Income Tax

HOW TO FUCK INCOME TAX: by Justice Orlando B.
Bareng
PART I
Income Tax: A tax on all yearly profits arising from property, professions, trades
or offices, or as a tax on a person’s income, emoluments, profits and the like. It is
a direct tax on actual or presumed income of a taxpayer received, accrued or
realized during the taxable year, which the law does not expressly exempt from
taxation.
Note: A taxable transaction shall be subject to only one kind of income tax.
Types of Income Tax:
1. Personal Income Tax
2. Regular Corporate Income Tax
3. MCIT
4. Capital gains tax/CGT
5. Tax on passive investment income
6. Fringe benefit Tax
7. Branch Profit remittance Tax
8. Improperly Accumulated Earnings Tax
9. Final Withholding Tax
Income Tax System

1. Global System: All income received by the taxpayer are grouped together,
without any distinction as to the type or nature of the income, and after
deducting therefrom expenses and other allowable deductions, are
subjected to a tax at a graduated or fixed rate.
2. Schedular System: The various types/items of income are classified
accordingly and are accorded different tax treatments, in accordance with
schedules characterized by graduated tax rates. Since these types of
income are treated separately, the allowable deductions shall likewise vary
for each type of income.
Characteristics of Income Tax:
1. Direct Tax: It is a tax demanded from the very person who, it is intended or
desired, should pay it. The tax burden is borne by the income recipient
upon whom the tax is imposed.
2. Progressive Tax: Tax base increases as the tax rate increases.
3. Comprehensive: It adopts the citizenship principle, the residence principle
and the source principle.
4. Semi-schedular or semi-global
“Whatever you do, do it for God’s glory” 1 Corinthians 10:31
5. American origin
When is income taxable?
a) The money or property received is income, gain or profit (and not mere
return of capital). There must be a closed and completed transaction.
(Note: any appreciation in the value of the property without sale or
exchange is not taxable)
b) The income, gain or profit is received (actually or constructively), accrued,
or realized during the taxable year. (it must be recognized: remember the
rule on holding period; long—term deposit)
c) The income, gain or profit is not exempt from income tax by law, the
Constitution or treaty.
Income vs. Capital
Income differs from capital in that income is any wealth which flows into the
taxpayer other than a return of capital, while capital constitutes the investments
which is the source of income. Therefore, capital is fund, while income is the flow.
Capital is wealth, while income is the service of wealth. Capital is the tree, while
income is the fruit. Income is liable to income tax while capital or return of capital
is exempt from tax. (Madrigal Vs. Rafferty)
Realization Tests in determining income:
a) Realization test/Severance test: There is no taxable income until there is

separation from capital of something of exchangeable value, thereby
supplying the realization or transmutation which would result in the receipt
of income.
b) Claim of right doctrine: A taxable gain is conditioned upon the presence of
a claim of right to the alleged gain and the absence of a definite
unconditional obligation to return or repay that which would otherwise
constitute a gain.
c) Income from whatever source: All income not expressly excluded or
exempted from the class of taxable income, irrespective of the voluntary or
involuntary action of the taxpayer in producing the income, and regardless
of the source of income, is taxable.

d) Economic benefit test: Any economic benefit to the employee that
increases his networth, whatever may have been the mode by which it is
effected, is taxable.
Gross Income: All income from whatever source derived (whether legal or illegal
source), including (but not limited to) compensation for services, including fees,
commissions, and similar items; income from business; gains derived from
dealings in property; interest; rents; royalties; dividends; annuities; prizes and
winnings; pensions; and partner’s distributive share of the gross income of GPP.
However, since the passive incomes are already subject to different rates and
taxed finally at source, they are no longer included in the computation of gross
income, which determines taxable income.
Net Income: means gross income less statutory deductions and exemptions. It is
referred to as “taxable income” under Section 31 of the 1997 Tax Code.
To whom income is taxable: Income from the sales of goods or properties is

taxable to the owner-seller of the goods or properties, including rights thereto,
but income from sale of services is taxable to the person who renders the
services.
SOURCE PRINCIPLE AND RULE
Source Principle: An alien or foreign corporation is subject to Philippine income

tax because he/it derives income tax within the Philippines. Thus, a non-resident
alien or non-resident foreign corporation is liable to pay income tax on his income
from sources within the Philippines, such as dividend, interest, rent or royalty,
despite the fact that he has not set foot in the Philippines.
Source Rule: The source rule to determine whether the income shall be treated as
income from within or outside the Philippines can be found in Sec. 42 of the 1997
Tax Code. If a certain type of income is not included in the enumeration of Section
42, the generating source of the income or the place of activity is controlling as to
whether the said income is from sources within the Philippines or not. (Note:
Section 42 only determine the source, not the taxability of the income)
Within the Philippines
1. Interest: Residence of the debtor or the obligor: If the obligor or debtor is a

resident of the Philippines, the interest income is treated as income from
within the Philippines. It does not matter whether the loan agreement is
signed in the Philippines or abroad or the loan proceeds will be used in a
project inside or outside the country.
2. Dividends: Residence of the corporation paying the dividend: Dividends
received from a domestic corporation or from a foreign corporation are
treated as income within the Philippines, unless less than 50% of the gross
income of the foreign corporation for the 3-year period preceding the
declaration of such dividends was derived from sources within the
Philippines, in which case, only the 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 shall be treated as income from sources within the Philippines.
3. Services: Place of performance of the service: If the service is to be
performed in the Philippines, the income is treated as from sources within
the Philippines, regardless of the residence of the payor, of the place in
which the contract for service was executed, or the place of payment.
4. Rentals and Royalties: Location or use of the property: If the property is
located or used in the Philippines, the gain or income is treated as income
from sources within the Philippines.
5. Sale of Real Property: Location of the property: If the real property sold is
located within the Philippines, the gain is considered as income from the
Philippines.
6. Personal Property: Place of sale: Income derived from the purchase and
sale of personal property shall be treated as derived entirely from the
country in which sold (the place where the property is marketed). The rule
is different to personal property produced (in whole or in part) by the
taxpayer within the Philippines and sold without the Philippines, or
produced (in whole or in part) by the taxpayer without and sold within the
Philippines, in which case any gain derived shall be treated as derived partly
from sources within and partly from sources without the Philippines.
7. Shares of stock in a domestic corporation: Within the Philippines: Gain ,
profit or income from the sale of shares of stock in a domestic corporation
shall be treated as entirely from sources within the Philippines, regardless
of where the said shares are sold.
TAXPAYER
TAX ON INDIVIDUALS
I. CITIZENS (RESIDENT AND NON-RESIDENT) AND RESIDENT ALIENS

Types of Income Tax Imposable;
a. Basic Tax: regular income tax
b. Tax on Passive Incomes
*Capital Gains Tax on sale of shares of stock in a Domestic Corporation
*Capital Gains Tax on sale of Real Property
*Final Tax on other Passive Incomes
A: BASIC TAX: REGULAR INCOME TAX: TREATMENT
A.1: RESIDENT CITIZEN: is a citizen of the Philippines residing therein, unless he

qualifies as a non-resident citizen under Section 22(e) of the NIRC of 1997.
Tax Treatment: The general rule is a resident citizen is taxable on all income
derived from all sources within and without the Philippines. His Regular Taxable
Income for each taxable year shall be subject to the scheduler tax rates of 20% to
35% (old law: 5%-32%).
A.2: NON-RESIDENT CITIZEN:
1) A citizen of the Philippines who establishes to the satisfaction of the

Commissioner the fact of his physical presence abroad with a definite
intention to reside therein.
2) A citizen of the Philippines who leaves the Philippines during the taxable
year to reside abroad, either as an emigrant or for employment on a
permanent basis.
3) A citizen of the Philippines who works and derives income abroad and
whose employment thereat requires him to be physically present abroad
most of the time during the taxable year.
4) A citizen who has been previously considered as non-resident citizen who
arrives in the Philippines at any time during the taxable year to reside
permanently in the Philippines shall likewise be treated as a non-resident
citizen for the taxable year in which he arrives in the Philippines with
respect to his income derived from sources abroad until the date of his
arrival in the Philippines. (DUAL-STATUS)
Tax treatment: The income of a non-resident citizen derived from all sources
within the Philippines for each taxable year shall be subject to Income tax.
A.3: RESIDENT ALIENS: An alien actually present in the Philippines who is not a
mere transient or sojourner is a resident of the Philippines. What the law requires
for an alien to be considered as a resident of the Philippines is merely physical or
bodily presence in a given place for a period of time, not the intention to make it
a permanent place of abode.
Tax treatment: The income of a resident alien individual derived during the
taxable year from all sources within the Philippines shall be subject to Philippine
Income tax.
B. PASSIVE INCOME OF CITIZENS AND RESIDENT ALIENS
Passive income of a citizen or a resident alien may either be:
a) Passive income subject to final tax- refers to an income which tax due is
fully collected through the withholding tax system in the form of final
withholding tax. The recipient is no longer required to include the item of
income subjected to “final tax” as part of his gross income in his gross
returns.(see page 89 casasola for the rates)
b) Passive income Not subject to the final tax- These are the passive incomes
not subject to the final withholding tax and therefore should be included in
the determination of the gross income which will be subject to regular
income tax rates. Example: Sale to the government of real property which is
considered as capital asset where the seller has opted to subject it either to
the regular income tax based on the FMV or gross selling price of the said
property, whichever is higher, should be subject to tax under section 24 (A)
(2) of the tax code.
B.3: PASSIVE INVESTMENT INCOME
1. Interest: See discussion on interest in composition of gross income

2. Royalties: See discussion on interest in composition of gross income
3. Prizes: See discussion on interest in composition of gross income
4. Other Winnings: See discussion on interest in composition of gross
income
5. Dividends: See discussion on interest in composition of gross income
II: NON-RESIDENT ALIEN: A non-resident alien individual is an alien individual

whose residence is not in the Philippines and who is not a citizen thereof:

Non-resident alien engaged in trade or business in the Philippines: An alien
individual who has a legitimate business in the Philippines. Provided, however,
that if the period of the aggregate period of the alien’s stay in the Philippines is
more than 180 days during a calendar year, he shall be deemed a “non-resident
alien doing business in the Philippines.
A. BASIC TAX: He is taxed on his income from sources within the Philippines
(after deducting personal and additional exemptions, if any) at a graduated
tax rates of 20% to 35%, while his passive income shall be subject to final
tax.
B. TAX ON PASSIVE INCOME
B.1: CGT ON SALE OF SHARES OF STOCK OF A DC: Same with Citizens and
resident alien
B.2: CGT ON SALE OF REAL PROPERTY: Same with Citizens and resident
aliens
B.3: Gross income from all sources within the Philippines derived by the
non-resident cinematographic film owners, lessor or distributors, shall be
subject to 20% final tax.
B.4: Gross income derived from contracts by subcontractors from service
contractors engaged in petroleum operations as defined under PD 87 (also
known as the oil exploration and development act), as imposed under pd
1354: 8% in lieu of all taxes, national and local.
B.5: Interest: See discussion on interest in composition of gross income
B.6: Royalties: See discussion on interest in composition of gross income
B.7: Prizes: See discussion on interest in composition of gross income
B.8: Other Winnings: See discussion on interest in composition of gross
income
B.9: Dividends: See discussion on interest in composition of gross income
Non-resident alien not engaged in trade or business: an alien individual who has
no legitimate business in the Philippines and whose stay thereat does not exceed
180 days during a taxable year.
Tax Treatment: The income derived from all sources within the Philippines shall
be subject to the final withholding tax rates. (See schedule below)

Gross amount of interest, cash and/or property 25%
dividends, rents, salaries, wages, premiums, annuities,
compensation, remuneration, emoluments, or other
fixed or determinable annual or periodic or casual
gains, profits and income and capital gains on other
assets.
CGT on sale of shares of stock 15% flat base (5-10% old
law)
CGT on sale of real property 6%
III: ALIEN INDIVIDUALS SUBJECT TO PREFERENTIAL RATE
A. There shall be levied, collected, and paid for each taxable year upon the
gross income received by every alien individual employed by RHQs and
ROHQ’s established in the Philippines by multinational companies as
salaries, wages, annuities, compensation, remuneration and other
emoluments, such as honoraria and allowances from such RQQs and
ROHQ’s, a final withholding tax equal to 15% of such gross income. (Same
with employees of OBUs and Petroleum Contractors and Subcontractors)
B. Filipinos working in RHQ/ROHQ may avail the same tax treatment provided
that the following are met:
A) Position and Function Test- The employee must occupy a managerial or
technical position and must actually be exercising such managerial or
technical functions pertaining to the said position.
B) Compensation threshold- The employee must have received, or is due to
receive under a contract of employment, a gross annual taxable
compensation of at least P975,000.
C) Exclusivity test- The Filipino managerial or technical employee must be
exclusively working for the RHQ or ROHQ as a regular employee and not
just a consultant or contractual personnel. Exclusivity means having just
one employer at a time.
IV: GENERAL PROFESSIONAL PARTNERSHIPS : a partnership formed by

professionals for the sole purpose of exercising their common profession, no part
of income of which is derived from engaging in any trade or business. It is not a
taxable entity for income tax purposes since it is only acting as a “pass-through”
entity where its income is ultimately taxed at the hands of the partners
comprising it.
Each partner shall report as gross income his distributive share, actually or
constructively received, in the net income of the partnership.
Deductions: Since the taxable income is in the hands of the partner, as a rule,
apart from the expenses claimed by the GPP in determining its net income, the
individual partner can still claim deductions incurred or paid by him that
contributed to the earning of the income taxable to him.
V: Taxable partnerships: All other partnerships, no matter how created or

organized, which include unregistered joint ventures and business partnerships,
are considered as taxable corporations subject to corporate income tax. The
partners are considered as stockholders, hence, their distributive share are taxed
as dividends subject to the final withholding tax of 10%..
VI. Co-ownership: A co-ownership may become an unregistered general

partnership and therefore becomes a taxable corporation if the co-owners
appoint an administrator who manages the affairs of the co-ownership by making
investments therein from which profits are realized. This applies even if there was
already a partition ordered by the court should the joint management be given to
one of the co-owners. Note: A co-ownership is automatically converted into an
unregistered partnership the moment the said common properties and/or income
derived therefrom are used as a common fund with the intent to make profits for
the heirs in proportion to their respective shares in the inheritance.
VII: JOINT VENTURE: Taxable if the following requisites are met: a) each party to
the joint venture must make a contribution, not necessarily of capital, but by way
of services, skills, knowledge, material or money; (b) There must be an intent to
make profits which must be shared among the parties; (c) There must be a joint
proprietary interest and right of control over the subject matter of the enterprise;
and (d) Usually, there is a single business or transaction.
Rule: As a general rule, a joint venture is not taxed as a corporation and is taxed
just like a GPP which means that the co-venturers are taxed only on their
individual company’s share in the profits. However, the JV should be:
1. For undertaking of a construction project;

2. Involve joining or pooling of resources by licensed local contractors, that is
licensed as general contractor by the PCAB;
3. These local contractors are engaged in the construction business;

