the purpose of its organization may be, is subject to the tax, except as provided in Section 27,
relative to exemptions from tax on corporations. A corporation is not exempt simply and only because
it is primarily not organized and operated for profit.
SECTION 17. Dividends received by a corporation from a domestic corporation. Dividends
received by a domestic or resident foreign corporation from a domestic corporation subject to tax are
taxable only to the extent of 25 per cent thereof. All other classes of income (except net capital gains,
Section 34) of corporations are taxable in full. Likewise dividends from a foreign corporation, whether
resident or non-resident, are taxable in full. (See Sections 250 to 256 of these regulations relative to
taxation of dividends and other distributions.)
SECTION 17-A. Tax on life insurance companies. Every life insurance company organized in or
existing under the laws of the Philippines, or foreign life insurance company authorized to carry on
business in the Philippines are taxable on their total net investment income derived from interest,
dividends and rents from all sources whether within or without the Philippines, to the flat rate of 6-
1/2%. However, purely cooperative insurance companies or associations which are conducted by the
members thereof with the money collected from among themselves and solely for their own protection
and not for profit are exempt from income tax.
The total net investment income of domestic life insurance companies means the gross investment
income received during the taxable year from rents, dividends and interest less deductions for real
estate expenses, depreciation, interest paid within the taxable year on its indebtedness except on
indebtedness incurred to purchase or carry obligation the interest upon which is wholly exempt from
taxation under existing laws, and such investment expenses paid during the taxable year as are
ordinary and necessary in the conduct of its investment. The total net investment income of foreign
life insurance companies doing business here is that portion of their gross world investment income
which bears the same ratio to such income as their total Philippines reserve (whether kept in the
Philippines or abroad) bears to their total world reserve less that portion of their total world investment
expenses which bears the same ratio to such expenses as their total Philippine investment income
bears to their total world investment income. The following equation simplifies this formula:
PGI = PR/WR x WGI
PIE = PGI/WGI x WIE
PGI - PIE = PNI
Legend:
PGI is Philippine Gross Investment Income
PNI is Philippine Net Investment Income
PR is Total Philippine Reserve
WR is Total World Reserve
WGI is World Gross Investment Income
Revenue Regulations 02-40
PGI is Philippine Gross Investment Income
WIE is Total World Investment Expenses
PIE is Philippine Investment Expense
In both cases, the deductible expenses must be connected with the investment income subjected to
tax. For the proper determination of the income tax liability of resident foreign life insurance
companies, they should submit the necessary financial statement reflecting the nature of the
investment income and corresponding expenses. These financial statements must be duly certified by
an independent certified public accountant and authenticated by a Philippine consular official.
Foreign life insurance companies not doing business in the Philippines are subject to the normal
income tax on their income received from sources within the Philippines. They are subject to tax at
the rate of 30% like any other foreign corporation.
Domestic life insurance companies and foreign life insurance companies doing business in the
Philippines are not allowed to deduct from their gross income the net additions, if any, required by law
to be made within the year to reserve funds and the sums other than dividends paid within the year on
policy and annuity contracts. (Proposed by the BIR. If adopted, this will supersede Sec. 124 of
existing regulations.)
(Section 25 of the Code)
SECTION 18. Taxation of corporation formed or utilized for avoidance of tax. Section 25 imposes
for each year, in addition to the tax imposed by Section 24 a tax of 25 per cent on the undistributed
portion of the profits or surplus of a corporation which is formed or availed of for the purpose of
preventing the imposition of the tax upon its shareholders or members or the shareholders or
members of any other corporation through the medium of permitting gains or profits to accumulate
instead of dividing or distributing them. However, banks, insurance companies, personal holding
companies and foreign personal holding companies as defined in Chapter VIII, are excepted from
taxation under Section 25. The tax imposed by Section 25 applies whether the avoidance was
accomplished through the formation or use of only one corporation or a chain of corporations. For
example, if the capital stock of the M Corporation is held by the N Corporation so that the dividend
distributions of the M Corporation would not be returned as income subject to the tax on individuals
until distributed in turn by the N Corporation to its individual shareholders, nevertheless the tax
imposed by Section 25 applies to the M Corporation, if that corporation is formed or availed of for the
purpose of preventing the imposition of the tax upon the individual shareholders of the N Corporation.
A foreign corporation, whether resident or non-resident, is subject to the tax provided for under
Section 25 in the same manner and under the same circumstances as a domestic corporation.
SECTION 19. Purpose to avoid tax; evidence; burden of proof; definitions of holding or investment
company. The Collector of Internal Revenue's determination that a corporation was formed or
availed of for the purpose of avoiding the tax on its shareholders or members is subject to disproof by
competent evidence. The existence or non-existence of the purpose may be indicated by
circumstances other than the evidence specified in Section 25(b), and whether or not such purpose
was present depends upon the particular circumstances of each case. In other words, a corporation is
subject to taxation under Section 25 if it is formed or availed of for the purpose of preventing the
imposition of the progressive rates of tax upon shareholders through the medium of permitting
earnings or profits to accumulate, even though the corporation is not a mere holding or investment
company 50 per cent or more of the outstanding stock of which is owned directly or indirectly by one
person, and does not have an unreasonable accumulation of earnings or profits; and on the other
hand, the fact that a corporation is such a company or has an accumulation is not absolutely
conclusive against it if, by clear and convincing evidence, the taxpayer satisfies the Commissioner of
Internal Revenue that the corporation was neither formed nor availed of for the purpose of avoiding
the tax on individuals. All the other circumstances which might be construed as evidence of the
purpose to avoid the tax on shareholders cannot be outlined, but among other things the following will
be considered: (1) Dealings between the corporation and its shareholders, such as withdrawal by the
shareholders as personal loans or the expenditure of funds by corporation for the personal benefit of
the shareholders, and (2) the investment by the corporation of undistributed earnings in assets having
no reasonable connection with the business. The mere fact that the corporation distributed a large
part of its earnings for the year in question does not necessarily prove that earnings were not
permitted to accumulate beyond reasonable needs or that the corporation was not formed or availed
Page 3 of 40
of to avoid the tax upon shareholders.
If the Commissioner of Internal Revenue determined that the corporation was formed or availed of for
the purpose of avoiding the progressive rates of tax on individuals through the medium of permitting
earnings or profits to accumulate, and the taxpayer contests such determination of fact by litigation,
the burden of proving the determination wrong by a preponderance of evidence, together with the
corresponding burden of first going forward with evidence, is on the taxpayer under principles
applicable to income tax cases generally, and this is so even though the corporation is not a mere
holding or investment company and does not have an unreasonable accumulation of earnings or
profits. However, if the corporation is a mere holding or investment company, then the law gives
further weight to the presumption of correctness already arising from the Commissioner of Internal
Revenue's determination by expressly providing an additional presumption of the existence of a
purpose to avoid the tax upon shareholders, while if earnings or profits are permitted to accumulate
beyond the reasonable needs of the business then the law adds still more weight to the
Commissioner of Internal Revenue's determination by providing that irrespective of whether or not the
corporation is a mere holding or investment company, the existence of such an accumulation is
determinative of the purpose to avoid the tax upon shareholders unless the taxpayer proves the
contrary by such a clear preponderance of all the evidence that the absence of such a purpose is
unmistakable.
SECTION 20. Holding and investment companies. A corporation having practically no activities
except holding property, and collecting the income therefrom or investing therein, shall be considered
a holding company within the meaning of Section 25. If the activities further include, or consist
substantially of, buying and selling stocks, securities, real estate, or other investment property
(whether upon an outright or a marginal basis) so that the income is derived not only from the
investment yield but also from profits upon market fluctuations, the corporation shall be considered an
investment company within the meaning of Section 25.
SECTION 21. Unreasonable accumulation of profits. An accumulation of earnings or profits
(including the undistributed earnings or profits of prior years) is unreasonable if it is not required for
the purposes of the business, considering all the circumstances of the case. It is not intended,
however, to prevent accumulations of surplus for the reasonable needs of the business if the purpose
is not to prevent the imposition of the tax upon shareholders. No attempt is here made to enumerate
all the ways in which earnings or profits of a corporation may be accumulated for the reasonable
needs of the business. Undistributed income is properly accumulated if retained for working capital
needed by the business; or if invested in additions to plant reasonably required by the business; or if
in accordance with contract obligations placed to the credit of a sinking fund for the purpose of retiring
bonds issued by the corporation. The nature of the investment of earnings or profits is immaterial if
they are not in fact needed in the business. Among other things, the nature of the business, the
financial condition of the corporation at the close of the taxable year, and the use of the undistributed
earnings or profits will be considered in determining the reasonableness of the accumulations.
The business of a corporation is not merely that which it has previously carried on, but includes in
general any line of business which it may undertake. However, a radical change of business when a
considerable surplus has been accumulated may afford evidence of a purpose to avoid the tax. If one
corporation owns the stock of another corporation in the same or a related line of business and in
effect operates the other corporation, the business of the latter may be considered in substance
although not in legal form the business of the first corporation. Earnings or profits of the first
corporation put into the second through the purchase of stock or otherwise may, therefore, if a
subsidiary relationship is established, constitute employment of the income in its own business.
Investment by a corporation of its income in stock and securities of another corporation is not of itself
to be regarded as employment of the income in its business. The business of one corporation may not
be regarded as including the business of another unless the other corporation is a mere
instrumentality of the first; to establish this it is ordinarily essential that the first corporation own all or
substantially all of the stock of the second.
The Commissioner of Internal Revenue may require any corporation to furnish a statement of its
accumulated earnings and profits, the name and address of, and number of share held by each of its
shareholders or members, and the amounts that would be payable to each, if the income of the
Revenue Regulations 02-40
corporation were distributed.
(Section 26 of the Code)
SECTION 22. General co-partnerships. General co-partnerships, when duly registered, are not
subject to income tax, but are required to file returns of their income on B.I.R. Form No. 17.04 for the
purpose of furnishing information as to the share in the gains or profits which each partner shall
include in his individual return. Individuals carrying on business in general co-partnership are,
however, taxable upon their distributive shares of the net income of such partnership, whether
distributed or not, and are required to include such distributive shares in their individual returns. The
returns of duly registered general co-partnerships should be rendered on or before April 15 of each
year or within sixty days after the end of their fiscal year depending on whether their books are kept
on the calendar or on the fiscal year basis. (Conforms with amendments by R.A. 2343, effv. June 20,
1959.)
SECTION 23. Distributive shares of partners. The distributive share of the net profit of a general
co-partnership must be included in the individual returns of the partners. But where the result of
partnership operation is a loss, the loss will be divisible by the partners in the same proportion as the
net income would have been divisible (or, if the partnership agreement provides for the division of a
loss in a manner different from the division of a gain, in the manner so provided) and may be taken by
the individual partners in their respective returns of income.
(Section 27 of the Code)
SECTION 24. Proof of exemption. In order to establish its exemption, and thus be relieved of the
duty of filing returns of income and paying the tax, it is necessary that every organization claiming
exemption file an affidavit with the Commissioner of Internal Revenue, showing the character of the
organization, the purpose for which it was organized, its actual activities, the sources of its income
and its disposition, whether or not any of its income is credited to surplus or inures or may inure to the
benefit of any private shareholder or individual, and in general, all facts relating to its operations which
affect its right to exemption. To such affidavit should be attached a copy of the charter or articles of
incorporation, the by-laws of the organization, and the latest financial statement showing the assets,
liabilities, receipts, and disbursement of the organization.
Upon receipt of the affidavit and other papers by the Commissioner of Internal Revenue, the
organization will be informed whether or not it is exempt. When an organization has established its
right to exemption, it need not thereafter make and file a return of income as required under Section
46 of the Tax Code. However, the organization should file on or before April 15 of each year, an
annual information return under oath, stating its gross income and expenses incurred during the
preceding year, and a certificate showing that there has not been any substantial change in its By-
Laws, Articles of Incorporation, manner of operation and activities as well as sources and disposition
of income. (As amended by Revenue Regulations No. 7-64, approved November 25, 1964.)
SECTION 25. Agricultural and horticultural organizations. The organizations contemplated by
subsection (a) of Section 27 of the Code as entitled to exemption from income taxation are those
which (1) have no net income inuring to the benefit of any member; (2) are educational or instructive
in character; and (3) have as their objects the betterment of the conditions of those engaged in such
pursuits, the improvement of the grade of their products, and the development of a higher degree of
efficiency in their respective occupations. Organizations such as provincial fairs and like associations
of a quasi-public character, which are designed to encourage the development of better agricultural
and horticultural products through a system of awards, prizes, or premiums, and whose income
derived from gate receipts, entry fees, donations, etc., is used exclusively to meet the necessary
expenses of upkeep and operation, are thus exempt. On the other hand, associations which have for
their purpose, for example, the holding of periodical race meets, the profits from which may inure to
the benefit of their shareholders, are not exempt. Similarly, corporations engaged in growing
agricultural or horticultural products or raising live stock or similar products for profits are not exempt
from tax under this paragraph.
SECTION 26. Mutual savings bank. In order that a corporation may be entitled to exemption as a
mutual savings bank, it must appear that it is an organization (1) which has no capital stock
represented by shares, and (2) whose earnings less only the expenses of operation, are distributable
Page 4 of 40
wholly among the depositors. If it appears that the organization has shareholders who participate in
the profits, the organization will not be exempt from income tax.
SECTION 27. Fraternal beneficiary societies. A fraternal beneficiary society is exempt from tax
only if operated under the "lodge system", or for the exclusive benefit of the members of a society so
operating. "Operating under the lodge system" means carrying on its activities under a form of
organization that comprises local branches, chartered by a parent organization and largely self-
governing, called lodges, chapters, or the like. In order to be exempt, it is also necessary that the
society should have an established system for payment to its members or their dependents of life,
sick, accident, or other benefits.
SECTION 28. Building and loan associations. (Now subject to tax, as amended by Sec. 4, R.A.
82.)
SECTION 29. Cemetery companies. A cemetery company may be entitled to exemption, (1) if it is
owned by and operated exclusively for the benefit of its lot owners, or (2) if it is not operated for profit.
Any cemetery corporation chartered solely for burial purposes and not permitted by its charter to
engage in any business not necessarily incident to that purpose, is exempt from income tax, provided
that no part of its net earnings inures to the benefit of any private shareholder or individual. A
cemetery company which fulfills the other requirement of the statute may be exempt, even though it
issues preferred stock entitling the holders to dividend at a fixed rate, provided that its articles of
incorporation require (a) that the preferred stock shall be retired at par as soon as sufficient funds are
realized from sales, and (b) that all funds not required for the payment of dividends upon or for the
retirement of preferred stock shall be used by the company for the care and improvement of the
cemetery property.
A cemetery company having a capital stock represented by shares, or which is operated for profit or
for the benefit of persons other than its members, does not come within the exempted class.
SECTION 30. Religious, charitable, scientific, athletic, cultural, and educational corporations. A
corporation falling among those enumerated in subsection (e) of Section 27 is exempt from tax on its
income (other than income of whatever kind and character from its properties, real or personal) if such
corporation meets two tests: (a) It must be organized and operated for one or more of the specified
purposes; and (b) no part of its net income must inure to the benefit of private stockholders or
individuals.
The income of such corporation which is considered as income from their properties, real or personal,
generally consists of income from corporate dividends, rentals received from their properties, interests
received from such capital loaned to other persons, income from agricultural lands owned by such
corporations, profits from the sale of property, real or personal, and other similar income. ASIETa
Income not derived from their properties, real or personal, are exempt. For example, in the case of a
religious corporation, income from the conduct of strictly religious activities, such as fees received for
administering baptismals, solemnizing marriages, attending burials, holding masses, and other like
income, is exempt. In the case of an educational corporation, income from the holding of an
educational fair or exhibit is exempt. However, if such exempt income is invested by the corporation,
the income from such investment, as interests from the capital where the capital has been loaned or
dividends on stock where the capital has been invested in shares of stock, will constitute taxable
income. Donations and other similar contributions received by such corporation from other persons
are exempt.
The clause "except income expressly exempt by this Title" appearing in subsection (e) of Section 27
refers to those classes of income which, in accordance with subsection (b) of Section 29, are exempt
from taxation under Title II.
Charitable corporations include an association for the relief of the families of clergymen, even though
the latter make a contribution to the fund established for this purpose; or for furnishing the services of
trained nurses to persons unable to pay for them; or for aiding the general body of litigants by
improving the efficient administration of justice. Educational corporations may include associations
Revenue Regulations 02-40
whose sole purpose is the instruction of the public. But associations formed to disseminate
controversial or partisan propaganda are not educational within the meaning of the law. Scientific
corporations include an association for the scientific study of law with a view to improving its
administration.
It does not prevent exemption that private individuals, for whose benefit a charity is organized, receive
the income of the corporation or association. The law refers to individuals having a personal and
private interest in the activities of the corporation, such as stockholders. If, however, a corporation
issues "voting shares", which entitle the holders upon the dissolution of the corporation to receive the
proceeds of its property, including accumulated income, the right to exemption ceases to exist, even
though the by-laws provide that the shareholders shall not receive any dividend or other return upon
their shares.
SECTION 31. Business leagues. A business league is an association of persons having some
common business interest, which limits its activities to work for such common interest and does not
engage in a regular business of a kind ordinarily carried on for profit. Its work need not be similar to
that of a chamber of commerce or board of trade. If it engages in a regular business of a kind
ordinarily carried on for profit, the fact that the business is conducted on a cooperative basis or
produces only sufficient income to be self-sustaining, is not ground for exemption. An association
engaged in furnishing information to prospective investors, to enable them to make sound
investments, is not exempt, since its members have no common business interest, even though all of
its income is devoted to the purpose stated. A clearing house association, not organized for profit, no
part of the net income of which inures to any private shareholder or individual, is exempt provided its
activities are limited to the exchange of checks, and similar work for the common benefit of its
members. An association of persons who are engaged in the transportation business, whether by land
or water, which is designed to promote the legitimate objects of such business, and all of the income
of which is derived from membership dues and is expended for office expenses is exempt from tax.
SECTION 32. Civic leagues. Civic leagues entitled to exemption comprise those not organized for
profit but operated exclusively for purposes beneficial to the community as a whole. In general,
organizations engaged in promoting the welfare of mankind are exempt from tax.
SECTION 33. Social clubs. The exemption applies to practically all social and recreation clubs
which are supported by membership fees, dues, and assessments. If a club, by reason of the
comprehensive powers granted in the charter, engages in business or in agriculture or horticulture, for
profit, such club is not organized and operated exclusively for pleasure, recreation, or social
purposes, and any profit realized from such activities is subject to tax.
SECTION 34. Mutual insurance companies and like organizations. It is necessary to exemption
that the income of the company be derived solely from assessments, dues, and fees collected from
members. If income is received from other sources, the corporation is not exempt. Income, however,
from sources other than those specified does not prevent exemption where its receipt is a mere
incident of the business of the company. Thus the receipt of interest upon a working bank balance, or
of the proceeds of the sale of badges, office supplies, or equipment, will not defeat the exemption.
The same is true of the receipt of interest upon Government bonds, where they were purchased and
were afterwards sold. Where, however, such bonds are bought as a permanent investment, the
receipt of the interest destroys the exemption. The receipt of what is, in substance, an entrance fee,
charged by a mutual fire insurance company as a condition of membership, does not render the
company taxable, although this fee is called a premium. If an organization issues policies for
stipulated cash premiums, or if it requires advance deposits to cover the cost of the insurance and
maintains investments from which income is derived, it is not entitled to exemption. On the other
hand, an organization may be entitled to exemption, although it makes advance assessment for the
sole purpose of meeting future losses and expenses, provided that the balance of such assessments
remaining on hand at the end of the year is retained to meet losses and expenses or is returned to
members. An organization of a purely local character is one whose business activities are confined to
a particular community, place, or district, irrespective, however, of political subdivisions.
SECTION 35. Farmers' cooperative marketing and purchasing association. Cooperative
associations, acting as sales agents for farmers or others, in order to come within the exemption must
Page 5 of 40
establish that for their own account they have no net income. Cooperative dairy companies, which are
engaged in collecting milk and disposing of it or the products thereof and distributing the proceeds,
less necessary operating expenses, among their members upon the basis of the quantity of milk or of
butter fat in the milk furnished by such members are exempt from the tax. If the proceeds of the
business are distributed in any other way than on such a proportionate basis, the company will be
subject to tax. A farmers' association is not exempt from taxation where in accounting to farmers
furnishing produce for the proceeds of sales it deducts more than the necessary selling expenses
incurred. Cooperative associations acting as purchasing agents are not expressly exempt from tax,
but rebates made to purchasers, whether or not members of the association, in proportion to their
purchases may be excluded from gross income in computing the net income subject to tax. Any
profits made from non-members and distributed to members in the guise of rebates are, of course,
subject to tax.
Cooperative marketing associations duly incorporated under Act No. 3425, known as the Cooperative
Marketing Law are exempt from income tax. (See also R.A. 702 exempting cooperative marketing
associations.)
(Section 28 of the Code)
SECTION 36. Meaning of net income. The tax imposed by law is upon income. In the computation
of the tax, various classes of income must be considered: (a) Income, in the broad sense, meaning all
wealth which flows into the tax-payer other than as a mere return of capital. It includes the forms of
income specifically described as gains and profits, including gains derived from the sale or other
disposition of capital assets. Income cannot be determined merely by reckoning cash receipts, for the
statute recognizes as income determining factor other items, among which are inventories, accounts
receivable, property exhaustion, and accounts payable for expenses incurred. (b) Gross income,
meaning income (in the broad sense) less income which is by statutory provision or otherwise exempt
from the tax imposed by law. (c) Net income, meaning gross income less statutory deductions. The
statutory deductions are, in general, though not exclusively, expenditures other than capital
expenditures, connected with production of income. (d) In the case of a taxpayer other than a
corporation as defined in Section 84 (b) of the Code, net income means gross income less
exemptions. Ordinarily the net income is to be computed in accordance with the method of accounting
regularly employed in keeping the books of the taxpayer.
SECTION 37. Computation of net income. Net income must be computed with respect to a fixed
period. That period is twelve months ending December 31st of every year except in the case of a
corporation filing returns on a fiscal year basis in which case net income will be computed on the
basis of such fiscal year. Items of income and of expenditures, which as gross income and
deductions, are elements in the computation of net income, need not be in the form of cash. It is
sufficient that such items may be appraised in terms of money. The time as of which any item of gross
income or any deduction is to be accounted for must be determined in the light of the fundamental
rule that the computation shall be made in such a manner as would clearly reflect the taxpayer's
income. If the method of accounting regularly employed by him in keeping his books clearly reflects
his income, it is to be followed with respect to the time as of which items of gross income and
deductions are to be accounted for, otherwise the computation of net income shall be made in such
manner as in the opinion of the Commissioner of Internal Revenue would clearly reflect it.
SECTION 38. Bases of computation. Approved standard methods of accounting will be ordinarily
regarded as clearly reflecting income. A method of accounting will not, however, be regarded as
clearly reflecting income unless all items of gross income and all deductions are treated with
reasonable consistency. All items of gross income shall be included in the gross income for the
taxable year in which they are received by the taxpayer and deductions taken accordingly, unless in
order clearly to reflect income such amounts are to be properly accounted for as of a different period.
For instance, in any case in which it is necessary to use an inventory, no accounting in regard to
purchases and sales will correctly reflect income except an accrual method. A taxpayer is deemed to
have received items of gross income which have been credited to or set apart for him without
restriction. On the other hand, appreciation in value of property is not even an accrual of income to a
taxpayer prior to the realization of such appreciation through sale or conversion of the property. (For
methods of accounting and determination of accounting period, see Sections 166 to 169 of these
regulations.)
Revenue Regulations 02-40
(Section 29(a) of the Code)
SECTION 39. What gross income includes. Gross income includes, in general, compensation for
personal and professional services, business income, profits from sales of and dealings in property,
interests, rents, dividends, and gains, profits, and income derived from any source whatever, unless
exempt from tax by law. In general, income is the gain derived from capital, from labor, or from both
combined, provided it be understood to include profit gained through a sale or conversion of capital
assets. Profit of citizens, resident aliens, or domestic corporations derived from sales in foreign
commerce must be included in their gross income. Income may be in the form of cash or of property.
For the treatment of dividends for purposes of the tax, see Sections 250 to 256 of these regulations.
For the treatment of capital gains, see Sections 132 to 135 of these regulations.
SECTION 40. Compensation for personal services. Where no determination of compensation is
had until the completion of the services, the amount received is ordinarily income for the taxable year
of its determination, if the return is rendered on the accrual basis; or, for the taxable year in which
received, if the return is rendered on a receipts and disbursements basis. Commissions paid
salesman, compensation for services on the basis of a percentage of profits, commissions on
insurance premiums, tips, and pensions or retiring allowances paid by private persons or by the
Government of the United States or of the Philippines (except pensions exempt by law from tax) are
income to the recipients; as are also marriage fees, baptismal offerings, sums paid for saying masses
for the dead, and other contributions received by a clergyman, evangelists, or religious worker for
services rendered. However, so-called pensions awarded by one to whom no services have been
rendered are mere gifts or gratuities and are not taxable.
SECTION 41. Compensation paid other than in cash. Where services are paid for with something
other than money, the fair market value of the thing taken in payment is the amount to be included as
income. If the services were rendered at a stipulated price, in the absence of evidence to the contrary,
such price will be presumed to be the fair value of the compensation received. Compensation paid 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 the employee in cash. When living quarters are furnished in addition to cash salary,
the rental value of such quarters should be reported as income.
SECTION 42. Compensation paid in promissory notes. Promissory notes or other evidence of
indebtedness received in payment for services, and not merely as security for such payment,
constitute income to the amount of their fair market value. A taxpayer receiving as compensation a
note regarded as good for its face value at maturity, but not bearing interest, shall treat as income as
of the time of receipt the fair discounted value of the note at that time. Thus, if it appears that such a
note is or could be discounted on a 6 per cent basis, the recipient shall include such note in his gross
income to the amount of its face value less discount computed at the prevailing rate for such
transactions.
If the payment due on a note so accounted for are met as they become due, there should be included
as income in respect of each such payment so much thereof as represents recovery for the discount
originally deducted.
SECTION 43. Gross income from business. In the case of a manufacturing, merchandising, or
mining business, "gross income" means the total sales, less the cost of goods sold, plus any income
from investments and from incidental or outside operations or sources. In determining the gross
income, subtractions should not be made for depreciation, depletion, selling expenses or losses, or
for items not ordinarily used in computing the cost of goods sold.
SECTION 44. Long term contracts. Income from long-term contracts is taxable for the period in
which the income is determined, such determination depending upon the nature and terms of the
particular contract. As used herein the term "long-term" contracts means building, installation, or
construction contracts covering a period in excess of one year. Persons whose income is derived in
whole or in par from such contracts may, as to such income, prepare their returns upon the following
bases:
Page 6 of 40
(a) Gross income derived from such contracts may be reported upon the basis of percentage of
completion. In such case there should accompany the return certificate of architects, or engineers
showing the percentage of completion during the taxable year of the entire work performed under
contract. There should be deducted from such gross income all expenditures made during the taxable
year on account of the contract, account being taken of the material and supplies on hand at the
beginning and end of the taxable period for use in connection with the work under the contract but not
yet so applied. If upon completion of a contract, it is found that the taxable net income arising
thereunder has not been clearly reflected for any year or years, the Commissioner of Internal
Revenue may permit or require an amended return.
(b) Gross income may be reported in the taxable year in which the contract is finally completed and
accepted if the taxpayer elects as a consistent practice to so treat such income, provided such
method clearly reflects the net income. If this method is adopted there should be deducted from gross
income all expenditures during the life of the contract which are properly allocated thereto, taking into
consideration any material and supplies charged to the work under the contract but remaining on
hand at the time of the completion.
Where a taxpayer has filed his return in accordance with the method of accounting regularly
employed by him in keeping his books and such method clearly reflects the income, he will not be
required to change to either of the methods above set forth. If a taxpayer desires to change his
method of accounting in accordance with paragraphs (a) and (b) above, a statement showing the
composition of all items appearing upon his balance sheet and used in connection with the method of
accounting formerly employed by him, should accompany his return.
SECTION 45. Gross income of farmers. A farmer reporting on the basis of receipts and
disbursements (in which no inventory to determine profits is used) shall include in his gross income
for the taxable year (1) the amount of cash or the value of merchandise or other property received
from the sale of live stock and produce which were raised during the taxable year or prior years, (2)
the profit from the sale of any live stock or other items which were purchased, and (3) gross income
from all other sources. The profit from the sale of live stock or other items which were purchased is to
be ascertained by deducting the cost from the sales price in the year in which the sale occurs, except
that in the case of the sale of animals purchased as draft or work animals, or solely for breeding or
dairy purposes and not for resale, the profit shall be the amount of any excess of the sales prices over
the amount representing the difference between the cost and the depreciation theretofore sustained
and allowed as a deduction in computing net income.
In the case of a farmer reporting on the accrual basis (in which an inventory is used to determine
profits), his gross profits are ascertained by adding to the inventory value of live stock and products
on hand at the end of the year the amount received from the sale of live stock products, and
miscellaneous receipts for hire of teams, machinery, and the like, during the year, and deducting from
this sum the inventory value of live stock and products on hand at the beginning of the year and the
cost of live stock and products purchased during the year. In such cases all live stock raised or
purchased for sale shall be included in the inventory at their proper valuation determined in
accordance with the method authorized and adopted for the purpose. Also, live stock acquired for
drafts, breeding, or dairy purposes and not for sale may be included in the inventory, instead of being
treated as capital assets subject to depreciation, provided such practice is followed consistently by the
taxpayer. In case of the sale of any live stock included in an inventory their cost must not be taken as
an additional deduction in the return of income, as such deduction will be reflected in the inventory.
In every case of the sale of machinery, farm equipment, or other capital assets (which are not to be
included in an inventory if one is used to determine profits) any excess over the cost thereof less the
amount of depreciation theretofore sustained and allowed as a deduction in computing net income,
shall be included as gross income. Where farm produce is exchanged for merchandise, groceries, or
the like, the market value of the article received in exchange is to be included in gross income. Rents
received in crop shares shall be returned as of the year in which the crop shares are reduced to
money or a money equivalent. Proceeds of insurance, such as fire and typhoon insurance on growing
crops, should be included in gross income to the amount received in cash or its equivalent for the
crop injured or destroyed. If a farmer is engaged in producing crops which take more than a year from
the time of planting to the time of gathering and disposing, the income therefrom may be computed
upon the crop basis; but in any such cases the entire cost of producing the crop must be taken as a
Revenue Regulations 02-40
deduction in the year in which the gross income from the crop is realized. EaICAD
As herein used the term "farm" embrace the farm in the ordinarily accepted sense, and includes
stock, dairy, poultry, fruit, and truck farms, also plantations, ranches, and all land used for farming
operations. All individuals, partnerships, or corporations that cultivate, operate, or manage farms for
gain or profit either as owners, or tenants, are designated farmers. A person cultivating or operating a
farm for recreation or pleasure, the result of which is a continual loss from year to year, is not
regarded as a farmer.
SECTION 46. Sale of patents and copyrights. A taxpayer disposing of patents or copyrights by
sale should determine the profit or loss arising therefrom by computing the difference between the
selling price and the cost. The taxable income in the case of patents or copyrights acquired prior to
March 1, 1913, should be ascertained in accordance with the provisions of section 136 of these
regulations. The profit or loss thus ascertained should be increased or decreased, as the case may
be, by the amounts deducted on account of depreciation of such patent or copyrights since March 1,
1913, or since the date of acquisition if subsequent thereto.
SECTION 47. Sale of goodwill. Gain or loss from a sale of goodwill results only when the
business, or a part of it, to which the goodwill attaches is sold, in which case the gain or loss will be
determined by comparing the sale price with the cost or other basis of the assets, including goodwill.
If specific payment was not made for goodwill acquired after March 1, 1913, there can be no
deductible loss with respect thereto, but gain may be realized from the sale of goodwill built up
through expenditures which have been currently deducted. It is immaterial that goodwill may never
have been carried on the books as an asset but the burden of proof is on the taxpayer to establish the
cost or fair market value on March 1, 1913, of the goodwill sold.
SECTION 48. Annuities and insurance policies. Annuities paid by religious, charitable, and
educational corporations under an annuity contract are subject to tax to the extent that the aggregate
amount of the payments to the annuitant exceeds the amounts paid by him as consideration for the
contract. An annuity charged upon devised land is taxable to a donee-annuitant, whether paid by the
devisee out of the rents of the land or from other sources. The devisee is not required to return as
gross income the amount of rent paid to the annuitant, and he is not entitled to deduct from his gross
income any sums paid to the annuitant. Amounts received by an insured as a return of premiums paid
by him under life insurance, endowment, or annuity contracts, such as the so-called "dividends" of a
mutual insurance company, which may be credited against the current premium, are not subject to
tax. Distributions on paid-up policies which are made out of earnings of the insurance company
subject to tax are in the nature of corporate dividends and should be included in the taxable income of
the individual, without any credit for the amount of tax paid by the corporation at source.