4. The JV itself must likewise be duly licensed as such by the PCAB.
CORPORATIONS
I: DOMESTIC CORPORATIONS: Those corporations created or organized in the

Philippines under its laws. As a general rule, the law imposes a 30% normal
corporate income tax rate in the taxable income received by the domestic
corporations and taxable partnerships, no matter how created or organized,
during each taxable year from all sources, whether derived from within the
Philippines and without the Philippines.
Preferential Tax Rate Constitutional exemption Exemption under Sec. 30

Proprietary (operated by non-stock, non-profit Non-stock, non-profit
private person) EDUCATIONAL institution corporation or
educational institutions (ARTICLE XIV, Sec. 4) association “organized
and hospitals which are (School only) and operated exclusively”
non-profit. for charitable purposes.
(school and hospital)
10% preferential tax on Revenues and assets used Incomes received by
their taxable income actually, directly and them in their character as
except passive incomes exclusively for a charitable institution
under Sec 27(d). educational purposes are exempt from taxes.
(exempted also from vat shall be exempt from
based on constitution) taxes and duties.
LIMITATION: LIMITATION: LIMITATION:
Predominance test: If the The Constitution does not It must be “organized and
gross income from distinguish with respect operated exclusively” for
unrelated trade, business to the source of origin of charitable purposes. The
or other activity of the the income, hence, the last paragraph of Section
said proprietary and non- income of such institution 30 of the NIRC expressly
profit educational from whatever source qualifies that income
institution exceeds 50% shall be tax exempt as from activities for profit is
of the total gross income long as it could fully taxable “regardless of the
from all sources, then the substantiate that the disposition made of such
entire income shall be revenues derived are income.” [In case of
subject to the regular actually, directly, and proprietary, non-profit
corporate income tax rate exclusively used for educational
of 30%. Unrelated: not educational purposes. institution/hospitals, it is
substantially related to subject to preferential tax
the exercise or rate of 10% of its net
performance by such income derived from
educational institution or profitable activities which
hospital of its primary is substantially related to
purpose or function. its primary purpose or
function.]
Note on Constitutional Exemption: The phrase “actually, directly, and exclusively
used for educational purposes” is not limited to property actually indispensable
therefore but extends to facilities which are incidental to and reasonably
necessary for the accomplishment of said purpose.
Note on Charitable Institution/Association: Non-stock, non-profit corporations or

associations which claim to be charitable or social welfare but are not organized
and operated “exclusively” for charitable or social welfare purposes are not
entitled to the exemption under Sec. 30 of the Tax Code, and their taxable income
shall be subject to ordinary 30% corporate income tax. [In case of proprietary,
non-profit educational institution/hospitals, it is subject to preferential tax rate of
10% of its net income derived from profitable activities which is substantially
related to its primary purpose or function.] Further, the income from the
property of the organization or corporation under sec 30, paragraph (e) and (g) of
the Tax Code is taxable regardless of whence such income is derived and how it is
used or disposed of.
Substantive test of charity: Charity is essentially a gift to an indefinite number of

persons which lessens the burden of government. In other words, charitable
institutions provide for free goods and services to the public which would
otherwise fall on the shoulder of the government.
Treatment of Income derived from dormitories, canteens and bookstores by

non-stock, non-profit educational institution: There must be evidence to show
actual, direct and exclusive use of said income for educational purposes.
Treatment of interest income from bank deposits and yields from deposit
substitutes by non-stock, non-profit educational institution: There must be a
showing that the incomes are included in the school’s annual information return
and duly audited financial statements together with; (a) certifications from
depository banks as to the amount of interest income earned from passive
investments not subject to the 20% final tax: (b) certification of actual, direct and
exclusive utilization of said income for educational purposes; (c) Board resolution
on proposed project to be funded out of the money deposited in the banks or
placed in money market placements, which must be actually, directly and
exclusively for educational purposes.
PASSIVE INCOME OF DOMESTIC CORPORATION WHICH ARE SUBJECT TO FINAL
WITHHOLDING TAX. (See casasola page 133 and TRAIN LAW, almost the same
treatment with passive income of citizens and resident aliens…see previous
discussion)
Note: The dividends received by a domestic corporation from another domestic

corporation are not subject to income tax, but dividends received by Domestic
Corporation from a foreign corporation are subject to income tax and shall form
part of the gross income because there is no law exempting this type of dividend
from income tax.
Minimum Corporate Income Tax (MCIT)
A MCIT of 2% of the gross income as of the end of the taxable year (whether
calendar or fiscal year, depending on the accounting period employed) is imposed
upon any domestic corporation beginning on the fourth taxable year immediately
following the taxable year in which such corporation commenced its business
operations. The MCIT shall be imposed whenever such corporation has zero or
negative income or whenever the amount of MCIT is greater than the normal
income tax computed due from such corporation.
Note: MCIT is applicable only to corporations whose operations are covered by

the normal corporate income tax.
Rationale: The imposition of the MCIT is designed to forestall the prevailing

practice of domestic corporations and resident foreign corporations of
overclaiming deductions in order to reduce their income tax payments. It
prevents tax evasion and minimizes tax avoidance schemes achieved through
sophisticated and artful manipulations of deductions and other stratagems.
The MCIT is not tax on the capital as it is imposed on the gross income. It is
neither an additional tax imposition because it is imposed in lieu of the normal
net income tax and only if the normal income tax is suspiciously low.
MCIT on Quarterly Corporate Income Tax
In the computation of tax due for the taxable quarter, if the computed quarterly
MCIT is higher than the quarterly normal income tax, the tax due to be paid for
such taxable quarter at the time of filing the quarterly corporate income tax
return shall be the MCIT which is 2% of the gross income as of the taxable
quarter. Expanded withholding tax, quarterly corporate income tax payments
under the normal income tax, and the MCIT paid in the previous taxable quarter/s
are allowed to be applied against the quarterly MCIT due.
Normal Income Tax is higher than MCIT at the end of the year: Quarterly MCIT
paid and quarterly normal income tax payments in the taxable quarters of the
same taxable year shall be credited against the normal income tax at the end of
the taxable year if in the preparation and filing of the annual income tax due, it
appears that the normal income tax due is higher than the computed annual
MCIT. Moreover, excess MCIT in the prior year/s (subject to the prescriptive
period allowed for its creditability), expanded withholding taxes in the current
year and excess expanded withholding taxes in the prior year shall be allowed to
be credited against the annual income tax computed under the normal income
tax rules. (Note: Any excess of the MCIT over the normal income tax as
computed under sec. 27 (A) of the Tax Code shall be carried forward on an
annual basis and credited against the normal income tax for three (3)
immediately succeeding years.)
MCIT is higher than NCIT at the end of the year: Excess MCIT from the previous
taxable year/s shall not be allowed to be credited against the computed annual
MCIT due as the same can only be applied against normal income tax.
Relief from the MCIT: The secretary of finance , upon recommendation of the
Commissioner, may suspend the imposition of the MCIT upon submission of proof
by the applicant-corporation, duly verified by the Commissioner’s authorized
representative, that the corporation sustained substantial losses on account of
prolonged labor dispute or because of force majeure, or because of legitimate
business reverses.
MCIT NOT CREDITED: recorded as deferred charges (not allowable as deductions)
II: RESIDENT FOREIGN CORPORATION: A resident foreign corporation is a

corporation organized, authorized or existing under the laws of any foreign
country, but engaged in trade or business in the Philippines.
Tax treatment: The law imposes a 30% normal corporate income tax rate in the
taxable income received by the resident foreign corporations during each taxable
year from all sources derived from within the Philippines.

Basis: Taxability of a foreign corporation’s income depends upon the locus of the
activity, property or services giving rise thereto. The income tax does not require
as a condition sine quanon the conduct of business in the Philipppines in order
that foreign corporations may be taxed on their income. It is sufficient that such
income is derived from an activity within the Philippines. Place of activity, not
place of business is controlling.
Engaged in trade or business: Carrying on a business with the idea of progression

and continuity. It is more than a single act or transaction; it involves some
continuity of actions. However, if an isolated transaction, which if repeated would
be a transaction in a business, is proved to have been undertaken with the intent
that it should be the first of several transactions, that is with the intent of carrying
on a business, then it is a first transaction in an existing business.
Note: A foreign corporation transacting business in the Philippines independently

from its branch is not considered the same juridical entity as its branch office in
the Philippines. The transaction becomes one of the foreign corporation, not of
the branch. Consequently, the taxpayer is the foreign corporation, not the branch
or the resident foreign corporation.
MCIT: Same treatment with domestic corporations. However, only the gross
income from sources within the Philippines shall be considered for such purposes.
C. Foreign corporations not subject to MCIT-

a) International Carrier
b) Offshore Banking Units
c) Regional Operations Headquarters
d) Firms that are tax under special income tax regime (PEZA LAW)
INTERNATIONAL CARRIERS
International Carriers: Refer to foreign airline corporations or foreign shipping

corporations doing business in the Philippines having been granted landing rights
in any Philippine port to perform international air/shipping activities or
flight/shipping operations anywhere in the world which is subject to “Gross
Philippine Billings Tax of 2.5%.
Gross Philippine Billing: the amount of gross revenue derived from the carriage of
persons, excess baggage, cargo and mail originating from the Philippines in a

continuous and uninterrupted flight, irrespective of the place of sale or issue and
place of payment of the ticket or passage document.
Originating Rule: To form part of the GPB, the passenger, excess baggage cargo or
mail must originate in the Philippines.
a) Where the passenger, excess baggage, cargo or mail originally commencing

their flights from any Philippine port to any other port or point outside the
Philippines.
b) Chartered flights of passengers, their excess baggage, cargo and/or mail
originally commencing their flights from any foreign port and whose stay in
the Philippines is for more than 48 hours prior to embarkation save in cases
where the flight of the airplane belonging to the same airline company
failed to depart within 48 hours by reason of force majeure.
c) Chartered flights of passengers, their excess baggage, cargo, and/or mail
originally commencing their flights from any Philippine port to any foreign
port; and
d) Transshipment of passengers, excess baggage, cargo and/or mail, originally
commencing their flights from a foreign port, at any port inside the
Philippines on another aircraft belonging to the same airline company shall
not be considered as originating from the Philippines, unless the time
intervening between arrival and departure of said passengers, their excess
baggage, cargo and/or mail exceeds 48 hours.
Note: Off-line air carriers having general sales agents in the Philippines are
engaged in or doing business in the Philippines and that their income from the
sales of passage documents is income from within the Philippines, which income
is similarly subject to tax imposed on resident foreign corporations under the Tax
Code. (South African Airways vs. CIR)
OFFSHORE BANKING UNIT
OBU: A branch, subsidiary, or affiliate of a foreign banking corporation which is

duly authorized by the Bangko Sentral ng Pilipinas, as a separate accounting unit,
to transact offshore banking business in the Philippines.
FCDU(Foreign Currency Deposit Unit): an accounting unit or department in a local

bank or in an existing local branch of foreign banks, which is authorized by the
BSP to operate under the expanded foreign currency deposit system.
Tax treatment: Income derived by banks from its FCDUs or OBUs with respect to
foreign currency transactions with nonresidents, OBUs in the Philippines, and
local commercial banks, including branches of foreign banks authorized to
transact business with FCDUs/EFCDUs are exempt from income taxes pursuant to
Sec. 28 of the NIRC, as amended.
Interest income derived by bank from its FCDU/EFCDU or OBU from foreign
currency loans granted to residents other than OBUs and FCDUs/EFCDUs is
subject to 10% preferential tax.
BRANCH PROFIT REMITTANCE TAX
Requisites:
1. Applicable only to foreign corporations;

2. There must be an outward remittance;
3. The profits remitted were from sources within the philippines.
Tax Treatment: Profits remitted abroad by a branch office to its head office which
are effectively connected with its trade or business in the Philippines are subject
to 15% Branch Profit Remittance Tax. To be effectively connected, it is not
necessary that the income be derived from the actual operation of taxpayer-
corporation’s trade or business; it is sufficient that the income arises from the
business activity in which the corporation is engaged. (Marubeni vs. CIR)
REGIONAL OPERATING HEADQUARTERS
Note: Those Regional Headquarters in the Philippines by multinational companies

and which headquarters do not earn or derive income in from within the
Philippines and do not participate in any manner in the management of any
subsidiary or branch office they might have in the Philippines nor solicit market
goods and services shall not be subject to income tax.
ROHQ Tax treatment: The ROHQ of a multinational company is a foreign

business entity which is allowed to derive income in the Philippines by performing
qualifying services to its affiliates, subsidiaries or branches in the Philippines, in
the Asia-Pacific Region and other foreign markets. It is subject to 10% preferential
tax rate on their taxable income.
Passive Income: See discussion on composition of gross income.

III: NON-RESIDENT FOREIGN CORPORATION
A foreign corporation not engaged in trade or business within the Philippines.
Tax Treatment: The income of non-resident foreign corporation derived from all
sources within the Philippines, such as interests, dividends, rents, royalties,
salaries, premiums, annuities, emoluments or other fixed or determinable
periodic or casual gains, profits and income, and capital gains (except capital gains
from sale of shares of stock not traded in the local stock exchange) shall be
subject to the 30% final withholding tax based on the gross income received
during each taxable year.
Other Incomes of Foreign Corporation
On gross income of non-resident cinematographic film

owner, lessor or distributor. 25%
On gross rental income or charter fees derived by non-
resident owner or lessor of vessels from the leases or 4.5%
charters to Filipino citizens or corporations as approved by
MARINA
On gross rental income of non-resident lessor of aircraft,
machineries and other equipment. 7.5%
On interest income on foreign loans derived by non-resident
foreign corporation. 20%
Net capital gains from sale of shares of stock not traded in
local stock exchange. 15% (same w/
others)
Intercorporate dividends from a domestic corporation 15% see below
Tax rate on the intercorporate dividends derived by non-resident foreign

corporations:
a) While the general rule is that a foreign corporation is the same juridical
entity as its branch office in the Philippines, however, when the
corporation transacts business in the Philippines directly and
independently of its branch, the taxpayer would be the foreign
corporation itself and subject to the dividends tax similarly imposed on
nonresident foreign corporation under Sec. 28 of the Tax Code. The
dividends attributable to the head office of the nonresident foreign
corporation would not qualify as dividend earned by its Philippine

branch which is considered as resident foreign corporation exempt from
the intercorporate dividends tax received from a domestic corporation.
b) Normally, a tax rate of 30% is imposed on corporations. But since the
Philippines seeks to lessen the impact of double taxation between
countries, it imposes only the lower preferential tax rate of 15% on the
dividends derived by nonresident corporations from a domestic
corporation, subject to the condition that the country in which the non-
resident corporation is domiciled, shall allow a credit against the tax due
from the non-resident foreign corporation taxes deemed to have been
paid in the Philippines equivalent to 15%, which represents the
difference between the regular income tax rate and the 15% tax on
dividends.
Tax Sparing Rule: connotes that the 15% represents the difference between the
regular income tax rate of 30% and the 15% tax on dividends. It is the amount of
tax forgone by the Philippine government in favor of the non-resident foreign
corporation the purpose of which is to encourage foreign investors to conduct
business in the country.
Note: In case of the sale of shares of stock of the non-resident foreign corporation
which it owns in another foreign corporation, the same is not subject to income
tax under our jurisdiction because the income derived therefrom is considered as
a foreign-sourced income which is not subject to the final withholding tax.
IMPROPERLY ACCUMULATED EARNINGS TAX
The 10% improperly accumulated earnings tax imposed on the improperly

accumulated taxable income shall only apply to closely-held corporations formed
or availed for the purpose of avoiding the income tax, by permitting earnings and
profits to accumulate beyond the reasonable needs of the business, instead of
dividing or distributing said profits to its shareholders.
Consequence: Once the profit has been subjected IAET, the same shall no longer
be subjected to IAET in later years even if not declared as dividend.
Notwithstanding the imposition of IAET, profits which have been subjected to
IAET, when finally declared as dividends, shall nevertheless be subject to tax on
dividends imposed under the Tax Code.