SECTION 49. Improvements by lessees. When buildings are erected or improvements made by a
lessee in pursuance of an agreement with the lessor, and such buildings or improvements are not
subject to removal by the lessee, the lessor may at his option report the income therefrom upon either
of the following bases;
(a) The lessor may report as income at the time when such buildings or improvements are
completed the fair market value of such buildings or improvements subject to the lease.
(b) The lessor may spread over the life of the lease the estimated depreciated value of such
buildings or improvements at the termination of the lease and report as income for each year of
the lease an aliquot part thereof.
If for any other reason than a bona fide purchase from the lessee by the lessor the lease is
terminated, so that the lessor comes into possession or control of the property prior to the time
originally fixed for the termination of the lease, the lessor receives additional income for the year in
which the lease is so terminated to the extent that the value of such buildings or improvements when
he became entitled to such possession exceeds the amount already reported as income on account
of the erection of such buildings or improvements. No appreciation in value due to causes other than
the premature termination of the lease shall be included. Conversely, if the building or improvements
are destroyed prior to the expiration of the lease, the lessor is entitled to deduct as a loss for the year
when such destruction takes place the amount previously reported as income because of the erection
Page 7 of 40
of such buildings or improvements, less any salvage value subject to the lease to the extent that such
loss was not compensated for by insurance. If the buildings or improvements destroyed were
acquired prior to March 1, 1913, the deduction shall be based on the cost or the value subject to the
lease to the extent that such loss was not compensated for by insurance. HSaCcE
SECTION 50. Forgiveness of indebtedness. The cancellation and forgiveness of indebtedness
may amount to a payment of income, to a gift, or to a capital transaction, dependent upon the
circumstances. If, for example, an individual performs services for a creditor, who, in consideration
thereof cancels the debt, income to that amount is realized by the debtor as compensation for his
services. If, however, a creditor merely desires to benefit a debtor and without any consideration
therefor cancels the debt, the amount of the debt is a gift from the creditor to the debtor and need not
be included in the latter's gross income. If a corporation to which a stockholder is indebted forgives
the debt, the transaction has the effect of the payment of a dividend.
SECTION 51. When income is to be reported. Gains, profits, and income are to be included in the
gross income for the taxable year in which they are received by the taxpayer, unless they are included
when they accrue to him in accordance with the approved method of accounting followed by him. If a
person sues in one year on a pecuniary claim or for property, and money or property is recovered on
a judgment therefore in a later year, income is realized in that year, assuming that the money or
property would have been income in the earlier year if then received. This is true of a recovery for
patent infringement. Bad debts or accounts charged off subsequent to March 1, 1913, because of the
fact that they were determined to be worthless, which are subsequently recovered, whether or not by
suit, constitute income for the year in which recovered, regardless of the date when amounts were
charged off.
SECTION 52. Income constructively received. Income which is credited to the account of or set
apart for a taxpayer and which may be drawn upon by him at any time is subject to tax for the year
during which so credited or set apart, although not then actually reduced to possession. To constitute
receipt in such a case the income must be credited to the taxpayer without any substantial limitation
or restriction as to the time or manner of payment or condition upon which payment is to be made. A
book entry, if made, should indicate an absolute transfer from one account to another. If the income is
not credited, but is set apart, such income must be unqualifiedly subject to the demand of the
taxpayer. Where a corporation contingently credits its employees with bonus stock, but the stock is
not available to such employees until some future date, the mere crediting on the books of the
corporation does not constitute receipt.
SECTION 53. Examples of constructive receipt. When interest coupons have matured and are
payable, but have not been cashed, such interest payment though not collected when due and
payable, is nevertheless available to the taxpayer and should therefore be included in his gross
income for the year during which the coupons matured. This is true if the coupons are exchanged for
other property instead of eventually being cashed. Defaulted coupons are income for the year in
which paid. The distributive share of the profits of a partner in a general co-partnership duly registered
is regarded as received by him, although not distributed. Interest credited on savings bank deposits,
even though the bank nominally has a rule, seldom or never enforced, that it may require so many
days' notice in advance of cashing depositors' checks, is income to the depositor when credited. An
amount credited to shareholders of a building and loan association, when such credit passes without
restriction to the shareholder, has taxable status as income for the year of the credit. When the
amount of such accumulations has not become available to the shareholder until the maturity of a
share, the amount of any share in excess of the aggregate amount paid in by the shareholder is
income for the year of maturity of the share.
SECTION 54. Creation of corporate sinking fund. If a corporation in order solely to secure
payment of its bonds or other indebtedness, places property in trust, or sets aside certain amounts in
a sinking fund under the control of a trustee who may be authorized to invest and reinvest such sums
from time to time, the property or fund thus set aside by the corporation and held by the trustee is an
asset of the corporation, and any gain arising therefrom is income of the corporation and shall be
included as such in its annual return.
SECTION 55. Acquisition or disposition by a corporation of its own capital stock. Whether the
Revenue Regulations 02-40
acquisition or disposition by a corporation of share of its own capital stock gives rise to taxable gain or
deductible loss depends upon the real nature of the transaction, which is to be ascertained from all its
facts and circumstances. The receipt by a corporation of the subscription price of shares of its capital
stock upon their original issuance gives rise to neither taxable gain nor deductible loss, whether the
subscription or issue price be in excess of, or less than, the par or stated value of such stock.
But if a corporation deals in its own shares as it might in the shares of another corporation, the
resulting gain or loss is to be computed in the same manner as though the corporation were dealing in
the shares of another. So also if the corporation receives its own stock as consideration upon the sale
of property by it, or in satisfaction of indebtedness to it, the gain or loss resulting is to be computed in
the same manner as though the payment had been made in any other property. Any gain derived from
such transaction is subject to tax, and any loss sustained is allowable as deduction where permitted
by the provisions of Title II.
SECTION 56. Contributions by shareholders. Where a corporation requires additional funds for
conducting its business and obtains such needed money through voluntary pro rata payments by its
shareholders, the amounts so received being credited to its surplus account or to a special capital
account, will not be considered income, although there is no increase in the outstanding shares of
stock of the corporation. The payments in such circumstances are in the nature of voluntary
assessments upon, and represent an additional price paid for, in shares of stock held by the individual
shareholders, and will be treated as an addition to and as a part of the operating capital of the
company.
SECTION 57. Sale and retirement of corporate bonds. (1) (a) If bonds are issued by a corporation
at their face value, the corporation realizes no gain or loss. (b) If thereafter the corporation purchases
and retires any of such bonds at a price in excess of the issuing price or face value, the excess of the
purchase price over the issuing price or face value is a deductible expense for the taxable year. (c) If,
however, the corporation purchases and retires any of such bonds at a price less than the issuing
price or face value, the excess of the issuing price or face value over the purchase price is gain or
income for the taxable year.
(2) (a) If bonds are issued by a corporation at a premium, the net amount of such premium is gain or
income which should be prorated or amortized over the life of the bond. (b) If thereafter the
corporation purchases and retires any of such bonds at a price in excess of the issuing price minus
any amount of premium already returned as income, the excess of the purchase price over the
issuing price minus any amount of premium already returned as income (or over the face value plus
any amount of premiums not yet returned as income) is a deductible expenses for the taxable year.
(c) If, however, the corporation purchases and retires any of such bonds at a price less than the
issuing price minus any amount of premium already returned as income, the excess of the issuing
price minus any amount of premium already returned as income (or of the face value plus any amount
of premium not yet returned as income) over the purchase price is gain or income for the taxable year.
(3) (a) If bonds are issued by a corporation at a discount, the net amount of such discount is
deductible and should be prorated or amortized over the life of the bonds. (b) If thereafter the
corporation purchases and retires any of such bonds at a price in excess of the issuing price plus any
amount of discount already deducted, the excess of the purchase price over the issuing price plus any
amount of discount already deducted (or over the face value minus any amount of discount not yet
deducted), is a deductible expense for the taxable year. (c) If, however, the corporation purchases
and retires any of such bonds at a price less than the issuing price plus any amount of discount
already deducted, the excess of the issuing price plus any amount of discount already deducted (or of
the face value minus any amount of discount not yet deducted) over the purchase price is gain or
income for the taxable year.
SECTION 58. Income of corporation from leased property. Where a corporation has leased its
property in consideration that the lessee shall pay in lieu of other rental an amount equivalent to a
certain rate of dividend on the lessor's capital stock or the interest on the lessor's outstanding
indebtedness, together with taxes, insurance or other fixed charges, such payments shall be
considered rental payments and shall be returned by the lessor corporation as income,
notwithstanding the fact that the dividends and interest are paid by the lessee directly to the
Page 8 of 40
shareholders and bondholders of the lessor. The fact that a corporation has conveyed or let its
property and has parted with its management and control, or has ceased to engage in the business
for which it was originally organized, will not relieve it from liability to the tax. While the payments
made by the lessee directly to the bondholders or shareholders of the lessor are rentals as to both the
lessee and lessor (rentals paid in one case and rentals received in the other), to the bondholders and
the shareholders, such amounts are interest and dividend payments received as from the lessor and
as such shall be accounted for in their returns.
SECTION 59. Gross income of a corporation in liquidation. When a corporation is dissolved, its
affairs are usually wound up by a receiver or trustee in dissolution. The corporate existence is
continued for the purpose of liquidating the assets and paying the debts, and such receiver or trustee
stands in the stead of the corporation for such purposes. Any sales of property by them are to be
treated as if made by the corporation for the purpose of ascertaining the gain or loss.
SECTION 60. Gross income of foreign corporations. The gross income of a foreign corporation
subject to tax consists of its gross income from sources within the Philippines. Gross income from
sources within the Philippines, as applied to foreign corporations, shall include interest received on
bonds, notes, or other interest-bearing obligations issued by residents, corporate or otherwise, as well
as income derived from dividends on the capital stock or from the net earnings of domestic or resident
foreign corporations, joint stock companies, associations, or insurance companies, dividends from
other foreign corporations to the extent provided in Section 37 of the Code, and likewise income from
rentals and royalties from all sources within the Philippines.
(Section 29(b) of the Code)
SECTION 61. Exclusions from gross income. The term "gross income" as used in the Act does not
include those items of income exempted by statute or by fundamental law. Such tax-free income
should not be included in the income tax return unless information regarding it is specifically called for.
The exclusion of such income should not be confused with the reduction of gross income by the
application of allowable deductions.
SECTION 62. Proceeds of insurance. The proceeds of life-insurance policies, paid by reason of
the death of an insured to his estate or to any beneficiary (individual, partnership, or corporation, but
not a transferee for a valuable consideration), directly or in trust, are excluded from the gross income
of the beneficiary. It is immaterial whether the proceeds are received in a single sum or in
installments. If, however, such proceeds are held by the insurer under an agreement to pay interest
thereon, the interest payments must be included in gross income. Amounts received (other than
amounts paid by reason of the death of the insured and interest payments on such amounts) under a
life insurance, endowment, or annuity contract are excluded from gross income but, if such amounts
(when added to amounts received before the taxable year under such contract) exceed the aggregate
premiums or consideration paid (whether or not paid during the taxable year) then the excess shall be
included in gross income. However, in the case of a transfer for a valuable consideration, by
assignment or otherwise, of a life insurance, endowment, or annuity contract, or any interest therein,
only the actual value of such consideration and the amount of the premiums and other sums
subsequently paid by the transferee are exempt from taxation.
SECTION 63. Amounts received as compensation for injuries or sickness. The amounts received
by an insured or his estate or beneficiaries through accident or health insurance or under workmen's
compensation acts as compensation for personal injuries or sickness are excluded from the gross
income of the insured, his estate, and other beneficiaries. Any damages recovered by suit or
agreement on account of such injuries or sickness are similarly excluded from the gross income of the
individual injured or sick, if living, or of his estate or other beneficiaries entitled to receive such
damages, if dead.
SECTION 64. Gifts and bequests. Property received as a gift or received under a will or testament
or through legal succession, is exempt from the income tax, although the income therefrom or income
derived from its investment, sale, or otherwise is not. An amount of principal paid under a marriage
settlement is a gift. Neither alimony nor an allowance based on a separation agreement is taxable
income.
(Section 30(a) of the Code)
Revenue Regulations 02-40
SECTION 65. Business expenses. Business expenses deductible from gross income include the
ordinary and necessary expenditures directly connected with or pertaining to the taxpayer's trade or
business. The cost of goods purchased for resale, with proper adjustment for opening and closing
inventories, is deducted from gross sales is computing gross income. Among the items included in
business expenses are management expenses, commissions, labor, supplies, incidental repairs,
operating expenses of transportation, equipment used in the trade or business, traveling expenses
while away from home solely in the pursuit of a trade or business, advertising and other selling
expenses, together with insurance premiums against fire, storm, theft, accident, or other similar
losses in the case of a business, and rental for the use of business property. A taxpayer is entitled to
deduct the necessary expenses paid in carrying on his business from his gross income from whatever
source.
SECTION 66. Traveling expenses. Traveling expenses as ordinarily understood, include
transportation expenses and meals and lodging. If the trip is undertaken for other than business
purposes, the transportation expenses are personal expenses, and the meals and lodging are living
expenses, and therefore, not deductible. If the trip is solely on business, the reasonable and
necessary traveling expenses, including transportation expenses, meals and lodging, become
business instead of personal expenses.
(a) If, then, an individual, whose business requires him to travel receives a salary as full
compensation for his services, without reimbursement for traveling expenses, or is employed on
a commission basis with no expense allowance, his traveling expenses, including the entire
amount expended far meals and lodging, are deductible from gross income.
(b) If an individual receives a salary and is also repaid his actual traveling expenses, he shall
include in gross income, the amount so repaid and may deduct such expenses. aDcHIC
(c) If an individual receives a salary and also an allowance for meals and lodging, as for example, a
per diem allowance in lieu of subsistence, the amount of the allowance should be included in
gross income and the cost of such meals and lodging may be deducted therefrom.
A payment for the use of a sample room at a hotel for the display of goods is a business
expense. Only such expenses as are reasonable and necessary in the conduct of the business and
directly attributable to it may be deducted. A taxpayer claiming the benefit of the deductions referred
to herein must attach to his return a statement showing (1) the nature of the business in which he is
engaged; (2) the number of days away from home during the taxable year on account of business; (3)
the total amount of expenses incident to meals and lodging while absent from home and business
during the taxable year; (4) the total amount of other expenses incident to travel and claimed as a
deduction.
Claim for the deductions referred to herein must be substantiated, when required by the
Commissioner of Internal Revenue by record showing in detail the amount and nature of the
expenses incurred.
SECTION 67. Cost of materials. Taxpayers carrying materials and supplies on hand should
include in expenses the charges for materials and supplies only to the amount that they are actually
consumed and used in operation during the year for which the return is made, provided that the cost
of such materials and supplies has not been deducted in determining the net income for any previous
year. If a taxpayer carries incidental materials or supplies on hand for which no record of consumption
is kept or of which physical inventories at the beginning and end of the year are not taken, it will be
permissible for the taxpayer to include in his expenses and deduct from gross income the total cost of
such supplies and materials as were purchased during the year for which the return is made, provided
the net income is clearly reflected by this method.
SECTION 68. Repairs. The cost of incidental repairs which neither materially add to the value of
the property nor appreciably prolong its life, but keep it in an ordinarily efficient operating condition,
may be deducted as expense, provided the plant or property account is not increased by the amount
of such expenditure. Repairs in the nature of replacement, to the extent that they arrest deterioration
and appreciably prolong the life of the property should be charged against the depreciation reserves if
such account is kept.
Page 9 of 40
SECTION 69. Professional expenses. A professional may claim as deductions the cost of supplies
used by him in the practice of his profession, expenses paid in the operation and repair of
transportation equipment used in making professional calls, dues to professional societies and
subscriptions to professional journals, the rent paid for office rooms, the expenses of the fuel, light,
water, telephone, etc.; used in such offices, and the hire of office assistants. Amounts currently
expended for books, furnitures, and professional instruments and equipment, the useful life of which
is short, may be deducted. But amounts expended for books, furniture, and professional instruments
and equipment of a permanent character are not allowable as deductions. SEHTIc
SECTION 70. Compensation for personal services. Among the ordinary and necessary expenses
paid or incurred in carrying on any trade or business may be included a reasonable allowance for
salaries or other compensation for personal services actually rendered. The test of deductibility in the
case of compensation payments is whether they are reasonable and are, in fact, payments purely for
service. This test and its practical application may be further stated and illustrated as follows:
(1) Any amount paid in the form of compensation, but not in fact as the purchase price of
services, is not deductible. (a) An ostensible salary paid by a corporation may be a
distribution of dividend on stock. This is likely to occur in the case of a corporation having
few shareholders, practically all of whom draw salaries. If in such a case the salaries are in
excess of those ordinarily paid for similar services, and the excessive payment correspond
or bear a close relationship to the stockholdings of the officers or employees, it would seem
likely that the salaries are not paid wholly for services rendered, but that the excessive
payments are a distribution of earnings upon the stock. (b) An ostensible salary may be in
part payment for property. This may occur, for example, where a partnership sells out to a
corporation, the former partners agreeing to continue in the service of the corporation. In
such a case it may be found that the salaries of the former partners are not merely for
services, but in part constitute payment for the transfers of their business.
(2)
(2) The form or method of fixing compensation is not decisive as to deductibility. While any form of
contingent compensation invites scrutiny as a possible distribution of earnings of the enterprise,
it does not follow that payments on a contingent basis are to be treated fundamentally on any
basis different from that applying to compensation at a flat rate. Generally speaking, if contingent
compensation is paid pursuant to a free bargain between the employer and the individual made
before the services are rendered, not influenced by any consideration on the part of the
employer other than that of securing on fair and advantageous terms the services of the
individual, it should be allowed as a deduction even though in the actual working out of the
contract it may prove to be greater than the amount which would ordinarily be paid.
(3) In any event the allowance for compensation paid may not exceed what is reasonable in all the
circumstances. It is in general just to assume that reasonable and true compensation is only
such amount as would ordinarily be paid for like services by like enterprises in like
circumstances. The circumstances to be taken into consideration are those existing at the date
when the contract for services was made, not those existing at the date when the contract is
questioned.
SECTION 71. Treatment of excessive compensation. The income tax liability of the recipient in
respect of an amount ostensibly paid to him as compensation, but not allowed to be deducted as such
by the payer, will depend upon the circumstances of each case. Thus, in the case of excessive
payments by corporations, if such payments correspond or bear a close relationship to stockholdings,
and are found to be distribution of earnings or profits, the excessive payments will be treated as
dividend. If such payments constitute payment for property, they should be treated by the payer as a
capital expenditure and by the recipient as part of the purchase price. HSCcTD
SECTION 72. Bonuses to employees. Bonuses to employees will constitute allowable deductions
from gross income when such payments are made in good faith and as additional compensation for
the services actually rendered by the employees, provided such payment, when added to the
stipulated salaries, do not exceed a reasonable compensation for the service rendered. It is
immaterial whether such bonuses are paid in cash or in kind or partly in cash and partly in kind.
Donations made to employees and others, which do not have in them the element of compensation or
Revenue Regulations 02-40
are in excess of reasonable compensation for services, are not deductible from gross income.
SECTION 73. Pensions, compensation for injuries. Amounts paid for pensions to retired
employees or to their families or others dependent upon them, or on account of injuries received by
employees, and lump-sum amounts paid or accrued as compensation for injuries, are proper
deductions as ordinary and necessary expenses. Such deductions are limited to the amount not
compensated for by insurance or otherwise. When the amount of the salary of an officer or employee
is paid for a limited period after his death to his widow or heirs, in recognition of the services rendered
by the individual, such payments may be deducted. Salaries paid by employers to employees who are
absent in the military, naval or other service of the Government, but who intend to return at the
conclusion of such service, are allowable deductions. (See Section 118 of these regulations, relative
to pension trust.)
SECTION 74. Rentals. Where a leasehold is acquired for business purposes for a specified sum,
the purchaser may take as a deduction in his return an aliquot part of such sum each year, based on
the number of years the lease has to run. Taxes paid by a tenant to or for a landlord for business
property are additional rent and constitute a deductible item to the tenant and taxable income to the
landlord, the amount of the tax being deductible by the latter. The cost borne by a lessee in erecting
buildings or making permanent improvements on ground of which he is lessee is held to be a capital
investment and not deductible as a business expense. In order to return to such taxpayer his
investment of capital, an annual deduction may be made from gross income of an amount equal to
the cost of such improvements divided by the number of years remaining of the term of lease, and
such deduction shall be in lieu of a deduction for depreciation. If the remainder of the term of lease is
greater than the probable life of the buildings erected, or of the improvements made, this deduction
shall take the form of an allowance for depreciation.
SECTION 75. Expenses of farmers. A farmer who operates a farm for profit is entitled to deduct
from gross income as necessary expenses all amounts actually expended in the carrying on of the
business of farming. The cost of ordinary tools of short life or small cost, such as hand tools, including
shovels, rakes, etc., may be included. The cost of feeding and raising livestock may be treated as an
expense deduction, in so far as such cost represents actual outlay, but not including the value of farm
produce grown upon the farm or the labor of the taxpayer. Where a farmer is engaged in producing
crops which take more than a year from the time of planting to the process of gathering and disposal,
expenses deducted may be determined upon the crop basis, and such deductions must be taken in
the year in which the gross income from the crop has been realized. The cost of farm machinery,
equipment, and farm buildings represents a capital investment and is not an allowable deduction as
an item of expense. Amounts expended in the development of farms, orchards, and ranches, prior to
the time when the productive state is reached may be regarded as investments of capital. Amounts
expended in purchasing work, breeding or dairy animals are regarded as investments of capital, and
may be depreciated unless such animals are included in an inventory in accordance with Section 149
of these regulations. The purchase price of transportation equipment even when wholly used in
carrying on farm operations, is not deductible but is regarded as an investment of capital. The cost of
gasoline or fuel, repairs, and upkeep of the transportation equipment if used wholly in the business of
farming is deductible as an expense; if used partly for business purposes and partly for the pleasure
or convenience of the taxpayer or his family, such cost may be apportioned according to the extent of
the use for purposes of business and pleasure or convenience, and only the proportion of such cost
justly attributable to business purposes is deductible as a necessary expense. If a farm is operated for
recreation or pleasure and not on a commercial basis, and if the expenses incurred in connection with
the farm are in excess of the receipt therefrom, the entire receipts from the sale of products may be
ignored in rendering a return of income, and the expenses incurred, being regarded as personal
expenses, will not constitute allowable deduction.
SECTION 76. When charges are deductible. Each year's return, so far as practicable, both as to
gross income and deductions therefrom, should be complete in itself, and taxpayers are expected to
make every reasonable effort to ascertain the facts necessary to make a correct return. The
expenses, liabilities, or deficit of one year cannot be used to reduce the income of a subsequent year.
A taxpayer has the right to deduct all authorized allowances and it follows that if he does not within
any year deduct certain of his expenses, losses, interests, taxes, or other charges, he can not deduct
them from the income of the next or any succeeding year. If it is recognized, however, that particularly
Page 10 of 40
in a going business of any magnitude there are certain overlapping items both of income and
deduction, and so long as these overlapping items do not materially distort the income, they may be
included in the year in which the taxpayer, pursuant to a consistent policy, takes them into his
accounts. Judgments or other binding judicial adjudication, on account of damages for patent
infringement, personal injuries, or other cause, are deductible from gross income when the claim is so
adjudicated or paid, unless taken under other methods of accounting which clearly reflect the correct
deduction, less any amount of such damages as may have been compensated for by insurance or
otherwise: If subsequent to its occurrence, however, a taxpayer first ascertains the amount of a loss
sustained during a prior taxable year which has not been deducted from gross income, he may render
an amended return for such preceding taxable year including such amount of loss in the deduction
from gross income and may in proper cases file a claim for refund of the excess tax paid by reason of
the failure to deduct such loss in the original return. A loss from theft or embezzlement occurring in
one year and discovered in another is ordinarily deductible for the year in which sustained.
SECTION 77. Expenses allowable to non-resident aliens and foreign corporations. The expenses
allowable to a non-resident alien or a foreign corporation consist of only such expenses as are
incurred in carrying on any business or trade conducted within the Philippines exclusively.
(Section 30(b) of the Code)
SECTION 78. Interest. Interest paid or accrued within the taxable year on indebtedness may be
deducted from gross income, except that interest on indebtedness incurred or continued to purchase
bonds and other securities, the interest upon which is exempt from tax, is not deductible. Interest paid
by the taxpayer on a mortgage upon real estate of which he is the legal or equitable owner, even
though the taxpayer is not directly liable upon the bond or not secured by such mortgage, may be
deducted as interest on his indebtedness.
In the case of a non-resident alien individual or foreign corporation, the allowable deduction will be the
proportion of such interest which the amount of gross income from sources within the Philippines
bears to the amount of gross income from all sources within and without this country; however, to
avail of this deduction, such non-resident alien individual or foreign corporation shall include in the
return all the information necessary for its calculation.
Interest paid by a corporation on scrip dividends is an allowable deduction. So-called interest on
preferred stock, which is in reality a dividend thereon, can not be deducted in computing net income.
In the case of banks and loan or trust companies, interest paid within the year on deposits or on
moneys received for investment and secured by interest-bearing certificates of indebted issued by
such hank or loan or trust company may be deducted from gross income.
SECTION 79. Interest on capital. Interest calculated for cost-keeping or other purposes on
account of capital or surplus invested in the business, which does not represent a charge arising
under an interest-bearing obligation, is not allowable deduction from gross income.
(Section 30(c) of the Code)
SECTION 80. Taxes in general. As a general rule, taxes are deductible with the exception of those
with respect to which the law does not permit deduction. However, in the case of a non-resident alien
individual and a foreign corporation, deduction is allowed only if and to the extent that the taxes for
which deduction is claimed are connected with income from sources within the Philippines.
Import duties paid to the proper customs officers, and business, occupation, license, privilege, excise
and stamp taxes and any other taxes of every name or nature paid directly to the Government of the
Philippines or to any political subdivision thereof, are deductible. The word "taxes" means taxes
proper and no deductions should be allowed for amounts representing interest, surcharge, or
penalties incident to delinquency. Postage is not a tax. Automobile registration fees are considered
taxes. Taxes are deductible as such only by the person upon whom they are imposed. Thus the
merchants' sales tax imposed by law upon sales is not deductible by the individual purchaser even
though the tax may be billed to him as a separate item.
In computing the net income of an individual no deduction is allowed for the taxes imposed upon his
interest as shareholder of a bank or other corporation, which are paid by the corporation without
Revenue Regulations 02-40
reimbursement from the taxpayer. The amount so paid should not be included in the income of the
shareholder.
In the case of corporate bonds or other obligations containing a tax-free covenant clause the
corporation paying a tax or any part of it, for someone else pursuant to its agreement is not entitled to
deduct such payment from gross income on any ground.
SECTION 81. Income tax imposed by the Government of the Philippines. The law does not permit
the deduction of the income tax paid to or accrued in favor of the Government of the Philippines, and
in no case may the taxpayer avail of such deduction.
SECTION 82. Income, war-profits, and excess-profits taxes imposed by the authority of a foreign
country. Income, war-profits, and excess-profits taxes imposed by the authority of a foreign country
(including the United States and possessions thereof) are allowed as deductions only if the taxpayer
does not signify in his return his desire to have to any extent the benefits of the provisions of law
allowing credits against the tax for taxes of foreign countries. In the case of a citizen of a foreign
country residing in the Philippines whose income from sources within such foreign country is not
subject to income tax, only that portion of the taxes paid to such foreign country which corresponds to
his net income subject to the Philippine income tax shall be allowed as deduction.
SECTION 83. Estate, inheritance, and gift taxes: taxes assessed against local benefits. Estate,
inheritance, and gift taxes are not deductible.
So-called taxes, more properly assessments, paid for local benefits, such as street, sidewalk, and
other like improvements, imposed because of and measured by some benefit inuring directly to the
property against which the assessment is levied, do not constitute an allowable deduction from gross
income. A tax is considered assessed against local benefits when the property subject to the tax is
limited to the property benefited. Special assessments are not deductible, even though an incidental
benefit may inure to the public welfare. The taxes deductible are those levied for the general public
welfare, by the proper taxing authorities at a like rate against all property in the territory over which
such authorities have jurisdiction. When assessments are made for the purpose of maintenance or
repair of local benefits, the taxpayer may deduct assessments paid as an expense incurred in
business, if the payment of such assessments is necessary to the conduct of his business. When the
assessments are made for the purpose of constructing local benefits, the payments by the taxpayer
are in the nature of capital expenditures and are not deductible. Where assessments are made for the
purpose of both construction and maintenance or repairs, the burden is on the taxpayer to show the
allocation of the amounts assessed to the different purposes. If the allocation can not be made, none
of the amounts so paid is deductible.
SECTION 84. Analysis of credit for taxes: If the taxpayer signifies in his return his desire to claim a
credit for taxes, the basis of such credit, in the case of a citizen of the Philippines, whether resident or
non-resident, and in the case of a domestic corporation, is as follows: (a) The amount of any income,
war-profits, and excess-profits taxes paid or accrued during the taxable year to any foreign country;
and (b) an individual's proportionate share of any such taxes of which he is a partner or of an estate
or trust of which he is a beneficiary paid or accrued during the taxable year to a foreign country if his
distributive share of the income of such partnership or trust is reported for taxation under Title II of the
Code.
In the case of an alien resident of the Philippines who signifies in his return his desire to claim a credit
for such taxes the basis of the credit is as follows: (a) The amount of any such taxes paid or accrued
during the taxable year to any foreign country if the foreign country of which such alien resident is a
citizen or subject, in imposing such taxes, allows a similar credit to citizens of the Philippines residing
in such country; and (b) his proportionate share of any such taxes of a partnership of which he is a
partner or an estate or trust of which he is a beneficiary paid or accrued during the taxable year to any
foreign country if his distributive share of the net income of such partnership or trust is reported for
taxation under Title II of the Code, and if the foreign country of which such alien resident is a citizen or
subject, in imposing such taxes, allows a similar credit to citizens of the Philippines residing in such
country.
Page 11 of 40
If a taxpayer signifies in his return his desire to claim credit for taxes, such action will be considered to
apply to income, war-profits, and excess-profits taxes paid to all foreign countries (including the
United States and possessions thereof), and no portion of any such taxes shall be allowed as a
deduction from gross income.
SECTION 85. Meaning of terms. The "amount of any income, war-profits, and excess-profits taxes
paid or accrued during the taxable year" means taxes proper (no credit being given for amounts
representing interest or penalties) paid or accrued during the taxable year on behalf of the taxpayer
claiming credit. "Foreign country" means any foreign state or political subdivision thereof, or any
foreign political entity, which levies and collects income, war-profits, or excess-profits taxes, and
includes the United States or any political subdivision thereof.
SECTION 86. Conditions of allowance of credits. If the taxpayer signifies in his return his desire to
claim credit for income, war-profits, or excess-profits taxes paid other than to the Philippines, the
income tax return must be accompanied by the appropriate form prescribed by the Commissioner of
Internal Revenue. The form must be carefully filled in with all the information there called for and with
the calculations of credits there indicated, and must be duly signed and sworn to or affirmed. If credit
is sought for taxes already paid the form must have attached to it the receipt for each such tax
payment. If credit is sought for taxes accrued, the form must have attached to it the return on which
each such accrued tax was based. This receipt or return so attached must be either the original, a
duplicate original, a duly certified or authenticated copy, or a sworn copy. In case only a sworn copy of
a receipt or return is attached, there must be kept readily available for comparison on request the
original, a duplicate original, or a duly certified or authenticated copy. If the receipt of the return is in a
foreign language, a certified translation thereof must be furnished by the taxpayer. Any additional
information necessary for the determination of the amount of income derived from sources without the
Philippines and from each foreign country shall, upon the request of the Commissioner of Internal
Revenue, be furnished by the taxpayer.
In the case of a credit sought for a tax accrued but not paid, the Commissioner of Internal Revenue
may in addition require as a condition precedent to the allowance of credit a bond from the taxpayer. It
shall be in such sum as the Commissioner of Internal Revenue may prescribe, and shall be
conditioned for the payment by the taxpayer of any amount of tax found due upon any
redetermination of the tax made necessary by such credit proving incorrect, with such further
conditions as the Commissioner of Internal Revenue may require. This bond shall be executed by the
taxpayer, or the agent or representative of the taxpayer, as principal, and by sureties satisfactory to
and approved by the Commissioner of Internal Revenue.
If it is the desire of the taxpayer to claim as a credit and not as a deduction accrued income, war-
profits, and excess profits taxes imposed by the authority of any foreign country or possession of the
United States but at the time the return is made it is impossible to estimate the amount of such taxes
that may have accrued for the period for which the return is made, the form required under this
section may be filed at a later date but a credit cannot be allowed for such taxes unless the taxpayer
signifies in his return his desire to have to any extent the benefits of Section 30(c) (3) to (9).