Note: For the purpose of determining the source of earnings or profits declared or
distributed from accumulated income for each taxable year, the dividends shall be
deemed to have been paid out of the most recently accumulated profits or
surplus and shall constitute a part of the annual income of the distribute for the
year in which received.
IMMEDIACY TEST: the “reasonable needs of the business” mean the immediate
needs of the business, and is generally held that if the corporation did not prove
an immediate need for the accumulation of the earnings and profits, the
accumulation was not for reasonable needs of the business and the penalty tax
would apply.
Amount that may be retained: 100% of the paid-up capital or the amount
contributed to the corporation representing the par value of the shares of stock,
hence, any excess capital over and above par shall be excluded.
Presumption: The fact that a corporation is a mere holding or investment

company shall be prima facie evidence of a purpose to avoid the tax upon its
shareholders or members. The term “holding or investment company” shall refer
to a corporation having practically no activities except holding property, and
collecting income therefrom or investing the same.
EXEMPTIONS FROM TAX ON CORPORATIONS
Construction: Because taxes are the lifeblood of the nation, statutes that allow
exemptions are construed strictly against the grantee and liberally in favor of the
government. Otherwise stated, any exemption from the payment of a tax must be
clearly stated in the language of the law. It cannot be merely implied therefrom.
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 showing
the character of the organization, the purpose for which it is organized, its usual
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 operation which
affect the right to exemption. The AOI, the by-laws and the latest financial
statement must be attached to the affidavit.

Failure to file proof of exemption: The proof of exemption required by the
Income Tax Regulations is intended to relieve the taxpayer of the duty of filing
returns and paying the tax. The failure to observe the requirement called for
therein cannot constitute a waiver of the right to enjoy the exemption. To hold
otherwise would be tantamount to incorporating into the laws some legislative
matter by administrative regulation.
Note: The income of whatever kind and character of the foregoing organizations
from any of their properties, real or personal, or from any of their activities for
profit regardless of the disposition made of such income shall be subject to tax.
A. Exempt agricultural and horticultural organizations

1-Have no net income inuring to the benefit of any member
2- Educational or instructive in character
3-Have as their objects the betterment of the conditions of those engaged
in such pursuits, the improvement of the grade of the products, and the
development of higher degree of efficiency in their respective occupation.
B. Exempt mutual savings bank
1-No capital stock represented by shares, and
2-Whose earnings less only the expenses of operation, are distributable
wholly among the depositors.
C. Exempt fraternal beneficiary society

1-It must be operated under the “lodge system” or for the exclusive benefit
of the members of a society operating it.
2- The society should have an established system for payment to its
members or their dependents of life, sick, accident, or other benefits.
D. Exempt cemetery
1- Owned by and operated exclusively for the benefit of the lot owners;
2- It is not operated for profit
E. Non-stock, non-profit corporation or association organized and operated
exclusively for religious, scientific, athletic, or cultural purposes or for
rehabilitation of veterans: Exempt from tax on its income (other than
income of whatever kind and character from its properties, real or
personal)
F. Non-stock, non-profit corporation or association organized and operated
exclusively for charitable purposes: See discussion on corporation.
G. Exempt business league
H. Exempt civic league
I. Exempt non-stock, non-profit educational institution: See discussion on
corporation.
J. Exempt mutual insurance companies: The income of the company be
derived solely from assessments, dues and fees collected from its
members.
K. Exempt farmers’ cooperative marketing and purchasing associations.
PASSIVE INCOMES
Note: Gross income is broad enough to include all passive income subject to
specific rates or final tax. However, since these passive incomes are already
subject to different rates and taxed finally at source, they are no longer included
in the computation of gross income, which determines taxable income.
THREE TYPES OF PASSIVE INCOME (ALMOST) COMMON TO ALL TAXPAYERS
A. CAPITAL GAINS TAX ON SALE OF SHARES OF STOCKS: Capital gains tax on

sale of shares of stocks not traded in the local stock exchange: a 15% (5%-
10% old law) flat rate shall be imposed as capital gains tax on the net
capital gains from sales, barter, exchange or other disposition of shares of
stock in a domestic corporation, NOT, listed and traded in the stock
exchange. (Regardless of kind of taxpayer)
Note the following:
*shares of stock which are listed and traded in the local stock exchange,
the transaction is exempted from CGT but subject to (6/10 new) ½ of 1%
stock transaction tax based on the gross selling price or gross value in
money of the shares of stock sold or transferred.
*Sale made by a dealer in securities- Ordinary income subject to basic tax.
*Dealings in the Shares of Stock of a Foreign Corporation: Not subject to
CGT but to the scheduler rates of 20%-35% in the case of individual sellers
and the normal corporate income tax rate of 30% in case of corporate-
seller.
Note: 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, when the subscription or issue price be in excess of, or
less than, the par or the stated value of such stock.
B. CAPITAL GAINS TAX ON SALE OF REAL PROPERTY: The sale of real property
by an individual or domestic corporation will be subject to the Capital
Gains Tax if the said property is considered as his/its capital asset which is
located in the Philippines, including pacto de retro sales and other forms of
conditional sales.
Note: Foreign corporations, either resident or non-resident are not entitled

to the preferential tax rates on their gain from sale of real property
classified as capital assets because there is no similar express provision as
that granted to domestic corporations. Subject to NCIT.
Presumed gain: The conclusive presumption of law is that there is a gain

whenever somebody sells a real property considered as capital asset, and
that the basis of the 6% Capital Gains Tax shall be the gross selling price or
the fair market value at the time of sale, whichever is higher.
Note: Capital assets vs. Ordinary assets: Capital assets are generally
properties that are not used in trade or business of the taxpayer. On the
other hand, ordinary assets are properties used in trade or business or
primarily held for sale of the taxpayer.
Note: Transfer for insufficient consideration: A deemed gift subject to tax

arises only if a tax is avoided as a result of selling a property at a price lower
than its fair market value. In the case of sale of real property classified as
capital assets (24D1) and subject to CGT, the tax is always based on the
gross selling price or fair market value, whichever is higher, and therefore,
there can be no instance where a seller can avoid any tax by selling his
capital assets below its fair market value.
Note: Sale of Real property to government: In case of disposition of real

property classified as capital asset by individuals to the government or any
of its political subdivisions or agencies or GOCC, the tax to be imposed shall
be either under the scheduler rates wherein the capital gains shall be added
to the gross income earned during the taxable year or to the final tax on
presumed capital gains, at the option of the individual taxpayer-seller.
Installment sale:

If the buyer is individual not engage in trade or business:
i: Installment plan: No withholding on periodic installment payments. The
applicable rate of tax based on the gross selling price or fair market value of
the property at the time of the execution of the contract to sell, whichever
is higher, shall be withheld on the last installment or installments
immediately prior to such last installment, if the last installment is not
sufficient to cover the tax due, to be paid by the seller until the tax is fully
paid.
ii: Cash basis: Deferred-payment sale (that is, payment exceeds 25% of the
gross selling price): The buyer shall withhold the tax based on the gross
selling price or fair market value of the property, whichever is higher, on
the first installment.
If the buyer is engaged in trade or business:

i: Installment plan: The tax shall be deducted and withheld by the buyer on
every installment which tax shall be based on the ratio of actual collection
of the consideration against the agreed consideration appearing in the
contract to sell applied to the gross selling price or fair market value of the
property at the time of execution of the contract to sell, whichever is
higher.
ii: Cash basis: The buyer shall withhold the tax based on the gross selling
price or fair market value of the property, whichever is higher, on the first
installment.
Sale of Principal Residence: If the purpose for the sale of principal residence
is to buy a new principal residence within 18 calendar months from the date
of the sale or disposition, the sale, barter or exchange of the said principal
residence shall not be subject to the CGT. (Rule applicable only to individual
taxpayer)
Requisites:
1. The commissioner shall be notified by the taxpayer within 30days from

the date of sale or disposition through a prescribed return of his
intention to avail of the tax exemption.
2. The exemption can only be availed once every 10 years.
3. The proceeds must be fully utilized in acquiring or constructing a new
principal residence within 18 months from the sale or disposition. If there
is no full utilization of the proceeds of sale or disposition, the portion of

the gain presumed to have been realized from the sale or disposition
shall be subject to CGT.
NOTE: No CAR/Tax clearance certificate shall be issued to the buyer

unless the capital gains tax due on the sale, transfer or exchange of real
property has been fully paid in Authorized Agent Bank of the Revenue
district Office where the property being transferred is located.
Failure to redeem: In case of non-redemption of properties sold during

involuntary sales, regardless of the type of proceedings and personality of
the mortgagees/sellers or entities, the CGT, if the property is a capital
asset; or the Creditable Withholding Tax, if the property is ordinary asset;
the VAT ; and the DST shall become due. The buyer shall be deemed to
have withheld the CGT or CWT due from the sale. The CGT/CWT return
shall be filed after the expiration of the statutory period for redemption.
C. CASH OR PROPERTY DIVIDENDS
Dividends: a dividend is defined as a corporate profit set aside, declared,

and ordered by the directors to be paid to the stockholders on demand or
at a fixed time. Until the cash or property dividend is declared, the
corporate profits belong to the corporation and not to the stockholders,
and are liable for the payment of debts of the corporation. (Fisher vs. CIR)
Taxable dividends:
a. Where a corporation distributes all of its assets in complete liquidation
or dissolution, the gain realized or loss sustained by the stockholder,
whether individual or corporate, is a taxable income or a deductible loss, as
the case may be.
b. Any distribution made to the shareholders or members of a corporation
shall be deemed to have been made from the most recently accumulated
profits or surplus, and shall constitute a part of the annual income of the
distribute for the year in which received.
Tax treatment of cash dividends received from Domestic Corporation by

the following stockholders:
a) A resident citizen: The dividends received by citizens and resident aliens

from domestic corporation are subject to 10% final withholding tax.
b) Non-resident alien engaged in trade or business (1%): Cash or property

dividends actually or constructively received from domestic corporations
are subject to 20% final withholding tax.
c) Non-resident alien not engaged in trade or business (1% ): Dividends

derived by a non-resident alien from a domestic corporation are subject
to 25% final withholding tax.
d) Domestic corporation (1%): The dividends received by a domestic

corporation from another domestic corporation are not subject to
income tax. Note: dividends received by a domestic corporation from a
foreign corporation is included in the computation of the gross income
and thus, subject to income tax because there is no law exempting this
type of dividend from income tax.
e) Non-resident foreign corporation (1%): Subject to 15% tax rate on

intercorporate dividends received from domestic corporation subject to
the condition that the country in which the non-resident foreign
corporation is domiciled allows a tax credit of 15%.
Stock Dividend: A stock dividend which represents the transfer of surplus

to capital account is not subject to income tax because they are not
realized income. The provisions of the Tax Code imposing a tax on dividend
income only refers to cash and property dividends, thus, making stock
dividends exempt from income tax.
Rule on Taxability of Stock dividend:

a) A stock dividend constitutes income if it gives the shareholder an
interest different from that which his former stockholdings represented.
b) A stock dividend does not constitute income if the new shares confer no
rights or interest 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.
Cancellation or Redemption of Dividend stock: It constitutes taxable

income if it is issued as dividend at such time and in such manner as to
make the distribution and cancellation or redemption, in whole or in part,
essentially equivalent to the distribution of a taxable dividend, the amount
so distributed in redemption or cancellation of the stock shall be

considered taxable income to the extent that it represents a distribution of
earnings or profits.
Dividends declared in the guise of treasury stock dividend to avoid the

effect of income taxation is taxable.
Disguised Dividends: those income payments made by a domestic

corporation, which is a subsidiary of a non-resident foreign corporation, to
the latter ostensibly for services rendered by the latter to the former, but
which payment are disproportionately larger than the actual value of the
service rendered.
Income Constructively received: Income which is credited to the account of

or set aside 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 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.
Note: Mere increase or appreciation in the value of shares of stock cannot

be considered income for income tax purposes. Since “a mere advance in
the value of the property of a person or corporation in no sense constitute
“income” specified in the revenue law.”
PASSIVE INCOMES COMMON TO DOMESTIC CORPORATION, RESIDENT FOREIGN

CORPORATION, CITIZENS AND RESIDENT ALIEN
A. Interest income from CURRENCY bank deposit in and yield or any other
monetary benefit from deposit substitutes and trust funds and similar
arrangements derived from sources within the Philippines.
Interest: Compensation allowed by law or fixed by the parties for the use or
forbearance of money or as damage for its detention. In general, interests
received or credited to the account of the depositor or investor are
included in their gross income, unless they are (a) exempt from tax, or (b)
subject to final tax at preferential rate under the 1997 Tax Code or under
the applicable tax treaty.

Deposit Substitute: An alternative form of obtaining funds from the public
from the public, other than deposits, through the issuance, endorsement,
or acceptance of debt instruments for the borrower’s own account, for the
purpose of relending or purchasing of receivables and other obligations, or
financing their own needs or the needs of their agent or dealer.
INCOME INTEREST FROM PHILIPPINE CURRENCY DEPOSIT AND DEPOSIT

SUBSTITUTE
1. Interest income derived from currency bank deposit and yield or any
other monetary benefit from deposit substitutes and from trust funds and
similar arrangements derived from sources within the Philippines.
*Citizens, resident aliens, non-resident aliens engaged in trade or business
in the Philippines, domestic corporations and resident foreign corporations:
20% FWT.
*Non-resident aliens not engaged in trade or business in the Philippines:
25% FWT.
*Non-resident foreign corporation: 30% FWT (unless it is from foreign loan,
which is subject to 20% FWT)
*Interest income derived from an instrument that does not qualify as a
deposit substitute is subject to 20% creditable withholding tax.
2. Issuance of government debt instruments and securities is deemed as

falling within the coverage of “deposit substitutes,” therefore interest
income derived therefrom shall be subject to the applicable FWT.
3. LONG-TERM DEPOSITS: Certificate of time deposit or investment in the

form of savings, common or individual trust funds, deposit substitutes,
investment management accounts and other investments with a maturity
period of not less than 5 years, the form of which shall be prescribed by the
BSP and issued by banks only to INDIVIDUALS (except non-resident alien
not engaged in trade or business in the Philippines) in denominations of
P10,000 and other denominations prescribed by the BSP. EXEMPT
Note: Interest income from long-term deposit or investment that is pre-

terminated by the depositor or investor before the 5th year shall be subject
to the graduated tax rates of FWT on the entire income and shall be
deducted and withheld by the depository bank from the proceeds of the

long-term deposit or investment certificate based on the remaining
maturity thereof as follows:
1. 4 years to less than 5 years: 5%

2. 3 years to less than 4 years: 12%
3. Less than 20 years : 20%
Interest from long-term deposit (not exempted)
1. Received by Non-resident alien not engage in trade or business:

20%FWT
2. Received by non-resident foreign corporation: 30%FWT
3. Received by a domestic corporation/resident foreign corporation: 30%
RCIT
B. Interest Income derived from a depository bank under the expanded

foreign currency deposit system
Gross interest income from foreign currency deposits with an OBU or FCDU
in the Philippines is subject to a FWT of 15% (7 ½% old law) if the interest
income is received by a citizens, resident aliens, domestic corporations, and
resident foreign corporation.
Note: Any income of non-residents, whether individual or corporations,

from transactions with depositary banks under the EFCD system shall be
exempt from any income tax.
Note: If the foreign currency deposit is with a bank located outside the
Philippines, the interest income is subject to the graduated income tax
rates (if the depositor is a resident citizen) or the NCIT rate of 30% (if the
depositor is a domestic corporation). Take note that interest income on
FCD with a bank located outside the Philippines by a non-resident citizen,
alien individual, and foreign corporation is exempt from income tax,
pursuant to the express provisions of the Tax Code.
C. ROYALTY:
Passive Income: when a person pays a royalty to another for the use of its
intellectual property, such as copyrights, patents, trademarks, such royalty
is a passive income of the owner thereof subject to withholding tax.

Note: The payor is required to deduct and withhold final taxes on royalty
payments when royalty is paid or is payable. After which, the corresponding
return and remittance must be made within 10 days after the end of each
month.
RULES ON ROYALTY:
Royalty Paid By a Domestic Corporation
1. Recipient is a citizen or a resident alien, or a non-resident alien engaged

in trade or business in the Philippines, or a domestic corporation, or a
resident foreign corporation.
-20% final withholding (income) tax, except royalty on books, other

literary works and musical compositions which is subject to 10% final
tax.
2. Recipient is a non-resident alien not engaged in trade or business in the

Philippines
-25% final withholding (income) tax, unless a lower tax rate is allowed
under an existing tax treaty.
3. Recipient is a non-resident foreign corporation

-30% final withholding tax, unless a lower tax rate is allowed under an
existing tax treaty.
Royalty paid by a foreign corporation
1. Recipient is a resident citizen and a domestic corporation

Subject to tax at the graduated rates of tax ranging from 20% to 25% (in
case of resident citizen) or at 30% (in the case of domestic corporation),
because they are liable to income tax on worldwide income
2. Recipient is a non-resident citizen, an alien and a foreign corporation

Since they are liable to Philippine income tax only on income, the source
of which is from the Philippines, they are exempt from income on the

royalties received from a foreign corporation whose property or interest
is not located or used in the Philippines
D. Gross Income derived from contracts by sub-contractors from service

contractors engaged in petroleum operations as defined under PD 87 (Oil
Exploration and Development Act), as imposed under PD 1354: Citizens,
resident alien, non-resident alien engaged in trade or business, domestic
corporation and resident foreign corporation are subject to 8% tax on such
income in lieu of any and all taxes, national and local.
PASSIVE INCOME COMMON TO DOMESTIC CORP. AND RESIDENT FOREIGN

CORP.
A. Interest income derived by a resident depository bank under the FCD

system from foreign currency loans granted by such depository banks to
residents other than OBUs and other banks under the FCD system shall be
subject to 10% final withholding tax. Although the payor-barrower is the
one constituted by law to withhold and remit the 10% final tax, the laws
and jurisprudence do not absolve the FCDU/OBU from the direct liability to
pay the tax, if the payor-barrower fails to perform its duty as withholding
agent.
PASSIVE INCOME COMMON TO CITIZENS & RES. ALIEN AND NON-RES-ALIEN

ENGAGED
A. PRIZES AND WINNINGS: Prizes (except prizes amounting to P10,000 or less

which are subject to the basic tax) and other winnings (except PCSO and
Lotto winnings which are exempt from income tax) are subject to 20% final
withholding tax.
General rule: Contest awards or prizes received from an employer or

another are generally taxable.
Exception:
1. Amounts received as prizes and awards made primarily in recognition of

religious, charitable, scientific, educational, artistic, literary or civic
achievement are not taxable and are considered exclusions from gross
income but only if:

a) The recipient was selected without any action on his part to enter the
contest or proceeding; and
b) The recipient is not required to render substantial future services as a
condition to receiving the prize or award.
2. All prizes and awards granted to athletes in local and international

sports competition and tournaments whether held in the Philippines or
abroad and sanctioned by their National Sports Associations shall be
excluded from gross income. (Philippine Olympic Committee under the
Philippine Sports Commission)
PASSIVE INCOME COMMON TO NON-RES ENGAGED AND NON-RES FOREIGN

CORP
A. A final tax of 25% shall be imposed on the gross income of non-resident

foreign cinematographic film owner, lessor or distributor.
PASSIVE INCOME EXCLUSIVE ON NON_RESIDENT FOREIGN CORPORATION
A. On gross rental income or charter fees derived by non-resident owner or

lessor of vessels from the leases or charters to Filipino citizens or
corporations as approved by the MARINA. 4.5% Final tax
B. On gross income of non-resident lessor of aircraft, machineries and other
equipment. 7.5% Final Tax
C. Interest on foreign loans extended by non-resident foreign corporations is
subject to 20% final withholding tax, unless a lower rate is imposed under
an existing treaty. If the loan is granted by a foreign government or by a
financial institution owned, controlled or enjoying refinancing from the
foreign government, or an international or regional financing institution
established by governments, the interest income of the lender shall not be
subject to the Final withholding tax.
PART II
TAXABLE INCOME
Methods of determining the net taxable income

a) Expenditure method: It is a method of determining income by which the
aggregate yearly expenditures are deducted from the yearly income, not
the expenditures incurred each month and declared thereafter, to arrive at
the net taxable income.
b) Net worth or inventory method: It is a form of determining income from
any available facts or evidence, so that the tax may be assessed and
collected. It is based on assets or properties appearing in the name of the
taxpayer or in the name of his dummies or friends, without the taxpayer
being able to give reasonable explanation for their existence.
c) Sales method or percentage of receipts method: In the absence of
adequate records, the Commissioner can reconstruct gross profit by
ascertaining the total sales or receipts and then applying an average of
gross profit to such sales or receipts. He can also reconstruct taxable
income by applying an average percentage of taxable income to gross
income. Such average may be taken from return filed or from figures
reflecting gross profit and net profit of businesses similar to that of the
taxpayer.
GROSS INCOME
Note: The passive income subject to specific rates or final taxes were already
discussed in the prior discussion. They are no longer included in the computation
of gross income, which determines taxable income.
I: COMPENSATION FOR SERVICES IN WHATEVER FORM PAID:
Note: Subject to withholding on wages under section 79, however, the tax
withheld is not final a final tax and is subject to the result of the computation of
tax liability in the Final Adjustment Return.
All remuneration for services performed by an employee for his employer under
an employer-employee relationship, unless specifically excluded by the Code. The
name by which the remuneration for services is designated is immaterial. Further,
the basis upon which the remuneration is paid is immaterial in determining
whether the remuneration constitutes compensation.
Compensation or wage which is subject to withholding tax on compensation does

not include remuneration paid to the following:

a. For agricultural labor paid entirely in products of the farm where the labor
is performed;
b. For domestic service in a private home;
c. For casual labor not in the course of the employer’s trade or business; or
d. For services by a citizen or resident of the Philippines for a foreign
government or international organization.
Compensation paid other than in cash:
1. The FMV of the thing taken in payment is the amount to be included as

income;
2. If shares of stock were given to an employee in consideration of his services
to the corporation, the value of the shares of stock given shall constitute as
taxable compensation income to the recipient because it is compensation
for services rendered under an employer-employee relationship, hence
subject to income tax. The par value or the stated value of the shares
issued shall constitute as deductible expense to the corporation provided it
has been subjected to the withholding tax on compensation.
3. When living quarters are furnished in addition to cash salary, the rental
value of such quarters should be reported as income.
Compensation made in promissory note: Promissory notes or other evidence of

indebtedness received in payment of services, and not merely as security for such
payment constitute income to the amount of their fair market value.
Tax treatment of fixed and variable allowances: Any amount paid specifically,
either as advances or reimbursements for travelling, representation and other
bona fide ordinary and necessary expenses incurred or reasonably expected to be
incurred by the employee in the performance of his duties are not compensation
subject to withholding tax on compensation, if the following conditions are
satisfied:
a) It is for ordinary and necessary traveling and representation or

entertainment expenses paid or incurred by the employee in the pursuit of
the trade, business or profession; and
b) The employee is required to account/liquidate for the expenses in
accordance with the specific requirements of substantiation for each
category of expenses. The excess of advances made over actual expenses

shall constitute taxable income if such amount is not returned to the
employer.
Note: Backwages, allowance, and benefits awarded in labor dispute constitute

renumeration for services that would have been performed by the employee in
the year when actually rendered, or during the period of his dismissal from
service which was subsequently ruled to be illegal. The employee should report as
income and pay the corresponding income taxes by allocating or spreading his
backwages, allowances and benefits thru the years from his separation up to the
final decision of the court awarding the backwages.
Stock option plans: Any income derived by the employees from their exercise of
stock options is considered as compensation income subject to income tax and
withholding tax. The option has value only if, at the time of the exercise, the stock
is worth more than the price fixed on the grant date.
II: GROSS INCOME DERIVED FROM THE CONDUCT OF TRADE OR BUSINESS OR

EXERCISE OF PROFESSION
Business and trade: Gross income derived from doing business shall be equivalent
to gross sales less sales return, discounts and allowances and cost of goods sold.
Cost of goods sold shall include all business expense directly incurred to produce
the merchandise to bring them to their present location and use.
Sale of services: gross income means gross receipts less sales returns, allowances,
discounts and cost of service. Cost of services shall mean all direct costs and
expenses necessarily incurred to provide the services required by the customers
and clients including salaries and cost of facilities and cost of supplies.
Note: Employer-employee relationship exists only where the person rendering

employment services is an individual and not a corporation. Moreover, the true
test in determining the relationship between the parties is that if he renders
independent occupation, representing the will of his employer only as to the
result of his work and not as to the means and methods by which the work is to
be accomplished, he is a contractor.
Professional income: Fees received by a professional from the practice of his

profession, provided that there is no employer-employee relationship between
him and his clients. The existence of the employer-employee relationship
determines whether the income shall be treated as compensation income or
professional income.
III: GAINS DERIVED FROM DEALINGS IN PROPERTY
A. SHARES OF STOCK OF DOMESTIC CORPORATION
Note: CGT on SOS and Stock transaction tax. See discussion on passive
income.
Income on sale of SOS subject to the basic tax: The resulting gain or loss in
the sale of, barter, exchange or other disposition of shares of stock held as
ordinary assets, is considered as ordinary income subject to the scheduler
rates in case of individual or NCIT rate in case of corporation.
Acquisition or disposition by a corporation of its own capital stock: 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 share of another.
The gain or loss resulting is to be computed in the same manner as though
the payment had been made in another property. Any gain derived from
such transactions is subject to tax, and any loss sustained is allowable as
deduction where permitted by the provisions of the Tax Code.
B. DEALINGS IN REAL PROPERTY
Sale of Capital assets: See discussion on CGT on real property.
Sale of Ordinary Assets: Income realized from the sale of ordinary assets is
subject to the ordinary income tax and the said income shall be declared in
the quarterly/annual income tax return. The income constitutes either
income derived from the conduct of trade or business or a gain from the
dealings in property. Subject to creditable withholding tax.
When the real property should be treated as ordinary assets:
A) If the seller or transferor is a real estate dealer, the real property sold is
an ordinary asset, and the ordinary gain, if any, is subject to the
graduated tax of 20% to 35% (if an individual who is a citizen, or a
resident or non-resident alien engaged in trade or business in the
Philippines, or 25% final tax if a non-resident alien not engaged in trade
or business in the Philippines), or to the 30% normal corporate income
tax (if a domestic corporation or a resident foreign corporation, unless
exempt from tax because it is a socialized housing.)
B) If the seller or transferor is not a real estate dealer, determine whether
the real property sold or transferred is (a) used in the taxpayer’s trade,
business or profession or (b) treated as fixed asset used in his trade, or
business or profession, subject to depreciation. If the answer in either of
the two cases above is in affirmative, the real property shall be treated
as ordinary asset.
Deed of exchange: There are two different taxable transactions.
Note: Assignment of right upon completion of payment of the purchase

price of real property but before the execution of Deed of Sale, is a
separate sale of real property.
Failure to redeem: In case of non-redemption of properties sold during

involuntary sales, regardless of the type of proceedings and personality of
the mortgagees/sellers or entities, the CGT, if the property is a capital
asset; or the Creditable Withholding Tax, if the property is ordinary asset;
the VAT ; and the DST shall become due. The buyer shall be deemed to
have withheld the CGT or CWT due from the sale. The CGT/CWT return
shall be filed after the expiration of the statutory period for redemption.
Real property located outside the Philippines: The gain from the sale or
other disposition of real property not located in the Philippines, regardless
of classification, by resident citizens and domestic corporations shall be
subject to the graduated income tax (if a resident citizen) or NCIT (if
domestic corporation), since they are taxed on worldwide income.
Capital assets other than SOS and Real Property
Generally, income realized from the sale of capital assets are not to be
reported as part of the gross income of an individual in the income tax
return as they are already subject to the final withholding tax. However,
income or capital gains derived from the sale of OTHER CAPITAL ASSETS of
an individual taxpayer, which are not subject to the FWT, should be
declared or reported as part of the gross income in the annual income tax
return of the individual taxpayer, wherein the taxable income shall be
subject to the scheduler rates.
Note: Only 50% of long-term capital gains are recognized as subject to

income tax, if derived by an individual taxpayer, while 100% of the capital
gains are subject to income tax, if derived by an individual taxpayer from
short-term capital asset transaction.
IV: INTEREST
See discussion on passive income.
Interest income derived from an instrument that does not qualify as a deposit
substitute is subject to 20% creditable withholding tax. (basic tax)
Interest income derived by Resident Citizen and Domestic Corporation from