SECTION 87. Redetermination of tax when credit proves incorrect. In case credit has been given
for taxes accrued, or a proportionate share thereof, and the amount that is actually paid on account of
such taxes, or a proportionate share thereof, is not the same as the amount of such credit, or in case
any tax payment credited is refunded in whole or in part, the taxpayer shall immediately notify the
Commissioner of Internal Revenue. The Commissioner of Internal Revenue will thereupon
redetermine the amount of the tax of such taxpayer for the year or years for which such incorrect
credit was granted. The amount of tax, if any, due upon such redetermination shall be paid by the
taxpayer upon notice and demand by the Commissioner of Internal Revenue. The amount of tax, if
any, shown by such redetermination to have been overpaid shall be credited or refunded to the
taxpayer in accordance with the provisions of Section 309 of the Code.
SECTION 88. Countries which do or do not satisfy the similar credit requirements. A country
satisfies the similar credit requirement of Section 30(c)(3)(B), as to income tax paid to such country,
either by allowing to citizens of the Philippines residing in such country a credit for the amount of
income taxes paid to the Philippines. A country does not satisfy the similar credit requirement of
Revenue Regulations 02-40
Section (30)(c)(3)(B) if it does not allow any credit to citizens of the Philippines residing in such
country for the amount of income taxes paid to the Philippines, or if such country does not impose any
income taxes. If the country of which a resident alien is a citizen or subject does not allow to a Filipino
citizen residing in such country a credit for taxes paid by such citizen to another foreign country, no
credit is allowed to such resident alien for taxes paid by him to such foreign country.
SECTION 89. When credit for taxes may be taken. The credit for taxes provided by Section (30)
(c)(3) to (9) may ordinarily be taken either in the return for the year in which the taxes accrued or in
which the taxes were paid, dependent upon whether the accounts of the taxpayer are kept and his
returns filed upon the accrual basis or upon the cash receipts and disbursements basis. Section 30(c)
(6) allows the taxpayer, at his option and irrespective of the method of accounting employed in
keeping his books, to take such credit for taxes as may be allowable in the return for the year in which
the taxes accrued. An election thus made must be followed in returns for all subsequent years, and no
portion of any such taxes will be allowed as a deduction from gross income.
SECTION 90. Domestic corporation owning a majority of the stock of foreign corporation. In the
case of a domestic corporation which owns a majority of the voting stock of a foreign corporation from
which it receives dividends in any taxable rear, the credit for foreign taxes includes not only the
income, war profits and excess-profits taxes paid or accrued during the taxable year to any foreign
country by such domestic corporation, but also income, war-profits and excess-profits taxes deemed
to have been paid determined by taking the same proportion of any income, war-profits, and excess-
profits taxes paid or accrued by such controlled foreign corporation to any foreign country upon or
with respect to the accumulated profits of such foreign corporation from which such dividends were
paid, which the amount of any such dividends received bears to the amount of such accumulated
profits. The amount of taxes deemed to have been paid is limited, however, to an amount of the tax
against which the credit for foreign taxes is taken, which the amount of such dividends bears to the
amount of the entire net income of the domestic corporation in which such dividends are included. If
dividends are received from more than one controlled foreign corporation, the limitation is to be
computed separately for the dividends received from each controlled foreign corporation. If the credit
for foreign taxes includes taxes deemed to have been paid, the taxpayer must furnish the same
information with respect to the taxes deemed to have been paid as it is required to furnish with
respect to the taxes actually paid or accrued by it. Taxes paid or accrued by a controlled foreign
corporation are deemed to have been paid by the domestic corporation for purposes of credit only.
cSTHAC
SECTION 91. Non-resident aliens and foreign corporations not allowed credits against the tax.
Non-resident aliens and foreign corporations may not claim credits against the tax from taxes of
foreign countries.
SECTION 92. Limitation on credit for foreign taxes. The amount of credit for foreign taxes shall be
subject to the following limitations:
(a) The amount of the credit in respect to the tax paid or accrued to any country shall not exceed the
same proportion of the tax against which such credit is taken, which the taxpayer's net income
from sources within such country taxable under Title II bears to his entire net income for the
same taxable year; and
(b) The total amount of the credit shall not exceed the same proportion of the tax against which such
credit is taken, which the taxpayer's net income from sources without the Philippines taxable under
Title II bears to his entire net income for the same taxable year.
(Section 30(d) of the Code)
SECTION 93. Losses by individuals. Losses sustained by individuals during the year not
compensated for by insurance or otherwise are fully deductible (except by non-resident aliens)
(a) If incurred in a taxpayer's trade; or
(b) If incurred in any transaction entered into for profits; or
(c) Of property not connected with the trade or business if arising from fires, storm, shipwreck, or
other casualty, or from robbery, theft or embezzlement. No loss shall, however, be allowed as a
deduction if at the time of filing of the return, such loss has been claimed as deduction for estate
or inheritance tax purposes in the estate or inheritance tax return.
Page 12 of 40
SECTION 94. Losses by corporations. Domestic corporations may deduct losses actually
sustained and charged off within the year and not compensated for by insurance or otherwise.
SECTION 95. Losses by non-resident alien and foreign corporation. Non-resident aliens and
foreign corporations are allowed only losses sustained in business or trade conducted within the
Philippines, losses of property within the Philippines arising from fires, storms, shipwreck, or other
casualty and from robbery, theft, or embezzlement, and losses actually sustained in transactions
entered into for profit in the Philippines, although not connected with their trade or business, not
compensated by insurance or otherwise.
SECTION 96. Losses generally. Losses must usually be evidenced by closed and completed
transactions. Proper adjustment must be made in each case for expenditures or items of loss properly
chargeable to capital account, and for depreciation, obsolescence, amortization, or depletion.
Moreover, the amount of the loss must be reduced by the amount of any insurance or other
compensation received, and by the salvage value, if any, of the property. A loss on the sale of
residential property is not deductible unless the property was purchased or constructed by the
taxpayer with a view to its subsequent sale for pecuniary profit. No loss is sustained by the transfer of
property by gift or death. Losses sustained in illegal transactions are not deductible. EAISDH
SECTION 97. Voluntary removal of buildings. Loss due to the voluntary removal or demolition of
old buildings, the scrapping of old machinery, equipment, etc., incident to renewals and replacements
will be deductible from gross income. When a taxpayer buys real estate upon which is located a
building, which he proceeds to raze with a view to erecting thereon another building, it will be
considered that the taxpayer has sustained no deductible expense on account of the cost of such
removal, the value of the real estate, exclusive of old improvements, being presumably equal to the
purchase price of the land and building plus the cost of removing the useless building.
SECTION 98. Loss of useful value. When through some change in business conditions, the
usefulness in the business of some or all of the capital assets is suddenly terminated, so that the
taxpayer discontinues the business or discards such assets permanently from use of such business,
he may claim as deduction the actual loss sustained. In determinating the amount of the loss,
adjustment must be made, however, for improvements, depreciation and the salvage value of the
property. This exception to the rule requiring a sale or other disposition of property in order to
establish a loss requires proof of some unforeseen cause by reason of which the property has been
prematurely discarded, as, for example, where an increase in the cost or change in the manufacture
of any product makes it necessary to abandon such manufacture, to which special machinery is
exclusively devoted, or where new legislation directly or indirectly makes the continued profitable use
of the property impossible. This exception does not extend to a case where the useful life of property
terminates solely as a result of those gradual processes for which depreciation allowance are
authorized. It does not apply to inventories or to other than capital assets. The exception applies to
buildings only when they are permanently abandoned or permanently devoted to a radically different
use, and to machinery only when its use as such is permanently abandoned. Any loss to be
deductible under this exception must be charged off in the books and fully explained in returns of
income.
SECTION 99. Shrinkage in value of stocks. A person possessing stock of a corporation can not
deduct from gross income any amount claimed as a loss merely on account of shrinkage in value of
such stock through fluctuation of the market or otherwise. The loss allowable in such case is that
actually suffered when the stock is disposed of. If stock of a corporation becomes worthless, its cost
or other basis determined in accordance with these regulations may be deducted by the owner in the
taxable year in which the stock became worthless, provided a satisfactory showing of its
worthlessness be made, as in the case of bad debts.
SECTION 100.Losses of farmers. Losses incurred in the operation of farms as business
enterprises are deductible from gross income. If farm products are held for favorable markets, no
deduction on account of shrinkage in weight or physical value or by deterioration in storage shall be
allowed, except as such shrinkage may be reflected in an inventory if used to determine profits. The
total loss by storm, flood, or fire of a prospective crop is not a deductible loss in computing net
income. A farmer engaged in raising and selling stock, cattle, sheep, horses, etc., is not entitled to
Revenue Regulations 02-40
claim as a loss the value of animals that perish from among those animals that were raised on the
farm, except as such loss is reflected in an inventory if used. If livestock has been purchased after
March 1, 1913, for any purpose, and afterwards dies from disease, exposure, or injury, or is killed by
order of the authorities, the actual purchase price of such stock, less any depreciation allowable as a
deduction in computing net income, with respect to such perished, livestock, and also any insurance
or indemnity recovered, may be deducted as a loss. The actual cost of other property (with proper
adjustment for depreciation), which is destroyed by order of the authorities, may in like manner be
claimed as a loss; but if reimbursement is made in whole or in part on account of stock killed or
property destroyed, the amount received shall be reported as income for the year in which
reimbursement is made. The cost of any feed, pasturage, or care which has been deducted as an
expense of operation shall not be included as part of the cost of the stock for the purpose of
ascertaining the amount of a deductible loss. If gross income is ascertained by inventories, no
deduction can be made for livestock or products lost during the year, whether purchased for resale,
produced on the farm, as such losses will be reflected in the inventory by reducing the amount of
livestock or products on hand at the close of the year. If an individual owns and operates a farm, in
addition to being engaged in another trade, business or calling, and sustains a loss from such
operation of the farm, then the amount of loss sustained may be deducted from gross income
received from all sources, provided the farm is not operated for recreation or pleasure. IEaCDH
SECTION 101.Capital losses; losses on wash sales of stock or securities. Losses on sales or
exchanges of capital assets are allowed to the extent provided in section 34 of the Code. If any
securities which are capital assets become worthless during the taxable year, the loss resulting
therefrom shall be considered as a loss from the sale or exchange, on the last day of such taxable
year, of capital assets. Losses on "wash sales" of stock or securities are treated in section 33 of the
Code.
(Section 30 (e) of the Code)
SECTION 102.Bad debts. Where all the surrounding circumstances indicate that a debt is
worthless, and the debt is charged off on the books of the taxpayer within the year, the same may be
allowed as a deduction in computing net income. There should accompany the return a statement
showing the propriety of any deduction claimed for bad debts. Before a taxpayer may charge off and
deduct a debt, he must ascertain and be able to demonstrate, with a reasonable degree of certainty,
the uncollectibility of the debt. Any amount subsequently received on account of a bad debt previously
charged off and allowed as a deduction for income tax purposes, must he included in gross income
for the taxable year in which received. In determining whether a debt is worthless the Commissioner
of Internal Revenue will consider all pertinent evidence, including the value of the collateral, if any,
securing the debt and the financial condition of the debtor.
Where the surrounding circumstances indicate that a debt is worthless and uncollectible and that legal
action to enforce payment would in all pro-ability not result in the satisfaction of execution on a
judgment, a showing of those facts will be sufficient evidence of the worthlessness of the debt for the
purpose of deduction. Bankruptcy is generally an indication of the worthlessness of at least a part of
an unsecured and unpreferred debt. Actual determination of worthlessness in bankruptcy is
sometimes possible before and at other times only when a settlement in bankruptcy shall have been
had. Where a taxpayer ascertained a debt to be worthless and charged it off in one year, the mere
fact that bankruptcy proceedings instituted against the debtor are terminated in a later year,
confirming the conclusion that the debt is worthless, will not authorize shifting the deduction to such
later year. If a taxpayer computes his income upon the basis of valuing his notes or accounts
receivable at their fair market value when received, which may be less than their face value, the
amount deductible for bad debts in any case is limited to such original valuation.
SECTION 103.Examples of bad debts. Worthless debts arising from unpaid wages, salaries, rents,
and similar items of taxable income will not be allowed as a deduction unless the income such items
represent has been included in the return of income for the year in which the deduction as a bad debt
is sought to be made or in a previous year. Only the difference between the amount received in
distribution of the assets of a bankrupt and the amount of the claim may be deducted as a bad debt.
The difference between the amount received by a creditor of a decedent in distribution of the assets
of the decedent's estate and the amount of his claim may be considered a worthless debt. A
purchaser of accounts receivable which can not be collected and are consequently charged off the
Page 13 of 40
hooks as bad debt is entitled to deduct them, the amount of deduction to be based upon the price he
paid for them and not upon their face value.
Where under foreclosure of a mortgage, the mortgagee buys the mortgaged property and credits the
indebtedness with the purchase price, the difference between the purchase price and the
indebtedness will not be allowable as a deduction for a bad debt, for the property which was security
for the debt stands in the place of the debt. The determination of loss in such case is deferred until the
disposal of the property.
SECTION 104.Securities becoming worthless. If any securities which are capital assets are
ascertained to be worthless and charged off within the taxable year, the loss resulting therefrom shall,
except in the case of a bank or trust company incorporated under the laws of the Philippines or of the
United States a substantial part of whose business is the receipt of deposits, be considered as a loss
from the sale or exchange, on the last day of such taxable year, of capital assets.
(Section 30(f) of the Code)
SECTION 105.Depreciation. A reasonable allowance for the exhaustion, wear and tear, and
obsolescence of property used in the trade or business may be deducted from gross income. For
convenience such an allowance will usually be referred to as depreciation, excluding from the term
any idea of a mere reduction in market value not resulting from exhaustion, wear and tear, or
obsolescence. The proper allowance for such depreciation of any property used in the trade or
business is that amount which should be set aside for the taxable year in accordance with a
reasonable consistent plan whereby the aggregate of the amount so set aside, plus the salvage
value, will, at the end of the useful life of the property in business, equal the basis of the property. Due
regard must also be given to expenditures for current upkeep.
SECTION 106.Depreciable property. The necessity for a depreciation allowance arises from the
fact that certain property used in the business gradually approaches a point where its usefulness is
exhausted. The allowances should be confined to property of this nature. In the case of tangible
property, it applies to that which is subject to wear and tear, to decay or decline from natural causes,
to exhaustion and to obsolescence due to the normal progress of the art, as where machinery or other
property must be replaced by a new invention, or due to the inadequacy of the property to the growing
needs of the business. It does not apply to inventories or to stock in trade, nor to land apart from the
improvements or physical development added to it. It does not apply to bodies of minerals which
through the process of removal suffer depletion. Property kept in repair may, nevertheless, be the
subject of a depreciation allowance. The deduction of an allowance for depreciation is limited to
property used in the taxpayer's trade or business. No such allowance may be made in respect to
automobiles or other transportation equipment used solely for the pleasure, a building used by the
taxpayer solely as his residence, nor in respect of furniture or furnishings therein, personal effects, or
clothing; but properties and costumes used exclusively in a business, such as theatrical business,
may be the subject of a depreciation allowance.
SECTION 107.Depreciation of intangible property. Intangibles, the use of which in the trade or
business is definitely limited in duration, may be the subject of a depreciation allowance. Examples
are patents, copyrights, and franchises. Intangibles, the use of which in the business or trade is not so
limited, will not usually be a proper subject of such an allowance. If however, an intangible asset
acquired through capital outlay is known from experience to be of value in the business for only a
limited period, the length of which can be estimated from experience with reasonable certainty, such
intangible asset may be the subject of a depreciation allowance, provided the facts are fully shown in
the return or prior thereto to the satisfaction of the Commissioner of Internal Revenue.
SECTION 108.Capital sum recoverable through depreciation allowances. The capital sum to be
replaced by depreciation allowances is the cost or other basis of the property in respect of which the
allowance is made. To this amount should be added from time to time the cost of improvements,
additions, and betterment and from it should be deducted from time to time the amount of any definite
loss or damage sustained by the property through casualty, as distinguished from the gradual
exhaustion of its utility which is the basis of the depreciation allowance. Where the lessee of real
property erects buildings, or makes permanent improvements which become part of the realty and
income has been returned by the lessor as a result thereof, as provided in Section 49 of these
Revenue Regulations 02-40
regulations, the capital sum to be replaced by depreciation allowance is the same as though no such
buildings had been erected or such improvements made. No depreciation deduction will be allowed in
the case of property which has been amortized to its scrap value and is no longer in use. AaSCTD
SECTION 109.Method of computing depreciation allowance. The capital sum to be replaced
should be charged off over the useful life of the property, either in equal annual installments or in
accordance with any other recognized trade practice, such as an apportionment of the capital sum
over units of production. Whatever plan or method of apportionment is adopted must be reasonable
and must have due regard to operating conditions during the taxable period. While the burden of proof
must rest upon the taxpayer to sustain the deductions taken by him, such deductions must not be
disallowed unless shown by clear and convincing evidence to be unreasonable. The reasonableness
of any claim for depreciation shall be determined upon the conditions known to exist at the end of the
period for which the return is made. If it develops that the useful life of the property will be longer or
shorter than the useful life as originally estimated under all the then known facts, the portion of the
cost or other basis of the property not already provided for through depreciation allowances should be
spread over the remaining useful life of the property as reestimated in the light of the subsequent
facts, and depreciation deductions taken accordingly.
SECTION 110. Obsolescence. With respect to physical property the whole or any portion of which
is clearly shown by the taxpayer as being affected by economic conditions that will result in its being
abandoned at a future date prior to the end of its normal useful life, so that depreciation deductions
alone are insufficient to return the cost (or other basis) at the end of its economic term of usefulness,
a reasonable deduction for obsolescence, in addition to depreciation, may be allowed in accordance
with the facts obtaining with respect to each item of property concerning which a claim for
obsolescence is made. No deductions for obsolescence will be permitted merely because, in the
opinion of a taxpayer, the property may become obsolete at some later date. This allowance will be
confined to such portion of the property on which obsolescence is definitely shown to be sustained
and can not be held applicable to an entire property unless all portions thereof are affected by the
conditions to which obsolescence is found to be due.
SECTION 111. Depreciation of patent or copyright. In computing depreciation allowance in the
case of a patent or copyright, the capital sum to be replaced is the cost or other basis of the patent or
copyright. The allowance should be computed by an apportionment of the cost or other basis of the
patent or copyright over the life of the patent or copyright since its grant, or since its acquisition by the
taxpayer, or since March 1, 1913, as the case may be. If the patent or copyright was acquired from
the Government, its cost consists of the various Government fees, cost of drawings, experimental
models, attorney's fees, development or experimental expenses, etc., actually paid. Depreciation of a
patent can be taken on the basis of the fair market value as of March 1, 1913, only when affirmative
and satisfactory evidence of such value is offered. Such evidence should whenever practicable be
submitted with the return. If the patent becomes obsolete prior to its expiration, such proportion of the
amount on which its depreciation may be based as the number of years of its remaining life bears to
the whole number of years intervening between the basic date when it legally expires may be
deducted, if permission to do so is specifically secured from the Commissioner of Internal Revenue.
Owing to the difficulty of allocating to a particular year the obsolescence of a patent, such permission
will be granted only if affirmative and satisfactory evidence that the patent became obsolete in the
year for which the return is made is submitted to the Commissioner of Internal Revenue. The fact that
depreciation has not been taken in prior years does not entitle the taxpayer to deduct in any taxable
year a greater amount for depreciation than would otherwise be allowable. AcDHCS
SECTION 112. Depreciation of drawings and models. Where a taxpayer has incurred expenditures
in his business for designs, drawings, patterns, models, or work of an experimental nature calculated
to result in improvement of his facilities or his product, if the period of usefulness of any such asset
may be estimated from experience with reasonable accuracy, it may be the subject of depreciation
allowances spread over such estimated period of usefulness. The facts must be fully shown in the
return or prior thereto to the satisfaction of the Commissioner of Internal Revenue. Except for such
depreciation allowances no deduction shall be made by the taxpayer against any sum so set up as an
asset except on the sale or other disposition of such asset at a loss or on proof of a total loss thereof.
SECTION 113. Charging off depreciation. A depreciation allowance, in order to constitute an
Page 14 of 40
allowable deduction from gross income, must be charged off. The particular manner in which it shall
be charged off is not material, except that the amount measuring a reasonable allowance for
depreciation must be either deducted directly from the book value of the assets or preferably credited
to a depreciation reserve account, which must be reflected in the annual balance sheet. The
allowances should be computed and charged off with express reference to specific items, units, or
groups of property, each item or unit being considered separately or specifically included in a group
with others to which the same factors apply. The taxpayer should keep such records to each item or
unit of depreciable property as will permit the ready verification of the factors used in computing the
allowance for each year for each item, unit, or group.
SECTION 114. Depreciation in the case of farmers. A reasonable allowance for depreciation may
be claimed on farm buildings (other than a dwelling occupied by the owner), farm machinery, and
other physical property. A reasonable allowance for depreciation may also be claimed on live stock
acquired for work, breeding, or dairy purposes, unless they are included in an inventory used to
determine profits in accordance with these regulations. Such depreciation should be based on the
cost or other basis and the estimated life of the live stock. If such live stock be included in an
inventory no depreciation thereof will be allowed, as the corresponding reduction in their value will be
reflected in the inventory.
SECTION 115. Statement to be attached to return. To each return in which depreciation charges
are claimed, there should be attached a statement showing the item, unit, or group of depreciable
property, the cost price or its market value as of March 1, 1913, if acquired prior to that date, the rate
of charge, amount previously deducted, and the amount claimed in the return. These data must agree
with those appearing in the books of the taxpayer.
(Section 30(g) of the Code)
SECTION 115-A-1. General Circular V-332, January 6, 1961 Who is entitled to deduct depletion.
In order to be entitled to percentage depletion allowance, the taxpayer must have an economic
interest in the property. To acquire an economic interest, the taxpayer must have a capital investment
in the property and not a mere economic advantage. The taxpayer must have acquired at least, by
investment, any interest in oil or gas or mineral in place, and secures, by any form of legal
relationship, income derived from the extraction of the oil, gas or mineral, to which he must look for a
return of his capital. Thus the parties entitled to share in oil or mineral extracted, or the gross
proceeds therefrom (including the parties to a lease providing for royalty payments of stated amounts
per unit mined) have economic interests in the oil or minerals in place. That is, they, as owners of the
rights in oil or other mineral in place, share the income from production, and the depletion allowances
thereon are regarded as designed to permit tax-free recovery of at least their capital investments in
such property rights.
SECTION 115-A-2. Basis for depletion. On oil or gas wells the percentage depletion allowance is
fixed at 27 1/2% of gross income while on mines, the percentage depletion allowance varies in
accordance with the class of minerals. The gross income basis is the amount remaining after
deducting therefrom rents or royalties paid or incurred by the taxpayer in respect to the property. In
both cases, the total percentage depletion allowance shall in no case exceed 50% of the net income
or profit.
Illustration
Subject: Oil and gas wells (1) (2)
Gross income after deducting rents and royalties P100.00 P100.00
27 1/2% thereof 27.50 27.50
Net income or net profit 50.00 70.00
50/ of net income or net profit 25.00 35.00
Allowance depletion 25.00 27.50
Under column (1) P25.00 is the allowance depletion because the allowable percentage cannot
exceed 50% of the net profit or net income. Under column (2), the allowable depletion is P27.50
because it does not exceed 50% of either the net income or net profit.
SECTION 115-A-3. Definition of terms. For purposes of the depletion allowance for oil and gas
Revenue Regulations 02-40
wells and mines, the following terms and phrases shall have the meaning indicated:
(a) Gross income. Gross income means the "gross income from the property". The gross income
in the case of gas and oil wells is the amount for which the taxpayer sells the oil and gas in the
immediate vicinity of the well. If the oil and gas are not sold on the property but are manufactured or
converted into a refined product prior to sale, the gross income from the property shall be assumed to
be equivalent to the representative market or field price (as of the date of sale) of the oil and gas
before conversion or transportation.
"Gross income from the property" means, in the case of mines, the gross income from mining. The
gross income from mining consists of the proceeds from the sales of ores or minerals extracted from
the mining property. Where ores are sent abroad where the ordinary treatment processes are applied
or where they are refined and where they are sold, the actual cost of ocean freight as well as
insurance, should be deducted from the actual selling price for gross income purposes. Also where
minerals or mineral products are sold or consigned abroad by the lessee or owner of the mine under
C.I.F. terms, the actual cost of ocean freight and insurance should be deducted. ECDHIc
(b) Mining. The term "mining" includes not merely the extraction of the ores or minerals from the
ground but also the ordinary treatment process normally applied by mine owners or operators in order
to obtain the commercially marketable mineral product or products, and so much of the transportation
of ores or minerals (whether or not by common carrier) from the point of extraction from the ground to
the plants or mills in which the ordinary treatment processes are applied thereto as is not in excess of
50 miles unless the Commissioner of Internal Revenue finds that the physical and other requirements
are such that the ore or mineral must be transported a greater distance to such plants or mills.
(c) Extraction of the ores or minerals from the ground. The term "extraction of the ores or
minerals from the ground" includes the extraction by mine owners or operators of ores or minerals
from the waste or residue of prior mining. Thus income derived from the working over of tailings, piles
or culm banks is included in determining "gross income from the property". The length of time
between the prior mining and extraction of ores or minerals from the waste or residue of such mining
is immaterial. Whether the waste or residue results from the application of ordinary treatment
processes or from the process of removal from the ground, income derived therefrom is within the
term "gross income from the property". To be included in "gross income from the property", income
derived from the extraction of ores or minerals from the waste or residue of prior mining must come
from such extraction by the mine owner or operator himself.
(d) Ordinary treatment processes. The term "ordinary treatment processes" includes the
following:
(1) In the case of coal-cleaning, breaking, sizing, dust-allaying, treating to prevent freezing, and
loading for shipment;
(2) In the case of sulfur recovered by the Frasch process pumping to vats, cooling, breaking, and
loading for shipment;
(3) In the case of iron ore, bauxite, ball and sagger clay, rock asphalt, and minerals which are
customarily sold in the form of a crude mineral product sorting, concentrating; and sintering
to bring to shipping grade and form, and loading for shipment;
(4) In the case of lead, zinc, copper, gold, silver, or fluorspar ores, potash, and ores which are not
customarily sold in the form of the crude mineral product-crushing, grinding, and beneficiation by
concentration (gravity, flotation, amalgamation, electrostatic, or magnetic) cyanidation, leaching,
crystallization, precipitation (but not including as an ordinary treatment process electrolytic
deposition, roasting, thermal or electric smelting, or refining), or by substantially equivalent
processes, or extraction of the product or products from the ore, including the furnacing of
quicksilver ores; and
(5) The pulverization of talc, the burning of magnesite, and the sintering and modulizing of
phosphate rock.
(e) Net income or net profit. "Net income" or "net profit" means the taxpayer's taxable income
from the property. Net income or net profit (computed without allowance for depletion) means the
"gross income from the property" less the allowable deductions attributable to the mineral property
upon which the depletion is claimed and the allowable deductions attributable to the treatment
processes insofar as they relate to the product of such property, including overhead and operating
expenses, development costs properly charged to expense, depreciation, taxes, losses sustained,
Page 15 of 40
etc. Deductions not directly attributable to particular properties or processes shall be fairly allocated.
(f) Property. For the purpose of computing the depletion allowance in the case of mines and
wells, the term "property" means each separate interest owned by the taxpayer in each mineral
deposit in each separate tract or parcel of land.
If a taxpayer owns two or more separate operating mineral interests which constitute part or all of an
operating unit, he may elect to form (a) one aggregation of, and to treat as one property, any two or
more of such interests and (b) to treat as a separate property each such interest which he does not
elect to include within the aggregation referred to in (a). Separate operating mineral interests which
constitute part or all of an operating unit may be aggregated whether or not they are included in
contiguous tracts or parcels. A taxpayer may not elect to form more than one aggregation of operating
mineral interests within any one operating unit. Such election may be made by the taxpayer by the
giving of notice of such election to the Commissioner of Internal Revenue not later than the time
prescribed for filing of the return and any such election so made shall be binding upon the taxpayer
for all subsequent taxable years, except that the Commissioner of Internal Revenue may consent to a
different treatment of the interest with respect to which the election has been made.
SECTION 115-A-4. Depletion deductible by non-resident aliens or foreign corporations. A non-
resident alien individual or a foreign corporation is entitled to an allowance for depletion of oil and gas
wells or mines located in the Philippines. (Gen. Cir. V-332 implements Sec. 30(g), Tax Code, as
amended by R.A. 2698)
(Section 30(h) of the Code)
SECTION 116. When contributions or gifts may be deducted. Contributions or gifts within the
taxable year are deductible to an aggregate amount not in excess of 6 per centum, in the case of an
individual, and 3 per centum, in the case of a corporation, of the taxpayer's taxable net income, if
actually paid or made to or for the use of the Government of the Philippines or any political
subdivision thereof for exclusively public purposes or to domestic corporations or associations
organized and operated exclusively for religious, charitable, scientific, athletic, cultural or educational
purposes, or to societies for the prevention of cruelty to children or animals, provided that no part of
the net income of which inures to the benefit of any private stockholders or individual.
In connection with claims for deductions, there shall be stated on returns of income the name and
address of each organization to which a gift was made and the approximate date and the amount of
the gift in each case. Where the gift is other than money, the basis for calculation of the amount
thereof shall be the fair market value of the property at the time of the gift. Contributions or gifts paid
or made to corporations or associations specified in the law will only be allowed as deduction when
the taxpayer attaches to his return the receipt duly signed by the responsible officer of the
corporations or associations to which the contributions or gifts has been paid or made. If desired, said
receipt will be returned to the taxpayer after they have served their purpose.
(Section 30(i) of the Code)
SECTION 117. Allowance of deductions and credits. Unless a non-resident alien individual shall file
or cause to be filed with the Commissioner of Internal Revenue, a true and accurate return of income
from all sources, corporate, or otherwise, within the Philippines, regardless of amount, the tax shall be
collected on the basis of the gross income (not the net income) from sources within the Philippines. In
case of failure to file such return, the Commissioner of Internal Revenue will cause a return of income
to be made and include therein the income of such non-resident alien from all source concerning
which he has information, and he will assess the tax and collect it from one or more of the sources of
income of such non-resident alien within the Philippines, without allowance for deductions or credit.
(Cf. effect of Sec. 22(b) as amended by R.A. 2343.)
(Section 30(j) of the Code)
SECTION 118. Payments to employees' pension trusts. An employer who adopts or has adopted a
reasonable pension plan, actuarially sound, and who establishes, or has established, and maintains a
pension trust for the payment of reasonable pensions to his employees shall be allowed to deduct
from gross income reasonable amounts paid to such trust, in accordance with the pension plan
(including any reasonable amendment thereof), as follows:
Revenue Regulations 02-40
(a) If the plan contemplates the payment to the trust, in advance of the time when pensions are
granted, of amounts to provide for future pensions payments, then (1) reasonable amounts paid to the
trust during the taxable year representing the pension liability applicable to such year, determined in
accordance with the plan, shall be allowed as a deduction for such year as an ordinary and necessary
business expense, and in addition (2) one-tenth of a reasonable amount transferred or paid to the
trust during the taxable year to cover in whole or in part the pension liability applicable to the years
prior to the taxable year, or so transferred or paid to place the trust on a sound financial basis, shall
be allowed as a deduction for the taxable year and for each of the nine succeeding taxable years.
(b) If the plan does not contemplate the payment to the trust, in advance of the time when pensions
are granted, of amounts to provide for future pension payments, then (1) reasonable amounts paid to
the trust during the taxable year representing the present value of the expected future payments in
respect of pensions granted to employees retired during the taxable year shall be allowed as
deduction for such year as an ordinary and necessary business expense, and in addition (2) one tenth
of a reasonable amount transferred or paid to the trust during the taxable year to cover in whole or in
part the present value of the expected future payments in respect of pensions granted to employees
retired prior to the taxable year, or so transferred or paid to place the trust on a sound financial basis,
shall be allowed as a deduction for the taxable year and for each of the nine succeeding taxable
years.
(Section 30(k) of the Code)
SECTION 118-A. Optional standard deduction. In lieu of the deductions allowed under this
section an individual, other than a non-resident alien, may elect a standard deduction. Such optional
standard deduction shall be in the amount of one thousand pesos or in an amount equal to ten per
centum of his gross income, whichever is the lesser. Unless the taxpayer signifies in his return his
intention to elect the optional standard deduction he shall be considered as having availed himself of
the deductions allowed in the preceding subsection. The Secretary of Finance shall prescribe the
manner of the election. Such election when made in the return shall be irrevocable for the taxable
year for which the return is made.