FCDU and from sources outside the Philippines: If the foreign currency deposit is
with a bank located outside the Philippines, the interest income is subject to the
graduated income tax rates (if the depositor is a resident citizen) or the NCIT rate
of 30% (if the depositor is a domestic corporation). Take note that interest income
on FCD with a bank located outside the Philippines by a non-resident citizen, alien
individual, and foreign corporation is exempt from income tax, pursuant to the
express provisions of the Tax Code.
V: RENTAL INCOME
The amount paid for the use or lease or enjoyment of property is rental income to
the owner of the property. Any additional amount paid, directly or indirectly, by
the lessee in consideration for the said lease is considered rental. (Creditable
withholding tax)
Note: if the rented property is being used in business, said rental income shall be
subject to the expanded withholding tax of 5% to be withheld by the lessee.
Failure on the part of the lessee to withhold and remit the said withholding tax
shall not entitle him to claim the rental expense as deduction from his gross
income.
Treatment of buildings or improvements which are not subject to removal:

a) Outright method: The lessor may report as income at the time when the
buildings or improvements are completed the fair market value of such
buildings or improvements subject to the lease.
b) Spread-out method: The lessor may spread over the life of the lease the
estimated depreciated value of such building or improvements at the
termination of the lease and report as income for each year of the lease an
aliquot part thereof.
Note: if the improvements are in lieu of rent, the value thereof is income to
the landlord only in the year of termination of the lease.
Prepaid or advance rental: shall only be considered as rental income of the lessor
once the advance rental is utilized by the lessee. Otherwise, it will only be treated
as security deposit which is not considered income. But the entire amount of the
advance rental is considered as taxable income to the lessor in the year received,
if so received under a claim of right and without restriction as to its use, and
regardless of the accounting method employed.
Note: If lodging is furnished in the business premises of the employer and the
employee is required to accept such lodging as a condition of his employment,
then the value of said lodging will not be taxable. It is merely for the convenience,
comfort and pleasure of the employer.
Long-term contract (dunno why it is here): Persons whose gross income is

derived in whole or in part from such contracts shall report such income upon the
basis of percentage of completion.
VI: ROYALTY
Active Business Income: royalty is a valuable property that can be developed and
sold on a regular basis for a consideration. Thus, any gain derived therefrom is
considered as an active business income subject to the normal income tax. It is a
special form of rental for the use of intangible property. Creditable withholding
tax?
Passive Income: when a person pays a royalty to another for the use of its
intellectual property, such as copyrights, patents, trademarks, such royalty is a

passive income of the owner thereof subject to withholding tax. Note: The payor
is required to deduct and withhold final taxes on royalty payments when royalty is
paid or is payable. After which, the corresponding return and remittance must be
made within 10 days after the end of each month.
RULES ON ROYALTY:
Royalty paid by domestic corporation: see discussion on passive income
Royalty paid by a foreign corporation
1. Recipient is a resident citizen and a domestic corporation

-Subject to tax at the graduated rates of tax ranging from 20% to 25% (in
case of resident citizen) or at 30% (in the case of domestic corporation),
because they are liable to income tax on worldwide income
Recipient is a non-resident citizen, an alien and a foreign corporation

-Since they are liable to Philippine income tax only on income, the source of
which is from the Philippines, they are exempt from income on the
royalties received from a foreign corporation whose property or interest is
not located or used in the Philippines
Discussion on most-favored nation clause General Principle) (equality of

international treatment): The appearance of “most-favored-nation clause”
in a tax treaty means that a contracting state will grant to a resident of the
other contracting state the lower tax rate or exemption the former has
granted to a resident of a third state. Note: The similarity in the
circumstances of payment of taxes is a condition for the enjoyment of the
most-favored-nation treatment precisely to underscore the need for
equality of treatment. Mamalateo 196.
VII: DIVIDEND INCOME
Note: dividends received by a domestic corporation from a foreign corporation is

included in the computation of the gross income and thus, subject to income tax
because there is no law exempting this type of dividend from income tax.

Income Constructively received: Income which is credited to the account of or set
aside 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 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.
Note: Mere increase or appreciation in the value of shares of stock cannot be

considered income for income tax purposes. Since “a mere advance in the value
of the property of a person or corporation in no sense constitute “income”
specified in the revenue law.”
VIII: ANNUITIES AND PROCEEDS FROM LIFE INSURANCE
If part of annuity payment represents interest, then it is a taxable income. If the

annuity is a return of premium, it is not taxable.
Insurance: As a general rule, proceeds from life insurance received by the

beneficiaries or other types of insurance are not subject to income tax if they are
just mere return of capital. However, if such proceeds are held by the insurer
under the agreement to pay interest thereon, the interest payments must be
included in gross income.
IX: PRIZES AND WINNINGS
See discussion on passive income:
Only prizes amounting to P10,000 or less are subject to the normal income tax.
Creditable Withholding Tax?
X: PENSIONS
Retirement benefits and pensions received, other than those received under laws
on pension benefits excluded from gross income, are considered taxable income.
XI: PARTNER’S DISTRIBUTIVE SHARE FROM THE NET INCOME OF A GPP
Although the GPP is exempt from income tax as an entity, the partner’s
distributive share in the net income of the GPP is included in the gross income of
the partner.
Taxable partnership: In the case, however, of a taxable partnership, the taxable
income declared by a partnership for a taxable year which is subject to tax under
Sec. 27 (A) of the Tax Code, after deducting the Corporate income tax imposed
therein, shall be deemed to have been actually or constructively received by the
partners in the same taxable year and shall be subject to the dividends tax under
Section 24(B) of the Tax Code. Thus, the shares are not included in the taxable
gross income.
XII: GROSS INCOME FROM WHATEVER SOURCE
The law imposes a tax on income from whatever source which means that “it
includes income whether coming from legal or illegal sources.” The theory
underlying the taxability of income derived from illegal sources is based on the
principle that an unlawful or prohibited business is not exempt from the payment
of taxes that it would have to pay if it were lawful business.
When a taxpayer acquires earnings, lawfully or unlawfully, without the

consensual recognition, express or implied, of an obligation to repay and without
restriction as to their disposition, he has received taxable income, even though he
may still be adjudged to restore its equivalent. To treat the embezzled funds not
as taxable income would perpetuate injustice by relieving embezzlers of the duty
of paying income taxes on the money they enrich themselves with through
embezzlement, while honest people pay their taxes on conceivable type of
income.
Note: In swindling, the liability of to pay tax is based on the swindler’s having
realized a taxable income from his swindling activities and will not affect his
obligation to make restitution. Payment of the tax is a civil obligation imposed by
law while restitution is a civil liability arising from crime.
Recovery of Bad debts: The general rule is that recovery of amounts deducted in
prior years would result to income. However, where the deduction did not result
in tax benefit, the subsequent recovery is not taxable income. (tax-benefit rule)
Unutilized campaign funds: To be considered as exempt from income tax, these

campaign contributions must have been utilized to cover a candidate’s
expenditure for hi electoral campaign.

Any candidate, who fails to file with the COMELEC the appropriate SOCE, shall be
automatically precluded from claiming such expenditures as deductions from his
campaign contributions. AS such, the entire amount of such campaign
contributions shall be considered as directly subject to income tax.
Forgiveness of indebtedness: Not taxable if it was cancelled by mere

consideration of liberality.
1. Payment of income: indebtedness was cancelled for consideration;

2. Gift: liberality. (donor’s tax0
3. Payment of dividends: creditor corporation forgives a debt of stockholder.
EXCLUSIONS FROM GROSS INCOME

Items of income which are not included in the taxable income. These are items of
income which are excluded by the Constitution, by tax treaties, by the Tax Code
itself, and by special tax laws from gross income and considered exempt from
income tax.
Exclusion Deduction Tax Credit
Actually income received Expenses and other Amount of tax previously

or earned by the taxpayer allowable deductions as paid by the taxpayer
but is not taxable as provided for by laws whether erroneously,
income because of which are incurred for illegally or excessively
exemption provided by engaging in trade or paid or thru the
law or by tax treaties business or exercise of withholding tax system,
profession. but which later on can be
claimed as tax credit
deductible from the tax
liability of the taxpayer.
Nature of exclusions: Exclusions from gross income are in the nature of tax
exemptions, and it behooves upon the taxpayer to establish them convincingly.
The rationale for the exclusions from gross income are as follows:
1. Exclusions from gross income merely represent return of capital and are
not treated as income, gain or profit.

2. Some items of exclusion in the gross income may be subject to another kind
of tax.
3. Some items of exclusions are income, gain or profits that are expressly
exempt from tax under the Constitution, treaties, the Tax Code itself, or
under special laws.
I: PROCEEDS OF LIFE INSURANCE PAID TO THE HEIRS
Since insurance is compensatory in nature, the receipt is merely considered as a

return of capital. Hence, the proceeds of life insurance policy of the insured paid
to the beneficiaries by reason of death of the insured are excluded from the gross
income of his beneficiaries because nothing flows to the beneficiaries other than
a mere return of capital. It is immaterial whether the proceeds are received in a
single sum or in installments.
Exception: If however, the proceeds of the life insurance are held by the insurer
under an agreement to pay interest thereon, the interest payments must be
included in gross income.
II: AMOUNT RECEIVED BY INSURED AS RETURN OF PREMIUM
General Rule: Excluded
Exception: If the amounts received exceed the aggregate premiums or

consideration paid by the insured, then the excess shall be included in gross
income.
III: VALUE OF PROPERTY ACQUIRED BY GIFT, BEQUESTS, AND DEVISES
Where there was no prior agreement or negotiations between two parties that
one party will be compensated for the services rendered, the transfer having
been made gratuitously should be treated as gift subject to donor’s tax and
should be excluded from the gross income of the recipient.
IV: 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 for personal
injuries or sickness are excluded from the gross income of the insured, his estate

or beneficiaries. Obviously, the damage is considered by law as a mere return of
capital.
V: INCOME EXEMPT UNDER TREATY
The provision of a tax treaty must take precedence over and above the provision
of the local taxing statute consonant with the principle of international comity.
Tax treaties are accepted limitations to the power of taxation.
VI RETIREMENT BENEFITS, PENSIONS, GRATUITIES, ETC
Note: Additional payments in the form of gifts for the loyalty and invaluable
services given by private employers on top of the retirement benefits under a
reasonable private benefit plan should not form part of the retirement benefits
exempt from income tax. Rather, it should be taxed as a taxable gift to the donor
who/which is subject to donor’s tax.
In order to avail of the exemption of the retirement benefits under R.A 7641
from private employers without any retirement plans, the following conditions
must be met:
1. The retirement benefits must be received under the existing CBA or other
agreements;
2. This is given in the absence of retirement plan or agreement providing for
retirement benefits;
3. The retiring employee has served at least 5 years in the establishment;
4. That he is not less than 60 years of age but not more than 65, which is
declared as the compulsory retirement age;
5. He shall be entitled to retirement pay equivalent to at least ½ month salary
for every year of service, a fraction of at least 6 months being considered as
one whole year.
Exemption under a reasonable benefit plan
1. The plan must be reasonable;

2. The benefit plan must be approved by the BIR;
3. The retiring official or employee must have been in service of the same
employer for at least 10 years and at least 50 years old at the time of
retirement;

4. The retiring official or employee should not have previously availed of the
privilege under the retirement benefit plan of the same or another
employer.
Additional payments in the form of gifts for the loyalty and invaluable services
given by private employers on top of the retirement benefits under a
reasonable private benefit plan: Subject to donor’s tax, hence, not included in
the gross income.
Terminal Leave: not a salary but a retirement gratuity not subject to income tax.
Pension: not a salary nor gratuity, but a vested right. The right to a public pension
is of statutory origin.
Separation pay: Excluded (including ex-gratia payments)
Requisites:
a) The employee or official was terminated from service for any cause beyond
his control.
b) The separation from service of the official must not be asked or initiated by
him.
c) The separation was not of his own making
d) Whether or not the separation is beyond the control of the official or
employee, being essentially a question of fact, shall be duly established by
the employer by competent evidence. (employer-withholding agent)
Exception: when an employee is lawfully dismissed for serious misconduct or

those involving moral turpitude, he is not entitled to separation pay. Thus, any
payment made by an employer to an employee on account of lawful dismissal
constitutes compensation regardless of whether the employer is legally bound by
contract, statute, or otherwise, to make such payment.
Other excluded payments: Social Security benefits from other country, payment
by US Veterans Administration, SSS, GSIS benefits.
MISCELLENEOUS ITEMS

Exempt from income tax, therefore excluded from gross income: Income derived
from investment in the Philippines in loans, stocks, bonds, or other domestic
securities, or from interest in banks in the Philippines by:
a) Foreign government
b) Financing institutions owned, controlled, or enjoying refinancing from
foreign government.
c) International or regional financial institutions established by foreign
governments.
Note: A stipulation in a Loan Agreement between a borrower (government

agency) and a private International Bank, as a lender, that the interest income to
be derived by the lender shall be made free from all Philippine Tax is valid. The tax
from the said loan is not exempt from taxes but the government agency will
assume the Philippine taxes that may be imposed thereon, which is not contrary
to law, morals, good customs, public order, or public policy. (The income is
exempt only when the recipient is the government agency)
Note: Interest on the loans granted by a private international financial institution

and entered into an executive agreement between the President of the
Philippines and the president of another country is not exempt from income tax.
The act of tax exemption is an act of taxation which is inherently legislative. A
mere executive agreement cannot provide for a tax exemption. An executive
agreement is not treated as a tax treaty.
Income derived by the Government: Income derived by the government or its

political subdivision from any public utility or from the exercise of any essential
governmental function accruing to the Government of the Philippines or to any
political subdivision thereof shall be excluded from the gross income and
therefore exempt from income tax.
Exempt Prizes and awards: See previous discussion
13th month pay: The gross benefits received by officials and employees of public
and private entities in the form of 13th month pay and other benefits are excluded
from the gross income for income tax purposes to the extent of P30,000.00.

De minimis Benefits: these are actually fringe benefits which are non-taxable.
They need not be reported in the preparation of income tax return because they
are exempt from taxes.
a) Monetized unused vacation leave credits of private employees not

exceeding 10 days during the year.
b) Monetized unused leave credits of government officials or employees
during the year.
c) Medical allowance to dependents of employees not exceeding P750 per
employee per semester or P125 per month.
d) Rice subsidy of P1,500.00 or 1 sack of 50kg rice per month amounting to
not more than P1,500.00.
e) Uniform and clothing allowance not exceeding P5,000.00 per annum
f) Actual yearly medical benefits not exceeding P10,000.00 per annum.
g) Laundry allowance not exceeding P300.00 per month; and
h) Employees achievement awards, with annual monetary value not
exceeding 10,000.00 pesos received by the employee under established
written plan which does not discriminate in favor of highly paid employees.
i) Gifts during cristmas and major anniversary celebrations not exceeding
P5,000 per employee per annum.
j) Daily meal allowance for overtime work not exceeding 25% of the basic
minimum wage.
FRINGE BENEFIT
A final withholding tax of 32% is imposed on the grossed up monetary value of

fringe benefit furnished , granted or paid by the employer to the employee,
except rank-and-file employees, whether such employer is an individual,
professional partnership or a corporation, regardless of whether the corporation
is taxable or not, or the government and its instrumentalities, except when:
1. The fringe benefit is required by the nature of or necessary to the trade,

business or profession of the employer.
2. When the fringe benefit is for the convenience or advantage of the
employer.

Treatment: As a general rule, the amount of taxable fringe benefit and the fringe
benefit tax shall constitute allowable deductions from gross income of the
employer.
Economic incidence: Tax incidence falls upon the individual who ultimately bears
the burden or ultimately has to pay the tax.
Statutory incidence: Individuals who are responsible for physically remitting a

particular tax to the government.
Who is liable: It is the employer who is legally required to pay the fringe benefit
tax. The fringe benefit tax is imposed as a final withholding tax placing the legal
obligation to the employer to remit the tax, such that, if the tax is not paid, the
legal recourse of the BIR is to go after the employer.
Grossed-up monetary value: The GUMV of the fringe benefit represents the
whole amount of income realized by the employee which includes the net
amount of money or the net monetary value of property which has been received
plus the amount of fringe benefit tax thereon otherwise due from the employee,
but paid by the employer and in behalf of his employee.
Fringe Benefit Tax granted to non-resident alien individuals
1. Non-resident alien individual not engaged in trade or business: subject to

the FBT of 25% of the grossed up monetary value of the fringe benefit.
2. 15 % FBT on other alien individuals: (a) employed by regional or area
headquarters and regional operating headquarter of a multi-national
company, including its Filipino employees employed and occupying the
same position as those of its aforesaid employees; (b) Alien individual
employed by an OBU of a foreign bank established in the Philippines
including its Filipino employees employed and occupying the same position
as those of its aforesaid employees; (c) Alien individual employed by
foreign service contractor and sub-contractor engaged in petroleum
operations in the Philippines, including its Filipino employees employed and
occupying the same position as those of its aforesaid employees.
Computation of FBT
a. Valuation of the benefit granted

1. If the FB is granted in money, or is directly paid by the employer, then
the value is the amount granted or paid;
2. If the FB is granted or furnished by the employer in property other than
money and ownership is transferred to the employee, then the value of
the FB shall be equal to the FMV of the property;
3. If the fringe benefit is granted or furnished by the employer in property
but the ownership is not transferred to the employee, the value of the
FB is equal to the depreciation value of the property.
b. Determination of the proportion or percentage of the benefit which is
subject to the FBT.
Guidelines for valuation of specific types of Fringe Benefits and determination

of the Monetary Value:
I: Housing privilege:
a. Leased of residential property as the usual place of residence of the

employee: The value of the benefit shall be the amount of rental paid
thereon by the employer, as evidenced by the lease contract. MV: 50% of
the value of the benefit.
b. Residential property owned by the employer and used by the employee
as usual place of residence: The annual value of the benefit is 5% of the
market value of the land and improvement. MV: 50% of the value of the
benefit.
c. Purchased of residential property on installment basis to be used by the
employee as his usual place of residence: The value of the benefit shall be
5% of the acquisition cost, exclusive of interests. MV: 50% of the value of
the benefit.
d. Purchased of residential property and transfer of ownership thereof to
the employee: The value of the benefit shall be the employer’s acquisition
cost or zonal value, whichever is higher. MV: 100%.
e. Purchased of residential property and transfer of ownership thereof to
the employee for insufficient consideration: The value of the benefit shall
be the difference between the Fair market value or zonal value, whichever
is higher, and the cost to the employee. MV: 100%
f. Housing privilege of AFP: Not subject to FBT.

g. Housing unit which is situated inside or adjacent to the premises of a
business or factory: shall not be considered as a taxable Fringe benefit.
h. Temporary housing for an employee who stays in a housing unit for 3
months or less shall not be considered a taxable fringe benefit.
EXPENSES
a. Expenses incurred or paid by the employee but which are paid or

reimbursed by the employer shall be treated as taxable fringe benefits,
except when the expenditures are duly receipted for and in the name of the
employer and the expenditures do not partake the nature of personal
expense attributable to the employee.
b. Representation and Transportation Allowances which are fixed in amounts
and regularly received by the employees as part of their monthly
compensation income shall not be treated as taxable fringe benefit but the
same shall be considered as taxable compensation income.
MOTOR VEHICLE:
1. Purchased by employer in the name of employee: The value of the benefit

is the acquisition cost. MV: 100%
2. Employer provides cash for purchase of vehicle in the name of the
employee: The value of the benefit shall be the cash received. MV: 100%
3. Purchased in installment basis: The value of the benefit shall be the
acquisition cost, divided by 5 years. MV: 100%
4. Part of the payment is shouldered by the employer: The value of the
benefit shall be the amount shouldered. MV: 100%
5. Employer owns and maintains a fleet of motor vehicle for the use of
business and employees: The value of the benefit shall be the acquisition
cost of all motor vehicles not normally used for sales, freight, delivery
service and other non personal use divided by 5 years. MV: 50%
6. Employer leases and maintains a fleet of motor vehicle for the use of
business and employees: The value of the benefit shall be the amount of
rental payments for motor vehicles not normally used for sales, freight,
delivery service and other non personal use divided by 5 years. MV: 50%
7. Used of aircrafts owned and maintained by the employer: treated as
business use and not subject to FBT.

8. Used of yatch: subject to FBT, the value of the benefit shall be measured
based on the depreciation of a yatch at an estimated useful life of 20 years.
IV: HOUSEHOLD EXPENSES: expenses of the employee which are borne by the
employer for household personnel, such as salaries of household help, personal
driver of the employee, or other similar expenses shall be subject to FBT.
V: INTEREST ON LOAN AT LESS THAN THE MARKET RATE: If the employer lends
money to his employee free of interest or at a rate of lower than 6%, such
interest foregone by the employer or the difference of the interest assumed by
the employee and the rate of 6% shall be treated as taxable fringe benefit.
VI:MEMBERSHIP FEES, DUES, AND OTHER EXPENSES BORNE BY THE EMPLOYER

FOR HIS MANAGER OR SUPERVISOR, IN SOCIAL AND ATHLETIC CLUBS OR OTHER
SIMILAR ORGANIZATIONS: Shall be treated as taxable benefits in full. Note: the
assignment of shares fom the previous assignee-manager of an assignor-
corporation to a new assignee-manager is not subject to income tax because
there is no real change of ownership that will take place considering that it is still
the assignor-corporation who is still the owner of the shares. However the playing
rights benefit is subject to FBT.
VII: EXPENSES FOR FOREIGN TRAVEL: Reasonable business expenses which are
paid by the employer for the foreign travel of his employee for the purpose of
attending business meetings or conventions shall not be treated as taxable fringe
benefit. The cost of economy and business class airplane ticket shall not be
subject to a FBT. However, 30% of the cost of first class airplane ticket shall be
subject to FBT.
VIII: HOLIDAY AND VACATION PAY
IX: EDUCATIONAL ASSISTANCE TO THE EMPLOYEE OR HIS DEPENDENTS: General

rule: subject to FBT. Exception: the education or study involved is directly
connected with the employer’s trade, business or profession, and there is a
contract between them that the employee will remain in the employ of the
employer for the period of time that they have mutually agreed upon.
X: LIFE OR HEALTH INSURANCE AND OTHER NON_LIFE INSURANCE PREMIUMS

OR SIMILAR AMOUNTS IN EXCESS OF WHAT THE LAW ALLOWS

XI: STOCK OPTION PLANS
___________________________________________________
ALLOWABLE DEDUCTIONS
Allowable deductions: the items of deductions enumerated under Section 34,
including the special deductions allowed to insurance companies under section 34
of the Code. Provided, that in the case of an individual and a corporation entitled
to claim the Optional Standard Deduction (OSD), under Section 34, in lieu of the
deductions enumerated under Sec 34, the tem “allowable deductions” shall mean
the aforesaid OSD.
Note: legislative grace doctrine: An income tax deduction is allowed as a matter of

legislative grace. The burden of clearly showing the right to the claimed deduction
is on the taxpayer. Only as there is a clear provision of law can any particular
deduction be allowed, and the taxpayer seeking a deduction must be able to
point to an applicable statute and show that he comes within its terms.
Taxpayers not allowed to claim the allowable deductions
a) Taxpayers earning compensation income arising from personal services

rendered under an employer-employee relationship ( except for the
deduction on premium payments on health and hospitalization insurance
under Sec 34M)
b) Non-resident individual not engaged in trade or business within the
Philippines.
c) Non-resident foreign corporations
d) Other taxpayers taxed under special tax regime.
Construction of Deductions: Deductions for income tax purposes partakes the

nature of a tax exemption, then it must also be strictly construed against the
taxpayer, who must prove by convincing evidence that he is entitled to the
deduction claimed.
TAXPAYER DEDUCTIONS
Individual earning pure compensation 1. Personal and additional exemption
income (except non-resident alien not 2. Premium payments on
engaged in trade or business) health/hospitalization insurance.
Individuals deriving income from trade 1. Personal and additional exemption
or business, or exercise of profession.
2. Premium payments on
health/hospitalization insurance.
3. Itemized and OSD
Corporations (except non-resident Itemized deductions and OSD
corporation)
Rules on deductibility:
a) Deductions must be ordinary and necessary and must be paid or incurred in

connection with the taxpayer’s trade, business or exercise of profession.
b) Deductions must be paid or incurred during the taxable year.
c) Deductions must be supported by adequate receipts or invoices; and
d) Deductible expenses (if subject to withholding tax) must have been
subjected to withholding tax
e) Deductions must be legitimately paid.
FIRST DEDUCTION: ORDINARY AND NECESSARY TRADE, BUSINESS OR

PROFESSIONAL EXPENSES
Business Expense: expenditures related to the conduct of the business of the

taxpayer and deductible in the year incurred.
Capital expense: Expenditures that improve or add to the value of the property or
equipment of the business. They are not immediately deductible, but may be
deducted overtime in the form of “Allowance for depreciation.”
Accrual method: expenses not claimed as deduction in the current year when
they are incurred cannot be claimed as deduction from income for the succeeding
year.
Professional expenses: cost of supplies, expenses paid in operation and repair of

transportation equipment used in making professional calls, dues to professional
societies, subscription to professional journals, rent paid for office rooms, (fule,
light, water, telephone expenses used in office), salaries of staffs, (books,
furniture, and professional equipments and instruments, the useful life of which is
short), training expenses, and other necessary expenses.
1. SALARIES AND OTHER FORMS OF COMPENSATION FOR PERSONAL SERVICES

ACTUALLY RENDERED

Reasonable allowance for salaries or other compensation for personal services
actually rendered. The test of deductibility in the case of compensation payment
is whether they are reasonable and are, in fact, payments purely for personal
services. Any amount paid in the form of compensation, but not in fact as the
purchase price of service, is not deductible.
Bonuses: Allowed as deductions from the gross income when such payments are
made in good faith and as additional compensation for the services actually
rendered by the employees, provided such payments, when added to the
stipulated salaries, do not exceed a reasonable compensation for the services
rendered.
Pensions; Compensations for injuries: Amounts of 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.
2. FRINGE BENEFITS EXPENSE
The company can deduct the amount of the grossed-up monetary value of the
fringe benefit given to the managers or supervisors as a fringe benefit expense
provided that the said fringe benefits given had been subjected to the Final
Withholding Tax on Fringe benefits.
3. TRAVELLING/TRANSPORTATION EXPENSES
Essential Requisites:
a) Expense must be reasonable and necessary.

b) It must be paid or incurred while away from home.
c) It must be paid or incurred in the conduct of trade or business or exercise
of profession.
4. RENTAL EXPENSE
Note: The cost borne by a lessee in erecting buildings or making permanent

improvement on the ground of which he is a 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 the
gross income of an amount equal to the cost of such improvements divided by the
number of years remaining of the terms of lease.
5. ENTERTAINMENT, AMUSEMENT AND REPRESENTATION EXPENSES
Note: It must not exceed the ceiling of .50% of net sales for sellers of goods or
properties or 1% of net revenues for sellers of services.
6. MINOR OR ORDINARY REPAIRS AND MAINTENANCE
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 expenses, provided the plant or property
account is not increased by the amount of such expenditure.
7. COST OF MATERIALS AND SUPPLIES
8. ADVERTISING AND OTHER SELLING EXPENSES
Advertising to stimulate the current sale of merchandise or use of services:

deductible as business expense.
Advertising designed to stimulate the future sale of merchandise or use of

service: it must be spread out over reasonable period of time.
9. PROFESSINAL SERVICES
10. TRAINING EXPENSES
11. MANAGEMENT EXPENSES
12. OTHER NECESSARY BUSINESS EXPENSES
NOTES:
1. Capital expenditures are not deductible during the year but can be
amortized.
2. Pre-operating expenses or organizational expenses of a corporation are
considered as capital expenditure and are therefore, not deductible in the
year they are paid or incurred. But taxpayers who incur these expenses and
subsequently enter the trade or business to which the expenditures relate
can elect to amortize these expenditures over a period of not less than 60
months. Organizational expenses are amortized across the life of the firm.
3. Substantiation requirements: No expenses shall be allowed as deduction
from gross income unless the taxpayer shall substantiate with sufficient
evidence, such as official receipts or other adequate record, the amount of
the expenses being deducted and the direct connection or relation of the
expense being deducted to the development, management, operation
and/or conduct of the trade, business or profession of the taxpayer.
4. Bribery and kickback not allowed as deduction: Amount constituting as a
bribe to a government official in order to facilitate the processing of a
transaction from a government office is not allowed as deduction from the
gross income. However, on the part of the subject approving official, who
received the said amount as a bribe, the said amount would constitute as a
taxable income because all income from legal or illegal sources whatsoever
are taxable absent any clear provision of law exempting the same from
income tax.
5. Political campaign expenses or contributions to a candidate in an election
not allowed as deduction.
NOTE: EXPENSES ALLOWABLE TO PRIVATE EDUCATIONAL INSTITUTION
In addition to the express allowable deductions stated above, a private

educational institution, referred to under section 27(b) of the tax code, may at its
option, elect either:
A. To deduct expenditures otherwise considered as capital outlays of

depreciable assets incurred during the taxable year for the expansion of
school facilities; or
B. To deduct allowance for depreciation thereof under subsection 34 (f).
SECOND DEDUCTION: INTEREST
(Interest subject to final tax cannot be deducted)
Requisites for deductibility:
1. That there must be an indebtedness:

2. There should be an interest expense paid or incurred upon such
indebtedness during the taxable year.
3. The indebtedness must be that of the taxpayer.
4. The indebtedness must be connected with the taxpayer’s trade, business or
exercise of profession.
5. The interest must not be incurred to finance petroleum operations;
6. The interest must be legally due.
7. The interest payment arrangement must not be between related taxpayers
as mandated by 34(b)(2)(b), in relation to section 36(b).
8. The interest must not be incurred to finance petroleum operations.
9. In case of interest incurred to acquire property used in trade, business or
exercise of profession, the same was not treated as capital expenditure.
10.That the allowable deduction for interest expense shall be reduced by 33%
of the interest income subject to the final tax.
11.The interest is not expressly disallowed by law.
Interest on unpaid taxes: interest incurred or paid by the taxpayer on all unpaid
business-related taxes shall be fully deductible from the gross income and shall
not be subject to the limitation on deduction heretofore mentioned.
Interest that may be deducted in the taxable year: In general, interest expense
shall be taken for the taxable year in which “paid or incurred” or “paid or accrued)
depending upon the method of accounting upon the basis of which the taxable
income is computed, unless in order to clearly to clearly reflect the income, the
deduction should be taken as of a different period. Thus, a self-employed
individual is allowed to deduct from his gross income the entire amount of
interest expense actually paid during the taxable year. However, if the interest
expense is paid in advance and the accounting method used by the individual is
the cash-basis accounting method, such interest expense paid in advance shall
not be allowed as deduction. However, it shall only be allowed as deduction in the
year when he has fully paid his liability. Note: that in the case of interest
periodically amortized, if the indebtedness is payable in periodic amortization, the
amount of interest which corresponds to the amount of the principal amortized
or paid during the year shall be allowed as deduction in such taxable year.
RELATED TAXPAYERS
1. Between family members;

2. Between an individual and the corporation more than 50% in value of the
OCS of which is owned, directly or indirectly, by or for the same individual.
3. Between two corporations more than 50% in value of the OCS of each of
which is owned, directly or indirectly, by or for the same individual.
4. Between grantor and a fiduciary of any trust.