(Section 31 of the Code)
SECTION 119. Personal, living, and family expenses. Personal, living, and family expenses are not
deductible. Insurance paid on a dwelling owned and occupied by a taxpayer is a personal expense
and not deductible. Premiums paid for life insurance by the insured are not deductible. In the case of
a professional man who rents a property for residential purposes, but incidentally receives his clients,
patients, or callers in connection with his professional work (his place of business being elsewhere),
no part of the rent is deductible as a business expense. If however, he uses part of the house for his
office, such portion of the rent as is properly attributable to such office is deductible. Where the father
is legally entitled to the services of his minor children, any allowances which he gives them, whether
said to be in consideration of services or otherwise, are not allowable deductions in his return of
income. Alimony, and an allowance paid under a separation agreement are not deductible from gross
income.
SECTION 120.Capital expenditures. No deduction from gross income may be made for any
amounts paid out for new buildings or for permanent improvements or betterments made to increase
the value of the taxpayer's property, or for any amount expended in restoring property or in making
good the exhaustion thereof for which an allowance for depreciation or depletion or other allowance is
or has been made. Amounts expended for securing a copyright and plates, which remain the property
of the person making the payments, are investments of capital. The cost of defending or perfecting
title to property constitutes a part of the cost of the property and is not a deductible expense. The
amount expended for architect's services is part of the cost of the building. Commissions paid in
purchasing securities are a part of the cost of such securities. Commissions paid in selling securities
are an offset against the selling price. Expenses of the administration of an estate, such as court
costs, attorney's fees, and executor's commissions, are chargeable against the "corpus" of the estate
and are not allowable deductions. Amounts to be assessed and paid under an agreement between
bondholders or shareholders of a corporation, to be used in a reorganization of the corporation, are
investments of capital and not deductible for any purpose in return of income. DaACIH
Page 16 of 40
In the case of a corporation, expenses for organization, such as incorporation fees, attorney's fees
and accountants' charges, are ordinarily capital expenditures; but where such expenditures are
limited to purely incidental expenses, a taxpayer may charge such items against income in the year in
which they are incurred. A holding company which guarantees dividends at a specified rate on the
stock of a subsidiary corporation for the purpose of securing new capital for the subsidiary and
increasing the value of its stockholdings in the subsidiary may not deduct amounts paid in carrying out
this guaranty in computing its net income, but such payments may be added to the cost of its stock in
the subsidiary.
SECTION 121.Premiums on life insurance of employees. Any amounts paid for premiums on any
life insurance policy covering the life of an officer or employee or of any person financially interested
in the business of the taxpayer when the taxpayer is directly or indirectly a beneficiary under such
policy are not deductible.
SECTION 122.Losses from sales or exchanges of property. No deduction is allowed in respect of
losses from sales or exchanges of property, directly or indirectly
(a) Between members of a family. As used in Section 31, the family of an individual shall include
only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal
descendants;
(b) Except in the case of distributions in liquidation, between an individual and a corporation more
than fifty per centum in value of the outstanding stock of which is owned, directly or indirectly, by or for
such individual;
(c) Except in the case of distributions in liquidation, between two corporations more than 50 per cent
in value of the outstanding stock of each of which is owned, directly or indirectly, by or for the same
individual, if either one of such corporations with respect to the taxable year of the corporation
preceding the date of the sale or exchange was, under the law applicable to such taxable year, a
personal holding company or a foreign personal holding company;
(d) Between a grantor and a fiduciary of any trust;
(e) Between the fiduciary of a trust and the fiduciary of another trust, if the same person is a grantor
with respect to each trust; or
(f) Between a fiduciary of a trust and a beneficiary of such trust.
(Section 32 of the Code)
SECTION 123.Gross income of insurance companies. In general, the gross income of insurance
companies consists of their total revenue from the operation of the business and of their income from
all other sources within the taxable year, except as otherwise provided by the statute. Gross income
includes net premiums (that is, gross premium less returned premiums on policies not taken),
investment income, profits from the sale of assets, and all gains, profits, and income reported to the
Insurance Commissioner, except income specifically exempt from tax. A net decrease in reserve
funds required by law within the taxable year must be included in the gross income to the extent that
such funds are released to the general uses of the company and increase its free assets. Any net
decrease in reserves shall be added to the gross income, unless the company shall show that such
decrease resulted from the application of reserves to the purposes for which they were established.
SECTION 124.Gross income of life insurance companies. A life insurance company shall not
include in gross income such portion of any actual premiums received from any individual policyholder
as is paid back or credited to or treated as an abatement of premium of such policyholder within the
taxable year. (a) "Paid back" means paid in cash. (b) "Credited to" means held to the credit of,
including dividends applied to pay renewal premiums, to purchase additional paid-up insurance or
annuities, or to shorten the endowment or premium-paying period. It does not include dividends
provisionally ascertained and apportioned upon deferred dividends policies. Dividends provisionally
ascertained, apportioned, or credited on deferred dividends policies can not be excluded or deducted
from gross income for the reason that the assured has no vested or enforceable right in them and can
not at the time of the ascertainment, apportionment, or credit, not until the maturity of the policy, avail
himself of such dividends; and in the event of the death of the assured prior to the expiration of the
deferred dividend period, the amount so ascertained, apportioned, or credited lapses. (c) "Treated as
an abatement of premium" means of the premium for the taxable year. Where the dividend paid back
is in excess of the premium received from the policyholder within the taxable year there may be
Revenue Regulations 02-40
excluded from gross income only the amount of such premium received, and where no premium is
received from the policyholder within the taxable year the company is not entitled to exclude from its
premiums received from other policyholders an amount in respect to such dividend payment. (See
changes in Sec. 24(b), Tax Code.)
SECTION 125.Gross income of mutual insurance companies. The gross income of mutual
insurance companies (other than life) consists of their total revenue from the operation of the
business and of their income from all other sources within the taxable year, except as otherwise
provided by the statute. Premiums received by mutual marine insurance companies which are paid
out for reinsurance should be eliminated from gross income and the payments for reinsurance, from
disbursement. Deposit premiums on perpetual risks received and returned by mutual fire insurance
companies should be treated in the same manner, as no reserve will be recognized covering liability
for such deposits. The earnings on such deposits, including such portion, if any, of the premium
deposits as are not returned to the policyholders upon cancellation of the policies, must be included in
the gross income.
SECTION 126.Deductions allowed insurance companies. Insurance companies are entitled to the
same deductions from gross income as other corporations, and also to the deduction of the net
addition required by law to be made within the taxable year to reserve funds and of the sums other
than dividends paid with the taxable year on policy and annuity contracts. "Paid" includes "accrued" or
"incurred" (construed according to the method of accounting upon the basis of which the net income
is computed) during the taxable year, but does not include any estimate for losses incurred but not
reported during the taxable year. As payments on policies there should be reported all death, disability
and other policy claims (other than dividends as above specified) paid within the year, including fire,
accident and liability losses, matured endowments, annuities, payments on installment policies and
surrender values actually paid.
SECTION 127.Special deductions allowed mutual insurance companies. Mutual insurance
companies (other than mutual life and mutual marine insurance companies), which require their
members to make premium deposits to provide for losses and expenses, are allowed to deduct from
gross income the aggregate amount of premium deposits returned to their policyholders or retained
for the payment of losses, expenses, and reinsurance reserves. In determining the amount of
premium deposits retained by a mutual fire or mutual casualty insurance company for the payment of
losses, expenses, and reinsurance reserves, it will be presumed that losses and expenses have been
paid out of earnings and profits other than premiums to the extent of such earnings and profits. If,
however, any portion of such amount is applied during. the taxable year to the payment of losses,
expenses, or reinsurance reserves, or which a separate allowance is taken, then such portion is not
deductible; and if any portion of such amount for which an allowance is taken is subsequently applied
to the payment of expenses, losses, or reinsurance reserves, then such payment can not be
separately deducted. The amount of premium deposits retained for the payment of expenses and
losses and the amount of such expenses and losses, may not both be deducted. A company which
invests part of the premium deposits so retained by it in interest-bearing securities may, nevertheless,
deduct such part, but not the interest received on such securities. A mutual fire insurance company
which has a guaranty capital is taxed like other mutual fire insurance companies. A stock fire
insurance company operated on the mutual plan to the extent of paying dividends to certain classes
of policyholders, may make a return on the same basis as a mutual fire insurance company with
respect to its business conducted on the mutual plan.
SECTION 128.Special deductions allowed mutual marine insurance companies. Mutual marine
insurance companies should include in gross income the gross premiums collected and received by
them less amounts paid for reinsurance. They may deduct from gross income amounts repaid to
policyholders on account of premiums previously paid by them together with the interest actually paid
upon such amounts between the date of ascertainment and the date of payment thereof. The
remainder of the premiums accordingly forms part of the net income of the company, except to the
extent that it is subject to then deductions allowed such insurance companies and other corporations.
SECTION 129.Net addition to reserve funds. All policy premiums on which net addition to reserve
is computed, must be included in gross income. Insurance companies may deduct from gross income
the net addition required by law to be made within the taxable year to reserve funds. When the
Page 17 of 40
reserve at the end of the year is less than at the beginning of the year there is a "released reserve",
and the amount so released must be included in gross income. In the case of assessment insurance
companies, whether domestic or foreign, the actual deposit of sums with the officers of the
Government of the Philippines, pursuant to law, as addition to guaranty or reserve funds shall be
treated as being payments required by law to reserve funds. In the case of life insurance companies,
the net addition to the "reinsurance reserve" and the "reserve for supplementary contracts", and in the
case of fire, marine, accident, liability, and other insurance companies, the net addition to the
"unearned premium reserves", and only such other reserves as are specifically required by the statute
will be allowed as deductions. ADEacC
SECTION 130.Copy of report to Insurance Commissioner to be furnished the Commissioner of
Internal Revenue. To facilitate the auditing of income tax returns, insurance companies shall submit
to the Commissioner of Internal Revenue together with returns of income, wherever possible a copy
of their annual report to the Insurance Commissioner.
(Section 33 of the Code)
SECTION 131.Losses from wash sales of stock or securities. (a) A taxpayer cannot deduct any
loss claimed to have been sustained from the sale or other disposition of stock or securities, if, within
a period beginning thirty days before the date of such sale or disposition and ending thirty days after
such date (referred to in this section as the sixty-one-day period), he has acquired (by purchase or by
an exchange upon which the entire amount of gain or loss was recognized by law), or has entered
into a contract or option so to acquire, substantially identical stock or securities. However, this
prohibition does not apply in the case of a dealer in stock or securities if the sale or other disposition
of stock or securities is made in the ordinary course of its business as such dealer.
(b) Where more than one loss is claimed to have been sustained within the taxable year from the
sale or other disposition of stock or securities, the provisions of this section shall be applied to the
losses in the order in which the stock or securities the disposition of which resulted in the respective
losses were disposed of (beginning with the earliest disposition). If the order of disposition of stock or
securities disposed of at a loss on the same day cannot be determined, the stock or securities will be
considered to have been disposed of in the order in which they were originally acquired (beginning
with earliest acquisition).
(c) Where the amount of stock or securities acquired within the sixty-one day period is less than the
amount of stock or securities sold or otherwise disposed of, then the particular shares of stock or
securities the loss from the sale or other disposition of which is not deductible shall be those with
which the stock or securities acquired are matched in accordance with the following rule:
The stock or securities acquired will be matched in accordance with the order of their acquisition
(beginning with the earliest acquisition) with an equal number of the shares of stock or securities sold
or otherwise disposed of.
(d) Where the amount of stock or securities acquired within the sixty- one-day period is not less than
the amount of stock or securities sold or otherwise disposed of, then the particular shares of stock or
securities the acquisition of which resulted in the nondeductibility of the loss shall be those with which
the stock or securities disposed of are matched in accordance with the following rule:
The stock or securities sold or otherwise disposed of will be matched with an equal number of the
shares of stock or securities acquired in accordance with the order of acquisition (beginning with the
earliest acquisition) of the stock or securities acquired.
(e) The acquisition of any security which results in the non-deductibility of a loss under the
provisions of this section shall be disregarded in determining the deductibility of any other loss.
(f) The word "acquired" as used in this section means acquired by purchase or by an exchange
upon which the entire amount of gain or loss was recognized by law, and comprehends cases where
the taxpayer has entered into a contract or option within the sixty-one-day period to acquire by
purchase or by such an exchange.
Revenue Regulations 02-40 Page 18 of 40

EXAMPLE (1): A, whose taxable year is the calendar year, on December 1, 1939, purchased 100
shares of common stock in the M Company for P10,000 and on December 15, 1939, purchased 100
additional shares for P9,000. On January 2, 1940, he sold the 100 shares purchased on December 1,
1939, for P9,000. Because of the provisions of Section 33 no loss from the sale is allowable as a
deduction.
SECTION 133.Percentage taken into account. In computing net income, only 50 per cent of the
gain or loss recognized upon the sale or exchange for a capital asset shall be taken into account.
Thus, in the case of a merchandising concern which has an "ordinary net income" (net income
exclusive of net gains from the sale or exchange of capital assets) of P10,000 and a net capital gain
of P5,000, the net income subject to tax will be P10,000 plus P2,500 (50 % of P5,000), of P12,500.

EXAMPLE (2): A, whose taxable year is the calendar year, on September 21, 1939, purchased 100 SECTION 134.Limitation on capital losses. Losses from sales or exchanges of capital assets are
shares of the common stock of the M Company for P5,000. On December 21, 1939, he purchased 50 allowed only to the extent of the gains from such sales or exchanges. If the dealings of the taxpayer in
shares of substantially identical stock for P2,750, and on December 26, 1939, he purchased 25 capital assets during the year result in a net capital loss, such loss cannot be deducted from his
additional shares of such stock for P1,125. On January 2, 1940, he sold for P4,000 the 100 shares ordinary income, inasmuch as capital losses are allowable only to the extent of capital gains. In the
purchased on September 21, 1939. There is an indicated loss of P1,000 on the sale of the 100 case, for example, of a taxpayer, engaged in buying and selling goods, having an ordinary net income
shares. Since within the sixty-one-day period A purchased 75 shares of substantially identical stock, of P20,000, capital gains of P5,000 and capital losses of P3,000 the taxable net income is computed
the loss on the sale of 75 of the shares (P3,750 less P3,000, or P750) is not allowable as a deduction as follows:
because of the provisions of Section 33. The loss on the sale of the remaining 25 shares (P1,250 less
P1,000, or P250) is deductible subject to the limitations provided in Sections 31(b) and 34. The basis Ordinary net income P20,000
of the 50 shares purchased December 21, 1939, the acquisition of which resulted in the non-
deductibility of the loss (P500) sustained on 50 of the 100 shares sold on January 2, 1940, is P2,500 Gains from sales of capital assets
(the cost of 50 of the shares sold on January 2, 1940), plus P750 [the difference between the (as stocks or securities) P5,000
purchase price of the 50 shares acquired on December 21, 1939, (P2,750) and the selling price of 50 50% of such gains P2,500
of the shares sold on January 2, 1940 (P2,000)], or P3,250. Similarly the basis of the 25 shares Losses from sales of capital assets P3,000
purchased on December 26, 1939, the acquisition of which resulted in the nondeductibility of the loss 50% of such losses P1,500
(P250) sustained on 25 of the shares sold on January 2, 1940, is P1,250 plus P125, or P1,375. (See Net taxable capital gains 1,000
Section 143 of these regulations.)
Taxable net income P21,000
EXAMPLE (3): A, whose taxable year is the calendar year, on September 15, 1938, purchased 100 =======
shares of the stock of the M Company for P5,000. He sold these shares on February 1, 1940, for If such taxpayer had an ordinary net income of P20,000, capital gains of P2,000 and capital losses of
P4,000. On each of the four days from February 15, 1940, to February 18, 1940, he purchased 50 P7,000, the taxable net income would be computed as follows:
shares of substantially identical stock for P2,000. There is an indicated loss of P1,000 from the sale of Ordinary net income P20,000
the 100 shares on February 1, 1940, but since within the sixty-one-day period A purchased not less Losses from sales of capital assets
than 100 shares of substantially identical stock, the loss is not deductible. The particular shares of (as stocks or securities) P7,000
stock the purchase of which resulted in the nondeductibility of the loss are the first 100 shares 50% of such losses P3,500
purchased within such period, that is, the 50 shares purchased on February 15, 1940, and the 50 Gains from sales of capital assets 2,000
shares purchased on February 16, 1940. 50% of such gains 1,000
(Section 34 of the Code)
Net capital losses P2,500
SECTION 132.Definition of "capital assets." The law provides that the term "capital assets" shall Taxable net income P20,000
be held to mean property held by the taxpayer (whether or not connected with his trade or business), ======
but does not include stock in trade of the taxpayer or other property of a kind which would properly be (The net capital loss of P2,500 is not deductible in arriving at the taxable net income inasmuch as
included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by capital losses are allowed only to the extent of capital gains.)
the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or
property, used in the trade or business, of a character which is subject to the allowance for SECTION 134-A. Capital loss carry-over-Illustration. A, an individual has the following incomes
depreciation provided in subsection (f) of Section 30 of the Code. The term "capital asset" includes all and losses:
classes of property not specifically excluded by Section 30(a). 1946 Net income from business 1,000
Dividends received 750
The exclusion from the term "capital assets" of property used in the trade or business of a taxpayer of Interest earned500
a character which is subject to the allowance for depreciation provided in Section 30(f) of the Code is Capital gains on capital assets held for 8 months 5,000
limited to property used by the taxpayer in the trade or business at the time of the sale or exchange. It Capital losses on capital assets held for 9 months 10,000
has no application to gains or losses arising from the sale of real property used in the trade or 1947 Net income from business 2,000
business to the extent that such gain or loss is allocable to the land, as distinguished from depreciable Interest earned 200
improvements upon the land. To such gain or loss allocable to the land, the limitations of Section Capital gains on capital assets held for 15 months 5,000
34(b) and (c) apply (such limitation may be inapplicable to a dealer in real estate, but, if so, it is In 1946, his taxable income is computed as follows:
because he holds the land primarily for sale to customers in the ordinary course of his trade or Income from business, dividends and interest P2,250
business, not because land is subject to a depreciation allowance). Gains or losses from the sale or Capital gains and losses:
exchange of property used in the trade or business of the taxpayer of a character which is subject to Capital gains P5,000
the allowance for depreciation provided in Section 30(f) of the Code, will not be subject to the Less-Capital losses 10,000
percentage provisions of Section 34(b) and losses from such transactions will not be subject to the
limitation of losses provided in Section 30(c). (Real property used in taxpayer's trade or business is no Net loss carried over to 1947 (P5,000)
longer capital asset per Am. R.A. 82.)
Net income subject to tax P2,250
Revenue Regulations 02-40 Page 19 of 40

In 1947, his taxable income is computed as follows: acquired prior to March 1, 1913. To avoid complexity no adjustment has been made in these
Income from business and interest P2,200 examples for depreciation or depletion.
Capital gains and losses:
Capital gains P5,000 In the case of property acquired before March 1, 1913, when its fair market value as of that date is in
excess of its cost, the taxable gain is the excess of the amount realized therefor over such fair market
One-half P2,500 value.

Less-Capital loss carried over (#) 2,250 ILLUSTRATION I
Net capital gain 250 Fair Market
Cost Value Sale Price Taxable gain
Net income subject to tax P2,450 Mar. 1, 1913
====== P20,000 P30,000 P40,000 P10,000
# The net capital loss of P5,000 sustained in 1946 and carried over in 1947 is reduced to P2,250 for Excess of amount realized over fair
the reason that the net income from business and other sources (not including capital gain), for the market value as of March 1, 1913.
year 1946 is only P2,250. Gain attributed to the period prior
to March 1, 1913 not taxable.
If a bank or trust company incorporated under the laws of the Philippines or of the United States, a In the case of property acquired before March 1, 1913, when its fair market value as of that date is
substantial part of whose business is the receipt of deposits, sells any bond, debenture, note, or lower than its cost, the deductible loss is the excess of such fair market value over the amount
certificate or other evidence of indebtedness issued by any corporation (including one issued by a realized therefor.
government or political subdivision thereof), with interest coupons or in registered form, any loss
resulting from such sale shall not be subject to the limitation contained in Section 34(c) and shall not ILLUSTRATION II
be included in determining the applicability of such limitation to other losses. Fair Market
Cost Value Sale Price Taxable gain
SECTION 135.Gains and losses from short sales. For income tax purposes, a short sale is not Mar. 1, 1913
deemed to be consummated until the delivery of property to cover the short sale. If the short sale is P20,000 P10,000 P6,000 P4,000
made through a broker and the broker borrows property to make delivery, the short sale is not Excess of fair market value over
deemed to be consummated until the obligation of the seller created by the short sale is finally amount realized. Loss attributable to
discharged by delivery of property to the brokers to replace the property borrowed by such broker. the period prior to March 1, 1913, not
(Section 35 of the Code) deductible.
No gain or loss is recognized in the case of property acquired before March 1, 1913, and sold or
SECTION 136.Basis for determining gain or loss from sale of property. For the purpose of disposed of at more than cost but at less than its fair market value as of that date.
ascertaining the gain or loss from the sale or exchange of property, the basis is the cost of such
property, or in the case of property which should be included in the inventory, its latest inventory ILLUSTRATION III
value. But in the case of property acquired before March 1, 1913, when its fair market value as of that Fair Market
date is in excess of its cost, the gain to be included in gross income is the excess of the amount Cost Value Sale Price Taxable gain
realized therefor over such fair market value. (See illustration I, Section 137 of these regulations). Mar. 1, 1913
Also in the case of property acquired before March 1, 1913, when its fair market value as of that date P20,000 P60,000 P40,000 No taxable gain or deductible
is lower than its cost the deductible loss is the excess of such fair market value over the amount loss.
realized therefor. (See Illustration II, Id.). No gain or loss is recognized in the case of property sold or Reason: A gain on whole transaction,
exchanged (a) at more than cost but less than its fair market value as of March 1, 1913 (See which gain is attributed to period prior
Illustration III, Id.), or (b) at less than cost but at more than its fair market value as of March 1, 1913. to March 1,1913.
(See Illustration IV, Id., Id., Id.) In any case proper adjustment must be made in computing gain or loss No gain or loss is recognized in the case of property acquired before March 1, 1913, and sold or
from the exchange or sale of property for any depreciation or depletion sustained and allowable as disposed of at less than cost but at more than its fair market value as of that date.
deduction in computing net income; the amount of depreciation previously charged off by the taxpayer
shall be deemed to be true depreciation sustained unless shown by clear and convincing evidence to ILLUSTRATION IV
be incorrect. What the fair market value of property was as of March 1, 1913, is a question of fact to Fair Market
be established by evidence which will reasonably and adequately make it appear. The nature and Cost Value Sale Price Taxable gain
extent of the sales and the circumstances under which they were made should be considered. Prices Mar. 1, 1913
received at forced sales or for small lots of property may be and often are no real indication of the P20,000 P6,000 P10,000 No taxable gain or deductible
value of the amount of property in question. For instance, sales from time to time of a small number of loss.
shares of stock is little indication of the value of a large or controlling interest in the corporation. If the Reason: A loss on whole transaction,
taxpayer can not determine the cost of securities purchased prior to March 1, 1913, because of the which loss is attributable to period
loss, destruction, or failure to keep records, the value of the securities at the date of approximate date prior to March 1, 1913.
of acquisition may be used in determining the cost basis for purposes of computing the gain or loss Where the cost is equal to or greater than the fair market value as of March 1, 1913, and the selling
from the sale of the securities. When the date or approximate date of acquisition is unknown, no price exceeds the cost, the gain to be included in gross income is the excess of the selling price over
general rule can be stated for determining the cost value of such securities. Each case must be the cost.
considered separately upon its own facts.
ILLUSTRATION V
SECTION 137.Illustrations of the computation of gain or loss from the sale or exchange of property Fair Market
Revenue Regulations 02-40
Cost Value Sale Price Taxable gain
Mar. 1, 1913
P20,000 P10,000 P40,000 P20,000
Reason: Gain on whole transaction,
all of which is attributable to period
subsequent to March 1, 1913.
Where the fair market value as of March 1, 1913, is equal to or greater than the cost and the selling
price is less than the cost, the deductible loss is the amount by which the cost exceeds the selling
price.
ILLUSTRATION VI
Fair Market
Cost Value Sale Price Taxable gain
Mar. 1, 1913
P20,000 P30,000 P10,000 P10,000
Reason: Loss on whole transaction, all
of which is attributable to period
subsequent to March 1, 1913. Only
actual loss sustained deductible.
SECTION 138.Sale of property acquired by gift. In computing the gain or loss from the sale or
other disposition of property acquired by gift, the basis shall be the selling price and the fair market
value of the property at the time the gift was made, or its fair market value as of March 1, 1913, if
acquired prior thereto, determined in accordance with the next two preceding sections. In the case of
gifts made on or after July 1, 1939, the value taken as a basis for gift tax purposes shall be
considered as the fair market value in computing gain or loss from the sale or other disposition of the
property.
SECTION 139.Sale of property acquired by devise, bequests, or inheritance. In computing the gain
or loss from the sale or other disposition of property acquired by devise, bequest, or inheritance, the
basis shall be the fair market price or value of such property at the time of the death of the decedent.
The term "property acquired by bequest, devise, or inheritance" as used herein includes (a) such
property interests as the taxpayer has received as the result of a transfer, or creation of a trust, in
contemplation of or intended to take effect in possession or enjoyment at or after death, and (b) such
property interest as the taxpayer has received as the result of the exercise by a person of a general
power of appointment (1) by will, or (2) by deed executed in contemplation of or intended to take
effect in possession or enjoyment at or after death. In the case of property acquired by gift, bequest,
devise, or inheritance, prior to March 1, 1913, the taxable gain or deductible loss from the sale or
other disposition thereof shall be computed in accordance with sections 136 and 137 of these
regulations. In the case of property acquired by bequest, devise or inheritance, its value as appraised
for the purpose of the inheritance tax shall be deemed to be its fair market value when acquired.
SECTION 140.Exchange of property. Gain or loss arising from the acquisition and subsequent
disposition of property is realized only when as the result of a transaction between the owner and
another person the property is converted into other property (a) that is essentially different from the
property disposed of, and (b) that has a market value. The requirement that the property received in
exchange must be "essentially different from the property disposed of" implies that there must be a
change in substance and not merely a change in form. By way of illustration, if a taxpayer owning ten
shares of stock exchanges his stock certificate for a voting trust certificate, no income is realized. The
term "market value" means the fair value of the property in money as between one who wishes to
purchase and one who wishes to sell. It is not, however, what can be obtained for the property when
the owner is under peculiar compulsion to sell or the purchaser to buy; nor is it a purely speculative
value which an owner could not reasonably expect to obtain for the property although he might
possibly be fortunate enough to do so. "Market value" is the price at which a seller willing to sell at a
fair price and a buyer willing to buy at a fair price, both having reasonable knowledge of the facts, will
trade. Evidence as to the assets and liabilities of a corporation and as to its earnings may furnish
definite indications of the market value of its stock.
SECTION 141.Determination of gain or loss from the exchange of property. The amount of income
Page 20 of 40
derived or loss sustained from an exchange of property is the difference between the market value at
the time of the exchange of the property received in exchange and the original cost, or other basis, of
the property exchange. If the property exchanged was acquired prior to March 1, 1913, see Sections
136 and 137 of these regulations.
SECTION 142.Readjustment of interest in a registered copartnership. When a partner retires from
a duly registered copartnership, or the partnership is dissolved, he realizes a gain or loss measured
by the difference between the price received for his interest and the cost to him of his interest in the
partnership including in such cost the amount of his share in any undistributed partnership net income
earned since he became a partner on which the income tax has been paid. However, if such interest
in the partnership was acquired prior to March 1, 1913, both the cost as hereinbefore provided and
the amount of such interest as of date, plus the amount of the shares in any undistributed partnership
net income earned since March 1, 1913, on which the income tax has been paid, shall be ascertained
and the taxable gain derived or the deductible loss sustained shall be computed as provided in
Sections 136 and 137 of these regulations. If the partnership distributes its assets in kind and not in
cash, the partner realizes gain or suffers loss according to the market value of the property received
in liquidation. Whenever a new partner is admitted, to a partnership, or any existing partnership is
reorganized, the facts as to such change or reorganization should be fully set forth in the next return
of income, in order that the Commissioner of Internal Revenue may determine whether any gain or
loss has been realized by any partner.
SECTION 143.Basis of stock or securities acquired in "wash sales". In the sale or other disposition
of stocks or securities the acquisition of which (or the contract or option to acquire which) resulted in
the non deductibility of the loss from the sale or other disposition of substantially identical stock or
securities the basis shall be the basis of the substantially identical stock so sold or disposed of,
increased or decreased, as the case may be, by the difference, if any, between the price at which the
stock or securities was acquired and the price at which such substantially identical stock or securities
were sold or otherwise disposed of. The application of this rule may be illustrated by the following
examples:
EXAMPLE (1): A purchased a share of common stock of the X Corporation for P100 in 1936, which he
sold January 15, 1940, for P80.00. On February 1, 1940, he purchased a share of common stock of
the same corporation for P90.00. No loss from the sale is recognized under Section 33 of the Code.
The basis of the new share is P110; that is, the basis of the old share (P100) increased by P10,
excess of the price at which the new share was acquired (P90) over the price at which the old share
was sold (P80).
EXAMPLE (2): A purchased a share of common stock of the X corporation for P100 in 1936, which he
sold January 15, 1940, for P80. On January 1, 1940, he purchased a share of common stock of the
same corporation for P70. No loss from the sale is recognized under Section 33 of the Code. The
basis of the new share is P90; that is, the basis of the old share (P100) decreased by P10, the excess
of the price at which the old share was sold (P80) over the price at which the new share was acquired
(P70). (See Section 131 of these regulations).
SECTION 143-A. Excerpts from B.I.R. General Circular No. V-253 publishing Republic Act No. 1921
amending Section 35 of the Code, particularly subsection (c) thereof:
Features of the Amendment
1. Before and after the amendment. Under the provisions of subsection (c) of Section 35 of the
National Internal Revenue Code, before its amendment by Republic Act No. 1921, when
property is exchanged for another property, the property received in exchange shall, for the
purpose of determining gain or loss, be treated as the equivalent of cash to the amount of its fair
market value.
Paragraph 1 of subsection (c) of section 35 of the Tax Code after the amendment states the general
rule that upon the sale or exchange of property, the entire amount of gain or loss as the case may be,
is recognized, while paragraphs 2 and 3 give the exceptions where gain or loss is not recognized, or
gain is recognized only in part.
Revenue Regulations 02-40
2. Exceptions to the rule recognizing gain or loss in exchanges of property solely in kind. Under
paragraph 2 of subsection (c) of Section 35 of the Tax Code after its amendment by Republic Act
No. 1921, no gain or loss shall be recognized in the following cases of exchanges made in
pursuance of a plan of merger or consolidation:
(a) By a corporation: If a corporation, a party to a merger or consolidation, in pursuance of such plan
of merger or consolidation, exchanges property solely for stock in another corporation, a party to the
merger or consolidation.
(b) By a shareholder: A shareholder who exchanges his stock in a corporation which is a party to the
merger or consolidation solely for stock of another corporation, also a party to the merger or
consolidation.
(c) By a security holder: A security holder of a corporation which is a party to the merger or
consolidation, who exchanges his securities in such corporation solely for stock or securities in
another corporation, a party to the merger or consolidation.
3. Recognition of gain in part but not loss, where exchanges are not solely in kind.
(a) By a shareholder or security holder. If in connection with an exchange made by a shareholder
or security holder described in the above exceptions, he receives not only stock or securities,
permitted to be received without recognition of loss or gain, but also money and/or other property,
then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of
money and the fair market value of such other property. The loss, if any, to the shareholder or security
holder from such an exchange is not to be recognized to any extent. However, if the distribution of
such other property and/or money to a shareholder in the course of a merger or consolidation has the
effect of the distribution of a taxable dividend, there shall be taxed to the distributee as a taxable
dividend such an amount of the gain recognized on the exchange as is not in excess of the
distributee's ratable share of the undistributed earnings and profits of the corporation, and as a capital
gain, the remainder, if any, of the gain so recognized.
Example: A, in connection with a merger or consolidation in 1957 exchanges a share of stock in
the X Corporation (a party to the merger or consolidation) purchased in 1939 at a cost of P100 for a
share of stock of the Y Corporation (also a party to the merger or consolidation), which has a fair
market value of P90, plus P20 in cash. The gain from the transaction is P10 and is recognized and
taxed as a gain from the exchange of property. However, if the share of stock received had a fair
market value of P70, the loss from the transaction of P10 would not be recognized.