5. Between the fiduciary of a trust and the fiduciary of another trust if the
same person is a grantor with respect to each trust.
6. Between a fiduciary of a trust and a beneficiary of such trust.
INTEREST EXPENSE ON A CAPITAL EXPENDITURE INCURRED TO ACQUIRE

PROPERTY USED IN TRADE, BUSINESS OR EXERCISE OF A PROFESSION:
TREATMENT
1. Outright deduction: A deduction in full in the year when incurred, the

provisions of section 36(A) (2) and (3) to the contrary notwithstanding.
2. Treated as capital expenditure: The taxpayer may claim only as a
deduction the periodic amortization/depreciation of such expenditure.
(Capitalization of the interest payments)
THIRD DEDUCTION: TAXES
Taxes allowed: “Taxes” means tax proper and no deductions should be allowed
for amounts representing interest, surcharge, or penalties incident to the
delinquency. “direct tax only”
Requisites of deductibility
1. Taxes must be paid or incurred in connection with the taxpayer’s trade or
business or exercise of profession;
2. Tax must be imposed by law directly on the taxpayer;
3. Taxes must be paid or incurred during the taxable year;
4. Taxes must be those allowed and not disallowed to be deducted from the
gross income under section 34 (c);
5. Said taxes must be duly substantiated by OR.
Taxes allowed: Indirect taxes, Taxes payable to the bureau of customs, Local
taxes, Automobile registration fee for vehicle being used in business or practice of
profession, any other taxes of every name or nature paid to the directly to the
government or to any political subdivision thereof. 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.
Non-deductible: Income tax (except FBT), foreign income tax of any foreign
country, except when a resident citizen, domestic corporation or estate signifies
in his/its return his/its desire to have the benefits of crediting against his taxes
payable in the Philippines the taxes he/it paid in foreign countries, estate tax,
donor’s tax, STT, tax assessed against local benefits of a kind tending to increase

the value of the property assessed, taxes not connected to the trade, business or
profession, energy tax and FWT.
Tax-benefit rule: The general rule is that recovery of amounts deducted in prior
years would result to income. However, where the deduction did not result in tax
benefit, the subsequent recovery is not taxable income.
Tax credit of taxes paid in foreign country: An alien individual and a foreign
corporation shall not be allowed to credit against the taxes paid in the Philippines
the taxes paid in foreign countries because they are subject to Philippine income
tax only on income derived from sources within the Philippines.
FOURTH DEDUCTION: LOSSES
Losses which are allowed as deductions from gross income are those actually
sustained during the taxable year and not compensated for by insurance or other
forms of indemnity.
Types:
1. Casualty losses
2. NOLCO
3. Capital Losses and securities becoming worthless
4. Special Losses:
1. Losses from wash sales of stocks or securities;
2. Wagering losses;
3. Abandonment losses;
I: Casualty losses: refers to the complete or partial destruction of property

resulting from an identifiable event of sudden, unexpected or unusual nature.
Value of the casualty loss: Deductible casualty loss shall be the difference
between the value of property immediately preceding casualty and its value
immediately thereafter, but shall not exceed the amount equal to the cost or
other adjusted basis of the property, or depreciated cost in case of property used
in business and reduced by any insurance or other compensation received.
II: Net Operating Loss Carry-over (NOLCO): The excess of allowable deduction
over gross income of the business in a taxable year. The net operating losses
which have not been previously offset as deduction from gross income shall be
carried over as deduction from gross income for the next 3 consecutive taxable
years. (individual engaged in trade, domestic and foreign corporation.)

See change in ownership, casasola 333
In relation to OSD: An individual who claims OSD shall not simultaneously claim
deduction of the NOLCO. Provided further that, the 3-year reglementary period
shall continue to run notwithstanding the fact that the aforesaid individual availed
of the OSD during the said period.
In relation to MCIT: Corporation cannot enjoy the benefit of NOLCO for as long as
it is subject to MCIT in any taxable year. The 3-year reglementary period shall
continue to run notwithstanding the fact that the corporation paid its income tax
under the MCIT computation.
III: CAPITAL LOSSES AND SECURITIES BECOMING WORTHLESS:
A. Capital Losses: Losses from the sales or exchange of capital assets. Capital
losses from sales or exchange of capital assets are deductible only to the
extent of the capital gains from such sales or exchanges of capital assets of
both individuals and corporations. If the dealings of the taxpayer in capital
assets during the year result in a net capital loss, such loss cannot be
deducted from his ordinary income, inasmuch as capital losses are
allowable only to the extent of capital gains. (Note: Gains subject to the
FWT is not includible to the gross income)
B. Securities considered as worthless: Shares of stock when offered for sale

or requested for share redemption, no amount can be realized by the
owner of the share. Securities becoming worthless, which are capital
assets, shall be considered as a loss from the sale or exchange of capital
assets on the last day of such taxable year. (ordinary asset: not deductible:
loss not realized.)
IV: SPECIAL DEDUCTIONS:
a. Losses from wash sales of stocks or securities: The term “wash sale of
stocks or securities” is a sale or other disposition of stock or securities
where the taxpayer has acquired or has entered into a contract or option to
acquire substantially identical stocks or securities within 61-day period,
beginning 30 days before the sale and ending 30 days after the sale. Losses
from wash sale are not deductible from the gross income, except it is a loss
incurred by a dealer in securities in ordinary course of business.
b. Wagering losses: Losses from wagering transactions shall be allowed only
to individuals to the extent of the wagering gains or winnings from such
transactions.
c. Abandonment losses: In the event a contract area where petroleum
operations are undertaken is partially or wholly abandoned, all
accumulated exploration and development expenditures pertaining thereto
shall be allowed as deduction.
FOURTH DEDUCTION: BAD DEBTS
Bad debts: Those debts resulting from worthlessness or uncollectibility, in whole

or in part, of amounts due to the taxpayer by others, arising from money lent or
from uncollectible amounts of income from goods sold or services rendered
actually ascertained to be worthless and charged off within the taxable year.
Requisites of deductibility:
1. There must be existing indebtedness due to the taxpayer which must be

valid and legally demandable;
2. The same must be connected with the taxpayer’s trade, business or
practice of profession;
3. The same must not be sustained in a transaction entered into by related
parties;
4. The same must be actually charged off in the books of accounts of the
taxpayer as of the end of the taxable year; and
5. The same must be actually ascertained to be worthless and uncollectible as
of the end of the taxable year and even in the future.
Ascertained to be worthless: While a mere hope probably will not justify

postponement of the deduction, a reasonable possibility of recovery will permit
the account to be carried along notwithstanding that the probabilities are that the
debt may not be collected at all. The creditor may offer evidence to show some
expectation that the debts would have been paid in the intervening years, and
that subsequently, the hope was shattered or appeared to have been unfounded.
Note: Recovery of bad debts, subject to the tax benefit rule.
FIFTH DEDUCTION: DEPRECIATION
Depreciation: A reasonable allowance for exhaustion, wear and tear, and

obsolescence of property in the trade or business may be deducted from gross
income.
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
useful life, so that depreciation alone are insufficient to return the cost at the end
of its economic term of usefulness, a reasonable deduction for obsolescence, in
addition to depreciation, may be allowed in accordance with facts obtaining with
respect to each item of property concerning which a claim for obsolescence is
made.
1. The allowance for depreciation must be sustained by person who owns or
who has capital investment in the property;
2. The allowance for depreciation must be reasonable in that the amount of
depreciation must be in accordance with the depreciation method adopted
by the company.
3. The property must have a limited useful life.
4. The allowance for depreciation should not exceed the cost of the property.
5. The schedule of the allowance must be attached to the return.
Note: Only one vehicle for land transport is allowed for the use of an official or
employee, the value of which should not exceed P2,400,000.00.
Note: The income tax law does not authorized depreciation of an asset beyond its
acquisition cost. The reason is that deductions from gross income are privileges,
not a matter of right.
Methods of computing allowance for depreciation:
a. Straight-line method: The method is to the effect that the rate and the
base are constant. Under this method, the cost or other basis of the
property less its estimated salvage value is deductible in equal annual
amounts over the period of the estimated useful life of the property.
b. Declining-balance method: The fixed percentage of diminishing book value
method is to the effect that the rate of yearly depreciation remains the
same but the base upon which rate is applied diminished form year to year.
c. Sum-of-the-year method: 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.
SIXTH DEDUCTION: DEPLETION
Depletion: refers to the exhaustion of natural resources owing to production or

severance. The allowance for depletion is based on the theory that the
extractions of minerals gradually exhaust the capital investment in the mineral
deposit. These deductions are allowed only to mining entities which own an
economic interest in the mineral deposits. The allowable cost of depletion
deduction shall be limited only to the extent of the capital invested in the
particular mining property.
SEVENTH DEDUCTION: CHARITABLE AND OTHER CONTRIBUTIONS
1. The contribution must have been actually made to entities specified by law;
2. The contribution must have been made within the taxable year;
3. It must be evidenced by adequate receipts or records;
4. For contributions other than money, the amount shall be based on the
acquisition cost of the property not the fair market value of the property.
At the time of the contribution.
5. For contributions subject to statutory limitations, the same must not
exceed 10% in the case of individuals (engaged in trade or business) or 5%
in the case of corporations of the said taxpayer’s taxable income before
deducting the charitable contributions.
Donations deductible in full:
1. Donations to government: To finance , to provide for, or to be used in

undertaking priority activities in education, health, youth and sports
development, human settlements, science and culture, and in economic
development according to a national priority plan determined by NEDA.
2. Donations to certain foreign institutions or international organizations: In
pursuance of treaty.
3. Donations to accredited non-stock, non-profit corporations/NGOS. The
level of administrative expense of which shall, on an annual basis and in no
case to exceed 30% of the total expense.
EIGHT DEDUCTION: RESEARCH AND DEVELOPMENT EXPENDITURE
Requisites:
1. Research or development expenditures were paid or incurred in connection
with the taxpayer’s trade, business or practice of profession.
2. The same had been paid or incurred during the taxable year as ordinary and
necessary expenses.
3. The same had not been charged to the capital account.
NINETH DEDUCTION: PENSION TRUSTS

Note: deduction applicable only to the employer on account of its contribution to
a private pension plan for the benefit of its employees.
OPTIONAL STANDARD DEDUCTION:
Who may avail:

1. Individuals and taxable estates and trusts, except individuals earning pure
compensation income and non-resident aliens.
2. Corporations, except nonresident foreign corporations.
Note: The taxpayer must signify in his/its return filed for the first quarter his
intention to elect OSD as deduction, otherwise, he/ it is considered as having
availed of the itemized deduction. The election to avail of the OSD is irrevocable
for the year in which made; however , he/it can change to itemized deduction in
succeeding years if he/it opts it. The OSD allowed shall be a maximum of 40% of
gross sales or receipts during the taxable year.
GPP opting to avail the OSD: For purpose of computing the distributive share of
the partners, the net income of the GPP shall be computed in the same manner as
a corporation. As such, a GPP may claim either the itemized deduction or the in
lieu thereof, it can opt avail of the OSD allowed to corporations in claiming the
deductions in an amount not exceeding 40% of its gross income. The net income
determined by either claiming the itemized deduction or OSD from the GPP’s
gross income is the distributable net income from which the share of each partner
is to be determined. Each partner shall report as gross income his distributive
share, actually or constructively received, in the net income of the partnership.
Partners of GPP may claim deduction: The GPP is not a taxable entity for income
tax purposes since it is only acting as a mere “pass-through” entity where its
income is ultimately taxed to the partners comprising it. Claiming further
deduction shall be guided by the following rules:
1. GPP avails Itemized deductions: Since the taxable income is in the hands of
the partner, as a rule, apart from the expenses claimed by the GPP in
determining its net income, the individual partner can still claim deductions
incurred or paid by him that contributed to the earning of the income
taxable to him. Provided, that in claiming itemized deductions, the partner
is precluded from claiming the same expenses already claimed by the GPP.
2. GPP avails OSD: If GPP avails of OSD in computing its net income, the
partners comprising it can no longer claim further deduction from their
share in the said net income because the OSD will answer for both items of
deduction allowed to GPP and its partners. Further, the partners’
distributive share in the GPP is treated as his gross income not his gross
sales/receipts and the 40% OSD allowed to individuals is specifically
mandated to be deducted not from his gross income but from his gross
sales/receipts. Provided, however, that if GPP opts for the OSD, the
individual partner may still claim 40% of its gross income from trade,
business or practice of profession but not to include his share from the net
income of the GPP.
Irrevocability of option: The election to avail of the OSD is irrevocable for the
year in which made. Thus, a taxpayer who avails of the OSD in the first quarter of
its/his taxable year shall have to claim the same OSD in determining its/his
taxable income for the rest of the year.
OTHER DEDUCTION:
OTHER ONE: PREMIUM PAYMENTS ON HEALT AND/OR HOSPITALIZATION

INSURANCE OF AN INDIVIDUAL TAXPAYER:
Requisites:
a. Hospitalization insurance must actually have been taken by the individual
for himself and/or for the members of his family.
b. The individual availing either earns purely compensation income or earning
business income or engaged in the practice of profession.
c. The gross income of the family of the individual does not exceed P250,000
for the taxable year.
d. The amount of the premium deductible does not exceed P2400 per family
or P200 per month during the taxable year.
e. In case of married individuals, only the spouse claiming additional
exemption shall be entitled to this deduction.
OTHER TWO: ALLOWANCE OF PERSONAL EXEMPTION FOR INDIVIDUAL

TAXPAYER (repealed)
ITEMS NOT DEDUCTIBLE
1. Personal, living and family expenses.

2. Any amount paid out for new buildings or permanent improvements, or
betterments made to increase the value of any property or estate.
3. Any amount expended in restoring property or in making good the
exhaustion thereof for which an allowance is or has been made;
4. Premiums paid in life insurance policy covering the life of any officer or
employee, or of any person financially interested in any trade or business
carried on by the taxpayer, individual or corporate, when the taxpayer is
directly or indirectly a beneficiary under such policy.
Losses from sales or exchanges of property: No deduction shall in any case be

allowed in respect of losses from sales or exchanges of property directly or
indirectly between related persons.
LOSSES FROM WASH SALES OF STOCK OR SECURITIES
CAPITAL GAINS AND LOSSES: (APPLICABLE ONLY TO CAPITAL ASSETTS SUBJECT

TO THE ORDINARY INCOME TAX: NOT TO PROPERTIES SUBJECT TO FWT)
CAPITAL ASSETS SUBJECT TO FWT: real properties as enumerated in the civil

code in case of individual taxpayer: Only lands and buildings in case of
corporation(DC)
Capital assets: Means 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 included in the inventory of the
taxpayer if on hand at the close of the taxable year, or property held by 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 depreciation provided in section 34(F) or real property used
in trade or business of the taxpayer.
Note: Properties classified as ordinary assets for being used in business by the
taxpayer engaged in business other than real estate business are automatically
converted into capital asset upon showing that the same have not been used in
business for more than 2 years prior to the consummation of the transaction
involving said properties.
Net Capital Gain: Excess of the gains from sales or exchanges of capital assets
over the losses from such sales or exchanges.
Net Capital loss: Excess of the losses from sales or exchanges of capital assets
over the gains from such sales or exchanges.
NOTE: Gains or losses from the sale or exchange of capital assets of INDIVIDUAL
TAXPAYER is subject to the percentage provision of section 39(b): Thus, only the
following percentages of the gain or loss recognized upon the said sale or
exchange shall be taken into account in computing net capital gain, net capital
loss, and net income:
1. 100% if the capital asset has been held for not more than twelve months;
2. 50% if the capital asset has been held for more than 12 months.
Capital loss limitation rule: Capital losses from sales or exchanges of capital
assets are allowed only to the extent of the gains from such sales or exchanges. If
the dealings of the taxpayer in capital assets during the taxable year result in a
net capital loss, such loss cannot be deducted from his ordinary income. The
rationale of this rule is to insure that only costs or expenses incurred in earning
the income shall be deductible for income tax purposes consonant with the
requirement of the law that only necessary expenses are allowed as deductions
from the gross income.
Net Capital Loss Carry-over: If any taxpayer, other than a corporation, sustains in
any taxable year a net capital loss, such loss (in an amount not in excess of the net
income for such year) shall be treated in the succeeding taxable year as a loss
from the sale or exchange of a capital asset held for not more than 12 months.
DETERMINATION OF GAIN OR LOSS IN EXCHANGE OF PROPERTY
1. Purchase: the basis is the acquisition cost;

2. Inheritance: FMV as of the moment of death of the decedent;
3. Donation: Basis is the cost in the hands of the donor or the last previous
owner who did not acquire it by donation. If the basis however, is greater
than the FMV of the property at the time of donation, then, for purposes of
determining loss, the basis shall be the FMV.
4. Less than adequate consideration: the amount paid by the transferee.
5. The adjusted basis of 1-4 above, if the acquisition cost of the property is
increased by the amount of improvements that materially add to the value
of the property or appreciably prolong its life less accumulated
depreciation;
6. The substituted basis, if the property was acquired in a previous tax-free
exchange.
____________________________________
TAX FREE EXCHANGE:
The entire amount of the gain or loss shall be recognized upon the sale or
exchange of property, except as herein provided:
A. MERGER AND CONSOLIDATION

1. . A corporation which is a party to a merger or consolidation, exchanges
property solely for stock in a corporation, which is a party to a merger or
consolidation;
2. A shareholder exchanges stock in a corporation which is a party to the
merger or consolidation, solely for the stock of another corporation, also
a party to the merger or consolidation;
3. A security holder of a corporation, which is a party to the merger or
consolidation, exchanges his securities in such corporation, solely for the
stock or securities in another corporation, a party to the merger or
corporation.
B. TRANSFER TO GAIN CONTROL OF THE CORPORATION: No gain or loss shall

be recognized if the property is transferred to a corporation by a person in
exchange for stock or unit of participation in such a corporation of which as
a result of such exchange, said person, alone or together with others, not
exceeding 4 persons, gains control of said corporation. Note: stocks issued
for services shall not be considered as issued in return of property. (NOTE:
THERE MUST BE AN INCREASE IN THE STOCKHOLDINGS)
Note: The law merely defers the recognition of the gain or loss insofar as
the transferor and transferee is concerned. Thus, upon the subsequent sale
or disposition of the property covered by the tax-free exchange by the
transferor or the transferee, the historical cost or basis shall be used for
determining gain or loss from the subsequent sale.
____________________________
ACCOUNTING PERIOD
Calendar accounting period: This is the taxable period adopted by individuals or

corporations using the “calendar year,” which is a period of 12 months starting
from January 1 and ending on dec. 31.
Fiscal accounting period: This is the taxable period adopted by corporations using
the “fiscal year,” which is a period of 12 months ending on the last day of any
month other than December.
Short accounting period: This is an accounting period adopted by a taxpayer in

the case of a return made for fractional part of a year or which is period of less
than 12 months.
ACCOUNTING METHOD: The accounting method for tax purposes must be one
generally employed in keeping the taxpayer’s books, provided that the method
clearly reflects the income. In case of conflict between the provisions of the tax
code and that of the generally accepted accounting principles, the provisions of
the tax code and its implementing regulations shall prevail.
A. Cash accounting method: All items of income actually received during the
year shall be accounted for in such taxable year and the corresponding
expenses actually paid shall also be claimed as deductions during the year.
B. Accrual accounting method: Under the accrual method of accounting,
income, gains and profits are included in the gross income when earned
regardless of whether or not actually received, and the expenses are
allowed as deductions from the gross income when actually incurred,
although not yet paid. This is allowed because expenses not being claimed
as deduction by the taxpayer in the current year when they are incurred
cannot be claimed as deduction from the income for the succeeding year.
Note: amounts of income accrue where the right to receive them becomes
fixed, where there is created an enforceable liability.
C. Installment payment basis method: Appropriate when collections extends
over relatively long period of time and there is a strong possibility that full
collection will not be made. As customers make installment payments, the
seller recognizes the gross profit on sale in proportion to the cash collected.
D. Deferred payment basis method: Method being applied by real estate
dealers in their sale of real properties, which although the mode of
payment being employed is on installment basis, the said sale shall be
considered as on a cash basis when the initial payments in the year of sale
of the real properties exceed 25% of the gross selling price.
E. Percentage of completion: Method applicable in the case of a building,
installation or construction contract covering a period in excess of one year
whereby the gross income derived from such contract may be reported
upon the basis of percentage of completion or progress work. Long term
contract are required to be reported using this method only.
All-events-test: The test requires: (1) fixing of a right to income or liability to pay;
and (2) the availability of the reasonable accurate determination of such income
or liability. “Reasonable accuracy” implies something less than an exact amount
or completely accurate amount.
-------------------------------------------
WITHHOLDING: Under the withholding tax system, the payor is the taxpayer upon
whom the tax is imposed, while the withholding agent simply acts as an agent or
collector of the government to ensure the collection of taxes.
Withholding agent: Under the withholding system, the agent-payor becomes a

payee by fiction of law. His liability is direct and independent from the taxpayer,
because the income tax is still imposed on and due from the latter. The agent is
not liable for the tax as no wealth flowed into him- he earned no income. The
government’s cause of action against the withholding agent is not for the
collection of income tax, but for the enforcement of the withholding provision of
section 53 of the tax code, compliance with which is imposed on the withholding
agent and not upon the taxpayer. Note: the taxpayer who earned the income on
the transaction remains liable for the payment of tax as the taxpayer shares the
responsibility of making certain that the tax is properly withheld by the
withholding agent, so as to avoid any penalty that may arise from the non-
payment of the withholding tax due.
Authority of the withholding agent to file a claim for refund: The withholding
agent has the legal right to file a claim for refund for two reasons. First, he is
considered as taxpayer under the NIRC as he is personally liable for the
withholding tax as well as for deficiency assessments, surcharges and penalties,
should the amount of the tax withheld be finally found to be less than the amount
that should have been withheld. Second, as an agent of the taxpayer, his
authority to file the necessary income tax return and to remit the withheld to the
government impliedly includes the authority to file a claim for refund and to bring
an action for recovery of such claim. Note: While the withholding agent has the
right to recover the taxes illegally or erroneously collected, he nevertheless has
the obligation to remit the same to the taxpayer.
TAXABLE ESTATE AND TRUST
The income tax imposable upon individuals shall apply to the income of estates or
of any kind of property held in trust, including:
1. Income accumulated in trust- (a) for the benefit of unborn or unascertained
person or persons with contingent interests; (b) Income accumulated or
held for future distribution under terms of the will or trust;
2. Income which is to be distributed currently by the fiduciary to the
beneficiaries;
3. Income collected by a guardian of an infant which is to be held or
distributed or distributed as the court may direct;
4. Income received by estates of deceased persons during the period of
administration or settlement of the estate;
5. Income which, in the discretion of the fiduciary, may be either distributed
to the beneficiaries or accumulated.
EXEMPT: Employees’ trust which forms part of a pension, stock bonus or profit
sharing plan of the employer for the benefit of some or all of his employees. It is
necessary however that the trust instrument is duly registered with the BIR and
that it is impossible under the said instrument that any part of the corpus or
income to be used for, or diverted to, purposes other than for the exclusive
benefit of his employees.
OTHER EXEMPT TRUST:

1. Revocable trust: The trust itself is exempt from income tax, but the
trustor/grantor is subject to the payment of the income tax of the trust;
2. Trust, the income of which, in whole or in part, may be held or distributed
for the benefit of the grantor: The trust itself is exempt from income tax,
but if part of the income of the trust is distributed for the benefit of the
grantor, the same shall be included in the grantor’s return.
INCOME TAXABLE TO THE BENEFICIARIES:

1. General rule: The income tax of estate or trust shall be computed upon the
taxable income of the estate and shall be paid by the fiduciary.
Consequently, the taxable income of an estate is free from tax when
distributed to the beneficiaries.
2. 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.
DISTRIBUTION OF DIVIDENDS:
Rule on liquidation: Where a corporation distributes all of its assets in complete

liquidation or dissolution, the gain realized or loss sustained by the stockholder,
whether individual or corporate, is taxable income or deductible loss, as the case
may be.
Stock dividend: A stock dividend representing the transfer of surplus to the

capital account shall not be subject to tax. However, if a corporation cancels or
redeems stock issued as dividend at such time and manner as to make the
distribution and cancellation or redemption, in whole or in part, essentially
equivalent to the distribution of a taxable dividend, the amount so distributed in
redemption or cancellation of the stock shall be considered as taxable income to
the extent that it represents a distribution of earnings or profits.

Constructive receipt of dividends by partners: The taxable income declared by a
partnership for a taxable year which is subject to tax after deducting the
corporate income tax imposed therein shall be deemed actually or constructively
received by the partners in the same taxable year and shall be taxed to them in
their individual capacity, whether distributed or not.
_________________
FINAL ADJUSTMENT RETURN
Note: If the taxpayer has paid excess quarterly income taxes, it may be entitled
to a tax credit or refund as shown in its FAR which may be carried over and
applied against the estimated quarterly income tax liabilities for the taxable
quarters of the succeeding taxable years. But once the taxpayer exercised the
option to carry-over , such option is irrevocable for that taxable period and no
application for cash refund or issuance of a tax credit certificate shall be allowed.
(carry-over, not limited to 1 taxable year)
______________________________________________________

Income Tax

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Income Tax

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HOW TO FUCK INCOME TAX: by Justice Orlando B.

Income Tax System

Characteristics of Income Tax:

When is income taxable?

Income vs. Capital

Realization Tests in determining income:

a) Realization test/Severance test: There is no taxable income until there is

“Whatever you do, do it for God’s glory” 1 Corinthians 10:31

To whom income is taxable: Income from the sales of goods or properties is

SOURCE PRINCIPLE AND RULE

Source Principle: An alien or foreign corporation is subject to Philippine income

Within the Philippines

1. Interest: Residence of the debtor or the obligor: If the obligor or debtor is a

I. CITIZENS (RESIDENT AND NON-RESIDENT) AND RESIDENT ALIENS

“Whatever you do, do it for God’s glory” 1 Corinthians 10:31

A: BASIC TAX: REGULAR INCOME TAX: TREATMENT

A.1: RESIDENT CITIZEN: is a citizen of the Philippines residing therein, unless he

A.2: NON-RESIDENT CITIZEN:

1) A citizen of the Philippines who establishes to the satisfaction of the

B. PASSIVE INCOME OF CITIZENS AND RESIDENT ALIENS

Passive income of a citizen or a resident alien may either be:

B.3: PASSIVE INVESTMENT INCOME

1. Interest: See discussion on interest in composition of gross income

II: NON-RESIDENT ALIEN: A non-resident alien individual is an alien individual

“Whatever you do, do it for God’s glory” 1 Corinthians 10:31

B. TAX ON PASSIVE INCOME

“Whatever you do, do it for God’s glory” 1 Corinthians 10:31

III: ALIEN INDIVIDUALS SUBJECT TO PREFERENTIAL RATE

IV: GENERAL PROFESSIONAL PARTNERSHIPS : a partnership formed by

V: Taxable partnerships: All other partnerships, no matter how created or

VI. Co-ownership: A co-ownership may become an unregistered general

1. For undertaking of a construction project;

“Whatever you do, do it for God’s glory” 1 Corinthians 10:31

I: DOMESTIC CORPORATIONS: Those corporations created or organized in the

Preferential Tax Rate Constitutional exemption Exemption under Sec. 30

Note on Charitable Institution/Association: Non-stock, non-profit corporations or

Substantive test of charity: Charity is essentially a gift to an indefinite number of

Treatment of Income derived from dormitories, canteens and bookstores by

Note: The dividends received by a domestic corporation from another domestic

Minimum Corporate Income Tax (MCIT)

Note: MCIT is applicable only to corporations whose operations are covered by

Rationale: The imposition of the MCIT is designed to forestall the prevailing

MCIT on Quarterly Corporate Income Tax

MCIT NOT CREDITED: recorded as deferred charges (not allowable as deductions)

II: RESIDENT FOREIGN CORPORATION: A resident foreign corporation is a

“Whatever you do, do it for God’s glory” 1 Corinthians 10:31

Engaged in trade or business: Carrying on a business with the idea of progression

Note: A foreign corporation transacting business in the Philippines independently

C. Foreign corporations not subject to MCIT-

International Carriers: Refer to foreign airline corporations or foreign shipping

“Whatever you do, do it for God’s glory” 1 Corinthians 10:31

a) Where the passenger, excess baggage, cargo or mail originally commencing

OFFSHORE BANKING UNIT

OBU: A branch, subsidiary, or affiliate of a foreign banking corporation which is

FCDU(Foreign Currency Deposit Unit): an accounting unit or department in a local

BRANCH PROFIT REMITTANCE TAX

1. Applicable only to foreign corporations;

REGIONAL OPERATING HEADQUARTERS

Note: Those Regional Headquarters in the Philippines by multinational companies

ROHQ Tax treatment: The ROHQ of a multinational company is a foreign

Passive Income: See discussion on composition of gross income.

A foreign corporation not engaged in trade or business within the Philippines.

Other Incomes of Foreign Corporation

On gross income of non-resident cinematographic film