(b) By a corporation. If, in pursuance of a plan of merger or consolidation above described, the
transferor corporation receives not only stock permitted to be received without the recognition of gain
or loss, but also money and/or other property, then, if such money and/or other property received by
the corporation is distributed by it pursuant to the plan of merger or consolidation, no gain to the said
corporation will be recognized. If the other property and/or money received by the corporation is not
distributed by it pursuant to the plan of merger and consolidation, the gain, if any, to the corporation
from the exchange will be recognized in an amount not in excess of the sum of money and the fair
market value of the other property so received which is not distributed. In either case no loss from the
exchange will be recognized.
4. Assumption of liability. Where upon an exchange described in the foregoing exceptions, a
taxpayer receives stock or securities which would be permitted to be received without the recognition
of gain if it were the sole consideration, and as part of the consideration, another party to the
exchange assumes a liability of the taxpayer, or acquires from the taxpayer property subject to a
liability, such assumption or acquisition shall not be considered as money and/or other property, and
shall not prevent the exchange from being within the exceptions. Accordingly, the assumption of the
aforesaid liabilities is not to be treated as other property or money for the purpose of determining the
amount of realized gain.
5. Basis of stock or securities for the purpose of determining gain or loss upon subsequent sale.
(a) By the transferor corporation, or its shareholder or security holder. The basis of the stock or
securities received by the transferor corporation or its shareholder or security holder upon the
exchange specified in the above exceptions shall be the same as the basis of the property, stock or
securities exchanged decreased by the money received and the fair market value of the other
Page 21 of 40
property received, and increased by the amount treated as dividend of the shareholder and the
amount of any gain that was recognized on the exchange. The other property or "boot" received in
exchange shall have as basis its fair market value.
Examples:
1. A purchased a share of stock in the X Corporation in 1939 for P100. Pursuant to a plan of merger
or consolidation, A in 1957 exchanged his share for one share in the Y Corporation, worth P90 and
P30 in cash. A realized a gain of P20 upon the exchange. The basis of the share of stock in the Y
Corporation is P90, that is, the basis of the share in the X Corporation (P100) less the amount of
money received by A (P30) plus the amount of the gain recognized on the exchange (P20).
2. A purchased a share of stock in the X Corporation in 1939 for P100. Upon a merger or
consolidation of the X Corporation in 1957, A received in place of his stock in the X Corporation a
share of stock in the Y Corporation worth P60, a Treasury Bond worth P50, and in addition P20 in
cash. A realized a gain of P30 upon the exchange. The basis of the property received in exchange is
the basis of the old stock decreased in the amount of money received (P20) and increased in the
amount of gain that was recognized (P30), which results in a basis for the property received of P110.
This basis of P110 is apportioned between the Treasury Bond and the share of stock, the basis of the
Treasury Bond being its fair market value at the date of the exchange, P50, and of the share of stock,
the remainder, P60.
(b) By the transferee. The basis of the property transferred in the hands of the transferee shall be
the same as it would be in the hands of the transferor, increased by the amount of the gain
recognized to the transferor on the transfer.
(c) If corporation shareholder or security holder received several kinds of stock or securities.
When securities of a single class were exchanged for new securities of different classes where no
gain or loss was recognized, the proper method of apportionment is to allocate to each class of new
securities that proportion of the original basis which the market value of the particular class bears to
the market value of all securities received on the date of the exchange, for purposes of determining
the gain or loss on the subsequent sale of any of the new securities. For example, if 100 shares of
common stock par value P100, are exchanged for 50 shares of preferred and 50 shares of common
each of P100 par value, and the cost of the old stock was P250 per share, or P25,000, but the market
value of the preferred stock on the date of the exchange was P110 per share, or P5,500 for the 50
shares, and the market value of the common was P440 per share or P22,000 for the 50 shares of
common, one-fifth of the original cost, or P5,000, would be regarded as the cost of the preferred and
four-fifths, or P20,000 as the cost of the common.
As previously shown cash "boot" operates in the first instance to reduce basis. Then to this result
must be added the gain recognized. The remainder is to be allocated between the several types of
stock and securities permitted to be received without the recognition of gain or loss. To illustrate: The
taxpayer in a nontaxable exchange trades A stock which cost P100 for one share of common stock
and one share of preferred stock of B corporation, together worth P100 (P100 each), and P50 cash.
The basis for the share of B common stock will therefore be P50 (1/2 of P100) and the B preferred
stock will likewise take a P50 basis.
6. Definitions:
(a) The term "securities" means bonds and debentures but not "notes" of whatever class or duration.
(b) The term "merger" or "consolidation" shall be understood to mean the ordinary merger or
consolidation, or the acquisition by one corporation of all or substantially all the properties of another
corporation solely for stock. In order that a transaction may be regarded as a merger or consolidation
within the purview of the amendment, it must be undertaken for a bona fide business purpose and not
solely for the purpose of escaping the burden on taxation. In determining whether a bona fide
business purpose exists, each and every step of the transaction shall be considered and the whole
transaction or series of transactions shall be treated as a single unit. The term "property" shall be
taken to include the cash assets of the transferor for purpose of determining whether the property
transferred constitutes a substantial portion of the property of the transferor. "Substantially all" as
used under this amendment means the acquisition by one corporation of at least 80% of the assets,
including cash, of another corporation, which has the element of permanence and not merely
momentary holding.
Revenue Regulations 02-40
(Section 36 of the Code)
SECTION 144.Need of inventories. In order to reflect the net income correctly, inventories at the
beginning and end of each year are necessary in every case in which the production, purchase or
sale of merchandise is an income producing factor. The inventory should include raw materials and
supplies on hand that have been acquired for sale, consumption, or use in productive processes
together with all finished or partly finished goods. Only merchandise title to which is vested in the
taxpayer should be included in his inventory. Accordingly the seller should include in his inventory
goods under contract for sale but not yet segregated and applied to the contract and goods out upon
consignment, but should exclude from inventory goods sold, title to which has passed to the
purchaser. A purchaser should include in inventory merchandise purchased, title to which has passed
to him although such merchandise is in transit or for other reasons has not been reduced to physical
possession, but should not include goods ordered for future delivery transfer of title to which has not
yet been effected.
SECTION 145.Valuation of inventories. The law provides two tests to which each inventory must
conform. (1) It must conform as nearly as possible to the best accounting practice in the trade or
business, and (2) it must clearly reflect the income. It follows, therefore, that inventory rules can not
be uniform but must give effect to trade customs which come within the scope of the best accounting
practice in the particular trade or business. In order to clearly reflect income, the inventory practice of
a taxpayer should be consistent from year to year, and greater weight is to be given to consistency
than to any particular method of inventory or basis of valuation, as long as the method or basis used
is substantially in accord with these regulations. An inventory that can be used under the best
accounting practice in a balance sheet showing the financial position of the taxpayer is, as a general
rule, regarded as clearly reflecting his income.
The bases of valuation most commonly used by business concerns and which meet the requirements
of the Income Tax Law are (a) cost price or (b) cost or market price, whichever is the lower. Any goods
in an inventory which are unsalable at normal prices or unusable in the normal way because of
damage, imperfections, shop wear, changes of style, odd or broken lots, or other similar causes,
including second hand goods taken in exchange, should be valued at "bona fide" selling prices
whether basis (a) or (b) is used, or if such goods consist of raw materials or partly finished goods held
for use or consumption, they should be valued upon a reasonable basis, taking into consideration the
usability and the condition of the goods, but in no case shall such value be less than the scrap value.
"Bona fide" selling price means actual offerings of goods during a period ending not later than thirty
days after inventory date. The burden of proof will rest upon the taxpayer to show that such
exceptional goods as are valued upon such selling bases come within the classifications indicated
above, and he shall maintain such records of the disposition of the goods as will enable a verification
of the inventory to be made.
In respect to normal goods, whichever basis (a) or (b) is adopted must be applied with reasonable
consistency to the entire inventory. Taxpayers were given the option to adopt either basis (a) or (b) for
their 1921 inventories, and the basis adopted for that year is controlling and a change can now be
made after permission is secured from the Commissioner of Internal Revenue. Goods taken in the
inventory which have been so intermingled that they can not be identified with specific invoices will be
deemed to be either (a) the goods most recently purchased or produced and the cost thereof will be
the actual cost of the goods purchased or produced during the period in which the quantity of goods in
the inventory has been acquired, or (b) where the taxpayer maintains book inventories in accordance
with a sound accounting system in which the respective inventory accounts are charged with the
actual cost of the goods purchased or produced and credited with the value of the goods used,
transferred, or sold, calculated upon the basis of the actual cost of the goods acquired during the
taxable year (including the inventory at the beginning of the year) the net value as shown by such
inventory accounts will be deemed to be the cost of the goods on hand. The balances shown by such
inventories should be verified by physical inventories at reasonable intervals and adjusted to conform
therewith.
Inventories should be recorded in a legible manner, properly computed and summarized, and should
be preserved as a part of the accounting record of the taxpayer. The inventories of taxpayers on
whatever basis taken will be subject to investigation by the Commissioner of Internal Revenue and
Page 22 of 40
the taxpayer must satisfy the Commissioner of Internal Revenue of the correctness of the price
adopted.
The following methods, among others, that are sometimes used in taking or valuing inventories, are
not in accord with these regulations and therefore their use for income tax purposes is prohibited, viz.:
(1) Deducting from the inventory a reserve for price changes, or an estimated depreciation in the
value thereof.
(2) Taking work in process, or other parts of the inventory, at a nominal price or at less than its
proper value.
(3) Omitting portions of the stock on hand.
(4) Using a constant price or nominal value for a so called normal quantity of materials or goods in
stock.
(5) Including stock in transit, either shipped to or from the taxpayer, the title to which is not vested in
the taxpayer.
SECTION 146.Inventories at cost price. Cost means:
(1) In the case of merchandise on hand at the beginning of the taxable year, the inventory price of
such goods.
(2) In the case of merchandise purchased since the beginning of the taxable year, the invoice price
less trade or other discounts, except strictly cash discounts, approximating a fair interest rate, which
may be deducted or not at the option of the taxpayer, provided a consistent course is followed. To this
net invoice price should be added transportation or other necessary charges incurred in acquiring
possession of the goods.
(3) In the case of merchandise produced by the taxpayer since the beginning of the taxable year, (a)
the cost of raw materials and supplies entering into or consumed in connection with the products; (b)
expenditures for direct labor; (c) indirect expenses incident to and necessary for the production of the
particular article, including therein a reasonable proportion of management expenses, but not
including any cost of selling or return on capital whether by way of interest or profit.
(4) In any industry in which the usual rules for computation of cost of production are inapplicable,
costs may be approximated upon such basis as may be reasonable and in conformity with
established trade practice in the particular industry. Among such cases are: (a) Farmers and raisers of
1ivestock; (b) miners and manufacturers who by a single process or uniform series of processes
derive a product of two or more kinds, size or grade, the unit cost of which is substantially alike; and
(c) retail merchants who use what is known as the "retail method" in ascertaining approximate cost.
cCaSHA
SECTION 147.Inventories at market price. Under ordinary circumstances, and for normal goods in
an inventory "market price" means the current bid price prevailing at the date of the inventory for the
particular merchandise in the volume in which usually purchased by the taxpayer and is applicable in
the cases (a) of goods purchased and on hand, and (b) of basic elements of cost (materials, labor,
and burden) in goods in process of manufacture and in finished goods on hand; exclusive, however,
of goods on hand or in process of manufacture for delivery upon firm sales contracts (i.e., those not
legally subject to cancellation by either party) at fixed prices entered into before the date of the
inventory, which goods must be inventoried at cost. Where no open market exists or where quotations
are nominal due to stagnant market condition, the taxpayer must use such evidence of a fair market
price at the date or dates nearest the inventory as may be available, such as specific purchase or
sales by the taxpayer or others in reasonable volume and made in good faith, or compensation paid
for cancellation of contracts for purchase commitments. Where the taxpayer in the regular course of
business has offered for sale such merchandise at prices lower than the current price as above
defined, the inventory may be value at such prices and the correctness of prices will be determined by
reference to the actual sales of the taxpayer for a reasonable period before and after the date of the
inventory. Prices which vary materially from the actual prices so ascertained will not be accepted as
reflecting the market price.
SECTION 148.Inventories by dealers in securities. A dealer in securities who in his books of
account regularly inventories unsold securities on hand either
(a) At cost;
(b) At, cost or market, whichever is lower; or
(c) At market value.
Revenue Regulations 02-40
may make his return upon the basis upon which his accounts are kept; provided that a description of
the method employed shall be included in or attached to the return, that all the securities must be
inventoried by the same method, and that such method must be adhered to in subsequent years,
unless another method be authorized by the Commissioner of Internal Revenue. A dealer in securities
in whose books of accounts separate computations of the gain or loss from the sale of the various lots
of securities sold are made on the basis of the cost of each lot shall be regarded, for the purposes of
this section, as regularly inventorying his securities at cost. For the purposes of this rule a dealer in
securities is a merchant of securities, whether an individual, partnership; or corporation, with an
established place of business, regularly engaged in the purchase of securities and their resale to
customers; that is, one who as a merchant buys securities and sells them to customers with a view to
the gains and profits that may be derived therefrom. If such business is simply a branch of the
activities carried on by such person, the securities inventoried as here provided may include only
those held for purposes of resale and not for investment. Taxpayers who buy and sell or hold
securities for investment or speculation, irrespective of whether such buying or selling constitutes the
carrying on of a trade or business, and officers of corporations and members of partnerships who in
their individual capacities buy and sell securities, are not dealers in securities within the meaning of
this rule.
SECTION 149.Inventories of livestock raisers and other farmers.
(1) Farmers may change the basis of their returns from that of receipts and disbursements to that of
an inventory basis, which necessitates the use of opening and closing inventories for the year in
which the change is made. There should be included in the opening inventory all farm products
(including livestock) purchased or raised which were on hand at the date of the inventory, but
inventories must not include real estate, buildings, permanent improvements, or any other fixed
assets.
(2) Because of the difficulty of ascertaining actual cost of livestock and other farm products, farmers
who render their returns upon an inventory basis may at their option value their inventories for the
current taxable year according to the "farm-price method" which provides for the valuation of
inventories at market price less cost of marketing. If the use of the "farm-price method" of valuing
inventories for any taxable year involves a change in method of pricing inventories from that
employed in prior years, the opening inventory for the taxable year in which the change is made
should be brought in at the same value as the closing inventory for the preceding taxable year. If such
valuation of the opening inventory for the taxable year in which the change is made results in an
abnormally large income for that year, there may be submitted with the return for such taxable year an
adjustment statement for the preceding year based on the "farm-price method" of valuing inventories;
upon the amount of which adjustments the tax, if any be due, shall be assessed and paid at the rate
of tax in effect for such preceding year.
(3) Where returns have been made in which the taxable net income has been computed upon
incomplete inventories, the abnormality should be corrected by submitting with the return for the
current taxable year a statement for the preceding year in which such adjustments shall be made as
are necessary to bring the closing inventory for the preceding year into agreement with opening
complete inventory for the current taxable year.
SECTION 150.Inventories of miners and manufacturers. A taxpayer engaged in mining or
manufacturing who by a single process or uniform series of processes derives a product of two or
more kinds, sizes or grades, the unit cost of which is substantially alike, and who in conformity to a
recognized trade practice allocates an amount of cost to each kind, size, or grade of product which in
the aggregate will absorb the total cost of production, may use such allocated cost a the basis for
pricing inventories, provided such allocation bears a reasonable relation to the respective selling
values of the different kinds of products.
SECTION 151.Inventories of retail merchants. Retail merchants who employ what is known as the
"retail method" of pricing inventories may make their returns upon that basis, provided that the use of
such method, is designated upon the returns, that accurate accounts are kept and that such method
is consistently adhered to unless a change is authorized by the Commissioner of Internal Revenue.
Under this method the goods in the inventory are ordinarily priced at the selling prices and the total
Page 23 of 40
retail value of the goods in each department or of each class of goods is reduced to approximate cost
by deducting the percentage which represents the difference between the retail selling value and the
purchase price. This percentage is determined by departments of a store or by classes of goods, and
should represent as accurately as may be the amounts added to the cost prices of the goods to cover
selling and other expenses of doing business and for the margin of profit. In computing the
percentage above mentioned, proper adjustment should be made for all mark-ups and mark-downs.
A taxpayer maintaining more than one department in his store or dealing in classes of goods carrying
different percentages of gross profit should not use a percentage of profit based upon an average of
his entire business but should compute and use in valuing his inventory the proper percentages for
the respective departments or classes of goods.
(Section 37 of the Code)
SECTION 152.Income from sources within the Philippines. The law divides the income of
taxpayers into three classes:
(1) Income which is derived in full from sources within the Philippines;
(2) Income which is derived in full from sources without the Philippines; and
(3) Income which is derived partly from sources within and partly from sources without the
Philippines.
Non-resident alien individuals and foreign corporations are taxable only upon income from sources
within the Philippines. Citizens and residents of the Philippines and domestic corporations are taxable
upon income derived from sources both within and without the Philippines. EAcTDH
The taxable income from sources within the Philippines includes that derived in full from sources
within the Philippines and that portion of the income which is derived partly from sources within and
partly from sources without the Philippines which is allocated or apportioned to sources within the
Philippines.
SECTION 153.Interest. Interest on bonds or notes or other interest bearing obligations of
residents, corporate or otherwise, constitutes income from sources within the Philippines.
SECTION 154.Dividends. Gross income from sources within the Philippines includes dividends, as
defined by Section 83 of the Code:
(a) From a domestic corporation; and
(b) From a foreign corporation unless less than 50 per cent of its gross income for the three-year
period ending with the close of its taxable year preceding the declaration of such dividends, or for
such part of such period as it has been in existence, was derived from sources within the Philippines;
but only in an amount which bears the same ratio to such dividends as the gross income of the
corporation for such period derived from sources within the Philippines bears to its gross income from
all sources.
Dividends will be treated as an income from sources within the Philippines unless the taxpayer
submits sufficient data to establish to the satisfaction of the Commissioner of Internal Revenue that
they should be excluded from gross income under Section 37(a)(2)(B).
SECTION 155.Compensation for labor or personal services. Gross income from sources within the
Philippines includes compensation for labor or personal services performed within the Philippines
regardless of the residence of the payor, of the place in which the contract for service was made, or of
the place of payment. If a specific amount is paid for labor or personal services performed in the
Philippines, such amount shall be included in the gross income. If no accurate allocation or
segregation of compensation for labor or personal services performed in the Philippines can be made,
or when such labor or service is performed partly within and partly without the Philippines, the amount
to be included in the gross income shall be determined by an apportionment of the time basis, i.e.,
there shall be included in the gross income an amount which bears the same relation to the total
compensation as the number of days of performance of the labor or services within the Philippines
bears to the total number of days performance of labor or services for which the payment is made.
Wages received for services rendered inside the territorial limits of the Philippines and wages of an
alien seaman earned on a coastwise vessel are to be regarded as from sources within the
Philippines.
Revenue Regulations 02-40
SECTION 156.Rentals and royalties. Gross income from sources within the Philippines includes
rentals or royalties from property located within the Philippines or from any interest in such property,
including rentals or royalties for the use of or the privilege of using in the Philippines, patents,
copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises, and other
like property. The income arising from the rental of property whether tangible or intangible located
within the Philippines, or from the use of property, whether tangible or intangible, located within the
Philippines, is from sources within the Philippines.
SECTION 157.Sale of real property. Gross income from sources within the Philippines includes
gain, computed under the provisions of Section 35, derived from the sale or other disposition of real
property located in the Philippines. For the treatment of capital gains and losses, see Sections 132 to
135 of these regulations.
SECTION 158.Income from sources without the Philippines. Gross income from sources without
the Philippines includes:
(1) Interest other than that specified in Section 37(a)(1), as being derived from sources within the
Philippines;
(2) Dividends other than those derived from sources within the Philippines as provided in Section
37(a)(2);
(3) Compensation for labor or personal services performed without the Philippines;
(4) Rentals or royalties derived from property without the Philippines or from any interest in such
property, including rentals or royalties for the use of or for the privilege of using without the
Philippines, patents, copyrights, secret processes and formulas, goodwill, trade-marks, trade
brands, franchises, and other like property; and
(5) Gain derived from the sale of real property located without the Philippines. AEIDTc
SECTION 159.Sale of personal property. Income derived from the purchase and sale of personal
property shall be treated as derived entirely from the country in which sold. The world "sold" includes
"exchanged". The "country in which sold" ordinarily means the place where the property is marketed.
This section does not apply to income from the sale of personal property produced (in whole or in
part) by the taxpayer within and sold without the Philippines or produced (in whole or in part) by the
taxpayer without and sold within the Philippines. (See Section 162 of these regulations.)
SECTION 160.Apportionment of deductions. From the items specified in Section 37(a) as being
derived specifically from sources within the Philippines there shall be deducted the expenses, losses,
and other deductions properly apportioned or allocated thereto and a ratable part of any other
expenses, losses or deductions which can not definitely be allocated to some item or class of gross
income. The remainder shall be included in full as net income from sources within the Philippines. The
ratable part is based upon the ratio of gross income from sources within the Philippines to the total
gross income.
EXAMPLE: A non-resident alien individual whose taxable year is the calendar year, derived gross
income from all sources for 1939 of P180,000, including therein:
Interest on bonds of a domestic corporation P9,000
Dividends on stock of domestic corporation 4,000
Royalty for the use of patents within the Philippines 12,000
Gain from sale of real property located within the Philippines 11,000
net income attributable to sources within the Philippines shall be computed by an accounting which
Total P36,000
that is, one-fifth of the total gross income was from sources within the Philippines. The remainder of
the gross income was from sources without the Philippines, determined under Section 37(c).
The expenses of the taxpayer for the year amounted to P78,000. Of these expenses the amount of
P8,000 is properly allocated to income from sources within the Philippines and the amount of P40,000
is properly allocated to income from sources without the Philippines.
The remainder of the expense, P30,000, cannot be definitely allocated to any class of income. A
Page 24 of 40
ratable part thereof, based upon the relation of gross income from sources within the Philippines to
the total gross income, shall be deducted in computing net income from sources within the
Philippines. Thus, there are deducted from the P36,000 of gross income from sources within the
Philippines expenses amounting to P14,000 (representing P8,000 properly apportioned to the income
from sources within the Philippines and P6,000, a ratable part (one-fifth) of the expenses which could
not be allocated to any item or class of gross income). The remainder, P22,000, is the net income
from sources within the Philippines.
SECTION 161.Other income from sources within the Philippines. Items of gross income other than
those specified in Section 37(a) and (c) shall be allocated or apportioned to sources within or without
the Philippines, as provided in Section (37)(e).
The income derived from the ownership or operation of any farm, mine, oil or gas well, other natural
deposit, or timber, located within the Philippines, and from the sale by the producer of the products
thereof within or without the Philippines, shall ordinarily be included in gross income from sources
within the Philippines. If, however, it is shown to the satisfaction of the Commissioner of Internal
Revenue that due to the peculiar conditions of productions and sale in a specific case or for other
reasons all of such gross income should not be allocated to sources within the Philippines and to
sources without the Philippines shall be made as provided in Section 162 of these regulations.
Where items of gross income are separately allocated to sources within the Philippines, there shall be
deducted therefrom, in computing net income, the expenses, losses, and other deductions properly
apportioned or allocated thereto and a ratable part of other expenses, losses, or other deductions
which cannot definitely be allocated to some item or class of gross income.
SECTION 162.Income from the sale of personal property derived from sources partly within and partly
without the Philippines. Items of gross income not allocated by Sections 152 to 159 or 161 of these
regulations to sources from within or without the Philippines shall (unless unmistakably from a source
within or a source without the Philippines) be treated as derived from sources partly within and partly
without the Philippines.
The portion of such income derived from sources partly within the Philippines and partly within a
foreign country which is attributable to sources within the Philippines shall be determined according to
the following rules and cases:
PERSONAL PROPERTY PRODUCED AND SOLD: Gross income derived from the sale of
personal property produced (in whole or in part) by the taxpayer within the Philippines and sold within
a foreign country, or produced (in whole or in part) by the taxpayer within a foreign country and sold
within the Philippines shall be treated as derived partly from sources within the Philippines and partly
from sources within a foreign country under one of the cases below. As used herein the word
"produced" includes created, fabricated, manufactured, extracted, processed, cured, or aged.
CASE 1. Where the manufacturer or producer regularly sells a part of his output to wholly
independent distributors or other selling concerns in such a way as to establish fairly an independent
factory or production price or shows to the satisfaction of the Commissioner of Internal Revenue
that such an independent factory or production price has been otherwise established unaffected by
considerations of tax liability, and the selling or distributing branch or department of the business is
located in a different country from that in which the factory is located or the production carried on, the
treats the products as sold by the factory or productive department of the business to the distributing
or selling department at the independent factory price as established. In all such cases the basis of
the accounting shall be fully explained in a statement attached to the return.
CASE 2. Where an independent factory or production price has not been established as provided
under Case 1, the net income shall first be computed by deducting from the gross income derived
from the sale of personal property produced (in whole or in part) by the taxpayer within the Philippines
and sold within a foreign country or produced (in whole or in part) by the taxpayer within a foreign
country and sold within the Philippines, the expenses, losses, or other deductions properly
apportioned or allocated thereto and a ratable part of any expenses, losses, or other deductions
Revenue Regulations 02-40
which can not definitely be allocated to some item or class of gross income. Of the amount of net
income so determined, one-half shall be apportioned in accordance with the value of the taxpayer's
property within the Philippines and within the foreign country, the portion attributable to sources within
the Philippines being determined by multiplying such one half by a fraction the numerator of which
consists of the value of the taxpayer's property within the Philippines, and the denominator of which
consists of the value of the taxpayer's property both within the Philippines and within the foreign
country. The remaining one-half of such net income shall be apportioned in accordance with the gross
sales of the taxpayer within the Philippines and within the foreign country, the portion attributable to
sources within the Philippines being determined by multiplying such one-half by a fraction the
numerator of which consists of the taxpayer's gross sales for the taxable year or period within the
Philippines, and the denominator of which consists of the taxpayer's gross sales for the taxable year,
or period both within the Philippines and within the foreign country. The "gross sales of the taxpayer
within the Philippines" means the gross sales made during the taxable year which were principally
secured, negotiated, or effected by employees, agents, offices, or branches of the taxpayer's
business resident or located in the Philippines. The term "gross sales" as used in this paragraph
refers only to the sales of personal property produced (in whole or in part) by the taxpayer within the
Philippines and sold within a foreign country or produced (in whole or in part) by the taxpayer within a
foreign country and sold within the Philippines, and the term "property" includes only the property held
or used to produce income which is derived from such sales. Such property should be taken at its
actual value, which in the case of property valued or appraised for purposes of inventory,
depreciation, depletion, or other purposes of taxation shall be the highest amount at which so valued
or appraised, and which in other cases shall be deemed to be its book value in the absence of
affirmative evidence showing such value to be greater or less than the actual value. The average
value during the taxable year or period shall be employed. The average value of property as above
prescribed at the beginning and end of the taxable year or period ordinarily may be used, unless by
reason of material changes during the taxable year or period such average does not fairly represent
the average for such year or period, in which event the average shall be determined upon a monthly
or daily basis. Bills and accounts receivable shall (unless satisfactory reason for a different treatment
is shown) be assigned or allocated to the Philippines when the debtor resides in the Philippines.
HCIaDT
CASE 3. Applications for permission to base the return upon the taxpayer's books of account will be
considered by the Commissioner of Internal Revenue in the case of any taxpayer who, in good faith
and unaffected by considerations of tax liability, regularly employs in his books of account a detailed
allocation of receipts and expenditures which reflects more clearly than the processes or formulas
herein prescribed, the income derived from sources within the Philippines.
SECTION 163.Foreign steamship companies. The returns of foreign steamship companies whose
vessels touch ports of the Philippines should include as gross income, the total receipts of all out-
going business whether freight or passengers. With the gross income thus ascertained, the ratio
existing between it and the gross income from all parts, both within and without the Philippines of all
vessels, whether touching ports of the Philippines or not, should be determined as the basis upon
which allowable deductions may be computed, the principle being that allowable deductions shall be
computed upon a basis which recognizes that the income arising and accruing from business done if
any from this country shall bear its share, and no more, of expense, incident to the earning or creation
of such income, in the ratio that the gross income arising in and from this country bears to the entire
gross income arising from business done both within and without this country. In other words, the net
income of a foreign steamship company doing business in or from this country is ascertained for the
purpose of the income tax, by deducting from the gross receipts from outgoing business such a
portion of the aggregate expenses, losses, etc., as such receipts bear to the aggregate receipts from
all ports of all vessels, including in each case incoming of a nonshipping character but incidental, to
the shipping business such as dividends from investments, interests on deposits, etc. For example
Given
(a) Gross receipts from outgoing freights and passengers
from P.I. ports P20,000
(b) Gross receipts from outgoing freights and passengers
from all ports other than those of P. I 200,000
(c) Interests and other nonshipping income received by P.I.
Page 25 of 40
office 5,000
(d) Interests, dividends, and other nonshipping income received
by all offices other than those in P.I. 50,000
(e) Total expenses and deductions of the company as a whole,
including those incurred by P.I. office 150,000
Computation of P.I. Net Income
(f) P.I. Gross Income:
Freights and passengers P20,000
Interest and other income 5,000
Total 25,000
(g) P.I. expenses:
P.I. gross income
x World's expenses, or
World's gross income
20,000 plus 5,000
x 150,000, or
200,000 plus 20,000 plus 50,000 plus 5,000
25,000
x 150,000 = 13,636
275,000
(h) P.I. net income:
P.I. gross income less P.I. expenses, or
P25,000 less P13,636 = P11,364
SECTION 164.Telegraph and cable service. A foreign corporation carrying on the business of
transmission of telegraph or cable messages between points in the Philippines and points outside the
Philippines derives income partly from sources within and partly from sources without the Philippines.
(1) GROSS INCOME. The gross income from sources within the Philippines derived from such
services shall be determined by adding (a) its gross revenues derived from messages originating in
the Philippines and (b) amounts collected abroad on collect messages originating in the Philippines
and deducting from such sum amounts paid or accrued for transmission of messages beyond the
company's own circuit. Amounts received by the company in the Philippines with respect to collect
messages originating without the Philippines shall be excluded from gross income.
(2) NET INCOME. In computing net income from sources within the Philippines there shall be
allowed as deductions from gross income determined in accordance with paragraph (1): (a) all
expenses incurred in the Philippines (not including any general overhead expenses), incident to the
carrying on of the business in the Philippines; (b) all direct expenses incurred abroad in the
transmission of messages originating in the Philippines (not including any general overhead expenses
or maintenance, repairs, and depreciation of cable and not including any amount already deducted in
computing gross income); (c) depreciation of property (other than cables) located in the Philippines
and used in the trade or business therein; and (d) a proportionate part of the general overhead
expenses [not including any items incurred abroad corresponding to those enumerated in (a), (b), and
(c)], and of maintenance, repairs, and depreciation of cables of the entire cable system of the
enterprise based on the ratio which the number of words originating in the Philippines bears to the
total words transmitted by the enterprise.
SECTION 165.Computation of income. If a taxpayer has gross income from sources within or
without the Philippines as defined by Section 37 (a) or (c) together with gross income derived partly
from sources within and partly from sources without the Philippines, the amounts thereof, together
with the expenses and investment applicable thereto, shall be segregated, and the net income from
sources within the Philippines shall be separately computed therefrom.
(Section 38 of the Code)
SECTION 166.General rule. The method of accounting regularly employed by the taxpayer in
keeping his books, if such method clearly reflects his income is to be followed with respect to the time
as of which items of gross income and deductions are to be accounted for. If the taxpayer does not
Revenue Regulations 02-40
regularly employ a method of accounting which clearly reflects his income, the computation shall be
made in such manner as in the opinion of the Commissioner of Internal Revenue clearly reflects it.
(See Section 137 of these regulations for computation of net income, and Section 38 for bases of
computation. For the use of inventories, see Sections 144 to 151 of these regulations.)
SECTION 167.Methods of accounting. It is recognized that no uniform method of accounting can
be prescribed for all taxpayers, and the law contemplates that each taxpayer shall adopt such forms
and systems of accounting as are in his judgment best suited to his purpose. Each taxpayer is
required by law to make a return of his true income. He must, therefore, maintain such accounting
records as will enable him to do so. Any approved standard method of accounting which reflects
taxpayer's income may be adopted. Among the essentials are the following:
(1) In all cases in which the production, purchase, or sale of merchandise of any kind is an income
producing factor, inventories of the merchandise on hand (including finished goods, work in process,
raw materials, and supplies) should be taken at the beginning and end of the year and used in
computing the net income of the year in accordance with Sections 144 to 151 of these regulations;
(2) Expenditures made during the year should be properly classified as between capital and income;
that is to say, expenditures for items of plant, equipment, etc., which have a useful life extending
substantially beyond the year should be charged to a capital account and not to an expense account;
and
(3) In any case in which the cost of capital assets is being recovered through deductions for wear
and tear, depletion, or obsolescence, any expenditure (other than ordinary repairs) made to restore
the property or prolong its useful life should be added to the property account or charged against the
appropriate reserve and not to current expenses.
SECTION 168.Changes in accounting methods. The true income, computed under the law shall in
all cases be entered in the return. If for any reason the basis of reporting income subject to tax is
changed, the taxpayer shall attach to his return a separate statement setting forth for the taxable year
and for the preceding year the classes of items differently treated under the two systems, specifying in
particular all amounts duplicated or entirely omitted as the result of such change.
A taxpayer who changes the method of accounting employed in keeping his book shall, before
computing his income upon such new method for purposes of taxation, secure the consent of the
Commissioner of Internal Revenue. For the purposes of this action, a change in the method of
accounting employed in keeping books means any change in the accounting treatment of items of
income or deductions, such as a change from cash receipts and disbursements method to the accrual
method, or vice versa; a change involving the basis of valuation employed in the computation of
inventories (see Sections 144 to 151 of these regulations); a change from the cash or accrual method
to the long-term contract method, or vice versa; a change in the long-term contract method from the
percentage of completion basis to the completed contract basis or vice versa (see Section 44 of these
regulations); or a change involving the adoption of, or a change in the use of, any other specialized
basis of computing net income such as the crop basis. Application for permission to change the
method of accounting employed and the basis upon which the return is made shall be filed within 90
days after the beginning of the taxable year to be covered by the return. The application shall be
accompanied by a statement specifying all amounts which would be duplicated or entirely omitted as
a result of the proposed change. Permission to change the method of accounting will not be granted
unless the taxpayer and the Commissioner of Internal Revenue agree to the terms and conditions
under which the change will be effected.
SECTION 169.Accounting period. Income tax returns, whether for individuals or for corporations,
associations, or partnerships, are required to be made and their income computed for each calendar
year ending on December 31st of every year. However, corporations, associations, or partnerships
may with the approval of the Commissioner of Internal Revenue first secured, file their returns and
compute their income on the basis of a fiscal year which means an accounting period of twelve
months ending on the last day of any month other than December. But in no instance shall individual
taxpayers be authorized to establish a fiscal year as basis for filing their returns and computing their
income. (For authority to file on fiscal year basis see Section 172 of these regulations.)
(Section 39 of the Code)
SECTION 170.When included in gross income. Except as otherwise provided in Section 39 in the
Page 26 of 40
case of the death of a taxpayer, gains, profits, and income are to be included in the gross income for
the taxable year in which they are received by the taxpayer, unless they are included as of a different
period in accordance with the approved method of accounting followed by him. If a taxpayer has died
there shall also be included in computing net income for the taxable period in which he died amounts
accrued up to the date of his death if not otherwise properly includible in respect of such period or a
prior period, regardless of the fact that the decedent may have kept his books and made his returns
on the basis of cash receipts and disbursements.
(For income not reduced to possession but considered as constructively received and for examples of
constructive receipt, see Sections 52 and 53 of these regulations. For the treatment of income from
long-term contracts, see Section 44 of these regulations.)
(Section 40 of the Code)
SECTION 171."Paid or incurred" and "paid or accrued". (a) The terms "paid or incurred" and "paid
or accrued" will be construed according to the method of accounting upon the basis of which the net
income is computed by the taxpayer. The deductions and credits must be taken for the taxable year in
which "paid or accrued" or "paid or incurred", unless in order clearly to reflect the income such
deductions or credits should be taken as of a different period. If a taxpayer desires to claim a
deduction or a credit as of a period other than the period in which it was "paid or accrued" or "paid or
incurred", he shall attach to his return a statement setting forth his request for consideration of the
case by the Commissioner of Internal Revenue together with a complete statement of the facts upon
which he relies. However, in his income tax return he shall take the deduction or credit only for the
taxable period in which it was actually "paid or incurred", or "paid or accrued", as the case may be.
Upon the audit of the return, the Commissioner of Internal Revenue will decide whether the case is
within the exception provided by the law, and the taxpayer will be advised as to the period for which
the deduction or credit is properly allowable.
(b) The provisions of paragraph (a) of this section in general are not applicable with respect to the
taxable period during which the taxpayer dies. In such case there shall also be allowed as deductions
and credits for such taxable period amounts accrued up to the date of his death if not otherwise
allowable with respect to such period or a prior period, regardless of the fact that the decedent was
required to keep his books and make his returns on the basis of cash receipts and disbursements.
(See also Section 76 of these regulations.)
(Section 41 of the Code)
SECTION 172.Change of accounting period. If a corporation, including a duly registered general
co-partnership, desires to change its accounting period from fiscal year to calendar year or from
calendar year to fiscal year, or from one fiscal year to another, it shall at any time not less than thirty
days prior to the date fixed in Section 46(b) of the Code for the filing of its return on the basis of its
original accounting period submit a written application to the Commissioner of Internal Revenue
designating the proposed date for the closing of its new taxable year, together with a statement of the
date on which the books of account were opened and closed each year for the past three years, the
date on which the taxable year began and ended as shown on the returns filed for the past three
years, and the reasons why the change in accounting period is desired. (See also Section 46(d) of the
Code.)
(Section 42 of the Code)
SECTION 173.Returns for periods of less than twelve months. No return can be made for a period
of more than twelve months. A separate return for a fractional part of a year is therefore required
whenever there is a change, with the approval of the Commissioner of Internal Revenue, in the basis
of computing net income from one taxable year to another taxable year. The periods to be covered by
such separate returns in the several cases are stated in Section 42(a). The requirements with respect
to the filing of a separate return and the payment of tax for a part of a year are the same as for the
filing of a return and the payment of tax for a full taxable year closing at the same time. DAETcC
(Section 43 of the Code)
SECTION 174.Sale of personal property on installment plan. Dealers in personal property
ordinarily sell either for cash or on the personal credit of the purchaser or on the installment plan.
Dealers who sell on the installment plan usually adopt one of four ways of protecting themselves in
case of default
Revenue Regulations 02-40
(a) By an agreement that title is to remain in the vendor until the purchaser has completely
performed his part of the transaction;
(b) By a form of contract in which title is conveyed to the purchaser immediately, but subject to a lien
for the unpaid portion of the selling price;
(c) By a present transfer of title to the purchaser, who at the same time executes a reconveyance in
the form of a chattel mortgage to the vendor; or
(d) By conveyance to a trustee pending performance of the contract and subject to its provisions.
The general purpose and effect being the same in all of these cases, the same rule is uniformly
applicable. The general rule prescribed is that a person who regularly sells or otherwise disposes of
personal property on the installment plan, whether or not title remains in the vendor until the property
is fully paid for, may return as income therefrom in any taxable year that proportion of the installment
payments actually received in that year which the total or gross profit (that is, sales less cost of goods
sold) realized or to be realized when the property is paid for, bears to the total contract price. Thus the
income of a dealer in personal property on the installment plan may be ascertained by taking as
income that proportion of the total payments received in the taxable year from installment sales (such
payments being allocated to the year against the sales of which they apply) which the total or gross
profit realized or to be realized on the total installment sales made during each year bears to the total
contract price of all such sales made during that respective year. No payments received in the taxable
year shall be excluded in computing the amount of income to be returned on the ground that they
were received under a sale the total profit from which was returned as income during a taxable year
or years prior to the change by the taxpayer to the installment basis of returning income. Deductible
items are not to be allocated to the years in which the profits from the sales of a particular year are to
be returned as income, but must be deducted for the taxable year in which the items are "paid or
incurred" or "paid or accrued", as provided by Section 40 and 84(q) of the Code. A dealer who desires
to compute his income on the installment basis shall maintain books of account in such a manner as
to enable an accurate computation to be made on such basis in accordance with the provisions of this
section.
The income from a casual sale or other casual disposition of personal property (other than property of
a kind which should properly be included in inventory) may be reported on the installment basis only if
(1) the sale price exceeds P1,000 and (2) the initial payments do not exceed 25 per cent of the selling
price.
If for any reason the purchaser defaults in any of his payments, and the vendor returning income on
the installment basis repossesses the property sold whether title thereto had been retained by the
vendor or transferred to the purchaser, gain or loss for the year in which the repossession occurs is to
be computed upon any installment obligations of the purchaser which are satisfied or discharged
upon the repossession or are applied by the vendor to the purchase or bid price of the property. Such
gain or loss is to be measured by the difference between the fair market value of the property
repossessed and the basis in the hands of the vendor of the obligations of the purchaser which are so
satisfied, discharged, or applied, with proper adjustment for any other amounts realized or costs
incurred in connection with the repossession. The basis in the hands of the vendor of the obligations
of the purchaser satisfied, discharged, or applied upon the repossession of the property shall be the
excess of the face value of such obligations over an amount equal to the income which would be
returnable were the obligations paid in full. No deduction for a bad debt shall in any case be taken on
account of any portion of the obligations of the purchaser which are treated by the vendor as not
having been satisfied, discharged, or applied upon the repossession, unless it is clearly shown that
after the property was repossessed the purchaser remained liable for such portion; and in no event
shall the amount of the deduction exceed the basis in the hands of the vendor of the portion of the
obligations with respect to which the purchaser remained liable after the repossession. If the property
repossessed is bid in by the vendor at a lawful public auction or judicial sale, the fair market value of
the property shall be presumed to be the purchase or bid price thereof in the absence of clear and
convincing proof to the contrary. The property repossessed shall be carried on the books of the
vendor at its fair market value at the time of the repossession.
If the vendor chooses as a matter of consistent practice to return the income from installment sales on
the straight accrual or cash receipts and disbursement basis, such a course is permissible.
SECTION 175.Sale of real property involving deferred payments. Under Section 43 deferred-
payment sales of real property include (a) agreements to purchase and sale which contemplate that a
Page 27 of 40
conveyance is not to be made at the outset, but only after all or a substantial portion of the selling
price has been paid, and (b) sales in which there is an immediate transfer of title, the vendor being
protected by a mortgage or other lien as to deferred payments. Such sales either under (a) or (b), fall
into two classes when considered with respect to the terms of sale, as follows:
(1) Sales of property on the installment plan, that is, sales in which the payments received in cash or
property other than evidences of indebtedness of the purchaser during the taxable year in which the
sale is made do not exceed 25 per cent of the selling price.
(2) Deferred-payment sales not on the installment plan, that is sales in which the payments received
in cash or property other than evidences of indebtedness of the purchaser during the taxable year in
which the sale is made exceed 25 per cent of the selling price.
In the sale of mortgaged property the amount of the mortgage, whether the property is merely taken
subject to the mortgage or whether the mortgage is assumed by the purchaser, shall be included as a
part of the "selling price" but the amount of the mortgage, to the extent that it does not exceed the
basis to the vendor of the property sold, shall not be considered as a part of the "initial payments" or
of the "total contract price", as those terms are used in Section 43 of the Code, in Sections 174 and
176 of these regulations, and in this section. The term "initial payments" does not include amounts
received by the vendor in the year of sale from the disposition to a third person of notes given by the
vendee as part of the purchase price which are due and payable in subsequent years. Commissions
and other selling expenses paid or incurred by the vendor are not to be deducted or taken into
account in determining the amount of the "initial payments," the "total contract price", or "the selling
price". The term "initial payments" contemplates at least one other payment in addition to the initial
payment. If the entire purchase price is to be paid in a lump sum in a later year, there being no
payment during the first year, the income may not be returned on the installment basis. Income may
not be returned on the installment basis where no payment in cash or property, other than evidences
of indebtedness of the purchaser, is received during the first year, the purchaser having promised to
make two or more payments, in later years.
SECTION 176.Sale of real property on installment plan. In transactions included in class (1) in the
preceding section the vendor may return as income from such transactions in any taxable year that
proportion of the installment payments actually received in that year which the total profit realized or
to be realized when the property is paid for bears to the total contract price.
If the purchaser defaults in any of his payments, and the vendor returning income on the installment
basis reacquires the property sold, whether title thereto had been retained by the vendor or
transferred to the purchaser, gain or loss for the year in which the reacquisition occurs is to be
computed upon any installment obligations of the purchaser which are satisfied or discharged upon
the reacquisition or are applied by the vendor to the purchase or bid price of the property. Such gain
or loss is to be measured by the difference between the fair market value of the property acquired
(including the fair market value of any fixed improvements placed on the property by the purchaser)
and the basis in the hands of the vendor of the obligations of the purchaser which are so satisfied,
discharged, or applied, with proper adjustment for any other amounts realized or costs incurred in
connection with the reacquisition. The basis in the hands of the vendor of the obligations of the
purchaser satisfied, discharged, or applied upon the reacquisition of the property will be the excess of
the face value of such obligations over an amount equal to the income which would be returnable
were the obligations paid in full. No deduction for a bad debt shall in any case be taken on account of
any portion of the obligations of the purchaser which are treated by the vendor as not having been
satisfied, discharged, or applied upon the reacquisition of the property, unless it is clearly shown that
after the property was reacquired the purchaser remained liable for such portion; and in no event shall
the amount of the deduction exceed the basis in the hands of the vendor of the portion of the
obligations with respect to which the purchaser remained liable after the acquisition. If the property
reacquired is bid in by the vendor at a foreclosure sale, the fair market value of the property shall be
presumed to be the purchase or bid price thereof in the absence of clear and convincing proof to the
contrary. If the property reacquired is subsequently sold, the basis for determining gain or loss is the
fair market value of the property at the date of reacquisition (including the fair market value of any
fixed improvements placed on the property by the purchaser).
If the vendor chooses as a matter of consistent practice to turn the income from installment sales on
the straight accrual or cash receipts and disbursements basis, such a course is permissible, and the
sales will be treated as deferred-payment sales not on the installment plan.
Revenue Regulations 02-40
SECTION 177.Deferred-payment sale of real property not on installment plan. In transactions
included in class (2) in Section 175 of these regulations, the obligations of the purchaser received by
the vendor are to be considered as the equivalent of cash.
If the vendor has retained title to the property and the purchaser defaults in any of his payments, and
the vendor repossesses the property, the difference between (1) the entire amount of the payments
actually received on the contract and retained by the vendor plus the fair-market value at the time of
repossession of fixed improvements placed on the property by the purchaser and (2) the sum of the
profits previously returned as income in connection therewith and an amount representing what would
have been a proper adjustment for exhaustion, wear and tear, obsolescence, amortization, and
depletion of the property during the period the property was in the hands of the purchaser had the
sale not been made will constitute gain or loss, as the case may be to the vendor for the year in which
the property is repossessed, and the basis of the property in the hands of the vendor will be the
original basis at the time of the sale plus the fair market value at the time of repossession, of fixed
improvements placed on the property by the purchaser. If the vendor has previously transferred title to
the purchaser, and the purchaser defaults in any of his payments and the vendor reacquired the
property, such reacquisition shall be regarded as a transfer by the vendor, in exchange for the
property for such of the purchaser's obligations as are applied by the vendor to the purchase or bid
price of the property. Such an exchange will be regarded as having resulted in the realization by the
vendor of gain or loss, as the case may be for the year of reacquisition, measured by the difference
between the fair market value of the property including fixed improvements placed by the purchaser
on the property, and the amount of the obligations of the purchaser which were applied by the vendor
to the purchase or bid price of the property. The fair market value of the property reacquired shall be
presumed to be the amount for which it is bid in by the vendor in the absence of clear and convincing
proof to the contrary. If the property reacquired is subsequently sold the basis for determining gain or
loss is the fair market value of the property at the date of reacquisition including the fair market value
of the fixed improvements placed on the property by the purchaser.
SECTION 178.Sale of real estate in lots. Where a tract of land is purchased with a view to dividing
it into lots or parcels of ground to be sold as such, the entire fair market value as of March 1, 1913, or
the cost, if acquired subsequently to that date, shall be equitably apportioned to the several lots or
parcels and made a matter of record on the books of the taxpayer, to the end that any gain derived
from the sale of any such lots or parcels may be returned as income for the year in which the sale
was made. This rule contemplates that there will be a measure of gain or loss on every lot or parcel
sold, and not that the capital invested in the entire tract shall be extinguished before any taxable
income shall be returned. The sale of each lot or parcel will be treated as a separate transaction and
the gain or loss will be accounted for accordingly.
SECTION 178(a). In all cases where a taxpayer sells during the year real or personal property on
the installment basis, there should be attached to the income tax return a statement of each sale
made during the year containing the following information:
(a) Name of buyer
(b) Address of buyer
(c) Date of sale
(d) Selling price
(e) Payments received during the year corresponding to each sale.
(This new section has been inserted in Revenue Regulations No. 2 by Revenue Regulations No. 8-65
dated June 1, 1965. Took effect upon their promulgation in the Official Gazette on September 27,
1965).
(Section 44 of the Code)
SECTION 179.Determination of the taxable net income of a controlled taxpayer. (A) DEFINITIONS.
When used in this section
(1) The term "organization" includes any organization of any kind, whether it be a sole
proprietorship, a partnership, a trust, an estate, or a corporation or association, irrespective of the
place where organized, where operated, or where its trade or business is conducted, and regardless
of whether domestic or foreign, whether exempt or taxable, or whether affiliated or not.
(2) The terms "trade" or "business" include any trade or business activity of any kind, regardless of
Page 28 of 40
whether or where organized, whether owned individually or otherwise, and regardless of the place
where carried on.
(3) The term "controlled" includes any kind of control, direct or indirect, whether legally enforceable,
and however exercisable or exercised. It is the reality of the control which is decisive, not its form or
the mode of its exercise. A presumption of control arises if income or deductions have been arbitrarily
shifted.
(4) The term "controlled taxpayer" means any one of two or more organizations, trades, or
businesses owned or controlled directly or indirectly by the same interests. aCHDST
(5) The terms "group" and "group of controlled taxpayers" mean the organizations, trades, or
businesses owned or controlled by the same interests.
(6) The term "true net income" means, in the case of a controlled taxpayer, the net income (or, as
the case may be, any item or element affecting net income) which would have resulted to the
controlled taxpayer, had it in the conduct of its affairs (or, as the case may be, in the particular
contract, transaction, arrangement, or other act) dealt with the other member or members of the group
at arm's length. It does not mean the income, the deductions, or the item or element of either,
resulting to the controlled taxpayer by reason of the particular contract, transaction, or arrangement,
the controlled taxpayer, or the interests controlling it, chose to make (even though such contract,
transaction, or arrangement be legally binding upon the parties thereto).
(b) SCOPE AND PURPOSE. The purpose of Section 44 is to place a controlled taxpayer on a tax
parity with an uncontrolled taxpayer, by determining, according to the standard of an uncontrolled
taxpayer, the true net income from the property and business of a controlled taxpayer. The interests
controlling a group of controlled taxpayers are assumed to have complete power to cause each
controlled taxpayer so to conduct its affairs that its transactions and accounting record truly reflect the
net income from the property and business of each of the controlled taxpayers. If, however, this has
not been done, and the taxable net incomes are thereby understated, the statute contemplates that
the Commissioner of Internal Revenue shall intervene, and, by making such distributions,
apportionments, or allocations as he may deem necessary of gross income or deductions, or of any
item or element affecting net income, between/or among the controlled taxpayers constituting the
group, shall determine the true net income of each controlled taxpayer dealing at arm's length with
another uncontrolled taxpayer. The standard to be applied in every case is that of an uncontrolled
taxpayer. Section 44 grants no right to a controlled taxpayer to apply its provisions at will, nor does it
grant any right to compel the Commissioner of Internal Revenue to apply such provisions.
(c) APPLICATION. Transactions between the controlled taxpayer and another will be subjected to
special scrutiny to ascertain whether the common control is being used to reduce, avoid, or escape
taxes. In determining the true net income of a controlled taxpayer, the Commissioner of Internal
Revenue is not restricted to the case of improper accounting, to the case of a fraudulent, colorable, or
sham transaction, or to the case of a device designed to reduce or avoid tax by shifting or distorting
income or deductions. The authority to determine true net income extends to any case in which either
by inadvertence or design the taxable net income in whole or in part, of a controlled taxpayer, is other
than it would have been had the taxpayer in the conduct of his affairs been an uncontrolled taxpayer
dealing at arm's length with another uncontrolled taxpayer.
(Section 45 of the Code)
SECTION 180.Individual returns. Returns, in duplicate, are required of: (a) Every citizen or resident
alien having a gross income of P1,800 or more for the taxable year; (b) every non-resident alien
having income from sources within the Philippines irrespective of amount; and (c) guardians, trustees,
executors, administrators, receivers, conservators, and all others acting in any fiduciary capacity,
when, for the taxable year, the gross income of the person, trust, or estate for whom or which they act
reaches P1,800. (See Section 214 of these regulations.)
For each calendar year, every person whether married or single, having a gross income from all
sources of P1,800 or over, including dividends, excepting stock dividends, must make a return of
income although the tax has been paid at source and the return shows no tax liability. Whether or not
an individual is the head of a family or has dependents is immaterial in determining his liability to
render a return. The husband shall include in his return the income derived not only from his services,
labor, or industry or the income derived from the conjugal partnership but also the income of the wife
derived from her industry or labor as well as that derived from her separate, data, or paraphernal
property. Where, however, the filing of one consolidated return is impracticable, married persons may
Revenue Regulations 02-40
file separate returns but the incomes declared in such returns will be consolidated and the tax
computed on such consolidated income.
The law requires that the income of unmarried minors derived from property received from a living
parent shall be included in the return of the parent, except (1) when the gift tax imposed under
Chapter II of Title III of the Code has been paid on such property, or (2) where the transfer of such
property is exempt from the gift tax.
A signature affixed to a return is presumed to be genuine.
SECTION 181.When and where to file individual returns. The return must be filed with the
Commissioner of Internal Revenue, provincial revenue agent, or treasurer of the province, city or
municipality in which the taxpayer has his legal residence or principal place of business, on or before
April 15th of the year following that for which the return is filed.
When the last due date for filing return falls on Sunday or a legal holiday, the last due date will be held
to be the day following such Sunday or legal holiday, or if placed on the mails, it should be posted in
ample time to reach the Commissioner of Internal Revenue, provincial revenue agent or treasurer of
the province, city, or municipality in which the taxpayer has his legal residence or principal place of
business, under ordinary handling of mail, on or before the date on which the return is required to be
filed. When question is raised as to whether or not the return was posted in ample time to reach the
proper official, the envelope in which the return was transmitted and the return should be submitted to
the Commissioner of Internal Revenue with such comment and recommendation as the receiving
officer may consider proper to make.
SECTION 182.Persons under disability. If the taxpayer is unable to make his own return, on
account of minority, illness, absence or non-residence, the return may be made by his duly authorized
agent or representative or by the guardian or other person charged with the care of his person or
property, the principal and his representative or guardian assuming the responsibility of making the
return and incurring penalties provided for erroneous, false, or fraudulent returns.
SECTION 183.Form of return. Individual returns shall be prepared on B.I.R. Form No. 17.01. The
forms may be had from the office of the Commissioner of Internal Revenue in Manila, or in the office
of the provincial treasurers or their deputies.
A taxpayer will not be excused from making a return by the fact that no return form has been
furnished him. Taxpayers not supplied with the proper forms should make application therefor to the
Commissioner of Internal Revenue or to the provincial treasurers, or their deputies in ample time to
have their returns prepared, verified, and filed with the proper official on or before the due date. Each
taxpayer should carefully prepare his return so as to fully and clearly set forth the data therein called
for. Imperfect or incorrect returns will not be accepted as meeting the requirements of the statute.
(There are now BIR Provincial Revenue Officers.)
(Section 46 of the Code)
SECTION 184.Corporation returns. Corporations are required to make returns of income in
duplicate, regardless of the amount of their net income.
A corporation claiming exemption from tax and from the filing of returns must establish its right to
exemption in accordance with the procedure set forth in Section 24 of these regulations, otherwise it
will be amenable to the penalties for failure to file returns.
In the case of ordinary corporations, partnerships, and joint accounts (cuentas en participacion), the
return shall be on the form prescribed for corporations (B.I.R Form No. 17.02), and the returns of
insurance companies, on the prescribed form (B.I.R. Form No. 17.03). A corporation having an
existence during any portion of a taxable year is required to make a return. A corporation which has
received a charter, but has never perfected its organization, and which has transacted no business
and had no income from any source, may upon presentation of the facts to the Commissioner of
Internal Revenue be relieved from the necessity of making a return so long as it remains in an
unorganized condition. In the absence of a proper showing to the Commissioner of Internal Revenue
such corporation must file the necessary return.
Page 29 of 40
A corporation desiring to change its accounting period from calendar year to fiscal year must comply
with the procedure set forth in Section 172 of these regulations relative to the change in accounting
period of corporations.
SECTION 185.Returns of insurance companies. Insurance companies transacting business in the
Philippines or deriving income from sources therein are required to file returns of income. The return
shall be made on the prescribed form (B.I.R. Form No. 17.03).
SECTION 186.Returns of foreign corporations. Every foreign corporation having income from
sources within the Philippines must make a return of income on the form prescribed for corporation
(B.I.R. Form No. 17.02). If such a corporation has no office or place of business in this country, but
has a resident agent therein, the latter shall make the return. Although the foreign corporation is not
engaged in business in this country and has no office, branch, or agency in the Philippines, it is
required to make a return if it has received income from sources within the Philippines.
SECTION 187.Time and place for filing corporate returns. Returns of corporations, associations, or
partnerships must be filed on or before the fifteenth day of April in each year or on or before the 15th
day of the fourth month following the close of a duly designated fiscal year. The return, if placed in the
mails, should be posted in ample time to reach the Commissioner of Internal Revenue, provincial,
revenue agent, or treasurer of the province, city or municipality in which is located the principal office
of the corporation where its books of account and other data are kept, on or before the last due date
for the filing of the return. When the last due date falls on Sunday or a legal holiday, the returns may
be filed without penalty on the next succeeding business day. (Conforms with Am. by R.A. 2343.)
(Section 47 of the Code)
SECTION 188.Extension of time for filing returns. The Commissioner of Internal Revenue may, in
meritorious cases, grant a reasonable extension of time for filing returns of income. Requests for such
extension of time must be submitted before the last day of the period for filing returns. Absence or
sickness is considered as reasonable cause, whereas, inability to close the books or to gather
information required due to various circumstances will be subject to careful investigations before the
request for extension is favorably considered.
(Section 48 of the Code)
SECTION 189.Returns by receiver. Receivers, trustees in dissolution, trustees in bankruptcy, and
assignees, operating the property or business of corporations, partnerships, or associations must
make returns of income for such corporations, partnerships or associations covering each year or part
of the year during which they are in control. Notwithstanding that the powers and functions of a
corporation are suspended and that the property and business are for the time being in the custody of
the receiver, trustee, or assignee, subject to the order of the court, such receiver, trustee, or assignee
stands in the place of the corporate officers and is required to perform all the duties and assume all
the liabilities which would devolve upon the officers of the corporation were they in control. A receiver
in charge of only part of the property of a corporation, however, as a receiver in mortgage foreclosure
proceedings involving merely a small portion of its property, need not make a return of income.
(Section 49 of the Code)
SECTION 190.Returns of duly registered general co-partnerships. Duly registered general
copartnerships are required to render, in duplicate, a return of their earnings, profits and income,
setting forth the items of the gross income and the deductions allowable, and the names and
addresses of the individuals who would be entitled to the net earnings, profits, and income, if
distributed. (See sections 22 and 23 of these regulations.)
(Section 50 of the Code)
SECTION 191.Verification of returns. All income tax returns must be verified by the oath or
affirmation of the person rendering them. Oath may be taken before any officer authorized to
administer oaths or if desired, before the Commissioner of Internal Revenue or any internal-revenue
officer especially deputized by him or authorized by law to administer oaths, free of charge.
SECTION 192.Discovery of understatement of income. If the amount of income declared in a
Revenue Regulations 02-40
return has been found to be understated, the Commissioner of Internal Revenue or any internal-
revenue officer shall notify the taxpayer of such fact, and the taxpayer may, if he so desires, under a
sworn statement, present testimony to the contrary and disprove the findings made.
(Section 51 of the Code)
SECTION 193.Assessment of tax. All income tax returns filed with the provincial revenue agents or
with the treasurers of provinces, cities, or municipalities must be stamped with the date of their receipt
and immediately forwarded to the Commissioner of Internal Revenue. All assessments of income tax
shall be made by the Commissioner of Internal Revenue and all taxpayers shall be notified of the
amount for which they are respectively liable on or before the first day of May of each successive
year. In the case of a corporation filing returns on the basis of a fiscal year, it shall be notified of the
amount for which it is liable on or before the first day of the fifth month following the close of its fiscal
year. (See changes made by R.A. 2343, effv. June 20, 1959, introducing here self assessment.)
SECTION 194.Payment of tax. The total amount of tax assessed shall be paid on or before the
fifteenth day of April following the close of the calendar year by the person subject to tax, and in the
case of a corporation, by the president, vice-president, or other responsible officer thereof. In the case
of corporations filing returns on the basis of a fiscal year, the total amount of tax shall be paid on or
before the fifteenth day of the fourth month following the close of the fiscal year. (Conforms with
amendments by R.A. 2343, effv. June 20, 1959.)
Where the tax assessed against the taxpayer is in excess of P500, the taxpayer may elect to pay the
tax in two equal installments. The first installment shall be paid on or before the date prescribed in
section 51 (a) and the second installment on or before the fifteenth day of July following the close of
the calendar year or on or before the fifteenth day of the seventh month following the close of the
fiscal year, as the case may be. Upon failure to pay any installment on the date fixed for its payment,
the whole amount of the tax unpaid becomes due and payable, together with the delinquency
penalties. (Conforms with amendments by R.A. 2343, effv. June 20, 1959.)
SECTION 195.Commissioner's authority to make returns. In cases wherein taxpayers have
neglected or refused to make return, and in cases wherein returns are found, upon examination or
otherwise, to be erroneous, false, or fraudulent, the Commissioner of Internal Revenue shall upon
discovery thereof, make a return upon the best evidence obtainable, and the tax so discovered to be
due, together with the penalties prescribed, shall be assessed and the amount thereof shall be paid
immediately upon notice and demand.
SECTION 196.Surcharge and interest in case of delinquency. Upon failure to pay any tax or
installment thereof, of any deficiency tax, when the same is due, a penalty of 5 per cent of the amount
of tax unpaid, and interest at the rate of 1 per cent per month upon the said tax from the time the
same became due until paid, shall be added to the amount of such tax. (See Sec. 51(b) to (e) as
amended by R.A. 2343, effv. June 20, 1959.)
(Section 52 of the Code)
SECTION 197.Receipts for income tax payments. It shall be the duty of the collecting officer to
acknowledge the receipt of the payment of income tax due from each taxpayer by issuing the
requisite Revenue Official Receipt (B.I.R. Form No. 25.24).
(Section 53 of the Code)
SECTION 198.Withholding tax at source. Withholding is required (a) of a tax of 20 per centum in
the case of fixed or determinable annual or periodical income, including dividends or net gains or net
profits received from corporations, partnerships or associations, payable to non-resident alien
individuals not engaged in trade or business and not having an office or place of business in the
Philippines; and (b) of a tax of 20 per centum in the case of interest upon bonds, obligations or
securities issued by domestic or resident foreign corporations, containing a so-called tax-free
covenant clause, payable either to citizens or aliens, residents or non-residents, where the owner of
such interest income does not file with the withholding agent a signed notice on B.I.R. Form No. 17.13
claiming the benefit of personal exemption. Subject to the exception just mentioned, withholding taxes
takes place in all cases of payments of interest upon tax-free covenant bonds or other securities
regardless of the place where such bonds or securities are issued or marketed and the interest
Page 30 of 40
thereupon paid. Bonds issued under a trust deed containing a tax-free covenant are treated as if they
contain such a covenant.
SECTION 199.Fixed or determinable annual or periodical income. Only fixed or determinable
annual or periodical income is subject to withholding. The statute specifically includes in such income,
interests, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, and
emoluments, but other kinds of income may be included, as for instance, royalties.
Income is fixed when it is to be paid in amounts definitely pre-determined. On the other hand, it is
determinable whenever there is a basis of calculation by which the amount to be paid may be
ascertained.
The income need not be paid annually if it is paid periodically; that is to say, from time to time,
whether or not at regular intervals. That the length of time during which the payments are to be made
may be increased or diminished in accordance with some one's will or with the happening of an event
does not make the payments any the less determinable or periodical. A salesman working by the
month for a commission on sales which is paid or credited monthly receives determinable periodical
income. The income derived from the sale in the Philippines of property whether real or personal, is
not fixed or determinable annual or periodical income.
Dividends from every domestic corporation are subject to the withholding provisions of the law.
Dividends from a foreign corporation are subject to withholding if (1) such foreign corporation is
engaged in trade or business within the Philippines or has an office or place of business therein, and
(2) more than 85 per cent of its gross income for the three-year period ending with the close of its
taxable year preceding the declaration of such dividends (or for such part of such period as the
corporation has been in existence) was derived from sources within the Philippines. In case the
owners of any securities are not known to the withholding agent, the latter should deduct and withhold
a tax of 20 per cent on the interest on such securities.
SECTION 200.Payments to non-resident alien individuals. The law requires withholding of the tax
on income payable to a non-resident alien individual not engaged in trade or business in the
Philippines and not having an office or place of business therein. A non-resident alien individual is
presumed not to be engaged in trade or business in the Philippines and not to have an office or place
of business therein, unless the withholding agent has definite knowledge that such resident is
engaged in trade or business in the Philippines and of the name and address of his resident agent in
this country, or unless the withholding agent definitely knows that such non-resident has an office or
place of business in the Philippines and of the location of such office or place of business. An
individual whose address is without the Philippines is presumed to be a non-resident alien, unless the
withholding agent has definite knowledge that such person is either a citizen or a resident of the
Philippines. An individual whose address is within the Philippines, may be presumed to be a resident
of the Philippines, unless the withholding agent has reason to believe that such individual, not being a
citizen of the Philippines, has not established residence in this country.
In case of doubt, a withholding agent may always protect himself by withholding the tax due, and
promptly causing a query to be addressed to the Commissioner of Internal Revenue for the
determination of whether or not the income paid to an individual is not subject to withholding. In case
the Commissioner of Internal Revenue decides that the income paid to an individual is not subject to
withholding the withholding agent may thereupon remit the amount of tax withheld.
SECTION 201.Exception from withholding. Withholding of a tax on interests upon bonds or other
obligations containing a tax-free covenant clause shall not be required in the case of a citizen or
resident alien individual if he files with the withholding agent when presenting interest coupons for
payment, not later than February 1 following the taxable year, an ownership and exemption certificate
on the requisite form (B.I.R. Form No. 17.13) claiming a personal exemption or credits for
dependents. The withholding agent shall forward such certificate to the Commissioner of Internal
Revenue with a letter of transmittal. The income of domestic and resident foreign corporations is free
from withholding.
SECTION 202.Ownership certificates for interest coupons. The owners, except domestic and
resident foreign corporations, of bonds or other obligations containing a tax-free covenants clause,
Revenue Regulations 02-40
issued by a domestic or resident foreign corporation, when presenting interest coupons for payment,
shall file a certificate of ownership on B.I.R. Form No. 17.13, for each issue of bonds, showing the
name and address of the debtor corporation, the name and address of the owner of the bonds, the
nature of the obligations, the amount of interest and its due date, and the amount of any tax withheld.
In the case of corporate bonds or similar obligations not containing a tax-free covenant clause, no
ownership certificates are required. But ownership certificates are required in the case of such bonds
if the owner is unknown to the withholding agent. Ownership certificates need not be filed in the case
of interest payments on bond or similar obligations of the United States or of the Government of the
Philippines or of any political subdivision thereof.
Where in connection with the sale of its property payment of the bonds or other obligations of a
corporation is assumed by the assignee, such assignee, whether an individual, partnership,
corporation, province, city or municipality, must deduct and withhold such taxes as would have been
required to be withheld by the assignor had not such sales and transfer been made.
SECTION 203.Return and payment of tax withheld. (a) Every withholding agent shall make an
annual return in duplicate, on B.I.R. Form No. 17.43 of the tax withheld from interest on corporate
bonds or other obligations on or before the 15th day of April of each year for the preceding calendar
year. (b) Every person required to deduct and withhold any tax from income other than such bond
interest shall make an annual return thereon, in duplicate, on B.I.R. Form No. 17.43 on or before April
15 of each year for each non-resident alien individual not engaged in trade or business within the
Philippines and not having any office or place of business therein, to whom income other than bond
interest was paid during the previous taxable year. The entire amount of the income from which the
tax was withheld shall be included in gross income without deduction for such payment of the tax.
(Conforms with amendments by R.A. 2343, effv. June 20, 1959.)
The tax due on withholding income tax returns are payable at the same time and in the same manner
as taxes due on individual returns.
SECTION 204.Income of recipient. Income upon which the tax is required to be withheld at source
shall nevertheless be included in the return of the recipient of such income. However, the amount of
tax withheld shall be credited against the amount of income tax due on such return, and the amount, if
any, by which the tax withheld at source exceeds the tax due on the return shall be refunded in
accordance with the provisions of Section 309 of the Code.
(Section 54 of the Code)
SECTION 205.Withholding of tax on income of nonresident foreign corporations, firms, etc. All
persons, corporations, partnerships, and associations, having the control, receipt, custody, disposal,
or payment of interest, dividends, rents, salaries, wages, premiums, annuities, compensations,
remunerations, emoluments, or other fixed or determinable annual or periodical gains, profits, and
income received or obtained from sources within the Philippines by a non-resident alien firm,
copartnership, corporation, association, trust company, trustee, and insurance company, not engaged
in business or trade within the Philippines and not having an office or place of business therein, are
required to withhold a tax of 30 per cent thereon, file the requisite withholding return on the prescribed
form (B.I.R. Form No. 17.43), and pay the tax withheld, in accordance with the provisions of sections
198 to 204 of these regulations. The withholding provisions of the law are likewise applicable to the
income derived from interest upon bonds, mortgages, or deeds of trust, or other interest-bearing
obligations of a domestic or resident foreign corporation, firm or association, whether or not the bonds
and other such obligations, or securities contain the so-called tax-free covenant clause, and
regardless of the place where such bonds, obligations, or securities are issued, negotiated, or
marketed and the interest thereon paid, in case where such interest-income is received or obtained
by, or paid to, a non-resident alien firm, corporation, association, trust company, or trustee, not
engaged in business or trade within the Philippines and not having an office or place of business
therein. (Conforms with amendments by R.A. 2343, effv. June 20, 1959.)
A foreign corporation is presumed not to be engaged in trade or business within the Philippines and
not to have office or place of business therein, unless the withholding agent has definite knowledge
that such foreign corporation is in fact engaged in trade or business in the Philippines and of the
name and address of its resident agent, or unless the withholding agent has definite knowledge that
Page 31 of 40
such foreign corporation has a branch office or business in this country and of the location of such
branch office or place of business.
(Section 55 of the Code)
SECTION 206.Income tax not otherwise collectible from taxpayer chargeable to his representative.
It is the intent and purpose of the law to charge and collect income tax imposed under Title II of the
Code on all gains, profits, and income of a taxable class, and the tax is required to be paid by the
owner of such gains, profits. and income or by the proper representative having the receipt, custody,
control, or disposal of the same. Thus, where a non-resident has charged a resident, under a power
of attorney, to sell in his behalf property, real or personal in the Philippines, the proper tax due may be
collected from the owner of the gains or profits or from the representative who had the receipt,
custody, control or disposal of such gains, profits, or income, as the personal liability of such
representative.
(Sections 56 to 60 of the Code)
SECTION 207.Estates and trusts. "Fiduciary" is a term which applies to all persons or corporations
that occupy positions of peculiar confidence towards others, such as trustees, executors, or
administrators; and a fiduciary, for income tax purposes, is any person or corporation that holds in
trust an estate of another person or persons. In order that a fiduciary relationship may exist, it is
necessary that a legal trust be created.
In general, the income of a trust for the taxable year which is to be distributed to the beneficiaries
must be returned by and will be taxed to the respective beneficiaries, but the income of a trust which
is to be accumulated or held for future distribution, whether consisting of ordinary income or gain from
the sale of assets included in the corpus of the trust, must be returned by and will be taxed to the
trustee. Three exceptions to this general rule are found in the law: (1) in the case of revocable trust
(Section 59); (2) in the case of a trust the income of which, in whole or in part, may be held or
distributed for the benefit of the grantor (Section 60); and (3) in the case of a trust administered in a
foreign country [Section 57(c)]. In the first case, the income from such part of the trust estate title to
which may be revested in the grantor should be included in the grantor's return. In the second case,
part of the income of the trust, which may be held or distributed for the benefit of the grantor, should
be included in the grantor's return. In the third case, the trustee is not entitled to the deductions
mentioned in subsections (a) and (b) of Section 57 and the net income of the trust undiminished by
any amounts distributed, paid or credited to beneficiaries will be taxed to the trustees; however, the
income included in the return of the trustees is not to be included in computing the income of the
beneficiaries.
SECTION 208.Consolidation of incomes of two or more trusts. Section 56(b)(2) expressly requires
the consolidation of the income of two or more trusts where the creator of the trust in each instance is
the same person and the beneficiary in each instance is the same. The tax due on the consolidated
income will be collected from the trustees in proportion to the net income of the of the respective
trusts. (See Section 215 of these regulations.)
SECTION 209.Estates and trusts taxed to fiduciary. In the case of a decedent's estate the
settlement of which is the object of testamentary or intestate proceedings, the fiduciary, executor, or
administrator is required to file an annual return for the estate up to the final settlement thereof. In the
same manner, the fiduciary is required to file a yearly return covering the income of a trust, whether
created by will or deed, for accumulation of income, whether for unascertained persons or persons
with contingent interests or otherwise. In both cases the income of the estate or trust is taxed to the
fiduciary. Where under the terms of a will or deed, the trustee, may in his discretion, distribute the
income or accumulate it, the income is taxed to the trustee, irrespective of the exercise of his
discretion. The imposition of the tax is not affected by the fact that an ultimate beneficiary may be a
person exempt from tax.
SECTION 210.Estate and trust taxed to beneficiaries. In the case of (a) a trust the income of which
is to be distributed annually or regularly; (b) an estate of a decedent the settlement of which is not the
object of judicial testamentary or intestate proceedings; and (c) properties held under a co-ownership
or tenancy in common, the income is taxable directly to the beneficiary or beneficiaries. Each
beneficiary must include in his return his distributive share of the net income of the trust, estate, or co-
Revenue Regulations 02-40
ownership. In the case of trusts which are in whole or in part subject to revocation by the grantor, or
which are for the benefit of the grantor, the income of the trust is to be included in computing the net
income of the grantor.
SECTION 211. Decedent's estate administration. The "period of administration or settlement of the
estate" is the period required by the executor or administrator to perform the ordinary duties
pertaining to administration, in particular, the collection of assets and the payment of debts and
legacies. Estates during the period of administration have but one beneficiary and that beneficiary is
the estate.
No taxable income is realized from the passage of property to the executor or administrator on the
death of the decedent, even though it may have appreciated in value since the decedent acquired it.
In the event of delivery of property in kind to a legatee or distributee, no income is realized. Where,
however, prior to the settlement of the estate, the executor or administrator sells property of a
decedent's estate for more than the appraised value placed upon it at the death of the decedent, the
excess is income, taxable to the estate. Where property is sold after the settlement of the estate by
the devisee, legatee or heir at a price greater than the appraised value placed upon it at the time he
inherited the property from the decedent, he is taxable individually on any profit derived. An allowance
paid a widow or heir out of the corpus of the estate is not deductible from gross income.
SECTION 212.Liability for tax on estate or trusts. Liability for payment of the tax attaches to the
person of an executor or administrator up to and after his discharge, where prior to distribution and
discharge he had notice of his tax obligations or failed to exercise due diligence in determining
whether or not such obligations existed. Liability for the tax also follows the estate itself, and when the
estate has been distributed, the heirs, devisees, legatees, and distributors may be required to
discharge the amount of the tax due and unpaid, to the extent of and in proportion to any share
received. The same consideration apply to other trusts. Where the tax has been paid on the net
income of an estate or trust by the fiduciary, the net income on which the tax is paid is free from tax
when distributed to the beneficiaries.
SECTION 213.Exemption allowed to estate or trusts. An estate or a trust is allowed a personal
exemption of P1,800. Each beneficiary is entitled to but one personal exemption, no matter from how
many trusts he may receive income.
(Section 61 of the Code)
SECTION 214.Fiduciary returns. Fiduciaries are required to make returns of income on B.I.R.
Form No. 17.01, in duplicate, when the gross income of the person, trust, or estate for whom or which
they act amounts to P1,800 or more and will be subject to all the provisions of law which apply to
individuals. A fiduciary making return shall make oath that he has sufficient knowledge of the affairs of
the person trust, or estate for whom or which he acts to enable him to make such return, and that the
same is, to the best of his knowledge and belief, true and correct. A return by one of two or more joint
fiduciaries in the form prescribed filed in the municipality or city in which such fiduciary resides shall
be sufficient compliance with the requirement for fiduciary returns.
A fiduciary acting as the guardian of a minor or other incapacitated person must make a return for
such minor or incapacitated person and pay the tax, unless such minor or incapacitated person
himself makes a return or cause it to be made. The parent is held to be the natural guardian of a
minor child.
SECTION 215.Returns in case of two or more trusts. Where, in the case of more than one trust,
the creator of the trust in each instance is the same person and the trustee in each instance is the
same but the beneficiaries are different, the trustee should make a separate return for each of the
trusts in his hands. When a trustee holds trust created by different persons for the benefit of the same
beneficiary, he should also make a return for each trust separately. But where a person creates two or
more trusts in favor of the same beneficiary [Section 56(b) (2)] appointing two or more trustees, the
latter should each make a separate return for each trust but in such case the Commissioner of
Internal Revenue will consolidate the net incomes of the different trusts and compute the tax on such
consolidated income, allowing only one absolute exemption of 1,800.
Page 32 of 40
SECTION 216.Return by receiver. A receiver who stands in the place of an individual or
corporation must render a return of income and pay the tax for his trust, but a receiver of only part of
the property of an individual or corporation need not. If the receiver acts for an individual the return
shall be on B.I.R. Form No. 17.01. When acting for a corporation a receiver is not treated as a
fiduciary, and in such case the return shall be made, as if by the corporation itself, on B.I.R. Form No.
17.02.
(Section 62 of the Code)
SECTION 217.Fiduciaries indemnified against claims for taxes paid. Fiduciaries are indemnified
against the claims or demands of every beneficiary for all payments of taxes which they shall be
required to make and they shall have credit for such payments in any accounting which they make as
such fiduciaries.
(Section 63 of the Code)
SECTION 218.Tax on personal holding companies. Section 63 imposes for such taxable year
beginning after December 31, 1938 (in addition to the tax imposed by Section 24 of the Code), a tax
upon corporations classified as personal holding companies. Corporations so classified are exempt
from the additional tax on corporation improperly accumulating surplus imposed by Section 25, but
are not exempt from the other taxes imposed by Title II of the Code. Unlike the tax imposed by
Section 25, the tax imposed by Section 63 applies to all personal holding companies defined as such
in Section 64, regardless of whether or not they were formed or availed of to accumulate earnings or
profits for the purpose of avoiding the tax upon shareholders. The tax imposed by Section 63 is 45 per
cent of the amount of the undistributed net income.
A foreign corporation, whether resident or non-resident, which is classified as a personal holding
company under Section 64 (not including a foreign personal holding company as defined in Section
67) is subject to the tax imposed by Section 63 with respect to its income from sources within the
Philippines. The term "personal holding company" as used in Chapter VIII of Title II of the Code does
not include a foreign corporation if (1) its gross income from sources within the Philippines for the
period specified in Section 37(a) (2) (B) is less than 50 per cent of its total gross income from all
sources and (2) all of its stock outstanding during the last half of the taxable year is owned by
nonresident alien individuals, whether directly or indirectly through other foreign corporations.
(Section 64 of the Code)
SECTION 219.Definition of personal holding company. A personal holding company is any
corporation (other than a corporation specified in section 64(b) which for the taxable year meets (a)
the gross income requirement specified in Section 220 of these regulations, and (b) the stock
ownership requirement specified in Section 221 of these regulations. Both requirements must be
satisfied and both must be met with respect to each taxable year.
SECTION 220.Gross income requirement. To meet the gross income requirement, it is necessary
that either of the following percentages of gross income of the corporation for the taxable year be
personal holding company income as defined in Section 65:
(a) Eighty per cent or more; or
(b) Seventy per cent or more if the corporation has been classified as a personal holding company
for any taxable year beginning after December 31, 1938, unless
(1) A taxable year has intervened since the last taxable year for which it was so classified,
during no part of the last half of which the stock ownership requirement specified in Section
64(a) (2) exists; or
(2) Three consecutive years have intervened since the last taxable year for which it was so
classified, during each of which its personal holding company income was less than 70 per
cent of its gross income.
In determining whether the personal holding company income is equal to the required percentage of
the total gross income, the determination must not be made upon the basis of gross receipts, since
gross income is not synonymous with gross receipts. For a further discussion of what constitutes
"gross income", see Section 29 of the Code and the regulations prescribed under that section.
SECTION 221.Stock ownership requirements. To meet the stock ownership requirement, it is
Revenue Regulations 02-40
necessary that at some time during the last half of the taxable year more than 50 per cent it value of
the outstanding stock of the corporation be owned, directly or indirectly, by or for not more than five
individuals: For such purpose, the ownership of the stock must be determined as provided in Section
66.
In the event of any change in the stock outstanding during the last half of the taxable year, whether in
the number of shares or classes of stock, or whether in the ownership thereof, the conditions existing
immediately prior .and subsequent to each change must be taken into consideration.
In determining whether the statutory conditions with respect to stock ownership are present at any
time during the last half of the taxable year, the phrase "in value" shall, in the light of all the
circumstances, be deemed the value of the corporate stock outstanding at such time (not including
treasury stock). This value may be determined upon the basis of the company's net worth, earning
and dividend paying capacity, appreciation of assets, together with such other factors as have a
bearing upon the value of the stock. If the value of the stock is greatly at variance with that reflected
by the corporate books the evidence of such value should be filed with the return. In any case where
there are two or more classes of stock outstanding, the total value of the stock should be allocated
among the different classes according to the relative value of each class therein.
The rules stated in the last two preceding paragraphs are equally applicable in determining the stock
ownership requirement specified in Section 65(e); relating to personal service contracts and Section
65(f), relating to the use of corporation property by a shareholder. The stock ownership requirement
specified in these sections relates, however, to the stock outstanding at anytime during the entire
taxable year and not merely during the last half thereof.
(Section 65 of the Code)
SECTION 222.Personal holding company income. The term "personal holding company income"
means the portion of the gross income which consists of the following:
(1) DIVIDENDS. The term "dividends" includes dividends as defined in Section 83 (a), and
amounts required to be included in gross income under Section 69 (b) of this Code. It does not
include stock dividends (to the extent that they do not constitute income to the shareholders with the
meaning of Section 83(b) of the Code) and liquidating dividends.
(2) INTEREST (other than interest constituting rent). The term "interest" means any amount,
includible in gross income, received for the use of money loaned except that it does not include
interest constituting rent [see subparagraph (1)].
(3) ROYALTIES (other than mineral, oil, or gas royalties). The term "royalties" include amounts
received for the privilege of using patents, copyrights, secret processes and formulas, good will, trade
marks, trade brands, franchises, and other like property. It does not include rents, or overriding
royalties received by an operating company. As used in this paragraph the term "overriding royalties"
means amounts received from the sublease by the operating company which originally leased and
developed the natural resources property in respect of which such overriding royalties are paid.
(4) ANNUITIES. The term "annuities" includes annuities only to the extent includible in the
computation of gross income. [See Section 29(b) (2)].
(5) GAINS FROM THE SALE OR EXCHANGE OF STOCK OR SECURITIES. The term "gains
from the sale or exchange of stock or securities" as used in Section 65(b) applies to all gains
(including gains from liquidation dividends and other distributions from capital) from the sale or
exchange of stock or securities includible in gross income. The term "stock or securities" as used in
Section 65(b) includes shares or certificates of stock, or interest in any corporation (including any joint
stock company, insurance, company association, or other organization classified as a corporation
under Title II) certificates of interest or participation in mineral royalty, or leave, collateral trust
certificates, voting trust certificates, stock rights or warrants, bonds, debentures, certificates of
indebtedness, notes, car trusts certificates, bills of exchange, obligations issued by or on behalf of a
Government, State, Territory, or political subdivision thereof. In the case of "regular dealers in stock or
securities" the term does not include gains derived from the sale or exchange of stock or securities
made in the normal course of business. The term "regular dealer in stock or securities" means
corporations with an established place of business regularly engaged in the purchases of stock or
securities and their resale to customers, but such corporations are not dealers with respect to stock or
securities held for speculation or investment.
(6) GAINS FROM FUTURES TRANSACTIONS IN COMMODITIES. Gains from futures
Page 33 of 40
transactions in commodities include gains from futures transactions in any commodity on or subject to
the rules of a board of trade or commodity exchange, but do not include gains from cash transactions
or gains by a producer, processor, merchant, or handler of the commodity, which arise out of bonafide
hedging transactions reasonably necessary to the conduct of its business in the manner in which such
business is customarily and usually conducted by others. In general, personal holding company
income includes gains on futures contracts which are speculative. Futures contracts representing true
hedges against price fluctuations in spot goods are not speculative transactions, though not
concurrent with spot transactions. Futures contracts which are not hedges against spot transactions
are speculative unless they are hedges against concurrent futures or forward sales or purchases.
(7) INCOME FROM ESTATES AND TRUSTS. The income from estates and trusts which is to be
included in personal holding company income consists of the income from estates and trusts which is
required to be included in the gross income of the corporation under Section 29 in relation to Section
56 of the Code, together with the gains derived by the corporation from the sale or other disposition of
any interest in an estate or trust.
(8) AMOUNTS RECEIVED UNDER PERSONAL SERVICE CONTRACTS. Amounts includible in
personal holding company income as amount received under personal service contracts consist of
amounts received pursuant to a contract under which the corporation is to furnish personal services,
and amounts received from a sale or other disposition of such a contract, if
(a) Some person other than the corporation has the right to designate (by name or by description)
the individual who is to perform the services or if the individual who is to perform the services is
designated (by name or by description) in the contract; and
(b) At some time during the taxable year 25 per cent or more in value of the outstanding stock of the
corporation is owned, directly or indirectly, by or for the individual who has performed, is to perform, or
may be designated (by name or by description), as the one to perform such services. For this purpose
the stock ownership must be determined as provided in Section 66 of the Code.
The application of Section 65(e) may be illustrated by the following examples:
Example (1): A, whose profession is that of an actor, owns all of the outstanding capital stock of the M
Corporation. The Corporation entered into a contract with A under which A was to perform personal
services for the person or persons whom the M Corporation might designate, in consideration of
which A was to receive P10,000 a year from the M Corporation. The M Corporation entered into a
contract with the O Corporation in which A was designated to perform personal services for the O
Corporation in consideration of which the O Corporation was to pay the M Corporation P500,000 a
year. The P500,000 received by the M Corporation from the O Corporation constitutes a personal
holding company income.
Example (2): The N Corporation, the entire outstanding capital stock of which is owned by four
individuals, is engaged in engineering. The N Corporation entered into a contract with the O
Corporation to perform engineering services for the O Corporation, in consideration of which the O
Corporation was to pay the N Corporation P50,000. The individual who was to perform the services
was not designated (by name or by description) in the contract and no one but the N Corporation had
the right to designate (by name or by description) such individual. The P50,000 received by the N
Corporation from the O Corporation does not constitute personal holding company income. HTaIAC
(9) COMPENSATION FOR USE OF PROPERTY. The compensation for the use of, or the right to
use, the property of the corporation which is to be included in personal holding company income
consists of amounts received as compensation (however designated and from whomsoever received)
for the use of, or the right to use, property of the corporation in any case in which, at any time during
the taxable year 25 per cent or more in value of the outstanding stock of the corporation is owned,
directly or indirectly, by or for an individual entitled to the use of the property, whether such right is
obtained directly from the corporation or by means of a sublease or other arrangement. The property
may consist of a yacht, a city residence, a country house, or any other kind of property.
(10) RENTS (including interest constituting rent). The rents which are to be included in personal
holding company income consist of compensation, however, designated including charter fees, etc.,
for the use of, or the right to use, real property, or any other kind of property and the interest on debts
bowed to the corporation, to the extent such debts represent the price for which real property held
primarily for sale to customers in the ordinary course of its trade or business was sold or exchanged
by the corporation, but do not include amounts constituting personal holding company income under
Section 65(f) and paragraph (9) of this section. However, rents do not constitute personal holding
company income if constituting 50 per cent or more of the gross income of the corporation.
(II) MINERAL, OIL, OR GAS ROYALTIES. The income from mineral, oil, or gas royalties is to be
included as personal holding company income, unless (A) the aggregate amount of such royalties
Revenue Regulations 02-40 Page 34 of 40

constitutes 50 percent or more of the gross income of the corporation for the taxable year and (B) the 10
aggregate amount of deductions allowable for expenses under Section 30 (a) of the Code (other than His wife's brother's
compensation for personal services rendered by the shareholders of the corporation) equals 15 per wife AWBW 10 BWBW 10 CWBW 10 DWBW 10 EWBW
cent or more of the gross income of the corporation for the taxable year. 110
The term "mineral, oil, or gas royalties" means all royalties, except "overriding royalties", received Individual's partner AP 10 - - - - - - - -
from any interest in mineral, oil, or gas royalties. As used in this paragraph the term "overriding
royalties" means amounts received from the sublease by the operating company which originally By applying the statutory rule provided in Section 66(a) five individuals own more than 50 per cent of
leased and developed the natural resources property in respect of which such overriding royalties are the outstanding stock as follows:
bid. A (including AF, AW, AB, AS, ASHS, AP) 160
(Section 66 of the Code) B (including BF, BW, BB, BS, BSHS) 160
CW (including C, CS, CWF, CWB) 220
SECTION 223.Stock ownership. For the purpose of determining whether DB (including D, DF, DBW) 200
(a) A corporation is a personal holding company in so far as such determination is based on the EWB (including EW, EWF, EWBW) 170
stock ownership requirement specified in Section 64(a) (2), or
(b) Amounts received under a personal service contract or from the sale of such a contract Total, or more than 30 per cent 910
constitute personal holding company income in so far as such determination is based on the stock
ownership requirement specified in Section 65 (e), or Individual A represents the obvious case where the head of the family owns the bulk of the family
(c) Compensation for the use of property constitutes personal holding company income in so far as stock and naturally is the head of the group. A's partner owns to shares of the stock. Individual B
such determination is based on the stock owner-ship requirement specified in Section 65(f), stock represents the case where he is still head of the group because of the ownership of stock by his
owned by an individual includes stock constructively owned by him as provided in Section 66. All immediate family. Individuals C and D represent cases where the individuals fall in groups headed in
forms and classes of stock, however denominated, which represent the interests of shareholders, C's case by his wife and in D's case by his brother because of the preponderance of holdings on the
members, or beneficiaries in the corporation shall be taken into consideration. part of relatives by marriage. Individual E represents the case where the preponderant holding of
others eliminate that individual from the group.
SECTION 224.Stock not owned by individual. In determining the ownership of stock for any of the
purposes set forth in the preceding section, stock owned, directly or indirectly, by or for a corporation, The method of applying the family and partnership rule as illustrated in the foregoing example also
partnership, estate, or trust shall be considered as being owned proportionately by its shareholders, applies in determining the ownership of stock for the purposes stated in (b) and (c) of Section 223 of
partners, or beneficiaries. For example, if A and B, two individuals, are the exclusive and equal these regulations.
beneficiaries of a trust or estate, and if such trust or estate owns the entire capital stock of the M
Corporation, and if the M Corporation in turn owns the entire capital stock of the N Corporation, then SECTION 226.Options. In determining the ownership of stock for any of the purposes set forth in
the stock of both the M Corporation and the N Corporation shall be considered as being owned Section 223 of these regulations if any person has an option to acquire stock, such stock may be
equally by A and B as the individuals owning the beneficial interest therein. considered as owned by person. The term "option" as used in this section includes an option to
acquire such an option and each one of a series of such options, so that the person who has an
SECTION 225.Family and partnership ownership. In determining the ownership of stock for any of option on an option to acquire stock may be considered as the owner of the stock.
the purposes set forth in Section 223 of these regulations, an individual shall be considered as owning (Section 67 of the Code)
the stock owned, directly or indirectly, by or for his family or by or for his partner. For the purposes of
such determination the family of an individual includes only his brothers and sisters (whether by the SECTION 227.Definition of foreign personal holding company. A foreign personal holding company
whole or half blood), spouse, ancestors, and lineal descendants. is any foreign corporation (other than a corporation exempt from taxation under Section 27 of the
Code) which for the taxable year meets (a) the gross income requirements specified in Section 67 (a)
The application of the family and partnership rule in determining the ownership of stock for the (1), and (b) the stock ownership requirement specified in Section 67(a) (2). Both requirements must
purpose set forth in (a) of Section 223 of these regulations is illustrated by the following example: be satisfied and both must be met with respect to each taxable year.
A foreign corporation which comes within the classification of a foreign personal holding company for
Example: The M Corporation at some time during the last half of the taxable year had 1,800 shares of any taxable year beginning after December 31, 1938, is not subject to taxation for such taxable year
outstanding stock, 450 of which were held by various individuals having no relationship to one another under Section 25 of the Code but may be subject to taxation under that section for other taxable
and none of whom were partners, and the remaining 1,350 were held by 51 shareholders as follows: years. The fact that a foreign corporation is a foreign personal holding company does not relieve the
Relationship Shares Shares Shares Shares Shares corporation from liability for the tax imposed generally under Section 24 upon foreign corporations,
An individual A 100 B 20 C 20 D 20 E 20 since such tax applies regardless of the classification of the foreign corporation as a-foreign personal
His father AF 10 BF 10 CF 10 DF 10 EF 10 holding company.
His wife AW 10 BW 40 CW 40 DW 40 EW 40
His brother AB 10 BB 10 CB 10 DB 10 EB 10 SECTION 228.Gross income requirement. To meet the gross income requirement, it is necessary
His son AS 10 BS 40 CS 40 DS 40 ES 40 that either of the following percentages of gross income of the corporation for the taxable year be
His daughter by foreign personal holding company income in accordance with Section 68 in relation to Section 65 of
former marriage the Code:
(son's half sister) ASHS 10 BSHS 40 CSHS 40 DSHS 40 ESHS (a) Sixty per cent of more; or
40 (b) Fifty per cent or more if the foreign corporation has been classified as a foreign personal holding
His brother's wife ABW 10 BBW 10 CBW 10 DBW 160 EBW company for the taxable year ending after December 31, 1938, unless
10 (1) A taxable year has intervened since the last taxable year for which it was so classified,
His wife's father AWF10 BWF 10 CWF 110 DWF 10 EWF during no part of which the stock ownership requirement specified in Section 67 (a) (z) exist; or
10 (2) Three consecutive years have intervened since the last taxable year for which it was so
His wife's brother AWB10 BWB 10 CWB 10 DWB 10 EWB classified, during each of which its foreign personal holding company income was less than 50
Revenue Regulations 02-40
per cent of its gross income.
In determining whether the foreign personal holding company income is equal to the required
percentage of the total gauss income, the determination must not be made on the basis of gross
receipts since gross income is not synonymous with gross receipts. For a further discussion on what
constitutes "gross income," see Section 29(n) and the regulations prescribed under that section.
SECTION 229.Stock ownership requirement. To meet the stock ownership requirement it is
necessary that at some time in the taxable year more than 50 per cent in value of the outstanding
stock of the foreign corporation be owned, directly or indirectly, by or for not more than five individuals
who are citizens or residents of the Philippines.
In the event of any change in the stock outstanding during the taxable year, whether in the number of
shares or classes of stock, or whether in the ownership thereof, the conditions existing immediately
prior and subsequent to each change must be taken into consideration, since a corporation comes
within the classification if the statutory conditions with respect to stock ownership are present at any
time during the taxable year.
In determining whether the statutory conditions with respect to stock ownership are present at any
time during the taxable year, the phrase "in value" shall, in the light of all the circumstances, be
deemed the value of the corporate stock outstanding at such time (not including treasury stock). This
value may be determined upon the basis of the company's net worth, earning and dividend paying
capacity, appreciation of assets, together with such other factors as have a bearing upon the value of
the stock. If the value of the stock which is used is greatly at variance with that reflected by the
corporate books, the evidence of such value should be filed with the return. In any case where there
are two or more classes of stock outstanding, the total value of all the stock should be allocated
among the different classes according to the relative value of each lass therein. DIcSHE
(Section 68 of the Code)
SECTION 230.Gross income and stock ownership requirements of foreign personal holding
companies. For the purpose of determining whether a foreign corporation satisfies the gross
income requirement prescribed under Section 67(a)(1), the same items of income classified under
Section 65 as personal holding company income shall, if received by a foreign corporation, be
considered as foreign personal holding company income. In determining whether a foreign
corporation satisfies the stock ownership requirement prescribed under Section 67(a) (2) the rules
established in Section 66 shall apply.
(Section 69 of the Code)
SECTION 231.Income of foreign personal holding companies taxed to Philippine shareholders. (a)
General rule. Section 69 does not impose a tax on. foreign personal holding companies. The
undistributed net income (from all sources), of such companies, however, must be included in the
manner and to the extent set forth in this section, in the gross income of their "Philippine
shareholders", that is, the shareholders who are individual citizens or residents of the Philippines.
(b) AMOUNT INCLUDIBLE IN GROSS INCOME. Each Philippine shareholder, who was a
shareholder on the day in the taxable year of the, foreign personal holding company which was the
last day on which the stockholders satisfying the stock ownership requirement of Section 67(a)(2),
hereinafter referred to as the "Philippines group", existed with respect to the company, shall include in
his gross income a dividend, for the taxable year in which or with which the taxable year of the
company ends, the amount he would have received as a dividend if on such last day there has been
distributed by the company and received by the shareholders an amount which bears the same ratio
to the net income of the company for the taxable year as the portion of such taxable year up to and
including such last day bears to the entire taxable year.
The undistributed net income of the foreign personal holding company is includible only in the gross
income of the Philippine shareholders who were shareholders in the company on the last day of its
taxable year on which the Philippine groups existed with respect to the company. Such Philippine
shareholders, accordingly, are determined by the stock holdings as of such specified time. This
applies to every Philippine shareholder who was a shareholder in the company at the specified time
regardless of whether the Philippine shareholder is included with the Philippine group.
Page 35 of 40
The Philippine shareholders must include in their gross income their distributive shares of that
proportion of the undistributed net income for the taxable-year of the company which is equal in ratio
to that which the portion of the taxable year up to and including the last day on which the Philippine
group with respect to the company existed bears to the entire taxable year. Thus if the last day in the
taxable year on which the required Philippine group existed was also the end of the taxable year, the
portion of the taxable year up to and including such last day would be equal to 100 per cent and in
such case, the Philippine shareholders would be required to return their distributive shares in the
entire undistributed net income. But if the last day on which the required Philippine group existed was
September 30, and the taxable year was a calendar year, the portion of the taxable year up to and
including such last day would be equal to nine-twelfths of the undistributed net income.
The amount which each Philippine shareholder must return is that amount which he would have
received as a dividend if the above specified portion of the undistributed net income had in fact been
distributed by the foreign personal holding company as a dividend on the last day of its taxable year
on which the required Philippine group existed. Such amount is determined, therefore, by the interest
of the Philippine shareholder in the foreign personal holding company, that is, by the number of
shares of stock owned by the Philippine shareholder and the relative rights of his class of stock, if
there are several classes of stock outstanding. Thus, if a foreign personal holding company has both
common and preferred stock outstanding and the preferred shareholders are entitled to a specific
dividend before any distribution may be made to the common shareholders, then the assumed
distribution of the stated portion of the undistributed net income must first be treated as a payment of
the specified dividend on the preferred stock before any part may be allocated as a dividend on the
common stock.
The assumed distribution of the required portion of the undistributed net income must be returned as
dividend income by the Philippine shareholders for their respective taxable years in which or with
which the taxable year of the foreign personal holding company ends. In applying this rule, the date
as of which the Philippine group last existed with respect to the company is immaterial. CTDHSE
(Section 70 of the Code)
SECTION 232.Information returns by officers and directors of certain foreign corporations. (a)
REQUIREMENT FOR FILING RETURNS. (1) General. Under Section 70 (a), on the 15th day of
each month which begins after July 1, 1939, each individual who on such 15th day is an officer or, a
director of a foreign corporation which, with respect to its taxable year preceding the taxable year in
which such month occurs, was a foreign personal holding company, is required to file with the
Commissioner of Internal Revenue a monthly information return as provided in Section 70(a). The
Commissioner of Internal Revenue may authorize the filing of returns covering periods longer than a
month.
(2) RETURNS JOINTLY MADE. If two or more officers or directors of a foreign corporation are
required to file information returns for any period under Section 70(a), any two or more of such
officers or directors may, in lieu of filing separate returns for such period, jointly execute and file one
return.
(b) FORM OF RETURN. The return under Section 70(x). of the Code and this section shall be
made on the form prescribed by the Commissioner of Internal Revenue. Each officer or director
should carefully prepare his return so as to set forth fully and clearly the information called for therein
and by the applicable regulations. Returns which have not been so prepared will not be considered as
meeting the requirements of the law.
(c) CONTENTS OF RETURN. The return shall, in accordance with provisions of this section and
the instructions on the form, set forth with respect to the preceding period the following information:
(1) Name and address of corporation;
(2) Kind of business in which the corporation is engaged;
(3) Date of incorporation;
(4) The country under the laws of which the corporation is incorporated;
(5) Number of shares and par value of common stock of the corporation outstanding as of the
beginning and end of the period;
(6) Number of shares and par value of preferred stock of the corporation outstanding as of the
beginning and end of the period, the rate of dividend on such stock and whether such dividend is
cumulative or noncumulative;
Revenue Regulations 02-40
(7) A description of the convertible securities issued by the corporation, including a statement of the
face value of, and rate of interest on, such securities:
(8) The name and address of each shareholder, the class and number of shares held by each,
together with any changes in stock holdings during such period;
(9) The name and address of each holder of securities convertible into stock of the corporation, the
class, number and face value of the securities held by each, together with any changes in the holding
of such securities during the period;
(10) A certified copy of any resolution or plan, and any amendments thereof or supplements thereto,
for or in respect of the dissolution of the corporation of the liquidation of the whole or any part of its
capital stock; and
(11) Such other information as may be required by the return form.
If a person is required to file a return under Section 70(a) of the Code and this section with
respect to more than one foreign corporation, a separate return must be filed with respect to each
foreign corporation.
(d) VERIFICATION OF RETURNS. All returns required by Section 70(a) and this section shall be
verified under oath or affirmation of the parties rendering the same.
SECTION 233.Annual information returns by officers and directors of certain foreign corporations.
(a) Requirement for filing returns.
(1) GENERAL. Under Section 70(b), on the sixtieth day after the close of the taxable year of a
foreign personal holding company each individual who on such sixtieth day is an officer or director of
the corporation shall file with the Commissioner of Internal Revenue an annual information return as
provided in that section of the Code and this section.
(2) RETURNS JOINTLY MADE. If two or more officers or directors of a foreign corporation are
required to file annual information returns under Section 70(b) for any taxable year of the corporation
any two or more of such officers or directors may in lieu of filing separate annual returns for such
taxable year, jointly execute and file one annual return.
(b) FORM OF RETURN. The return under Section 70(b) and this section shall be made on the
form prescribed by the Commissioner of Internal Revenue. Each officer or director should carefully
prepare his returns so as to set forth fully and clearly the information called for therein and by the
applicable regulations. Returns which have not been so prepared will not he considered as meeting
the requirements of the law.
(c) CONTENTS OF RETURN. The return shall, in accordance with the provisions of this section
and the instructions on the form, set forth with respect to the taxable year of the foreign personal
holding company the following information:
(1) The gross income, deductions and credits, net income, and undistributed net income of the
foreign personal holding company for such taxable year, in complete detail;
(2) The same information with respect to such taxable year which is required by Section 70(a) and
paragraph (c) of the preceding section, except that if all the required returns with respect to such year
have been filed under Section 70(a) and the preceding section, no information under Section 70(b) (2)
and this paragraph need be set forth in such annual return; and
(3) Such other information as may be required by the return form.
(d) VERIFICATION OF RETURNS. All returns required by Section 70(b) and this section shall be
verified under oath or affirmation of the parties rendering the same.
(Section 71 of the Code)
SECTION 234.Information returns by shareholders of certain foreign corporations.
(a) REQUIREMENT FOR FILING RETURNS.
(1) General. On the 15th day of each month which begins after July 1, 1939 each Philippine
shareholder, by or for whom 50 per cent or more in value of the outstanding stock of a foreign
corporation is owned, directly or indirectly [including, in the case of an individual, stock owned by
members of his family as defined in Section 66(b)], if such foreign corporation with respect to its
taxable year preceding the taxable year in which such month occurs was a foreign personal
holding company, shall file with the Commissioner of Internal Revenue an information, return as
provided in Section 71(a). The Commissioner of Internal Revenue may authorize the filing of
returns covering period longer than a month.
(2) Duplicate returns. If a shareholder in a foreign corporation files, as an officer or director in
such corporation, the returns required by Section 70(b), such returns shall be considered as
returns filed under Section 71(a).
Page 36 of 40
(b) FORM OF RETURN. The return under Section 71(a) shall be made on the form prescribed by
the Commissioner of Internal Revenue. Each shareholder should carefully prepare his return so as to
set forth fully and clearly the information called for therein and by the applicable regulations. Returns
which have not been so prepared will not be considered as meeting the requirements of the law.
(c) CONTENTS OF RETURN. The return shall, in accordance with the provisions of this section
and the instructions on the form, set forth with respect to the preceding period the same information
as required, to be shown on that form by Section 70(a) and paragraph (c) of Section 232 of these
regulations.
If a person is required to file a return under Section 71(a) of the Code and this section with respect to
more than one foreign corporation, a separate return must he filed with respect to each foreign
corporation.
(d) VERIFICATION OF RETURNS. All returns required by Section 71(a) of the Code and this
section shall be verified under oath or affirmation of the parties rendering the same.
SECTION 235.Annual information returns by shareholders of certain foreign corporations.
(a) REQUIREMENT FOR FILING RETURNS.
(1) General. Under Section 71(b) of the Code, on the sixtieth day after the close of the taxable
year of a foreign personal holding company, each Philippine shareholder, by or for whom on such
sixtieth day 50 per cent or more in value of the outstanding stock of the company is owned, directly or
indirectly [including the case of an individual stock owned by members of his family as defined in
Section 66(b)], shall file with the Commissioner of Internal Revenue an information returns as
provided in that section and this section.
(2) Duplicate returns. If a shareholder in a foreign corporation files as an officer or director in such
corporation, the return required by Section 70(b), such returns shall be considered as returns filed
under Section 71(b).
(b) FORM OF RETURN. The return under Section 71(b) shall be made on the form prescribed by
the Commissioner of Internal Revenue. Each shareholder should carefully prepare his return so as to
set forth fully and clearly the information called for therein and by the applicable regulations. Returns
which have not been so prepared will not be considered as meeting the requirements of the law.
(c) CONTENTS OF RETURN. The return shall, in accordance with the provisions of this section
and the instructions on the form, set forth with respect to the taxable year of the foreign personal
holding company the same information which is required under Section 71(a), paragraph (c) of
Section 232 of these regulations and paragraph (c) of the preceding section, except that if all the
required returns with respect to such year have been filed under Section 71(a), no return under
Section 71(b) is required.
If a person is required to file an annual return under Section 71(b) with respect to more than one
foreign personal holding company, a separate return must be filed with respect to each foreign
personal holding company.
(d) VERIFICATION OF RETURNS. All returns required by Section 71(b) and this section shall be
verified under oath or affirmation of the parties rendering the same.
(Section 72 of the Code)
SECTION 236.Ad valorem penalty for failure to file return. In case of a failure to make and file a
return or list within the time prescribed by law, not due to willful neglect, where such return or list is
voluntarily filed by the taxpayer without notice from the Commissioner of Internal Revenue or other
officer and it is shown that the failure to file it in due time was due to a reasonable cause, no
surcharge will be added to the amount of tax due on the return. In such cases, in order to avoid the
imposition of the surcharge, the taxpayer must make a statement showing all the facts alleged as a
reasonable cause for failure to file the return on time in the form of an affidavit which should be
attached to the return. If the Commissioner of Internal Revenue is satisfied that the delinquency was
due to a reasonable cause, no surcharge will be added to the tax due on the return. Whether or not
reasonable cause exists will depend upon the circumstances of each case. As a general rule, if the
taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the
return within the prescribed time, the delay will be considered as being due to a reasonable cause.
In case of a failure to make and file a return or list within the time prescribed by law, not due to willful
neglect, where the taxpayer voluntarily files the return without notice from the Commissioner of
Internal Revenue or other officer and attaches to such return the affidavit mentioned in the preceding
paragraph but where the Commissioner of Internal Revenue is not satisfied as to the reasonableness
Revenue Regulations 02-40
of the cause of the delinquency, a surcharge of 25 per cent will be added to the amount of tax due on
the return.
In case the failure to make and file a return or list within the time prescribed by law is due to willful
neglect a surcharge of 50 per cent will be added to the amount of tax due on the return. There is
willful neglect in the case of a taxpayer who, being liable to file a return, knowingly delays the filing of
such return. Where the filing of the return has been delayed for a considerable length of time, the
delinquency will be presumed to be due to willful neglect.
The amount of surcharge so added to the tax due on the return shall be collected at the same time
and in the same manner and as part of the tax unless the tax has been paid before the discovery of
the cause giving rise to the imposition of the surcharge, in which case the amount so added shall be
collected in the same manner as the tax.
SECTION 237.Ad valorem penalty for false or fraudulent return. In case a false or fraudulent return
or list is made, the Commissioner of Internal Revenue shall add to the tax ascertained to be due on
the true net income of the taxpayer a surcharged of 50 per cent of the amount of such tax. If payment
has been made on the basis of such false or fraudulent return before the discovery of the falsity or
fraud, the basis of the surcharge of 50 per cent will be the amount of the tax due on the true net
income less the amount so paid.
(Section 73 of the Code)
SECTION 238.Penalty for failure to file return or to pay tax. Any person liable to pay the tax, to
make a return or to supply information required under Title II of the Code, who refuses or neglects to
pay such tax, to make such return or to supply such information at the time or times specified in each
case shall be punished by a fine of not more than P2,000 or by imprisonment for not more than six
months, or both. In case of a corporation failing to file its, return or pay the tax, the penalty prescribed
under the first paragraph of Section 73 will be imposed upon the president, vice-resident, or other
responsible officer required to file the return of the corporation or pay the tax due from the same, in
accordance with the provisions of Section 46(a) and 51(b) of the Code. In the case of a duly
registered general copartnership, failing to file the return required under Section 49 of the Code, the
penalty prescribed under the first paragraph of Section 73 will be imposed upon the managing partner
or other responsible officer of such partnership.
SECTION 239.Penalty imposed upon person causing a false or fraudulent corporate return to be
filed. If a false or fraudulent return is filed for a corporation or duly registered general
copartnership, the individual or any officer thereof causing such return to be filed shall be punished by
a fine not exceeding P4,000 or by imprisonment for not more than one year, or both.
(Section 74 of the Code)
SECTION 240.Penalty on corporation refusing or neglecting to make return. A corporation or duly
registered general copartnership, refusing or neglecting to make a return required under Title II of the
Code, or, rendering a false or fraudulent return, will be liable to a fine of not exceeding P20,000. The
fine imposed under Section 74 will be paid by the corporation or duly registered general copartnership
as an entity, and is in addition to the penalty which may be imposed under Section 73 of the Code
upon the president, vice-president, or other responsible officer of a corporation or duly registered
general copartnership.
(Section 75 of the Code)
SECTION 241.Return of information as to payments of dividends. Every domestic resident foreign
corporation is hereby required to render a return, in duplicate, on the form prescribed for corporations
(B.I.R. Form No. 17.02) of its payments of profits or dividends to stock holders for the taxable year or
period covered by the return, stating the name and address of each stockholder, the number and
class of shares owned by him, the date and amount of such dividend paid him, and when the surplus
out of which it was paid was accumulated. Such return should be verified by the oath or affirmation of
the person rendering the same.
(Section 76 of the Code)
SECTION 242.Application for and issuance of license for collecting foreign items. Every individual
Page 37 of 40
or organization undertaking, for profit or otherwise, the collection of dividends or interest on foreign
securities (not payable in the Philippines) by means of coupons, checks, or bills of exchange shall,
upon application, obtain a license therefor from the Commissioner of Internal Revenue. The
application shall show the name, address, occupation, and status (as to citizenship or nationality and
residence) of the applicant.
(Section 77 of the Code)
SECTION 243.Return of information as to payments of P1,800 or more. All persons, corporations,
partnerships, and associations, making payment to another person of fixed or determinable income of
P1,800 or more in a taxable year must render a return thereof to the Commissioner of Internal
Revenue within the time fixed for the filing of the annual returns of said person, corporations,
partnerships, and associations. The name and address of the recipient of the income should be
stated, if possible. Although to make necessary a return of information the income must be fixed or
determinable, it need not be annual or periodical.
The names of all employees to whom payments of P1,800 or over a year are made, whether such
total sum is made up of wages, salaries, commissions, or compensation in any other form, must be
reported. Compensations in kind, such as living quarters, meals, and lodging, are taxable income to
the recipient and, as such, should be reported if the sum total of the same and the other
compensation in cash received shall amount to P1,500 or more during the year.
In the case of payments of annual or periodical income to nonresident alien individual or to foreign
corporations or firm not engaging in trade or business within the Philippines and not having any office
or place of business therein, the return by withholding agents shall constitute and be treated as return
of information.
SECTION 243.Return of information as to payments of P1,800 or more. All persons, corporations,
partnerships and associations making payments to another of fixed or determinable income of P1,800
or more in a taxable .year must render a return thereof in duplicate on the form prescribed therefor
(BIR Form No. 17.01-B). These forms should be attached to and filed together with the annual income
tax returns of said persons, corporations, partnerships and associations as payers, within the time
fixed by law for the filing of income tax returns. The payments referred to herein do not include the
following:
(1) Dividend payments mentioned under Section 75 of the National Internal Revenue Code.
(2) Salaries, wages, bonuses, and other compensations in kind, such as living quarters, meals, and
lodging which are subject to withholding tax and reported in W-2 forms as provided for under
Republic Act 590.
(3) Payments subject to withholding tax at source enumerated under Section 53 of the National
Internal Revenue Code.
Examples of income covered by these regulations and to be declared in BIR Form 17.01-B are
interests, rents, commissions, royalties, advertisements, professional fees, and the like, arising
generally from payments between payers and recipients who have no employer-employee
relationship.
(Revenue Regulations No. 9-65 amending and superseding section 243 appearing on page 723. As of
October 20, 1965, these Regulations, dated June 30, 1965, have not yet been published in the Official
Gazette).
(Section 78 of the Code)
SECTION 244.Return of corporation contemplating dissolution or retiring from business. All
corporations, partnership, joint accounts and associations, contemplating dissolution or retiring from
business without formal dissolution shall, within 30 days after the approval of such resolution
authorizing their dissolution, and within the same period after their retirement from business, file their
income tax returns covering the profit earned or business done by them from the beginning of the
year up to the date of such dissolution or retirement and pay the corresponding income tax due
thereon upon demand by the Commissioner of Internal Revenue to addition to the income tax return
required to be filed they shall also submit within the same period the following:
(a) Copy of the resolution authorizing such dissolution;
Revenue Regulations 02-40
(b) Balance sheet at the date of dissolution or retirement and a profit and loss statement covering
the period from the beginning of the taxable year to the date of dissolution or retirement;
(c) In the case of a corporation, the names end addresses of the shareholders and the number and
par value of the shares held by each; and in the case of a partnership, joint-account or
association, the name of the partners or members and the capital contributed by each;
(d) The value and a description of, the assets received in liquidation by each shareholder;
(e) The name and address of each individual or corporation, other than shareholders, if any,
receiving assets at the time of dissolution together with a description and the value of the assets
received by such individuals or corporations; and the consideration, if any, paid by each of them
for the assets received.
(Section 79 of the Code)
SECTION 245.Return of information by brokers. When required by the Commissioner of Internal
Revenue, each person doing business as a broker shall render a return or statement showing the
names and addresses of customers to whom or for whom payments were made or from whom
business was transacted during the calendar year or other specified period, and giving all other
particulars which may be needed by the Commissioner of Internal Revenue.
(Section 80 of the Code)
SECTION 246.Information returns as to formation, etc., of foreign corporation. (a) IN GENERAL.
Any attorney, accountant, fiduciary, bank, trust company, financial institution, or other person, who,
after July 5, 1939, aids, assists, counsels, or advises in, or with respect to, the formation,
organization, or reorganization of any foreign corporation (including a foreign association or
partnership) shall file with the Commissioner of Internal Revenue, within thirty days after giving such
aid, assistance, counsel or advise, an information return; as provided in Section 80 and this section.
The return must be filed in every such case (1) regardless of the nature of the counsel or advice
given, whether for or against the formation, organization, or reorganization of the foreign corporation,
or the nature of the aid or assistance rendered and (2) regardless of the action taken upon the advice
or counsel, that is, whether the foreign corporation is actually formed, organized, or reorganized.
If, in a particular case, the aid, assistance, counsel or advice given by any person extends over a
period of more than one day and not for more than thirty days, such persons, to avoid the multiple
filing of returns, may file a single return for the entire period. In such case, the return shall be filed
within thirty days from the first day of such period: If, in a particular case, the aid, assistance, counsel,
or advice given by any person extends over a period of more than thirty days, such person may file a
return at the end of each thirty days included within such period and at the end of the fractional part of
a thirty day period, if any, extending beyond the last full thirty days. In each such case, the return must
disclose all the required information which was not reported on a prior return.
(b) SPECIAL PROVISIONS. (1) Employers. In the case of aid, assistance, counsel, or advice
in, or with respect to, the formation, organization, or reorganization of a foreign corporation given by a
person in whole or in part through the medium of subordinates or employees (including in the case of
a corporation the officers thereof), the return of the employer must set forth to the full extent all
information prescribed by these regulations, including that which, as an incident to such employment,
is within the possession or knowledge or under the control of such subordinates or employees.
(2) EMPLOYEES. The obligation of a subordinate or employee (including in the case of a
corporation the officers thereof) to file a return with respect to any aid, assistance, counsel, or advice
in, or with respect to, the formation, organization, or reorganization of a foreign corporation, given as
an incident to his employment, will be satisfied if a complete and adequate return as prescribed by
these regulations is duly filed by the employer setting forth all of the information within the possession
or knowledge or under the control of such subordinate or employee.
Clerks, stenographers, and other subordinates or employees, rendering aid or assistance solely of a
clerical or mechanical character in, or with respect to, the formation, organization or reorganization of
a foreign corporation are not required to file returns by reason of such services.
(3) RETURNS JOINTLY MADE. If two or more persons aid, assist, counsel, or advise in, or with
respect to, the formation, organization, or reorganization of a particular foreign corporation, any two or
more of such persons may, in lieu of filing several returns jointly execute and file one return.
Page 38 of 40
(c) PENALTIES. For criminal penalties for failure to file the return required by Section 80, see
Section 73 of the Code.
(d) CONTENTS OF RETURNS. The return shall set forth the following information to the full
extent such information is within the knowledge or possession or under the control of the person
required to file the return.
(1) The name and address of the person (or persons) to whom and the person (or persons) for
whom or on whose behalf the aid, assistance, counsel, or advice was given;
(2) A complete statement of the aid, assistance, counsel, or advice given;
(3) Name and address of the foreign corporation and the country under the laws of which it was
formed, organized, or reorganized;
(4) The months and year when the foreign corporation was formed, organized, or reorganized;
(5) A statement of how the formation, organization, or reorganization of the foreign corporation was
effected;
(6) A complete statement of the reasons for, and the purposes sought to be accomplished, by, the
formation, organization, or reorganization of the foreign corporation;
(7) A statement showing the classes and kinds of assets transferred to the foreign corporation in
connection with formation, organization, or reorganization, including a detailed list of any stock or
securities included in such assets, and a statement showing the names and addresses of the persons
who were the owners of such assets immediately prior to the transfer;
(8) The names and addresses of the shareholders of the foreign corporation at the time of the
completion of its formation, organization, or reorganization, showing the classes of stock and number
of shares held by each;
(9) The name and address of the person (or persons) having custody of the books of account and
records of the foreign corporation;
(10) Such other information as may be required by the return form; and
(11) Where any of the information required to be furnished is withheld because its character is
claimed to be privileged as a communication between attorney and client within the meaning of
Section 80, the return must so state and must contain a complete statement of the nature and the
circumstances of the communication on which a decision as to the propriety of the claim of privilege
may be reached.
If a person aids, assists, counsels, or advises in or with respect to, the formation, organization, or
reorganization of more than one foreign corporation, a separate return must be filed with respect to
each foreign corporation.
(e) VERIFICATION OF RETURN. All returns required by Section 80 and this section shall be
verified under oath or affirmation.
(Section 81 of the Code)
SECTION 247.Disposition of income tax returns. All income tax returns filed with the
Commissioner of Internal Revenue constitute public records which shall be open to inspection under
rules and regulations prescribed by the Secretary of Finance with the approval of the President of the
Philippines. The circumstances under which income tax returns may be inspected by interested
parties are dealt with under separate regulations.
SECTION 248.Publication of list of persons filing returns and paying taxes. The second paragraph
of Section 81 expressly authorizes the Commissioner of Internal Revenue, with the approval of the
Secretary of Finance, to cause to be prepared and published in any newspaper or made available to
public inspection through other means, lists containing the names and addresses of persons who
have filed income tax returns, or lists of those who paid income taxes, or both such kinds of lists.
(Section 82 of the Code)
SECTION 249.Recovery of tax. A suit or proceeding may be maintained for the recovery of any
internal-revenue tax alleged to have been erroneously or illegally assessed and collected, in
accordance with Section 306 of the Code. However, where the Commissioner of Internal Revenue
believes that a return is false or fraudulent or contains any understatement or undervaluation and
Revenue Regulations 02-40
proceeds to assess and collect the tax due, no portion of the tax so collected shall be recovered by
any suit unless it is proved that the return was not in fact false or fraudulent and did not contain any
understatement or undervaluation, except with respect to return is made in good faith regarding
annual depreciation of oil or gas wells and mines.
(Section 83 of the Code)
SECTION 250.Dividends. Dividends, for the purpose of the law, comprise any distribution whether
in cash or other property, in the ordinary course of business, even though extraordinary in amount,
made by a domestic or resident foreign corporation, joint-stock company, partnership, joint account
(cuentas en participacion), association, or insurance company to the shareholders or members out of
its earnings or profits accumulated since March 1, 1913.
Although interest on certain Government bonds and other similar obligations is not taxable when
received by a corporation, upon amalgamation with the other funds of the corporation, such income
loses its identity and when distributed to shareholders, is taxable to the same extent as other
dividend.
A taxable distribution made by a corporation to individual stockholders or members shall be included
is the gross income of the distributees when the cash of other property is unqualifiedly made subject
to their demand. Dividends, in cash or other property received by an individual, are subject to tax in
his hands in the same manner another income.
Dividends, whether in cash or other property, received by a domestic or resident foreign corporation
from a domestic corporation are taxable only to the extent of 25 per cent thereof in accordance with
Section 24 of the Code. Dividends received by a domestic corporation from a foreign corporation,
whether resident or nonresident, are taxable to the extent that they constitute income from sources
within the Philippines, as provided in Section 37 (a) (2) (b) of the Code. Dividends paid by the
domestic corporation to a nonresident foreign corporation are taxable in full. (For definition of the
different classes of corporations, see Section 84 of the Code).
SECTION 251.Dividends paid in property. Dividends paid in securities or other property (other than
its own stock), in which the earnings of a corporation have been invested, are income to the recipients
to the amount of the full market value of such property when receivable by individual stockholders.
When receivable by corporations, the amount of such dividends includible for purposes of the tax on
corporations are specified in Section 24 of the Code. (See also Section 250 of these regulations). A
dividend paid in stock of another corporation is not a stock dividend, even though the stock distributed
was acquired through the transfer by the corporation declaring the dividends of property to the
corporation the stock of which is distributed as a dividend. Where a corporation declares a dividend
payable in a stock of another corporation, setting aside the stock to be so distributed and notifying the
stockholders of its action, the income arising to the recipients of such stock is its market value at the
time the dividend becomes payable. Scrip dividends are subject to tax in the year in which the
warrants are issued.
SECTION 252.Stock dividends. A stock dividend which represents the transfer of surplus to capital
account is not subject to income tax. However a dividend in stock may constitute taxable income to
the recipients thereof notwithstanding the fact that the officers or directors of the corporation (as
defined in Section 84) choose to call such distribution as a stock dividend. The distinction between a
stock dividend which does not, and one which does, constitute income taxable to the shareholder is
the distinction between a stock dividend which works no change in the corporate entity, the same
interest in the same corporation being represented after the distribution by more shares of precisely
the same character, and a stock dividend where there either has been a change of corporate identity
or a change in the nature of the shares issued as dividends whereby the proportional interest of the
shareholders after the distribution is essentially different from his former interests. A stock dividend
constitutes income if it gives the shareholder an interest different from that which his former stock
holdings represented. A stock dividend does not constitute income if the new shares confer no
different rights or interests than did the old the new certificates plus the old representing the same
proportionate interest in the net assets of the corporation as did the old.
SECTION 253.Sale of stock received as dividends. Stock issued by a corporation, as a dividend,
Page 39 of 40
does not constitute taxable income to a stockholder in such corporation, but gain may be derived or
loss sustained by the stockholder, whether individual or corporate, from the sale of such stock, which
gain or loss will be treated as arising from the sale or exchange of a capital asset. (See Section 34 of
the Code.) The amount of gain derived or loss sustained from the sale of such stock, or from the sale
of the stack with respect to which it is issued, shall be determined in accordance with the following
rules:
(a) Where the stock issued as dividend is all or substantially the same character or preference as
the stock upon which the stock dividend is paid, the cost of each share (or when acquired prior
to March 1, 1913, the fair market value as of such date) will be the quotient of the cost (or such
fair market value) of the old shares of stock divided by the total number of the old and new
shares.
(b) Where the stock issued as a dividend is in whole or in part of a character or preference
materially different from the stock upon which the stock dividend is paid, the cost (and when
acquired prior to March 1, 1913, the fair market value as of such date) of the old shares of stock
shall be divided between such old stock and the new stock, in proportion, as nearly as may be,
to the respective value of each class of stock, old and new, at the time the new shares of stock
are issued, and the cost (or when acquired prior to March 1, 1913, the fair market value as of
such date) of each share of stock will be the quotient of the cost (or such fair market value as of
March 1, 1913) of the class to which such share belongs divided by the number of shares in that
class.
(c) Where the stock with respect to which a stock dividend is issued was purchased at different
times and at different prices and the identity of the lots can. not be determined, any sale of the
original stock, will be charged to the earliest purchases of such stock, and any sale of dividend
stock issued with respect to such stock will be presumed to have been made from the stock
issued with respect to the earliest purchased stock, to the amount of the dividend chargeable to
such stock.
(d) Where the stock with respect to which a stock dividend is declared was purchased at different
times and at different prices, and the dividend stock issued with respect to such stock can not be
identified as having been issued with respect to any particular lot of such stock, then any sale of
such dividend stock will be presumed to have been made from the stock issued with respect to
the earliest purchased stock, to the amount of the stock dividend chargeable to such stock.
SECTION 254.Declaration and subsequent redemption of a stock dividend. A true stock dividend is
not subject to tax on its receipt in the hands of the recipient. Nevertheless, if a corporation, after the
distribution of a stock dividend, proceeds to cancel or redeem its stock at such time and in such
manner as to make the distribution and cancellation or redemption essentially equivalent to the
distribution of a taxable dividend, the amount received in redemption or cancellation of the stocks
shall be treated as a taxable dividend to the extent of the earnings or profits accumulated by such
corporation since March 1, 1913.
SECTION 255.Sources of distribution. For the purpose of income taxation every distribution made
by a corporation is made out of earnings or profits to the extent thereof and from the most recently
accumulated earnings or profits. In determining the source of a distribution, consideration should be
given first, to the earnings or profits of the taxable year; second, to the earnings or profits
accumulated since February 28, 1913, only in the case where, and to the extent that, the distribution
made during the taxable year are not regarded as out of the earnings or profits of the taxable year
and all the earnings or profits accumulated since February 28, 1913, have been distributed; and,
fourth, to sources other than earnings or profits only after the earnings or profits have been
distributed.
SECTION 256.Distribution in liquidation. In all cases where a corporation (as defined in Section
84) distributes all of its property or assets in complete liquidation or dissolution, the gain realized from
the transaction by the stockholder, whether individual or corporate, is taxable to the extent recognized
in Section 34(b) of the Code. For this purpose, the term "complete liquidation" includes any one of a
series of distributions made by a corporation in complete cancellation or redemption of all of its stock
in accordance with a bona fide plan of liquidation under which the transfer of all the assets under
liquidation is to be complete within a reasonable time from the date of the first distribution, usually not
to exceed one year from the time of such first distribution. If the amount received by the stockholder in
Revenue Regulations 02-40 Page 40 of 40

liquidation is less than the cost or other basis of the stock, the loss in the transaction is deductible to
the extent allowed in Section 34(c) of the Code.
(Section 84 of the Code)

SECTION 257.Income and deductions of American citizens residing in the Philippines. Under
subsection (u) of Section 84, a citizen of the United States residing in the Philippines, is taxable on
income from sources both within and without the Philippines, except income from sources within the
United States. Accordingly, items of deductions allocable to income of such taxpayer from sources
within the United States are not deductible from his income subject to Philippine income tax. (Deemed
repealed since our independence).

SECTION 258. Effective date. These regulations shall take effect upon their promulgation in the
Official Gazette.

(Promulgated February 11, 1941, XXXIX Off. Gaz., No. 18, page 325)

Recommended by:

BIBIANO L. MEER
Collector of Internal Revenue

MANUEL ROXAS
Secretary of Finance